The FRB, FDIC and OCC (the “Agencies”) issued three joint proposed rules (the “Proposed Capital Rules”) that would enhance bank regulatory capital requirements and implement Basel III capital reforms in the U.S. and the Agencies also issued a final market risk capital rule (the “Final Market Risk Capital Rule”).  These regulatory initiatives are regarded as the most extensive changes to bank capital requirements in two decades.  The following is a brief, general summary of the Proposed Capital Rules and the Final Market Risk Capital Rule.  The Alert will cover sections of these releases and certain issues raised by these releases in greater detail in future issues.

Proposed Capital Rules

The Agencies issued the Proposed Capital Rules in the form of three notices of proposed rulemaking that are intended to restructure the Agencies’ capital requirements into “a harmonized, comprehensive framework,” and to revise the capital requirements to be consistent with both Basel III capital standards and Dodd-Frank Act requirements, including the Dodd-Frank Act minimum capital requirements for bank holding companies and savings and loan holding companies under the so-called Collins Amendment and the requirement that references to credit ratings be removed from bank capital rules and other regulations.

The first Proposed Capital Rule applies to banks, savings associations and savings and loan holding companies of any size and to bank holding companies with consolidated assets of $500 million or more (“Banking Organizations”) and increases both the quantity and quality of capital required.  Quantitative enhancements proposed include:

(1)    a minimum common equity Tier 1 capital ratio of 4.5% of risk-weighted assets (a new requirement);

(2)    a minimum total Tier 1 capital ratio of 6% (increased from 4%);

(3)    a minimum total (Tier 1 and Tier 2) capital ratio of 8% (unchanged);

(4)    a minimum Tier 1 leverage ratio of 4% of unadjusted assets;

(5)    for certain banking organizations with extensive off-balance sheet activities, a supplementary Tier 1 leverage ratio of 3% that would take into account off-balance sheet items;

(6)    a capital conservation buffer of common equity Tier 1 capital in an amount above the minimum risk-based capital requirements equal to 2.5% of total risk weight assets; and

(7)    a countercyclical buffer for “advanced approaches” Banking Organizations, initially set at zero, but which can be activated by both regulators.

The first Proposed Capital Rule would also revise certain capital definitions and, generally, make the capital requirements more stringent and “improve the loss absorbency of regulatory capital.”  For example, goodwill, which the Agencies noted “is the largest deductible item” for many Banking Organizations, would be deducted from common equity tier 1.  Moreover, the first Proposed Capital Rule would revise the Prompt Corrective Action rules to incorporate the revised regulatory capital requirements. 

The second Proposed Capital Rule would also apply to all Banking Organizations.  This Proposed Capital Rule would harmonize the Agencies’ calculation of risk-weighted assets and expand the number of risk-weighted categories.  The second Proposed Capital Rule would increase the required capital for certain categories of assets, including higher-risk residential mortgages, higher-risk construction real estate loans and certain exposures related to securitizations.  The Agencies stated that the second Proposed Capital Rule would also provide incentives for trading and clearing derivatives through central counterparties.  The second Proposed Capital Rule would also establish calculations for risk-weighted assets that do not involve the use of credit ratings.

The third Proposed Capital Rule would only apply to Banking Organizations subject to the “advanced approaches” rule (generally, those with $250 billion or more in total assets or on‑balance sheet foreign exposures of at least $10 billion) or the market risk rule (generally those with aggregate trading assets and trading liabilities at least equal to 10% of total assets or $1 billion) or both.  The Agencies said that the third Proposed Capital Rule would enhance the risk sensitivity of the advanced approaches rule by incorporating Basel III’s advanced approaches standards to “better address counterparty credit risk and interconnectedness among financial institutions.”  Under the third Proposed Capital Rule, for example, there are increased capital requirements for exposures to non-regulated financial institutions and to regulated financial institutions with total assets of $100 billion or more.

Comments on the Proposed Capital Rules are due by September 7, 2012.  The Proposed Capital Rules are expected to go into effect on January 1, 2013, but Banking Organizations would not be required to be in full compliance with the final version of the Proposed Capital Rules until January 1, 2019.

Final Market Risk Capital Rule

The Final Market Risk Capital Rule would apply to any bank holding company, national bank, state member bank or state nonmember bank that has trading assets and trading liabilities equal or greater than 10% of its total assets or $1 billion (“Covered Banking Organizations”).  If in effect today, there would be approximately 25 Covered Banking Organizations.  The Final Market Risk Capital Rule reflects certain comments to proposed versions of the Rule, see the December 13, 2011 Financial Services Alert.  The Final Market Risk Capital Rule, among other things, takes into account changes to the Basel Committee’s international standards, increased sensitivity to risk, enhanced prudential requirements on internal models, increased disclosure obligations and elimination of reliance on credit ratings.  The effective date of the Final Market Risk Capital Rule is January 1, 2013.