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Basel III (or the Third Basel Accord) is a global, voluntary regulatory standard on bank capital adequacy, stress testing and market liquidity risk.

It was agreed upon by the members of the Basel Committee on Banking Supervision in 2010-11, and was scheduled to be introduced from 2013 until 2015; changes from April 1, 2013 extended implementation

until March 31, 2018 however.

The third installment of the Basel Accords was developed in response to the deficiencies in financial regulation revealed by the late-2000s financial crisis.

Basel III was supposed to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage.

Source

 

 

 

 

 

 

Current Implementation Status of Basel III

April 17, 2012

 

 

Introduction


The process of implementing the new rules of Basel III for the prudential regulation of banks is progressing quickly on a worldwide basis. This article takes stock of the current status of implementation in some of the major international jurisdictions.

 

 

 

Analysis

 

EUROPEAN UNION


At the European level Basel III will be implemented through the "Regulation of the European Parliament and of the Council on prudential requirements for credit institutions and investment firms" and the "Directive of the European Parliament and of the Council on the access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms" (CRD IV Regulation and CRD IV Directive - together "CRD IV").

 

The majority of the existing CRD prudential requirements as well as the bulk of Basel III reforms will be included in the CRD IV Regulation as part of the Commission's planned single rule book. The Commission aims for agreement on CRD IV to be reached by summer 2012.

 

The European Parliament (EP) procedure files for the CRD IV Directive and the CRD IV Regulation, currently give June 12, 2012 as an indicative date for the Parliament to consider CRD IV in plenary session. The Commission plans for the proposed CRD IV Regulation and CRD IV Directive to come into force on January 1, 2013, with full implementation of their requirements by January 1, 2019.

 

Member states are expected to transpose the CRD IV Directive into national law by December 31, 2012. If approved, the legislation will take effect from January 1, 2013 and will follow the Basel III transitional timetable set by the Basel Committee.

 

During the past few months, the EP and the EU Council of Finance Ministers (ECOFIN) have put forward their respective positions on CRD IV.

 

The rapporteur at the EP, Mr. Othmar Karas, published his first report on amendments on the CRD IV Directive on December 14, 2011 and amendments to the new CRD IV Regulation on December 16, 2011.

 

The report stresses the importance of a maximum harmonization (single rule book). It also proposed some amendments and highlighted certain issues which include, among others:

  1. Provisions to improve the corporate governance should ensure that there is no conflict of interest and that remuneration policy and top salaries are aligned with the long term interest of a financial institution.
     

  2. The structure of the supervisory boards in banks of the different EU countries should be improved.
     

  3. The CRD IV Directive should include less detailed rules on the Countercyclical Buffer that can be set by national authorities within a range of 0 and 2.5% of risk weighted assets. The respective rules should rather be set by the European Systemic Risk Board (ESRB).
     

  4. The leverage ratio, while being a useful, simple and hard to manipulate backstop against the building of excessive leverage, should serve as a backstop mechanism under Pillar II (only) and not be disclosed before a final decision on its introduction has been made.
     

  5. The requirements for management and capitalization of the counterparty credit risk when engaging in the derivatives markets need to be adapted to the outcome of decisions on the Regulation on OTC derivatives, central counterparties, and trade repositories (EMIR).

The Karas Report has in the meantime been amended and supplemented by more than 2,000 amendment proposals by members of the EU parliament.

Following discussions about the CRD IV Regulation and CRD IV Directive in the second half of 2011 by the EU Parliament, the Danish Council of the EU published compromise proposals, dated January 9, 2012 and March 4, 2012, taking into account some of the changes debated and considered in the parliamentary discussion.


In January 2012, the European Central Bank (ECB) published its opinion on the European Commission's legislative proposals for CRD IV. The ECB welcomed the Commission's approach to CRD IV and reaffirmed its support for the development of a single European rulebook for all financial institutions.


In March 2012, the European Parliament's Committee on Economic and Monetary Affairs (ECON) published the draft reports containing proposed amendments to the CRD IV Directive and the CRD IV Regulation.


The first reading of the CRD IV Directive and CRD IV Regulation in the European Parliament's Committee on Economic and Monetary Affairs (ECON) is currently scheduled for April 25, 2012. The first reading of both legislative proposals in the plenary session of the EU Parliament is currently scheduled for June 12, 2012.

