## wp17181

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### I. INTRODUCTION AND SUMMARY
- Post-2008 reforms led to the Dodd-Frank Act (DFA) with strengthened capital and liquidity requirements, highest for systemically important financial institutions (SIFIs).
- The Financial CHOICE Act (FCA) proposes a regulatory “off-ramp” for “qualifying bank holding companies” (QBOs) conditional on leverage ratios.
- FCA proposal: a 10 percent leverage ratio threshold to qualify as a QBO and be exempted from many DFA/Basel rules, including Enhanced Prudential Standards, mandatory supervisory and company-run stress tests, single counterparty credit limits, minimum requirements on liabilities (Total Loss Absorbing Capacity), and submission of living wills.
- U.S. Treasury report (June 12, 2017) echoes many FCA proposals, including an off-ramp conditional on capital levels and regulatory relief for small and medium-sized banks.
- Key finding: small banks (total assets below $3 billion) with capital gaps to the QBO threshold would tend not to opt for the off-ramp because:
  - Small banks generally have less risky assets (lower RWA density).
  - For small banks to prefer FCA off-ramp, RWA density would need to be almost 120 percent (per text: "would have to be almost 120 percent to meet the off-ramp criterion").
- Large banks (total assets more than $3 billion) with higher average RWA density are closer to qualifying for the off-ramp given current capital levels.
- SIFIs face higher DFA capital charges: minimum risk-based Tier 1 of 6 percent + fully phased-in capital conservation buffer of 2.5 percent + SIFI surcharge of up to 4.5 percent = total Tier 1 capital requirement of 13.0 percent.
- For SIFIs to meet the off-ramp criterion under FCA, RWA density would need to exceed 77 percent.
- Moral hazard/regulatory arbitrage risk: banks may increase RWA imprint and risk-taking to qualify for the off-ramp, reducing effective capital charges and resilience—this is present irrespective of bank size but more likely among large banks with high RWA density.

### II. ANALYSIS OF REGULATORY REGIMES
- Sample: 579 banks as of 2016Q4 (SNL data).
  - 326 banks (representing 80 percent of the sample) would not have leverage ratios high enough to qualify for FCA off-ramp.
  - Aggregate capital gap to 10-percent Tier 1 leverage ratio: US$200 billion in Tier 1 capital (or equivalent deleveraging) for the banking system as a whole.
  - If supervisors expect at least 1 percentage point above regulatory minimum (i.e., 11-percent Tier 1 leverage ratio), then 442 banks, representing 95 percent of total banking system assets, would not qualify unless they increased Tier 1 capital by a total of $365 billion (or deleveraged equivalently).
- Cost of replacing debt with equity:
  - Increasing equity in capital structures would increase the sample’s funding costs by approximately $14 billion a year (net effect).
  - If supervisors’ comfort zone is 11-percent Tier 1 leverage ratio, annual funding costs would increase by $26 billion a year.
  - Taxes on operating income would also increase as more equity reduces interest deductibility (effect not included in above estimates).
- Shortfalls to 10 Percent Tier 1 Leverage Ratio (largest individual shortfalls, US$ billion):
  - JP Morgan Chase & Co: 40.4
  - Wells Fargo: 20.3
  - Bank of America: 23.4
  - Citigroup: 0
  - US Bancorp: 4.3
  - Bank New York Mellon: 11.4
  - State Street Bank: 8.5
  - Banks with TA < US$50 billion: 21.4
  - Banks with TA >= US$50 billion: 178.7

