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REGULATORS APPROVE FINAL RULE FOR BASEL III IMPLEMENTATION The Federal Reserve Board announced its approval on July 2 of a final rule to implement the Basel III regulatory capital reforms and certain changes required under the DoddFrank Act. The Basel III reforms were created to address "shortcomings in capital requirements, particularly for larger, internationally active banking organizations, that became apparent during the recent financial crisis," the U.S. central bank explained in a statement. Consistent with the international Basel III framework, the approved rule includes a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5 percent as well as a common equity tier 1 capital conservation buffer of 2.5 percent of risk-weighted assets. The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets from 4 percent to 6 percent and includes a minimum leverage ratio of 4 percent for all banking institutions. For the largest, most internationally active banking organizations, the rule includes a new minimum supplementary leverage ratio that takes into account off-balance sheet exposures. In terms of quality of capital, the final rule emphasizes common equity tier 1 capital, "the most loss-absorbing form of capital," and implements strict eligibility criteria for regulatory capital instruments. It also improves the methodology for calculating risk-weighted assets to enhance risk sensitivity. "This framework requires banking organizations to hold more and higher quality capital, which acts as a financial cushion to 42 absorb losses, while reducing the incentive for firms to take excessive risks," said Fed chairman Ben Bernanke. "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 Fed also announced a number of changes in the rule designed to address concerns about the regulatory burden on smaller community banks. According to the central bank's statement, data from March shows nine out of 10 financial institutions with less than $10 billion in assets would meet the common equity tier 1 minimum plus a buffer of 7 percent, making the impact from the finalized rule minimal. In the area of residential loans, the rule will continue to apply existing risk-based capital standards, including a 50 percent risk weight for safely underwritten first-lien mortgages that are not past due. Community banks will also have a longer transition period to meet the new requirements. According to the Fed, the phase-in for smaller banking organizations will not begin until January 2015, while the phase-in period for larger banks starts in January 2014. "I'm pleased that we were able to agree on a rulemaking that not only improves the quantity and quality of capital for banks of all sizes, but does so in a way that minimizes the burden on community banks," said Comptroller of the Currency Thomas Curry, who declared his intention to sign the final rule by mid-July. "I think those are important accommodations, and it is entirely appropriate that they apply to the community banks and thrifts that had nothing to do with bringing on the crisis." Exactly one week later, federal regulators released a proposal to double the leverage ratio for the "largest, most systemically significant" banks. In separate statements, the Office of the Comptroller of the Currency (OCC), FDIC, and the Federal Reserve Board proposed a rule that would require insured depository institutions of certain banks to meet a 6 percent supplementary leverage ratio to be considered "well capitalized." The proposal would also require covered bank holding companies to maintain a tier 1 capital leverage buffer of at least 2 percent above the minimum supplementary leverage ratio requirement of 3 percent, for a total of 5 percent, the regulators stated. Currently, the proposed rule would apply to eight banks. If adopted, the rule would take effect on January 1, 2018. At the same time, the OCC signaled it approved the final rule on regulatory capital under Basel III. The FDIC also revealed it approved an interim final rule (IFR) that is identical to the Basel III rule from the Federal Reserve and OCC. "I'm pleased that the new capital rule not only improves the quantity and quality of capital, but does so in a way that minimizes the burden on community banks and federal savings associations," Curry said. The OCC stated one key change to the final rule from the preliminary proposal issued in mid-June is the final rule does not change the current treatment of residential mortgage exposures. "This was an important issue for many community banking organizations seeking to continue to meet the credit needs of their customers," according to the OCC. Jeremiah Norton, FDIC director, expressed his support for the IFR, but acknowledged the rule "contains a number of provisions that fail to address known and potential risks to the banking system." For one, he stated, the "U.S. housing market was at the center of the financial crisis—yet today we are not modernizing the risk-weights on banks' mortgage loans." KNOW THIS Residential shadow inventory was under 2 million units as of April, down 34% from its peak in 2010, CoreLogic reports.

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