Risk-Based Capital Standards: Establishment of a Risk-Based Capital Floor
Summary of the relevant sections of Dodd-Frank Act
On June 6, 2011, the OCC, Federal Reserve, and FDIC (the “agencies”) have jointly issued a draft final rule amending the advanced risk-based capital adequacy standards to conform to provisions in Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The rule establishes a floor for the risk-based capital for applicable banking organizations.
The Dodd-Frank Act requires that a minimum risk-based capital requirement be established on a consolidated basis for insured depository institutions, depository institution holding companies, and nonbank financial companies supervised by the Federal Reserve (“covered institutions”). In addition, it requires that the minimum leverage and risk-based capital requirements are not less than the generally applicable capital requirements. These shall serve as a floor for any capital requirements.
Risk-Based Capital Floor
The rule requires covered institutions, which operate under the agencies’ advanced approaches risk-based capital rules, to meet the higher of (a) the minimum requirements under the general risk-based capital rules and (b) the minimum requirements under the advanced approaches risk-based capital rules.
For the purpose of a smooth transition to the advanced approach, the rules have a series of transitional floors over a period of three years (at a minimum) following a firm’s completion of an acceptable parallel run. During these three years, the firm’s risk-based capital ratios are equal to the lesser of (a) the firm’s ratios calculated under advanced approach rules; or (b) the firm’s ratios calculated under general risk-based capital rules.
Note: Under the advanced approach, the firm is allowed to operate with lower minimum risk-based capital requirements during the transitional period as opposed to the general risk-based capital rules.
The rules are applicable to the largest, internationally active banking organizations. A firm must use the advanced approaches rules only if one of the following criteria is met:
It has consolidated assets equal to • $250 billion or more;
- It has consolidated total on-balance sheet foreign exposures equal to $10 billion or more; or
- It is a subsidiary of a bank holding company or bank that is required to use the advanced approaches rules.
The rule is not expected to have an immediate effect on the banking industry because all covered institutions are currently using the general risk-based capital rules to compute capital requirements. The final rule states that amendments to the rules will not result in an increase of obligations, reporting, record-keeping, or compliance requirements. The final rule will be effective 30 days after publication in the Federal Register; publication is expected soon.
Risk-Based Capital Standards: Advanced Capital Adequacy Framework—Basel II; Establishment of a Risk-Based Capital Floor