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OVERSIGHT OF BASEL III: IMPACT OF PROPOSED 

CAPITAL RULES 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING THE OVERSIGHT OF BASEL III 

NOVEMBER 14, 2012 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

RICHARD C. SHELBY, Alabama 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

DWIGHT FETTIG, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

CHARLES YI, Chief Counsel 

LAURA SWANSON, Policy Director 

GLEN SEARS, Senior Policy Advisor 

JEFF SIEGEL, Senior Counsel 

ANDREW OLMEM, Republican Chief Counsel 

JELENA MCWILLIAMS, Republican Senior Counsel 

MIKE PIWOWAR, Republican Chief Economist 

BETH ZORC, Republican Counsel 

DAWN RATLIFF, Chief Clerk 

RIKER VERMILYE, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)

C O N T E N T S 

WEDNESDAY, NOVEMBER 14, 2012 

Page 

Opening statement of Chairman Johnson ............................................................. 1 

Prepared statement .......................................................................................... 26 

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 2 

Senator Brown 

Prepared statement ................................................................................... 26 

WITNESSES 

Michael S. Gibson, Director, Division of Banking Supervision and Regulation, 

Board of Governors of the Federal Reserve System .......................................... 4 

Prepared statement .......................................................................................... 28 

Responses to written questions of: 

Senator Shelby ........................................................................................... 93 

Senator Menendez ..................................................................................... 104 

Senator Warner ......................................................................................... 106 

Senator Wicker .......................................................................................... 109 

John C. Lyons, Chief National Bank Examiner, Office of the Comptroller 

of the Currency ..................................................................................................... 6 

Prepared statement .......................................................................................... 43 

Responses to written questions of: 

Senator Shelby ........................................................................................... 110 

Senator Menendez ..................................................................................... 117 

Senator Warner ......................................................................................... 118 

Senator Wicker .......................................................................................... 120 

George French, Deputy Director, Policy, Division of Risk Management Supervision, Federal Deposit Insurance Corporation ................................................. 7 

Prepared statement .......................................................................................... 84 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Statement submitted by John von Seggern, President and Chief Executive 

Officer, Council of Federal Home Loan Banks .................................................. 123 

Statement submitted by the Independent Community Banks of America ......... 142 

(III)

(1) 

OVERSIGHT OF BASEL III: IMPACT OF 

PROPOSED CAPITAL RULES 

WEDNESDAY, NOVEMBER 14, 2012 

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Committee met at 2:35 p.m., in room SD–538, Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of the Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN TIM JOHNSON 

Chairman JOHNSON. I call this hearing to order. 

After the financial crisis, Congress passed Wall Street Reform 

into law and asked our regulators to strengthen the financial sector 

by enhancing capital standards and prudential supervision. In addition, Federal banking agencies negotiated the Basel III accords, 

an agreement with other Nations’ banking agencies. The proposed 

capital rules under discussion today implement that agreement. 

These are complex rules, and today we will hear from the experts 

at the Fed, OCC, and FDIC about the important goals they hope 

to accomplish with these proposed rules, as well as their potential 

impact. 

Since the rules were proposed in June, Members of this Committee have heard a number of concerns about these rulemakings 

from former Federal regulators, current State regulators, industry 

participants, and academics. These concerns are documented in 

over 2,000 comment letters submitted by a wide range of stakeholders, including community banks and insurance companies. 

While most agree the higher levels of capital are appropriate, the 

details of how to improve bank capital will have a broad impact 

and must be closely examined. 

Specifically, with respect to community banks, I appreciate that 

your agencies have undertaken a number of efforts to explain the 

proposed rules to community banks, including issuing a capital estimation tool for banks to evaluate how the proposed rules will impact them. However, I am concerned that the proposed risk weights 

could have an adverse impact on small banks’ ability and willingness to offer mortgages, especially in rural areas. I look forward to 

hearing more today about how the risk weights were determined 

for mortgages, securitizations, and mortgage servicing rights, and 

what kind of impact these rules might have on our housing market. 

I also want to hear more about the proposed treatment of ‘‘accumulated other comprehensive income.’’ At a time where interest 

rates cannot get much lower, we should pay particular attention to 

2 

how new rules could make interest rate management more difficult, especially for smaller banks. 

In addition, I am concerned by the treatment of the business of 

insurance in the proposed rules. Before moving forward with applying these rules to insurance companies, the banking agencies 

should take additional time to work with State insurance regulators, the Federal Insurance Office, and the independent insurance expert on the Financial Stability Oversight Council to better 

understand the insurance accounting framework and risk-based 

capital model currently used. This feedback should then be used to 

develop a capital framework that is more suitable for financial institutions engaged in the traditional business of insurance and give 

these companies appropriate time to implement the new framework. 

A strong capital base is a key component of a resilient financial 

system. This was a major lesson of the financial crisis in 2008, and 

your agencies are to be commended in your efforts to steadily recapitalize the U.S. banking system and establish new standards. 

But while capital can serve as an important loss-absorbing buffer, 

capital alone will not prevent financial firms from failing and potentially threatening the broader financial stability. It is important 

that capital standards are well calibrated with other supervisory 

requirements, including new rules mandated by the Wall Street 

Reform Act. I look forward to hearing how each of your agencies 

is coordinating the ongoing rulemakings to ensure all of the pieces 

fit together. 

I believe we share the same goal of strong and harmonized capital rules to promote financial stability, but before moving forward, 

it is important to understand how the regulators have considered, 

and will continue to consider, the concerns being raised. I encourage your agencies to take the appropriate amount of time needed 

to get these rules right. 

Last, I want to applaud you all for the steps your agencies took 

last week to provide clarity on the Basel III rules’ effective date. 

This was well in advance of the previously announced January 1, 

2013, effective date, and I believe the announcement was very useful to those companies working to comply with these rules. 

With that, I will turn to Ranking Member Shelby. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. Thank you very 

much for calling this hearing at this time. I think it is very, very 

important. 

Today, as the Chairman has pointed out, the Committee will 

hear from the Federal Reserve, the OCC, and the FDIC about their 

proposed rules to implement the Basel III international accord. The 

primary goal of Basel III is to strengthen bank capital requirements. I think this is a worthy goal as strong capital requirements 

are essential for a safe and sound banking system and also to protect against taxpayer-funded bailouts. 

Unfortunately, one of the clear lessons of the financial crisis is 

that bank regulators set capital requirements too low. In their proposals, the agencies themselves admit that when the crisis came, 

and I will quote, ‘‘the amount of high-quality capital held by banks 

3 

globally was insufficient to absorb losses.’’ We know this on this 

Committee. And as a result, taxpayers were called upon to bail out 

our banks, and our economy suffered its worst crisis since the 

Great Depression. 

In light of this recent history, I support the agencies’ goal of enhancing capital levels to protect American taxpayers from having 

to bail out banks down the road. Yet given the failure of bank regulators to set appropriate capital levels before the crisis, I cannot 

help but doubt the regulators’ ability to set them correctly after the 

crisis. But there is hope. 

Accordingly, I believe this Committee must rigorously, Mr. Chairman, review the agencies’ proposals to ensure that the goal of 

Basel III is actually achieved. We should not, I think, simply rely 

on the agencies’ assurances that their proposed rules will leave our 

banks properly capitalized. We have been down that road before. 

Instead, the agencies I hope would demonstrate to this Committee 

and to the public that their proposed rules are supported by proper 

data and rigorous economic analysis. 

Regrettably, the agencies have so far not provided sufficient data 

and analysis of their proposals. That is why weeks ago I wrote to 

the agencies asking them to publicly released detailed estimates of 

how capital levels will change for U.S. banks under Basel III, how 

the agencies determine that those levels will leave the U.S. banking system well capitalized, and what will be the compliance cost. 

All that is important. These were basic questions that should be 

publicly answered before this rulemaking proceeds. 

I do not believe that it will surprise anyone to learn that the 

agencies finally responded, Mr. Chairman, to my letter yesterday, 

right on the eve of this hearing. Unfortunately, their response relies largely on studies by the Basel Committee which use data only 

from the very largest banks. For example, one key study included 

data from only 13 U.S. banks. In addition, the Basel Committee’s 

quantitative impact study aggregates country results. It does not 

specifically show how Basel III will impact the U.S., which we are 

interested in first and foremost here. 

Even more troubling, the agencies state that they believe Basel 

III is appropriate based on the losses experienced by U.S. banks, 

but they do not up to now provide data to support this conclusion. 

You must do that. 

It is time, I think, that our banking regulators stop outsourcing 

their economic analysis to the Basel Committee and start doing 

their own work. They need to determine, I believe, how Basel III 

will impact our diverse and unique banking system and the overall 

U.S. economy. They also need, I believe, to end their cloistered approach to rulemaking. 

First, the public has the right to know the consequences of adopting Basel III, including how it will impact the stability of the U.S. 

banking system, economic growth in the U.S., and the ability of 

American consumers to obtain loans. The public’s right to know, I 

believe, is even more pronounced given the agencies’ failure to 

proper set capital requirements before the crisis. Moreover, there 

are growing doubts about Basel III’s model-based approach to setting capital requirements. We should know what it is. You should 

be able to defend it. 

