Fitch: Most U.S. Banks Able to Meet Tougher Capital Standards
Most U.S. banks should be able to meet tougher standards set by U.S. banking regulators in their final capital rules, Fitch Ratings said. The new requirements are positive for financial stability. But there are some concessions for smaller banks, including not requiring the application of unrealized gains and losses to common equity Tier 1 capital (CET1). The adoption of these rules formalizes a two-tier banking system as the most stringent rules will apply to the largest banks, while smaller banks will not be subject to the full panoply of rules, Fitch said.
Fitch believes the banks it rates are well positioned and capitalized to cope with the implementation of the Basel III rules. In particular, Fitch considers that most of its rated banks would be likely to achieve a full 7% CET1 ratio ahead of full implementation. The largest banks, those designated as global systemically important financial institutions (G-SIFIs) already exceed the required minimum, and with few exceptions, would also meet G-SIFI buffers.
However, there are some challenging elements for banks under the new rules. Chief among them will be the inclusion of unrealized gains and losses reported in other comprehensive income (OCI) in regulatory capital ratios for banks under the advanced approaches. There will be a one-time opt-out on this for banks under the standardized approach. Banks subject to this requirement will need to manage their balance sheets carefully to minimize OCI fluctuations, and thus will need to operate with an adequate cushion above minimum requirements. It may also serve as a partial disincentive for banks to migrate to the advanced approaches, as the potential benefit of lower risk-weightings may be offset by the OCI volatility, according to Fitch.
There will be a softer capital approach for smaller, simpler banks. For example, the rules will grandfather capital treatment for trust preferred securities (TRUPs) for banks below $15 billion in assets. The original proposal would have phased out capital treatment for these instruments. These concessions mean that the full set of capital standards will only apply to the largest, more complex banks using the advanced approach, Fitch noted.
However, Fitch said, all banks will have to hold a 4.5% minimum CET1 as a percentage of risk-weighted assets and a 2.5% capital conservation buffer in line with Basel III. If the capital buffer is breached, management bonuses can be curtailed in addition to dividends and other capital distributions.
Fitch considers the changes to the U.S. leverage ratio modest as they eliminate the 3% requirement for banks with high supervisory ratings or subject to the market risk rule. Instead, all banks will have to meet the minimum 4% requirement with a tighter Tier 1 capital definition. Banks under the advanced approaches will also be subject to the Basel III leverage ratio (referred to as the supplementary ratio). Although the minimum is 3%, it is calculated on a different basis, as it includes off-balance sheet exposures such as the grossing-up of derivatives to include collateral and cash. Assessment of the impact of this is difficult based on public financial data.
The final rule kept the risk weights for residential mortgages consistent with existing practice at 50% for prudently underwritten 1-4 family mortgage loans and 100% for all others, rather than the more punitive treatment originally proposed. This should be generally neutral for banks, although they will need to meet the higher 7% CET1 standard. Considering the recently adopted Qualified Mortgage rule (QM), Fitch expects banks are likely to reduce the origination and sales of non-traditional mortgage products.
On July 2, the Federal Reserve Board (FRB) approved a final rule that will implement the Basel III reforms in the U.S. The Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC) are expected to approve the rule at their upcoming board meetings. Collectively, the FRB, OCC and FDIC are the U.S. banking regulators. Implementation will start in January 2014 for most banks and 2015 for smaller banks, Fitch said.
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