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Categorized | Banks

Fed eyes rise in banks’ commodities capital

Posted on September 23, 2016

GULF OF MEXICO - APRIL 21: In this handout image provided be the U.S. Coast Guard, fire boat response crews battle the blazing remnants of the off shore oil rig Deepwater Horizon in the Gulf of Mexico on April 21, 2010 near New Orleans, Louisiana. An estimated leak of 1,000 barrels of oil a day are still leaking into the gulf. Multiple Coast Guard helicopters, planes and cutters responded to rescue the Deepwater Horizon's 126 person crew. (Photo by U.S. Coast Guard via Getty Images)©Getty

Banks will have to carry billions of dollars in extra capital if they trade hazardous materials such as oil and natural gas under a proposed US regulation meant to lessen the risks of liability from spills, explosions and other catastrophes.

The Federal Reserve on Friday released a proposed rule governing Wall Street’s involvement in physical commodities that would stiffen capital requirements, tighten limits on trading activity, remove banks from the business of running power plants and restrict their activities in the copper market. Banks that stay in the market despite the restrictions would have to reveal their commodities holdings to the public.

    The proposal comes after years of deliberation during which many of the largest banks on Wall Street retreated from the business of handling raw materials. Pressure from the Fed and the collapse of global commodity markets hastened their exit.

    The bank likely to be hardest hit would be Goldman Sachs, which has stood by its vast commodities franchise, known as J Aron, delivering oil to refineries and natural gas to utilities.

    Fed staff said the proposal, now open for public comment, would “better address the potential legal, reputational, and financial risks posed by such activities, particularly those that can result from an environmental catastrophe”.

    Since 2003, the Fed has given 12 banks authority to wade into the physical commodities trading business, a province traditionally dominated by commercial producers and merchants such as BP, Cargill or Vitol. But US lawmakers have raised questions about the risks these businesses present to banks and the financial system.

    Under the Fed’s proposal, banks using this authority would have to assign a risk weight of 300 per cent to their physical commodity holdings. For example, a tank holding $1m of petrol would have a risk weight of $3m. Based on a 10 per cent capital requirement, this would require an additional $300,000 of capital.

    Two banks, Goldman and Morgan Stanley, were “grandfathered” under a 1999 law to be allowed to own pieces of commodities infrastructure such as power plants and oil terminals, in addition to the materials that pass through them.

    Any commodities or assets held under this exemption would have what Fed officials called a punitive 1,250 per cent risk weight, requiring capital equal to the value of the underlying commodity or asset.

    While Goldman continues to trade physical commodities, it has sold infrastructure such as coal mines and power plants. Morgan Stanley has also largely disposed of its physical commodities assets after selling off fuel distributor TransMontaigne and its global oil merchant business.

    In aggregate, the 14 banks affected by the rule could face up to $4bn in additional capital requirements, Fed officials said. The proposal comes two weeks after the Fed urged Congress to repeal the law giving Goldman and Morgan Stanley their exemption.