 

 

 

GERMANY


On February 10, 2012 the German Federal Council (Bundesrat, i.e. the second chamber of the German federal parliament) which represents the individual German states (Länder) and their particular regional political view published a statement on the Commission's proposal for the CRD IV Regulation and CRD IV Directive.

 

Among others, this statement addresses the following issues:

  1. The German Federal Council would prefer an implementation of Basel III rather by way of a directive (and not by way of a directly applicable regulation). Contrary to a regulation a directive must be transposed into national law.

     

    Such implementation would pass through a process of democratic control of national legislative authorities which would allow to adjust the Basel III rules to specific national situations and requirements.

     

  2. The implementation of Basel III in Germany should consider the needs and particularities of small to medium-sized credit institutions (i.e. banks whose balance sheet totals do not exceed EUR 70 billion and which focus on regional retail banking) and their particular (lower) risk profile.

     

    For such small to medium-sized credit institutions the German Federal Council proposes the following special treatment under the Basel III implementation:
     

    1. to exclude such small to medium-sized credit institutions from the leverage ratio and net stable funding ratio;
       

    2. to consider the diversity of legal forms by establishing the relevant criteria for own funds and for deductions from common equity tier 1 items in order to ensure that small and medium-sized credit institutions do not suffer any disadvantages in comparison to larger financial institutions; and
       

    3. to exclude the small to medium-sized credit institutions from a directly binding effect of the technical standards which the European Banking Authority (EBA) would be authorized to issue under the CRD IV Regulation and CRD IV Directive. Such standards should rather become binding for small and medium-sized institutions only if adopted by the national banking authorities which should carefully consider whether such rules are in fact necessary for small and medium-sized institutions.

       

  3. Pursuant to the German Federal Council the EBA should not be authorized to develop draft regulatory technical standards for determining which financial institutions are considered as saving banks or cooperative banks.

     

    The EBA would otherwise have the authority to interfere with the national corporate law rules of Member States governing cooperative banks and savings banks.

     

  4. The German Federal Government is called to carefully assess the EBA's technical rule setting powers set out in the Commission proposal.

     

    Those rules which are of mandatory importance should be set forth in the CRD Regulation or CRD Directive itself and the authority to issue such rules should not be delegated to the EBA.

The statement by the German Federal Council is not a binding rule setting but merely expresses the opinion of the German Federal Council and contains recommendations for the German government in its further negotiations with the other EU member states on the appropriate approach for the implementation of Basel III within the European Union.

 

Nonetheless, it should be taken as an indication that the "single rule book" approach taken by the proposal of the European Commission is seen skeptically within this chamber of the German parliament.

 

 


FRANCE


In France, both assemblies of the Parliament are working on the Commission's proposal for the CRD IV Regulation and the CRD IV Directive. The Lower Chamber, the Assemblée Nationale (the "NA"), published a report in January 2012.

 

The main conclusions of this report are the following:

  1. The NA is concerned by the impact that the accelerated implementation of Basel III will have on the financing of the "real economy" and has summoned the government to carry out an assessment thereon;
     

  2. The NA stresses the need to have a consistent approach and implementation in all relevant jurisdictions in order to avoid regulatory shopping and arbitrage. In this respect, it emphasizes the need to develop cooperation with the United States;
     

  3. The NA welcomes the proposal to reduce to the extent possible reliance by credit institutions on external credit ratings; and
     

  4. The NA calls for the European Union to propose regulation of shadow banking in the context of the G20.

On March 6, 2012 the French Sénat (the "Senate", i.e. the second chamber of the French parliament) published a report including the Senate statement on the Commission's proposal for the CRD IV Regulation and CRD IV Directive.

 

Among others, this statement reiterates the conclusions of the NA's above report and addresses the following issues:

  1. The Senate supports a maximum harmonization of prudential ratios, as proposed by the European Commission through a single rule book. It has noted that this maximum harmonization should be accompanied by a strong European supervision.
     

  2. With regard to capital ratios, the Senate has emphasized that the levels and quality of the composition proposed by the European Commission are likely to strengthen the banks solvency. However, the implementation of Basel III should consider national particularities in risk weighting, especially lending to small and medium enterprises, leasing or property loans.
     

