Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule

Federal RegisterOct 11, 2013

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Parts 3, 5, 6, 165, and 167

[Docket ID OCC-2012-0008]

RIN 1557-AD46

FEDERAL RESERVE SYSTEM

12 CFR Parts 208, 217, and 225

[Docket No. R-1442; Regulations H, Q, and Y]

RIN 7100-AD 87

Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule

AGENCY:

Office of the Comptroller of the Currency, Treasury; and the Board of Governors of the Federal Reserve System.

ACTION:

Final rule.

SUMMARY:

The Office of the Comptroller of the Currency (OCC) and Board of Governors of the Federal Reserve System (Board), are adopting a final rule that revises their risk-based and leverage capital requirements for banking organizations. The final rule consolidates three separate notices of proposed rulemaking that the OCC, Board, and FDIC published in the

Federal Register

on August 30, 2012, with selected changes. The final rule implements a revised definition of regulatory capital, a new common equity tier 1 minimum capital requirement, a higher minimum tier 1 capital requirement, and, for banking organizations subject to the advanced approaches risk-based capital rules, a supplementary leverage ratio that incorporates a broader set of exposures in the denominator. The final rule incorporates these new requirements into the agencies' prompt corrective action (PCA) framework. In addition, the final rule establishes limits on a banking organization's capital distributions and certain discretionary bonus payments if the banking organization does not hold a specified amount of common equity tier 1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements. Further, the final rule amends the methodologies for determining risk-weighted assets for all banking organizations, and introduces disclosure requirements that would apply to top-tier banking organizations domiciled in the United States with $50 billion or more in total assets. The final rule also adopts changes to the agencies' regulatory capital requirements that meet the requirements of section 171 and section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The final rule also codifies the agencies' regulatory capital rules, which have previously resided in various appendices to their respective regulations, into a harmonized integrated regulatory framework. In addition, the OCC is amending the market risk capital rule (market risk rule) to apply to Federal savings associations, and the Board is amending the advanced approaches and market risk rules to apply to top-tier savings and loan holding companies domiciled in the United States, except for certain savings and loan holding companies that are substantially engaged in insurance underwriting or commercial activities, as described in this preamble.

DATES:

Effective date:

January 1, 2014, except that the amendments to Appendixes A, B and E to 12 CFR Part 208, 12 CFR 225.1, and Appendixes D and E to Part 225 are effective January 1, 2015, and the amendment to Appendix A to 12 CFR Part 225 is effective January 1, 2019.

Mandatory compliance date:

January 1, 2014 for advanced approaches banking organizations that are not savings and loan holding companies; January 1, 2015 for all other covered banking organizations.

FOR FURTHER INFORMATION CONTACT:

OCC: Margot Schwadron, Senior Risk Expert, (202) 649-6982; David Elkes, Risk Expert, (202) 649-6984; Mark Ginsberg, Risk Expert, (202) 649-6983, Capital Policy; or Ron Shimabukuro, Senior Counsel; Patrick Tierney, Special Counsel; Carl Kaminski, Senior Attorney; or Kevin Korzeniewski, Attorney, Legislative and Regulatory Activities Division, (202) 649-5490, Office of the Comptroller of the Currency, 400 7th Street SW., Washington, DC 20219.

Board: Anna Lee Hewko, Deputy Associate Director, (202) 530-6260; Thomas Boemio, Manager, (202) 452-2982; Constance M. Horsley, Manager, (202) 452-5239; Juan C. Climent, Senior Supervisory Financial Analyst, (202) 872-7526; or Elizabeth MacDonald, Senior Supervisory Financial Analyst, (202) 475-6316, Capital and Regulatory Policy, Division of Banking Supervision and Regulation; or Benjamin McDonough, Senior Counsel, (202) 452-2036; April C. Snyder, Senior Counsel, (202) 452-3099; Christine Graham, Senior Attorney, (202) 452-3005; or David Alexander, Senior Attorney, (202) 452-2877, Legal Division, Board of Governors of the Federal Reserve System, 20th and C Streets NW., Washington, DC 20551. For the hearing impaired only, Telecommunication Device for the Deaf (TDD), (202) 263-4869.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction

II. Summary of the Three Notices of Proposed Rulemaking

A. The Basel III Notice of Proposed Rulemaking

B. The Standardized Approach Notice of Proposed Rulemaking

C. The Advanced Approaches Notice of Proposed Rulemaking

III. Summary of General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking; Overview of the Final Rule

A. General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking

1. Applicability and Scope

2. Aggregate Impact

3. Competitive Concerns

4. Costs

B. Comments on Particular Aspects of the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking

1. Accumulated Other Comprehensive Income

2. Residential Mortgages

3. Trust Preferred Securities for Smaller Banking Organizations

4. Insurance Activities

C. Overview of the Final Rule

D. Timeframe for Implementation and Compliance

IV. Minimum Regulatory Capital Ratios, Additional Capital Requirements, and Overall Capital Adequacy

A. Minimum Risk-Based Capital Ratios and Other Regulatory Capital Provisions

B. Leverage Ratio

C. Supplementary Leverage Ratio for Advanced Approaches Banking Organizations

D. Capital Conservation Buffer

E. Countercyclical Capital Buffer

F. Prompt Corrective Action Requirements

G. Supervisory Assessment of Overall Capital Adequacy

H. Tangible Capital Requirement for Federal Savings Associations

V. Definition of Capital

A. Capital Components and Eligibility Criteria for Regulatory Capital Instruments

1. Common Equity Tier 1 Capital

2. Additional Tier 1 Capital

3. Tier 2 Capital

4. Capital Instruments of Mutual Banking Organizations

5. Grandfathering of Certain Capital Instruments

6. Agency Approval of Capital Elements

7. Addressing the Point of Non-Viability Requirements Under Basel III

8. Qualifying Capital Instruments Issued by Consolidated Subsidiaries of a Banking Organization

9. Real Estate Investment Trust Preferred Capital

B. Regulatory Adjustments and Deductions

1. Regulatory Deductions From Common Equity Tier 1 Capital

a. Goodwill and Other Intangibles (Other Than Mortgage Servicing Assets)

b. Gain-on-sale Associated With a Securitization Exposure

c. Defined Benefit Pension Fund Net Assets

d. Expected Credit Loss That Exceeds Eligible Credit Reserves

e. Equity Investments in Financial Subsidiaries

f. Deduction for Subsidiaries of Savings Associations That Engage in Activities That Are Not Permissible for National Banks

2. Regulatory Adjustments to Common Equity Tier 1 Capital

a. Accumulated Net Gains and Losses on Certain Cash-Flow Hedges

b. Changes in a Banking Organization's Own Credit Risk

c. Accumulated Other Comprehensive Income

d. Investments in Own Regulatory Capital Instruments

e. Definition of Financial Institution

f. The Corresponding Deduction Approach

g. Reciprocal Crossholdings in the Capital Instruments of Financial Institutions

h. Investments in the Banking Organization's Own Capital Instruments or in the Capital of Unconsolidated Financial Institutions

i. Indirect Exposure Calculations

j. Non-Significant Investments in the Capital of Unconsolidated Financial Institutions

k. Significant Investments in the Capital of Unconsolidated Financial Institutions That Are Not in the Form of Common Stock

l. Items Subject to the 10 and 15 Percent Common Equity Tier 1 Capital Threshold Deductions

m. Netting of Deferred Tax Liabilities Against Deferred Tax Assets and Other Deductible Assets

3. Investments in Hedge Funds and Private Equity Funds Pursuant to Section 13 of the Bank Holding Company Act

VI. Denominator Changes Related to the Regulatory Capital Changes

VII. Transition Provisions

A. Transitions Provisions for Minimum Regulatory Capital Ratios

B. Transition Provisions for Capital Conservation and Countercyclical Capital Buffers

C. Transition Provisions for Regulatory Capital Adjustments and Deductions

1. Deductions for Certain Items Under Section 22(a) of the Final Rule

2. Deductions for Intangibles Other Than Goodwill and Mortgage Servicing Assets

3. Regulatory Adjustments Under Section 22(b)(1) of the Final Rule

4. Phase-out of Current Accumulated Other Comprehensive Income Regulatory Capital Adjustments

5. Phase-out of Unrealized Gains on Available for Sale Equity Securities in Tier 2 Capital

6. Phase-in of Deductions Related to Investments in Capital Instruments and to the Items Subject to the 10 and 15 Percent Common Equity Tier 1 Capital Deduction Thresholds (Sections 22(c) and 22(d)) of the Final Rule

D. Transition Provisions for Non-qualifying Capital Instruments

1. Depository Institution Holding Companies With Less Than $15 Billion in Total Consolidated Assets as of December 31, 2009 and 2010 Mutual Holding Companies

2. Depository Institutions

3. Depository Institution Holding Companies With $15 Billion or More in Total Consolidated Assets as of December 31, 2009 That Are Not 2010 Mutual Holding Companies

4. Merger and Acquisition Transition Provisions

5. Phase-out Schedule for Surplus and Non-Qualifying Minority Interest

VIII. Standardized Approach for Risk-weighted Assets

A. Calculation of Standardized Total Risk-weighted Assets

B. Risk-weighted Assets for General Credit Risk

1. Exposures to Sovereigns

2. Exposures to Certain Supranational Entities and Multilateral Development Banks

3. Exposures to Government-sponsored Enterprises

4. Exposures to Depository Institutions, Foreign Banks, and Credit Unions

5. Exposures to Public-sector Entities

6. Corporate Exposures

7. Residential Mortgage Exposures

8. Pre-sold Construction Loans and Statutory Multifamily Mortgages

9. High-volatility Commercial Real Estate

10. Past-Due Exposures

11. Other Assets

C. Off-balance Sheet Items

1. Credit Conversion Factors

2. Credit-Enhancing Representations and Warranties

D. Over-the-Counter Derivative Contracts

E. Cleared Transactions

1. Definition of Cleared Transaction

2. Exposure Amount Scalar for Calculating for Client Exposures

3. Risk Weighting for Cleared Transactions

4. Default Fund Contribution Exposures

F. Credit Risk Mitigation

1. Guarantees and Credit Derivatives

a. Eligibility Requirements

b. Substitution Approach

c. Maturity Mismatch Haircut

d. Adjustment for Credit Derivatives Without Restructuring as a Credit Event

e. Currency Mismatch Adjustment

f. Multiple Credit Risk Mitigants

2. Collateralized Transactions

a. Eligible Collateral

b. Risk-management Guidance for Recognizing Collateral

c. Simple Approach

d. Collateral Haircut Approach

e. Standard Supervisory Haircuts

f. Own Estimates of Haircuts

g. Simple Value-at-Risk and Internal Models Methodology

G. Unsettled Transactions

H. Risk-weighted Assets for Securitization Exposures

1. Overview of the Securitization Framework and Definitions

2. Operational Requirements

a. Due Diligence Requirements

b. Operational Requirements for Traditional Securitizations

c. Operational Requirements for Synthetic Securitizations

d. Clean-up Calls

3. Risk-weighted Asset Amounts for Securitization Exposures

a. Exposure Amount of a Securitization Exposure

b. Gains-on-sale and Credit-enhancing Interest-only Strips

c. Exceptions Under the Securitization Framework

d. Overlapping Exposures

e. Servicer Cash Advances

f. Implicit Support

4. Simplified Supervisory Formula Approach

5. Gross-up Approach

6. Alternative Treatments for Certain Types of Securitization Exposures

a. Eligible Asset-backed Commercial Paper Liquidity Facilities

b. A Securitization Exposure in a Second-loss Position or Better to an Asset-Backed Commercial Paper Program

Credit Risk Mitigation for Securitization Exposures

8. N

-to-default Credit Derivatives

IX. Equity Exposures

A. Definition of Equity Exposure and Exposure Measurement

B. Equity Exposure Risk Weights

C. Non-significant Equity Exposures

D. Hedged Transactions

E. Measures of Hedge Effectiveness

F. Equity Exposures to Investment Funds

1. Full Look-Through Approach

2. Simple Modified Look-Through Approach

3. Alternative Modified Look-Through Approach

X. Insurance-related Activities

A. Policy Loans

B. Separate Accounts

C. Additional Deductions—Insurance Underwriting Subsidiaries

XI. Market Discipline and Disclosure Requirements

A. Proposed Disclosure Requirements

B. Frequency of Disclosures

C. Location of Disclosures and Audit Requirements

D. Proprietary and Confidential Information

E. Specific Public Disclosure Requirements

XII. Risk-Weighted Assets—Modifications to the Advanced Approaches

A. Counterparty Credit Risk

1. Recognition of Financial Collateral

a. Financial Collateral

b. Revised Supervisory Haircuts

2. Holding Periods and the Margin Period of Risk

3. Internal Models Methodology

a. Recognition of Wrong-Way Risk

b. Increased Asset Value Correlation Factor

4. Credit Valuation Adjustments

a. Simple Credit Valuation Adjustment Approach

b. Advanced Credit Valuation Adjustment Approach

5. Cleared Transactions (Central Counterparties)

6. Stress Period for Own Estimates

B. Removal of Credit Ratings

1. Eligible Guarantor

2. Money Market Fund Approach

3. Modified Look-through Approaches for Equity Exposures to Investment Funds

C. Revisions to the Treatment of Securitization Exposures

1. Definitions

2. Operational Criteria for Recognizing Risk Transference in Traditional Securitizations

3. The Hierarchy of Approaches

4. Guarantees and Credit Derivatives Referencing a Securitization Exposure

5. Due Diligence Requirements for Securitization Exposures

6. N

-to-Default Credit Derivatives

D. Treatment of Exposures Subject to Deduction

E. Technical Amendments to the Advanced Approaches Rule

1. Eligible Guarantees and Contingent U.S. Government Guarantees

2. Calculation of Foreign Exposures for Applicability of the Advanced Approaches—Insurance Underwriting Subsidiaries

3. Calculation of Foreign Exposures for Applicability of the Advanced Approaches—Changes to Federal Financial Institutions Examination Council 009

