Final Basel III Rules Revealed: Community Banks Aren’t Completely off the Hook

The Basel III final rules recently released make clear one thing: Small, community banks are getting a break. It may not actually feel that way. In fact, community bank CEOs across the country tell me they are very frustrated with new regulation, with Basel III, with the Dodd-Frank Act and with examiners scrutinizing their banks and coming up with problems that never seemed to be a problem before. The overarching theme is that more regulation is coming down the pike, Basel III’s final rules are just one part, and they will be burden to digest and implement.

“It’s a massive rule where they consolidated three notices of proposed rulemakings,” says Dennis Hild, a former Federal Reserve bank examiner and Crowe Horwath LLP director. Even though Hild is based in Washington, D.C. and it is his job to understand this stuff, even he admitted he had a lot of reading to do. So it will be a bundle for a small bank CEO to figure out, too. “There is still much to learn. We need to dig through it. We need to find out what’s important.”

The news in late June and early July that the Federal Reserve Board, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corp. (FDIC) would jointly mitigate some of the proposals most onerous to community banks was a welcome, if small, relief in a heavily regulated industry.

Under the final Basel III rule:

• Banks under $15 billion in assets can continue to count trust-preferred securities—known as TRuPS—as Tier 1 capital.
• Banks can continue to risk-weight residential mortgages as they had under the original Basel I regime. The final rule abandons a proposal to institute a complicated formula of risk weights for residential mortgages.
• All but the largest banks (above $250 billion in assets) can keep available-for-sale securities on the balance sheet without having to adjust regulatory capital levels based on the current market value of those securities. Banks have a one-time opportunity to opt-out on their first regulatory call report after Jan. 1, 2015 from what’s called the accumulated other comprehensive income (AOCI) filter. If they miss doing so, they can’t opt-out later.

FDIC Chairman Martin J. Gruenberg specifically said in a press release that changes to the final rule had been made because of community bank objections. The Federal Reserve even published a guide just for community banks to explain the new rules. The Independent Community Bankers of America (ICBA) acknowledged the gesture on behalf of community banks but said in a statement that it still supported an outright exemption from Basel III capital standards for community banks.

It doesn’t appear that community banks will be getting that. The goal of the new rules is to improve the quality and quantity of capital maintained by banks, should another financial crisis take place.

Most community banks will have to comply with the higher regulatory capital standards under the Basel III final rules. Small bank holding companies with less than $500 million in assets are exempt, but their depository institutions must comply. Thrifts and thrift holding companies also must comply with the new rules. The FDIC estimated that 95 percent of insured depository institutions already meet the capital standards required under the final rules. Still, bank management teams, and the bank boards that oversee them, will have to figure out if their banks need to raise capital, and if so, how.

Many other aspects of Basel III will impact community banks as well. Bank officers have been calling consultants and law firms to figure out the impact of the new rules.

One of the biggest questions has been how an acquisition might subject a bank to new rules under Basel III, say if an acquisition bumps the bank above $15 billion in assets. How will the TRuPS on the merged companies’ books be treated?

The biggest banks might feel deterred from M&A if it propels them into the ranks of “advanced approach” institutions, which are those with more than $250 billion in assets or more than $10 billion in on-balance sheet foreign exposure, such as foreign government debt. Such a category subjects those banks to special Basel III rules and higher standards. Also, under yet another proposed rule from all three federal banking regulators, bank holding companies with more than $700 billion in combined total assets or $10 trillion in assets under custody must maintain double the current minimum leverage ratio of 3 percent to be considered “well capitalized.” Regulators estimate only eight institutions in the country would be subject to this leverage requirement.

One aspect of Basel III that might impact community banks is exposure to certain “high volatility” commercial real estate loans, usually acquisition and development loans, which will require higher risk weights. There also will be limitations on certain kinds of deferred tax assets, says Hild.

His advice? Don’t freak out right now. Banks will have time to figure this out.

Although banks with more than $250 billion in assets will have to comply with new capital rules during a phase-in period that starts January 1, 2014, smaller institutions have until January 1, 2015 to begin phasing in the new standards. That will certainly be enough time to figure out if Basel III is a non-event for your organization.