  3. As regards the retention by credit institutions of some of the risks transferred into their balance sheets, the Senate has requested an increase from 5% to 10% of the minimum rate of securitized assets retention.
     

  4. With respect to the leverage ratio, the Senate considered that the principle of its insensitivity to risk must be maintained in order to assure its efficiency (notwithstanding the critics of penalizing credit to small and medium enterprises and to local authorities). The observation period relating to the leverage ratio should be used to assess the impact of introducing a binding leverage ratio. The assessment should also include the appropriate calibration and the appropriateness of establishing the leverage ratio as a flexible ratio.
     

  5. With regard to structural reforms of the European banking sector, the Senate would like that the possibility and consequences of a separation of investment banking and retail banking be considered by the group of high level experts set up by the European Commissioner Michel Barnier.

The Senate's and NA's reports are not binding rulings but merely express the opinions of the French Senate and NA and contain recommendations for the French government in its further negotiations with the other EU member states on the appropriate approach for the implementation of Basel III within the European Union.

 

Nonetheless, they should be taken as an indication that the "single rule book" approach taken by the proposal of the European Commission is seen favorably within the French Parliament.

 

 

 

UNITED KINGDOM


In the United Kingdom, the Financial Services Authority has announced that it is carrying out discussions with the banking and investment industry through a number of working groups.

 

Subsequently, it will conduct a formal consultation on the regulatory rules that it will make for purposes of implementing the CRD IV Directive and, to the extent necessary, the CRD IV Regulation. It has not yet published a timetable for this consultation.


The development in the EU of the CRD IV Regulation and CRD IV Directive coincides with the recent publication of the Report of the Independent Commission on Banking. This Report recommended that banks carrying on retail business should not be permitted to carry on certain types of non-retail business.

 

Such banks will be known as "ring-fenced" banks, and the Commission proposed that they should be subject to capital requirements that are higher than the capital requirements laid down by Basel III and, therefore, by the CRD IV Regulation and the CRD IV Directive.


The proposal to subject ring-fenced banks to higher capital requirements than required by the CRD IV Regulation and the CRD IV Directive is causing tension within the EU.

 

The European Commission has proposed that maximum harmonization should apply to the CRD IV Regulation and the CRD IV Directive, meaning that member states would not have discretion to impose higher requirements for banks authorized in their jurisdictions. Nevertheless, the UK government has indicated its intention to adopt the recommendations of the Report of the Independent Commission on Banking.

 

The issue has become politicized, and was given as one of the reasons for the UK refusing to support the adoption of revisions to the EU Treaty in December 2011.

 

 

 

UNITED STATES


In the United States, Basel III implementation will require rulemaking by the federal banking agencies (the Federal Reserve Board, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation).

 

As of yet, the federal banking agencies have not issued a proposed rule implementing Basel III. They have suggested that such a proposal will be issued in the first half of 2012. Under the U.S. Administrative Procedures Act, the proposed rule must be issued for public comment, the agencies must then review and consider all comments filed.

 

After the close of the public comment period and sufficient review, the agencies can then issue a final rule.


Although no Basel III rules have been issued yet, some aspects of Basel III have been implemented in other aspects of U.S. bank regulation. For instance, the recent stress tests conducted by the Federal Reserve of the largest bank holding companies, used a measure of at least 5% tier 1 common equity under the stress scenarios as a minimum requirement before companies would be permitted to make any capital distributions.1

 

In addition, the Federal Reserve has stated in its proposed rule implementing enhanced supervision of large bank holding companies and systemically important non-bank financial institutions that it intends to implement the G-SIB surcharge called for by the Basel Committee consistent with the Committee’s 2014-2016 implementation, and noted that Basel III rules are a necessary prerequisite.

 

 

 

HONG KONG


Hong Kong plans to follow the timetables set out by the Basel Committee on the implementation of Basel III and on transitional arrangements. This means implementation will begin on January 1, 2013 with full implementation by January 1, 2019.


Basel III will be implemented in Hong Kong through amendments to the Banking Ordinance, Banking (Capital) Rules and Banking (Disclosure) Rules.