4. Applicability of the Final Rule

5. Change to the Definition of Probability of Default Related to Seasoning

6. Cash Items in Process of Collection

7. Change to the Definition of Qualifying Revolving Exposure

8. Trade-related Letters of Credit

9. Defaulted Exposures That Are Guaranteed by the U.S. Government

10. Stable Value Wraps

11. Treatment of Pre-Sold Construction Loans and Multi-Family Residential Loans

F. Pillar 3 Disclosures

1. Frequency and Timeliness of Disclosures

2. Enhanced Securitization Disclosure Requirements

3. Equity Holdings That Are Not Covered Positions

XIII. Market Risk Rule

XIV. Additional OCC Technical Amendments

XV. Abbreviations

XVI. Regulatory Flexibility Act

XVII. Paperwork Reduction Act

XVIII. Plain Language

XIX. OCC Unfunded Mandates Reform Act of 1995 Determinations

I. Introduction

On August 30, 2012, the Office of the Comptroller of the Currency (OCC) the Board of Governors of the Federal Reserve System (Board) (collectively, the agencies), and the Federal Deposit Insurance Corporation (FDIC) published in the

Federal Register

three joint notices of proposed rulemaking seeking public comment on revisions to their risk-based and leverage capital requirements and on methodologies for calculating risk-weighted assets under the standardized and advanced approaches (each, a proposal, and together, the NPRs, the proposed rules, or the proposals).

The proposed rules, in part, reflected agreements reached by the Basel Committee on Banking Supervision (BCBS) in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (Basel III), including subsequent changes to the BCBS's capital standards and recent BCBS consultative papers.

Basel III is intended to improve both the quality and quantity of banking organizations' capital, as well as to strengthen various aspects of the international capital standards for calculating regulatory capital. The proposed rules also reflect aspects of the Basel II Standardized Approach and other Basel Committee standards.

77 FR 52792 (August 30, 2012); 77 FR 52888 (August 30, 2012); 77 FR 52978 (August 30, 2012).

Basel III was published in December 2010 and revised in June 2011. The text is available at

http://www.bis.org/publ/bcbs189.htm.

The BCBS is a committee of banking supervisory authorities, which was established by the central bank governors of the G-10 countries in 1975. More information regarding the BCBS and its membership is available at

http://www.bis.org/bcbs/about.htm.

Documents issued by the BCBS are available through the Bank for International Settlements Web site at

http://www.bis.org.

The proposals also included changes consistent with the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act);

would apply the risk-based and leverage capital rules to top-tier savings and loan holding companies (SLHCs) domiciled in the United States; and would apply the market risk capital rule (the market risk rule)

to Federal and state savings associations (as appropriate based on trading activity).

Public Law 111-203, 124 Stat. 1376, 1435-38 (2010).

The agencies' and the FDIC's market risk rule is at 12 CFR part 3, appendix B (OCC); 12 CFR parts 208 and 225, appendix E (Board); and 12 CFR part 325, appendix C (FDIC).

The NPR titled “Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective Action”

(the Basel III NPR), provided for the implementation of the Basel III revisions to international capital standards related to minimum capital requirements, regulatory capital, and additional capital “buffer” standards to enhance the resilience of banking organizations to withstand periods of financial stress. (Banking organizations include national banks, state member banks, Federal savings associations, and top-tier bank holding companies domiciled in the United States not subject to the Board's Small Bank Holding Company Policy Statement (12 CFR part 225, appendix C)), as well as top-tier savings and loan holding companies domiciled in the United States, except certain savings and loan holding companies that are substantially engaged in insurance underwriting or commercial activities, as described in this preamble.) The proposal included transition periods for many of the requirements, consistent with Basel III and the Dodd-Frank Act. The NPR titled “Regulatory Capital Rules: Standardized Approach for Risk-weighted Assets; Market Discipline and Disclosure Requirements”

(the Standardized Approach NPR), would revise the methodologies for calculating risk-weighted assets in the agencies' and the FDIC's general risk-based capital rules

(the general risk-based capital rules), incorporating aspects of the Basel II standardized approach,

and establish alternative standards of creditworthiness in place of credit ratings, consistent with section 939A of the Dodd-Frank Act.

The proposed minimum capital requirements in section 10(a) of the Basel III NPR, as determined using the standardized capital ratio calculations in section 10(b), would establish minimum capital requirements that would be the “generally applicable” capital requirements for purpose of section 171 of the Dodd-Frank Act.

77 FR 52792 (August 30, 2012).

77 FR 52888 (August 30, 2012).

The agencies' and the FDIC's general risk-based capital rules are at 12 CFR part 3, appendix A (national banks) and 12 CFR part 167 (Federal savings associations) (OCC); 12 CFR parts 208 and 225, appendix A (Board); and 12 CFR part 325, appendix A, and 12 CFR part 390, subpart Z (FDIC). The general risk-based capital rules are supplemented by the market risk rule.

See

BCBS, “International Convergence of Capital Measurement and Capital Standards: A Revised Framework,” (June 2006), available at

http://www.bis.org/publ/bcbs128.htm (Basel II).

See

section 939A of the Dodd-Frank Act (15 U.S.C. 78o-7 note).

See

77 FR 52856 (August 30, 2012).

The NPR titled “Regulatory Capital Rules: Advanced Approaches Risk-Based Capital Rule; Market Risk Capital

Rule”

(the Advanced Approaches NPR) included proposed changes to the agencies' and the FDIC's current advanced approaches risk-based capital rules (the advanced approaches rule)

to incorporate applicable provisions of Basel III and the “Enhancements to the Basel II framework” (2009 Enhancements) published in July 2009

and subsequent consultative papers, to remove references to credit ratings, to apply the market risk rule to savings associations and SLHCs, and to apply the advanced approaches rule to SLHCs meeting the scope of application of those rules. Taken together, the three proposals also would have restructured the agencies' and the FDIC's regulatory capital rules (the general risk-based capital rules, leverage rules,

market risk rule, and advanced approaches rule) into a harmonized, codified regulatory capital framework.

77 FR 52978 (August 30, 2012).

The agencies' and the FDIC's advanced approaches rules are at 12 CFR part 3, appendix C (national banks) and 12 CFR part 167, appendix C (Federal savings associations) (OCC); 12 CFR part 208, appendix F, and 12 CFR part 225, appendix G (Board); 12 CFR part 325, appendix D, and 12 CFR part 390, subpart Z, appendix A (FDIC). The advanced approaches rules are supplemented by the market risk rule.

See

“Enhancements to the Basel II framework” (July 2009), available at

http://www.bis.org/publ/bcbs157.htm.

The agencies' and the FDIC's tier 1 leverage rules are at 12 CFR 3.6(b) and 3.6(c) (national banks) and 167.6 (Federal savings associations) (OCC); 12 CFR part 208, appendix B, and 12 CFR part 225, appendix D (Board); and 12 CFR 325.3, and 390.467 (FDIC).

The agencies are adopting the Basel III NPR, Standardized Approach NPR, and Advanced Approaches NPR in this final rule, with certain changes to the proposals, as described further below. (The Board approved this final rule on July 2, 2013, and the OCC approved this final rule on July 9, 2013. The FDIC approved a similar regulation as an interim final rule on July 9, 2013.) This final rule applies to all banking organizations currently subject to minimum capital requirements, including national banks, state member banks, state nonmember banks, state and Federal savings associations, top-tier bank holding companies (BHCs) that are domiciled in the United States and are not subject to the Board's Small Bank Holding Company Policy Statement, and top-tier SLHCs that are domiciled in the United States and that do not engage substantially in insurance underwriting or commercial activities, as discussed further below (together, banking organizations). Generally, BHCs with total consolidated assets of less than $500 million (small BHCs) remain subject to the Board's Small Bank Holding Company Policy Statement.

See

12 CFR part 225, appendix C (Small Bank Holding Company Policy Statement).

Certain aspects of this final rule apply only to banking organizations subject to the advanced approaches rule (advanced approaches banking organizations) or to banking organizations with significant trading activities, as further described below.

Likewise, the enhanced disclosure requirements in the final rule apply only to banking organizations with $50 billion or more in total consolidated assets. Consistent with section 171 of the Dodd-Frank Act, a BHC subsidiary of a foreign banking organization that is currently relying on the Board's Supervision and Regulation Letter (SR) 01-1 is not required to comply with the requirements of the final rule until July 21, 2015. Thereafter, all top-tier U.S.-domiciled BHC subsidiaries of foreign banking organizations will be required to comply with the final rule, subject to applicable transition arrangements set forth in subpart G of the rule.

The final rule reorganizes the agencies' regulatory capital rules into a harmonized, codified regulatory capital framework.

See

section 171(b)(4)(E) of the Dodd-Frank Act (12 U.S.C. 5371(b)(4)(E)); see also SR 01-1 (January 5, 2001), available at

http://www.federalreserve.gov/boarddocs/srletters/2001/sr0101.htm

. In addition, the Board has proposed to apply specific enhanced capital standards to certain U.S. subsidiaries of foreign banking organizations beginning on July 1, 2015, under the proposed notice of rulemaking issued by the Board to implement sections 165 and 166 of the Dodd-Frank Act. See 77 FR 76628, 76640, 76681-82 (December 28, 2012).

As under the proposal, the minimum capital requirements in section 10(a) of the final rule, as determined using the standardized capital ratio calculations in section 10(b), which apply to all banking organizations, establish the “generally applicable” capital requirements under section 171 of the Dodd-Frank Act.

See

note 12,

supra.

Risk-weighted assets calculated under the market risk framework in subpart F of the final rule are included in calculations of risk-weighted assets both under the standardized approach and the advanced approaches.

Under the final rule, as under the proposal, in order to determine its minimum risk-based capital requirements, an advanced approaches banking organization that has completed the parallel run process and that has received notification from its primary Federal supervisor pursuant to section 121(d) of subpart E must determine its minimum risk-based capital requirements by calculating the three risk-based capital ratios using total risk-weighted assets under the standardized approach and, separately, total risk-weighted assets under the advanced approaches.

The lower ratio for each risk-based capital requirement is the ratio the banking organization must use to determine its compliance with the minimum capital requirement.

These enhanced prudential standards help ensure that advanced approaches banking organizations, which are among the largest and most complex banking organizations, have capital adequate to address their more complex operations and risks.

The banking organization must also use its advanced-approaches-adjusted total to determine its total risk-based capital ratio.

See

section 10(c) of the final rule.

II. Summary of the Three Notices of Proposed Rulemaking

A. The Basel III Notice of Proposed Rulemaking

As discussed in the proposals, the recent financial crisis demonstrated that the amount of high-quality capital held by banking organizations was insufficient to absorb the losses generated over that period. In addition, some non-common stock capital instruments included in tier 1 capital did not absorb losses to the extent previously expected. A lack of clear and easily understood disclosures regarding the characteristics of regulatory capital instruments, as well as inconsistencies in the definition of capital across jurisdictions, contributed to difficulties in evaluating a banking organization's capital strength. Accordingly, the BCBS assessed the international capital framework and, in 2010, published Basel III, a comprehensive reform package designed to improve the quality and quantity of regulatory capital and build additional capacity into the banking system to absorb losses in times of market and economic stress. On August 30, 2012, the agencies and the FDIC published the NPRs in the

Federal Register

to revise regulatory capital requirements, as discussed above. As proposed, the Basel III NPR generally would have applied to all U.S. banking organizations.

Consistent with Basel III, the Basel III NPR would have required banking organizations to comply with the following minimum capital ratios: (i) A new requirement for a ratio of common equity tier 1 capital to risk-weighted assets (common equity tier 1 capital ratio) of 4.5 percent; (ii) a ratio of tier 1 capital to risk-weighted assets (tier 1 capital ratio) of 6 percent, increased from 4 percent; (iii) a ratio of total capital to risk-weighted assets (total capital ratio) of 8 percent; (iv) a ratio of

tier 1 capital to average total consolidated assets (leverage ratio) of 4 percent; and (v) for advanced approaches banking organizations only, an additional requirement that the ratio of tier 1 capital to total leverage exposure (supplementary leverage ratio) be at least 3 percent.

The Basel III NPR also proposed implementation of a capital conservation buffer equal to 2.5 percent of risk-weighted assets above the minimum risk-based capital ratio requirements, which could be expanded by a countercyclical capital buffer for advanced approaches banking organizations under certain circumstances. If a banking organization failed to hold capital above the minimum capital ratios and proposed capital conservation buffer (as potentially expanded by the countercyclical capital buffer), it would be subject to certain restrictions on capital distributions and discretionary bonus payments. The proposed countercyclical capital buffer was designed to take into account the macro-financial environment in which large, internationally active banking organizations function. The countercyclical capital buffer could be implemented if the agencies and the FDIC determined that credit growth in the economy became excessive. As proposed, the countercyclical capital buffer would initially be set at zero, and could expand to as much as 2.5 percent of risk-weighted assets.

