Bank Regulators Approve Final Rule To Implement Basel III Capital Requirements In The United States

Keywords: bank regulators, final rule, Basel III, capital requirements

On July 2, 2013, the Board of Governors of the Federal Reserve System ("Board") approved a final rule ("Final Rule") to establish a new comprehensive regulatory capital framework for all US banking organizations.1 On July 9, 2013, the Final Rule was approved by the Office of the Comptroller of the Currency ("OCC") and (as an interim final rule) by the Federal Deposit Insurance Corporation ("FDIC") (together with the Board, the "Agencies").

The Final Rule brings the United States substantially into compliance with the Basel III capital framework agreed upon internationally in December 2010, replaces the existing US modified Basel I risk-based capital regime (the "Current Rules") with one based in part on the Basel II standardized approach (previously proposed but not adopted in the United States) and in part on the Basel II advanced approaches, and implements several changes to the US regulatory capital regime required by the Dodd- Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"). The new US capital framework imposes higher minimum capital requirements, additional capital buffers above those minimum requirements, a more restrictive definition of capital, and higher risk weights for various assets, which in combination result in substantially more demanding capital standards for US banking organizations.

For large US banking organizations subject to the "advanced approaches" method of computing risk-based regulatory capital ("Advanced Banks") - i.e., those with $250 billion or more in total consolidated assets or $10 billion or more in foreign exposures, as well as other banking organizations that successfully opt-in - the Final Rule takes effect on January 1, 2014. For the majority of US banking organizations that will operate only under the "standardized approach" ("Standardized Banks"), the Final Rule takes effect one year later, on January 1, 2015.

Aside from a handful of key changes primarily responding to the concerns of smaller, less complex banking organizations and some technical clarifications, the major elements of the capital framework adopted in the Final Rule are largely unchanged from the Agencies' capital proposals issued in June 2012 (collectively, the "Proposed Rules").2 In particular, Advanced Banks received little relief from the most controversial aspects of the Proposed Rules. Moreover, during the Board's consideration of the Final Rule, Governor Tarullo stated that although the Final Rule represents the "last step" in reform of the US regulatory capital framework for the vast majority of US banks,3 four significant additional capital measures are still to come for the eight US banking organizations that have been identified by the Basel Committee on Banking Supervision (the "Basel Committee") as Global Systemically Important Banks ("G-SIBs"). In fact, on July 9, 2013, the Agencies released a joint notice of proposed rulemaking (the "Leverage Ratio NPR") to implement the first of these four additional capital measures: an enhanced supplementary leverage ratio for US G-SIBs.4

This Legal Update identifies key aspects of the Final Rule and highlights and places in context the forthcoming additional capital requirements for the largest US banking organizations, including the enhanced supplementary leverage ratio requirement set forth in the Leverage Ratio NPR.

1. SCOPE

   The Final Rule applies to all banking organizations currently subject to minimum capital requirements, including national banks, state member banks, state nonmember banks, state and federal savings associations, top-tier US bank holding companies ("BHCs") with more than $500 million in total consolidated assets, and most top-tier savings and loan holding companies ("SLHCs"). In a change from the Proposed Rules, SLHCs with significant commercial or insurance underwriting activities are not subject to the Final Rule. The Board has stated that it will take additional time to evaluate the appropriate regulatory capital framework for these entities.5

2. MINIMUM CAPITAL REQUIREMENTS6

   New Minimum Risk-Based Capital Ratios. The Final Rule adopts new minimum capital ratios that are consistent with the Basel III international package and unchanged from the Proposed Rules. These include a new 4.5% common equity tier 1 ("CET1") capital requirement, a 6.0% tier 1 capital requirement (increased from 4.0% under the Current Rules), and an 8.0% total capital requirement (same as under the Current Rules). All US banking organizations will calculate the numerator of their minimum capital ratios using the more restrictive definitions of capital under the Final Rule. Standardized Banks, which as noted above constitute the vast majority of US banking organizations, will apply only the standardized approach under the Final Rule to compute the denominator (i.e., risk-weighted assets) of their risk-based capital ratios. Advanced Banks will calculate their risk-weighted assets using the Final Rule's advanced approaches. However, for Advanced Banks, the standardized approach will be used to establish the minimum "generally applicable" capital floor requirements for purposes of section 171 of Dodd-Frank, commonly referred to as the Collins Amendment.