4 

Many commentators and even some regulators are concerned 

that the Basel III models are too complex and inaccurate to be relied upon. If the agencies want the public to have confidence—and 

that is very important—in Basel III, they need to make their case 

publicly, and this is a good place to start. 

Finally, by omitting key data and analysis from this important 

rulemaking, the agencies are also undermining the ability of Congress through this Committee to hold the agencies accountable. The 

public depends on Congress to conduct oversight and to ensure that 

the agencies do their jobs effectively. Without more information, it 

is impossible to determine if the proposed rules will actually set 

capital requirements at the appropriate levels. Congress cannot, I 

believe, effectively engage in oversight right here if we do not know 

what goes on behind closed doors at the agencies. 

It is my hope that the witnesses today can provide, at least to 

start, a more thorough and data-based explanation for their Basel 

III rule proposals. Both Congress and the public deserve a far better explanation than they have been given so far. I hope this will 

be a new day. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Thank you, Senator Shelby. 

Are there any other Members who wish to make a brief opening 

statement? 

[No response.] 

Chairman JOHNSON. Thank you all. I want to remind my colleagues that the record will be open for the next 7 days for opening 

statements and any other materials you would like to submit. Now 

I will briefly introduce our witnesses. 

Mr. Michael Gibson is the Director of the Division of Banking 

Supervision and Regulation at the Board of Governors of the Federal Reserve System. 

Mr. John Lyons is the Chief National Bank Examiner at the Office of the Comptroller of the Currency. 

Mr. George French is the Deputy Director of Policy in the Division of Risk Management Supervision at the Federal Deposit Insurance Corporation. 

I ask our witnesses to limit their testimony to 5 minutes. Your 

full statements will be submitted for the record. 

Mr. Gibson, you may proceed with your testimony. 

STATEMENT OF MICHAEL S. GIBSON, DIRECTOR, DIVISION OF 

BANKING SUPERVISION AND REGULATION, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. GIBSON. Chairman Johnson, Ranking Member Shelby, and 

Members of the Committee, thank you for the opportunity to testify 

on the proposed interagency changes to the regulatory capital 

framework for U.S. banking organizations. 

The recent financial crisis revealed that too many U.S. banking 

organizations were not holding enough capital to absorb losses during periods of severe stress. In addition, some instruments that 

counted as capital were not able to absorb losses as expected. In 

short, the crisis showed us that banks were too highly leveraged. 

In response, the banking agencies’ capital proposal would increase 

5 

both the quantity and quality of capital held by banking organizations of all sizes. 

Another lesson from the crisis was that the largest banking organizations were the most severely impacted. As a result, many items 

in the agencies’ proposal and in other regulatory reforms are appropriately focused on larger banking firms and would not apply to 

community banking organizations. 

We have assessed the impact of these proposed changes on banking organizations and the broader financial system. These analyses 

found that the stronger capital standards in our proposal would 

significantly lower the probability of banking crises and their associated economic losses, while having only a modest negative effect 

on gross domestic product and the cost of credit. The modest negative effects would be mitigated by the extensive transition periods 

provided in our proposal. 

Our impact analysis also showed that the vast majority of U.S. 

banking organizations, including approximately 90 percent of community banking organizations, would not be required to raise additional capital because they already meet the proposed higher minimum requirements on a fully phased-in basis. 

Community banking organizations play a vital role in the U.S. financial system. They can provide relationship-based lending in 

their local communities in a way that larger institutions would find 

difficult to duplicate. In developing the proposal, the agencies 

sought to strike the right balance between safety and soundness 

concerns and the regulatory burden associated with implementation, including the impact on community banking. We also conducted extensive industry outreach across the country, and we provided a tool to help smaller organizations estimate their capital levels under the proposal. As we consider the large volume of comments submitted by the public, the Federal Reserve will remain 

sensitive to concerns expressed by community banking organizations. 

Community banking organizations are particularly concerned 

about the proposed treatments of unrealized gains and losses on securities, otherwise known as AOCI, and residential mortgage exposures. They believe that elements of our proposal do not adequately 

take into account the community banking business model and that 

some aspects would have potential disproportionate effects on their 

organizations. We will be mindful of these comments when we consider potential changes to the proposal, and we will work to appropriately balance the benefits of a revised capital framework against 

its costs. 

The proposal would apply consolidated capital requirements to 

all assets owned by a depository institution holding company and 

its subsidiaries, including assets held by insurance companies. By 

treating all assets equally, the proposal would eliminate incentives 

to engage in regulatory capital arbitrage across different subsidiaries of the holding company. 

The proposal is also consistent with the Collins Amendment in 

Section 171 of the Dodd-Frank Act, which requires that bank capital requirements be a floor for depository institution holding company requirements. Depository institution holding companies with 

insurance activities have raised concerns that the proposed reguVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
6 

latory capital requirements are not suitable for the insurance business model. The Federal Reserve takes these comments seriously 

and will consider them carefully in determining how to appropriately apply regulatory capital requirements to depository institution holding companies with significant insurance activities. 

Thank you for the opportunity to describe the Federal Reserve’s 

efforts to reform the regulatory capital framework for U.S. banking 

organizations, and I will be happy to answer any questions you 

have for me. 

Chairman JOHNSON. Thank you, Mr. Gibson. 

Mr. Lyons, you may proceed. 

STATEMENT OF JOHN C. LYONS, CHIEF NATIONAL BANK EXAMINER, OFFICE OF THE COMPTROLLER OF THE CURRENCY 

Mr. LYONS. Chairman Johnson, Ranking Member Shelby, and 

Members of the Committee, I appreciate the opportunity to discuss 

the three proposed capital rules issued by the Federal banking 

agencies and their potential impact on the industry. We have received extensive comments on the proposals from banks of all sizes. 

In response to concerns raised by commenters, we announced last 

week that we will delay the January 1st effective date. We are especially mindful of the concerns that community bankers had 

raised about the potential burden and the impact these rules could 

have on their institutions. 

Our goal is simple: to improve the safety and soundness of our 

Nation’s banking system by ensuring that all banks of all sizes 

have sufficient capital to weather adverse conditions and unforeseen losses. Strong capital plays a vital role in promoting financial 

stability and moderating downturns by facilitate banks’ capacity to 

lend. 

During the recent cycle, the banks that were best able to meet 

the credit needs of their customers and communities were those 

with strong capital bases. This underscores the principle that higher capital standards that apply to all banks are essential to the financial strength of the industry and our Nation’s economy. 

Capital rules also need to reflect risks appropriately, and so 

under the proposal, riskier loans, such as certain types of nontraditional mortgages, would require more capital. We believe the proposals reinforce key objectives of the Dodd-Frank Act, specifically 

promoting financial stability and requiring higher capital for 

riskier firms and activities. 

The June rulemaking package consists of three Notices of Proposed Rulemakings (NPR). Each NPR calibrates requirements to 

the size and riskiness of institutions so that larger banks will hold 

more capital and meet stricter standards than smaller ones. These 

are not one-size-fits-all requirements. 

The first proposal introduces a new measure for regulatory capital called Common Equity Tier 1 and two new capital buffers—a 

capital conservation buffer that would apply to all banks, and a 

countercyclical buffer that would apply only to the largest institutions. For community banks, this would result in a Common Equity 

Tier 1 requirement of 7 percent of risk-weighted assets. For large, 

internationally active banks, this requirement could be as high as 

7 

13 percent when combined with a SIFI surcharge that is being considered internationally. 

The second proposal, the Standardized Approach NPR, would 

modify certain risk weighting so that riskier loans and activities require more capital. Here, too, distinctions are made between small 

and large banks as certain provisions of the NPR, such as those related to securitization and credit risk mitigation, would have little 

or no application to most community banks. 

The third proposal, the Advanced Approaches NPR, applies only 

to the largest internationally active institutions and does not affect 

community banks. To reduce possible adverse effects, especially for 

community banks that have less access to market sources of capital, the proposals include a lengthy transition period. 

Our preliminary assessment is that many community banks hold 

capital well above the existing and the proposed regulatory minimums. Nevertheless, we took steps to maximize opportunities for 

community bankers to learn about and to comment on the proposals. These steps included short summaries aimed at community 

banks, extensive outreach with community bankers, and a tool to 

help them assess the impact of their proposals. While we have received comments on many issues, three overarching concerns have 

been raised: 

First, many have cited the complexity of the rules. Community 

bankers in particular have questioned whether proposals should 

apply to them. 

Second, many have raised concerns about including unrealized 

losses and gains and available-for-sale debt securities and regulatory capital and volatility that could result in capital levels and 

other limits tied to regulatory capital such as lending limits. 

Third, bankers have expressed concerns about the recordkeeping 

burdens resulting from the proposed rules, the proposed use of 

loan-to-value measures for residential mortgages, and the higher 

risk weights that would be assigned to balloon residential mortgages. 

