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.
Current Implementation Status of Basel III
April 17, 2012
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.
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
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:
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
The structure of the supervisory boards
in banks of the different EU countries should be improved.
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).
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.
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).
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
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.
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
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
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.
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
to exclude such small to medium-sized
credit institutions from the leverage ratio and net
stable funding ratio;
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
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
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
The EBA would otherwise have the
authority to interfere with the national corporate law rules
of Member States governing cooperative banks and savings
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
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
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
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;
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;
The NA welcomes the proposal to reduce to
the extent possible reliance by credit institutions on
external credit ratings; and
The NA calls for the European Union to
propose regulation of shadow banking in the context of the
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:
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.
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.
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.
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.
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
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.
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
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
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.
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
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
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 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)
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
Key amendments include:
empowering the Hong Kong Monetary
Authority (the "HKMA")
prescribe, in rules, capital requirements
applicable to authorized institutions (AIs) which are
prescribe, in rules, liquidity
requirements applicable to AIs
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
issue and approve codes of practice
providing guidance on the rules on new capital and liquidity
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
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
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
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
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
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
surplus liquidity cannot be transferred
to conventional banks
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
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 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
Syndicated lending under Basel III
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
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
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.
The leverage ratio is the ratio of Tier 1 capital to gross assets, without
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 &
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
August 2, 2013
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
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
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
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,
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.
In general, the final rule applies to all banking organizations currently
subject to minimum capital requirements, including:
US federal and state chartered banks and
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
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)
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
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
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
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
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
Accordingly, the final rule assigns a 50% or
100% risk weight to exposures secured by residential mortgages.
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
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
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
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.
(1) Federal Reserve press release and final
rule available at
(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