### III. UNDERSTANDING DRIVERS OF CAPITAL GAPS
- Regulatory constraints summarized (simplified dynamic framework):
  - Capital K must satisfy liquidity-weighted and risk-weighted requirements and leverage ratio constraints, with notation for trading portfolio T (marketable securities), loan portfolio L (non-marketable securities), reserves R, and weights α and κ for liquidity and risk weights respectively.
  - Risk-weighted assets (RWA) defined as RWA = Σ κi Ri with 0 ≤ κi ≤ 1, and total assets A = Σ Ri; therefore RWA < A under assumptions (1).
- Comparative capital charge expressions:
  - Under DFA small banks: capital charge = 0.085 * RWA (8.5 percent on RWA).
  - Under FCA: leverage requirement = 0.10 * A (10 percent on assets).
  - Difference for small banks (equation (2)):
    - K_DFA_SB − K_FCA_SB = 0.085 * RWA − 0.10 * A = 0.085 * A * (RWA/A − 1.176)
  - Difference for SIFIs (equation (3)):
    - K_DFA_SIFI − K_FCA_SIFI = 0.13 * RWA − 0.10 * A = 0.13 * A * (RWA/A − 0.769)
- Interpretation of thresholds:
  - Small bank would opt for QBO when RWA/A > 1.176 (i.e., almost 118 percent) — under baseline formulas this is impractical so for most small banks DFA is less onerous than FCA.
  - SIFI would opt for QBO when RWA/A > 0.77 (77 percent).
  - Including off-balance sheet (OB) items totaling x percent of assets modifies SIFI threshold:
    - With x = 0.2 (20 percent OB items), equation (3*) yields threshold RWA/A > 0.923 (92.3 percent). Thus with OB items, FCA is less costly than DFA only for RWA density above 92.3 percent.
- Empirical RWA density for selected SIFIs (as of 12/31/2016; FDIC):
  - JP Morgan Chase & Co: Total assets 2,219 ($ billion); RWA 1,449 ($ billion); RWA density 65 (percent)
  - Wells Fargo: Total assets 1,755; RWA 1,240; RWA density 70 (percent)
  - Bank of America: Total assets 1,701; RWA 1,186; RWA density 70 (percent)
  - Citigroup: Total assets 1,350; RWA 973; RWA density 72 (percent)
  - US Bancorp: Total assets 441; RWA 352; RWA density 80 (percent)
  - Bank New York Mellon: Total assets 284; RWA 153; RWA density 54 (percent)
  - State Street Bank: Total assets 239; RWA 96; RWA density 40 (percent)
- Interpretation of Table 2:
  - Only US Bancorp (RWA density 80 percent) would already qualify as a QBO without adding capital; others would fall under DFA.
- RWA density and peer group averages (UBPR Peer group averages as of March 31 2017):
  - Peer group: Between $300 million and $1 billion
    - Tier 1 capital ratio (Tier 1 capital/RWA): 14.2
    - Tier 1 leverage ratio (Tier 1 capital/total assets): 10.3
    - RWA density (percent): 72
  - Peer group: Between $1 billion and $3 billion
    - Tier 1 capital ratio: 13.0
    - Tier 1 leverage ratio: 10.0
    - RWA density (percent): 76
  - Peer group: Above $3 billion
    - Tier 1 capital ratio: 12.7
    - Tier 1 leverage ratio: 9.9
    - RWA density (percent): 78
- Conclusion from peer group data:
  - Small banks would generally find DFA risk-based capital requirements less onerous than a flat 10-percent leverage ratio under FCA given observed RWA densities and capital ratios.

### IV. POLICY CONSIDERATIONS AND RISKS
- Financial stability rationale for maintaining DFA risk-based capital:
  - FCA off-ramp may encourage regulatory arbitrage and moral hazard: banks could increase risk-taking to raise RWA density and qualify for QBO status, thereby lowering effective capital charges and increasing systemic risk.
  - The FCA off-ramp risks undermining countercyclical buffer building: when risks rise and DFA requirements tighten, the off-ramp could incentivize banks to migrate to FCA precisely when buffers are most needed.
- Distributional and unintended effects:
  - Relief intended for small and community banks may not materialize if large banks with higher RWA density are more likely to become QBOs.
  - Aggregate capital shortfalls and higher funding costs from equity substitution present trade-offs between regulatory relief and systemic resilience.
- Policy considerations highlighted:
  - Remove or limit optionality (QBO option) to avoid moral hazard—for example, mandate which banks can become QBOs or set the leverage ratio such that equation (3) is zero for a given percentage of banks corresponding to a given RWA/A ratio.
  - Consider imposing that all small banks must be QBOs while all SIFI banks continue under DFA, or otherwise mandate eligibility to remove incentive to increase RWA density.
  - Recognize that focusing solely on capital levels neglects liquidity, market, and counterparty risks; supervisors (Pillar 2) must complement Pillar 1 with increased market discipline (Pillar 3), transparency, and strengthened internal risk management and capital planning.
  - Address operational questions raised by proposals: e.g., what happens to QBOs that drop below a 10 percent leverage ratio—automatic switch to full DFA would require running both frameworks in parallel and increase compliance costs and inefficiencies.
- Suggested regulatory design to mitigate moral hazard (illustrated in Annex III):
  - Mandate a 10 percent leverage ratio up to the cut-off RWA/A = 117.6 percent (or up to 77 percent for a SIFI), then impose a gradual risk-based capital charge beyond the cut-off (captured by the green line in Annex III figure).