As we consider these issues, we will continue to look for ways to 

reduce burden and complexity while maintaining our key objectives 

of raising the quantity and quality of capital and matching capital 

to risk. These enhancements will lead to a stronger, more stable financial system. 

I appreciate your interest in this matter and would be happy to 

answer your questions. 

Chairman JOHNSON. Thank you, Mr. Lyons. 

Mr. French, you may proceed. 

STATEMENT OF GEORGE FRENCH, DEPUTY DIRECTOR, POLICY, DIVISION OF RISK MANAGEMENT SUPERVISION, FEDERAL DEPOSIT INSURANCE CORPORATION 

Mr. FRENCH. Thank you. Chairman Johnson, Ranking Member 

Shelby, and Members of the Committee, good afternoon. I appreciate the opportunity to testify on behalf of the FDIC about these 

proposed regulatory capital rules. My statement will focus on the 

two Notices of Proposed Rulemaking that pertain to community 

banks and some of the comments we have received. 

8 

One of these NPRs deals with the Basel III capital reforms. The 

core elements of Basel III would strengthen the quality of bank 

capital and increase its required level. These are basic concepts of 

capital adequacy that are relevant for any bank, and the Basel III 

NPR would apply them to all insured banks. 

The Basel III reforms also include a number of complex provisions targeted at large, internationally active banks. We have proposed to apply these only to the largest banks, so these large banks 

would need to comply with the basic changes to the definition and 

level of capital that are proposed for all banks and also with additional standards that address the unique risks they face. The Basel 

III NPR also preserves the fundamental role of the U.S. leverage 

ratio. The FDIC strongly supports the introduction of the leverage 

ratio in the Basel framework as a transparent and objective measure of capital adequacy. 

The second NPR that is relevant for community banks is the 

Standardized Approach NPR. It proposes a number of changes to 

the way banks compute risk-weighted assets and removes references to credit ratings consistent with the Dodd-Frank Act. I 

want to clarify that the changes to risk-weighted assets in the 

Standardized Approach NPR are separate and distinct from the 

international Basel III reform package. 

The FDIC has devoted significant efforts to outreach and technical assistance to help community banks understand how these 

proposals may affect them. We have received more than 1,500 comments at last count, and many of these comments express concern 

that the proposals will negatively affect community banks’ ability 

to serve the credit needs of their local communities. As the primary 

Federal regulator of the majority of community banks, the FDIC 

takes these comments very seriously. 

In the last 5 years, we have seen over 460 insured banks fail and 

many hundreds more in problem bank status. This painful episode 

has imposed significant costs on our national and local economies 

and illustrates the importance of banks having a strong capital 

base so that they can continue to lend in their communities, even 

during periods of economic adversity. 

Many commenters do acknowledge the importance of strong bank 

capital, but they also have concerns about specific aspects of the 

proposals, their complexity, or the totality of the potential effects. 

Among the more frequently mentioned specific issues are the residential mortgage rules in the Standardized Approach NPR and 

their interaction with other Dodd-Frank mortgage rules. 

In the Basel III NPR, many commenters have focused on the proposed treatment of available-for-sale debt securities and many others on the phase-out of the preexisting trust preferred securities of 

smaller organizations. 

Careful review of these and other comments is a critically important part of our process that gives us a better understanding of the 

potential unintended consequences and costs of the proposals. It is 

important to note that we have not reached decisions on any of 

these matters. These are proposed rules, not final rules, and we anticipate making changes in response to comments. 

The basic purpose of the Basel III framework is to strengthen the 

long-term quality and quantity of the capital base of the U.S. bankVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
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ing system. In light of the recent financial crisis, that would appear 

to be an appropriate and important goal. However, that goal should 

be achieved in a way that is responsive to the concerns expressed 

by community banks about the potential for unintended consequences. 

I would be happy to respond to your questions. 

Chairman JOHNSON. Thank you for your testimony. 

We will now begin asking questions of our witnesses. Would the 

clerk please put 5 minutes on the clock for each Member? 

Mr. Gibson, last week, Governor Duke said, ‘‘Before we issue 

final capital rules, we will do everything possible to address the 

concerns that have been expressed by community banks and still 

achieve the goal of having strong levels of high-quality capital built 

up over a reasonable and realistic transitional period in banks of 

all sizes, including community banks.’’ 

How exactly do you plan to address the concerns expressed by 

community banks and others while maintaining strong levels of 

capital? 

Mr. GIBSON. We believe that the vast majority of community 

banks already meet the higher level of capital that is proposed in 

the proposal, and our impact analysis has shown that to be the 

case. We have received a lot of comments from community banks 

on many aspects of the proposal, but mostly those comments are 

not aimed at the level of capital but at other aspects of the proposal. As I mentioned in my testimony, the treatment of unrealized 

gains and losses on securities, the proposed risk weights for residential mortgages, and various other things have been the focus of 

community bank comments. 

We will definitely consider those comments as we move forward 

on a final rule, and we think that the fact that community banks 

already have a strong capital base makes them well positioned to 

meet the higher requirements. And as Governor Duke mentioned 

in her comment, allowing a longer transition period is another way 

of easing the burden, including the costs of implementation for new 

IT systems and other implementation costs that community banks 

have also expressed concerns about. So we definitely will take a 

look at that as we move forward. 

Chairman JOHNSON. Mr. French, what impact will the current 

proposals have on the ability of community banks to offer balloon 

and second mortgages, especially in rural areas like we have in 

South Dakota? Also, will the current proposal make it more difficult for community banks to manage interest rate risk? 

Mr. FRENCH. Mr. Chairman, we have heard about both of these 

issues many times from our community banks in face-to-face meetings. We had a good discussion of these just last week at our Community Bank Advisory Committee. 

With regard to balloon loans, you know, we have heard the comment that many rural banks offer these loans. They are simple 

structures that the banks understand and have been making successfully for many years. So the question is whether, by trying to 

capture some of the more risky practices that we saw in the crisis, 

we are inappropriately sweeping these loans up in the proposed 

rule. And based on the comments, the commenters are very concerned about the impact this will have on these banks and the local 

10 

communities. We take those concerns very seriously, and it is one 

of the issues we are focused on as we review the comments. 

And with regard to AOCI, we have heard, again, many concerns 

about the volatility of regulatory capital that could come to pass as 

interest rates change, and the effect on managing things like legal 

lending limits, regulatory capital, capital planning, and also interest rate risk, because banks may feel forced to put more of their 

securities, their long-term securities, into the held-to-maturity 

bucket so that they will not face these fluctuations. That could 

limit their flexibility, to some extent, in addressing these changes 

in interest rates. 

So this is, once again, an area we have heard a tremendous 

amount of comments from virtually every bank that we have spoken to, and we are studying the comments closely and deciding 

how to proceed with our fellow regulators. 

Chairman JOHNSON. Mr. Lyons, should the capital rules alone fix 

all that went wrong in the financial crisis? Can more capital prevent all future financial crises? If not, what role should capital 

rules play and what role should other Wall Street reform rules play 

in mitigating future crises? Are you coordinating these rulemakings 

within and between the agencies to make sure the rules are complementary and not duplicative? 

Mr. LYONS. Mr. Chairman, capital is important, although we do 

not believe it is the sole solution. We have coupled that with regulation. And we believe strong supervision is a process that should 

be in place as well. So we really look at it as three legs—capital 

buffers and liquidity buffers as well, coupled with regulation, that 

we are discussing today, the proposals, the capital proposals, as 

well as strong supervision. 

Chairman JOHNSON. Mr. Gibson, what steps have you taken or 

will you take in consultation with insurance experts at the State 

and Federal level to better understand the differences between insurance companies and banks to ensure that the capital requirements in Basel III are well calibrated for the business of insurance? 

Mr. GIBSON. Congress has required us to set consolidated capital 

requirements for bank holding companies and savings and loan 

holding companies, including those that choose to own an insurance company, and our goal has been to set strong capital requirements for both the quality and quantity of capital. We have been 

consulting with a wide range of insurance experts since we got this 

responsibility as a result of the Dodd-Frank Act, and our responsibility for savings and loan holding companies began last year. Our 

supervisors have been responsible and have been supervising savings and loan holding companies, including those with insurance 

operations, since last year, and they have been working with the 

State insurance regulators, as they do that supervision. 

So far we have been learning a lot from insurance experts. Of 

course, the Federal Reserve has supervised insurance operations of 

bank holding companies for a long time, so we had a base of expertise to build on. We have received a lot of comments from insurance 

industry experts on many aspects of this proposal and we definitely 

intend to consider those comments carefully as we move forward. 

11 

Chairman JOHNSON. And, last, Mr. Lyons, with all the concerns 

that have been expressed, what time next year do you expect to 

issue a final rule? And how much time will you give companies to 

begin complying with the new requirements? 

Mr. LYONS. Senator, it is a complex rule. We acknowledge that. 

In respect of that, we extended the comment period, and we have 

extended the effective date. We have, as George indicated earlier, 

over 1,500 comments that we have received. We are going to review 

each one of those, each and every one, and we will take those into 

consideration when we work on a final proposal and move forward. 

