On July 2, the Federal Reserve Board approved final rules which will implement the risk-based and leverage capital requirements in the Basel III framework and relevant provisions mandated by the Dodd-Frank Act.  The rules will require all banks to hold increased levels of higher quality capital.  Specifically, the rules impose (i) a minimum common equity tier 1 capital requirement will increase from 2% to 4.5% of risk-weighted assets; (ii) a minimum tier 1capital requirement will increase from 4% to 6% of risk-weighted assets; and (iii) a new capital conservation buffer of 2.5% of risk-weighted assets.  These minimum capital requirements remain unchanged from the agencies proposal issued last June.  The rules also establish a minimum leverage ratio of 4 percent for all banking organizations.

The Federal Reserve Board received more than 2,600 comments on its proposed capital rules, most of which came from community banks.  In response to concerns raised by smaller and community banking organizations, the Federal Reserve Board walked away from more onerous capital requirements that would have substantially increased the risk-weightings for residential mortgages.  Instead, the final rule retains the risk-weights under current rules for residential mortgage loans, provided they are not restructured or modified.  Consistent with the proposal, residential mortgage exposures that are modified pursuant to the U.S. Treasury’s Home Affordable Mortgage Program (HAMP) will receive more favorable risk-weightings than other modified or restructured mortgage loans. In addition, the final rule would allow banking organizations that are not subject to the advanced approaches rule to make a one-time election to opt out of the requirement to include unrealized gains and losses in their regulatory capital.  Moreover, the final rule permits banks with less than $15 billion in assets to grandfather certain existing trust preferred securities in their capital accounting.  The final rules do not change the more stringent limits on the inclusion of mortgage servicing assets and deferred tax assets in regulatory capital calculations.

The final rule also extends the phase-in period for community banks.  Internationally active banks must begin to implement the new capital rules in January 2014, while all other banking organizations will have until January 2015 to begin to phase in the new capital requirements.