WASHINGTON — The Federal Reserve Board of Governors Tuesday unanimously approved the final version of new capital adequacy rules for banks, bringing the U.S. one step closer to implementation of tougher international capital reforms.
The reforms, commonly known as Basel III because they were created by the Basel Committee on Banking Supervision, were introduced in December 2010, in the aftermath of the global financial crisis, to address shortcomings of the existing Basel II Accord.
“Adoption of the capital rules today is a milestone in our post-crisis efforts to make the financial system safer,” said Federal Reserve Governor Daniel Tarullo, who is the board member in charge of financial supervision.
The U.S. framework will essentially have a backbone that is built upon the new Basel III capital adequacy standards, but it will also include certain modifications required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
“This framework requires banking organizations to hold more and higher quality capital, which acts as a financial cushion to absorb losses, while reducing the incentive for firms to take excessive risks,” said Federal Reserve Chairman Ben Bernanke.
According to Federal Reserve officials, approximately 100 U.S. banks will need to raise additional capital, which will total $4.5 billion in aggregate, by 2019 to comply with the new requirements.
“The implementation by the banks, by the examiners and by us here at the board will be critical,” Bernanke said. “We’ll need to ensure risk models are safe and well-developed and there are adequate safeguards.”
Under the new framework:
- The minimum ratio of tier one capital to risk-weighted assets that banks are required to maintain will increase from 4 percent to 6 percent.
- The definition of tier one capital will be narrowed to include only the most liquid of assets.
- Banks will also need to have a common equity tier one capital to risk-weighted assets ratio of at least 4.5 percent, along with a common equity tier one capital conservation buffer of 2.5 percent of risk-weighted assets. Existing rules in the U.S. do not prescribe a minimum common equity tier one capital ratio.
- A new minimum supplementary leverage ratio that takes into account off-balance sheet exposures will be introduced for large, internationally active banks.
A key difference between the U.S. framework and the original Basel Accord lies in how banks are required to calculate risk-weighted assets.
“The Basel Accord uses credit ratings to risk weigh certain exposures, but in the U.S. implementation we are unable to do that due the Dodd-Frank Act,” said Anna Lee Hewko, the Federal Reserve’s deputy associate director of banking supervision and regulation.
In addition, Hewko said, the U.S. rules have a a shorter phaseout period for capital instruments that will no longer qualify as tier one capital compared with the original accord.
Along with the bulk of the European Union, the U.S. is among the large handful of Basel Committee countries that have fallen behind in adopting the new Basel III standards. So far, only 11 of the 27 Basel Committee countries have fully implemented frameworks in place.
Interactive Graphic: Progress made by Basel Committee countries in adopting the new Basel III standards.Key – Yellow/2 = Draft regulation published; Orange/3 = Final rule published; Red/4 = Final rule in place
Critics of Basel III, most notably the International Institute of Finance, have argued that the new standards will significantly hurt economic growth. A study released by the Organization of Economic Cooperation and Development in February estimated that Basel III could reduce global gross-domestic-product growth by as much as 0.15 percent per year in the medium term. In addition, concerns have been raised about banks passing on the cost of higher capital requirements to customers by increasing lending spreads.