### Annex 1 and Supplementary Results (SNL data, end 2016)
- Leverage ratios by peer group (Table 4):
  - Peer groups by total assets: "Total assets < $50 billion", "> $50 billion", "$50-250 billion", "> $250 billion".
  - Median RWA/A: 77, 76, 79, 64.
  - Median leverage ratio: 6.54, 9.88, 10.27, 8.32.
  - Largest RWA/A: 111, 101, 101, 82.
  - Leverage ratio cut-off: 9.43, 13.13, 13.13, 10.66.
- Eligibility cut-offs and RWA density — interpretation:
  - The cut-off leverage ratio is the ratio needed in FCA for a bank with a given RWA density to be indifferent between DFA and FCA.
  - If FCA’s minimum leverage requirement ≥ cut-off, all banks (including those with extraordinarily high RWA density) would prefer DFA.
  - Small banks: RWA density needed to induce opting into FCA (QBO) is above 117.6 percent; thus small banks would generally prefer DFA.
  - For SIFIs: a SIFI could increase RWA density above 77 percent and be subject only to a flat 10 percent leverage ratio under FCA.
  - Among banks with total assets above $50 billion, 8 banks have RWA densities above 82 percent, with associated leverage ratio cut-offs between 10.66 and 13.13 percent.
  - Moral hazard: optionality to become a QBO can induce banks to reallocate toward higher RWA density to obtain regulatory relief from DFA risk-based capital requirements.
- Example: DFA vs FCA calculations (scenario parameters and equations):
  - For banks with total assets < $50 billion under DFA: regulatory capital weight = 8.5 percent applied to 50 percent of Treasuries (T) and to loan portfolio (L); includes a CCB of 2.5 percent.
  - For SIFIs under DFA: minimum regulatory risk-weighted Tier 1 capital ratio = 13 percent (including maximum SIFI surcharge).
  - FCA proposed leverage ratio: 10 percent applied to overall portfolio (T + L).
  - Equations:
    - (4) K_DFA_SB = 0.085 * [0.5 T + L]
    - (5) K_DFA_SIFI = 0.13 * [0.5 T + L]
    - (6) K_FCA = 0.10 * [T + L]
  - Key observations from the example:
    - For banks with assets < $50 billion, the colored plane (DFA minus FCA) lies under the 0-plane → FCA is more onerous for small banks; capital requirement under leverage ratio is greater than under DFA irrespective of portfolio composition.
    - For a SIFI, whether it would qualify as a QBO depends on balance-sheet composition: a SIFI may qualify as a QBO for most portfolio choices. Only for very large portfolios of Treasuries (exceeding 85 percent of the loan portfolio if Treasuries weight = 0.5, or exceeding 44 percent if the weight = 0.25) would SIFIs remain under DFA.
    - Using (5) and (6): capital-to-loan ratio under FCA is below capital-to-loan ratio under DFA for Treasuries-to-loans ratio below 86 percent for SIFIs.
- Portfolio composition evidence (Marketable securities T and T/L ratios, FDIC, as of December 31 2016):
  - Table 6a (T defined as securities and trading account assets; T/L percent):
    - JP Morgan Chase & Co: Total assets 2219, Marketable Securities T 529, T/L 31 (percent)
    - Wells Fargo: 1755, 423, 31
    - Bank of America: 1701, 480, 39
    - Citigroup: 1350, 458, 51
    - US Bancorp: 441, 111, 34
    - Bank New York Mellon: 284, 115, 68
    - State Street Bank: 239, 104, 77
  - Table 6b (T defined as securities in FDIC report; T/L percent):
    - JP Morgan Chase & Co: 2219, 328, 17
    - Wells Fargo: 1755, 387, 28
    - Bank of America: 1701, 407, 31
    - Citigroup: 1350, 328, 32
    - US Bancorp: 441, 109, 33
    - Bank New York Mellon: 284, 111, 64
    - State Street Bank: 239, 96, 67
  - Empirical implication: Typically, SIFIs have a Treasuries-to-loans ratio below 86 percent, so with a required capital weight of 13 percent on loans, the capital-to-loan ratio is less under FCA; there are no exceptions to this rule in Tables 6a and 6b.
- Annex I — Leverage and supplementary leverage ratios (SNL, as of end 2016):
  - JP Morgan Chase & Co: U.S. Leverage ratio 8.4, Supplementary leverage ratio 6.5
  - Wells Fargo: 9.0, 7.6
  - Bank of America: 8.9, 7.0
  - Citigroup: 10.1, 7.6
  - Goldman Sachs Group, Inc: 9.4, 6.5
  - Morgan Stanley: 8.4, 6.5

