On February 18, 2014, the Board of Governors of the Federal Reserve System (the “FRB”) approved a final rule (the “Final Rule”) implementing certain of the “enhanced prudential standards” mandated by Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or “Dodd-Frank”). The Final Rule applies the enhanced prudential standards to (i) U.S. bank holding companies (“U.S. BHCs”) with $50 billion (and in some cases, $10 billion) or more in total consolidated assets and (ii) foreign banking organizations (“FBOs”) with (x) a U.S. banking presence, through branches, agencies or depository institution subsidiaries, and (y) depending on the standard, certain designated amounts of assets worldwide, in the United States or in U.S. non-branch assets. The Final Rule’s provisions are the most significant, detailed and prescriptive for the largest U.S. BHCs and the FBOs with the largest U.S. presence—those with $50 billion or more in total consolidated assets and, in the case of FBOs, particularly (and with increasing stringency) for FBOs with combined U.S. assets of $50 billion or more or U.S. non-branch assets of $50 billion or more.
Posts Tagged ‘Capital requirements’
Pursuant to Section 165 of the Dodd-Frank Act, the Federal Reserve has issued a final rule to establish enhanced prudential standards for large U.S. bank holding companies (BHCs) and foreign banking organizations (FBOs).
U.S. BHCs: The final rule represents the latest in a series of U.S. regulations that apply heightened standards to large U.S. BHCs. As the graphic below illustrates, under the emerging post-Dodd-Frank prudential regulatory landscape for U.S. BHCs, the number and stringency of prudential standards generally increase with the size of the banking organization.
In our recent NBER working paper, Financing as a Supply Chain: The Capital Structure of Banks and Borrowers, we propose a novel framework to model joint debt decisions of banks and borrowers. Our framework combines the models used by bank regulators with the models used to explain capital structure in corporate finance. This structure can be used to explore the quantitative impact of government interventions such as deposit insurance, bailouts, and capital regulation.
A key new element of the Basel III framework for regulatory capital aims to improve banks’ management of their funding and liquidity profiles. Two new measures are proposed: a “net stable funding ratio”, and a “liquidity coverage ratio”. The net stable funding ratio has received relatively little attention due to its seemingly distant implementation date of 1 January 2018. However, its impact will be immediate and significant for many banking institutions.
Many factors drive banks toward acquisitions, including increasing efficiency due to size, loan/deposit growth opportunities, or expansion of geographical footprints. However, one consideration is always dominant—improving return on investment, or ROI. Whether short, intermediate, or long-term, ROI is the most critical factor in the M&A decision.
Prior to the recession, bank M&A had settled into a well-established, time-proven approach. Bank management established targets and criteria, while investment bankers, lawyers, and accountants facilitated the M&A structure and process, weighing tax and accounting issues. Accretive to earnings gained acceptance as one of the primary justifications for a transaction.
In the paper, Bank Capital and Financial Stability: An Economic Tradeoff or a Faustian Bargain?, forthcoming in the Annual Review of Financial Economics, I review the literature on the relationship between bank capital and stability. Higher capital contributes positively to financial stability. On this issue, there seems to be little disagreement. There is, however, disagreement in the literature on whether the high leverage in banking serves a socially-useful economic purpose, and whether regulators should permit banks to operate with such high leverage despite its pernicious effect on bank stability, and this disagreement seems at least as strong as that over the causes of the subprime crisis (Lo (2012)). Some of the disagreement over higher capital requirements is between those who emphasize the potential benefits of this in terms of reducing systemic risk and those who believe that sufficiently high capital requirements will generate various costs (e.g., lower lending and liquidity creation and the migration of key financial intermediation services to the unregulated sector).
On January 12, 2014 the Basel Committee on Banking Supervision (Basel Committee) issued the near final version of its leverage ratio and disclosure guidance (B3LR). The B3LR will be subject to further calibration until 2017 with final implementation expected by January 1, 2018.
The B3LR makes a number of significant changes to the Basel Committee’s June 2013 consultative paper (Consultative Paper) by easing the approach to measuring the exposures of off-balance sheet items. These changes address the industry’s concern that the Consultative Paper’s definition of exposure was too expansive (i.e., the leverage ratio’s denominator was too large).
In January 2014, the Basel Committee on Banking Supervision finalized its revisions to the Basel III leverage ratio. Compared to its June 2013 proposed revisions, the Basel Committee has made several important changes to the denominator of the Basel III leverage ratio, including with respect to the treatment of derivatives, securities financing transactions and certain off-balance sheet items.
On November 22, 2013, Federal Reserve Board Governor Daniel Tarullo delivered a speech at the Americans for Financial Reform and Economic Policy Institute outlining a potential regulatory initiative to limit short-term wholesale funding risks.  This proposal could increase capital requirements for and apply additional prudential standards to firms dependent on short-term funding, with a focus on securities financing transactions (“SFTs”)—repos, reverse repos, securities borrowing/lending and securities margin lending.
Last Friday, the Federal Reserve issued its summary instructions and guidance (the “CCAR 2014 Instructions”) for the supervisory 2014 Comprehensive Capital Analysis and Review program (“CCAR 2014”) applicable to bank holding companies with $50 billion or more of total consolidated assets (“Covered BHCs”). Eighteen Covered BHCs will be participating in CCAR for the fourth consecutive year in 2014. An additional 12 institutions will be participating in a full CCAR for the first time during this 2013─2014 cycle.
CCAR 2014 is being conducted under the Federal Reserve’s capital plan rule, which requires the submission and supervisory review of a Covered BHC’s capital plan under stressed conditions (the “Capital Plan Rule”). The Federal Reserve recently amended the Capital Plan Rule to clarify how Covered BHCs must incorporate the new Common Equity Tier 1 measure (“CET1”) and methodology for calculating risk-weighted assets from the recently adopted U.S. Basel III-based final capital rules into their capital plan submissions and Dodd-Frank stress tests for the 2013–2014 cycle. Under the Capital Plan Rule and CCAR 2014, a Covered BHC’s capital plan is evaluated by the Federal Reserve on both quantitative (that is, whether the Covered BHC can meet applicable numerical regulatory capital minimums and a Tier 1 common ratio of at least five percent) and qualitative grounds.