The Banking (Amendment) Ordinance (the "BAO") was enacted on February 29, 2012 to introduce a number of amendments to the Banking Ordinance for the purpose of putting in place the legal framework for implementing the Basel III capital, liquidity, and disclosure requirements in Hong Kong.

 

Key amendments include:

  1. empowering the Hong Kong Monetary Authority (the "HKMA") to,

    1. prescribe, in rules, capital requirements applicable to authorized institutions (AIs) which are locally incorporated

    2. prescribe, in rules, liquidity requirements applicable to AIs

    3. prescribe information which AIs have to disclose to the public relating to their state of affairs, profit and loss or compliance with applicable capital requirements or liquidity requirements

    4. issue and approve codes of practice providing guidance on the rules on new capital and liquidity requirements; and
       

  2. enlarging the review remit of the present Capital Adequacy Review Tribunal (CART) to cover also matters related to liquidity and disclosure for Basel III implementation, and to rename CART the "Banking Review Tribunal."

The rules on capital and liquidity requirements introduced under the BAO will cover various capital ratios, buffers, and liquidity ratios introduced by Basel III as well as their calculation methodologies.

 

As with the existing arrangements for the Banking (Capital) Rules and Banking (Disclosure) Rules, the HKMA will only be able to make rules in relation to capital, liquidity, and disclosure requirements after consultation with the Financial Secretary, the Banking Advisory Committee, the Deposit-Taking Companies Advisory Committee, and the two industry associations (i.e. the Hong Kong Association of Banks and the Association of Restricted Licence Bank and Deposit-taking Companies).


The provisions of the BAO will take effect in phases.

 

The provisions relating to capital requirements and the corresponding disclosure requirements will come into effect from January 1, 2013, while those relating to liquidity requirements will come into effect later in accordance with the Basel Committee's transitional timetable for Basel III implementation.

 

The HKMA will inform AIs when the relevant commencement notices are gazetted. The HKMA continues to work closely with the banking industry in implementing Basel III.

 

It has written to the Hong Kong Association of Banks and the Association of Restricted Licence Bank and Deposit-taking Companies on January 20, 2012 enclosing two consultation papers on the implementation of Basel III capital and liquidity standards, requesting comments by March 20, 2012.


The HKMA has commenced preparation for the amendment of the existing Banking (Capital) Rules and Banking (Disclosure) Rules for the purpose of effecting the first phase of Basel III implementation (including minimum risk-weighted capital adequacy ratios, definitions of capital and risk-weighting framework for counterparty credit risk) from January 1, 2013.

 

The HKMA plans to issue the draft amendment rules for statutory consultation in the third quarter of 2012, and to table the same to the Legislative Council in Hong Kong for negative vetting by the fourth quarter.

 

 

 

ISLAMIC FINANCE CONSIDERATIONS


Although most Islamic banks are positive about their ability to meet the targets set by the Basel Committee for the implementation of Basel III, the exact form of the requirements applicable to Islamic financial institutions is still a work in progress.

 

As with the two previous Basel protocols Basel III makes no distinction between conventional banks and Islamic financial institutions. This may cause some issues for Islamic banks. Islamic banks seem to be in a good position to meet the enhanced capital requirements specified by Basel III.

 

Islamic banks must comply with the regulations set by the Islamic Financial Services Board (IFSB) which imposes stricter capital requirements than those proposed in Basel III (Tier 1 and total capital requirements currently stand at 8% and 12%, respectively).


The liquidity requirements of Basel III will prove more difficult.

 

Islamic banks face two challenges in managing liquidity:

  1. surplus liquidity cannot be transferred to conventional banks
     

  2. constraints on their borrowing limits access to liquidity when the bank is under stress

Some regulators have acknowledged this issue.

 

The Central Bank of the United Arab Emirates has said that they will need to introduce new liquidity tools to ensure that Islamic banks will be able to implement the Basel III requirements. They have not yet indicated what these tools might be.


In addition, the IFSB is still in the process of reviewing its response to Basel III. The treatment of subordinated debt, hybrid debt capital and convertible contingent capital under Basel III will need to be considered and addressed. The final draft of the IFSB's revised protocols is scheduled for issuance in 2013.