The Basel III NPR proposed to apply a 4 percent minimum leverage ratio requirement to all banking organizations (computed using the new definition of capital), and to eliminate the exceptions for banking organizations with strong supervisory ratings or subject to the market risk rule. The Basel III NPR also proposed to require advanced approaches banking organizations to satisfy a minimum supplementary leverage ratio requirement of 3 percent, measured in a manner consistent with the international leverage ratio set forth in Basel III. Unlike the agencies' current leverage ratio requirement, the proposed supplementary leverage ratio incorporates certain off-balance sheet exposures in the denominator.

To strengthen the quality of capital, the Basel III NPR proposed more conservative eligibility criteria for regulatory capital instruments. For example, the Basel III NPR proposed that trust preferred securities (TruPS) and cumulative perpetual preferred securities, which were tier-1-eligible instruments (subject to limits) at the BHC level, would no longer be includable in tier 1 capital under the proposal and would be gradually phased out from tier 1 capital. The proposal also eliminated the existing limitations on the amount of tier 2 capital that could be recognized in total capital, as well as the limitations on the amount of certain capital instruments (for example, term subordinated debt) that could be included in tier 2 capital.

In addition, the proposal would have required banking organizations to include in common equity tier 1 capital accumulated other comprehensive income (AOCI) (with the exception of gains and losses on cash-flow hedges related to items that are not fair-valued on the balance sheet), and also would have established new limits on the amount of minority interest a banking organization could include in regulatory capital. The proposal also would have established more stringent requirements for several deductions from and adjustments to regulatory capital, including with respect to deferred tax assets (DTAs), investments in a banking organization's own capital instruments and the capital instruments of other financial institutions, and mortgage servicing assets (MSAs). The proposed revisions would have been incorporated into the regulatory capital ratios in the prompt corrective action (PCA) framework for depository institutions.

B. The Standardized Approach Notice of Proposed Rulemaking

The Standardized Approach NPR proposed changes to the agencies' and the FDIC's general risk-based capital rules for determining risk-weighted assets (that is, the calculation of the denominator of a banking organization's risk-based capital ratios). The proposed changes were intended to revise and harmonize the agencies' and the FDIC's rules for calculating risk-weighted assets, enhance risk sensitivity, and address weaknesses in the regulatory capital framework identified over recent years, including by strengthening the risk sensitivity of the regulatory capital treatment for, among other items, credit derivatives, central counterparties (CCPs), high-volatility commercial real estate, and collateral and guarantees.

In the Standardized Approach NPR, the agencies and the FDIC also proposed alternatives to credit ratings for calculating risk-weighted assets for certain assets, consistent with section 939A of the Dodd-Frank Act. These alternatives included methodologies for determining risk-weighted assets for exposures to sovereigns, foreign banks, and public sector entities, securitization exposures, and counterparty credit risk. The Standardized Approach NPR also proposed to include a framework for risk weighting residential mortgages based on underwriting and product features, as well as loan-to-value (LTV) ratios, and disclosure requirements for top-tier banking organizations domiciled in the United States with $50 billion or more in total assets, including disclosures related to regulatory capital instruments.

C. The Advanced Approaches Notice of Proposed Rulemaking

The Advanced Approaches NPR proposed revisions to the advanced approaches rule to incorporate certain aspects of Basel III, the 2009 Enhancements, and subsequent consultative papers. The proposal also would have implemented relevant provisions of the Dodd-Frank Act, including section 939A (regarding the use of credit ratings in agency regulations),

and incorporated certain technical amendments to the existing requirements. In addition, the Advanced Approaches NPR proposed to codify the market risk rule in a manner similar to the codification of the other regulatory capital rules under the proposals.

See

section 939A of Dodd-Frank Act (15 U.S.C. 78o-7 note).

Consistent with Basel III and the 2009 Enhancements, under the Advanced Approaches NPR, the agencies and the FDIC proposed further steps to strengthen capital requirements for internationally active banking organizations. This NPR would have required advanced approaches banking organizations to hold more appropriate levels of capital for counterparty credit risk, credit valuation adjustments (CVA), and wrong-way risk; would have strengthened the risk-based capital requirements for certain securitization exposures by requiring advanced approaches banking organizations to conduct more rigorous credit analysis of securitization exposures; and would have enhanced the disclosure requirements related to those exposures.

The Board proposed to apply the advanced approaches rule to SLHCs, and the agencies and the FDIC proposed to apply the market risk rule to SLHCs and to state and Federal savings associations.

III. Summary of General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking; Overview of the Final Rule

A. General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking

Each agency received over 2,500 public comments on the proposals from banking organizations, trade associations, supervisory authorities, consumer advocacy groups, public officials (including members of the U.S. Congress), private individuals, and other interested parties. Overall, while most commenters supported more robust capital standards and the agencies' and the FDIC's efforts to improve the resilience of the banking system, many commenters expressed concerns about the potential costs and burdens of various aspects of the proposals, particularly for smaller banking organizations. A substantial number of commenters also requested withdrawal of, or significant revisions to, the proposals. A few commenters argued that new capital rules were not necessary at this time. Some commenters requested that the agencies and the FDIC perform additional studies of the economic impact of part or all of the proposed rules. Many commenters asked for additional time to transition to the new requirements. A more detailed discussion of the comments provided on particular aspects of the proposals is provided in the remainder of this preamble.

1. Applicability and Scope

The agencies and the FDIC received a significant number of comments regarding the proposed scope and applicability of the Basel III NPR and the Standardized Approach NPR. The majority of comments submitted by or on behalf of community banking organizations requested an exemption from the proposals. These commenters suggested basing such an exemption on a banking organization's asset size—for example, total assets of less than $500 million, $1 billion, $10 billion, $15 billion, or $50 billion—or on its risk profile or business model. Under the latter approach, the commenters suggested providing an exemption for banking organizations with balance sheets that rely less on leverage, short-term funding, or complex derivative transactions.

In support of an exemption from the proposed rule for community banking organizations, a number of commenters argued that the proposed revisions to the definition of capital would be overly conservative and would prohibit some of the instruments relied on by community banking organizations from satisfying regulatory capital requirements. Many of these commenters stated that, in general, community banking organizations have less access to the capital markets relative to larger banking organizations and could increase capital only by accumulating retained earnings. Owing to slow economic growth and relatively low earnings among community banking organizations, the commenters asserted that implementation of the proposal would be detrimental to their ability to serve local communities while providing reasonable returns to shareholders. Other commenters requested exemptions from particular sections of the proposed rules, such as maintaining capital against transactions with particular counterparties, or based on transaction types that they considered lower-risk, such as derivative transactions hedging interest rate risk.

The commenters also argued that application of the Basel III NPR and Standardized Approach NPR to community banking organizations would be unnecessary and inappropriate for the business model and risk profile of such organizations. These commenters asserted that Basel III was designed for large, internationally-active banking organizations in response to a financial crisis attributable primarily to those institutions. Accordingly, the commenters were of the view that community banking organizations require a different capital framework with less stringent capital requirements, or should be allowed to continue to use the general risk-based capital rules. In addition, many commenters, in particular minority depository institutions (MDIs), mutual banking organizations, and community development financial institutions (CDFIs), expressed concern regarding their ability to raise capital to meet the increased minimum requirements in the current environment and upon implementation of the proposed definition of capital. One commenter asked for an exemption from all or part of the proposed rules for CDFIs, indicating that the proposal would significantly reduce the availability of capital for low- and moderate-income communities. Another commenter stated that the U.S. Congress has a policy of encouraging the creation of MDIs and expressed concern that the proposed rules contradicted this purpose.

In contrast, however, a few commenters supported the proposed application of the Basel III NPR to all banking organizations. For example, one commenter stated that increasing the quality and quantity of capital at all banking organizations would create a more resilient financial system and discourage inappropriate risk-taking by forcing banking organizations to put more of their own “skin in the game.” This commenter also asserted that the proposed scope of the Basel III NPR would reduce the probability and impact of future financial crises and support the objectives of sustained growth and high employment. Another commenter favored application of the Basel III NPR to all banking organizations to ensure a level playing field among banking organizations within the same competitive market.

Comments submitted by or on behalf of banking organizations that are engaged primarily in insurance activities also requested an exemption from the Basel III NPR and the Standardized Approach NPR to recognize differences in their business model compared with those of more traditional banking organizations. According to the commenters, the activities of these organizations are fundamentally different from traditional banking organizations and have a unique risk profile. One commenter expressed concern that the Basel III NPR focuses primarily on assets in the denominator of the risk-based capital ratio as the primary basis for determining capital requirements, in contrast to capital requirements for insurance companies, which are based on the relationship between a company's assets and liabilities. Similarly, other commenters expressed concern that bank-centric rules would conflict with the capital requirements of state insurance regulators and provide regulatory incentives for unsound asset-liability mismatches. Several commenters argued that the U.S. Congress intended that banking organizations primarily engaged in insurance activities should be covered by different capital regulations that accounted for the characteristics of insurance activities. These commenters, therefore, encouraged the agencies and the FDIC to recognize capital requirements adopted by state insurance regulators. Further, commenters asserted that the agencies and the FDIC did not appropriately consider regulatory capital requirements for insurance-based banking organizations

whose banking operations are a small part of their overall operations.

Some SLHC commenters that are substantially engaged in commercial activities also asserted that the proposals would be inappropriate in scope as proposed and asked that capital rules not be applied to them until an intermediate holding company regime could be established. They also requested that any capital regime applicable to them be tailored to take into consideration their commercial operations and that they be granted longer transition periods.

As noted above, small BHCs are exempt from the final rule (consistent with the proposals and section 171 of the Dodd-Frank Act) and continue to be subject to the Board's Small Bank Holding Company Policy Statement. Comments submitted on behalf of SLHCs with assets less than $500 million requested an analogous exemption to that for small BHCs. These commenters argued that section 171 of the Dodd-Frank Act does not prohibit such an exemption for small SLHCs.

2. Aggregate Impact

A majority of the commenters expressed concern regarding the potential aggregate impact of the proposals, together with other provisions of the Dodd-Frank Act. Some of these commenters urged the agencies and the FDIC to withdraw the proposals and to conduct a quantitative impact study (QIS) to assess the potential aggregate impact of the proposals on banking organizations and the overall U.S. economy. Many commenters argued that the proposals would have significant negative consequences for the financial services industry. According to the commenters, by requiring banking organizations to hold more capital and increase risk weighting on some of their assets, as well as to meet higher risk-based and leverage capital measures for certain PCA categories, the proposals would negatively affect the banking sector. Commenters cited, among other potential consequences of the proposals: restricted job growth; reduced lending or higher-cost lending, including to small businesses and low-income or minority communities; limited availability of certain types of financial products; reduced investor demand for banking organizations' equity; higher compliance costs; increased mergers and consolidation activity, specifically in rural markets, because banking organizations would need to spread compliance costs among a larger customer base; and diminished access to the capital markets resulting from reduced profit and from dividend restrictions associated with the capital buffers. The commenters also asserted that the recovery of the U.S. economy would be impaired by the proposals as a result of reduced lending by banking organizations that the commenters believed would be attributable to the higher costs of regulatory compliance. In particular, the commenters expressed concern that a contraction in small-business lending would adversely affect job growth and employment.

3. Competitive Concerns

Many commenters raised concerns that implementation of the proposals would create an unlevel playing field between banking organizations and other financial services providers. For example, a number of commenters expressed concern that credit unions would be able to gain market share from banking organizations by offering similar products at substantially lower costs because of differences in taxation combined with potential costs from the proposals. The commenters also argued that other financial service providers, such as foreign banks with significant U.S. operations, members of the Federal Farm Credit System, and entities in the shadow banking industry, would not be subject to the proposed rule and, therefore, would have a competitive advantage over banking organizations. These commenters also asserted that the proposals could cause more consumers to choose lower-cost financial products from the unregulated, nonbank financial sector.

4. Costs

Commenters representing all types of banking organizations expressed concern that the complexity and implementation cost of the proposals would exceed their expected benefits. According to these commenters, implementation of the proposals would require software upgrades for new internal reporting systems, increased employee training, and the hiring of additional employees for compliance purposes. Some commenters urged the agencies and the FDIC to recognize that compliance costs have increased significantly over recent years due to other regulatory changes and to take these costs into consideration. As an alternative, some commenters encouraged the agencies and the FDIC to consider a simple increase in the minimum regulatory capital requirements, suggesting that such an approach would provide increased protection to the Deposit Insurance Fund and increase safety and soundness without adding complexity to the regulatory capital framework.

B. Comments on Particular Aspects of the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking

In addition to the general comments described above, the agencies and the FDIC received a significant number of comments on four particular elements of the proposals: the requirement to include most elements of AOCI in regulatory capital; the new framework for risk weighting residential mortgages; the requirement to phase out TruPS from tier 1 capital for all banking organizations; and the application of the rule to BHCs and SLHCs (collectively, depository institution holding companies) with substantial insurance and commercial activities.

