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1 1 (January 11, 2019)

handle is hein.crs/govybc0001 and id is 1 raw text is: Conressona Reeac Seric 0 Updated January 11, 2019 Introduction to Bank Regulation: Leverage and Capital Ratio Requirements Banks generally must comply with a variety of requirements to hold minimum levels of capital. These requirements are designed to create certain benefits (e.g., fewer bank failures, more systemic stability) but impose certain costs (e.g., greater bank funding cost, reduced credit availability). Recent legislative changes have led regulators to propose rules that would alter a number of capital requirements. This In Focus provides a brief overview of these requirements and examines related policy issues. Background A bank's balance sheet is composed of assets, liabilities, and capital. A bank is exposed to potential losses on its assets, and its liabilities subject it to payment obligations to depositors and creditors. Capital instruments-unlike liabilities-generally do not require payment of a specified amount of money at a specified time. Thus, capital gives the bank the ability to absorb losses while continuing to meet its rigid obligations on liabilities and avoid failure. To decrease the likelihood of bank failures and to minimize taxpayer exposure, regulators generally require banks to meet a regulatory ratio requirement-i.e., to hold a minimum level of capital expressed as ratios between items on bank balance sheets. Current Requirements Banks must satisfy several different capital ratio requirements. A detailed examination of how these ratios are calculated is beyond the scope of this In Focus. (For a highly simplified example, see Figure 1.) Broadly speaking, capital ratios are one of two main types-a leverage ratio or a risk-based capital ratio. Leverage Ratio. A leverage ratio treats all assets the same, meaning banks must hold the same amount of capital against an exposure regardless of how risky the exposure is. All banks must maintain at least a minimum 4% leverage ratio of assets to a capital measure that includes equity, retained earnings, and other loss-absorbing balance sheet items. To be considered well capitalized-which lowers a bank's FDIC assessment fees, among other benefits-a bank must maintain a 5% leverage ratio. Furthermore, 19 large and complex U.S. banks classified as advanced approaches banks must maintain a minimum 3% supplementary leverage ratio (SLR) that uses an exposure measure that includes both balance sheet assets and certain other exposures to losses that do not appear on the balance sheet. Finally, a subset of eight of the largest and most complex U.S. banks classified as globally systemically important banks (G-SIBs) must meet an enhanced SLR (eSLR) requirement of 5% at the holding company level and 6% at the depository level. Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (P.L. 115-174) created an option for banks with less than $10 billion in assets to meet a higher leverage ratio-the Community Bank Leverage Ratio-in order to be exempt from having to meet the risk-based ratios described in the following paragraph. Bank regulators have issued a proposal to implement this provision wherein banks below the $10 billion threshold that meet at least a 9% ratio of equity and certain retained earnings to assets and had limited off- balance sheet exposures and limited securities trading activity (among other requirements) would qualify for the exemption. Risk-weighted Ratio. A risk-weighted ratio assigns a weight-a percentage based on the riskiness of the asset that the asset value is multiplied by-to reflect the fact that some assets are more likely to lose value than others. Riskier assets receive a higher risk weight, and thus banks must hold more capital against these assets. Figure I. Simplified Example Calculation Hypothetical Bank Balance Sheet Assets Funding U.S.Treasuries; $100 (Risk Weightn0%) Deposits: $200 Mortgages: $100 (RiskWeight - 50%) Debt (bonds): $85 Commercial Loans: $100 (RikWei = 100) Capital: $15 Leverage Rtia = Capital / (Treasuries + Mortgages + Comm. Loans) = $15 i ($100 + $100 + $100) = $15 1 $300 Risk-Weighted = Capital / (Treasuries x 0% + Mortgages x 50% + Comm. Loans x 100%) = $15 / ($0 + $50 + $100) = $15 / $150 Source: CRS. All banks are required to maintain at least a 4.5% risk- weighted ratio of equity and retained earnings, and ratios of 6% and 8% for capital measures that include additional loss-absorbing instruments. (To be considered well capitalized, banks must maintain an additional 2% above the minimum for those measures, raising them to 6.5%, 8%, and 10%, respectively.) To avoid limitations on capital distributions (such as dividend payments), banks must hold an additional 2.5% of high-quality capital on top of the minimum level, called the capital conservation buffer (CCB). In addition, advanced approaches banks could be subject to a 0-2.5% countercyclical buffer that can be deployed by the Federal Reserve (the Fed) if credit conditions warrant increasing capital (the buffer is currently and always has been set at 0%). Finally, the G-SIBs are subject to an additional capital surcharge of between 1% https:I/crsreports.conc -- -q

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