Chairman JOHNSON. Senator Shelby. 

Senator SHELBY. Thank you again, Mr. Chairman. 

My basic question to all three of you, and I will quote: ‘‘The Bank 

of England Governor, Mervyn King’’—and you are familiar with 

him, and a lot of us have a lot of respect for him—‘‘and several 

other prominent economists in the world have said that the Basel 

III capital standards are insufficient to prevent another crisis.’’ 

Do you disagree or do you agree? And if so, why? We will start 

with you, sir, Mr. Gibson. 

Mr. GIBSON. We feel that our proposal to raise the quality and 

quantity of bank capital is one of the most important pieces of the 

regulatory reform agenda. 

Senator SHELBY. I agree with that. 

Mr. GIBSON. Not by itself the complete agenda but one of the 

most important pieces, because we saw that capital leading into the 

crisis was too low. 

Senator SHELBY. What about liquidity, too? Is that very important at the right time with capital? 

Mr. GIBSON. Yes, we agree that liquidity reform is also an important piece of the reform agenda. 

Senator SHELBY. Mr. Lyons. 

Mr. LYONS. I would agree with what Michael has said, that capital and liquidity are both important, and we have surrounded the 

proposal here with—the Fed has prudential heightened standards 

that they are going to implement, and the FDIC will have resolution and living wills under Title 2. So we supplemented the regulation with what we think is stronger supervisory goals as well. 

Senator SHELBY. Mr. French. 

Mr. FRENCH. Senator, we agree that strong capital is an important check on excessive leverage in the system, and it is a vital 

shock absorber for losses that come along. 

Senator SHELBY. That is what it is for, is it not? 

Mr. FRENCH. That is correct. So we believe that this proposal is 

a significant strengthening of our current rules. 

Senator SHELBY. So all three of you believe that the capital requirements of Basel III, if implemented properly, will be sufficient? 

At least we hope so, right? Is that fair? Nobody knows, but that 

is what you believe, right? 

Mr. FRENCH. It provides substantial additional comfort compared 

to what we have now. 

Senator SHELBY. OK. Mr. Gibson, let me ask you this question, 

if I can: Traditionally, insurance companies have been regulated at 

the State level. The proposed Basel III rules will apply to financial 

holding companies that own insurers. In devising capital requireVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
12 

ments for holding companies that own insurance businesses, how 

much did the Fed rely on State insurance capital requirements, if 

they did? And explain how the Fed is coordinating its oversight of 

financial holding companies that own insurers with State insurance regulators who are the primary regulators? 

Mr. GIBSON. Our supervision and regulation of savings and loan 

holding companies that have insurance operations is limited to the 

holding company level. 

Senator SHELBY. And how many would that be, roughly? 

Mr. GIBSON. There are a couple dozen of those. 

Senator SHELBY. OK. 

Mr. GIBSON. There are, of course, thousands of insurance companies in the U.S., and all insurance companies are subject to Statebased regulation at the level of the insurance operating company. 

What we have the authority to do is for the holding company to set 

consolidated capital requirements and to consolidate its supervision. 

With respect to working with State insurance regulators, our supervisors are looking at the holding company risks, and they work 

closely with the State insurance regulators who are focused on the 

risks in the insurance business. 

Senator SHELBY. Let me pose this to all of you: The FDIC Director, Thomas Hoenig, recently gave a speech when he stated, and 

I will quote: ‘‘The poor record of Basel I, II, and II.5 is that of a 

system fundamentally flawed. Basel III is a continuation of these 

efforts, but with more complexity.’’ 

I have already quoted the Bank of England Governor. I also understand the Bank of England Executive Director of Financial Stability, Andrew Haldane, gave a speech and restated that the Basel 

framework ‘‘has spawned startling degrees of complexity and an 

over-reliance on probably unreliable models’’—which is always dangerous. 

My question to all three: Is the Basel framework too complex to 

really work? And will you know? And what testing did you do or 

will you do to determine the accuracy of the Basel III models? 

What did those tests show? Because I think we need to know. You 

have got a new regime here. We want it to work. Will it work? We 

do not know yet. It has not been tested. Mr. Gibson? 

Mr. GIBSON. One aspect of our capital proposal is that, in addition to a risk-based capital requirement, we also have a leveraged 

capital requirement which is based on a simpler measure of capital 

to assets. 

Senator SHELBY. Explain that as compared to the risk-based. 

Mr. GIBSON. The risk-based applies—— 

Senator SHELBY. The leverage-based. 

Mr. GIBSON. The leverage-based, it just takes the amount of assets on your balance sheet as the denominator, with no risk 

weighting or models involved. We feel that by having both of those, 

it is more effective at having strong capital than just one by itself, 

because one by itself could be gamed or arbitraged. By having the 

risk-based requirement, which is more complicated, in combination 

with the leverage ratio, you get some protection against that gaming by banks. 

Senator SHELBY. Mr. Lyons. 

13 

Mr. LYONS. Senator, I will address your impact analysis. We did 

do an impact analysis similar to the Fed, but different. We did 

come up with a similar conclusion that most of the banks, the vast 

majority of banks will hold capital well above the required minimums. And we will do further analysis as we go through. We asked 

the commenters for what they have determined based on the estimator tool that we provided them, what type of impact it would be 

to them as well. So we will take that into consideration as we move 

forward. 

Senator SHELBY. Mr. French. 

Mr. FRENCH. I do want to say that the FDIC as an institution 

has long supported simple and objective capital standards. 

Senator SHELBY. And they have worked, too, have they not? 

Mr. FRENCH. We believe so. And we have always supported the 

leverage ratio and pushed hard to have simple floors under the 

risk-based requirements. In fact, there is a Basel Committee subgroup that is looking at ways to simplify these rules going forward, 

and we actually chair that group. So we—— 

Senator SHELBY. Will you share that data with this Committee, 

you know, what you are doing and how you are doing it and why? 

Mr. FRENCH. Yes, we will. In terms of whether this will work, we 

are satisfied that, in terms of the overall level and the direction of 

this proposal, it is a substantive and meaningful strengthening of 

our capital system. We have to deal, of course, with all the specific 

comments about the specific aspects and the complexity. 

Senator SHELBY. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Reed. 

Senator REED. Well, thank you, Mr. Chairman. I want to follow 

up on Senator Shelby’s questions, but also note that Senator Shelby was just as astute when Basel II was before the Committee, and 

through his efforts and Senator Dodd’s efforts, Basel II was not embraced as enthusiastically here as in Europe, and when the crisis 

came, we were in a little bit better position, so thank you. 

Senator SHELBY. Two big skeptics right here. 

Senator REED. Well, you are a big skeptic; I am a half-size skeptic. He is a very big skeptic. 

Let me ask a basic question, Mr. Gibson, and that is, what legal 

obligation do we have to follow Basel III? It seems a very simpleminded question, but for the record, please. 

Mr. GIBSON. We do not have any legal obligation. It is not a treaty. But the member countries of the Basel Committee agree that 

having a global level playing field is important and holding banks 

in all the Basel Committee countries to high standards is important, and if we agree on what those standards are, we’ll have an 

easier time doing that. 

Senator REED. OK. So that we can shape to a degree our response to the Basel III concept, as you are doing right now, but 

also there is sort of a quid pro quo. If we are not stringent and we 

are not thoughtful about it, then we cannot expect the same process from other major financial countries. 

Mr. GIBSON. That is right. We do tailor the Basel Committee 

agreements to our local U.S. circumstances, and we are allowed to 

do that within the boundaries that are set up by the Basel Committee. 

14 

Senator REED. One of the flaws with Basel II was that there was 

a great deal of reliance on internal risk models, that banks were 

essentially grading themselves on their capital. Is that still prevalent in the Basel III proposals? 

Mr. GIBSON. The risk-weighting scheme in Basel II is maintained 

in Basel III. The change that is coming in Basel III is higher quantity and quality of capital requirements. 

One thing that we are doing in the Basel Committee is a study 

across Basel Committee countries of how the risk weights are actually put into practice, and that is one of the Basel Committee’s 

major initiatives for 2012 and is currently being worked on. We 

hope to learn from that process how each country is doing in terms 

of its banks’ implementing the standards in a consistent way because, as you say, that is very important for the standards to work. 

Senator REED. Indeed, but one of the problems which I think we 

mentioned with Basel II was that banks were—they were categorized, but they were the ones who were essentially evaluating 

their capital status. The regulators, of course, come in and review 

that. Is that still prevalent in Basel III? Is that still going to be 

the case? 

Mr. GIBSON. Yes, that aspect of Basel has not changed. 

Senator REED. Thank you very much. 

One of the other points that was made—and I am just reinforcing again a point that Senator Shelby made—Mr. French, you 

talked about and Mr. Gibson responded also about the importance 

of the leverage ratio as well as the risk-asset ratio. And that is 

something that we have had in the United States, but this is a new 

aspect for Basel III for the whole community. Is that correct? 

Mr. FRENCH. It is new in the Basel framework. We have had it 

in the U.S. really since the early 1980s, and then formally in the 

early 1990s. But it is an important step for the Basel Committee. 