1. Accumulated Other Comprehensive Income

AOCI generally includes accumulated unrealized gains and losses on certain assets and liabilities that have not been included in net income, yet are included in equity under U.S. generally accepted accounting principles (GAAP) (for example, unrealized gains and losses on securities designated as available-for-sale (AFS)). Under the agencies' and the FDIC's general risk-based capital rules, most components of AOCI are not reflected in a banking organization's regulatory capital. In the proposed rule, consistent with Basel III, the agencies and the FDIC proposed to require banking organizations to include the majority of AOCI components in common equity tier 1 capital.

The agencies and the FDIC received a significant number of comments on the proposal to require banking organizations to recognize AOCI in common equity tier 1 capital. Generally, the commenters asserted that the proposal would introduce significant volatility in banking organizations' capital ratios due in large part to fluctuations in benchmark interest rates, and would result in many banking organizations moving AFS securities into a held-to-maturity (HTM) portfolio or holding additional regulatory capital solely to mitigate the volatility resulting from temporary unrealized gains and losses in the AFS securities portfolio. The commenters also asserted that the proposed rules would likely impair lending and negatively affect banking organizations' ability to manage liquidity and interest rate risk and to maintain compliance with legal lending limits. Commenters representing community banking organizations in

particular asserted that they lack the sophistication of larger banking organizations to use certain risk-management techniques for hedging interest rate risk, such as the use of derivative instruments.

2. Residential Mortgages

The Standardized Approach NPR would have required banking organizations to place residential mortgage exposures into one of two categories to determine the applicable risk weight. Category 1 residential mortgage exposures were defined to include mortgage products with underwriting and product features that have demonstrated a lower risk of default, such as consideration and documentation of a borrower's ability to repay, and generally excluded mortgage products that included terms or other characteristics that the agencies and the FDIC have found to be indicative of higher credit risk, such as deferral of repayment of principal. Residential mortgage exposures with higher risk characteristics were defined as category 2 residential mortgage exposures. The agencies and the FDIC proposed to apply relatively lower risk weights to category 1 residential mortgage exposures, and higher risk weights to category 2 residential mortgage exposures. The proposal provided that the risk weight assigned to a residential mortgage exposure also depended on its LTV ratio.

The agencies and the FDIC received a significant number of comments objecting to the proposed treatment for one-to-four family residential mortgages and requesting retention of the mortgage treatment in the agencies' and the FDIC's general risk-based capital rules. Commenters generally expressed concern that the proposed treatment would inhibit lending to creditworthy borrowers and could jeopardize the recovery of a still-fragile housing market. Commenters also criticized the distinction between category 1 and category 2 mortgages, asserting that the characteristics proposed for each category did not appropriately distinguish between lower- and higher-risk products and would adversely impact certain loan products that performed relatively well even during the recent crisis. Commenters also highlighted concerns regarding regulatory burden and the uncertainty of other regulatory initiatives involving residential mortgages. In particular, these commenters expressed considerable concern regarding the potential cumulative impact of the proposed new mortgage requirements combined with the Dodd-Frank Act's requirements relating to the definitions of qualified mortgage and qualified residential mortgage

and asserted that when considered together with the proposed mortgage treatment, the combined effect could have an adverse impact on the mortgage industry.

See, e.g.,

the definition of “qualified mortgage” in section 1412 of the Dodd-Frank Act (15 U.S.C. 129C) and “qualified residential mortgage” in section 941(e)(4) of the Dodd-Frank Act (15 U.S.C. 78o-11(e)(4)).

3. Trust Preferred Securities for Smaller Banking Organizations

The proposed rules would have required all banking organizations to phase-out TruPS from tier 1 capital under either a 3- or 10-year transition period based on the organization's total consolidated assets. The proposal would have required banking organizations with more than $15 billion in total consolidated assets (as of December 31, 2009) to phase-out of tier 1 capital any non-qualifying capital instruments (such as TruPS and cumulative preferred shares) issued before May 19, 2010. The exclusion of non-qualifying capital instruments would have taken place incrementally over a three-year period beginning on January 1, 2013. Section 171 provides an exception that permits banking organizations with total consolidated assets of less than $15 billion as of December 31, 2009, and banking organizations that were mutual holding companies as of May 19, 2010 (2010 MHCs), to include in tier 1 capital all TruPS (and other instruments that could no longer be included in tier 1 capital pursuant to the requirements of section 171) that were issued prior to May 19, 2010.

However, consistent with Basel III and the general policy purpose of the proposed revisions to regulatory capital, the agencies and the FDIC proposed to require banking organizations with total consolidated assets less than $15 billion as of December 31, 2009 and 2010 MHCs to phase out their non-qualifying capital instruments from regulatory capital over ten years.

Specifically, section 171 provides that deductions of instruments “that would be required” under the section are not required for depository institution holding companies with total consolidated assets of less than $15 billion as of December 31, 2009 and 2010 MHCs.

See

12 U.S.C. 5371(b)(4)(C).

See

12 U.S.C. 5371(b)(5)(A). While section 171 of the Dodd-Frank Act requires the agencies to establish minimum risk-based and leverage capital requirements subject to certain limitations, the agencies and the FDIC retain their general authority to establish capital requirements under other laws and regulations, including under the National Bank Act, 12 U.S.C. 1,

et seq.,

Federal Reserve Act, Federal Deposit Insurance Act, Bank Holding Company Act, International Lending Supervision Act, 12 U.S.C. 3901,

et seq.,

and Home Owners Loan Act, 12 U.S.C. 1461,

et seq.

Many commenters representing community banking organizations criticized the proposal's phase-out schedule for TruPS and encouraged the agencies and the FDIC to grandfather TruPS in tier 1 capital to the extent permitted by section 171 of the Dodd-Frank Act. Commenters asserted that this was the intent of the U.S. Congress, including this provision in the statute. These commenters also asserted that this aspect of the proposal would unduly burden community banking organizations that have limited ability to raise capital, potentially impairing the lending capacity of these banking organizations.

4. Insurance Activities

The agencies and the FDIC received numerous comments from SLHCs, trade associations, insurance companies, and members of the U.S. Congress on the proposed capital requirements for SLHCs, in particular those with significant insurance activities. As noted above, commenters raised concerns that the proposed requirements would apply what are perceived as bank-centric consolidated capital requirements to these entities. Commenters suggested incorporating insurance risk-based capital requirements established by the state insurance regulators into the Board's consolidated risk-based capital requirements for the holding company, or including certain insurance risk-based metrics that, in the commenters' view, would measure the risk of insurance activities more accurately. A few commenters asked the Board to conduct an additional cost-benefit analysis prior to implementing the proposed capital requirements for this subset of SLHCs. In addition, several commenters expressed concern with the burden associated with the proposed requirement to prepare financial statements according to GAAP, because a few SLHCs with substantial insurance operations only prepare financial statements according to Statutory Accounting Principles (SAP). These commenters noted that the Board has accepted non-GAAP financial statements from foreign entities in the past for certain non-consolidated reporting requirements related to the foreign subsidiaries of U.S. banking organizations.

See

form FR 2314.

Some commenters stated that the proposal presents serious issues in light

of the McCarran-Ferguson Act.

These commenters stated that section 171 of the Dodd-Frank Act does not specifically refer to the business of insurance. Further, the commenters asserted that the proposal disregards the state-based regulatory capital and reserving regimes applicable to insurance companies and thus would impair the solvency laws enacted by the states for the purpose of regulating insurance. The commenters also said that the proposal would alter the risk-management practices and other aspects of the insurance business conducted in accordance with the state laws, in contravention of the McCarran-Ferguson Act. Some commenters also cited section 502 of the Dodd-Frank Act, asserting that it continues the primacy of state regulation of insurance companies.

The McCarran-Ferguson Act provides that “[N]o act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance . . . unless such Act specifically relates to the business of insurance.” 15 U.S.C. 1012.

31 U.S.C. 313(f).

C. Overview of the Final Rule

The final rule will replace the agencies' general risk-based capital rules, advanced approaches rule, market risk rule, and leverage rules in accordance with the transition provisions described below. After considering the comments received, the agencies have made substantial modifications in the final rule to address specific concerns raised by commenters regarding the cost, complexity, and burden of the proposals.

During the recent financial crisis, lack of confidence in the banking sector increased banking organizations' cost of funding, impaired banking organizations' access to short-term funding, depressed values of banking organizations' equities, and required many banking organizations to seek government assistance. Concerns about banking organizations arose not only because market participants expected steep losses on banking organizations' assets, but also because of substantial uncertainty surrounding estimated loss rates, and thus future earnings. Further, heightened systemic risks, falling asset values, and reduced credit availability had an adverse impact on business and consumer confidence, significantly affecting the overall economy. The final rule addresses these weaknesses by helping to ensure a banking and financial system that will be better able to absorb losses and continue to lend in future periods of economic stress. This important benefit in the form of a safer, more resilient, and more stable banking system is expected to substantially outweigh any short-term costs that might result from the final rule.

In this context, the agencies are adopting most aspects of the proposals, including the minimum risk-based capital requirements, the capital conservation and countercyclical capital buffers, and many of the proposed risk weights. The agencies have also decided to apply most aspects of the Basel III NPR and Standardized Approach NPR to all banking organizations, with some significant changes. Implementing the final rule in a consistent fashion across the banking system will improve the quality and increase the level of regulatory capital, leading to a more stable and resilient system for banking organizations of all sizes and risk profiles. The improved resilience will enhance their ability to continue functioning as financial intermediaries, including during periods of financial stress and reduce risk to the deposit insurance fund and to the financial system. The agencies believe that, together, the revisions to the proposals meaningfully address the commenters' concerns regarding the potential implementation burden of the proposals.

The agencies have considered the concerns raised by commenters and believe that it is important to take into account and address regulatory costs (and their potential effect on banking organizations' role as financial intermediaries in the economy) when the agencies establish or revise regulatory requirements. In developing regulatory capital requirements, these concerns are considered in the context of the agencies' broad goals—to enhance the safety and soundness of banking organizations and promote financial stability through robust capital standards for the entire banking system.

The agencies participated in the development of a number of studies to assess the potential impact of the revised capital requirements, including participating in the BCBS's Macroeconomic Assessment Group as well as its QIS, the results of which were made publicly available by the BCBS upon their completion.

The BCBS analysis suggested that stronger capital requirements help reduce the likelihood of banking crises while yielding positive net economic benefits.

To evaluate the potential reduction in economic output resulting from the new framework, the analysis assumed that banking organizations replaced debt with higher-cost equity to the extent needed to comply with the new requirements, that there was no reduction in the cost of equity despite the reduction in the riskiness of banking organizations' funding mix, and that the increase in funding cost was entirely passed on to borrowers. Given these assumptions, the analysis concluded there would be a slight increase in the cost of borrowing and a slight decrease in the growth of gross domestic product. The analysis concluded that this cost would be more than offset by the benefit to gross domestic product resulting from a reduced likelihood of prolonged economic downturns associated with a banking system whose lending capacity is highly vulnerable to economic shocks.

See

“Assessing the macroeconomic impact of the transition to stronger capital and liquidity requirements” (MAG Analysis), Attachment E, also available at:

http://www.bis.orpublIothp12.pdf.

See also

“Results of the comprehensive quantitative impact study,” Attachment F, also available at:

http://www.bis.org/publ/bcbs186.pdf.

See

“An assessment of the long-term economic impact of stronger capital and liquidity requirements,” Executive Summary, pg. 1, Attachment G.

The agencies' analysis also indicates that the overwhelming majority of banking organizations already have sufficient capital to comply with the final rule. In particular, the agencies estimate that over 95 percent of all insured depository institutions would be in compliance with the minimums and buffers established under the final rule if it were fully effective immediately. The final rule will help to ensure that these banking organizations maintain their capacity to absorb losses in the future. Some banking organizations may need to take advantage of the transition period in the final rule to accumulate retained earnings, raise additional external regulatory capital, or both. As noted above, however, the overwhelming majority of banking organizations have sufficient capital to comply with the final rule, and the agencies believe that the resulting improvements to the stability and resilience of the banking system outweigh any costs associated with its implementation.

The final rule includes some significant revisions from the proposals in response to commenters' concerns, particularly with respect to the treatment of AOCI; residential mortgages; tier 1 non-qualifying capital instruments such as TruPS issued by smaller depository institution holding companies; the applicability of the rule to SLHCs with substantial insurance or commercial activities; and the

implementation timeframes. The timeframes for compliance are described in the next section and more detailed discussions of modifications to the proposals are provided in the remainder of the preamble.

Consistent with the proposed rules, the final rule requires all banking organizations to recognize in regulatory capital all components of AOCI, excluding accumulated net gains and losses on cash-flow hedges that relate to the hedging of items that are not recognized at fair value on the balance sheet. However, while the agencies believe that the proposed AOCI treatment results in a regulatory capital measure that better reflects banking organizations' actual loss absorption capacity at a specific point in time, the agencies recognize that for many banking organizations, the volatility in regulatory capital that could result from the proposals could lead to significant difficulties in capital planning and asset-liability management. The agencies also recognize that the tools used by larger, more complex banking organizations for managing interest rate risk are not necessarily readily available for all banking organizations.