 

As Islamic banks must comply with both Basel III and the IFSB protocol, only then will Islamic banks know what must be done to comply with this latest round of regulation.

 

The timing of the IFSB report should not interfere with the implementation of the Basel III requirements by the 1 January 2019 deadline.

 

 

References 

1 - Comprehensive Capital Analysis and Review 2012: Methodology and Results for Stress Scenario Projections (March 13, 2012)

 

 

 

Implementation of Basel III Framework
by Louise McNabola
January 8, 2013


The Basel Committee on Banking Supervision discussed the progress of its members in implementing the Basel III capital adequacy reforms at its recent meeting on 13-14 December.

The Basel Committee has been actively monitoring on a continuing basis the progress of members in implementing the Basel III package of regulatory reforms and to date has published three progress reports on two reports to the G20.

The Chairman of the Basel Committee noted that while some jurisdictions have not been able to meet the planned start date, a large number will be ready to begin introducing the new capital requirements as planned on 1 January 2013.





 Syndicated lending under Basel III
by Rosali Pretorius, Andrew Barber and Juan Jose Manchado
March 25 2013

Basel III will introduce new liquidity and leverage ratios for banks, and recalibrate the capital requirements banks must meet. These measures will have far-reaching impacts including on the profile and administration of syndicated loans. In this article, Rosali Pretorius, Andrew Barber and Juan Jose Manchado look at some of the changes the syndicated lending market must prepare for.
 

 


Status of Basel III

Basel III does not have legal status. It must be implemented into the laws and regulations of member countries or blocs, such as the EU. The EU proposals have been the subject of significant debate, which has led to a delay to the originally planned implementation date of January 2013.

In early March 2013, the EU policy-makers reached agreement on policy issues. Final approvals and legislative text remain outstanding. January 2014 is the current target date for implementation in the EU, but further delays are possible. What we do know is the EU will implement the Basel III proposals through a package known as CRD IV, comprising a new Capital Requirements Directive (CRD) and Capital Requirements Regulation (CRR). This article refers to the Council text of 21 May 2012.
 

 


Key changes under Basel III

Key areas of change are the liquidity coverage ratio (LCR), net stable funding ratio (NSFR), leverage ratio and increased requirements on the quality and quantity of capital. While we still await the final text of EU measures implementing the new standards, banks should prepare for significant changes, including the ones discussed below.
 

 


Liquidity coverage ratio

The LCR requires banks to hold enough high-quality liquid assets (HQLA) to meet prescribed assumed net cash outflows during a 30-day stress scenario.

 

The original version would have required banks to assume a 100 per cent drawdown rate on a wide range of undrawn committed credit and liquidity facilities. This would have led to banks having to hold increased levels of HQLA to meet the LCR requirements.

The Basel Committee on Banking Standards (BCBS) has recently reviewed several parts of the LCR, and decided to relax these assumptions:

  • from 100 per cent down to 30 per cent for committed liquidity facilities to non-financial corporates

  • from 100 per cent down to 40 per cent for credit and liquidity facilities where the borrower is a financial institution subject to prudential supervision

There was no change to the prescribed drawdown rate on credit and liquidity facilities to SPVs (which remains 100 per cent).

Given the different assumptions that they must apply, lenders will need to categorize facilities and price them according to the bucket in which they fall. In some transactions, the purpose clause in loan documents is likely to become much more important, for example in showing that a revolving facility is not intended to be used as a liquidity facility.

BCBS has proposed a gradual phase-in for the LCR from 2015 to 2019.
 

 


Net stable funding ratio

The NSFR, which BCBS is still developing, seeks to ensure a sustainable maturity structure of assets and liabilities over a one-year period.

 

Assets that cannot be liquidated in less than a year must be backed by stable funding. This will impact banks that provide long-term finance, and could lead to a decline in such finance.
 

 


Leverage ratio

The leverage ratio is the ratio of Tier 1 capital to gross assets, without risk weighting.

 

Banks must meet a 3 per cent ratio, probably from 1 January 2018, although BCBS will review this in 2017. For this calculation, banks cannot set off assets against liabilities to reach a net position, and credit risk mitigation techniques, such as collateral and guarantees, cannot be taken into account.

