United States: Simplifying Capital For Community Banks

 Community bankers around the country had something extra to be thankful for this Thanksgiving: a joint notice of proposed rulemaking simplifying capital compliance. Under this proposal, which implements Section 201 of EGRRCPA,1 banks and their holding companies with total assets of less than $10 billion could generally opt out of the Basel III capital requirements if they have a "community bank leverage ratio" (CBLR) greater than 9 percent. Banks that opt out and maintain a CBLR greater than 9 percent would be considered well capitalized for purposes of Prompt Correction Action (PCA) requirements. Although the regulators have preliminarily set the threshold higher than many banks would have liked, the CBLR is still lower than the 9.95 percent some regulators have suggested at recent banker conferences or the industry average capitalization. We suspect holding companies with between $3 billion and $10 billion in total consolidated assets (and their subsidiary banks) will see limited utility in the 9 percent CBLR requirement to opt out (according to the proposal 56 percent of such holding companies qualify to opt out). Comments to the proposal are due within 60 days of publication in the Federal Register. There is no indication when the proposal would become effective (but likely not sooner than the third quarter of 2019).

Historical Background

For most of this country's history, bank capital was managed on a supervisory basis, not a legal basis. Capital was not formally a legal requirement until the International Lending Supervision Act of 1983 directed the banking regulators to establish minimum capital ratios. In 1985, the regulators established a total capital ratio of 6 percent and a primary capital ratio of 5.5 percent. There were no risk-weighted capital ratios.

Risk-weighted capital ratios were implemented in 1989 as a result of the Basel I capital accords. Under these new rules, the total risk-weighted capital ratio requirement was 8 percent and the leverage ratio requirement was 3 percent. The calibration of the risk-weighted ratio was taken from the Basel I capital accords, but the 3 percent leverage ratio was pushed through by the OCC over the FDIC's objection as explained publicly by the then-comptroller of the currency, Robert Clarke:

Now we three bank supervisors don't disagree with each other often. But sometimes we do. And we at the OCC have such a disagreement with the FDIC over what the leverage ratio in our guidelines should be. The FDIC has indicated that it wants the minimum to be 6 percent, including "hard" capital like stockholder equity and "soft" capital like the loan loss reserve. The OCC believes that a leverage ratio of 3 percent of capital to total assets is more appropriate, with all the capital represented by "hard" capital. We believe we are right and the FDIC is wrong. Here's why: A 6 percent ratio would, in effect, become the capital standard because it would cause many banks to hold capital in excess of what the risk-adjusted capital guidelines would demand.2

In 2013 the banking regulators implemented the Basel III capital accords, designed to address weaknesses in the capital framework that became apparent in the financial crisis of 2007–2009. The thing is, the Basel III capital accords were designed and calibrated with large banks in mind because the regulators who developed them are from countries whose banking sectors are dominated by a few large financial institution conglomerates. America is different. Community bankers have long bemoaned the regulatory burden, complexity and costs associated with the Basel III risk-weighting regime. In March 2017, and again in September 2017, the federal banking regulators expressed some sympathy with this view.

EGRRCPA

Enter the Economic Growth, Regulatory Relief, and Consumer Protection Act, which directed the banking regulators to develop a "community bank leverage ratio" (CBLR) of between 8 percent and 10 percent for "qualifying community banking organizations" (QCBO) (generally, banks or their holding companies with total consolidated assets of $10 billion or less). Under the regulators' proposal released on November 21, the CBLR would be 9 percent. If a QCBO opts out of Basel III and meets this ratio, then that entity (i) would be considered well-capitalized for purposes of PCA and (ii) would be considered to have met any other capital or leverage requirements. Below is a summary of the proposal in Q&A format:

Who is a QCBO?

A QCBO, or qualifying community banking organization, is a bank or holding company:

  1. with total consolidated assets of $10 billion or less calculated in accordance with Call Report/FR Y-9C instructions as of the end of the most recent calendar quarter;
  2. has off-balance sheet exposures of 25 percent or less of its assets (e.g., unused commitments, sold credit protection, off-balance sheet securitization exposures, etc.);
  3. has total trading assets and liabilities of 5 percent or less assets;
  4. has mortgage servicing assets of 25 percent or less of its CLBR tangible equity; and
  5. has temporary difference deferred tax assets (DTAs) of 25 percent or less of its CLBR tangible equity.

A QCBO can elect to opt out of Basel III and in to CBLR if it has a CBLR greater than 9 percent at the time of opt in.

Does "bank" include federal and state savings associations?

Yes.

Can the QCBO regime apply to holding companies?

Yes, it can apply to both bank holding companies and savings and loan holding companies. But remember, a QCBO can only opt out of Basel III if it has a CBLR greater than 9 percent at the time of the opt out. Bank holding companies that qualify as small bank holding companies are not affected by this rulemaking because they are not subject to the capital rule. However, bank holding companies with between $3 billion and $10 billion in total consolidated assets can only opt out of Basel III if they meet the greater than 9 percent CBLR requirement at opt-out. According to the proposal, as of June 30, 2018, there were 151 holding companies within this asset range and only 56 percent of such holding companies met the greater than 9 percent CBLR eligibility test. If a holding company is not eligible to opt out, it may be less likely their subsidiary banks would opt out, otherwise the holding company would calculate and report Basel III ratios and the subsidiary banks would calculate and report CBLR, arguably defeating the purpose of capital simplification.

