Regulators Pledge Basel Relief for Small Banks

WASHINGTON — Regulators pledged Wednesday to heed concerns of community banks and ensure that a final rule implementing Basel III capital and liquidity requirements does not harm smaller institutions.

Officials from the Federal Reserve Board, the Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency stressed to lawmakers that they are acutely aware of the possible burden adopting Basel III could have on such banks.

"We are the primary supervisor of the majority of community banks in this country and we do not want to create a situation where the compliance costs make them uncompetitive or unable to serve their important roles in their local communities," said George French, deputy director for risk management at the FDIC, at a hearing on the issue. "I think we are all in the position of looking at all of these letters and looking at all the individual issues that bankers have raised concerns and deciding how to proceed."

The Senate Banking Committee's hearing comes just a week after regulators said they would indefinitely delay the U.S.' adoption of Basel III as they sifted through the more than 2,000 comment letters they have received since issuing a series of proposals in June. The United States, along with other member nations, had pledged to begin implementation of Basel III by Jan. 1.

Regulators have not set a new deadline on when they expect to adopt the rules, but have provided assurances that they will provide a lengthy transition period.

The hearing marked the first time the Senate panel had weighed in on the proposals, which are designed to improve the quality and quantity of capital that banks of all sizes must hold to prevent a repeat of the financial crisis.

Several lawmakers raised concerns about individual provisions of the plan, including a proposal to treat sovereign debt as low risk. Under Basel III, sovereign debt has a zero risk-weight.

"I'm fascinated that sovereigns have a zero weight, period," said Sen. Bob Corker, R-Tenn. "That would mean our great thinkers around the world have decided that they would encourage U.S. banks to hold Spanish debt at zero risk weight. How did we succumb to a situation where all sovereign debt has a risk weighting of zero, especially during these times and watching what is happening around the world?"

Alabama Sen. Richard Shelby, the panel's top Republican, also pressed regulators on their ability to impose the right amount of capital requirements given their lackluster attempts in the past.

"In light of this recent history, I support the agencies' goal of enhancing capital levels to protect American taxpayers from having to bail out banks down the road," said Shelby. "Yet, given the failure of bank regulators to set appropriate capital levels before the crisis, I cannot help but doubt the regulators' ability to set them correctly after the crisis."

Shelby implored members of the committee to verify whether the capital requirements agreed upon by the Basel Committee on Banking Supervision are the right fit for U.S. banks.

"It is time that our banking regulators stop outsourcing their economic analysis to the Basel Committee and start doing their own work," said Shelby. "They need to determine how Basel III will impact our diverse and unique banking system and the overall U.S. economy."

In June, regulators released two proposals, the first of which would establish minimum capital requirements, a leverage ratio, and a countercyclical buffer. A second proposal would revamp the way banks must measure risk on certain assets in order to be more risk-sensitive. They also approved a final rule that would reduce banks' reliance on credit ratings in capital requirements.

Community bankers had mostly expected the majority of the Basel III plan to apply to them, including a core requirement that banks hold 7% in common Tier 1 capital.

But they were caught off guard by changes that dictate how much risk-based capital banks must hold against certain assets, such as foreign government securities, corporate exposures and residential exposures. Large banks share similar concerns on that part of regulators' plan.

Community banks have led a revolt against the proposals, arguing they could put them out of business.

In a statement, the Independent Community Bankers of America reiterated that banks with less than $50 billion of assets should be exempted from the rules.

"Basel III and the standardized approach introduce drastic changes to both the definition and calculation of regulatory capital that will negatively impact a fragile housing recovery and the overall economy," the trade group said in its statement. "For community banks, Basel III and the standardized approach are regulatory overkill and will have a devastating impact on small communities and rural areas."

During the hearing, regulators sought to convey that certain parts of the joint proposal would only apply to larger-sized banks.

"It is important to note that numerous items in this proposal, and in other recent regulatory reforms, are focused on larger institutions and would not be applicable to community banking organizations," said Michael Gibson, director of bank supervision for the Fed, in prepared testimony.

For example, community banks would be exempted from a countercyclical buffer, a second leverage ratio, stress testing requirements, and an additional capital surcharge that pertains only to the largest, most internationally active banks.

Regulators said they were aware of the complaints of small banks, and would take steps to mitigate any harmful impact the Basel III requirements could have.

"It is important to remember that these are proposed rules, not final rules, and we are very interested in feedback on all aspects of these proposals," said John Lyons, senior deputy comptroller of bank supervision policy and chief national bank examiner for the OCC.

He noted that regulators posed more than 80 questions in the proposals, including the potential for regulatory burden.

The FDIC's French agreed that regulators expect to make changes based on the comments received.

"The basic purpose of the Basel III framework is to strengthen the long-term quality and quantity of the capital base of the U.S. banking system," said French. "In light of the recent financial crisis, that would appear to be an appropriate and important goal. However, the goal should be achieved in a way that is responsive to the concerns expressed by community banks about the potential for unintended consequences."

Bankers from smaller-sized institutions have stressed the complexity of regulators' proposal, while also arguing they needed to ease up on provisions establishing new risk-based capital requirements for residential mortgages, and keep a filter that impacts how much capital have to hold against certain instruments.

At the hearing, regulators sought to address some of those specific concerns.

"We recognize that the proposed changes represent a comprehensive reform of regulatory capital standards and that the burden of reviewing and assessing the impact of new regulatory proposals can weigh especially heavily on community banks," said Lyons. "This is why we have taken several measures to reduce the burden of this rulemaking process for these banks – in the way we organized the proposals, in outreach we have conducted, and by distributing a tool to help bankers assess the potential impact of the proposals on their capital requirements."

Still, while regulators vowed to ensure that the impact on banks would be minimal, they argued for the necessity for stronger capital requirements, citing the hundreds of banks that have failed in the U.S. since the crisis.

"Strong capital standards have played an important role in moderating downturns and positioning the banking system to serve as a catalyst for recovery by ensuring that financial institutions stand ready to lend throughout the economic cycle," said Lyons. "Access to credit by businesses and consumers is critically important to promoting and achieving financial stability. The recent crisis demonstrated the consequences of having insufficient capital in the banking system of the U.S. and around the world."

Regulators have continually stressed that the proposal is meant to strengthen the capital held by smaller banks, but have also said that many institutions already meet the proposed requirements based on their internal analysis.

"The overall conclusion of these analyses was that the vast majority of banking organizations would not be required to raise additional capital because they already meet, on a fully phased-in basis, the proposed higher minimum requirements," said Gibson. "In addition, approximately 90% of community banking organizations already have sufficient capital to meet or exceed the proposed buffer, thus avoiding restrictions on capital distributions and certain executive bonus payments."