Banks and financial sector exchange traded funds may have one hand tied behind their back as the Federal Reserve finalizes additional capital requirements on Wall Street.
The Fed has placed a higher capital requirement for the eight largest banks, including a 4.5% capital “surcharge” for J.P. Morgan Chase (NYSE: JPM); 3.5% for Citigroup (NYSE: C); 3% for Bank of America (NYSE: BAC), Goldman Sachs Group (NYSE: GS) and Morgan Stanley (NYSE: MS); 2% for Wells Fargo (NYSE: WFC); 1.5% for State Street (NYSE: STT); and 1% for Bank of New York Mellon Corp. (NYSE: BK), reports Victoria McGrane for the Wall Street Journal.
The new surcharge comes on top of a base 7% common-equity capital requirement.
A number of large-cap financial ETFs include heavy tilts toward these companies. For instance, the SPDR S&P Bank ETF (NYSEArca: KBE) includes JPM 1.6%, C 1.6%, BAC 1.6%, WFC 1.6% and BK 1.5%. The Financial Select Sector SPDR (NYSEArca: XLF) holds WFC 8.6%, JPM 8.2%, BAC 6.0%, C 5.7%, GS 2.7%, MS 2.0%, STT 1.0% and BK 1.5.%.
J.P. Morgan was about $21 billion short of its required target as of December. The other banks currently hold enough capital to meet the requirement.
The surcharge can grow or shrink based on a bank’s changes in size, complexity and entanglements with other large firms. The excess capital helps diminish a company’s risk profile and provide a capital buffer in case of another financial crisis.
“A key purpose of the capital surcharge is to require the firms themselves to bear the costs that their failure would impose on others,” Fed Chairwoman Janet Yellen said. “They must either hold substantially more capital, reducing the likelihood that they will fail, or else they must shrink their systemic footprint, reducing the harm that their failure would do to our financial system.”
However, the increased capital buffer means banks will have less money available to work, which could lead to lower profits. The greater regulatory pressure on the financial sector may have also contributed to the lower long-term performance. For instance, XLF has returned an average annualized 14.3% over the past five years, whereas the S&P 500 index returned 17.3%.
Financial Select Sector SPDR
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Max Chen contributed to this article.