U.S. Banks Must Meet Basel Mark as Small Firms Get Easier Terms

July 2 (Bloomberg) -- Bloomberg Economics Editor Michael McKee breaks down the changes outlined for new capital rules for United States banks as the Federal Reserve is set to vote on the changes this afternoon. He speaks on Bloomberg Television's "In The Loop."

U.S. banking regulators agreed to ease requirements for some of the smallest lenders in a new set of capital standards designed to prevent a repeat of the 2008 crisis that almost destroyed the world’s financial system.

The changes came in the latest version of rules released today by the Federal Reserve, a year after they were first drafted and a week after European counterparts finished their own review. The Fed votes on the 972-page proposal later today, with the Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency scheduled to follow by July 9.

The U.S., along with 26 other members of the Basel Committee on Banking Supervision, must enact local regulations to carry out a 2010 revision of how minimum capital levels are set for the world’s banks. Those funds serve as a buffer against losses that might cause a global lender to collapse and bring down the entire financial system -- an improbable scenario for U.S. community banks with relatively few assets.

Community (CBNK) and regional banks don’t pose systemic risks when they fail,” said Coryann Stefansson, who heads the financial services regulatory practice at PricewaterhouseCoopers LLP. “So it’s easier to soften the rules on them without undermining the commitment to Basel or tougher capital rules.”

The rules published today narrow the definition of what counts as capital, in line with Basel’s revisions after the 2008 crisis. They also double the minimum ratio for capital and assets and reclassify derivatives and mortgage-based securities as more risky than in previous versions.

Second Standard

For the biggest lenders, it also includes a capital standard that doesn’t adjust for the risks of the banks’ assets, though an expected increase in that minimum wasn’t ready to be included in this version, according to people familiar with the discussions.

“This framework requires banking organizations to hold more and higher-quality capital, which acts as a financial cushion to absorb losses, while reducing the incentive for firms to take excessive risks,” Fed Chairman Ben S. Bernanke said in prepared remarks. “Banking organizations will be better able to withstand periods of financial stress, thus contributing to the overall health of the U.S. economy.”

Governor Daniel Tarullo, the Fed official in charge of financial regulation and bank oversight, said the capital rules revealed today are “a milestone in our post-crisis efforts to make the financial system safer.”

Community Banks

U.S. regulators surprised banks and analysts last year by applying the new Basel framework to most community banks. The U.S. had advocated the standard as a measure to rein in the largest international institutions. U.S. lawmakers and lobbyists said the smallest banks shouldn’t be included because they didn’t cause the 2008 crisis, couldn’t raise capital as easily as the big banks and might have to reduce lending.

Some of the rules, such as the non-risk-based leverage threshold, apply only to the biggest institutions or a smaller sub-group of the top six.

The final version released today softens the blow for the smallest firms. It allows almost all but the biggest firms to opt out of requirements that they take capital charges as the market valuation of their trading assets fluctuates. It also simplifies the risk calculation for mortgages, a process that community banks had argued was too cumbersome and expensive. Those banks, defined as taking deposits and making loans in their local areas, make up more than 90 percent of U.S. lenders, according to the FDIC.

Hybrid Holdings

Banks with less than $15 billion in assets were also allowed to retain some hybrid securities that otherwise would no longer count as capital under Basel III.

About 90 percent of bank holding companies with less than $10 billion in assets already meet the new minimum capital requirements, the Fed said in a staff memo today. The rest would need about $2 billion in added capital to comply. That shortfall was $3.6 billion in June 2012 when the rules were announced.

Almost 95 percent of firms with assets of more than $10 billion meet the requirements and the shortfall is $2.5 billion, down from $6 billion last year. The Fed didn’t say which banks fell below the standard. The almost decade-long transition period should give banks enough time to comply, the Fed said.

The rules go into effect Jan. 1 for the largest banks that use internal risk models to calculate capital needs while others get an extra year before starting to comply. The Basel framework has a stage-by-stage compliance scheme, with the requirements for capital going up every year until full levels are reached.

Basel Debate

The debate about banking standards revolves around rules designed by Basel’s committee of central bankers and regulators to improve and standardize safety guidelines that govern the world’s banks. The latest version is referred to as Basel III, and while the committee agreed on new standards in 2010, the members have revised components multiple times as local regulators worked to customize the rules to reflect conditions in their own markets.

Only half of the Basel members have completed their local rules so far. The European Union, which has accused the U.S. of dragging its feet, just completed its internal approval process last week. Banks have eight more years to fully comply.

The version published today by the U.S. includes a 3 percent capital minimum, known as the leverage requirement, that the Basel panel agreed upon in 2010. Under that standard, banks must hold equity and certain allowable hybrid securities equal to 3 percent of their assets.

Leverage Requirement

The U.S. is considering doubling that requirement for its largest lenders and plans to introduce another regulation to make that change, people familiar with the talks have said.

“The U.S. going beyond the internationally agreed leverage standard while Europe hasn’t even committed to it yet is the strongest sign so far that the implementation of Basel is diverging more than ever before,” said Barbara Matthews, managing director of BCM International Regulatory Analytics LLC, a Washington-based consulting firm.

The Basel regime previously gave firms leeway on how much capital they must have, letting banks hold a smaller amount to back assets classified as less risky. As more of the risk calculation shifted to complicated models that the institutions designed themselves, regulators such as Sheila Bair, the former FDIC chairman, questioned the credibility of the weightings.

The leverage rule provides a backstop by setting a fixed minimum for capital, regardless of how risky bankers say their holdings might be. By going above the internationally agreed figure, the U.S. could put pressure on Europe to reaffirm its wavering commitment on the standard, analysts have said.

EU Action

The EU has altered some parts of Basel III, widening the scope of what counts as capital to make it easier for its banks to reach Basel’s new minimums. When all assets are counted without risk consideration, their capital levels look much lower. The EU has wavered on the non-risk measure, saying further study is needed before committing to a binding threshold for the region’s banks.

The U.S. has translated the committee’s decision into local law with relatively few changes. The nation’s lenders had pushed for changes in calculating how quickly market values of trading assets would affect their capital levels.

They also asked regulators to soften restrictions on how much of their mortgage-servicing rights could be counted as part of the highest-quality capital. Basel III restricts such assets to 10 percent of capital. The U.S. kept that limit.

Completion of the rules will give the central bank leverage in international negotiations with countries that have yet to implement the rules, Tarullo said.

“Adoption of these rules means that we will have met international expectations for U.S. implementation of the Basel III capital framework,” Tarullo said. “This gives us a firm position from which to press our expectations that other countries implement Basel III fully and faithfully, thereby promoting global financial stability.”

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net or @yalman_bn on Twitter

To contact the editor responsible for this story: David Scheer in New York at dscheer@bloomberg.net; Christine Harper at charper@bloomberg.net.

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