Accordingly, under the final rule, and as discussed in more detail in section V.B of this preamble, a banking organization that is not subject to the advanced approaches rule may make a one-time election not to include most elements of AOCI in regulatory capital under the final rule and instead effectively use the existing treatment under the general risk-based capital rules that excludes most AOCI elements from regulatory capital (AOCI opt-out election). Such a banking organization must make its AOCI opt-out election in the banking organization's Consolidated Reports of Condition and Income (Call Report) or FR Y-9 series report filed for the first reporting period after the banking organization becomes subject to the final rule. Consistent with regulatory capital calculations under the agencies' general risk-based capital rules, a banking organization that makes an AOCI opt-out election under the final rule must adjust common equity tier 1 capital by: (1) Subtracting any net unrealized gains and adding any net unrealized losses on AFS securities; (2) subtracting any unrealized losses on AFS preferred stock classified as an equity security under GAAP and AFS equity exposures; (3) subtracting any accumulated net gains and adding any accumulated net losses on cash-flow hedges; (4) subtracting amounts recorded in AOCI attributed to defined benefit postretirement plans resulting from the initial and subsequent application of the relevant GAAP standards that pertain to such plans (excluding, at the banking organization's option, the portion relating to pension assets deducted under section 22(a)(5) of the final rule); and (5) subtracting any net unrealized gains and adding any net unrealized losses on held-to-maturity securities that are included in AOCI. Consistent with the general risk-based capital rules, common equity tier 1 capital includes any net unrealized losses on AFS equity securities and any foreign currency translation adjustment. A banking organization that makes an AOCI opt-out election may incorporate up to 45 percent of any net unrealized gains on AFS preferred stock classified as an equity security under GAAP and AFS equity exposures into its tier 2 capital.

A banking organization that does not make an AOCI opt-out election on the Call Report or applicable FR Y-9 report filed for the first reporting period after the banking organization becomes subject to the final rule will be required to recognize AOCI (excluding accumulated net gains and losses on cash-flow hedges that relate to the hedging of items that are not recognized at fair value on the balance sheet) in regulatory capital as of the first quarter in which it calculates its regulatory capital requirements under the final rule and continuing thereafter.

The agencies have decided not to adopt the proposed treatment of residential mortgages. The agencies have considered the commenters' observations about the burden of calculating the risk weights for banking organizations' existing mortgage portfolios, and have taken into account the commenters' concerns that the proposal did not properly assess the use of different mortgage products across different types of markets in establishing the proposed risk weights. The agencies are also particularly mindful of comments regarding the potential effect of the proposal and other mortgage-related rulemakings on credit availability. In light of these considerations, as well as others raised by commenters, the agencies have decided to retain in the final rule the current treatment for residential mortgage exposures under the general risk-based capital rules.

Consistent with the general risk-based capital rules, the final rule assigns a 50 or 100 percent risk weight to exposures secured by one-to-four family residential properties. Generally, residential mortgage exposures secured by a first lien on a one-to-four family residential property that are prudently underwritten and that are performing according to their original terms receive a 50 percent risk weight. All other one- to four-family residential mortgage loans, including exposures secured by a junior lien on residential property, are assigned a 100 percent risk weight. If a banking organization holds the first and junior lien(s) on a residential property and no other party holds an intervening lien, the banking organization must treat the combined exposure as a single loan secured by a first lien for purposes of assigning a risk weight.

The agencies also considered comments on the proposal to require banking organizations with total consolidated assets less than $15 billion as of December 31, 2009, and 2010 MHCs, to phase out their non-qualifying tier 1 capital instruments from regulatory capital over ten years. Although the agencies continue to believe that TruPS do not absorb losses sufficiently to be included in tier 1 capital as a general matter, the agencies are also sensitive to the difficulties community banking organizations often face when issuing new capital instruments and are aware of the importance their capacity to lend can play in local economies. Therefore, the final rule permanently grandfathers non-qualifying capital instruments in the tier 1 capital of depository institution holding companies with total consolidated assets of less than $15 billion as of December 31, 2009, and 2010 MHCs (subject to limits). Non-qualifying capital instruments under the final rule include TruPS and cumulative perpetual preferred stock issued before May 19, 2010, that BHCs included in tier 1 capital under the limitations for restricted capital elements in the general risk-based capital rules.

After considering the comments received from SLHCs substantially engaged in commercial activities or insurance underwriting activities, the Board has decided to consider further the development of appropriate capital requirements for these companies, taking into consideration information provided by commenters as well as information gained through the supervisory process. The Board will explore further whether and how the proposed rule should be modified for these companies in a manner consistent with section 171 of the Dodd-Frank Act and safety and soundness concerns.

Consequently, as defined in the final rule, a covered SLHC that is subject to the final rule (covered SLHC) is a top-tier SLHC other than a top-tier SLHC that meets the exclusion criteria set forth in the definition. With respect to commercial activities, a top-tier SLHC that is a grandfathered unitary savings

and loan holding company (as defined in section 10(c)(9)(A) of the Home Owners' Loan Act (HOLA))

is not a covered SLHC if as of June 30 of the previous calendar year, either 50 percent or more of the total consolidated assets of the company or 50 percent of the revenues of the company on an enterprise-wide basis (as calculated under GAAP) were derived from activities that are not financial in nature under section 4(k) of the Bank Holding Company Act.

This exclusion is similar to the exemption from reporting on the form FR Y-9C for grandfathered unitary savings and loan holding companies with significant commercial activities and is designed to capture those SLHCs substantially engaged in commercial activities.

12 U.S.C. 1461 et seq.

12 U.S.C. 1843(k).

See

76 FR 81935 (December 29, 2011).

The Board is excluding grandfathered unitary savings and loan holding companies that meet these criteria from the capital requirements of the final rule while it continues to contemplate a proposal for SLHC intermediate holding companies. Under section 626 of the Dodd-Frank Act, the Board may require a grandfathered unitary savings and loan holding company to establish and conduct all or a portion of its financial activities in or through an intermediate holding company and the intermediate holding company itself becomes an SLHC subject to Board supervision and regulation.

The Board anticipates that it will release a proposal for public comment on intermediate holding companies in the near term that would specify the criteria for establishing and transferring activities to intermediate holding companies, consistent with section 626 of the Dodd-Frank Act, and propose to apply the Board's capital requirements in this final rule to such intermediate holding companies.

See

section 626 of the Dodd-Frank Act (12 U.S.C. 1467b).

Under the final rule, top-tier SLHCs that are substantially engaged in insurance underwriting activities are also excluded from the definition of “covered SLHC” and the requirements of the final rule. SLHCs that are themselves insurance underwriting companies (as defined in the final rule) are excluded from the definition.

Also excluded are SLHCs that, as of June 30 of the previous calendar year, held 25 percent or more of their total consolidated assets in insurance underwriting subsidiaries (other than assets associated with insurance underwriting for credit risk). Under the final rule, the calculation of total consolidated assets for this purpose must generally be in accordance with GAAP. Many SLHCs that are substantially engaged in insurance underwriting activities do not calculate total consolidated assets under GAAP. Therefore, the Board has determined to allow estimated calculations at this time for the purposes of determining whether a company is excluded from the definition of “covered SLHC,” subject to possible review and adjustment by the Board. The Board expects to implement a framework for SLHCs that are not subject to the final rule by the time covered SLHCs must comply with the final rule in 2015. The final rule also contains provisions applicable to insurance underwriting activities conducted within a BHC or covered SLHC. These provisions are effective as part of the final rule.

The final rule defines “insurance underwriting company” to mean an insurance company, as defined in section 201 of the Dodd-Frank Act (12 U.S.C. 5381), that engages in insurance underwriting activities. This definition includes companies engaged in insurance underwriting activities that are subject to regulation by a State insurance regulator and covered by a State insurance company insolvency law.

D. Timeframe for Implementation and Compliance

In order to give covered SLHCs and non-internationally active banking organizations more time to comply with the final rule and simplify their transition to the new regime, the final rule will require compliance from different types of organizations at different times. Generally, and as described in further detail below, banking organizations that are not subject to the advanced approaches rule must begin complying with the final rule on January 1, 2015, whereas advanced approaches banking organizations must begin complying with the final rule on January 1, 2014. The agencies believe that advanced approaches banking organizations have the sophistication, infrastructure, and capital markets access to implement the final rule earlier than either banking organizations that do not meet the asset size or foreign exposure threshold for application of those rules or covered SLHCs that have not previously been subject to consolidated capital requirements.

A number of commenters requested that the agencies and the FDIC clarify the point at which a banking organization that meets the asset size or foreign exposure threshold for application of the advanced approaches rule becomes subject to subpart E of the proposed rule, and thus all of the provisions that apply to an advanced approaches banking organization. In particular, commenters requested that the agencies and the FDIC clarify whether subpart E of the proposed rule only applies to those banking organizations that have completed the parallel run process and that have received notification from their primary Federal supervisor pursuant to section 121(d) of subpart E, or whether subpart E would apply to all banking organizations that meet the relevant thresholds without reference to completion of the parallel run process.

The final rule provides that an advanced approaches banking organization is one that meets the asset size or foreign exposure thresholds for or has opted to apply the advanced approaches rule, without reference to whether that banking organization has completed the parallel run process and has received notification from its primary Federal supervisor pursuant to section 121(d) of subpart E of the final rule. The agencies have also clarified in the final rule when completion of the parallel run process and receipt of notification from the primary Federal supervisor pursuant to section 121(d) of subpart E is necessary for an advanced approaches banking organization to comply with a particular aspect of the rules. For example, only an advanced approaches banking organization that has completed parallel run and received notification from its primary Federal supervisor under section 121(d) of subpart E must make the disclosures set forth under subpart E of the final rule. However, an advanced approaches banking organization must recognize most components of AOCI in common equity tier 1 capital and must meet the supplementary leverage ratio when applicable without reference to whether the banking organization has completed its parallel run process.

Beginning on January 1, 2015, banking organizations that are not subject to the advanced approaches rule, as well as advanced approaches banking organizations that are covered SLHCs, become subject to: The revised definitions of regulatory capital; the new minimum regulatory capital ratios; and the regulatory capital adjustments and deductions according to the transition provisions.

All banking organizations must begin calculating standardized total risk-weighted assets in accordance with subpart D of the final rule, and if applicable, the revised

market risk rule under subpart F, on January 1, 2015.

Prior to January 1, 2015, such banking organizations, other than covered SLHCs, must continue to use the agencies' general risk-based capital rules and tier 1 leverage rules.

The revised PCA thresholds, discussed further in section IV.E of this preamble, become effective for all insured depository institutions on January 1, 2015.

Beginning on January 1, 2014, advanced approaches banking organizations that are not SLHCs must begin the transition period for the revised minimum regulatory capital ratios, definitions of regulatory capital, and regulatory capital adjustments and deductions established under the final rule. The revisions to the advanced approaches risk-weighted asset calculations will become effective on January 1, 2014.

From January 1, 2014 to December 31, 2014, an advanced approaches banking organization that is on parallel run must calculate risk-weighted assets using the general risk-based capital rules and substitute such risk-weighted assets for its standardized total risk-weighted assets for purposes of determining its risk-based capital ratios. An advanced approaches banking organization on parallel run must also calculate advanced approaches total risk-weighted assets using the advanced approaches rule in subpart E of the final rule for purposes of confidential reporting to its primary Federal supervisor on the Federal Financial Institutions Examination Council's (FFIEC) 101 report. An advanced approaches banking organization that has completed the parallel run process and that has received notification from its primary Federal supervisor pursuant to section 121(d) of subpart E will calculate its risk-weighted assets using the general risk-based capital rules and substitute such risk-weighted assets for its standardized total risk-weighted assets and also calculate advanced approaches total risk-weighted assets using the advanced approaches rule in subpart E of the final rule for purposes of determining its risk-based capital ratios from January 1, 2014 to December 31, 2014. Regardless of an advanced approaches banking organization's parallel run status, on January 1, 2015, the banking organization must begin to apply subpart D, and if applicable, subpart F, of the final rule to determine its standardized total risk-weighted assets.

The transition period for the capital conservation and countercyclical capital buffers for all banking organizations will begin on January 1, 2016.

A banking organization that is required to comply with the market risk rule must comply with the revised market risk rule (subpart F) as of the same date that it must comply with other aspects of the rule for determining its total risk-weighted assets.

Date

Banking organizations not subject to the advanced approaches rule and

banking organizations that are covered SLHCs *

January 1, 2015

Begin compliance with the revised minimum regulatory capital ratios and begin the transition period for the revised definitions of regulatory capital and the revised regulatory capital adjustments and deductions.

Begin compliance with the standardized approach for determining risk-weighted assets.

January 1, 2016

Begin the transition period for the capital conservation and countercyclical capital buffers.

Date

Advanced approaches banking organizations that are not SLHCs *

January 1, 2014

Begin the transition period for the revised minimum regulatory capital ratios, definitions of regulatory capital, and regulatory capital adjustments and deductions.

Begin compliance with the revised advanced approaches rule for determining risk-weighted assets.

January 1, 2015

Begin compliance with the standardized approach for determining risk-weighted assets.

January 1, 2016

Begin the transition period for the capital conservation and countercyclical capital buffers.

* If applicable, banking organizations must use the calculations in subpart F of the final rule (market risk) concurrently with the calculation of risk-weighted assets according either to subpart D (standardized approach) or subpart E (advanced approaches) of the final rule.

