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Impact of New Capital Rule on Community Banks

Equias Alliance | October, 2013

During the first two weeks of July 2013, the Federal agencies (OCC, Federal Reserve Board and FDIC) adopted significant changes to the US regulatory capital framework. It is being referred to as the “New Capital Rule”.

The new rule is effective January 1, 2015 for financial institutions with total consolidated assets of less than $250 billion. Many of the provisions will phase in over a period of years with full implementation required by January 1, 2019.

The New Capital Rule will apply to:

  • All insured banks and savings associations
  • Bank holding companies with more than $500 million in assets
  • Savings and loan holding companies domiciled in the US.

Although the banking industry was not able to obtain an overall exemption from the requirements for community banks, some key changes were made in the final rule relating to the current risk weights for mortgages; financial institutions with consolidated assets of less than $250 billion are allowed a one-time irrevocable option to permanently exclude AOCI from inclusion in regulatory capital; and Trust preferred securities can now be permanently included in Tier 1 capital, if certain conditions are met.


Key Changes


The New Capital Rule revises the definition of regulatory capital components; adds a new common equity tier 1 risk-based capital level; incorporates the revised capital requirements into the Prompt Corrective Action framework; implements a new capital conservation buffer; and provides a transition period for several aspects of the proposed rule.

Under the new rule, the new common equity tier 1 to risk-based capital ratio would be 4.5%; the additional tier 1 capital to risk-weighted assets would be 6%; the overall capital ratio would be 8%; the new capital conservation ratio would be 2.5%; and the tier 1 leverage ratio would remain at 4%. The definition of capital is revised to include common equity tier 1 capital as well as additional tier 1 capital (T1); and tier 2 (T2) capital.

Summary of Current Capital Ratios vs. New Capital Ratios


The chart below shows the new capital ratios:

New Conservation Buffer


Under the new rule, banks must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to bank executives.

New Capital Ratios Phase-in Schedule


The new rule provides for the phase-in of certain requirements beginning January 1, 2015 with full implementation required by January 1, 2019:

Source: Office of the Comptroller of the Currency (July 2013)

New Prompt Corrective Action Requirements (effective 1/1/15)

Source: Office of the Comptroller of the Currency (July 2013)

Risk Weights


The new rule increases the risk-weights for past due loans, certain high volatility commercial real estate loans, and some equity exposures.

Impact on BOLI


Under the new rule, General Account BOLI will continue to be risk-weighted at 100% as BOLI would be treated as a corporate exposure. Banks that have Separate Account BOLI will have three choices for the risk-weighting of assets. For banks that have Hybrid Separate Account BOLI, it is not clear whether these products will be treated as General Account or Separate Account for regula
tory capital purposes. If treated as General Account, it would be risk-weighted as a corporate exposure (100% risk-weighting). If the Hybrid Separate Account is treated as a Separate Account in calculating the required regulatory capital, it may be difficult for a community bank after January 1, 2015 to take advantage of the lower risk-weighting sometimes available with such a
product either (1) because of the complexities associated with verifying the risk-weighting of the underlying investments or (2) because of the risk-weighting provisions specified under the new Separate Account look-through rules. However, it should be noted, Basel III does not reduce or otherwise impact the credit protection
features provided by the Hybrid Separate Account policy structure.

In late October 2013, Equias Alliance will be publishing a separate report with a detailed analysis of the impact of the New Capital Rule on BOLI policies. In the meantime, for more information on Basel III and its impact on BOLI, please visit our website at www.equiasalliance.com and link on to the “Key Provisions of Recently Enacted Basel III New Capital Rule” or contact XXX at XXX@equiasalliance.com.

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