1 Reason Banks Are Underperforming Today

U.S. stocks are slipping this morning, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) down 0.43% and 0.08%, respectively, at 10:20 a.m. EDT.

The macro view
One possible explanation for this morning's decline is the June employment data released by payroll processor ADP, according to which private employers added 188,000 jobs last month. That figure easily trumps the 160,000 forecast obtained in a Reuters poll of economists.

Why would stronger-than-expected employment numbers push stock prices down? Investors may figure that this data will bolster the Fed's case for reining in its monthly bond purchases, a.k.a. "quantitative easing," which have been a source of support for the stock and bond markets. It's not clear what any of this has to do with equities' long-term fundamental value, but that's the logic of Wall Street.

Of course, the ADP numbers are a bit of a sideshow while the market waits for the June employment report from the Bureau of Labor Statistics, due at 8:30 a.m. EDT on Friday. (We'll have you covered Friday morning with the proper context to understand those numbers.)

The micro view
Bank capital requirements were on the agenda of yesterday's Federal Reserve board meeting, and bankers may not be pleased with the outcome. The Fed's mandate includes preserving the integrity of the U.S. banking system, and the organization has a supervisory role, particularly with regard to the largest, "systemically important" institutions.

The Fed will require banks to comply with multiple capital requirements. Most of these are part of the international norms set out in the new Basel III framework on capital adequacy. Basel III is based on the notion of "risk-adjusted assets," according to which banks should set aside different amounts of capital against different assets, depending on the assets' risk level. For example, U.S. Treasuries -- considered to be the safest asset -- require no capital provision, whereas the riskiest loans might require a 100% capital provision.

However, the Fed is likely to add a simpler leverage ratio that makes no adjustment for perceived riskiness and is therefore immune to banks fiddling with their risk models to "optimize" their risk-adjusted assets. The leverage ratio is calculated based on total assets. The Fed is also considering adding a capital charge for banks that are heavily reliant on wholesale funding -- repo markets are a less stable source of funds than bank deposits. This would penalize firms like Morgan Stanley (NYSE: MS  ) and Goldman Sachs (NYSE: GS  ) .

For banks like Wells Fargo (NYSE: WFC  ) , the news was mixed. On the one hand, the Fed adjusted its risk weights for mortgages downward, requiring mortgage lenders to hold less capital against them, but it didn't reduce the capital charge for "mortgage servicing rights," which represent the value of future servicing fees.

Bank share investors need to watch this space: As these regulations are finalized, shares will be rerated.

Many investors are concerned about investing in big banking stocks after the crash, but the sector has one notable standout. In a sea of mismanaged peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.

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GS $165.13 Down -2.89 -1.72%
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Morgan Stanley CAPS Rating: ***
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