WASHINGTON (CN) -U.S. financial regulators jointly proposed three rules to replace the nation's current bank capital requirements to comply with targets in the international Basel Committee on Banking Supervision's Basel III Accord.
The Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation are asking the public to comment on the proposed rules by September 7.
The first proposed rule would revise the risk-based and leverage capital requirements for all insured U.S. banks and savings associations with more than $500 million in assets by raising their tier one capital requirement and creating a new common equity tier one minimum capital requirement.
Tier one capital consists of unencumbered assets like stocks, bonds and other liquid assets declared on an institution's balance sheet. Under the proposed rule, institutions would have to hold 6 percent, a rise of 2 percent from the existing requirement, of their tier one capital against their total assets weighted by risk. Common equity is based on the value of a firm's common shares excluding preferred stock. The proposal would require firms to hold 4.5 percent of its common equity against risk weighted assets.
The rule would also impose a buffer over the minimum tier one capital requirements if a firm refused to limits on its ability to pay out bonuses.
For institutions with more than $250 billion in assets or $10 billion or more in foreign exposure, the second proposed rule would impose more conservative valuations of risk and require capital reserves to balance those risks, specifically those posed by counterparties to transactions.
In recognition of the contribution of the real estate bubble to the financial meltdown of 2008, such covered institutions would no longer be able to recognize the value of residential mortgages as financial collateral. Similarly, the rule would also exclude all non-investment grade debt securities from the definition of financial collateral.
The third proposed rule applies to firms with more than $50 billion in assets and contains a standardized approach for determining risk-weighted assets.
Risk weighting is the practice of reducing the value of an asset when assessing an institution's capital by a multiple based on the perceived risk of asset. Under the proposed rule, some holdings in the volatile commercial real estate sector would bear a 150 percent risk weighting as would exposure to residential mortgages that are 90 days past due while exposure to derivatives contracts and financial firms as counterparties would also have their risk weights increased.
In addition to the three proposed rules, the regulators finalized their market risk capital rule to require institutions to adjust their risk-based capital ratios to reflect the actual market risk in its trading activity, especially to credit default swaps, asset-backed securities and other derivatives.
During the recent financial crisis many financial institutions did not realize how inadequate their capital reserves were because their risk capital ratios were based on cumulative losses across and asset class and did not change when tranches of the asset class began to underperform.
For example, the increasing default rate on subprime mortgages was somewhat diluted by better performing prime mortgages so banks didn't hold onto more capital to cover potential losses.
The new rule looks for weakness in the underlying pool of assets and then requires increased capital reserves to cover the entire range of assets of that class.
The rule goes into effect January 1, 2013 and applies to banking organizations with aggregate trading assets and liabilities equal to 10 percent of total assets, or $1 billion or more.