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Board of Governors of the Federal Reserve System
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Federal Reserve Board of Governors

Opening Statement by Governor Elizabeth A. Duke

Thank you. I will focus my remarks on those elements of the rule that are most pertinent to community banks.

I want to begin by emphasizing that having adequate levels of high quality capital is just as crucial for smaller banks as it is for the largest institutions. The recent financial crisis demonstrated that community banks can still be devastated by economic turbulence even when they did nothing to cause the problem. The banks that were able to withstand the adverse economic conditions and continue to serve their communities were those that started with solid capital positions.

As proposed last year, the capital rule would have achieved the objective of increasing the quantity and quality of capital in banks of all sizes. But it also would have created substantial additional regulatory burden on community banks. In the final rule I believe we have maintained the objective of strengthening capital requirements but without the more onerous regulatory burden.

The Board received more than 2,600 comments on the proposal, with the majority of the comment letters coming from community banking organizations. In addition, the Federal Reserve sought input from community bankers through in-person meetings. Board staff held several large outreach sessions around the country geared toward community bankers, fielding hundreds of questions. I met personally with representatives from organizations of various sizes with different legal structures and business models. I know several members of the Board did the same. This outreach was critical to understanding how different elements of the proposal would affect individual banking organizations.

After hearing these concerns, numerous changes have been made to the proposal to reduce its complexity and to minimize the potential burden that would be placed on smaller and community banking organizations. While staff will discuss these changes in detail, I want to briefly comment on three changes in particular.

  • First, in light of commenter concerns about the burden of calculating the proposed risk weights for banking organizations' existing residential mortgage portfolios, and the potential reduction in credit availability due to the interaction of the proposal with other mortgage-related rulemakings, the final rule would retain the current risk weights for residential mortgage loans.
  • Second, the final rule would allow non-advanced approaches banking organizations to make a one-time election to opt out of the requirement to include most elements of AOCI in regulatory capital. While these banks would not be required to recognize unrealized gains and losses in their regulatory capital, they would not be permitted to switch back and forth to take advantage of unrealized gains and ignore unrealized losses.
  • Third, community banks objected to the phase-out of trust preferred securities as part of their tier 1 capital. In recognition of community banking organizations' limited access to the capital markets, the final rule would effectively grandfather certain existing trust preferred securities as permitted by the Dodd-Frank Act.

Ultimately, the relevant measure of the final rule is not to compare it to the proposal, but to evaluate it against existing regulatory capital requirements. In this regard, I believe that the final rule would strengthen the quality and quantity of bank capital without introducing unnecessary complexity or capital volatility for community banks. Compared to current regulatory capital requirements, the major changes that would affect community banks are:

  • The new common equity tier 1 capital requirement would require all banks to hold more common stock and retained earnings than is the case under current requirements. Because most community banks are already capitalized primarily with common stock, and because retained earnings are their primary source of additional capital, I view this new standard as a validation of the community bank capital model rather than an additional burden.
  • The minimum requirement for tier 1 capital would be increased from 4 percent to 6 percent. Trust preferred securities have become an important element in tier 1 capital for community banks. With the grandfathering of those instruments, the new tier 1 capital standard should impose only a minimal burden on most community banks.
  • The rule also would create a capital conservation buffer that would work to limit capital distributions as capital levels approach regulatory minimums. In their comments, community banks stressed their limited access to capital markets and resulting dependence on retained earnings. The capital buffer concept does not on its own require a bank to raise outside capital, rather it simply mandates earnings retention until capital is comfortably above regulatory minimums.
  • The numerator used for calculating various capital ratios would have more stringent limits on the inclusion of mortgage servicing assets and deferred tax assets, and their risk weights would also increase. Admittedly, this provision increases capital requirements for institutions with high concentrations of either of these types of assets, but in the crisis these assets proved less effective than expected for absorbing losses.
  • Lastly, the risk weights would increase for loans that are past due or on nonaccrual as well as for high volatility commercial real estate (HVCRE) loans. I want to emphasize that the higher risk weight for HVCRE loans applies only to a small subset of commercial real estate loans, that is, certain higher risk acquisition, development, or construction loans of the type that resulted in large losses during both the recent crisis and the savings and loan crisis. All other commercial real estate loans would retain their current risk weight.

In a continuing effort to improve communication with community banks about regulatory changes, staff has prepared a one-page summary designed specifically for community banks that describes the key changes discussed today. I am hopeful that this summary will allow community bankers to quickly zero in on the changes that affect them.

I would like to thank our staff for their strong and tireless efforts in finalizing these new capital requirements. I am confident that their work will greatly contribute to a stronger and more resilient banking industry that will benefit the overall economy. I will now turn it over to Mike Gibson.

Last update: August 2, 2013