http://www.fdic.gov/news/news/speeches/chairman/spmar2212.htmlImprovements in Capital StandardsIn the aftermath of the financial crisis, there has been an intensive international effort to strengthen bank capital standards. The result of these efforts is the Basel III capital agreement. In broad terms, the Basel III capital standards aim to improve the quality and increase the level of bank capital. Collectively, Basel III and other standards published by the Basel Committee address a number of features of capital regulation that allowed for an excessive use of leverage in the years leading up to the crisis. There are a number of such issues that are being addressed by Basel III and in a complementary way by the Dodd-Frank Act.
One of the lessons of the crisis was that high quality, loss-absorbing capital is essential to ensuring the safety and soundness of financial institutions. Basel III addresses this by establishing regulatory capital as "common equity tier 1." This results in a measure that is much closer to pure tangible common equity than the present tier 1 definition. Meeting regulatory requirements for common equity tier 1 capital will provide a much more realistic and meaningful assurance of a bank's ability to absorb losses.
In addition to the definition and quality of capital, Basel III also addresses the level of capital. At the beginning of the crisis, as today, the minimum tier 1 risk-based capital requirement was 4 percent of risk-weighted assets. Tier 1 capital was required to be "predominantly" equity. Thus, equity could comprise as little as 2 percent of risk-weighted assets.
Basel III increases the numerical minimum risk-based capital ratios. For the new concept of common equity tier 1, the Basel III minimum ratio is 4.5 percent of risk-weighted assets. For tier 1 and total capital the Basel III minimums are 6 percent and 8 percent, respectively. Capital buffers comprising common equity equal to 2.5 percent of risk-weighted assets are added to each of these minimums to enable banks to absorb losses during a stressed period while remaining above their regulatory minimum ratios.
Basel III also includes a "counter-cyclical buffer" intended to act as a stabilizer against significant asset bubbles as they develop. Specifically, regulators could increase the capital buffers by up to an additional 2.5 percent if they deem the economy to be in a period of excessive credit creation.
Basel III establishes, for the first time, an international leverage ratio. The Basel III leverage ratio is an important tool to ensure that capital exists to cover losses that the risk-based rules may categorize as minimal, but that can sometimes materialize anyway. The Basel Committee has also agreed that the largest internationally active banks should be subject to additional capital charges ranging from 1 percent to 2.5 percent of risk-weighted assets to account for the additional risk they pose to the financial system should they experience difficulties.2
In addition, to strengthen capital standards for trading book risk, the U.S. banking agencies issued a Notice of Proposed Rulemaking (NPR) in January 2011, to implement important reforms agreed to by the Basel Committee. These reforms will increase capital requirements to levels more appropriate for trading book assets. A second Market Risk NPR was issued in December 2011 to respond to section 939A of the Dodd-Frank Act. This NPR provides an alternative to credit ratings in computing trading book capital requirements. We are committed to working with our fellow regulators to finalize the important reforms to trading book capital requirements as soon as possible upon reviewing and appropriately addressing the public comments we receive.
The Basel Committee agreed that Basel III would be phased-in over a five-year period starting in 2013, and the banking agencies are drafting an NPR to implement Basel III in the United States. We believe that most U.S. banks currently hold sufficient capital to meet the Basel III capital standards. Banks that need more time by and large appear well positioned to meet the standards far ahead of the Basel timeline and mostly with retained earnings. Now that agreement has been reached on a more robust international capital standard, it is vital that the standard be implemented in a uniform manner. A comprehensive monitoring framework will be coordinated by the Basel Committee's Standards Implementation Group and will rely on peer reviews. It entails a review of members' domestic adoption and implementation timelines for the Basel regulatory capital framework.