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From Banking and Finance Law Daily, November 9, 2015

Agencies reconcile capital deductions under Volcker Rule, regulatory capital rule

By Richard A. Roth, J.D.

The banking prudential regulatory agencies have published interagency guidance that is intended to remedy the possibility that the interaction between the Volcker Rule and the joint regulatory capital rule could result in duplicate deductions from financial institutions’ tier 1 capital. The guidance gives a step-by-step process for calculating the appropriate deduction when an investment qualifies as an investment in a covered fund under the Volcker Rule and an investment in an unconsolidated financial institution (UFI) under the regulatory capital rule (OCC 2015-43FIL-50-2015SR 15-13).

The Volcker Rule, which is part of the Dodd-Frank Act, restricts banking organizations’ ability to engage in proprietary trading, or to hold interests in or have other relationships with, covered funds. The full amount of such an investment must be deducted from the organization’s tier 1 capital when the organization is determining whether it meets the required regulatory capital ratios.

The joint regulatory capital rule makes investments in UFIs subject to a tier 1 capital deduction as well. This creates a possible overlap if the entity in which an investment has been made qualifies as a covered fund and a UFI. The guidance is intended to avoid a double deduction.

Deduction methodology. The interagency guidance sets out a six-step process to be used by an institution that is concerned over possible double deductions:

  1. The company determines the amount of its covered fund investment that the Volcker Rule says is subject to a deduction from tier 1 capital.
  2. The company determines how much of that investment also is an investment in a UFI under the regulatory capital rule.
  3. If there is no overlap, the full investment must be deducted from tier 1 capital under the Volcker Rule.
  4. If there is an overlap, any amount that must be deducted from tier 1 capital under the regulatory capital rule will count toward what must be deducted under the Volcker Rule.
  5. Any part of what was calculated in the first step that was not deducted under the regulatory capital rule must be deducted under the Volcker Rule.

Priority. In its bulletin, the OCC specified that in the case of overlapping deductions, deductions required by the regulatory capital rule take priority. Deductions required only by the Volcker Rule should be calculated after deductions required by the regulatory capital rule.

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