ICBA Policy Resolution: Regulatory Capital; Basel III and the Standardized Approach

Position

  • ICBA supports strong capital requirements for all banks and their respective holding companies.
  • The community bank leverage ratio (CBLR), a critical provision of S. 2155, should be set at 8 percent rather than 9 percent, as proposed by the agencies. Banks with mortgage servicing assets of 50 percent or less rather than 25 percent or less, as proposed by the agencies, should be eligible for the CBLR.
  • ICBA supports a full exemption from Basel III for non-systemically important financial institutions (non-SIFIs). If a full exemption is not possible, ICBA proposes the following amendments:
    • A greater portion of the allowance for loan and lease losses should be included in regulatory capital.
    • The punitive treatment of mortgage servicing rights, deferred tax assets, and investments in other banks should be eased
    • Community banks should be exempt from the capital conservation buffer which disproportionately impact Subchapter S banks and mutual banks.
    • The high volatility commercial real estate (HVCRE) provisions of Basel III have a punitive impact on local economic growth and should not apply to community banks.
  • Capital standards should not disadvantage community banks relative to credit unions.
  • 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 Congress’ efforts to expand the types of municipal securities that can be categorized as high-quality liquid assets when calculating a bank’s liquidity coverage ratio. ICBA also believes that Fannie Mae and Freddie Mac securities should qualify as high-quality liquid assets.

Background

Community Bank Leverage Ratio

With the enactment of S. 2155, Congress mandated that the banking agencies create a community bank leverage ratio to allow banks with total consolidated assets of less than $10 billion to escape the regulatory burden of Basel III by adopting a simple, straightforward capital calculation. ICBA supports this capital simplification for applicable banks but advocates a minimum ratio of 8 percent rather than 9 percent as proposed by the agencies. Setting the ratio at 9 percent would exclude some 600 community banks that would be eligible if the ratio were 8 percent, as authorized by Congress. Eight percent would be well over the 5 percent leverage ratio requirement currently required of all well-capitalized banks. Finally, ICBA believes that regulators will view the community bank leverage ratio as a floor and will demand that community banks maintain a ratio above the “floor.” For this reason, ICBA advocates for a ratio no higher than 8 percent.

Additionally, the banking agencies have proposed to exclude from the community bank leverage ratio community banks with total mortgage servicing assets exceeding 25 percent of total consolidated assets. To avoid punishing banks that acquire mortgage servicing assets, ICBA believes that regulators should raise the cap on mortgage servicing assets to 50 percent of total consolidated assets.

Basel III

The originally proposed Basel III capital rules failed to recognize that community banks were not the cause of the financial crisis of 2008-09. Their simplified balance sheets, conservative lending, and common-sense underwriting shielded their regulatory capital from the losses incurred by large, complex, internationally-active and interconnected financial institutions. ICBA achieved major victories in the final Basel III 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 for their mortgage exposures, and grandfathering the inclusion of TruPS in tier 1 capital for certain community banks and TruPS issuances, consistent with Congressional intent. However, as described below, the Basel III final rule continues to burden community banks and must be further amended.

Recognition of ALLL Loss Absorption. Basel III largely fails to recognize the loss absorption abilities of ALLL and does not permit its inclusion in tier 1 capital. This failure is based on the agencies’ erroneous view that the allowance represents losses already present within a financial instrument. FASB’s CECL accounting guidance clarifies that the allowance actually represents the first layer of the capital cushion to absorb bank losses. As such it should be included in tier 1 capital. Moreover, because the CECL accounting guidance requires the allocation of more capital to ALLL, it results in a larger omission from tier 1 regulatory capital calculations. 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. (ICBA policy resolution titled: “Current Expected Credit Loss Model” recommends a five-year transition period for regulatory capital calculations at the point that a bank adopts CECL.)

Basel III Punishes Mortgage Servicing

Basel III punishes community banks that service mortgage loans by severely lowering the threshold deduction for holding mortgage servicing assets (MSAs) as well as almost tripling the risk weight assigned to MSAs when they are not deducted. The threshold deductions for mortgage servicing assets should be raised from 10 percent of common equity tier 1 capital to 50 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. Regulators have not presented any evidence that community bank MSAs 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 their balance sheets, MSAs are a natural hedge against rising interest rates. A proposal issued last year by the bank regulators to raise the threshold deduction on mortgage servicing assets is a positive first step. However, regulators must recognize the value of MSAs and adjust deductions to a level closer to their pre-Basel III levels.

Capital Conservation Buffer Harms All Community Banks

Basel III imposes a capital conservation buffer for all measures of minimum regulatory capital. This is harmful to all community banks, in particular for mutual banks and other banks that rely on retained earnings to build capital. Subchapter S shareholders, who rely on dividends to cover their tax liability on their share of the banks’ earnings, will be harmed when a bank is prevented from paying dividends because it has not satisfied the capital conservation buffer. This prospect will exacerbate Subchapter S banks’ difficulty in raising new capital. At a time when regulators are encouraging the formation of new community banks, the capital conservation buffer represents a roadblock.

High Volatility Commercial Real Estate

ICBA supports recent agency action to more narrowly define HVCRE as well as exclude all loans originated before 2015 in response to the passage of S. 2155. This important legislation will allow community banks to appropriately assign the 100 percent risk weight to quality acquisition, development and construction (AD&C) loans that would otherwise face capital surcharges. ICBA favors removal of the HVCRE designation altogether for community banks. Regulators have not demonstrated heightened risk with HVCRE loans, especially those originated by community banks. Well underwritten AD&C loans promote construction industry job creation and economic development in communities across the country.

High Quality Assets Must Be Recognized Under Liquidity Coverage Rules

ICBA believes that municipal debt as well as Fannie Mae and Freddie Mac mortgage-backed securities should be categorized as high-quality liquid assets, commensurate with their treatment in the capital markets, under liquidity coverage ratio rules. Failure to so categorize these widely-held securities will reduce their liquidity and adversely impact their fair values.

Staff Contact: James Kendrick

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