IV. Minimum Regulatory Capital Ratios, Additional Capital Requirements, and Overall Capital Adequacy

A. Minimum Risk-Based Capital Ratios and Other Regulatory Capital Provisions

Consistent with Basel III, the proposed rule would have required banking organizations to comply with the following minimum capital ratios: a common equity tier 1 capital to risk-weighted assets ratio of 4.5 percent; a tier 1 capital to risk-weighted assets ratio of 6 percent; a total capital to risk-weighted assets ratio of 8 percent; a leverage ratio of 4 percent; and for advanced approaches banking organizations only, a supplementary leverage ratio of 3 percent. The common equity tier 1 capital ratio is a new minimum requirement designed to ensure that banking organizations hold sufficient high-quality regulatory capital that is available to absorb losses on a going-concern basis. The proposed capital ratios would apply to a banking organization on a consolidated basis.

The agencies received a substantial number of comments on the proposed minimum risk-based capital requirements. Several commenters supported the proposal to increase the minimum tier 1 risk-based capital requirement. Other commenters commended the agencies and the FDIC for proposing to implement a minimum capital requirement that focuses primarily on common equity. These commenters argued that common equity is the strongest form of capital and that the proposed minimum common equity tier 1 capital ratio of 4.5 percent would promote the safety and soundness of the banking industry.

Other commenters provided general support for the proposed increases in minimum risk-based capital requirements, but expressed concern that the proposals could present unique challenges to mutual institutions because they can only raise common equity through retained earnings. A number of commenters asserted that the objectives of the proposal could be achieved through regulatory mechanisms other than the proposed risk-based capital requirements, including enhanced safety and soundness examinations, more stringent underwriting standards, and alternative measures of capital.

Other commenters objected to the proposed increase in the minimum tier 1 capital ratio and the implementation of a common equity tier 1 capital ratio. One commenter indicated that increases in regulatory capital ratios would severely limit growth at many community banking organizations and could encourage consolidation through mergers and acquisitions. Other commenters stated that for banks under $750 million in total assets, increased

compliance costs would not allow them to provide a reasonable return to shareholders, and thus would force them to consolidate. Several commenters urged the agencies and the FDIC to recognize community banking organizations' limited access to the capital markets and related difficulties raising capital to comply with the proposal.

One banking organization indicated that implementation of the common equity tier 1 capital ratio would significantly reduce its capacity to grow and recommended that the proposal recognize differences in the risk and complexity of banking organizations and provide favorable, less stringent requirements for smaller and non-complex institutions. Another commenter suggested that the proposed implementation of an additional risk-based capital ratio would confuse market observers and recommended that the agencies and the FDIC implement a regulatory capital framework that allows investors and the market to ascertain regulatory capital from measures of equity derived from a banking organization's balance sheet.

Other commenters expressed concern that the proposed common equity tier 1 capital ratio would disadvantage MDIs relative to other banking organizations. According to the commenters, in order to retain their minority-owned status, MDIs historically maintain a relatively high percentage of non-voting preferred stockholders that provide long-term, stable sources of capital. Any public offering to increase common equity tier 1 capital levels would dilute the minority investors owning the common equity of the MDI and could potentially compromise the minority-owned status of such institutions. One commenter asserted that, for this reason, the implementation of the Basel III NPR would be contrary to the statutory mandate of section 308 of the Financial Institutions, Reform, Recovery and Enforcement Act (FIRREA).

Accordingly, the commenters encouraged the agencies and the FDIC to exempt MDIs from the proposed common equity tier 1 capital ratio requirement.

12 U.S.C. 1463 note.

The agencies believe that all banking organizations must have an adequate amount of loss-absorbing capital to continue to lend to their communities during times of economic stress, and therefore have decided to implement the regulatory capital requirements, including the minimum common equity tier 1 capital requirement, as proposed. For the reasons described in the NPR, including the experience during the crisis with lower quality capital instruments, the agencies do not believe it is appropriate to maintain the general risk-based capital rules or to rely on the supervisory process or underwriting standards alone. Accordingly, the final rule maintains the minimum common equity tier 1 capital to total risk-weighted assets ratio of 4.5 percent. The agencies have decided not to pursue the alternative regulatory mechanisms suggested by commenters, as such alternatives would be difficult to implement consistently across banking organizations and would not necessarily fulfill the objective of increasing the amount and quality of regulatory capital for all banking organizations.

In view of the concerns expressed by commenters with respect to MDIs, the agencies and the FDIC evaluated the risk-based and leverage capital levels of MDIs to determine whether the final rule would disproportionately impact such institutions. This analysis found that of the 178 MDIs in existence as of March 31, 2013, 12 currently are not well capitalized for PCA purposes, whereas (according to the agencies' and the FDIC's estimates) 14 would not be considered well capitalized for PCA purposes under the final rule if it were fully implemented without transition today. Accordingly, the agencies do not believe that the final rule would disproportionately impact MDIs and are not adopting any exemptions or special provisions for these institutions. While the agencies recognize MDIs may face impediments in meeting the common equity tier 1 capital ratio, the agencies believe that the improvements to the safety and soundness of these institutions through higher capital standards are warranted and consistent with their obligations under section 308 of FIRREA. As a prudential matter, the agencies have a long-established regulatory policy that banking organizations should hold capital commensurate with the level and nature of the risks to which they are exposed, which may entail holding capital significantly above the minimum requirements, depending on the nature of the banking organization's activities and risk profile. Section IV.G of this preamble describes the requirement for overall capital adequacy of banking organizations and the supervisory assessment of capital adequacy.

Furthermore, consistent with the agencies' authority under the general risk-based capital rules and the proposals, section 1(d) of the final rule includes a reservation of authority that allows a banking organization's primary Federal supervisor to require the banking organization to hold a greater amount of regulatory capital than otherwise is required under the final rule, if the supervisor determines that the regulatory capital held by the banking organization is not commensurate with its credit, market, operational, or other risks. In exercising reservation of authority under the rule, the agencies expect to consider the size, complexity, risk profile, and scope of operations of the banking organization; and whether any public benefits would be outweighed by risk to an insured depository institution or to the financial system.

B. Leverage Ratio

The proposals would require a banking organization to satisfy a leverage ratio of 4 percent, calculated using the proposed definition of tier 1 capital and the banking organization's average total consolidated assets, minus amounts deducted from tier 1 capital. The agencies and the FDIC also proposed to eliminate the exception in the agencies' and the FDIC's leverage rules that provides for a minimum leverage ratio of 3 percent for banking organizations with strong supervisory ratings or BHCs that are subject to the market risk rule.

The agencies and the FDIC received a number of comments on the proposed leverage ratio applicable to all banking organizations. Several of these commenters supported the proposed leverage ratio, stating that it serves as a simple regulatory standard that constrains the ability of a banking organization to leverage its equity capital base. Some of the commenters encouraged the agencies and the FDIC to consider an alternative leverage ratio measure of tangible common equity to tangible assets, which would exclude non-common stock elements from the numerator and intangible assets from the denominator of the ratio and thus, according to these commenters, provide a more reliable measure of a banking organization's viability in a crisis.

A number of commenters criticized the proposed removal of the 3 percent exception to the minimum leverage ratio requirement for certain banking organizations. One of these commenters argued that removal of this exception is unwarranted in view of the cumulative impact of the proposals and that raising the minimum leverage ratio requirement for the strongest banking organizations may lead to a deleveraging by the institutions most able to extend credit in a safe and sound manner. In addition, the commenters cautioned the agencies and the FDIC that a restrictive leverage measure, together with more stringent

risk-based capital requirements, could magnify the potential impact of an economic downturn.

Several commenters suggested modifications to the minimum leverage ratio requirement. One commenter suggested increasing the minimum leverage ratio requirement for all banking organizations to 6 percent, whereas another commenter recommended a leverage ratio requirement as high as 20 percent. Another commenter suggested a tiered approach, with minimum leverage ratio requirements of 6.25 percent and 8.5 percent for community banking organizations and large banking organizations, respectively. According to this commenter, such an approach could be based on the risk characteristics of a banking organization, including liquidity, asset quality, and local deposit levels, as well as its supervisory rating. Another commenter suggested a fluid leverage ratio requirement that would adjust based on certain macroeconomic variables. Under such an approach, the agencies and the FDIC could require banking organizations to meet a minimum leverage ratio of 10 percent under favorable economic conditions and a 6 percent leverage ratio during an economic contraction.

In addition, a number of commenters encouraged the agencies and the FDIC to reconsider the scope of exposures that banking organizations include in the denominator of the leverage ratio, which is based on average total consolidated assets under GAAP. Several of these commenters criticized the proposed minimum leverage ratio requirement because it would not include an exemption for certain exposures that are unique to banking organizations engaged in insurance activities. Specifically, these commenters encouraged the Board to consider excluding assets held in separate accounts and stated that such assets are not available to satisfy the claims of general creditors and do not affect the leverage position of an insurance company. A few commenters asserted that the inclusion of separate account assets in the calculation of the leverage ratio stands in contrast to the agencies' and the FDIC's treatment of banking organization's trust accounts, bank-affiliated mutual funds, and bank-maintained common and collective investment funds. In addition, some of these commenters argued for a partial exclusion of trading account assets supporting insurance liabilities because, according to these commenters, the risks attributable to these assets accrue to contract owners.

The agencies continue to believe that a minimum leverage ratio requirement of 4 percent for all banking organizations is appropriate in light of its role as a complement to the risk-based capital ratios. The proposed leverage ratio is more conservative than the current leverage ratio because it incorporates a more stringent definition of tier 1 capital. In addition, the agencies believe that it is appropriate for all banking organizations, regardless of their supervisory rating or trading activities, to meet the same minimum leverage ratio requirements. As a practical matter, the agencies generally have found a leverage ratio of less than 4 percent to be inconsistent with a supervisory composite rating of “1.” Modifying the scope of the leverage ratio measure or implementing a fluid or tiered approach for the minimum leverage ratio requirement would create additional operational complexity and variability in a minimum ratio requirement that is intended to place a constraint on the maximum degree to which a banking organization can leverage its equity base. Accordingly, the final rule retains the existing minimum leverage ratio requirement of 4 percent and removes the 3 percent leverage ratio exception as of January 1, 2014 for advanced approaches banking organizations and as of January 1, 2015 for all other banking organizations.

With respect to including separate account assets in the leverage ratio denominator, the Board continues to consider this issue together with other issues raised by commenters regarding the regulatory capital treatment of insurance activities. The final rule continues to include separate account assets in total assets, consistent with the proposal and the leverage ratio rule for BHCs.

C. Supplementary Leverage Ratio for Advanced Approaches Banking Organizations

As part of Basel III, the BCBS introduced a minimum leverage ratio requirement of 3 percent (the Basel III leverage ratio) as a backstop measure to the risk-based capital requirements, designed to improve the resilience of the banking system worldwide by limiting the amount of leverage that a banking organization may incur. The Basel III leverage ratio is defined as the ratio of tier 1 capital to a combination of on- and off-balance sheet exposures.

As discussed in the Basel III NPR, the agencies and the FDIC proposed the supplementary leverage ratio only for advanced approaches banking organizations because these banking organizations tend to have more significant amounts of off-balance sheet exposures that are not captured by the current leverage ratio. Under the proposal, consistent with Basel III, advanced approaches banking organizations would be required to maintain a minimum supplementary leverage ratio of 3 percent of tier 1 capital to on- and off-balance sheet exposures (total leverage exposure).

The agencies and the FDIC received a number of comments on the proposed supplementary leverage ratio. Several commenters stated that the proposed supplementary leverage ratio is unnecessary in light of the minimum leverage ratio requirement applicable to all banking organizations. These commenters stated that the implementation of the supplementary leverage ratio requirement would create market confusion as to the inter-relationships among the ratios and as to which ratio serves as the binding constraint for an individual banking organization. One commenter noted that an advanced approaches banking organization would be required to calculate eight distinct regulatory capital ratios (common equity tier 1, tier 1, and total capital to risk-weighted assets under the advanced approaches and the standardized approach, as well as two leverage ratios) and encouraged the agencies and the FDIC to streamline the application of regulatory capital ratios. In addition, commenters suggested that the agencies and the FDIC postpone the implementation of the supplementary leverage ratio until January 1, 2018, after the international supervisory monitoring process is complete, and to collect supplementary leverage ratio information on a confidential basis until then.

At least one commenter encouraged the agencies and the FDIC to consider extending the application of the proposed supplementary leverage ratio on a case-by-case basis to banking organizations with total assets of between $50 billion and $250 billion, stating that such institutions may have significant off-balance sheet exposures and engage in a substantial amount of repo-style transactions. Other commenters suggested increasing the proposed supplementary leverage ratio requirement to at least 8 percent for BHCs, under the Board's authority in section 165 of the Dodd-Frank Act to implement enhanced capital requirements for systemically important financial institutions.

See

section 165 of the Dodd-Frank Act, 12 U.S.C. 5365.

With respect to specific aspects of the supplementary leverage ratio, some

commenters criticized the methodology for the total leverage exposure. Specifically, one commenter expressed concern that using GAAP as the basis for determining a banking organization's total leverage exposure would exclude a wide range of off-balance sheet exposures, including derivatives and securities lending transactions, as well as permit extensive netting. To address these issues, the commenter suggested requiring advanced approaches banking organizations to determine their total leverage exposure using International Financial Reporting Standards (IFRS), asserting that it restricts netting and, relative to GAAP, requires the recognition of more off-balance sheet securities lending transactions.

