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From Banking and Finance Law Daily, September 23, 2013

FDIC Chairman explains proposed minimum leverage capital increases

By Richard A. Roth, J.D.

The Federal Deposit Insurance Corporation’s recent proposal to increase the leverage capital requirement for the largest banking organizations is “one of the most important steps the banking agencies could take to strengthen the safety and soundness of the U.S. banking and financial systems,” FDIC Chairman Martin J. Gruenberg told the Third Annual American Banker Regulatory Symposium. The 3-percent minimum supplementary capital ratio established by Basel III is not high enough for the eight U.S. bank holding companies and subsidiaries that would be subject to the proposed 6-percent supplementary leverage ratio, Gruenberg told the conference.

The leverage ratio proposal was issued at the same time the Federal Reserve Board, Office of the Comptroller of the Currency, and FDIC adopted interim risk-based capital rules. According to Gruenberg, the capital rules require more and better quality risk-based capital for all U.S. banks by emphasizing Tier 1 capital. The FDIC worked hard to help community banks understand these rules when they were proposed and considered their comments carefully, Gruenberg said, and the result was a rule that strengthened capital requirements without undue burdens on smaller institutions.

Gruenberg added that the majority of U.S. banks already are in compliance with the new, stricter requirements.

Supplementary leverage ratio proposal. Basel III includes the first international leverage ratio, Gruenberg noted, and also calls for the 18 largest banking organizations subject to the advanced approaches rule to maintain a supplementary 3-percent ratio. This is stricter than current U.S. requirements, he said, because it includes some off-balance sheet exposures as part of the calculation. However, the federal regulatory agencies determined it still was not high enough for the largest organizations.

Under the proposal, the eight largest U.S. banking organizations—those with $700 billion in total consolidated assets or $10 trillion in assets under custody—would need to maintain a 6-percent supplementary leverage ratio if they are to be considered well capitalized. Gruenberg said that based on data from the third quarter of 2012, this would require the institutions to hold a total of $89 billion in additional capital.

Moreover, covered bank holding companies would be required to maintain a supplementary leverage ratio of 3 percent plus a buffer of 2 percent to avoid restrictions on capital distributions and executive compensation. Based on the same 2012 data, this would call for $63 billion in additional capital, Gruenberg said.

The FDIC chairman gave two reasons for the proposed higher requirements. First, the agencies determined that the 3-percent supplementary leverage ratio alone would not have meaningfully reduced the covered institutions’ growth in leverage before the financial crisis. Since one of the most important goals of the reformed capital rules is preventing the buildup of too much leverage, the FDIC saw this as “problematic.”

Second, leverage capital requirements and risk-based capital requirements are complementary, Gruenberg said—one capital requirement offsets potential weaknesses in the other. However, Basel III would increase risk-based capital of U.S. financial institutions significantly more than it would increase leverage requirements, resulting in more reliance on the risk-based capital ratios. Increasing the leverage ratio requirements will regain the desired balance.

Gruenberg added that the higher leverage ratios could help to offset any funding cost advantages the largest institutions could have over their smaller competitors.

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