I think it reflects their recognition from the crisis that many of the 

models really did need some objective constraints underneath 

them. 

Senator REED. And let me ask you another question, which 

comes to some of the comments I have heard, particularly from 

community banks, and that goes to—and you mentioned it, Mr. 

French, that now instead of being able to rely upon a rating by a 

credit rating agency, there has to be essentially an analysis by the 

institution of the creditworthiness of the value of the asset on the 

book or the liability. Is that one of the issues of complexity that is 

being raised by community banks? 

Mr. FRENCH. To some extent, yes. There are certain aspects that 

have not changed and, in fact, important aspects. If the bank holds 

a Treasury or an agency mortgage-backed security or whatever, it 

is going to keep doing what it has always done, which is use a 20- 

percent risk weight. If it does have a private label mortgage-backed 

or structured type of product, it is going to have to assess the structure of the securitization and apply a formula that would set capital based on the seniority of the tranche. 

So there is some concern about that. I would say, however, that 

a number of the servicer reports and vendors are starting to put 

out information that the banks can apply pretty easily. 

Senator REED. Thank you very much. 

15 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Corker. 

Senator CORKER. Thank you, sir, and I thank each of you for 

being here to testify. You know, we have read through the proposals and looked specifically at the sovereign debt issue, and you 

can almost imagine a lot of folks, heads of States in Basel sipping 

champagne and thinking about a way to create a mechanism where 

the banks around the world are there to create money, loan them 

money through all the prolific ways that all of us have right now. 

I am fascinated that sovereigns have a zero weighting, period, 

unless they are in default and it goes from zero to 150. So that 

would mean that our great thinkers around the world have decided 

that, for instance, today they would encourage U.S. banks to hold 

Spanish debt and have a zero risk weighting. I would just like for 

you all to explain to me how we have succumbed to a situation 

where all sovereign debt has a risk weighting of zero, especially 

during these times and what we are watching happen around the 

world. 

Mr. LYONS. Senator, I will try to answer that. I do believe sovereign ratings—we do apply the OECD rating to those institutions, 

so there is a rating that is assigned to them. I would have to double-check and get back to you on the rate. You are saying it is a 

zero rate or 150. I am thinking there may be something in between 

there based on the rating of the sovereign, but I would have to double-check for you. 

Senator CORKER. I do not think that is the case. Would one of 

the other two of you want to respond to that? 

Mr. FRENCH. I think you characterized it fairly. For practical 

purposes, most of the countries would be zero until default. Theoretically, there would be some other countries that have a rating 

that would not get them zero, but they are few and far between for 

practical purposes. I think you raise clearly a very important point, 

and I think my only observation might be, for practical purposes 

here in the U.S., many of those obligations are going to be held in 

trading accounts of large banks where these proposals are irrelevant. They are going to be holding capital against market risk for 

those things. You know, if we had had the ability to use credit ratings, we might have been able to apply those. We were not allowed 

to do that by Dodd-Frank. So we have, you know, these minds sitting around the table, and we have to figure out how is the U.S. 

going to assign grades to different countries. And it is a challenge, 

so we acknowledge the issue. 

Senator CORKER. I understand that these may well be in trading 

accounts, but I guess as people are looking at capital and they are 

trying to create a way of having return, and they know they can 

buy Spanish debt or some other debt of a sovereign and get a much 

greater yield, and you guys are not going to ping them on it, then 

you are basically encouraging them to buy risky sovereigns. It just 

makes no sense to me. And it is my understanding it was the Europeans that pressed us hard to move into this regime, and I am just 

wondering why we did not push back, especially since they are basically using their banking system to fund all the problems that 

they are having right now. 

16 

I mean, this seems to me something that would have just jumped 

out with alarms and we would have said this makes no sense and 

we are not going to be a part of this. 

Mr. FRENCH. You raise very good points. Again, here in the U.S., 

I think if we actually had a bank that was applying zero risk 

weights, we would probably be on them from the supervisory perspective. There would be probably securities depreciation in their 

account if they were certain countries, and we would—— 

Senator CORKER. So they really could not rely upon the Basel. 

You are saying that if they actually were an international type institution and they were relying on Basel and following those rules, 

you would come at them a different way and say, well, no, you really cannot do that? 

Mr. FRENCH. I think that for practical purposes, it is, again, the 

trading accounts of large banks. I do not think our smaller banks 

in the U.S. are for the most part buying these. That is my understanding. But I certainly take your points about—— 

Mr. GIBSON. I would just add that in our most recent stress test, 

we did impose a special look at exposures to a European stress 

event that did look at potential losses on those types of securities. 

So there are other tools besides regulatory capital rules to make 

sure that banks do not have excessive concentrations in sovereign 

debt. 

Senator CORKER. I have two more questions, and I really would 

just make a comment on the second one, and then ask a third and 

try to be very brief. The complexity issue is fascinating. I noticed 

with the mortgage issues you all have got this grid with eight 

boxes, and you grade mortgages, and I actually thank you for doing 

that and appreciate it, and I hope we sync that up with the QM 

and QRM, other issues that are not part of Basel that are coming 

down the road. 

But on credit card debt and auto debt and corporate debt, you 

do not do that. I just find that fascinating, that what you did, you 

spent, it sounds like, you know, months and months and months 

grading different mortgages, which I think we would all agree 

would be a good idea—subprime would be very different than 

prime with low debt ratios, but you do not do that on auto, you do 

not do that on corporate, you do not do that on credit. I just find 

it fascinating because each of them have those same complexities. 

If one of you would just answer why, then I will move to my last 

question and stop. 

Mr. GIBSON. I would say that the risk weights that you are describing are the ones in the standardized approach, and it is difficult to come up with a standardized simple way to risk-weight 

corporate loans. But for the most advanced largest banks that are 

on the more complicated approaches, they would be required to do 

a more sophisticated analysis of corporate and other exposures. 

Senator CORKER. OK. And then the countercyclical. I know Senator Warner, my friend from Virginia, we spent a lot of time a couple of years ago looking at how we can put in place something that 

is countercyclical. I actually think it is a novel idea that you guys 

have come up with this countercyclical buffer. No offense to you, 

but it seems that regulators always sort of are having fun when 

17 

things are great and then they over-regulate on the downside and 

create self-fulfilling prophecies both ways. 

I am just curious as to how we are going to have the wisdom to 

do this. I kind of like the idea, but, for instance, we have a pretty 

dovish Fed right now that does not want to create any panic. The 

Fed is probably the entity that would be doing this. Would they be 

willing to signal to folks that there is excessive debt out there? And 

would that create some kind of negativity in the marketplace, especially during a time like right now? Are you going to do it with algorithms, or is somebody just going to wake up one day and say, 

gosh, we have got excessive debt out there, and now all of a sudden 

everybody has a 2.5 percent charge? 

I am just curious as to how you think that is going to work. 

Mr. GIBSON. We are not in the situation of using the countercyclical buffer yet, so we have not completely spelled out the ways 

that we would do that. We would look at a variety of data indicators to try to get a sense of credit growth in the economy and 

whether there is excessive leverage and excessive credit growth. 

And then, you are right, it would be a tough call to actually turn 

on the countercyclical capital buffer. We have agreed that that is 

part of what the Basel Committee wants every country to be doing, 

and the burden will be on us to actually do it when the time comes. 

We are still pretty far from the point in the cycle where we will 

have to do that, but we are looking ahead and trying to think about 

how we would do that, what data we would look at, and so on. 

Senator CORKER. Well, we look forward to greater input, and I 

thank you for the time, Mr. Chairman. 

Chairman JOHNSON. Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman, and I want to 

thank all of you. I think we were all struggling with you to figure 

out how we get this right as well as with some level of simplicity 

as capital markets get more and more complex. I want to follow up 

on a couple items my friend Senator Corker raised. 

First of all, how do we make sure—just as I think you pressed 

the point about sovereign debt, on one level it is good that there 

will be other regulatory tools that would be available if banks were 

purchasing this debt and it was still zero weighted. But if we are 

thinking about this in the international context, how do we make 

sure that we are not still at a competitive disadvantage as American banks versus other banks that may not have that same level 

of scrutiny? 

Mr. GIBSON. Generally, I would say that we gain a competitive 

advantage by having strong capital and strong regulation in place. 

So the fact that we might be tougher on our banks, for example, 

through the stress test regime, at least currently that seems to be 

perceived as a strength in the market that U.S. banks have that 

strong regulation. We definitely worry about level playing field considerations, and as I mentioned earlier, the Basel Committee is 

spending more effort now looking at how countries are implementing regulations in different jurisdictions, which they did not 

used to spend very much time on. We think that is important to 

follow up on, but generally, we would argue that stronger regulation is a strength. 

