United States

Final rules issued for Basel III Capital Rules

FINANCIAL REPORTING INSIGHTS  | 

On Oct. 11, 2013, the final rules for Basel III were issued by the Office of the Comptroller of the Currency (OCC) and the Board of Governors of the Federal Reserve System. Aiming to make banks more resilient to periods of financial and economic stress, the rules will revise the risk-based regulatory capital framework for all national banks and federal savings associations.  

The final rules are derived from several sources: first, content from the Basel Committee's 2010 paper July 2013 “New Capital Rule Community Bank Guide,” various consultative papers of the Basel Committee, certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and finally, from public comments to the June 2012 notice of proposed rulemaking.

What community banks need to know is which aspects of the new rules have special relevance to them. In this article, we'll review some of the issues most relevant to smaller, non-complex banks that are not subject to the market risk rule or the advanced approaches capital rule.   

Fortunately, community banks have over a year to prepare for the new requirements, which will be phased in over a five-year period from 2015-2019.  The general rule is that banks subject to the advanced approaches rule (generally, large banks) must begin complying with the final rules on Jan. 1, 2014, whereas banks not subject to the advanced approaches rule (generally, small and community banks) are not required to begin complying until Jan. 1, 2015. For a complete implementation timetable for community banks, see the chart at the end of this article. 

Overview of the final rules relevant to community banks

The aim of the following changes is to improve the quality and increase the quantity of capital held by banking organizations. Beginning on Jan. 1, 2015, community banks will become subject to revised definitions of regulatory capital, new minimum regulatory capital and other rule changes, as follows:

Major changes from the current risk-based capital rule

  • Revisions to the minimum capital requirements and adjustments to prompt corrective action (PCA) thresholds

The new rule implements higher minimum capital requirements, as follows:

  • Establishes a new common equity tier 1 capital requirement
  • Establishes criteria that instruments must meet in order to be considered common equity tier 1 capital, additional tier 1 capital or tier 2 capital
  • Changes the new minimum capital to risk-weighted assets (RWA) requirement to a common equity tier 1 capital ratio of 4.5 percent and a tier 1 capital ratio of 6.0 percent
  • Changes the minimum leverage ratio (tier 1 capital to total assets) to 4.0 percent
  • Other changes to rules on quality of regulatory capital

The new rule changes other capital requirements, as follows:

  • Establishes stricter eligibility criteria for regulatory capital instruments that would disallow the inclusion of instruments such as trust preferred securities (TruPS) in tier 1 capital from now on
  • Places new constraints on the inclusion of minority interests, mortgage-servicing assets (MSA), deferred tax assets (DTA) and certain investments in the capital of unconsolidated financial institutions
  • Requires that most regulatory capital deductions be made from common equity tier 1 capital
  • Changes to capital conservation buffer

In order to avoid limitations on capital distributions, including certain discretionary bonus payments to executive officers, a bank must have a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets.

  • Credit ratings

The new requirement is pursuant to Section 939A of the Dodd-Frank Act that prohibits using references to external credit ratings in the regulations of federal agencies. Consequently, the new rule replaces the credit-ratings approach with a simplified supervisory formula approach in order to determine the appropriate risk weights for securitization exposures.

  • MSAs and DTAs

Under the new rule, MSAs and DTAs are subject to stricter limitations than those applicable under the current general risk-based capital rule. More specifically, certain DTAs arising from temporary differences, MSAs and significant investments in the capital of unconsolidated financial institutions in the form of common stock are each subject to an individual limit of 10 percent of common equity tier 1 capital elements and to an aggregate limit of 15 percent of common equity tier 1 capital elements. The amount of these items in excess of the 10 and 15 percent thresholds are to be deducted from common equity tier 1 capital.

Major changes from the June 2012 proposals

  • Residential mortgage exposures

The changes discussed in the June 2012 proposals are not included in the final rules; instead, the treatment of one-to four-family residential mortgage exposures remains the same as under the current risk-based capital rule. This includes a 50 percent risk weight for prudently underwritten first lien mortgage loans that are not past due and a 100 percent risk weight for all other residential mortgages.

  • Accumulated other comprehensive income (AOCI) filter

The June 2012 proposals would have required all banks to reflect most AOCI components in regulatory capital. The final rule gives non-advanced approaches banks a one-time option to filter certain AOCI components, which is comparable to the treatment under the current general risk-based capital rule.

  • Non-qualifying capital instruments and tier 1 capital

The proposal would have required TruPS and cumulative perpetual preferred stock to be phased out of tier 1 capital. The new rule exempts depository institution holding companies with less than $15 billion in total consolidated assets as of Dec. 31, 2009, or organized in mutual form as of May 19, 2010, from this requirement.

Capital instruments that were issued prior to May 19, 2010 by such depository institutions and that are currently in tier 1 capital, including TruPS and cumulative perpetual preferred stock, are grandfathered into tier 1 capital, subject to limits.

Capital requirements & the PCA framework

The final rule incorporates the new requirements into the PCA framework. PCA capital category thresholds have been revised to reflect the new capital ratio requirements, and they also introduce CET1 as a PCA capital category threshold, as follows:

Timeframe for implementation by community banks

The schedule for the small bank group is as follows:

For more information
For additional information on Basel III and how it affects your community bank organization, please contact Bob Browne, McGladrey LLP, at 816.751.4072, or at Bob.Browne@mcgladrey.com


In this issue

Final rules issued for Basel III Capital Rules

Seven Questions Your Company Should Answer About Your IT Disaster Recovery Plan

2013 McGladrey Financial Institution Systems Survey

Banks can drive growth, manage risk through M&A

Three banks, three risk management challenges, one solution

Wire fraud and identity theft: Risks and prevention for banks and consumers