ETF Trends
ETF Trends

The largest American banks may have to set aside more cash to strengthen balance sheets as a way to obviate further shocks, potentially putting additional strain on the financial sector and related exchange traded funds.

Fed governors Daniel Tarullo and Jerome Powell, in separate public comments, have hinted that the central bank would probably require eight of the largest U.S. banks to maintain more equity to pass its annual “stress test,” an examination implemented after the financial crisis to measure a banks ability to weather another downturn, the Wall Street Journal reports.

Any new requirements would further strain profitability and dividend payouts of these banks.

Banks and the financial sector have been lagging the broader market due to a combination of low interest rates, regulatory pressure, potential energy sector write-downs and increased litigation fees and fines.

Related: Energy Loan Woes Weigh on Financial ETFs

“It’s a tax on banking,” Goldman Sachs Group Inc. Chief Economist Steven Strongin said, referring broadly to new rules that he said go beyond what would have been required to prevent the 2008 crisis.

The financial sector is among the worst performing areas of the market this year.  Year-to-date, the Financial Select Sector SPDR (NYSEArca: XLF) is down 0.4%, iShares U.S. Financials ETF (NYSEArca: IYF) is up 0.6% and Vanguard Financials ETF (NYSEArca: VFH) is 0.7% higher. Meanwhile, the SPDR S&P Bank ETF (NYSEArca: KBE) fell 1.6% and PowerShares KBW Bank Portfolio (NYSEArca: KBWB) declined 3.3% so far this year.

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The new capital requirements are likely to be proposed formally later this year and won’t be expected to take effect before 2018. Nevertheless, banks will have to start adjusting their balance sheets sooner to phase in the changes.

“That’s not good for us,” J.P. Morgan Chase & Co. Chief Executive Officer James Dimon said. “Hopefully we’ll be able to adjust. We put a lot of power, money, people on to get these things right as we modify our business practices to meet the new rules.”

Related: Struggle and Trouble Ahead for Bank ETFs?

Current rules require banks during normal times to maintain an additional capital buffer of 3.5% in certain assets. The requirement was previously 4.5% before the firm made moves to shrink in size over the past year. Any further regulation could also force other big banks to shrink in size instead of meeting the higher capital requirements.

Financial Select Sector SPDR

For more information on the financial sector, visit our financial category.