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Bank Capital Rule Changes

Apr 26, 2019

Recently, the federal bank regulators finalized a new rule and proposed a new rule that could impact future regulatory capital calculations. Following is a summary of these rules.

Final Rule:  Phasing in CECL

As many banks have started digging into the various aspects of the new Accounting Standards Update for measuring and projecting credit losses within their loan portfolios, the federal banking agencies have collectively finalized revisions to regulatory capital rules in anticipation of the adoption of Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses. The final rule was announced jointly by the Federal Reserve, Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation on December 18, 2018, and is effective on April 1, 2019.

The final rule makes a number of changes to the regulatory capital rules in anticipation of the current expected credit losses (CECL) methodology in the ASU. For most banks, the rule’s most important feature will be its optional three-year phase-in of day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. Since the implementation of CECL will likely increase the allowance for credit losses for most banks upon adoption, this option can provide some relief to banks concerned about the impact this will have on regulatory capital ratios.

An electing bank must calculate transitional amounts for retained earnings, temporary differences in deferred tax assets, and credit loss allowances eligible for inclusion in regulatory capital. The transitional amounts are equal to the difference between the closing balance sheet amounts for these items for the year-end immediately prior to the adoption of CECL and the balance sheet amounts as of the beginning of the year in which CECL is adopted. If a bank decides to make the day-one transitional election, the CECL regulatory capital transitional amounts would be phased in at 25 percent per year over the next three years, so by the beginning of the fourth year, the bank will completely reflect in regulatory capital the day-one effects of CECL. The final ruling includes a good illustration of how these transitional amounts will be applied to regulatory capital components (see Table 1 in the attachment to FIL-20-2018).

A bank electing the transition period for the day-one effect must make the election in its Call Report or Form FR Y-9C, as applicable, in the quarter it first adopts CECL. For example, a bank which qualifies as a non-public business entity that adopts CECL as of January 1, 2022, must make the election in its regulatory report as of March 31, 2022.  A bank that does not make the election in the regulatory report in which it first reports credit loss allowances measured under CECL will not be permitted to make an election in subsequent reporting periods. Instead, the full effects of the CECL adoption will be recognized in its regulatory capital ratios in the first quarterly regulatory reporting after CECL adoption. One additional guideline under the final rule is that a depository holding company subject to the Federal Reserve Board’s capital rule and its subsidiary banking institution(s) are eligible to make a CECL transition election independent of one another.

Other changes made by the final rule include the following:

  • It revises the regulatory capital guidelines for credit loss allowances that can be included in tier 2 capital by replacing “allowance for loan and lease losses” with a newly defined term, “adjusted allowances for credit losses” (AACL), which includes credit loss allowances related to loans held for investment, off-balance-sheet exposures, and held-to-maturity debt securities.
  • It redefines the term “carrying value” so that carrying value is not reduced by any associated credit loss allowance for all assets other than available-for-sale (AFS) debt securities and purchased credit-deteriorated (PCD) assets.
  • It clarifies that the carrying value of a PCD asset is net of related allowances, which results in excluding all PCD allowances from inclusion in tier 2 capital.

The final ruling also includes considerations for the accounting treatment for business combinations, as well as additional requirements for advanced approaches for banking organizations.

Proposed Rule: Community Bank Leverage Ratio

In November 2018, the federal banking agencies issued a proposed rule that would provide qualifying banking organizations with an optional simplified capital adequacy requirement (the Community Bank Leverage Ratio, or CBLR). A qualifying banking organization must meet the following criteria:

  • Cannot be an advanced approaches bank
  • Total consolidated assets are less than $10 billion
  • Off-balance-sheet exposure is 25% or less of total consolidated assets
  • Trading assets and liabilities are 5% or less of total consolidated assets
  • Mortgage servicing assets (MSAs) are 25% or less of CBLR tangible equity (discussed below)
  • Deferred tax assets (DTAs) arising from temporary differences that could not be realized through net operating loss carrybacks are 25% or less of CBLR tangible equity (discussed below)

Banks that elect the CBLR will not have to calculate other regulatory capital ratios. The CBLR is calculated as CBLR tangible equity divided by average total consolidated assets less deductions from CBLR tangible equity. CBLR tangible equity is calculated as bank equity less:

  • Minority interest
  • Accumulated other comprehensive income (AOCI)
  • DTAs arising from temporary differences that could not be realized through net operating loss carrybacks
  • Goodwill and other intangible assets (not including MSAs)

As previously discussed, qualifying banks would only need to calculate the CBLR under the proposed rule. The CBLR ratio will become a proxy for Prompt Corrective Action (PCA) capital ratio categories as follows:

PCA Capital Category                      CBLR
Well capitalized                                   > 9.0%
Adequately capitalized                        ≥ 7.5%
Undercapitalized                                 < 7.5%
Significantly undercapitalized             < 6.0%

Banks with a CBLR less than 6.0% will have to calculate their regulatory capital using the normal PCA/Basel III framework.

For more information on the proposed CBLR rule, check out the following resources at the FDIC:

If you have any questions regarding either of these rules, please contact your Wipfli relationship executive.


Craig Gugliemetti, CPA
Senior Manager
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Brett D. Schwantes, CPA
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