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How Does Basel III Affect My Bank?

By: Charles Taylor

In June, the Office of the Comptroller of the Currency along with the other federal banking regulators published proposals to implement the Basel III capital rules.

These proposals are intended to increase the resiliency of the U.S. banking system as a whole by strengthening banking organizations of all sizes. They aim to improve the quality and quantity of capital, enhance the risk sensitivity of capital standards, and address other weaknesses in the capital regime that became apparent during and since the 2008 crisis.

The past five years have been difficult for many smaller banking organizations. More than 400 community banks and thrifts have failed. They failed for a number of reasons but, at the end of the day, they did not have enough high-quality capital in relation to the risks they had taken on. The proposed standards aim to raise the bar by doing a better job of requiring more capital where there is more risk so that, in combination with other supervisory and regulatory measures we have been taking since the crisis, the chances of failures will be lower in the future.

The June proposals came out as three notices of proposed rulemaking. Two of them apply to all banks, including community banking organizations: the Basel III NPR and the Standardized Approach NPR.

Proposed rules in the NPRs that apply to smaller banks and savings institutions include:

In the Basel III NPR

Capital definitions: A new narrow capital measure is introduced called Common Equity Tier 1, referred to as CET1. It is defined as outstanding common equity and related surplus, retained earnings, accumulated other comprehensive income, minority interests (subject to certain limitations) less goodwill and other adjustments. Tier 1 capital is then CET1 plus noncumulative perpetual preferred stock, with some adjustments. Total capital is Tier 1 plus Tier 2 — that is subordinated debt and preferred stock and some of the allowance for loan and lease losses, subject to some more adjustments. Trust-preferred securities are phased out of Tier 1 capital with a corresponding phase in to Tier 2 capital.

Regulatory capital minimums: To be adequately capitalized under PCA, CET1 would have to be at least 4.5 percent of risk-based assets beginning in 2015, Tier 1 capital would have to be 6 percent and total capital, 8 percent.

CET1 risk-based capital ratios: CET1 of at least 4.5 percent of risk-based assets would be adequately capitalized, and 6.5 percent well capitalized beginning in 2015. Below 4.5 percent would be undercapitalized and below 3 percent would be significantly undercapitalized.

Capital buffer: There would be a CET1 buffer of 2.5 percent above the minimum risk-based capital requirements needed to avoid capital distribution restrictions such as restrictions on dividends or discretionary bonus payments to executives. A bank would have to have a 7 percent CET1 ratio to be clear of distribution constraints. The buffer requirements would be subject to a transition period beginning in 2016 and would not be fully phased in until 2019.

AOCI treatment change: The current treatment of AOCI that neutralizes the impact on regulatory capital of unrealized gains and losses on AFS debt securities would be phased out beginning in 2014 and concluding in 2018. All unrealized gains and losses on AFS securities would flow through to CET1.

MSA limits: Stricter limits would be introduced on the amount of mortgage servicing assets that could be included in regulatory capital and starting in 2018, a risk weight of 250 percent would be required (compared with 100 percent now) for the amount that could be included.

In the Standardized Approach NPR

Changed residential mortgage treatment: Residential mortgage exposures not guaranteed by the U.S. government would be divided into two categories. Category 1 exposures would typically be lower risk. Category 2 exposures would typically be nontraditional loans that present higher risk. The proposed risk weights are based on loan characteristics and the loan-to-value. Category 1 exposure risk weights would range from 35–100 percent and category 2 exposure risk weights from 100–200 percent. While many risk weights would rise, weights on some of the safest category 1 exposures would actually fall.

Higher weights on some HVCRE: high-volatility commercial real estate loans, such as certain construction and development commercial real estate loans, and past-due loans, would both receive a 150 percent risk weight, versus the current risk weight of 100 percent. (HVCRE is defined as a credit facility that finances the acquisition, development or construction of real property unless it is a one-to-four family residential property or a CRE project that meets certain prudential criteria, including LTV limits and capital contributions.)

A capital charge for some short-term commitments: Short-term commitments — those with less than one-year maturity — would receive a 20 percent credit conversion factor, compared to no capital charge currently. Short- term commitments that were unconditionally cancellable would continue to receive a 0 percent CCF.

Basel Estimator Tools

Last month, the OCC and the other federal banking agencies posted two estimator tools to their websites to help community banks and thrifts comment on those proposals. One estimator is for banks and thrifts and the other is for their holding companies. Every banking organization can enter its regulatory reporting number in the Scoping Questions tab and then public data from their relevant regulatory reports will automatically populate most of the later spreadsheets.

The Scoping Questions tab also has a series of yes/no questions to establish which proposed rules are relevant. Every “yes” answer highlights field(s) in other tabs for a banking organization to fill in. Every “no” answer avoids those particular requirements. With two exceptions, the OCC expects that for most community banking organizations, the answers will be “no” to these scoping questions. Those exceptions are the questions about residential mortgages and securitization exposures under the standardized approaches.

The top of the Summary and Timeline tab shows three basic sets of numbers — the leverage and risk-based capital ratios for a banking organization under current rules, the proposed Basel III NPR taken alone, and the Basel III and Standardized Approach NPRs taken together. The tools allow organizations to change any input number and thereby run what-if scenarios.

The estimator tools are intended to help banking organizations develop their comments on the capital requirements in the proposed rules. For a complete rundown, see the OCC’s website, Each NPR has an addendum that is a summary for smaller organizations. The comment period ends Oct. 22.
Find the estimator at

Charles Taylor is deputy comptroller for regulatory policy at the Office of the Comptroller of the Currency.

Copyright (c) October 2012 by BankNews Media