   Capital Buffers. In addition to the minimum capital ratios, the Final Rule requires that all banking organizations maintain a "capital conservation buffer" consisting of CET1 capital in an amount equal to 2.5% of risk-weighted assets in order to avoid restrictions on their ability to make capital distributions and to pay certain discretionary bonus payments to executive officers. Thus, the capital conservation buffer effectively increases the minimum CET1 capital, tier 1 capital, and total capital requirements for US banking organizations to 7.0%, 8.5%, and 10.5%, respectively. Banking organizations with capital levels that fall within the buffer will be forced to limit dividends, share repurchases or redemptions (unless replaced within the same calendar quarter by capital instruments of equal or higher quality), and discretionary bonus payments. The limits consist of a sliding scale, so that as the buffer decreases, so does the maximum payout as a percentage of the banking organization's net income over the past four quarters. For Advanced Banks, the capital buffer may be increased during periods of "excessive credit growth" by an incremental "countercyclical capital buffer" of up to 2.5% of risk-weighted assets. In a change from the Proposed Rules, Advanced Banks would (after completing the "parallel run" process for migrating to the advanced approaches regime)7 be required to use the lesser of their standardized and advanced approaches risk-based capital ratios as the basis for calculating their capital conservation buffer (and any applicable countercyclical capital buffer). This change likely will increase the capital buffer for at least some Advanced Banks compared to the Proposed Rules.

   Leverage Ratios. Consistent with the Proposed Rules, the Final Rule imposes a tier 1 minimum leverage ratio of 4.0% for all banking organizations and an additional supplementary tier 1 leverage ratio of 3.0% for Advanced Banks. The 3.0% supplementary leverage ratio (which, consistent with Basel III, will take effect in January 2018 but be reported beginning in January 2015) incorporates in the denominator certain off-balance sheet exposures that are not included in the standard leverage ratio.8 Despite significant criticism from the industry, the Final Rule continues to include in the supplementary leverage ratio derivatives exposures based on potential future exposure (without collateral recognition) and 10 percent of unconditionally cancellable commitments.9

   As noted above, the Agencies on July 9, 2013, approved the Leverage Ratio NPR, which would apply to US top-tier BHCs with at least $700 billion in total consolidated assets or $10 trillion in assets under custody (i.e., the eight largest and most interconnected US banking organizations already identified as G-SIBs) and any insured depository institution subsidiary of these BHCs. For BHCs subject to the proposal, the Leverage Ratio NPR would establish a new 2.0% tier 1 "supplementary leverage buffer" requirement above the 3.0% supplementary leverage ratio requirement established in the Final Rule for all Advanced Banks, effectively increasing the supplementary leverage ratio requirement to 5.0% for these largest BHCs. The leverage buffer would function like the capital conservation buffer under the Final Rule, in that a BHC subject to the requirement that failed to maintain a leverage buffer of tier 1 capital in an amount greater than 2.0% of its total leverage exposure would be subject to restrictions on distributions and discretionary bonus payments.

   PCA Regime. The Final Rule makes certain conforming changes to the prompt corrective action ("PCA") regime for insured depository institutions based on the new minimum capital requirements. Among other things, the Final Rule introduces the minimum CET1 requirement into the PCA regime, incorporates changes to the capital definitions and deductions, adds the supplementary leverage ratio as a new PCA category for Advanced Banks, and increases the tier 1 risk-based capital requirement for each PCA category other than "critically undercapitalized." Under the Final Rule, the "well capitalized" standards consist of a minimum 5.0% leverage ratio requirement (same as under the existing PCA regime), plus the 3.0% supplementary leverage ratio for Advanced Banks; a 6.5% CET1 risk-based capital requirement (new); an 8.0% tier 1 risk-based capital requirement (increased from 6.0% required under the current PCA regime); and a 10.0% total risk-based capital requirement (same as under the existing PCA regime). The Leverage Ratio NPR would (if adopted) increase the supplementary leverage ratio "well capitalized" requirement for...