Federal banking regulators are trying to make life easier for regional and community banks by making changes to Basel III capital rules, particularly in areas that have been subject to banker complaints. Whether the changes provide real relief may be up to the bank.
Last week, the Federal Reserve Board, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency issued a proposal to “reduce regulatory burden” by simplifying regulatory capital rules that dictate how much capital banks must maintain. The rules mostly apply to banks subject to what’s known as “standardized approaches,” so it will generally impact banks and thrifts with less than $250 billion in total consolidated assets or less than $10 billion in total foreign exposure. Comments on the proposal are due within 60 days of publication in the Federal Register, which hadn't occurred as of Thursday morning.
“This is an effort to make lives for community banks a little bit easier,’’ says Luigi De Ghenghi, a partner in Davis Polk’s Financial Institutions Group. The big picture on all of this is that as the industry approached the 10-year mark for the start of the financial crisis, regulators are looking at ways to update rules as the health of the industry has improved. Still, regulators are sensitive to accusations that they may be exposing the industry to another financial crisis by rolling back rules too enthusiastically, industry observers say.
“The U.S banking agencies are walking a bit of a tight rope because on the one hand they want to be seen as simplifying the capital rules and giving an appropriate level of capital relief,’’ De Ghenghi says. “On the other hand, they don’t want to be seen as substantively weakening capital standards,” especially since lack of capital and risky loans were a factor in the failure of hundreds of community banks during and after the crisis.
It would be wrong to assume that this is coming out of the new Trump administration’s drive to provide financial regulatory relief, as detailed in the Treasury Department report in June. Although politics is always a factor, the latest proposal comes out of an Economic Growth and Regulatory Paperwork Reduction Act, which requires banking agencies to review regulations every 10 years and to get rid of “unduly burdensome regulations” while ensuring the safety and soundness of the financial system. The review kicked off in 2014 and concluded earlier this year.
One of the most important of the proposed changes deals with the definition and risk weighting of high volatility commercial real estate (HVCRE) loans, which are considered among the higher risk loans that banks make to developers and builders, such as non-recourse loans. But community bankers had complained that the HVCRE loan definition and exemptions were too complex to apply and that the risk weightings were too high for the risks these loans posed.
“The banks were pushing the trade associations to push members of Congress to say, ‘We need a fix here,’’’ says Dennis Hild, managing director at Crowe Horwath and former bank examiner and supervisory analyst with the Federal Reserve. “’We think we know what falls under the purview of a high volatility real estate loan and the regulators come in [for an exam] and there is a disagreement on certain sets of loans.’”
To respond to the need for clarification, the proposal creates a new high volatility loan category for loans going forward that focuses less on underwriting criteria and more on the use of the proceeds, according to De Ghenghi. It potentially includes a wider array of commercial real estate loans, but lowers the risk weight from 150 percent to 130 percent, meaning banks have to hold slightly less capital against these loans. Also, banks will be able to include higher amounts of mortgage servicing assets and certain deferred tax assets as common equity Tier 1 capital, a new tier of regulatory capital that was created after the financial crisis as part of the global agreement known as Basel III.
This will help “the institutions that have substantial amounts of mortgage servicing assets or deferred tax assets,” says Hild.
The agencies have summed up the proposal’s impact on community banks here. The 10-year review details several other changes already made or in the works to reduce the regulatory burden. Among them, the agencies made changes to provide institutions with up to $1 billion in assets, instead of the $500 million limit, with the opportunity for an 18-month exam cycle instead of a 12-month exam cycle, if they score highly on their exams. The agencies also proposed this summer to increase the threshold for requiring an appraisal on a commercial real estate loan from $250,000 to $400,000.