REGULATORY CAPITAL; BASEL III AND THE STANDARDIZED APPROACH
- ICBA supports strong capital requirements for all banks.
- Basel III should be amended to reflect changes to the treatment of the allowance for loan and lease losses (ALLL) in the FASB impairment project by recognizing the loss absorbing capacity of the ALLL. Specifically, ALLL should be included in additional Tier 1 capital in an amount up to 1.25 percent of risk weighted assets and the remaining balance of ALLL should qualify for inclusion in Tier 2 capital.
- ICBA opposes the Basel III deduction thresholds that are applied to mortgage servicing assets. The threshold deductions for mortgage servicing assets should be raised from 10 percent of common equity tier 1 capital to 100 percent of tier 1 capital. Additionally, for mortgage servicing assets that are not deducted, the risk weight should be restored to 100 percent from the overly punitive 250 percent under Basel III.
- Basel III should be amended to exempt community banks from the harsh provisions of the capital conservation buffer. In particular, Subchapter S banks should not be restricted from paying dividends to cover shareholders’ pro-rata tax liability. The buffer also has a disproportionate adverse impact on mutual banks as well as any bank that relies on retained earnings to build capital, particularly in a low interest rate environment.
- Capital standards should not disadvantage community banks relative to credit unions.
- ICBA supports the new enhanced supplementary leverage ratio standards that strengthen the leverage ratios for the eight largest financial institution holding companies and their subsidiary banks.
- Banking regulators should not impose liquidity coverage ratio restrictions on high-quality investment securities that would impact the liquidity of those securities for community banks.
ICBA supports strong minimum capital levels for all banks, including community banks. However, the original proposed Basel III capital rules for all financial institutions failed to recognize that community banks were not the cause of the recent financial crisis of 2008-09. Their simplified balance sheets, conservative lending practices, and common sense underwriting shielded their regulatory capital balances from the losses that heavily impacted the large, complex, internationally-active and interconnected financial institutions. ICBA achieved some major milestone victories in the Basel III final rule including the exclusion of AOCI with its capital volatility from common equity tier 1 capital, allowing community banks to continue using the Basel I risk weights rather than a punitive risk weight scheme for their mortgage exposures, and grandfathering the inclusion of TruPS as tier 1 capital for certain community bank financial institutions and TruPS issuances, consistent with Congressional intent. The Basel III final rule is not perfect and continues to punish community banks at a time when they need major regulatory relief from burdensome capital rules.
Recognition of ALLL Loss Absorption. Basel III largely fails to recognize the loss absorption abilities of ALLL by not permitting the inclusion of ALLL in tier 1 capital. Under the current expected credit loss model proposed by FASB, more regulatory capital will be allocated to the allowance, potentially resulting in a larger omission from the capital calculations. ICBA believes that ALLL should be included in tier 1 capital in an amount up to 1.25 percent of risk weighted assets and the remaining balance of ALLL should qualify for inclusion in Tier 2 capital.
Basel III Punishes Mortgage Servicing. Basel III punishes community banks that would like to service mortgage loans by severely lowering the threshold deduction for holding mortgage servicing assets as well as almost tripling the risk weight assigned to MSAs when they are not deducted. Regulators have not presented any evidence that community banks’ level of MSAs held in portfolio made any contribution to the financial crisis of 2008 and 2009. In fact, in an environment where banks are being asked to consider interest rate sensitivity in the balance sheet, MSAs are a natural hedge against rising interest rates that provide community banks with valuable risk protection. Severely curbing MSAs for community banks all but eliminates that protection.
Capital Conservation Buffer Harms All Community Banks. Most importantly, the Basel III final rule imposes a capital conservation buffer for all measures of minimum regulatory capital. This is harmful to all community banks. Mutual banks and other banks that rely on retained earnings to build capital will be disproportionately impacted. Moreover, the conservation buffer and is particularly damaging for Subchapter S banks. Subchapter S shareholders rely on dividends to cover their tax liability on their pro-rata share of the banks’ earnings. If a bank is prevented from paying dividends because it has not satisfied the capital conservation buffer, shareholders will be forced to find other means of covering their tax liability. This prospect will only exacerbate Subchapter S banks’ difficulty in raising new capital. Consequently, these institutions will be required to hold an additional buffer to ensure that they never put their shareholders at risk of violating the capital conservation buffer.
ICBA Supports Supplemental Leverage Ratio for Megabanks. ICBA supports the enhanced supplementary leverage ratio standards that apply to the eight largest financial institutions in the United States and that introduce common sense leverage ratios for these institutions. Higher leverage capital for the largest too-big-to-fail megabanks is a good first step in ensuring that these banks mitigate their risk to taxpayers.
Regulators Must Recognize Quality of Housing GSE Securities. ICBA is concerned that any restrictions placed on high quality mortgage assets like Fannie Mae and Freddie Mac mortgage-backed securities, financial instruments widely held by community banks, will reduce the liquidity of these securities and adversely impact their fair values. Regulators should ensure that GSE securities get high quality liquidity recognition commensurate with their treatment in the capital markets.
Staff Contact: James Kendrick