On July 27, the three federal banking agencies (the Agencies)[1] jointly proposed changes to the regulatory capital framework applicable to large banks and bank holding companies (the Proposal). The Proposal is the U.S. adaptation of the 2017 revisions to the Basel III capital regime promulgated by the Basel Committee on Banking Supervision. The 2017 revisions are commonly referred to as the Basel III Endgame.

Concurrent with the Proposal, the Federal Reserve proposed changes to the GSIB surcharge (discussed below).

Scope of proposal. The Proposal would apply to large banking organizations, which are those generally with total assets of $100 billion or more and their subsidiary depository institutions. Under the Agencies’ existing rules, banking organizations with $100 billion or more in total assets are divided into four categories. These categories, which are generally but not exclusively characterized by asset size, are:

• Category I: U.S. global systemically important banking organizations (GSIBs),
• Category II: banking organizations that are not U.S. GSIBs but have over $700 billion in total assets or over $75 billion in cross-jurisdictional exposures,
• Category III: banking organizations that are not included in Category I or II but have over $250 billion in total assets or greater than $75 billion in nonbank assets, off-balance sheet exposures, or weighted short-term wholesale funding, and
• Category IV: banking organizations that have $100 billion or more in total assets and are not in Category I-III.

There would be no change in the capital framework for smaller firms, except that those firms with significant trading activities would be subject to the market-risk capital provisions. In addition, large intermediate holding companies of foreign banking organizations would need to use the new “expanded risk-based approach” (explained below) to calculate risk-based capital requirements.

The Agencies estimate the Proposal would increase the aggregate binding common equity tier 1 capital requirements by about $170 billion, or 16%, for large banking organizations.

Changes to calculating regulatory capital (i.e., the numerator) for Category III and IV firms. The Proposal would remove the accumulated other comprehensive income (AOCI) opt-out currently available for Category III and IV firms. That is, banking organizations in Category III or IV would be required to recognize unrealized gains and losses in their available-for-sale securities portfolio. In addition, banking organizations in Category III or IV would become subject to the rules for capital deductions and for minority interests currently applicable to Category I and II firms.

Changes to the calculation of risk-weighted assets. The Proposal would do away with the “advanced approaches” measure used by Category I and II banking organizations, which relies on internal modelling and data to assess credit and operational risk. Under the Proposal, large banking organizations would be subject to a new, standardized “expanded risk-based approach” to calculate risk-weighted assets consistent with the Basel Endgame. This new approach would include standardized risk-weights for credit, equity, operational, and credit valuation adjustment risk. For market risk, internal models may still be used, subject to regulatory approval.

Dual Stack Calculation Requirement. Under the Proposal, large banking organizations would calculate their risk-based capital ratios under the existing standardized approach and the “expanded risk-based approach,” with the higher of the two used to set the firm’s minimum capital requirements.

Expanded Application of Supplementary Leverage Ratio and Countercyclical Capital Buffer Requirements. Category III and IV firms would become subject to the supplementary leverage ratio and, if activated, the countercyclical capital buffer.

Transition Period. The Agencies do not anticipate making a final rule effective before July 1, 2025. The Proposal contemplates a three-year phase-in period (i.e., through June 30, 2028) for most of its provisions.

Comment Period. The Agencies provided an extended 120-day comment period ending on November 30, 2023. Given the granularity of the proposed rule and the importance of the rule to banking organizations that fall within its scope, the public may need the full 120 days to provide comments.

Proposed Changes to the GSIB Surcharge (and FR Y-15)

If adopted, the Federal Reserve’s proposed changes to the GSIB surcharge would (i) measure indicators on the basis of average daily or monthly basis, rather than a single date, (ii) revise the systemic indicators for cross-jurisdictional claims and cross-jurisdictional liabilities to include derivatives, and (iii) measure surcharges in 10-basis point increments rather than the current 50-basis point increments to reduce “cliff effects.”

The Federal Reserve observes that the proposed changes to the GSIB surcharge and the FR Y-15 would have the most impact on foreign banking organizations currently subject to Category III or IV standards because of the proposed inclusion of derivatives in the cross-jurisdictional activity indicator. This change could result in some foreign banking organizations being subject to Category II standards, which would lead to the application of more stringent capital and liquidity requirements (e.g., daily liquidity reporting (rather than monthly or no reporting); monthly (rather than quarterly) liquidity stress testing; and full (rather than reduced) liquidity risk management).

The comment period for the proposed changes to the GSIB Surcharge and FR Y-15 also ends on November 30, 2023.

Next Steps and Impact

The controversial nature of the Proposal was on display in the open board meetings of the Federal Reserve and FDIC when, unusually, the Proposal faced dissent from multiple Federal Reserve governors (Governors Bowman and Waller) and members of the FDIC Board (Vice Chairman Hill and Director McKernan).

The Proposal is expected to generate many comments from a wide array of stakeholders that are expected to touch on the proposed risk-weights, the elimination of the ability to use internal models in most instances, and the scope of application. On this last matter, up until recently, we observe that Agency principals had suggested that the new regime would apply only to the largest banking organizations. Therefore, the proposed application to banking organizations with assets of $100 billion or more came as somewhat of a surprise although perhaps it should not have been surprising in light of the recent bank failures. Setting the threshold at $100 billion in total assets would result in banking organizations that are contemplating exceeding $100 billion in assets to think even harder about whether to manage their balance sheet to stay below the threshold or grow, for example, through a business combination, to a size where they can benefit from economies of scale given the increased regulatory burdens that the Proposal, if adopted, would entail.

[1] The Federal Deposit Insurance Corporation (the FDIC), the Board of Governors of the Federal Reserve System (the Federal Reserve), and the Office of the Comptroller of the Currency (the OCC).

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