Final Basel III Rules Have Bankers on Edge
Also unknown is if policymakers will tackle raising a proposed leverage ratio even higher—or wait until later to address that issue.What's certain is that the vote on a package of rules is just the start of the final stage of implementation of the agreement global regulators struck in 2010 in an effort to prevent another financial crisis.
Even once Basel III is finalized here, international regulators must still revise a global leverage ratio, currently set at 3%, while U.S. regulators must put also out proposed rules on liquidity requirements and a capital surcharge for the eight U.S. systemically important banks.
"You have to think about the whole Basel framework as a living organism these days," said Susan Krause Bell, a managing director of Promontory Financial Group and a former official at the Office of the Comptroller of the Currency, who also cited additional areas that global regulators are now beginning to look at, such as securitization and the trading book. "It's practically like software updates, you have to expect tweaks here and there, and revisions here and there. The fundamental Basel III framework proposed in December 2009, and finalized in 2010, was supposed to begin implementation at the beginning of this year. What still needs to be completed in Basel is the leverage ratio and the second liquidity pieces."
Even with a number of outstanding items that will be left off the table on Tuesday, observers said the final rule will still be critically important in its scope for institutions large and small.
"It will represent the most significant overhaul of U.S. bank capital standards since the U.S. adoption of Basel I almost a quarter of a century ago," said Andrew Fei, an associate at Davis Polk & Wardwell LLP and a Basel expert.
It isn't just the higher capital standards, but the narrower eligibility criteria for capital instruments, he said. The rule will also fundamentally change how banks will make capital deductions for such items as unrealized gains and losses and what they can count as regulatory capital.
Broadly, observers anticipate that the final rule will closely match the proposal released last June by all three banking agencies, with some possible technical changes as well as adjustments made in how the rules are applied to community banks. Each agency is required to sign off on the package, but the Fed is taking the first step. The Federal Deposit Insurance Corp. and the OCC have yet to announce plans for actions on the rules.
U.S. regulators released three proposals as part of the package of rules. The first would establish minimum capital and liquidity requirements for all banks. A second plan, known as the standardized approach, would fundamentally change risk weightings on assets. It is considered the most controversial piece of the package because of its impact on banks' capital ratios. The third proposal, known as the advanced approach, would add requirements for the largest banks, such as a leverage ratio and countercyclical buffer.
Community bankers strongly objected to the second plan because it changed the risk weightings for residential mortgages, a bread-and-butter product for community banks. Small banks have lobbied for a wholesale exemption from Basel III, which regulators are unlikely to grant.
Instead, some observers suspect regulators might punt on finalizing how banks should calculate their capital for residential mortgages, deferring on the issue until later. Such a move would diminish any potential immediate backlash from community bankers and their allies on Capitol Hill.
"If you think about it there wasn't that much controversial in the proposal when you ripped the community bank piece out of it," said Karen Shaw Petrou, a managing partner at Federal Financial Analytics Inc. "There were major technical questions like the AOCI (accumulate other comprehensive income) but there wasn't huge amount of anything else."
Regulators could argue that other recent regulations, such as the Consumer Financial Protection Bureau's qualified mortgage rule, require them to study the issue further.
"My guess is they're going to duck both the community banks in hopes that the storm blows over and the next round of mortgage discussions and buy some time on the grounds that they didn't know anything about qualified mortgage rule when they issued the proposed rule," said Petrou.
However, other observers expect that community banks will see the relief they've been seeking when it comes to mortgage risk-weights and a provision that would require banks to account for unrealized gains and losses of available-for-sale-securities when calculating capital requirements, because it eliminates a filter for AOCI.
"I don't think they'll exempt community banks totally," said Camden Fine, president of the Independent Community Bankers of America. "I'm anticipating that community banks will still be subject to Basel III guidelines, but I believe the regulators will significantly modify those guidelines favorably for community banks."
Lawmakers have been highly critical of the impact the package of rules could have on community banks, and have pressed regulators to make significant changes, if not exempt them entirely from Basel III. Rep. Shelly Moore Capito, R-W.Va., and Rep. Gregory Meeks, D-N.Y., reintroduced a bill shortly after the Fed announced plans to vote on a final rule calling on regulators to undertake an impact study on community banks before proceeding.
"Congress is already signaling if the community banks don't like this rule 'We're on you,'" said Petrou.
Fine said that all three regulatory agencies have been "very open" to community bank concerns and have "listened closely," often consulting smaller-sized institutions, since the proposal was released. But while he expects "regulators will respond to our concerns," he said he knows "that at some point Congress will respond to our concerns."