 

Banks must account for off-balance-sheet commitments in full (although under CRR there is a conversion factor for certain trade finance products, such as standby letters of credit, that was not included in Basel III itself).

 

Before 2018, banks must disclose calculation of the leverage ratio to their supervisors and the market (known as Pillar 2 & 3 disclosures).

The leverage ratio may make low-risk products less attractive for banks.
 

 


Use of IRBA

The CRR will require firms that calculate their credit risk-weighted exposure under the Internal Ratings Based Approach (IRBA) to apply a new asset value correlation multiplier of 1.25 to exposures to large financial sector entities and to unregulated financial entities.

 

The proposed definition of "unregulated financial entity" is broad enough to capture lending to a (non-financial) corporate group with a subsidiary for treasury operations, or to an SPV that on-lends money to a non-financial corporate client.

 

If that definition remains, banks will need to devote more resources to classifying borrowers correctly for the purpose of applying the multiplier.

Basel III also changes the risk-weights or "loss given default" applicable to certain exposures so that banks will need to hold more capital against those exposures. Notwithstanding Basel III, there seems to be growing regulatory opposition to banks’ use of the IRBA.

 

This is reflected in the FSA’s decision to withdraw the right of modeling for commercial property assets, and instead to force slotting, i.e. classifying loans into one of four categories, each category with a fixed risk-weight attached.




 

 Federal Reserve Approves Final Rule Implementing Basel III Capital Reforms
by Connie Friesen and William Shirley
August 2, 2013


Introduction

On July 2 2013 the Board of Governors of the Federal Reserve System approved a final rule that substantially revises the existing capital rules for US banking organizations.(1)

 

The final rule implements the regulatory capital reforms recommended by the Basel Committee on Banking Supervision in December 2010 - commonly referred to as Basel III - as well as additional capital reforms required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

 

Key reforms include increased requirements for both the quantity and quality of capital held by banks so that they are more capable of absorbing losses and withstanding periods of financial distress, and the establishment of alternative standards of creditworthiness in place of credit ratings.

Before the final rule, the Federal Reserve, together with the Comptroller of the Currency and the Federal Deposit Insurance Corporation, published three separate proposed rules (2) that, taken together, proposed a restructuring of the banking agencies' existing regulatory capital rules (for further details please see "Federal banking agencies issue proposed capital reforms").

 

The final rule consolidates the proposals and leaves most aspects of the proposals unchanged, including minimum risk-based capital requirements, capital buffers and many of the proposed risk weights.

 

However, the final rule makes several revisions to the proposals in order to reduce the regulatory burden for smaller banking organizations in response to comments received by the agencies, including retaining the current risk weights for residential mortgages in lieu of the proposed risk-weighting framework.

 

Additionally, smaller banking organizations are provided a longer transition period, with compliance starting on January 1, 2015, while larger banking organizations must begin compliance on January 1, 2014.

The Federal Reserve coordinated the final rule with the other agencies, which have not yet approved the final rule, but were scheduled to vote on it by July 9, 2013.

At the Federal Reserve's meeting to approve the final rule, there was discussion of four additional rulemakings currently in development that will apply to the eight US banking organizations that have been identified as global systemically important institutions.

This update highlights some of the key changes presented in the final rule.
 

 


Scope

In general, the final rule applies to all banking organizations currently subject to minimum capital requirements, including:

  • US federal and state chartered banks and savings associations

  • US bank holding companies with at least $500 million in total consolidated assets

  • US savings and loan holding companies that do not engage substantially in insurance underwriting or commercial activities

Certain parts of the final rule apply only to banking organizations that are subject to the advanced approaches rules (3) or banking organizations with significant trading activities.

 

In contrast to the proposals, savings and loan holding companies with substantial insurance underwriting or commercial activities will not be subject to the final rule at this time. The Federal Reserve will further consider the development of an appropriate capital framework for these companies.
 