If I qualify as a QCBO, do I have to use the CBLR framework?

No, you can choose to continue to abide by the existing Basel III capital framework.

So can I change my mind and jump back and forth between the CBLR and Basel III frameworks?

Generally, no. According to the proposal:

While the agencies would not place restrictions on the ability of [QCBO] to switch in and out of the CBLR framework, the agencies anticipate such changes to be rare and typically driven by significant changes in the banking organization's business activities. The agencies believe that some flexibility to reverse the election to use the CBLR framework is warranted to ensure that banking organizations can adjust their business strategies and activities over time. The agencies would expect a CBLR banking organization to be able to provide a rationale for opting out of the CBLR framework to its appropriate regulators, if requested.

What happens if I elect the CBLR framework, but then become disqualified as a QCBO (for example, by surpassing $10 billion in total assets)?

There is a limited grace period of two calendar quarters after which you either have to requalify as a QCBO or go back to Basel III compliance.

How do I calculate the numerator in the CBLR?

The numerator of the CBLR is referred to as the "CBLR tangible equity." It is the entity's total equity capital, as determined in accordance with Call Report or FR Y-9C instructions, prior to including minority interests, less: (i) accumulated other comprehensive income (AOCI); (ii) all intangible assets (other than MSAs); and (iii) DTAs, net of any related valuation allowances, that arise from net operating loss and tax credit carryforwards, each as of the end of the most recent calendar quarter.

How do I calculate the denominator in the CBLR?

The CBLR denominator is average total consolidated assets calculated in accordance with Call Report or FR Y-9C instructions, less intangible assets and DTAs subtracted from CBLR tangible equity.

What CBLR level do I have to maintain once I have opted in?

In order to meet minimum capital requirements, you must maintain a CBLR of 7.5 percent.

Explain to me the CBLR and the various PCA capital categories.

The agencies are proposing to establish the following CBLR levels for the following PCA capital categories:

  • Well capitalized – CBLR greater than 9 percent;
  • Adequately capitalized – CBLR of 7.5 percent or greater;
  • Undercapitalized – CBLR of less than 7.5 percent; and
  • Significantly undercapitalized – CBLR of less than 6 percent.

The standard PCA restrictions and obligations would apply to CBLR banks at these thresholds. Note that there is no threshold for critically undercapitalized. Once a CBLR bank's ratio falls below 6 percent, it must provide its regulator with information necessary to calculate its tangible equity ratio for purposes of determining whether the QCBO would be considered critically undercapitalized.

I am a state bank. How do these requirements interact with any state specific capital requirements?

This question is beyond the scope of this alert. However, there may be an argument that such state requirements are preempted.

I am under a capital maintenance requirement but qualify as a QCBO. If I elect CBLR compliance, how does that effect my capital maintenance requirement?

Arguably, there is no impact because capital maintenance provisions are enforceable in their own right and EGRRCPA says that compliance with the CBLR does not limit the existing flexibility of the banking agencies to demand higher capital levels where warranted. However, there would be little downside to asking the regulator to amend the requirement to provide an equivalent and appropriate CBLR so that the entity is not simultaneously calculating Basel III and CBLR capital ratios.

Will future capital maintenance enforcement provisions be couched as CBLR requirements if the entity qualifies for and abides by the CBLR regime?

It is not clear, and we will just have to wait and see what the regulators decide after the final rule. Presumably, this would be consistent with the regulation's overall stated aim of reducing regulatory burden.

What about all my existing contractual provisions that include representations and warranties, and/or obligations, tied to the Basel III capital framework? What about those?

While the answer to this question will turn on the language of a particular contractual provision, generally, those provisions would continue to apply as a matter of contract law even if an entity qualified as a QCBO and elected CBLR compliance. Entities should keep these thoughts in mind when negotiating future contractual provisions tied to capital compliance.

What other things should I keep in mind when deciding whether to elect CBLR?

The proposal discusses a number of other compliance areas that would change as a result of a CBLR election including federal deposit insurance assessments (which will be subject to a separate forthcoming FDIC proposal), and, at the federal level, any compliance requirement tied to a capital amount (e.g., bank premises approvals, lending limits, Regulation W, etc.).

I am a de novo. Can I qualify for CBLR?

The proposal does not mention de novos. There is nothing that precludes de novos that otherwise qualify as a QCBO from electing CBLR compliance, but it is unclear how the regulators would approach this question from a supervisory perspective.

Footnotes

 1 The Economic Growth, Regulatory Relief, and Consumer Protection Act, signed into law by President Trump on May 24, 2018.

2 Remarks by Robert L. Clarke, comptroller of the currency, before the Washington Forum, Washington, DC, April 4, 1989.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions