Today, in light of "continuing stress[ed] conditions in the financial markets" and the efforts of Bank Holding Companies (BHCs) to increase their overall capital levels, the Federal Reserve announced the adoption of a final rule that delays from March 31, 2009 until March 31, 2011, the effective date of new limits on the inclusion of trust preferred securities, cumulative perpetual preferred stock, and minority interests in the equity accounts of most consolidated subsidiaries (collectively, restricted core capital elements) in Tier 1 capital of BHCs. These new limits were announced in 2005.

As a result of the delay, for the next two years, BHCs may continue including restricted core capital elements in Tier 1 capital up to 25 percent of total core capital elements (including cumulative perpetual preferred stock and trust preferred securities). When the new capital requirements become effective in 2011, restricted core capital elements includable in Tier 1 capital of a BHC will be limited to 25 percent of the sum of core capital elements (including restricted core capital elements), net of goodwill, less any associated tax deferred liability, and restricted core capital elements (other than qualifying mandatory convertible preferred securities) of internationally active BHCs will be limited to 15 percent of the sum of core capital elements (including restricted core capital elements), net of goodwill, less any associated tax deferred liability.

Notwithstanding that 25% and 15% limits will not go into effect until 2011, the Fed has not retreated from its longstanding policy that a majority of Tier 1 capital must consist of common equity.

Further, the Fed's announcement does not represent a free pass for new issuances of restricted core capital instruments. The additional two-year period for compliance with the 2005 rules applies automatically only to restricted core capital instruments already outstanding. For any new issuance, a banking organization must consult with the appropriate Federal Reserve Bank. Accordingly, whether the announcement will give rise to a new round of trust preferreds and other instruments remains to be seen.

Since the original 2009 deadline was intended as a four-year phase-in period for compliance with the 2005 rules, a further two-year extension is not, in one sense, especially remarkable. In the current economic climate, however, the Fed's action is welcome insofar as maintaining some flexibility in the capital rules is anti-cyclical. Historically, in times of crisis, the federal banking agencies are pro-cyclical and have required more traditional capital at a time when banking organizations face the most difficulty in raising such capital.

Today's announcement also marks at least the fourth time in the last six months that the Fed has revised or interpreted its rules in a way designed to attract capital or to support the financial condition of banking organizations. In September, the Fed loosened its control rules to spur private, minority investments. In October, it allowed banking organizations to include in Tier 1 capital senior preferred stock sold to Treasury under the capital purchase program, and it (together with the other federal banking agencies) allowed banking institutions to recognize on an accelerated basis (for regulatory reporting purposes) losses on Fannie Mae and Freddie Mac stock as ordinary rather than capital losses.