Leveraging Basel III

New capital rules offer key exemptions for community banks, set regulatory precedent

By James Kendrick

After a year of delays, comment letters, meetings with regulators and even an ICBA petition that collected more than 17,000 signatures, the key Basel III capital rules are in the books. For community bankers, it lined up as a classic regulatory compromise. We did not get the complete exemption we’ve advocated since the original proposed rules were released in June 2012, but regulators did offer several important concessions for community banks. There was even a twist at the end, with a proposal to implement a stricter leverage ratio standard on the largest banking institutions.

Community bankers should be proud. We’ve made a significant difference on the potential impact of these rules on our industry, and the proposed leverage rules set an important precedent in our industry’s fight for tiered regulation. Of course, we still must be ready for the new reality of the regulatory capital rules.

Basel on the books

First things first, the core Basel III rules are now final, and community banks are not exempt. Despite their original formulation to enhance capital levels at the largest and riskiest financial institutions, the Basel III standards became an overnight concern when regulators issued proposed rules that applied the standards to all banks, regardless of size.

ICBA strongly advocated that the capital regulations exclude financial institutions with consolidated assets of $50 billion or less. After all, the megabanks on Wall Street, not community banks on Main Street, caused the financial crisis from which we are still recovering. Community banks and their customers should not have to pay the price.

The regulators were not convinced, at least not enough to grant a full pardon. But they did incorporate into their final rule several ICBA-supported accommodations to minimize the negative impact of the rules on community banks.

Concessions stand

Under the regulators’ adjustments, all banks will be able to continue using the Basel I risk weights for residential mortgages (i.e., 50 percent risk weight for exposures secured by a first lien on a one-to-four family residential property). Banks will not be subject to the more complex and onerous risk-weight schedule of Basel III, as originally proposed, which would have required loan-to-value ratios to calculate risk weights for mortgages.

Additionally, banks with assets under $250 billion will have the option not to include accumulated other comprehensive income (AOCI) as regulatory capital. This will ensure that community bank regulatory capital ratios will be less volatile. Further, bank holding companies with assets less than $15 billion can continue to include the proceeds from trust-preferred securities as regulatory capital, consistent with the provisions of the Collins Amendment of the Dodd-Frank Act.

An American precedent

Regulators didn’t stop there. In addition to the Basel III breaks for community banks, they also released a new plan to impose enhanced supplementary leverage ratio standards on certain large financial firms. The proposal would apply a 6 percent supplementary leverage ratio to the eight largest insured banking organizations and a 5 percent standard on their bank holding companies (institutions with $700 billion or more in assets or $10 trillion or more under custody).

ICBA came out strong in its support for the proposed rule, which would establish a critical precedent in our industry’s fight for tiered regulation that is proportional to risk. Targeting the leverage ratios of the largest and riskiest firms gives a needed boost to developing financial regulatory policies that distinguish between common-sense community banks and the nation’s largest and riskiest institutions. Further, by targeting the risky financial instruments that the largest institutions keep off their balance sheets, the rule will help offset their true level of risk to the rest of the financial system.

End of the beginning

ICBA will be here every step of the way to continue working with community banks and regulators alike to make this transition as easy as possible. Regulators said they are planning an outreach program to help community banks understand the Basel III rule and the changes it makes to existing capital requirements.

Community banks have until Jan. 1, 2015, to begin complying with the regulations, so the countdown has begun. While the battle of Basel III is coming to an end, we know this is just the beginning.

James Kendrick is vice president of accounting and capital policy at ICBA.