### Policy conclusions and recommendations
- Main conclusions:
  - Proposed FCA 10 percent leverage ratio would induce small banks to remain under DFA because DFA has a lower capital charge for these banks.
  - The RWA density that would induce small banks to opt to become QBO is above 117 percent, which would lead to excessive risk taking among them.
  - The 10 percent leverage ratio implies only SIFIs with RWA density over 77 percent (or 92 percent with 20 percent off-balance sheet items) may opt to be QBOs, reflecting riskier operations.
  - The option to be a QBO creates moral hazard: banks may increase RWA density to enjoy a flat 10 percent capital charge while obtaining higher expected returns and imposing greater systemic risk.
- Recommendations and considerations:
  - Remove or limit optionality (QBO option) to avoid moral hazard—for example, mandate which banks can become QBOs or set the leverage ratio such that equation (3) is zero for a given percentage of banks corresponding to a given RWA/A ratio.
  - Consider imposing that all small banks must be QBOs while all SIFI banks continue under DFA, or otherwise mandate eligibility to remove incentive to increase RWA density.
  - Supervisors should complement Pillar 1 with Pillar 2 and Pillar 3 measures: increased market discipline, transparency, strengthened internal risk management and capital planning.
  - Address operational questions: automatic switches between regimes would require running both frameworks in parallel and increase compliance costs and inefficiencies.
  - Suggested regulatory design to mitigate moral hazard: mandate a 10 percent leverage ratio up to the cut-off RWA/A = 117.6 percent (or up to 77 percent for a SIFI), then impose a gradual risk-based capital charge beyond the cut-off.

*Source: wp17181 - REFERENCES ____________________________________________________________17*

### REFERENCES ____________________________________________________________17

### REFERENCES ____________________________________________________________17

### I. INTRODUCTION AND SUMMARY
- Post-2008 reforms led to the Dodd-Frank Act (DFA) with strengthened capital and liquidity requirements, highest for systemically important financial institutions (SIFIs).
- Political debate and legislative proposals (notably the Financial CHOICE Act, FCA) propose a regulatory “off-ramp” for “qualifying bank holding companies” (QBOs) conditional on leverage ratios.
- FCA proposal: a 10 percent leverage ratio threshold to qualify as a QBO and be exempted from many DFA/Basel rules, including Enhanced Prudential Standards, mandatory supervisory and company-run stress tests, single counterparty credit limits, minimum requirements on liabilities (Total Loss Absorbing Capacity), and submission of living wills.
- U.S. Treasury report (June 12, 2017) echoes many FCA proposals, including an off-ramp conditional on capital levels and regulatory relief for small and medium-sized banks.
- Key finding: small banks (total assets below $3 billion) with capital gaps to the QBO threshold would tend not to opt for the off-ramp because:
  - Small banks generally have less risky assets (lower RWA density).
  - For small banks to prefer FCA off-ramp, RWA density would need to be almost 120 percent (per text: "would have to be almost 120 percent to meet the off-ramp criterion").
- Large banks (total assets more than $3 billion) with higher average RWA density are closer to qualifying for the off-ramp given current capital levels.
- SIFIs face higher DFA capital charges: minimum risk-based Tier 1 of 6 percent + fully phased-in capital conservation buffer of 2.5 percent + SIFI surcharge of up to 4.5 percent = total Tier 1 capital requirement of 13.0 percent.
- For SIFIs to meet the off-ramp criterion under FCA, RWA density would need to exceed 77 percent.
- Moral hazard/regulatory arbitrage risk: banks may increase RWA imprint and risk-taking to qualify for the off-ramp, reducing effective capital charges and resilience—this is present irrespective of bank size but more likely among large banks with high RWA density.

