Simplification of regulatory capital rules
Simplification of regulatory capital rules
Insight

Simplification of regulatory capital rules

Simplified capital rules for smaller institutions regarding certain threshold deductions and treatment of minority interests.

The federal banking agencies have simplified their capital rules for smaller institutions with regard to certain threshold deductions and the treatment of minority interests.

Key points

  • Regulatory reduction to U.S. banks with total assets less than $250 billion.
  • The federal banking agencies have issued a joint final rule that simplifies certain regulatory capital rules, including the capital treatment of mortgage servicing assets, certain deferred tax assets, investments in the capital instruments of unconsolidated financial institutions, and minority interests.
  • The final rule applies only to banking organizations that do not use the “advanced approaches” capital framework.
  • The final provisions related to threshold deductions and the treatment of minority interests will take effect on April 1, 2020; the final provisions addressing technical amendments will take effect on October 1, 2019.

The federal banking agencies (Federal Reserve, OCC, and FDIC) have adopted a final rule to simplify certain requirements in the agencies’ regulatory capital rules. The final rule is substantially similar to the proposed rule released in October 2017 with regard to the capital treatment of mortgage servicing assets (MSAs), deferred tax assets arising from temporary differences that an institution could not realize through net operating loss carrybacks (temporary difference DTAs), and nonsignificant and significant investments in the capital of unconsolidated financial institutions (UFIs) as well as the treatment of minority interests. Certain provisions, including a proposed revision to the definition of high volatility commercial real estate (HVCRE) exposures, which were included in the 2017 proposal, are not included in this final rule and are being addressed in separate rulemakings.

Applicability
The simplified requirements in the final rule apply only to banking organizations that are not subject to the advanced approaches capital rule (non-advanced approaches banks), which generally includes banking organizations with less than $250 billion in total consolidated assets and less than $10 billion in total foreign exposure.

However, the tailoring proposals released by the agencies in October 2018 and April 2019 for U.S. domestic organizations and foreign banking organizations, respectively, would revise the scope for advanced approaches banking organizations, potentially expanding the number of banking organizations permitted to use the simplified provisions in this final rule. If finalized as proposed, advanced approaches banking organizations would be defined to include only Category I and Category II banking organizations (U.S. GSIBS and U.S. non-GSIBS with $700 billion or more in total assets or $75 billion or more in cross-jurisdictional activity, and FBOs with $700 billion or more in combined U.S. assets or $75 billion or more in cross-jurisdictional activity), which would effectively raise the parameters for non-advanced approaches banks.

MSAs, DTAs, UFIs – Threshold deductions
For non-advanced approaches banks, the final rule:

  • Increases common equity tier 1 (CET1) capital threshold deductions from 10 percent to 25 percent for MSAs, temporary difference DTAs, and nonsignificant and significant investments in the capital of UFIs.
  • Eliminates the aggregate 15 percent CET1 threshold deduction for MSAs, temporary difference DTAs, and significant investments in the capital of UFIs.
  • Retains the 250 percent risk weight applicable to non-deducted amounts of MSAs and temporary difference DTAs.
  • Eliminates the need to distinguish between nonsignificant and significant investments in the capital of UFIs.
  • Eliminates the 250 percent risk weight to be applied to non-deducted amounts of significant investments in the capital of UFIs.
  • Requires a bank to apply the risk weight applicable to the exposure category of the investment for any non-deducted amount of investments in the capital of UFIs resulting in a range of risk-weights between 100 percent and 400 percent based on the capital rules.

Minority Interests
Under the final rule, non-advanced approaches will calculate the amount of minority interest includable in regulatory capital as:

i. Common equity tier 1 minority interest comprising up to 10 percent of the parent banking organization’s common equity tier 1 capital;

ii. Tier 1 minority interest comprising up to 10 percent of the parent banking organization’s tier 1 capital; and

iii. Total capital minority interest comprising up to 10 percent of the parent banking organization’s total capital.

In each case, the parent banking organization’s regulatory capital for purposes of these limitations would be measured before the inclusion of any minority interest and after the deductions from and adjustments to the regulatory capital of the parent banking organization described in the capital rule.

Technical amendments
The final rule includes a number of typographical and technical corrections as well as other changes to update or clarify parts of the agencies’ capital rule that are applicable to both advanced approaches and non-advanced approaches banking organizations.

A key provision is directed to Federal Reserve Board-regulated institutions and requires them to obtain the prior approval of the Board before redeeming or repurchasing common equity tier 1 capital instruments only to the extent otherwise required by law or regulation. Redemptions or repurchases of additional tier 1 capital instruments or tier 2 capital instruments will require prior approval.

Effective dates
The simplifications related to the threshold deductions (for MSAs, temporary difference DTAs, and investments in the capital of UFIs) and the treatment of minority interests will take effect on April 1, 2020.

The technical amendments will become effective October 1, 2019 though banking organizations may elect to adopt these amendments prior to the effective date.

HVCRE proposal
As noted above, the October 2017 proposed rule sought to replace the existing high volatility commercial real estate (HVCRE) exposure category as applied in the standardized approach for non-advanced approaches banks with a newly defined “high volatility acquisition, development, or construction (HVADC) exposure. However in May 2018, section 214 of the EGRRCPA statutorily defined an “HVCRE ADC exposure.” The agencies then proposed in September 2018 to revise the definition of an HVCRE exposure in the capital rule to conform to the statutory definition of an HVCRE ADC exposure. That proposal remains outstanding; it would apply to the calculation of risk-weighted assets for both the standardized approach and advanced approaches.

On July 12, 2019, the agencies released a new proposal that would expand on the September 2018 release to clarify that loans that solely finance the development of land for residential properties would meet the revised definition of HVCRE, unless the loan qualifies for another exemption.

KPMG perspective
The final rule is in keeping with the agencies’ efforts to tailor regulations to the size, complexity, and risk profile of institutions and, in particular, to simplify and “meaningfully” reduce the regulatory burden of community banking organizations.

The agencies reiterate they do not expect most non-advanced approaches banks to experience a “significant impact” from these simplifications but certain banking organizations with “substantial holdings” of MSAs, temporary difference DTAs, and UFIs could experience a “regulatory capital benefit.”

Notably, the implementation of the Current Expected Credit Loss (CECL) standard could create temporary difference DTAs upon implementation in 2020. The increase in the CET1 deduction threshold from 10 percent to 25 percent may mitigate some of the impact this increase could have on regulatory capital.