Fed approves a final Basel III rule for US, focus on Tier 1 capital

The Federal Reserve approved today a final Basel III rule for the US, including a focus on Tier 1 capital as the main capital monitoring mechanism. Looks like the US will follow the arguably distorted logic of Tier 1 for the foreseeable future. Details and next steps follow.

From the Fed’s notice released today:

The Federal Reserve Board on Tuesday approved a final rule to help ensure banks maintain strong capital positions that will enable them to continue lending to creditworthy households and businesses even after unforeseen losses and during severe economic downturns.

Under the final rule, minimum requirements will increase for both the quantity and quality of capital held by banking organizations. Consistent with the international Basel framework, the rule includes a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5 percent and a common equity tier 1 capital conservation buffer of 2.5 percent of risk-weighted assets that will apply to all supervised financial institutions. The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets from 4 percent to 6 percent and includes a minimum leverage ratio of 4 percent for all banking organizations. In addition, for the largest, most internationally active banking organizations, the final rule includes a new minimum supplementary leverage ratio that takes into account off-balance sheet exposures.

On the quality of capital side, the final rule emphasizes common equity tier 1 capital, the most loss-absorbing form of capital, and implements strict eligibility criteria for regulatory capital instruments. The final rule also improves the methodology for calculating risk-weighted assets to enhance risk sensitivity. anks and regulators use risk weighting to assign different levels of risk to different classes of assets–riskier assets require higher capital cushions and less risky assets require smaller capital cushions.

Here are the next steps, according to the Fed’s Daniel Tarullo:

First, we are very close to completion of a notice of proposed rulemaking that will establish a leverage ratio threshold for these firms above the Basel III required minimum. Despite its innovativeness in taking account of off-balance-sheet assets, the Basel III leverage ratio seems to have been set too low to be an effective counterpart to the combination of risk-weighted capital measures that have been agreed internationally.

Second, we should be ready in the next few months to issue a notice of proposed rulemaking concerning the combined amount of equity and long-term debt these firms should maintain in order to facilitate orderly resolution in appropriate circumstances.

Third, after the Basel Committee has completed final methodological refinements to its framework for capital surcharges on banking organizations of global systemic importance, we will issue a notice of proposed rulemaking to implement this framework in the United States. Given the current state of Basel Committee work, we may be looking at such a notice late this year.

The full press release is here.

Tarullo’s accompanying speech is here.

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