A capital idea: Basel accords are worldwide rules impacting financial services industry

By Claude Solnik
BridgeTower Media Newswires
 
LONG ISLAND, NY — The federal government is softening some regulations regarding capital for community banks, even as it imposes others that make it more difficult for those banks to lend, according to a banking trade group.

The Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency in late August put on hold the final phase of what’s known as the “Basel III” regulations for banks with less than $250 billion in assets.

The agencies in a joint statement said “as part of the recent review of regulations” under the Economic Growth and Regulatory Paperwork Reduction Act they are pausing the final stage of Basel III for community banks and “developing a proposal that would simplify the capital rules to reduce regulatory burden, particularly for community banks.”

The decision comes after numerous other Basel III regulations went into effect that the Independent Community Bankers of America said already make it tougher for them to lend.

“It deals with the phase in of Basel III standards,” Chris Cole, the Washington, D.C.-based ICBA’s executive vice president and senior regulatory counsel, said. “The regulators said we’re stopping the phase in and how it’s transitioning with respect to certain capital items, such as mortgage servicing assets and deferred tax assets.”

While the Paris accords regarding climate change are well known global regulations, the Basel accords in the banking world are worldwide rules impacting the financial services industry.

Although Basel, a city in Switzerland, may evoke images of a picturesque city, the rules have become synonymous with banking regulation.

“In response to the financial crisis of 2008 and 2009 that really impacted the largest banks internationally, U.S. banking regulators worked in tandem with international regulators as part of the Basel committee,” said James Kendrick, ICBA’s first vice president of accounting and capital policy.

An international group known as the Basel committee came together and “concluded that banks worldwide needed stronger capital standards,” Kendrick added.

These accords started with Basel I, meant to be less rigorous, finally reaching Basel III that is imposing limits on what banks can declare as capital.

“They did it in phases to give the banks an opportunity to make capital adjustments, to raise more capital or sell those assets,” Kendrick said.

At least initially, there was talk of applying Basel rules only to big banks. In the end, all banks had to comply with the rules.

“Basel III was intended to apply to the largest, systemically important banks all over the world,” Kendrick said. “What bank regulators did instead was apply the Basel III capital standards to all banks.”

While he said the rules were crafted for financial institutions such as J.P. Morgan Chase and Co., Bank of America and Citibank, Basel III instead has been applied to the more than 6,000 banks in the nation and others worldwide.

“This was an overly burdensome capital accord. It required community banks to hold more capital,” Kendrick added. “They had to write off a lot of high quality assets from their balance sheet.
Their capital balance suffered.”

A report by the treasury secretary recommended exempting banks with less than $10 billion from Basel III.

In what the ICBA sees as a bright spot, the federal government has hit the pause button on the final phase affecting certain “intangible” assets.

“Before Basel III, you could include some of these assets as capital,” Cole said. “Basel III said they don’t like these intangibles and would phase them out.”

The federal government already phased out 20 percent of certain assets the first year from calculations of a bank’s capital, 40 percent in the second year, 60 percent in the third and 80 percent before planning to eliminate them as capital.

“They froze it at 80 percent,” Cole added of regulators’ decision to not go the final mile and eliminate some types of capital from smaller banks’ calculations. “They’re going to take a look at the capital treatment of all these items with respect to community banks with assets of less than $250 billion.”

The government put a hold on eliminating tax assets from a community bank’s capital, allowing them to include 20 percent. A tax asset results from timing differences between income and expenses, resulting in an asset at a given moment with income and no expense.

The government also took similar action with something called a mortgage servicing asset, another intangible asset based on the fact that a bank can market other products to mortgage holders.
“If I have a right to service that mortgage, I have your name, customer number and can sell you other products,” Cole said. “It’s not the mortgage, but an intangible along the lines of good will.”

The treasury secretary’s report to the president recommended that “regulators should simplify and improve the calculation of capital requirements for mortgage servicing assets.”

Other regulations, though, already have been eliminated from calculating capital, eliminating investments in other banks in the form of stock from calculations of capital.

“The big one is a classification of real estate loans under the acronym of HVCRE or high volatility commercial real estate loans,” Kendrick said. “These are commercial loans for construction projects.”

Kendrick said community banks typically loan for construction of community hospitals, multifamily housing and shopping centers. If certain provisions are not met, the bank has to set aside more capital for those projects.

“In many cases, these are well underwritten,” Kendrick said. “These loans create jobs in the local community. They put people to work. Those loans are being penalized under Basel III. The bank has to set aside more capital. That isn’t changing.”

Increasing the assets banks must have to do these commercial real estate loans, Kendrick said, has a negative impact on lending and, therefore, on the economy.

“That is an area where community banks, particularly where the community bank is the only bank in town, is very negatively impacted,” Kendrick added. “They can originate the loan and hold it in their portfolio, but they have to set aside more capital.”

Under Basel I, these loans were classified as normal real estate loans with no difference between the construction and acquisition of a strip shopping center.

“Now regulators have said if you build these strip shopping centers, you as the bank have to require the investor to put up a great deal of funds in the project,” Kendrick said. “If not, the bank is penalized.”

The Trump administration has said it will seek to reduce bank regulation, even as many rules under the Basil accords remain in place.

Putting a hold on Basel III for community banks could be a first step toward further loosening regulations on community banks.

“They said this is a transitional fix and they will go back and look for a more permanent fix,” Kendrick added. “We don’t know at this point what they’re looking at. They are listening to community banks, paying attention to the negative impact this has.”
 

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