 


Quantity and quality of capital

Consistent with Basel III and the proposals, the final rule requires banking organizations to maintain the following minimum risk-based capital ratios, when fully phased in:

  • a new ratio of common equity Tier 1 capital to risk-weighted assets (common equity Tier 1 capital ratio) of 4.5%

  • a ratio of Tier 1 capital to risk-weighted assets (Tier 1 capital ratio) of 6%, increased from 4%

  • a ratio of total capital to risk-weighted assets (total capital ratio) of 8%

The final rule also imposes a leverage ratio of Tier 1 capital to average total consolidated assets of 4% without exception and, for advanced approaches banking organizations only, a supplementary leverage ratio of Tier 1 capital to total leverage exposure (including certain off-balance sheet exposures) of 3%.

In addition to the minimum risk-based capital ratios, the final rule establishes a capital conservation buffer applicable to all banking organizations that consists of common equity Tier 1 capital equal to at least 2.5% of risk-weighted assets.

 

This buffer could be extended for advanced approaches banking organizations by an additional countercyclical capital buffer if the federal banking agencies determine that the economy is experiencing excessive credit growth.

 

The countercyclical capital buffer would initially be set at zero and could expand to as much as 2.5% of risk-weighted assets. If a banking organization fails to hold capital above the minimum capital ratios and the capital conservation buffer (plus, for an advanced approaches banking organization, any applicable countercyclical capital buffer amount), it will be subject to certain restrictions on capital distributions and discretionary bonus payments.

 

The phase-in period for the capital conservation and countercyclical capital buffers for all banking organizations will begin on January 1, 2016.

As set forth in the proposals, the final rule revises the definition of 'capital' with an emphasis on the inclusion of common equity Tier 1 capital and establishes strict eligibility criteria for regulatory capital instruments.

 

Deductions from and adjustments to capital are generally stricter than under the current capital rules, including with respect to goodwill and other intangibles, mortgage servicing assets, deferred tax assets and non-significant investments in the capital of unconsolidated financial institutions.

 

The new definitions of 'regulatory capital' and 'capital ratios' are incorporated into the agencies' prompt corrective action framework. In addition, the final rule amends the agencies' current capital rules to improve the methodology for calculating risk-weighted assets to increase risk sensitivity.
 

 


Key changes to proposals

Although the final rule retains, in large measure, many of the provisions presented in the proposals, some significant changes to the proposals have been made. These are mainly designed to accommodate concerns voiced by smaller banking organisations and community banks.
 

Regulatory capital treatment of accumulated other comprehensive income
Accumulated other comprehensive income generally includes accumulated unrealized gains and losses on certain assets and liabilities that have not been included in net income, yet are included in equity under US generally accepted accounting principles.

 

Under the agencies' current general risk-based capital rules, most components of accumulated other comprehensive income are not reflected in a banking organization's regulatory capital.

 

In the proposals and the final rule, banking organizations must include all components of accumulated other comprehensive income in regulatory capital, excluding accumulated net gains and losses on cash-flow hedges that relate to the hedging of items that are not recognized at fair value on the balance sheet.

 

The agencies recognized that for many smaller banking organizations, the volatility in regulatory capital that could result from this requirement could lead to significant difficulties in capital planning and asset-liability management.

 

To address this concern, the final rule permits a non-advanced approaches banking organization to make a one-time election to opt out of including most elements of accumulated other comprehensive income in regulatory capital, and instead effectively use the existing treatment under the general risk-based capital rules.

 

The accumulated other comprehensive income opt-out election must be made in the first call report or FR Y-9 series report that is filed after the banking organization becomes subject to the final rule.
 


Grandfathering of certain trust preferred securities
The proposals would have required all banking organizations to phase out trust preferred securities from Tier 1 capital under either a three-year or 10-year transition period based on the organization's total consolidated assets.

 

Banking organizations with total consolidated assets of less than $15 billion as of December 31 2009 and banking organizations that were mutual holding companies as of May 19 2010 would have had to phase out their non-qualifying capital instruments, including trust preferred securities, from regulatory capital over 10 years.

Based on comments received on the proposals, the agencies acknowledged that this proposal would unduly burden community banking organizations that have limited ability to raise capital, potentially impairing their lending capacity.

 

The final rule therefore permanently grandfathers non-qualifying capital instruments (e.g. trust preferred securities and cumulative perpetual preferred stock) issued before May 19 2010 for inclusion in the Tier 1 capital of banking organizations with total consolidated assets of less than $15 billion as of December 31 2009 and banking organizations that were mutual holding companies as of May 19 2010.