### II. ANALYSIS OF REGULATORY REGIMES
- Sample: 579 banks as of 2016Q4 (SNL data).
  - 326 banks (representing 80 percent of the sample) would not have leverage ratios high enough to qualify for FCA off-ramp.
  - Aggregate capital gap to 10-percent Tier 1 leverage ratio: US$200 billion in Tier 1 capital (or equivalent deleveraging) for the banking system as a whole (Table 1).
  - If supervisors expect at least 1 percentage point above regulatory minimum (i.e., 11-percent Tier 1 leverage ratio), then 442 banks, representing 95 percent of total banking system assets, would not qualify unless they increased Tier 1 capital by a total of $365 billion (or deleveraged equivalently).
- Cost of replacing debt with equity:
  - Increasing equity in capital structures would increase the sample’s funding costs by approximately $14 billion a year (net effect).
  - If supervisors’ comfort zone is 11-percent Tier 1 leverage ratio, annual funding costs would increase by $26 billion a year.
  - Taxes on operating income would also increase as more equity reduces interest deductibility (effect not included in above estimates).
- Table 1 (Shortfall to 10 Percent Tier 1 Leverage Ratio) highlights largest individual shortfalls:
  - JP Morgan Chase & Co: 40.4 ($ billion)
  - Wells Fargo: 20.3 ($ billion)
  - Bank of America: 23.4 ($ billion)
  - Citigroup: 0 ($ billion)
  - US Bancorp: 4.3 ($ billion)
  - Bank New York Mellon: 11.4 ($ billion)
  - State Street Bank: 8.5 ($ billion)
  - Banks with TA < US$50 billion: 21.4 ($ billion)
  - Banks with TA >= US$50 billion: 178.7 ($ billion)

### III. UNDERSTANDING DRIVERS OF CAPITAL GAPS
- Regulatory constraints summarized (simplified dynamic framework):
  - Capital K must satisfy liquidity-weighted and risk-weighted requirements and leverage ratio constraints, with notation for trading portfolio T (marketable securities), loan portfolio L (non-marketable securities), reserves R, and weights α and κ for liquidity and risk weights respectively.
  - Risk-weighted assets (RWA) defined as RWA = Σ κi Ri with 0 ≤ κi ≤ 1, and total assets A = Σ Ri; therefore RWA < A under assumptions (1).
- Comparative capital charge expressions:
  - Under DFA small banks: capital charge = 0.085 * RWA (8.5 percent on RWA).
  - Under FCA: leverage requirement = 0.10 * A (10 percent on assets).
  - Difference for small banks (equation (2)):
    - K_DFA_SB − K_FCA_SB = 0.085 * RWA − 0.10 * A = 0.085 * A * (RWA/A − 1.176)
  - Difference for SIFIs (equation (3)):
    - K_DFA_SIFI − K_FCA_SIFI = 0.13 * RWA − 0.10 * A = 0.13 * A * (RWA/A − 0.769)
- Interpretation of thresholds:
  - Small bank would opt for QBO when RWA/A > 1.176 (i.e., almost 118 percent) — under baseline formulas this is impractical so for most small banks DFA is less onerous than FCA.
  - SIFI would opt for QBO when RWA/A > 0.77 (77 percent).
  - Including off-balance sheet (OB) items totaling x percent of assets modifies SIFI threshold:
    - With x = 0.2 (20 percent OB items), equation (3*) yields threshold RWA/A > 0.923 (92.3 percent). Thus with OB items, FCA is less costly than DFA only for RWA density above 92.3 percent.
- Empirical RWA density for selected SIFIs (Table 2, as of 12/31/2016; source FDIC):
  - JP Morgan Chase & Co: Total assets 2,219 ($ billion); RWA 1,449 ($ billion); RWA density 65 (percent)
  - Wells Fargo: Total assets 1,755; RWA 1,240; RWA density 70 (percent)
  - Bank of America: Total assets 1,701; RWA 1,186; RWA density 70 (percent)
  - Citigroup: Total assets 1,350; RWA 973; RWA density 72 (percent)
  - US Bancorp: Total assets 441; RWA 352; RWA density 80 (percent)
  - Bank New York Mellon: Total assets 284; RWA 153; RWA density 54 (percent)
  - State Street Bank: Total assets 239; RWA 96; RWA density 40 (percent)
- Interpretation of Table 2:
  - Only US Bancorp (RWA density 80 percent) would already qualify as a QBO without adding capital; others would fall under DFA.
- RWA density and peer group averages (Table 3, UBPR Peer group averages as of March 31 2017):
  - Peer group: Between $300 million and $1 billion
    - Tier 1 capital ratio (Tier 1 capital/RWA): 14.2
    - Tier 1 leverage ratio (Tier 1 capital/total assets): 10.3
    - RWA density (percent): 72
  - Peer group: Between $1 billion and $3 billion
    - Tier 1 capital ratio: 13.0
    - Tier 1 leverage ratio: 10.0
    - RWA density (percent): 76
  - Peer group: Above $3 billion
    - Tier 1 capital ratio: 12.7
    - Tier 1 leverage ratio: 9.9
    - RWA density (percent): 78
- Conclusion from peer group data:
  - Small banks would generally find DFA risk-based capital requirements less onerous than a flat 10-percent leverage ratio under FCA given observed RWA densities and capital ratios.