18 

Senator WARNER. Well, and the flip of that or kind of the converse of that is—and the Chairman has already raised this, and 

Senator Toomey and I put a letter together that I think the majority of our colleagues signed that said—and I think you all have responded in certain ways to make sure that we protect and not have 

a single one-size-fits-all for all our institutions. We are clearly 

unique in terms of the number of community-based banks, and I 

would like you to comment on, within these Basel negotiations, is 

America’s voice being heard another about making sure there is not 

a one-size-fits all? And then, two, while we have talked about these 

capital standards ranging from 6 to 13, it is also based upon their 

SIFI designation. You know, are we also making sure that the kind 

of unique aspect of our regional banks are getting their voices 

heard? 

Mr. GIBSON. The first point I would make in response is that the 

Basel agreements only apply to internationally active banks, so in 

the U.S. we are only committed to strictly apply the Basel standards to the largest internationally active banks. 

Senator WARNER. But as we know, what oftentimes happens 

with regulators is something that is legally applied for a big bank 

up here, by default becomes kind of best practice standards and 

trickles down then oftentimes into very small institutions that cannot deal with all of this additional regulatory burden. 

Mr. GIBSON. Sure, and we are resisting that in our proposal because we have proposed different things, in some aspects, for community banks than for large banks. We are definitely trying to implement regulatory reform in a way that minimizes the burden on 

community banks. That is a key priority for us because they do, as 

you say, play a critical role in the financial system and in their 

local communities. 

Senator WARNER. And comment on regional banks here in terms 

of how they will fit among that continuum as well? 

Mr. GIBSON. We draw a line at $250 billion in assets or $10 billion of foreign exposure, and that is the line above which we 

say—— 

Senator WARNER. It is either in or out. 

Mr. GIBSON. You are in or out, we strictly apply Basel standards 

above that line. 

Senator WARNER. A couple more questions I want to get to. One 

is—Senator Corker has left, but we did spend a lot of time about 

this notion of countercyclical, and we think it makes sense. Again, 

I have to say personally figuring out what is that trigger is a challenge. But I guess the other question I would have is even if we 

get that trigger right, if we think again from the standpoint of regional community-based banks, are we willing to drill down below 

a national level? Because we may very well have a roaring economy 

or a sinking economy at the national level, but a region that is 

doing much better. Think back to the 1990s in terms of some of the 

challenges that were faced in the Southwest and then, conversely, 

when that region roars. How do we make sure—and I am not being 

critical here because getting it right and then getting it right down 

at a lower level, but are you thinking if we get countercyclical, can 

we take it down one level lower to a regional base? 

19 

Mr. GIBSON. We have only proposed applying the countercyclical 

buffer from Basel to the large, internationally active banks in this 

proposal, and we have asked for comment on that, and we have 

gotten some comments that suggest we should apply it more widely 

than that. We are going to consider those comments as we go forward. 

Senator WARNER. I think that if it ends up floating into best 

practices, we need to consider, obviously, plus with a large economy, but lots of regional economies that may or may not track national data. 

Mr. GIBSON. Right, and that is challenging to apply a national 

capital standard against regional shocks. 

Senator WARNER. And the only thing—and, again, my time is up, 

and I will just put this—maybe you can comment later because I 

do not want to impose on other time. But, you know, we urged you 

to make sure we look at the insurance business, but as we think 

about those assets and think about some of those assets that are 

held on a much longer time horizon than banks are, trying to get 

that right as well is going to be a challenge, and I hope we can visit 

on it. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Toomey. 

Senator TOOMEY. Thanks, Mr. Chairman, and thanks, gentlemen, for being with us today. I, too, would like to follow up a little 

bit with the train of thought that Senator Corker was pursuing. 

You know, when you think about some of the things that have 

been happening recently in the context of, specifically, I am referring to massive deficits, there is a long history, of course, of examples of the use by Governments of financial repression to help fund 

their own irresponsible fiscal policy. I would argue that the explicit 

exemption of U.S. Treasurys from the Volcker Rule is an example 

of financial repression in the United States. And when I hear that 

we have pressure from the Europeans to put zero capital weight 

into sovereign debt that intuitively to most Americans sure as heck 

does not sound like it is anything close to risk free, why should we 

be confident that there is not politically motivated financial repression creeping into this regulatory regime? 

Mr. FRENCH. I will start. I think that from my experience, at 

least in the U.S. rulemaking process, we have a lot of very smart 

people on the staff who are trying to come up with proposals that 

would be an appropriate way to deal with sovereigns, and facing 

a number of constraints. One is that the U.S. is not allowed to use 

an external ratings-based approach by statute, and then, you know, 

when you put out the different ideas on the table, they all seem 

to be a challenge in one way or another to implement or pose 

issues. 

My impression is not that there is some external constraint or 

influence on the process. It is really more of, frankly, a technical 

challenge, and this was the way that it came out, and we recognize 

fully and embrace the concern that you point out that, from a riskbased capital standpoint, it is not zero. But, again, as a practical 

matter, many of these are dealt with in trading portfolios in our 

banks and in other ways. 

20 

So I am not disputing the concern about getting the risk wrong 

in this instance, but—— 

Senator TOOMEY. It just seems an extraordinary coincidence that 

something so counterintuitive to suggest that some of the most 

troubled economies of Europe could have a zero risk weighting, at 

the same time when it is very convenient for there to be incentives 

for banks to hold this debt strikes me as a little troubling. 

Let me ask another question. We have heard a lot of discussion 

about the complexity of this, and one of the things that I am concerned about is the cost of compliance. Do we know what it is going 

to cost the average American bank to comply with this? Say a regional bank—actually, a better example would be a small community bank, a $1 billion bank. What will it cost to comply, to figure 

out, evaluate this rule? This rule is 900-some-odd pages. Is that 

right? Do we know what that cost would be? 

Mr. FRENCH. Each of us did some required statutory analysis of 

the cost issue, and I can speak to the FDIC’s analysis. We looked 

at the cost of both the Standardized Approach Notice and the Basel 

III Notice. The costs in the area of the Standardized Approach were 

probably the most pronounced, in our estimation, and included the 

cost of implementing the mortgage provisions, gathering the data, 

some estimate for the cost of doing the securitization framework. 

And I think it came out to—you know, I think we concluded that 

for purposes of the statutory criteria, it will have a significant effect on a large number of small banks that it would. And so it 

was—— 

Senator TOOMEY. That it would what? 

Mr. FRENCH. That it would have a significant cost, and that conclusion was based on a criteria of whether the cost would exceed 

in the first year more than 2.5 percent of noninterest expense or 

more than 5 percent of annual salary and bonus. 

So based on the estimates that we did, we concluded it would 

have that cost effect. We asked for comment as part of the NPR 

on that analysis, and we are now getting comments that shed, I 

think, a great deal of additional light on the compliance costs, and 

those are some of the things that we have to address now as we 

proceed. 

Senator TOOMEY. Well, one of the things that really concerns me 

is that it is very likely to be very significant compliance costs for 

institutions that nobody has ever suggested are systemically significant and why we would, you know, force this cost on these 

banks in that context. I hope that you will seriously reconsider 

this. 

The last question I had is: I know that you have announced that 

the original planned effective date of January 1 is not going to be 

the date. What sort of date should the regulated firms expect to 

have a final rule that that will be effective? 

Mr. LYONS. Senator, as I said during my testimony and questions 

from Chairman Johnson, we received over 1,500 comments. We are 

reviewing each comment. It will take time, and we have extended 

the implementation date because of the number of comments we 

received. And we will need time to go through those. I hesitate to 

give you an exact date, but I guarantee you we are working hard 

and diligently to come out with a proposal as soon as possible. 

21 

Senator TOOMEY. OK. Thanks, Mr. Chairman. 

Chairman JOHNSON. Senator Bennet. 

Senator BENNET. Thank you, Mr. Chairman, and I would like to 

pick up right where Senator Toomey was leaving off in his second 

to the last question. These conversations can sound so clinical in 

Washington, but at home, what I am seeing among my community 

banks is, on the one hand, deep—well, first of all, the observation 

that Senator Toomey made that nobody has said that the community banks are in any way responsible for the cataclysm that we 

went through, and that is true. There were some, as Mr. French 

said, that failed—that is certainly true—but did not create systemic risk in the way the large institutions did. And the observation of the panel today that community banks already have a high 

capital base. So from their perspective, the question is what problem are you trying to solve here. And they are worried that they 

are catching it from two ends. One is that the capital requirements 

will diminish the opportunity for equity investors to earn a return 

on investment and their investment in community banks. And I do 

not need to tell you how difficult capital formation already is for 

these guys. And, on the other hand, the cost of compliance, which 

I appreciate very much, Mr. French, your response that it appears 

based on your review that the costs will be significant and you are 

going to have to revisit that. 

My worry, talking to folks in Colorado, is that they really worry 

that they are going to be driven out of business, and that this is 

going to lead to a consolidation that is going to mean many fewer 

community banks serving our rural areas in particular in the 

State. And I wonder, first of all—you know, if the market is driving 

consolidation, that is one thing. But if it is because of the regulatory burden that is solving a problem that does not actually exist 

in the community banks, that may not be the greatest answer. 

So I guess what I am looking for is some assurance that you really have heard the comments that you have reflected back to us 

today and that we are actually going to significantly change these 

rules to make sure that we are not driving that kind of consolidation. 

