Alert September 14, 2010

Basel Regulators Announce Higher Capital Standards

The Basel Committee on Banking Supervision (the “Basel Committee”) announced that the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee, agreed on new, higher capital standards for banking organizations at its meeting on September 12, 2010.  The President of the European Central Bank and Chairman of the Group of Governors and Heads of Supervision, Jean-Claude Trichet, noted that “the agreements reached today are a fundamental strengthening of global capital standards,” and that “their contribution to long term financial stability and growth will be substantial.”

The new standards will include a minimum common equity requirement of 4.5% (compared to the current requirement of 2%).  The phase-in period for this requirement will begin on January 1, 2013, with full implementation effective January 1, 2015.  The Tier 1 capital requirement, which includes common equity and other qualifying financial instruments, will increase from 4% to 6% over the same period.  The total capital requirement will remain at the existing level of 8%, and therefore will not need to be phased in.

In addition, banking organizations will be required to hold an additional capital conservation buffer of 2.5% to withstand periods of stress, bringing the total common equity requirements to 7% upon full implementation.  This capital conservation buffer will be phased in between January 1, 2016 and January 1, 2019.  While banking organizations that fail to meet the buffer would not be forced to raise additional capital, they would be subject to greater constraints on dividends, share buy-backs and bonuses the closer their regulatory capital ratios approach the minimum requirement.

Furthermore, a countercyclical capital buffer of between 0% and 2.5% of common equity or other fully loss absorbing capital will be implemented “according to national circumstances.”  This buffer, which would be introduced as an extension of the capital conservation buffer range, may be implemented differently in each country and will “only be in effect when there is excess credit growth that is resulting in a system wide build up of risk.”

The Basel Committee also announced that existing public sector capital injections will be grandfathered until January 1, 2018, while capital instruments that no longer qualify as non‑common equity Tier 1 capital or Tier 2 capital will be phased out over a 10-year period beginning on January 1, 2013.  In addition, instruments with an incentive to be redeemed will be phased out at their effective maturity date.  Moreover, while capital instruments that no longer qualify as common equity Tier 1 will be excluded from common equity Tier 1 as of January 1, 2013, instruments meeting all of the following three conditions will be phased out over the same 10-year period: (1) they are issued by a non-joint stock company; (2) they are treated as equity under the prevailing accounting standards; and (3) they receive unlimited recognition as part of Tier 1 capital under current national banking law.

In addition, the Basel Committee announced that regulatory adjustments, including deductions of amounts above the aggregate 15% limit for investments in financial institutions, mortgage servicing rights and deferred tax assets, will be subject to a transition period beginning on January 1, 2014, with full implementation effective on January 1, 2018.

The Basel Committee noted that “systemically important” banks should have “loss absorbing capacity beyond the standards” announced, and left open the possibility that such “systemically important” banks may be subject to stricter capital rules.

The FRB, the OCC and the FDIC issued a release supporting the new capital standards discussed above, calling the agreement “a significant step forward in reducing the incidence and severity of future financial crises, providing for a more stable banking system that is less prone to excess risk-taking.”

The Alert will continue to follow these issues closely.