### IV. POLICY CONSIDERATIONS AND RISKS
- Financial stability rationale for maintaining DFA risk-based capital:
  - FCA off-ramp may encourage regulatory arbitrage and moral hazard: banks could increase risk-taking to raise RWA density and qualify for QBO status, thereby lowering effective capital charges and increasing systemic risk.
  - The FCA off-ramp risks undermining countercyclical buffer building: when risks rise and DFA requirements tighten, the off-ramp could incentivize banks to migrate to FCA precisely when buffers are most needed.
- Distributional and unintended effects:
  - Relief intended for small and community banks may not materialize if large banks with higher RWA density are more likely to become QBOs.
  - Aggregate capital shortfalls and higher funding costs from equity substitution present trade-offs between regulatory relief and systemic resilience.

*Source: wp17181 - REFERENCES ____________________________________________________________17*

### Annex 1 reports the results for other peer groups, using SNL data, as of end 2016.

### wp17181 - Annex 1 reports the results for other peer groups, using SNL data, as of end 2016.

### Leverage ratios by peer group (Table 4)
- Peer groups by total assets: "Total assets < $50 billion", "> $50 billion", "$50-250 billion", "> $250 billion".
- Median RWA/A: 77, 76, 79, 64.
- Median leverage ratio: 6.54, 9.88, 10.27, 8.32.
- Largest RWA/A: 111, 101, 101, 82.
- Leverage ratio cut-off: 9.43, 13.13, 13.13, 10.66.
- Source note: SNL, as of end 2016 and authors’ calculations.

### Eligibility cut-offs and RWA density — interpretation
- The cut-off leverage ratio is the ratio needed in FCA for a bank with a given RWA density to be indifferent between DFA and FCA.
- If FCA’s minimum leverage requirement ≥ cut-off, all banks (including those with extraordinarily high RWA density) would prefer DFA.
- Small banks: RWA density needed to induce opting into FCA (QBO) is above 117.6 percent; thus small banks would generally prefer DFA.
- For SIFIs: a SIFI could increase RWA density above 77 percent and be subject only to a flat 10 percent leverage ratio under FCA.
- Among banks with total assets above $50 billion, 8 banks have RWA densities above 82 percent, with associated leverage ratio cut-offs between 10.66 and 13.13 percent.
- Moral hazard: optionality to become a QBO can induce banks to reallocate toward higher RWA density to obtain regulatory relief from DFA risk-based capital requirements.

### Example: DFA vs FCA calculations (equations and scenario parameters)
- Scenario parameters (text summary):
  - For banks with total assets < $50 billion under DFA: regulatory capital weight = 8.5 percent applied to 50 percent of Treasuries (T) and to loan portfolio (L); includes a CCB of 2.5 percent.
  - For SIFIs under DFA: minimum regulatory risk-weighted Tier 1 capital ratio = 13 percent (including maximum SIFI surcharge).
  - FCA proposed leverage ratio: 10 percent applied to overall portfolio (T + L).
- Equations (as in source):
  - (4) K_DFA_SB = 0.085 * [0.5 T + L]
  - (5) K_DFA_SIFI = 0.13 * [0.5 T + L]
  - (6) K_FCA = 0.10 * [T + L]
- Key observations from the example:
  - For banks with assets < $50 billion, the colored plane (DFA minus FCA) lies under the 0-plane → FCA is more onerous for small banks; capital requirement under leverage ratio is greater than under DFA irrespective of portfolio composition.
  - For a SIFI, whether it would qualify as a QBO depends on balance-sheet composition: a SIFI may qualify as a QBO for most portfolio choices. Only for very large portfolios of Treasuries (exceeding 85 percent of the loan portfolio if Treasuries weight = 0.5, or exceeding 44 percent if the weight = 0.25) would SIFIs remain under DFA.
  - Using (5) and (6): capital-to-loan ratio under FCA is below capital-to-loan ratio under DFA for Treasuries-to-loans ratio below 86 percent for SIFIs.

