September 17, 2013

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Key Elements Of The New Capital Rules

The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency adopted the much anticipated new capital rules implementing Basel III.  The new rules will become effective for community banks on January 1, 2015, with many provisions of the new rules phasing-in over a four-year period. This series will discuss the following:

• Part I. Overview  |  Entities Affected By The New Capital Rules (July 31, 2013)
• Part II. Changes To The Minimum Capital Requirements (August 13, 2013)
• Part III. Revised Regulatory Capital Calculation (September 3, 2013)
• Part IV. Changes To The Risk Weighting Of Assets    
• Part V. The Impact Of The Capital Conservation Buffer

Steps You Can Take to Prepare for the Changes to the Risk Weighting of Assets

• Review your current assets and holdings to determine whether their risk weightings will change under the new capital rules
• Test compliance by developing multiple capital scenarios based on the potential changes resulting from the new capital rules

Part IV.  Changes To The Risk Weighting Of Assets

The new capital rules emphasize the importance of capital and, consequently, increase the amount of capital that a banking organization must maintain.  Part II of this series addressed the general increase in the minimum capital ratios, as well as the implementation of a new Common Equity Tier 1 capital ratio.  Part III focused on the changes to the definitions of regulatory capital on how those changes further increased the minimum capital ratios.

Part IV focuses on the final component of capital:  risk-weighted assets.  The risk weights were revised by the new capital rules to harmonize the various bank regulatory agencies’ rules for calculating risk-weighted assets.  The revisions also enhance the risk weightings for certain assets and business lines.  Because capital ratios are calculated by dividing regulatory capital by risk-weighted assets, any change to the risk weightings applied to a banking organization’s assets also increases the minimum capital ratios that the organization will be expected to maintain.  

Because this series is solely a summary of these issues, we encourage you to contact us with any questions.

Determining The Appropriate Risk Weighting

The configuration of the risk weightings is exceptionally complex and technical, but, generally speaking, risk weightings for on-balance sheet assets are assigned by reference to the counterparty to the particular transaction, or by reference to the collateral or guarantor.  Risk weightings for off-balance sheet assets are calculated by multiplying the amount of the off-balance sheet exposure by a credit conversion factor to determine a credit equivalent amount and assigning the credit equivalent amount to a relevant risk weight category.

Point of Interest
The new capital rules provide for a 250% risk weight for any mortgage-servicing assets (“MSAs”), certain deferred tax assets (“DTAs”) and significant investments in unconsolidated financial institutions, which are not otherwise deducted from an organization’s regulatory capital.

Risk Weight Categories

The new capital rules change certain aspects of the risk weightings.  Below is a chart highlighting a few of the changes to the risk weightings under the new capital rule.

Resources

As with any new rulemaking, implementation of the required changes and thorough planning for the impact of new concepts will take time.  We urge you to begin the process of understanding how these rules will impact your organization as soon as possible.  To aid in this understanding, we have provided links to Parts I, II and III of our series, Basel III in Bite-Sized Pieces, and the following useful regulatory guidance for community banks:

Barack Ferrazzano Materials

• Basel III in Bite-Sized Pieces:  Part I.  Overview  |      Entities Affected By The New Capital Rules  (July 31, 2013)
• http://www.bfkn.com/fig_201307ca_baseliiiparti
• Basel III in Bite-Sized Pieces:  Part II.  Changes to the Minimum Capital Requirements  (August 13, 2013)
• http://www.bfkn.com/fig_201308ca_baseliiipartii
• Basel III in Bite-Sized Pieces:  Part III.  Revised Regulatory Capital Calculation  (September 3, 2013)
• http://www.bfkn.com/fig_201309ca_baseliiipartiv

Regulatory Materials

• Interagency New Capital Rule Community Bank Guide
• http://www.federalreserve.gov/bankinforeg/basel/files/capital_rule_community_bank_guide_20130709.pdf
• OCC New Capital Rule Quick Reference Guide for Community Banks
• http://www.occ.gov/news-issuances/news-releases/2013/2013-110c.pdf
• Expanded Community Bank Guide to the New Capital Rule for FDIC Supervised Banks
• http://www.fdic.gov/regulations/capital/Community_Bank_Guide_Expanded.pdf

Please feel free to contact us with any questions concerning the new capital rules or any other issues.