International Banking Rules Making Their Way into U.S.
After the financial crisis of the late 2000s, the global public’s view of the banking sector took a severe hit. This sparked a need to finalize the revisions to the Basel Accord (Basel II) in order to restore confidence in the banking system and gain the general public’s trust. One way of accomplishing this goal is by requiring banks to maintain strong capital positions to be able to withstand any future market shock. On June 7, the U.S. Federal Reserve issued the Basel III documents for public comment.
If you have regulatory reporting responsibility over banks, you should assess the proposals to understand how your or your client’s daily operations could be affected. The Federal Reserve has posted a Q&A on its website to discuss the specifics of Basel III. Each of the three proposed rulemakings is discussed below. Banking organizations that are not active internationally or are not subject to the market risk rules only need to review the first two notices of proposed rulemakings.
- Increase the quantity and quality of capital required by proposing a new minimum common equity tier 1 ratio of 4.5 percent of risk-weighted assets and a common equity tier 1 capital conservation buffer of 2.5 percent of risk-weighted assets, and raising the minimum tier 1 capital ratio from 4 percent to 6 percent of risk-weighted assets;
- Revise the definition of capital to improve the ability of regulatory capital instruments to absorb losses;
- Establish limitations on capital distributions and certain discretionary bonus payments if additional specified amounts, or "buffers," of common equity tier 1 capital are not met; and
- Introduce a supplementary leverage ratio for internationally active banking organizations.
The Federal Reserve’s second NPR created the Basel III integrated regulatory capital framework, Regulatory Capital Rules: Standardized Approach for Risk-weighted Assets; Market Discipline and Disclosure Requirements, which would apply to all banking organizations. This NPR would revise and harmonize the Board's rules for calculating risk-weighted assets to enhance risk sensitivity and address weaknesses that have been identified over the past several years. Banks and regulators use risk weighting to assign different levels of risk to different classes of assets--riskier assets require higher capital cushions and less risky assets require smaller capital cushions.
The Federal Reserve’s third NPR creating the Basel III integrated regulatory capital framework, Regulatory Capital Rules: Advanced Approaches Risk-based Capital Rule; Market Risk Capital Rule, would only apply to banking organizations that are subject to the banking agencies' advanced approaches rule or to their market risk rule. This NPR would enhance the risk sensitivity of the current rule for internationally active firms to better address counterparty credit risk and interconnectedness among financial institutions. It also would apply the advanced approaches rule and market risk capital rule to savings and loan holding companies that meet the relevant size, foreign exposure or trading activity thresholds. As part of the restructuring of the capital rules into an integrated framework, this NPR incorporates the final market risk rule that was approved by the Board into the framework.
In addition to the NPR, the Federal Reserve finalized rules that will better capture positions for which the market risk capital rule is appropriate, reduce procyclicality in market risk capital requirements, enhance sensitivity to risks that are not adequately captured by the current regulatory methodologies, and increase transparency through enhanced disclosures. This final rule implements certain revisions made by the Basel Committee on Banking Supervision to its market risk framework between 2005 and 2010.
Watch for developments as the new standards are vetted. What do you think? Will the Basel III requirements restore trust in the banking system?
Salome J. Tinker, CPA, Senior Technical Project Manager, Accounting Standards, American Institute of CPAs. Salome’s focus is accounting standards affecting depository and lending institutions and oversees the Depository Institutions Expert Panel. Prior to joining the AICPA, Salome worked for Fannie Mae, the Board of Governors of the Federal Reserve and the U.S. Army. She has a B.B.A. in Accounting from Howard University.