### Portfolio composition evidence (Tables 6a and 6b)
- Table 6a (Marketable securities T defined as securities and trading account assets; source FDIC, as of December 31 2016):
  - JP Morgan Chase & Co: Total assets ($billion) 2219, Marketable Securities T ($billion) 529, T/L (percent) 31
  - Wells Fargo: 1755, 423, 31
  - Bank of America: 1701, 480, 39
  - Citigroup: 1350, 458, 51
  - US Bancorp: 441, 111, 34
  - Bank New York Mellon: 284, 115, 68
  - State Street Bank: 239, 104, 77
- Table 6b (Marketable securities T defined as securities in FDIC report; source FDIC, as of December 31 2016):
  - JP Morgan Chase & Co: 2219, 328, 17
  - Wells Fargo: 1755, 387, 28
  - Bank of America: 1701, 407, 31
  - Citigroup: 1350, 328, 32
  - US Bancorp: 441, 109, 33
  - Bank New York Mellon: 284, 111, 64
  - State Street Bank: 239, 96, 67
- Empirical implication: Typically, SIFIs have a Treasuries-to-loans ratio below 86 percent, so with a required capital weight of 13 percent on loans, the capital-to-loan ratio is less under FCA; there are no exceptions to this rule in Tables 6a and 6b.

### Annex I and other summary statistics
- Annex I — Leverage and supplementary leverage ratios (SNL, as of end 2016):
  - JP Morgan Chase & Co: U.S. Leverage ratio 8.4, Supplementary leverage ratio 6.5
  - Wells Fargo: 9.0, 7.6
  - Bank of America: 8.9, 7.0
  - Citigroup: 10.1, 7.6
  - Goldman Sachs Group, Inc: 9.4, 6.5
  - Morgan Stanley: 8.4, 6.5

### Policy conclusions and recommendations (from the paper)
- Main conclusions:
  - Proposed FCA 10 percent leverage ratio would induce small banks to remain under DFA because DFA has a lower capital charge for these banks.
  - The RWA density that would induce small banks to opt to become QBO is above 117 percent, which would lead to excessive risk taking among them.
  - The 10 percent leverage ratio implies only SIFIs with RWA density over 77 percent (or 92 percent with 20 percent off-balance sheet items) may opt to be QBOs, reflecting riskier operations.
  - The option to be a QBO creates moral hazard: banks may increase RWA density to enjoy a flat 10 percent capital charge while obtaining higher expected returns and imposing greater systemic risk.
- Recommendations and considerations:
  - Remove or limit optionality (QBO option) to avoid moral hazard—for example, mandate which banks can become QBOs or set the leverage ratio such that equation (3) is zero for a given percentage of banks corresponding to a given RWA/A ratio.
  - Consider imposing that all small banks must be QBOs while all SIFI banks continue under DFA, or otherwise mandate eligibility to remove incentive to increase RWA density.
  - Recognize that focusing solely on capital levels neglects liquidity, market, and counterparty risks; supervisors (Pillar 2) must complement Pillar 1 with increased market discipline (Pillar 3), transparency, and strengthened internal risk management and capital planning.
  - Address operational questions raised by proposals: e.g., what happens to QBOs that drop below a 10 percent leverage ratio—automatic switch to full DFA would require running both frameworks in parallel and increase compliance costs and inefficiencies.
- Suggested regulatory design to mitigate moral hazard (illustrated in Annex III):
  - Mandate a 10 percent leverage ratio up to the cut-off RWA/A = 117.6 percent (or up to 77 percent for a SIFI), then impose a gradual risk-based capital charge beyond the cut-off (captured by the green line in Annex III figure).

*Source: wp17181 - Annex 1 reports the results for other peer groups, using SNL data, as of end 2016.*

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_Source: https://www.imf.org/-/media/files/publications/wp/2017/wp17181.pdf_