Several commenters criticized the proposed incorporation of off-balance sheet exposures into the total leverage exposure. One commenter argued that including unfunded commitments in the total leverage exposure runs counter to the purpose of the supplementary leverage ratio as an on-balance sheet measure of capital that complements the risk-based capital ratios. This commenter was concerned that the proposed inclusion of unfunded commitments would result in a duplicative assessment against banking organizations when the forthcoming liquidity ratio requirements are implemented in the United States. The commenter noted that the proposed 100 percent credit conversion factor for all unfunded commitments is not appropriately calibrated to the vastly different types of commitments that exist across the industry. If the supplementary leverage ratio is retained in the final rule, the commenter requested that the agencies and the FDIC align the credit conversion factors for unfunded commitments under the supplementary leverage ratio and any forthcoming liquidity ratio requirements.

Another commenter encouraged the agencies and the FDIC to allow advanced approaches banking organizations to exclude from total leverage exposure the notional amount of any unconditionally cancellable commitment. According to this commenter, unconditionally cancellable commitments are not credit exposures because they can be extinguished at any time at the sole discretion of the issuing entity. Therefore, the commenter argued, the inclusion of these commitments could potentially distort a banking organization's measure of total leverage exposure.

A few commenters requested that the agencies and the FDIC exclude off-balance sheet trade finance instruments from the total leverage exposure, asserting that such instruments are based on underlying client transactions (for example, a shipment of goods) and are generally short-term. The commenters argued that trade finance instruments do not create excessive systemic leverage and that they are liquidated by fulfillment of the underlying transaction and payment at maturity. Another commenter requested that the agencies and the FDIC apply the same credit conversion factors to trade finance instruments as under the general risk-based capital rules—that is, 20 percent of the notional value for trade-related contingent items that arise from the movement of goods, and 50 percent of the notional value for transaction-related contingent items, including performance bonds, bid bonds, warranties, and performance standby letters of credit. According to this commenter, such an approach would appropriately consider the low-risk characteristics of these instruments and ensure price stability in trade finance.

Several commenters supported the proposed treatment for repo-style transactions (including repurchase agreements, securities lending and borrowing transactions, and reverse repos). These commenters stated that securities lending transactions are fully collateralized and marked to market daily and, therefore, the on-balance sheet amounts generated by these transactions appropriately capture the exposure for purposes of the supplementary leverage ratio. These commenters also supported the proposed treatment for indemnified securities lending transactions and encouraged the agencies and the FDIC to retain this treatment in the final rule. Other commenters stated that the proposed measurement of repo-style transactions is not sufficiently conservative and recommended that the agencies and the FDIC implement a methodology that includes in total leverage exposure the notional amounts of these transactions.

A few commenters raised concerns about the proposed methodology for determining the exposure amount of derivative contracts. Some commenters criticized the agencies and the FDIC for not allowing advanced approaches banking organizations to use the internal models methodology to calculate the exposure amount for derivative contracts. According to these commenters, the agencies and the FDIC should align the methods for calculating exposure for derivative contracts for purposes of the supplementary leverage ratio and the advanced approaches risk-based capital ratios to more appropriately reflect the risk-management activities of advanced approaches banking organizations and to measure these exposures consistently across the regulatory capital ratios. At least one commenter requested clarification of the proposed treatment of collateral received in connection with derivative contracts. This commenter also encouraged the agencies and the FDIC to permit recognition of eligible collateral for purposes of reducing total leverage exposure, consistent with proposed legislation in other BCBS member jurisdictions.

The introduction of an international leverage ratio requirement in the Basel III capital framework is an important development that would provide a consistent leverage ratio measure across internationally-active institutions. Furthermore, the supplementary leverage ratio is reflective of the on- and off-balance sheet activities of large, internationally active banking organizations. Accordingly, consistent with Basel III, the final rule implements for reporting purposes the proposed supplementary leverage ratio for advanced approaches banking organizations starting on January 1, 2015 and requires advanced approaches banking organizations to comply with the minimum supplementary leverage ratio requirement starting on January 1, 2018. Public reporting of the supplementary leverage ratio during the international supervisory monitoring period is consistent with the international implementation timeline and enables transparency and comparability of reporting the leverage ratio requirement across jurisdictions.

The agencies are not applying the supplementary leverage ratio requirement to banking organizations that are not subject to the advanced approaches rule in the final rule. Applying the supplementary leverage ratio routinely could create operational complexity for smaller banking organizations that are not internationally active, and that generally do not have off-balance sheet activities that are as extensive as banking organizations that are subject to the advanced approaches rule. The agencies note that the final rule imposes risk-based capital requirements on all repo-style transactions and otherwise imposes constraints on all banking organizations' off-balance sheet exposures.

With regard to the commenters' views to require the use of IFRS for purposes of the supplementary leverage ratio, the agencies note that the use of GAAP in the final rule as a starting point to

measure exposure of certain derivatives and repo-style transactions, has the advantage of maintaining consistency between regulatory capital calculations and regulatory reporting, the latter of which must be consistent with GAAP or, if another accounting principle is used, no less stringent than GAAP.

See

12 U.S.C. 1831n(a)(2).

In response to the commenters' views regarding the scope of the total leverage exposure, the agencies note that the supplementary leverage ratio is intended to capture on- and off-balance sheet exposures of a banking organization. Commitments represent an agreement to extend credit and thus including commitments (both funded and unfunded) in the supplementary leverage ratio is consistent with its purpose to measure the on- and off-balance sheet leverage of a banking organization, as well as with safety and soundness principles. Accordingly, the agencies believe that total leverage exposure should include banking organizations' off-balance sheet exposures, including all loan commitments that are not unconditionally cancellable, financial standby letters of credit, performance standby letters of credit, and commercial and other similar letters of credit.

The proposal to include unconditionally cancellable commitments in the total leverage exposure recognizes that a banking organization may extend credit under the commitment before it is cancelled. If the banking organization exercises its option to cancel the commitment, its total leverage exposure amount with respect to the commitment will be limited to any extension of credit prior to cancellation. The proposal considered banking organizations' ability to cancel such commitments and, therefore, limited the amount of unconditionally cancellable commitments included in total leverage exposure to 10 percent of the notional amount of such commitments.

The agencies note that the credit conversion factors used in the supplementary leverage ratio and in any forthcoming liquidity ratio requirements have been developed to serve the purposes of the respective frameworks and may not be identical. Similarly, the commenters' proposed modifications to credit conversion factors for trade finance transactions would be inconsistent with the purpose of the supplementary leverage ratio—to capture all off-balance sheet exposures of banking organizations in a primarily non-risk-based manner.

For purposes of incorporating derivative contracts in the total leverage exposure, the proposal would require all advanced approaches banking organizations to use the same methodology to measure such exposures. The proposed approach provides a uniform measure of exposure for derivative contracts across banking organizations, without regard to their models. Accordingly, the agencies do not believe a banking organization should be permitted to use internal models to measure the exposure amount of derivative contracts for purposes of the supplementary leverage ratio.

With regard to commenters requesting a modification of the proposed treatment for repo-style transactions, the agencies do not believe that the proposed modifications are warranted at this time because international discussions and quantitative analysis of the exposure measure for repo-style transactions are still ongoing.

The agencies are continuing to work with the BCBS to assess the Basel III leverage ratio, including its calibration and design, as well as the impact of any differences in national accounting frameworks material to the denominator of the Basel III leverage ratio. The agencies will consider any changes to the supplementary leverage ratio as the BCBS revises the Basel III leverage ratio.

Therefore, the agencies have adopted the proposed supplementary leverage ratio in the final rule without modification. An advanced approaches banking organization must calculate the supplementary leverage ratio as the simple arithmetic mean of the ratio of the banking organization's tier 1 capital to total leverage exposure as of the last day of each month in the reporting quarter. The agencies also note that collateral may not be applied to reduce the potential future exposure (PFE) amount for derivative contracts.

Under the final rule, total leverage exposure equals the sum of the following:

(1) The balance sheet carrying value of all of the banking organization's on-balance sheet assets

less

amounts deducted from tier 1 capital under section 22(a), (c), and (d) of the final rule;

(2) The PFE amount for each derivative contract to which the banking organization is a counterparty (or each single-product netting set of such transactions) determined in accordance with section 34 of the final rule, but without regard to section 34(b);

(3) 10 percent of the notional amount of unconditionally cancellable commitments made by the banking organization; and

(4) The notional amount of all other off-balance sheet exposures of the banking organization (excluding securities lending, securities borrowing, reverse repurchase transactions, derivatives and unconditionally cancellable commitments).

Advanced approaches banking organizations must maintain a minimum supplementary leverage ratio of 3 percent beginning on January 1, 2018, consistent with Basel III. However, as noted above, beginning on January 1, 2015, advanced approaches banking organizations must calculate and report their supplementary leverage ratio.

D. Capital Conservation Buffer

During the recent financial crisis, some banking organizations continued to pay dividends and substantial discretionary bonuses even as their financial condition weakened. Such capital distributions had a significant negative impact on the overall strength of the banking sector. To encourage better capital conservation by banking organizations and to enhance the resilience of the banking system, the proposed rule would have limited capital distributions and discretionary bonus payments for banking organizations that do not hold a specified amount of common equity tier 1 capital in addition to the amount of regulatory capital necessary to meet the minimum risk-based capital requirements (capital conservation buffer), consistent with Basel III. In this way, the capital conservation buffer is intended to provide incentives for banking organizations to hold sufficient capital to reduce the risk that their capital levels would fall below their minimum requirements during a period of financial stress.

The proposed rules incorporated a capital conservation buffer composed of common equity tier 1 capital in addition to the minimum risk-based capital requirements. Under the proposal, a banking organization would need to hold a capital conservation buffer in an amount greater than 2.5 percent of total risk-weighted assets (plus, for an advanced approaches banking organization, 100 percent of any applicable countercyclical capital buffer amount) to avoid limitations on capital distributions and discretionary bonus payments to executive officers, as defined in the proposal. The proposal provided that the maximum dollar amount that a banking organization could pay out in the form of capital distributions or discretionary bonus payments during the current calendar quarter (the maximum payout amount)

would be equal to a maximum payout ratio, multiplied by the banking organization's eligible retained income, as discussed below. The proposal provided that a banking organization with a buffer of more than 2.5 percent of total risk-weighted assets (plus, for an advanced approaches banking organization, 100 percent of any applicable countercyclical capital buffer), would not be subject to a maximum payout amount. The proposal clarified that the agencies and the FDIC reserved the ability to restrict capital distributions under other authorities and that restrictions on capital distributions and discretionary bonus payments associated with the capital conservation buffer would not be part of the PCA framework. The calibration of the buffer is supported by an evaluation of the loss experience of U.S. banking organizations as part of an analysis conducted by the BCBS, as well as by evaluation of historical levels of capital at U.S. banking organizations.

“Calibrating regulatory capital requirements and buffers: A top-down approach.” Basel Committee on Banking Supervision, October, 2010, available at

www.bis.org.

The agencies and the FDIC received a significant number of comments on the proposed capital conservation buffer. In general, the commenters characterized the capital conservation buffer as overly conservative, and stated that the aggregate amount of capital that would be required for a banking organization to avoid restrictions on dividends and discretionary bonus payments under the proposed rule exceeded the amount required for a safe and prudent banking system. Commenters expressed concern that the capital conservation buffer could disrupt the priority of payments in a banking organization's capital structure, as any restrictions on dividends would apply to both common and preferred stock. Commenters also questioned the appropriateness of restricting a banking organization that fails to comply with the capital conservation buffer from paying dividends or bonus payments if it has established and maintained cash reserves to cover future uncertainty. One commenter supported the establishment of a formal mechanism for banking organizations to request agency approval to make capital distributions even if doing so would otherwise be restricted under the capital conservation buffer.

Other commenters recommended an exemption from the proposed capital conservation buffer for certain types of banking organizations, such as community banking organizations, banking organizations organized in mutual form, and rural BHCs that rely heavily on bank stock loans for growth and expansion purposes. Commenters also recommended a wide range of institutions that should be excluded from the buffer based on a potential size threshold, such as banking organizations with total consolidated assets of less than $250 billion. Commenters also recommended that S-corporations be exempt from the proposed capital conservation buffer because under the U.S. Internal Revenue Code, S-corporations are not subject to a corporate-level tax; instead, S-corporation shareholders must report income and pay income taxes based on their share of the corporation's profit or loss. An S-corporation generally declares a dividend to help shareholders pay their tax liabilities that arise from reporting their share of the corporation's profits. According to some commenters, the proposal disadvantaged S-corporations because shareholders of S-corporations would be liable for tax on the S-corporation's net income, and the S-corporation may be prohibited from making a dividend to these shareholders to fund the tax payment.

One commenter criticized the proposed composition of the capital conservation buffer (which must consist solely of common equity tier 1 capital) and encouraged the agencies and the FDIC to allow banking organizations to include noncumulative perpetual preferred stock and other tier 1 capital instruments. Several commenters questioned the empirical basis for a capital conservation buffer of 2.5 percent, and encouraged the agencies and the FDIC to provide a quantitative analysis for the proposal. One commenter suggested application of the capital conservation buffer only during economic downturn scenarios, consistent with the agencies' and the FDIC's objective to restrict dividends and discretionary bonus payments during these periods. According to this commenter, a banking organization that fails to maintain a sufficient capital conservation buffer during periods of economic stress also could be required to submit a plan to increase its capital.

