WASHINGTON — While regulators followed through Tuesday on a mandate to set an across-the-board capital floor, they signaled that bigger — and still-contentious — discussions lie ahead on more meaningful capital changes.
The Federal Deposit Insurance Corp.'s board finalized a rule ensuring that the nation's largest banks, which are subject to their own capital regime under the international Basel II accord, never hold less capital than what is required for smaller domestic banks. The regulation was required by an amendment to the Dodd-Frank Act sponsored by Sen. Susan Collins, R-Maine.
But the rule is just the start of post-crisis capital reforms. Many see the regime for large banks in Basel II — known as the "advanced approaches" — as inviting weak capital structures by allowing banks to use their own internal models to calculate risk. As a result, regulators have already proposed a new Basel III capital regime that includes a surcharge for systemically important firms to ensure they always hold more capital than other banks.
"Looking back over the crisis, it seems surprising, frankly, that we ever developed the advanced approach," FDIC Chairman Sheila Bair said at the board meeting. "Those were different times, however, when reliance on banks' risk models went almost unquestioned."
Bair called the Collins amendment "the single most important provision of the Dodd-Frank Act for strengthening the capital of the U.S. banking system."
But just as U.S. regulators battled each other while Basel II was under development, the financial crisis has not resolved their differences.
While John Walsh, the acting comptroller of the currency and an FDIC board member, supported the final rule, he also indicated continued support for the Basel II advanced approach, calling it a "more sophisticated and risk-sensitive approach to risk management" than Basel I. He also expressed concern that the Collins amendment will hurt large banks' international competitiveness and remove incentives to implement the advanced approaches.
"We remain committed to full implementation of the advanced approaches because we do hope that we will obtain the benefits of improved risk management," said Walsh.
Bair, who plans to step down from her position on July 8, said she hopes regulators repair problems with the advanced approach.
"While there is growing recognition that the advanced approach tends to produce risk-based capital numbers that are both low and highly subjective, large banks around the world still use it," she said. "Frankly, this concerns me. With their risk-based capital set by management assumptions, and no hard limits on leverage in those countries as of yet, the conditions exist for adverse surprises down the road in the world's banking system.
"I encourage my fellow board members who will remain after my departure to make the correction of this situation a priority through the implementation of the international leverage ratio and reduced reliance on banks' own models in setting risk-based capital."
But Walsh struck a decidedly different tone. He said the Collins amendment interferes with U.S. banks implementing Basel II.
"This is a move away from international consistency since large internationally-active U.S. banks will face a two-tiered test unlike comparable foreign banks," Walsh said. He added, "The advanced approaches are costly and complicated to implement. The incentive to implement them rigorously, I worry, is reduced if the simpler Basel I approaches that are already in place will suffice to determine capital."
The Collins amendment rule will be issued jointly with the Federal Reserve Board and Office of the Comptroller of the Currency. The regulation, which was unchanged from the agencies' December proposal, will become effective 30 days after publication in the Federal Register.
In the heightened regulatory atmosphere, companies that qualify for the advanced approaches currently have not lowered their capital below industry norms. But Basel II provided flexibility for large institutions to reduce capital in more favorable times.
The Collins amendment was meant to ensure that even under Basel II, U.S. banks and bank holding companies could never reduce their capital below the typical levels used by domestic regulators for other depository institutions, known as "generally acceptable risk-based capital requirements."
Under the new policy, large banks would not have to raise their capital per se, since all are generally above the minimums used by other institutions. The rule simply limits how far they could reduce capital in the future.
"The final rule removes the transitional floor periods in … the advanced approaches rule, and sets the generally applicable risk-based capital requirements as a permanent floor for the advanced approaches," FDIC staff said in the final rule.
The amendment also blocked firms from including trust-preferred securities in Tier 1 capital, but that ban is expected to be addressed in a separate rulemaking.
Yet while the Collins measure drew ample attention in the debate over Dodd-Frank, it may be less relevant now as international regulators draw up plans for a stronger Basel III regime and consider adding capital charges for systemically important financial institutions.
"In this environment, generally everybody is talking about increasing capital requirements. … In that sense, you could say the Collins amendment basically is just putting a floor in place," an FDIC official said on the condition of anonymity. "In some sense going forward, you could argue that it's not a binding floor because capital is going to go up anyway."
