A new regulatory capital framework for US banks has been introduced by the issuance on July 2 of final capital regulations (the Final Regulation) for bank holding companies and state-chartered member banks by the Board of Governors of the Federal Reserve System (Federal Reserve) and on July 8 of virtually identical rules for state-chartered non-member banks and national banks by, respectively, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) (collectively, the Agencies).
The Final Regulation (an approximately 1,000-page magnum opus) implements the most comprehensive changes to capital standards for the US banking system that have been made since the adoption of the Basel I rules in 1989. These changes blend the Basel III global capital standards and the Dodd-Frank Wall Street Reform and Consumer Protection Act-mandated standards into a comprehensive framework that contains significant changes from the proposed capital regulations (the Proposal) that were the subject of intense scrutiny from industry groups and Congress. In general, the Final Regulation increases the amount of capital that banking institutions will have to carry at the same time as it squeezes the definition of capital by requiring adjustments and deductions to what previously would have counted as capital. However, in recognition of the fact that the costs of imposing the new standards fully on small banks could outweigh the benefits they might provide, the Final Regulation has some special rules for banks with less than $15 billion in total assets and does not apply at all to bank holding companies (BHCs) with less than $500 million in consolidated assets unless the BHCs are engaged in a significant amount of nonbanking or off-balance sheet activities, or have large amounts of SEC-registered debt or equity securities. Further, the implementation of the Final Rule has been delayed to January 1, 2015, for all but the largest banks, which are subject to the so-called “non-standardized” approach.
Some of the most important changes being introduced by the Final Regulation can be summarized as follows:
- The Final Regulation for risk-weighting purposes requires eight percent total capital, of which 56.25 percent (4.5 percent in absolute terms) must consist of Common Equity Tier 1 capital (a new and strict definition of capital). Additional Tier 1 capital may comprise 18.75 percent (1.5 percent in absolute terms) of total capital, and Tier 2 capital may comprise 25 percent (two percent in absolute terms) of total capital. All the new capital ratios and risk weights will go into effect on January 1, 2015.
- Common Equity Tier 1 capital excludes non-cumulative perpetual preferred stock, qualifying minority interests and trust preferred securities. For institutions with less than $15 billion of assets, all such instruments, subject to certain limitations, may be included in Additional Tier 1 capital. For institutions with more than $15 billion in assets, only noncumulative perpetual preferred stock may be included in Additional Tier 1 Capital, with qualifying minority instruments and trust preferred securities moving to Tier 2 Capital. Common Equity Tier 1 capital also requires the deduction, among other things, of goodwill and other intangibles, as well as deferred tax assets that were produced by operating loss and tax credit carryforwards.
- The so-called capital conservation buffer of 2.5 percent, which must be comprised of Common Equity Tier 1 capital, will be phased in in four equal installments during the period from January 1, 2016 to January 1, 2019. By January 1, 2019, an institution must achieve a Total Capital ratio of 10.5 percent. Failure to achieve required increments will result in limitations of dividends payable and on discretionary bonus payments to high bank level officers.
- A standardized approach institution has a one-time opportunity to retain the existing capital treatment for accumulated other comprehensive income by opting out of the proposed new method. The one-time opt-out, which is permanent, must be taken when filing the first call report due after January 1, 2015, and, if selected, is expected to reduce regulatory capital volatility.
- The Final Regulation changes the rule in the Proposal that would have prevented dividends from being paid from surplus capital. Under the Final Regulation, dividends, if otherwise permissible, may be paid from surplus, net income or retained earnings.
- The Final Regulation retains the risk weighting standards for residential mortgages, such that prudently underwritten, performing mortgages will have a risk weight of 50 percent, and others will have a risk weight of 100 percent. Commercial real estate (CRE) loans will generally be risk weighted at 100 percent, except for high-volatility CRE loans, which will be risk weighted at 150 percent. Past-due loans will generally be weighted at 150 percent.
- The Final Regulation generally increases some of the components of capital for prompt corrective action standards. To be well-capitalized, institutions must have risk-based capital ratios for total capital of 10 percent or greater, Tier 1 capital of eight percent or greater, and Common Equity Tier 1 capital of 6.5 percent or greater, with a leverage ratio of at least five percent. These ratios will go into effect on January 1, 2015.
- Finally, top-tier BHCs (and certain savings and loan holding companies), whether public or not, that have more than $50 billion in assets must make public disclosures about their regulatory capital each quarter, beginning at the end of the first calendar quarter in 2015.