After considering these comments, the agencies have decided to maintain common equity tier 1 capital as the basis of the capital conservation buffer and to apply the capital conservation buffer to all types of banking organizations at all times. Application of the buffer to all types of banking organizations and maintenance of a capital buffer during periods of market and economic stability is appropriate to encourage sound capital management and help ensure that banking organizations will maintain adequate amounts of loss-absorbing capital going forward, strengthening the ability of the banking system to continue serving as a source of credit to the economy in times of stress. A buffer framework that restricts dividends and discretionary bonus payments only for certain types of banking organizations or only during an economic contraction would not achieve these objectives. Similarly, basing the capital conservation buffer on the most loss-absorbent form of capital is most consistent with the purpose of the capital conservation buffer as it helps to ensure that the buffer can be used effectively by banking organizations at a time when they are experiencing losses.

The agencies recognize that S-corporation banking organizations structure their tax payments differently from C corporations. However, the agencies note that this distinction results from S-corporations' pass-through taxation, in which profits are not subject to taxation at the corporate level, but rather at the shareholder level. The agencies are charged with evaluating the capital levels and safety and soundness of the banking organization. At the point where a decrease in the organization's capital triggers dividend restrictions, the agencies believe that capital should stay within the banking organization. S-corporation shareholders may receive a benefit from pass-through taxation, but with that benefit comes the risk that the corporation has no obligation to make dividend distributions to help shareholders pay their tax liabilities. Therefore, the final rule does not exempt S-corporations from the capital conservation buffer.

Accordingly, under the final rule a banking organization must maintain a capital conservation buffer of common equity tier 1 capital in an amount greater than 2.5 percent of total risk-weighted assets (plus, for an advanced approaches banking organization, 100 percent of any applicable countercyclical capital buffer amount) to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers.

The proposal defined eligible retained income as a banking organization's net income (as reported in the banking organization's quarterly regulatory reports) for the four calendar quarters preceding the current calendar quarter, net of any capital distributions and associated tax effects not already reflected in net income. The agencies and the FDIC received a number of comments regarding the proposed

definition of eligible retained income, which is used to calculate the maximum payout amount. Some commenters suggested that the agencies and the FDIC limit capital distributions based on retained earnings instead of eligible retained income, citing the Board's Regulation H as an example of this regulatory practice.

Several commenters representing banking organizations organized as S-corporations recommended revisions to the definition of eligible retained income so that it would be net of pass-through tax distributions to shareholders that have made a pass-through election for tax purposes, allowing S-corporation shareholders to pay their tax liability notwithstanding any dividend restrictions resulting from failure to comply with the capital conservation buffer. Some commenters suggested that the definition of eligible retained income be adjusted for items such as goodwill impairment that are captured in the definition of “net income” for regulatory reporting purposes but which do not affect regulatory capital.

See

12 CFR part 208.

The final rule adopts the proposed definition of eligible retained income without change. The agencies believe the commenters' suggested modifications to the definition of eligible retained income would add complexity to the final rule and in some cases may be counter-productive by weakening the incentives of the capital conservation buffer. The agencies note that the definition of eligible retained income appropriately accounts for impairment charges, which reduce eligible retained income but also reduce the balance sheet amount of goodwill that is deducted from regulatory capital. Further, the proposed definition of eligible retained income, which is based on net income as reported in the banking organization's quarterly regulatory reports, reflects a simple measure of a banking organization's recent performance upon which to base restrictions on capital distributions and discretionary payments to executive officers. For the same reasons as described above regarding the application of the capital conservation buffer to S-corporations generally, the agencies have determined that the definition of eligible retained income should not be modified to address the tax-related concerns raised by commenters writing on behalf of S-corporations.

The proposed rule generally defined a capital distribution as a reduction of tier 1 or tier 2 capital through the repurchase or redemption of a capital instrument or by other means; a dividend declaration or payment on any tier 1 or tier 2 capital instrument if the banking organization has full discretion to permanently or temporarily suspend such payments without triggering an event of default; or any similar transaction that the primary Federal supervisor determines to be in substance a distribution of capital.

Commenters provided suggestions on the definition of “capital distribution.” One commenter requested that a “capital distribution” be defined to exclude any repurchase or redemption to the extent the capital repurchased or redeemed was replaced in a contemporaneous transaction by the issuance of capital of an equal or higher quality tier. The commenter maintained that the proposal would unnecessarily penalize banking organizations that redeem capital but contemporaneously replace such capital with an equal or greater amount of capital of an equivalent or higher quality. In response to comments, and recognizing that redeeming capital instruments that are replaced with instruments of the same or similar quality does not weaken a banking organization's overall capital position, the final rule provides that a redemption or repurchase of a capital instrument is not a distribution provided that the banking organization fully replaces that capital instrument by issuing another capital instrument of the same or better quality (that is, more subordinate) based on the final rule's eligibility criteria for capital instruments, and provided that such issuance is completed within the same calendar quarter the banking organization announces the repurchase or redemption. For purposes of this definition, a capital instrument is issued at the time that it is fully paid in. For purposes of the final rule, the agencies changed the defined term from “capital distribution” to “distribution” to avoid confusion with the term “capital distribution” used in the Board's capital plan rule.

See

12 CFR 225.8.

The proposed rule defined discretionary bonus payment as a payment made to an executive officer of a banking organization (as defined below) that meets the following conditions: the banking organization retains discretion as to the fact of the payment and as to the amount of the payment until the payment is awarded to the executive officer; the amount paid is determined by the banking organization without prior promise to, or agreement with, the executive officer; and the executive officer has no contractual right, express or implied, to the bonus payment.

The agencies and the FDIC received a number of comments on the proposed definition of discretionary bonus payments to executive officers. One commenter expressed concern that the proposed definition of discretionary bonus payment may not be effective unless the agencies and the FDIC provided clarification as to the type of payments covered, as well as the timing of such payments. This commenter asked whether the proposed rule would prohibit the establishment of a pre-funded bonus pool with mandatory distributions and sought clarification as to whether non-cash compensation payments, such as stock options, would be considered a discretionary bonus payment.

The final rule's definition of discretionary bonus payment is unchanged from the proposal. The agencies note that if a banking organization prefunds a pool for bonuses payable under a contract, the bonus pool is not discretionary and, therefore, is not subject to the capital conservation buffer limitations. In addition, the definition of discretionary bonus payment does not include non-cash compensation payments that do not affect capital or earnings such as, in some cases, stock options.

Commenters representing community banking organizations maintained that the proposed restrictions on discretionary bonus payments would disproportionately impact such institutions' ability to attract and retain qualified employees. One commenter suggested revising the proposed rule so that a banking organization that fails to satisfy the capital conservation buffer would be restricted from making a discretionary bonus payment only to the extent it exceeds 15 percent of the employee's salary, asserting that this would prevent excessive bonus payments while allowing community banking organizations flexibility to compensate key employees. The final rule does not incorporate this suggestion. The agencies note that the potential limitations and restrictions under the capital conservation buffer framework do not automatically translate into a prohibition on discretionary bonus payments. Instead, the overall dollar amount of dividends and bonuses to executive officers is capped based on how close the banking organization's regulatory capital ratios are to its minimum capital ratios and on the earnings of the banking organization that are available for distribution. This approach provides appropriate

incentives for capital conservation while preserving flexibility for institutions to decide how to allocate income available for distribution between discretionary bonus payments and other distributions.

The proposal defined executive officer as a person who holds the title or, without regard to title, salary, or compensation, performs the function of one or more of the following positions: President, chief executive officer, executive chairman, chief operating officer, chief financial officer, chief investment officer, chief legal officer, chief lending officer, chief risk officer, or head of a major business line, and other staff that the board of directors of the banking organization deems to have equivalent responsibility.

See

76 FR 21170 (April 14, 2011) for a comparable definition of “executive officer.”

Commenters generally supported a more restrictive definition of executive officer, arguing that the definition of executive officer should be no broader than the definition under the Board's Regulation O,

which governs any extension of credit between a member bank and an executive officer, director, or principal shareholder. Some commenters, however, favored a more expansive definition of executive officer, with one commenter supporting the inclusion of directors of the banking organization or directors of any of the banking organization's affiliates, any other person in control of the banking organization or the banking organizations' affiliates, and any person in control of a major business line. In accordance with the agencies' objective to include those individuals within a banking organization with the greatest responsibility for the organization's financial condition and risk exposure, the final rule maintains the definition of executive officer as proposed.

See

12 CFR part 215.

Under the proposal, advanced approaches banking organizations would have calculated their capital conservation buffer (and any applicable countercyclical capital buffer amount) using their advanced approaches total risk-weighted assets. Several commenters supported this aspect of the proposal, and one stated that the methodologies for calculating risk-weighted assets under the advanced approaches rule would more effectively capture the individual risk profiles of such banking organizations, asserting further that advanced approaches banking organizations would face a competitive disadvantage relative to foreign banking organizations if they were required to use standardized total risk-weighted assets to determine compliance with the capital conservation buffer. In contrast, another commenter suggested that advanced approaches banking organizations be allowed to use the advanced approaches methodologies as the basis for calculating the capital conservation buffer only when it would result in a more conservative outcome than under the standardized approach in order to maintain competitive equity domestically. Another commenter expressed concerns that the capital conservation buffer is based only on risk-weighted assets and recommended additional application of a capital conservation buffer to the leverage ratio to avoid regulatory arbitrage opportunities and to accomplish the agencies' and the FDIC's stated objective of ensuring that banking organizations have sufficient capital to absorb losses.

The final rule requires that advanced approaches banking organizations that have completed the parallel run process and that have received notification from their primary Federal supervisor pursuant to section 121(d) of subpart E use their risk-based capital ratios under section 10 of the final rule (that is, the lesser of the standardized and the advanced approaches ratios) as the basis for calculating their capital conservation buffer (and any applicable countercyclical capital buffer). The agencies believe such an approach is appropriate because it is consistent with how advanced approaches banking organizations compute their minimum risk-based capital ratios.

Many commenters discussed the interplay between the proposed capital conservation buffer and the PCA framework. Some commenters encouraged the agencies and the FDIC to reset the buffer requirement to two percent of total risk-weighted assets in order to align it with the margin between the “adequately-capitalized” category and the “well-capitalized” category under the PCA framework. Similarly, some commenters characterized the proposal as confusing because a banking organization could be considered well capitalized for PCA purposes, but at the same time fail to maintain a sufficient capital conservation buffer and be subject to restrictions on capital distributions and discretionary bonus payments. These commenters encouraged the agencies and the FDIC to remove the capital conservation buffer for purposes of the final rule, and instead use their existing authority to impose restrictions on dividends and discretionary bonus payments on a case-by-case basis through formal enforcement actions. Several commenters stated that compliance with a capital conservation buffer that operates outside the traditional PCA framework adds complexity to the final rule, and suggested increasing minimum capital requirements if the agencies and the FDIC determine they are currently insufficient. Specifically, one commenter encouraged the agencies and the FDIC to increase the minimum total risk-based capital requirement to 10.5 percent and remove the capital conservation buffer from the rule.

The capital conservation buffer has been designed to give banking organizations the flexibility to use the buffer while still being well capitalized. Banking organizations that maintain their risk-based capital ratios at least 50 basis points above the well capitalized PCA levels will not be subject to any restrictions imposed by the capital conservation buffer, as applicable. As losses begin to accrue or a banking organization's risk-weighted assets begin to grow such that the capital ratios of a banking organization are below the capital conservation buffer but above the well capitalized thresholds, the incremental limitations on distributions are unlikely to affect planned capital distributions or discretionary bonus payments but may provide a check on rapid expansion or other activities that would weaken the organization's capital position.

Under the final rule, the maximum payout ratio is the percentage of eligible retained income that a banking organization is allowed to pay out in the form of distributions and discretionary bonus payments, each as defined under the rule, during the current calendar quarter. The maximum payout ratio is determined by the banking organization's capital conservation buffer as calculated as of the last day of the previous calendar quarter.

A banking organization's capital conservation buffer is the lowest of the following ratios: (i) The banking organization's common equity tier 1 capital ratio minus its minimum common equity tier 1 capital ratio; (ii) the banking organization's tier 1 capital ratio minus its minimum tier 1 capital ratio; and (iii) the banking organization's total capital ratio minus its minimum total capital ratio. If the banking organization's common equity tier 1, tier 1 or total capital ratio is less than or equal to its minimum common equity tier 1, tier 1 or total capital ratio, respectively, the banking organization's capital conservation buffer is zero.

The mechanics of the capital conservation buffer under the final rule are unchanged from the proposal. A

banking organization's maximum payout amount for the current calendar quarter is equal to the banking organization's eligible retained income, multiplied by the applicable maximum payout ratio, in accordance with Table 1. A banking organization with a capital conservation buffer that is greater than 2.5 percent (plus, for an advanced approaches banking organization, 100 percent of any applicable countercyclical capital buffer) is not subject to a maximum payout amount as a result of the application of this provision. However, a banking organization may otherwise be subject to limitations on capital distributions as a result of supervisory actions or other laws or regulations.

See, e.g.,

12 U.S.C. 56, 60, and 1831o(d)(1) and 12 CFR part 3, subparts H and I, 12 CFR part 5.46, 12 CFR part 5, subpart E, and 12 CFR part 6 (national banks) and 12 U.S.C. 1467a(f) and 1467a(m)(B)(i)(III) and 12 CFR part 165 (Federal savings associations);