Alert December 21, 2010

FDIC Board Approves Interagency Proposal to Set Risk-Based Capital Floor for Large Financial Institutions

On December 14, 2010, the Board of Directors of the FDIC approved a Joint Notice of Proposed Rulemaking titled “ Risk-Based Capital Standards: Advanced Capital Adequacy Framework-Basel II; Establishment of a Risk-Based Capital Floor”(the “Proposed Rule”).  The Proposed Rule implements certain provisions of Section 171 of the Dodd-Frank Act, which is more commonly known as the Collins Amendment. Section 171 of the Dodd‑Frank Act requires, in part, the risk-based capital rules that are applicable to all insured banks, regardless of international exposure or total asset size (the “generally applicable risk-based capital requirements”), to serve as a minimum for any capital requirements that the Federal banking agencies (the “Agencies”) may establish, including for large, internationally active banks and bank holding companies, as well as non-bank financial companies supervised by the FRB.  The Proposed Rule, which implements Section 171(b)(2) of the Dodd-Frank Act, would, if adopted, remove the transitional floor periods set forth in the “advanced approaches rule” of Basel II, as implemented in the United States, and would set the generally applicable risk-based capital requirements as a permanent floor for the advanced approaches.  The Proposed Rule would also amend the Agencies' general risk-based capital rules to allow banks to use the Bank Holding Company capital rules in certain situations to determine the capital requirements for low-risk assets that are not traditionally held by banks.

In 2007, the Agencies adopted the “advanced approaches rule” of Basel II in order to employ an advanced risk-based capital framework for certain large, internationally active banking institutions in the United States.  The “advanced approaches rule” establishes a series of transitional floors to provide a smooth transition to the advanced approaches rule and to limit temporarily the amount by which a banking organization’s risk-based capital requirements could decline relative to the generally applicable risk-based capital requirements.  Each transitional floor equals the lesser of the bank's (i) risk-based capital ratios calculated under the advanced approaches rule, and (ii) risk-based capital ratios calculated under the generally applicable risk-based capital requirements, with risk‑weighted assets multiplied by transitional floor percentages of 95% (for the first transitional floor period), 90% (for the second transitional floor period), and 85% (for the third transitional floor period).

As a result, the “advanced approaches rule” expressly allows for the possibility that the risk-based capital requirements of an institution subject to the “advanced approaches rule” could be lower than if such institution calculated its capital requirements solely under the generally applicable risk-based capital requirements.  Accordingly, the transitional floors under the “advanced approaches rule” do not comply with Section 171 of the Dodd-Frank Act.  Therefore, the Agencies are proposing in the Proposed Rule to replace the transitional floors set forth under the “advanced approaches rule” with a permanent floor, which would be equal to the minimum capital requirement computed using the generally applicable risk-based capital requirements.

Furthermore, Section 171 of the Dodd-Frank Act provides that the Agencies are not allowed to establish capital requirements that are “quantitatively lower” than the generally applicable capital requirements for insured depository institutions that were in effect on July 21, 2010 when the Dodd-Frank Act was signed into law.  The Proposed Rule notes that, to comply with this provision, the Agencies propose to perform a quantitative analysis of the likely effect on capital requirements as part of developing future amendments to the capital rules to ensure that any new capital framework is not quantitatively lower than the requirements in effect as of July 21, 2010.

The Proposed Rule also notes that certain institutions that are subject to the requirements of Section 171 of the Dodd-Frank Act (including non-bank financial companies supervised by the FRB and savings and loan holding companies) have not previously been subject to consolidated risk-based capital requirements.  While some of these entities may be similar in nature to depository institutions and bank holding companies subject to the generally applicable risk-based capital requirements, other such institutions may be different and have types of exposures and risks that were not considered or contemplated when the generally applicable risk-based capital requirements were established.  As a result, certain situations may arise where the FRB will need to evaluate the risk-based capital treatment of specific exposures not traditionally held by depository institutions, and which do not have a specific risk weight under the generally applicable risk-based capital requirements.  The Agencies are proposing to amend the generally applicable risk-based capital requirements to allow banks to use the bank holding company capital requirements for such assets, in order to permit a suitable capital requirement for low risk non-bank assets.  The circumstances would be limited to situations where a bank holds an asset under special authority and the asset poses substantially similar risks to an asset with a risk-weight lower than 100%.

Comments on the Proposed Rule will be due 60 days from its publication in the Federal Register.