Bank Capital and Liquidity Requirements: Basel Committee Oversight Body Announces Amendments to December 2009 “Basel III” Proposals to Strengthen Bank Capital and Liquidity Regulation

Sullivan & Cromwell LLP - July 28, 2010

On July 26, 2010, the Group of Governors and Heads of Supervision of the Basel Committee on Banking Supervision, the oversight body of the Basel Committee, announced that it had reached “broad agreement” on the capital and liquidity reform proposals initially published by the Committee in December 2009. The announcement describes in summary form changes, which it refers to as “amendments”, to the December 2009 proposals. The amendments respond to a number of the concerns raised by financial institutions in their comments on the December 2009 proposals. The amendments would:

  • Not require a complete deduction from Tier 1 common equity of mortgage servicing rights, deferred tax asset arising from timing differences and a limited amount of investments in common shares of unconsolidated financial institutions, subject to a cap for any one such component of 10% of Tier 1 common equity and for all such components in the aggregate of 15% of Tier 1 common equity.
  • Retain a leverage ratio but preliminarily “calibrate” the leverage ratio at 3% and adopt phase-in “milestones” with bank level disclosure of the ratio commencing January 1, 2015 and actual application of the ratio as a Pillar 1 capital measure commencing on January 1, 2018. The denominator in the ratio would be reduced by recognizing legally enforceable netting of derivatives (including credit derivatives) and applying a 10% credit conversion factor for unconditionally cancellable off-balance sheet commitments (as opposed to the 100% credit conversion factor in the December capital proposals).
  • In the liquidity coverage ratio, or “LCR”, lower the floors for assumed run-off rates for deposits and certain other sources of funds and expand – as a new concept of “Level 2” liquid assets – the scope of assets that are includible within the “stock of liquid assets” in the numerator of the ratio.
  • Although confirming the Basel Committee’s commitment to a net stable funding ratio, or “NSFR”, as a longer-term structural component of liquidity regulation to encourage longer-term funding, acknowledge the need for modifications to the initial proposal. Going forward, the Basel Committee proposes to issue a revised NSFR proposal by the end of this year and introduce a revised NSFR as a minimum standard by January 1, 2018 (as opposed to adopting a final NSFR by the end of this year, as initially proposed).

The amendments do not address, and presumably implicitly reject, a number of other industry concerns and related proposals raised in the comment process, including:

  • The required deduction from Tier 1 common equity of other types of intangible assets that banks believe have value (for example, credit card account relationships) and of defined benefit pension fund assets.
  • The volatility in the common equity component of Tier 1 capital that would result from reflecting in common equity (and not “filtering out” from common equity) unrealized gains or losses recognized on the balance sheet.
  • The capital surcharge on “systemically significant” banks discussed in paragraph 47 of the December 2009 capital proposals.
  • The potentially destabilizing effect that disclosure of the LCR and NSFR could have on some banks.
  • The broad concerns expressed by many commenters with the capital buffer proposals.

The release does not request comment on the amendments. Nor does it indicate that the Basel Committee will publish for further comment revised proposals reflecting the amendments described in the release, as many commenters had requested, or address whether its intention remains to adopt final proposals by December 31, 2010 with implementation, except as otherwise noted, by December 31, 2012. It appears, however, that the Basel Committee intends to meet those dates for adoption and implementation.