The Federal Reserve Board on Tuesday approved new rules requiring banks to set aside more capital to help protect against losses in the event of another major economic downturn.
The Fed's approval of the Basel III banking rules brings the U.S. closer to complying with an international agreement struck in 2010 by a committee of central bankers and regulators operating out of Basel, Switzerland.
The Basel committee's recommendations are intended to make the global banking system more resilient by requiring banks to keep more capital in their reserves. As such, the rules address one of the major concerns of the ‘too big to fail’ problem.
Most U.S. banks are already in compliance with the requirements approved Tuesday. However, the new capital rules are only the beginning, as the Fed plans to issue four more proposals in the coming months that will impose stricter standards for larger banks considered ‘systemically important.’
It has been a slow process to get the new rules in place, due mainly to push back from the big banks, which have warned that the measures could result instricter lending standards and a tightening of available credit. Regulators have been proceeding cautiously so as to not disrupt the economic recovery.
In addition to ensuring banks have adequate capital in their reserves, both in terms of quantity and quality, the proposed regulations will also allow banks to continue lending after unexpected losses.
‘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,’ Federal Reserve Chairman Ben Bernanke said. ‘With these revisions to our capital rules, banking organizations will be better able to withstand periods of financial stress, thus contributing to the overall health of the U.S. economy.’
The rules approved Tuesday are part of a broader framework that will include additional rules combined with changes required under the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency are expected to review and approve the new rules on July 9.
The final rule will also minimize the burden on smaller, community banks. For example, it is significantly different from the original proposal in terms of risk weighting for residential mortgages and the regulatory capital treatment of certain unrealized gains and losses and trust preferred securities for community banks.
What's more, the phase-in period for smaller banks will not begin until January 2015, whereas the phase-in period for larger institutions begins in January 2014. In addition, savings and loan holding companies with significant commercial or insurance underwriting activities will not be subject to the final rule until the Fed evaluates the appropriate regulatory capital framework for these entities.
‘Adoption of the capital rules today is a milestone in our post-crisis efforts to make the financial system safer,’ said Federal Reserve Governor Daniel Tarullo. ‘Along with the stress testing and capital review measures we have already implemented, and the additional rules for large institutions that are on the way, these new rules are an essential component of a set of mutually reinforcing capital requirements.’
Under the capital reserve rule, all banks must maintain a minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5% and a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets.
It also raises the minimum ratio of tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations.
For large, internationally active banking organizations, the final rule includes a new minimum supplementary leverage ratio that takes into account off-balance sheet exposures.