Mr. FRENCH. Certainly, from the FDIC’s perspective, I would say 

that our Chairman, our Acting Chairman Gruenberg, has been out 

in outreach meetings throughout the year. We have had meetings 

specifically on these notices with bankers around the country, 

many face-to-face meetings, and gotten a lot of letters. So, you 

know, as I said, we are the primary supervisor of the majority of 

community banks in this country, and we do not want to create a 

situation where the compliance costs make them uncompetitive or 

unable to serve their important roles in the local community. 

So, you know, I think we are all in a position of looking at all 

these letters, looking at all the individual issues where bankers 

have raised concerns, and deciding how to proceed, and we take the 

concerns very seriously. 

Senator BENNET. Mr. Gibson. 

Mr. GIBSON. I would agree with that. We have heard a lot of 

comments from community banks, and especially on this issue of 

the costs of implementation. We are learning a lot from the comments about particular aspects of the proposal that may have a disVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
22 

proportionate impact there. And we are going to carefully look at 

that as we move forward. 

Senator BENNET. And that is, I think, an important point, too, 

that their view is, whether it is well intentioned or not, it is having 

a disproportionate effect because they cannot spread those fixed 

costs over their institution in the same way that a larger institution is able to do it. That seems like a very reasonable concern to 

me. And I have, Mr. French, asked—because it is not of use to me 

in interacting with you when I get general complaints from people, 

too much regulation, too much this, too much—but when people 

can be specific and go to the trouble of being specific about it, I find 

it very helpful. I have asked my Colorado bankers to pull that information together, how many pages, how many lawyers, how 

much money are they going to spend, all that kind of stuff. And 

I would love the chance to share that with your director when we 

receive it in the hope that we can help inform the work. 

Mr. FRENCH. We would be glad to do that. 

Senator BENNET. OK. One last question, before I run out of time, 

on the European situation. I will ask Senator Warner’s question in 

a slightly different way. What is your confidence that the European 

institutions actually are in a position to comply with Basel III? You 

talked about the competitive advantage that the stronger balance 

sheets have in the United States. How about our worry that the 

counterparts in Europe just are not ready to do this? 

Mr. GIBSON. The European Union is at the same phase in the 

process as we are of proposing rules, having some draft rules out 

for comment but not yet final. So they are also not going to meet 

the January 1, 2013, implementation date, but one thing that is 

built into the Basel III agreement is a very long transition period 

out to 2019. We feel that is going to be sufficient to allow most 

banks to cope with the higher capital requirements that are coming. 

Senator BENNET. I am out of time, but I will send you my last 

question. 

Mr. Chairman, thank you very much. 

Chairman JOHNSON. Senator Brown. 

Senator BROWN. Thank you, Mr. Chairman. Thank you, members 

of the panel, for being with us this long today. 

I share the concerns of a number of Members of the Committee 

about insurance companies and wanted to say something about 

that and then ask a question about higher capital requirements. 

Congress clearly intended for regulators to respect the Statebased insurance system, regulatory system, when crafting capital 

rules. I believe that we provide the Fed with sufficient authority 

and flexibility under Dodd-Frank to do so. I appreciate you said 

you are taking seriously the concerns we have raised about insurance in carefully considering comments about this issue. My staff 

has asked for the Fed’s opinion regarding your legal authority. I 

would hope in the interest of transparency you would provide us 

with that information, if you would. And I appreciate your working 

with us on that. 

Mr. GIBSON. OK. 

Senator BROWN. My colleagues have already pointed out that 

rules can be manipulated. In addition to being too easily gamed, I 

23 

am concerned the current 3-percent Basel III leverage ratio or the 

4-percent U.S. leverage ratio are simply much too low. Mr. Haldane 

of the Bank of England, Sheila Bair, Tom Hoenig, and Anat 

Admadi at Stanford say that the ideal leverage ratio should be 

somewhere—not 3 or 4 percent but somewhere between 2 and 5 

times the current proposal. 

Section 165 of Dodd-Frank requires the Fed to establish special 

enhanced rules for both risk-based capital and pure leverage for 

the biggest systemically important banks. 

Will you consider establishing stronger leverage ratios than that 

provided in Basel III for the largest banks, the largest six or so 

banks, $800 billion to $2.2 trillion, $2.3 trillion, whatever the largest is now, either on an individual or group basis? Does that make 

sense to you? 

Mr. GIBSON. What we have proposed under Section 165 for domestic banking organizations—we have already put that proposal 

out for comment, and we have received a lot of comments, including in the capital aspect of that. We are working through those 

comments, and I cannot prejudge where we will wind up with that, 

but we have heard the comments that you have mentioned calling 

for significantly higher capital. It is one of the comments we have 

received. 

Senator BROWN. Can you tell me anything about your internal 

discussions about the inadequacy, if that is how you see it, of the 

3 percent or 4 percent from Basel III or from us? 

Mr. GIBSON. As I said before, we feel like having the leverage 

ratio in the U.S. was a valuable complement to the risk-based 

ratio, so I cannot really address your comment about the exact 

level of the leverage ratio that is the right one. We definitely found 

that having the leverage ratio prohibited some of the gaming of 

regulatory capital charges that took place elsewhere. We are very 

supportive of continuing with both the risk-based and the simple 

leverage ratio. 

In terms of what the level of the leverage ratio should be, that 

is included in this proposal that we are discussing here. We have 

got a lot of comments on that, including the comments that you are 

mentioning, and we are going to review those carefully as we move 

forward. 

Senator BROWN. Any thoughts, Mr. French or Mr. Lyons, on 

that? 

Mr. FRENCH. I would only add that, as I said, I think the FDIC 

has had an institutional predisposition to fairly simple and objective capital standards, including the leverage ratio. So in terms of 

the level, we have not engaged at that in terms of the specifics, 

and, again, I think as Mr. Gibson said, it would not be appropriate 

for me to prejudge where we might come out on the level. 

Senator BROWN. Mr. Lyons. 

Mr. LYONS. I would only point out, Senator, that those are minimums, and the expectation typically is in a bank that they would 

be higher than the minimums. And we have, as Mike indicated, 

surrounded that with heightened prudential standards, so there 

are other aspects of supervision that we can employ to provide for 

additional capital in institutions. 

24 

Senator BROWN. OK. Thank you. Mr. French said that his proclivity is toward simpler rather than more complex. I am concerned 

Basel III allows the largest banks—and I mentioned six largest, 

but wherever you cut them off in terms of size—to use complex internal models to determine capital requirements for transactions 

that were some of the most troublesome during the crisis— 

collateralized debt obligations, over-the-counter derivatives, all of 

that. It makes it easier for the largest banks to game the system 

because of their complexities, to use their own models to make 

themselves look less risky than they, in fact—or at least I think 

they are. Meanwhile, small banks that are already better capitalized do not engage in these complex transactions and do not have 

a team of lawyers to help them comply in so many cases. 

The Basel II modeling approach that we adopted relied on banks 

to calculate their own capital rules. How does this new framework, 

as you have proposed, reduce the ability of the biggest banks to use 

complexity and opacity to their advantage? I would like all three 

of you to answer that, but Mr. French especially. 

Mr. FRENCH. Well, one aspect that we have not discussed here 

today which is important to mention is the requirements of Section 

171 of the Dodd-Frank Act known as the Collins amendment, and 

that is an important and relevant provision for purposes of this discussion. Basically the requirement is that the large banks and any 

bank over a certain size would need to compute not only those Advanced Approach models-based capital requirements, but also the 

general capital requirements that any other bank would need to 

compute and hold to the higher of the two standards. So it basically is sort of a horizontal equity-type provision in the law that 

does have a significant effect in terms of constraining the potential 

benefits of those models. 

Senator BROWN. Mr. Lyons, are you concerned about the big 

banks gaming the system to look like they are less risky? 

Mr. LYONS. I think, as George indicated, the supplemental leverage ratio is based on average assets, so it does not involve models 

and risk-based. It is strictly on the average assets of the balance 

sheet as well as off-balance-sheet items as well. So in addition to 

a risk-based method, we have a balance sheet method as well. Couple that with supervision and recent—not recent but since the crisis, interagency guidance that we issued on modeled expectations 

of what banks should go through and the risk management they 

have around that, I think we supplemented the ratios with stronger supervision. 

Mr. GIBSON. I would just add that a lot of the complexity in our 

capital rules and in these proposals is aimed at the complex activities of the largest banks. So sometimes complex activities require 

complicated analysis. However, that only applies to the banks that 

are engaged in those trading activities, and, in fact, Basel III 

raised the capital requirements or is in the process of raising the 

capital requirements on a lot of those activities precisely because 

of some of the concerns that you mentioned. So the complexity is 

really being put on the banks that have the capacity to deal with 

it. Community banks would not be subject to these requirements 

because they do not engage in those sorts of complex activities. 

25 

Senator BROWN. Well, thank you to each of you. I think many of 

us on this Committee are concerned about an outside examiner’s 

ability to understand the huge number of transactions. The six biggest U.S. megabanks have some 14,000 combined subsidiaries. 