 

This change is also consistent with the exception provided for smaller banking organizations under Section 171 of the Dodd-Frank Act.
 


Risk weighting for residential mortgages
The agencies proposed a new framework for banking organizations to risk weight residential mortgages in the proposals.

 

Residential mortgage exposures would be placed into one of two categories based on certain characteristics to determine their applicable risk weight, with lower risk weights for Category 1 and higher risk weights for Category 2.

 

To address commenter concerns about the burden of calculating the proposed risk weights for existing mortgage portfolios and the potential effect of inhibiting credit availability when combined with other mortgage-related rulemakings, the final rule does not adopt the proposed risk weights, but retains the existing risk weights for residential mortgage exposures under the general risk-based capital rules.

 

Accordingly, the final rule assigns a 50% or 100% risk weight to exposures secured by residential mortgages.



Compliance dates

Generally, advanced approaches banking organizations that are not covered savings and loan holding companies must begin complying with the final rule on January 1 2014.

 

Banking organizations that are not subject to the advanced approaches rules and advanced approaches banking organizations that are covered savings and loan holding companies are granted more time and must begin complying with the final rule on January 1 2015.

The final rule provides the following information with respect to compliance dates for advanced approaches banking organizations that are not savings and loan holding companies:

  • January 1, 2014 - begin the transition period for the revised minimum regulatory capital ratios, definitions of regulatory capital and regulatory capital adjustments and deductions compliance with the revised advanced approaches rule for determining risk-weighted assets

  • January 1, 2015 - begin compliance with the standardized approach for determining risk-weighted assets

  • January 1, 2016 - begin the transition period for the capital conservation and countercyclical capital buffers

The final rule provides the following information with respect to compliance dates for banking organizations not subject to the advanced approaches rule and banking organizations that are covered savings and loan holding companies:

  • January 1, 2015 - begin compliance with the revised minimum regulatory capital ratios and begin the transition period for the revised definitions of regulatory capital and the revised regulatory capital adjustments and deductions; and the standardized approach for determining risk-weighted assets

  • January 1, 2016 - begin the transition period for the capital conservation and countercyclical capital buffers

If applicable, banking organizations must use the calculations under the market risk rule of the final rule concurrently with the calculation of risk-weighted assets according to either the standardized approach or advanced approaches of the final rule.

There is an exception to the general compliance dates for a bank holding company subsidiary of a foreign banking organization that is currently relying on the Federal Reserve's Supervision and Regulation Letter 01-1.(4)

 

Such entities are not required to begin complying with the final rule until July 21 2015 in accordance with Section 171 of the Dodd-Frank Act.
 

 


Further rulemakings for global systemically important institutions

At the Federal Reserve's board meeting to approve the final rule, Governor Daniel Tarullo discussed four rulemakings that are in development for the eight US banking organizations that have been identified as global systemically important institutions.

The Federal Reserve is close to completion of a proposal to establish a leverage ratio above the Basel III required minimum.

The Federal Reserve expects to issue a proposal in the next few months on the combined amount of equity and long-term debt that institutions should maintain to facilitate orderly resolution in appropriate circumstances.

After the Basel Committee on Banking Supervision has completed final methodological refinements to its framework for capital surcharges on global systemically important banking organizations, the Federal Reserve will issue a proposal to implement the framework in the United States.

The Federal Reserve is working on a proposal that will seek comment on possible additional measures to address risks related to short-term wholesale funding, including an additional capital requirement for institutions that are substantially dependent on such funding.



Endnotes

(1) Federal Reserve press release and final rule available at www.federalreserve.gov/newsevents/press/bcreg/20130702a.htm.
(2) 77 Fed Reg 52792 (August 30 2012); 77 Fed Reg 52888 (August 30 2012); 77 Fed Reg 52978 (August 30 2012).
(3) Generally, the advanced approaches rules are mandatory for banking organizations that have $250 billion or more in total consolidated assets or that have total consolidated on-balance sheet foreign exposure equal to $10 billion or more.
(4) SR 01-1 (January 5 2001) is available at www.federalreserve.gov/boarddocs/srletters/2001/sr0101.htm.

 

 

Additional Documentation