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1 1 (January 18, 2018)

handle is hein.crs/govcgzv0001 and id is 1 raw text is: 01;0i E.$~ & January 18, 2018 Financial Reform: Custody Banks and the Supplementary Leverage Ratio Vlhmt Dok Custody~ Banks D~o Custody banks engage in the safekeeping and servicing of assets owned by others. Custody banks may also perform services such as the settlement, holding, and reporting of customers' marketable securities and cash. Customers are often asset managers, mutual funds, retirement plans, insurance companies, corporations, endowments, other banks and financial entities, or large private investors. The other unique feature of custody banks is that they often act similarly to escrow in financial transactions, holding onto assets or collateral for the parties to a financial transaction such as a derivatives trade or a securities lending trade until the trade is finalized and the rightful owner of the asset or collateral collects it. Custody banks do not have a special charter, but are ordinary banks that engage in custody activities. The custody services industry is highly concentrated. According to one study, as of the end of the first quarter of 2017, the four largest custody banks were Bank of New York Mellon, State Street, J.P. Morgan, and Citigroup, and they held 47% of the total assets under custody in the United States, then totaling $103 trillion. Although the safekeeping function is not viewed as presenting much underlying credit risk (or risk of loss) to the custody bank itself, the sheer volume of transactions and size of related assets such banks hold highlight the crucial role custody banks play in the functioning of the global financial system. The Office of the Comptroller of the Currency (OCC) sees operational risk as one of the largest risks for custody banks, because the provision of custody services is largely dependent on the successful execution of very large volumes of operational tasks and transactions and requires sophisticated systems. Operational risk is broadly defined as the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events, such as cyberattacks. Figure 1 shows the U.S. banks with the largest custody businesses. Two of the banks, JP Morgan and Citigroup, are diversified conglomerates whose primary line of business is not custody services, and that also engage in investment banking and commercial lending. The other two, Bank of New York Mellon and State Street, according to their annual reports, derive the largest chunk of their revenue from investment servicing fees, including custody fees. Such fee-based revenue often entails lower risk than revenue from trading or lending activities, which carry credit and market volatility risk. Another bank, Northern Trust, though smaller in terms of total assets, also has a large custody business as a share of its total revenue. Figure I. Banks with Large Custody Businesses Based on Assets Under Custody (AUC) AUC ($trillion) End 2016 Bank of N ew Yo, rk MIe Io $29.9 State Street $28.8 .PMorgan $20.5 Cirigtoup $15.2 Top 4 To0t al 0P4.4 Source: The 2016 annual report for each bank. Custody banks have argued that some of the Basel III requirements implemented after the 2008 financial crisis were inappropriate for their business model, which focuses on the servicing of client assets. Basel III is an internationally agreed-upon set of measures developed by the Basel Committee on Banking Supervision in response to the financial crisis of 2007-2009. In particular, several custody banks have complained about the impact of the supplementary leverage ratio (SLR) under Basel III. They argued that it makes their fee-based, high-volume business disproportionately costly due to reasons discussed below. Supplemetzr L U Vt§'a z ,e atio a In response to the financial crisis, both the Dodd-Frank Act and Basel III requirements broadly aimed to increase banks' capital holdings to strengthen the financial system's resiliency against future crises. Basel III included risk- based capital requirements to ensure banks hold more capital against riskier assets. It also included a leverage ratio that imposed the same capital charge for every asset, no matter how safe, to provide a backstop and ensure banks hold a minimum amount of capital regardless of their type of assets. The leverage ratio also captures a certain size footprint of a bank's total financial activities. Currently, almost all U.S. banks and bank holding companies are subject to a minimum 4% leverage ratio, as measured by the ratio of a firm's high quality or tier 1 capital, over the sum of all its on-balance sheet assets. The U.S. Basel III SLR rule also requires large, internationally active U.S. banking organizations (typically, those with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposures) to meet a minimum 3% SLR. The SLR is measured as the ratio of a firm's tier 1 capital to the sum of all on-balance sheet assets and certain off-balance sheet exposures. The enhanced supplemental leverage ratio (eSLR) standard requires a U.S.-based global systemically important bank holding company (G-SIB) to hold an additional 2% buffer over the minimum SLR requirement for a total of 5% to avoid restrictions on capital gognpo goo g , q 'S a X 11L1\LXW1k\\\W,

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