November 30, 2023 | Stamford, CT — Proposed changes in rules governing global systemically important banks (GSIBs) could help eliminate the practice of “window dressing” by the biggest U.S. banks, potentially reducing unusual Q4 market activity reductions in repo financing and other activities.

U.S. banking regulators have recently proposed what is now known as the Basel III Endgame, a set of amendments to capital rules governing financial institutions with more than $100 billion in assets. In the existing regulatory framework, U.S. banks categorized as GSIBs are required to hold an added layer of capital because they are seen as “too big to fail.” The methodology used to categorize banks as systemically important relies on year-end data. 

“The current methodology creates a clear incentive for banks to temporarily improve their balance sheet position,” says Minal Chotai, Co-Head of Financial Resources at Coalition Greenwich and author of U.S. GSIB Rule Changes to Weigh on the Buy Side. “Almost all large U.S. financial institutions, albeit to varying degrees, now engage in window dressing—a temporarily reduction in their balance sheet in the last quarter of the financial year to lower their GSIB scores and minimize capital surcharges.”

In an effort to change this behavior and better measure each firm’s systemic footprint, the proposal would measure on an average basis over the full year the systemic indicators that are currently measured only as of year-end.

Impact on Balance Sheets and Liquidity
The proposed rule change should curb some Q4 market activity reductions. However, with the new methodology in place, banks that were benefiting from artificially low GSIB scores at year-end would likely incur higher capital surcharges. Those higher costs would then prompt banks to closely manage their balance sheets, likely causing them to decrease their market activity and/or pass along the increases to clients— neither of which is good for the buy side. 

“Eventually, higher capital costs will cascade down to the buy side,” says Minal Chotai. “However, the buy side should initiate a dialogue with their sell-side counterparts now to understand their position and explore mutually beneficial areas.” 

U.S. GSIB Rule Changes to Weigh on the Buy Side documents the extent of bank window dressing by analyzing changes in GSIB scores for select U.S. financial institutions. The report also examines in detail the implications the proposed rule amendments will have on the buy side and the wider financial industry.