Regulators Offer Relief for Small Banks in Basel III Final Rule

WASHINGTON — The Federal Reserve Board on Tuesday met to vote on a final Basel III package, which represents the most significant overhaul of regulatory capital requirements for U.S. institutions.

The package of rules jointly written by the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Fed will require thousands of banks to hold higher, more loss-absorbing capital in order to help prevent a repeat of the financial crisis.

"With these revisions to our capital rules, banking organizations will be better able to withstand periods of financial stress, thus contributing to the overall health of the U.S. economy," said Fed Chairman Ben Bernanke, in prepared remarks, ahead of the Fed board's vote.

Regulators by and large adhered to the initial draft proposal released last June, leaving most of the capital requirements unchanged, including two proposed leverage ratios. But as expected, some aspects of the rule were softened for community banks. Regulators made changes to risk-weights for residential mortgages and gave them a one-time opportunity to "opt-out" of a requirement to include unrealized gains and losses in their capital calculation. The rule would also effectively grandfather certain existing trust-preferred securities.

Additionally, smaller institutions were provided a longer transition period, with implementation starting on Jan.1, 2015, while larger banks must begin compliance on Jan. 1, 2014.

Under the final rule, financial institutions will have to hold a common equity Tier 1 capital ratio of 4.5%, a Tier 1 capital ratio of 6% and a total capital ratio of 8% of risk-weighted assets. All banks will also face a leverage ratio of 4%, while the largest institutions will also have to comply with an additional 3% supplemental ratio under the "advanced approaches," which would capture certain off-balance sheet exposures like derivatives.

At the board meeting, Fed Gov. Daniel Tarullo noted U.S. regulators are "very close" to completing a proposal that would increase the leverage ratio further for the eight U.S. banking organizations that have been identified as globally systemically important institutions.

Tarullo also highlighted several other requirements for such banks, including a mandate to issue long-term debt in order to facilitate an orderly resolution, a capital surcharge, and additional measures to address risks to short-term wholesale funding.

"Once final, these measures would round out a capital regime of complementary requirements that focus on different vulnerabilities and together compensate for the inevitable shortcoming in any single capital measures," said Tarullo.

Separately, regulators agreed to ask all banks, including smaller-sized institutions, to hold a capital conservation buffer of 2.5%of total risk-weighted assets. But the Fed said it would only apply a countercyclical buffer to the largest, internationally-active banks.

Regulators also stuck to the strict regulatory capital deductions from common equity Tier 1 capital. So, for example, banks will no longer be able to use deferred tax assets, mortgage servicing assets, and "significant" investments in the capital instruments of unconsolidated financial institutions. To alleviate some pressure on banks, regulators provided a lengthy transition to give banks an opportunity to comply with the capital deductions.

Additionally, because of new mortgage-related rulemaking, policymakers opted not to include proposed risk weights for residential mortgage exposures, and instead incorporated the risk weights for residential mortgages under the general risk-based capital rules, which will either assign a 50% or 100% rating.

Policymakers stressed the revisions to the capital standards would benefit the financial system by reducing systemic risk, and this benefit would ultimately outweigh any burden placed on banks.

As of today, according to analysis by the Fed, more than 95% of bank holding companies with less than $10 billion of assets already meet the current regulatory capital requirement of 4.5% minimum common equity Tier 1 ratio. Roughly 90% of bank holding companies with less than $10 billion of total assets already meet the 7% threshold of the minimum common equity Tier 1 ratio plus the conservation buffer, with an aggregate common equity shortfall of about $2 billion.

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