Someone calculate that to do the same audit at the largest banks 

as you do at—the same level of audit that you do at the community 

banks would take some 70,000 auditors. And, you know, the belief 

that these banks are—I am not asking for comment here, but the 

belief that these banks are too big—not just too big to fail but too 

big to manage and too big to regulate stays with us. And I think 

anything you can move toward coming out of Basel III that brings 

a simpler system that the banks cannot game is so very important. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Thank you again to our witnesses for being 

here today. Your hard work on these complicated rulemakings is 

appreciated, especially as we all work to make our financial system 

more stable. 

This hearing is adjourned. 

[Whereupon, at 3:58 p.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

26 

PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON 

After the financial crisis, Congress passed Wall Street Reform into law, and asked 

our regulators to strengthen the financial sector by enhancing capital standards and 

prudential supervision. In addition, Federal banking agencies negotiated the Basel 

III accords, an agreement with other Nations’ banking agencies. The proposed capital rules under discussion today implement that agreement. These are complex 

rules, and today we will hear from the experts at the Fed, OCC, and FDIC about 

the important goals they hope to accomplish with these proposed rules, as well as 

their potential impact. 

Since the rules were proposed in June, Members of this Committee have heard 

a number of concerns about these rulemakings from former Federal regulators, current State regulators, industry participants and academics. These concerns are documented in over 2,000 comment letters submitted by a wide range of stakeholders 

including community banks and insurance companies. 

While most agree the higher levels of capital are appropriate, the details of how 

to improve bank capital will have a broad impact and must be closely examined. 

Specifically, with respect to community banks, I appreciate that your agencies 

have undertaken a number of efforts to explain the proposed rules to community 

banks, including issuing a capital estimation tool for banks to evaluate how the proposed rules will impact them. However, I am concerned that the proposed risk 

weights could have an adverse impact on small banks’ ability and willingness to 

offer mortgages, especially in rural areas. I look forward to hearing more today 

about how the risk weights were determined for mortgages, securitizations, and 

mortgage servicing rights, and what kind of impact these rules might have on our 

housing market. 

I also want to hear more about the proposed treatment of ‘‘accumulated other 

comprehensive income.’’ At a time where interest rates cannot get much lower, we 

should pay particular attention to how new rules could make interest rate management more difficult, especially for smaller banks. 

In addition, I am concerned by the treatment of the business of insurance in the 

proposed rules. Before moving forward with applying these rules to insurance companies, the banking agencies should take additional time to work with State insurance regulators, the Federal Insurance Office, and the independent insurance expert 

on the Financial Stability Oversight Council to better understand the insurance accounting framework and risk-based capital model currently used. This feedback 

should then be used to develop a capital framework that is more suitable for financial institutions engaged in the traditional business of insurance, and give these 

companies appropriate time to implement the new framework. 

A strong capital base is a key component of a resilient financial system. This was 

a major lesson of the financial crisis in 2008, and your agencies are to be commended in your efforts to steadily recapitalize the U.S. banking system and establish new standards. But while capital can serve as an important loss-absorbing buffer, capital alone will not prevent financial firms from failing and potentially threatening the broader financial stability. It is important that capital standards are well 

calibrated with other supervisory requirements, including new rules mandated by 

the Wall Street Reform Act. I look forward to hearing how each of your agencies 

is coordinating the ongoing rulemakings to ensure all of the pieces fit together. 

I believe we share the same goal of strong and harmonized capital rules to promote financial stability, but before moving forward it is important to understand 

how the regulators have considered, and will continue to consider, the concerns 

being raised. I encourage your agencies to take the appropriate amount of time 

needed to get these rules right. 

Last, I want to applaud you all for the steps your agencies took last week to provide clarity on the Basel III rules’ effective date. This was well in advance of the 

previously announced January 1, 2013, effective date and I believe the announcement was very useful to those companies working to comply with these rules. 

PREPARED STATEMENT OF SENATOR SHERROD BROWN 

Thank you, Mr. Chairman, for holding this very important hearing, and thank 

you to the witnesses for their testimony. 

We are here to discuss the U.S. implementation of three new proposed rules on 

capital and leverage. 

Capital rules simply require banks to fund themselves with their own money— 

usually in the form of equity—instead of other people’s money, borrowed from the 

markets, regulators, or U.S. taxpayers. 

27 

Prior to the financial crisis, financial institutions relied upon too much borrowed 

money and flawed models that used smoke and mirrors to make their investments 

appear riskless. 

But they were not riskless. And when their assets declined by even the smallest 

amount, they were unable to pay their debts. 

As a result, the taxpayers were forced to step in and cover Wall Street’s risky 

bets. 

I am encouraged that there is now broad, bipartisan agreement among the Members of this Committee that adequate bank capital is an essential tool for protecting 

the financial system. 

Basel III is clearly an improvement over Wall Street’s old way of doing business, 

but I question whether the new rules get it right. 

First, are we properly defining and measuring capital? 

Clearly there were shortcomings in the regulators’ measurement of capital prior 

to the crisis. 

At the height of the crisis, seemingly healthy institutions had respectable levels 

of regulatory capital. 

According to the FDIC’s Thomas Hoenig, in 2007, the 10 largest banks had average risk-based capital ratios of 11 percent. But their tangible equity ratios were 

about 2.8 percent. 

As a result, markets lacked confidence in these institutions. 

According to Federal Reserve Governor Dan Tarullo, this was because investors 

ignored the more exotic instruments that qualified as capital and instead looked at 

tangible equity. 

This experience provides strong support for the view that we should focus on pure 

equity as a measure of a bank’s health. 

Second, are the levels sufficient to lessen the likelihood and severity of future crises? 

The Bank of England’s Andy Haldane estimates that global banks hold assets 

with average risk-weighting of 40 percent, meaning that the 10 percent risk-weighted Basel III ratio would amount to leverage or 25-to-1. 

Were a megabank’s assets to decline by 4 percent under that scenario, it would 

become insolvent. 

A number of studies have shown that the optimal risk-weighted assets to capital 

ratios are considerably higher than those contained in Basel III. 

Banks had considerably higher capital before the creation of the financial safety 

net. 

So we know that the international 3 percent leverage ratio is much too low—prior 

its failure, Bear Stearns had leverage of 33 to one. 

The U.S. benchmark of 4 percent is also too low—Haldane estimates that institutions would have needed a minimum 7 percent leverage to have survived the financial crisis. 

My legislation, the SAFE Banking Act calls for 10 percent tangible equity to total 

assets, not adjusted for risk and including those held off-balance sheet. 

Third, have we created a system of complex rules on top of complex banks that 

are excessively complex and opaque? 

The six largest banks currently have a combined 14,420 subsidiaries. 

Haldane has estimated that an average large bank would have to conduct more 

than 200 million calculations in order to determine their regulatory capital under 

the Basel II framework. 

Several million scenarios could arise from a large bank’s trading book alone. 

The evidence suggests that these complex and highly calibrated measurements do 

not work. 

Haldane has found that simple measures of equity and leverage actually have predictive value that is ten times greater than that of complex risk-weighted asset 

measurements. 

And finally, are we too focused on community banks or traditional insurance companies, and not enough on Wall Street megabanks? 

According to Dr. Hoenig, in 2009, the 20 largest financial institutions on average 

funded themselves with a mix of 3.5 percent equity capital, as compared to an equity capital ratio of 6 percent held by the second tier of institutions. 

These megabanks can use more leverage because implicit Government support, 

where the market assumes that the Government will step in to prevent them from 

failing, provides subsidies and it puts true community banks—those with less than 

$10 billion in assets—at a disadvantage. 

These incentives can be counteracted by requiring megabanks to increase their 

capital buffers. 

28 

1See, press release and proposal, www.federalreserve.gov/newsevents/press/bcreg/ 

20120612a.htm. 

I agree with Governor Tarullo that the proposed surcharges for the largest institutions are at the low end of the scale. 

We should do more to impose costs that will discourage banks from becoming ‘‘too 

big to fail.’’ 

This will benefit taxpayers, and it will benefit the community banks that compete 

with unfairly subsidized megabanks. 

These are all important questions, because we must ensure that Wall Street has 

a prudent amount of its own money to cover its losses. 

Thank you, Mr. Chairman. 

PREPARED STATEMENT OF MICHAEL S. GIBSON 

DIRECTOR, DIVISION OF BANKING SUPERVISION AND REGULATION, BOARD OF

GOVERNORS OF THE FEDERAL RESERVE SYSTEM

NOVEMBER 14, 2012 

Chairman Johnson, Ranking Member Shelby, and Members of the Committee, 

thank you for the opportunity to testify on the proposed interagency changes to the 

regulatory capital framework for U.S. banking organizations. In today’s testimony, 

I will provide an overview of the proposed changes and the main themes arising 

from the public comment process, especially as they relate to community banking 

organizations and depository institution holding companies with insurance activities. 

Overview of Proposed Changes 

The recent financial crisis revealed that the amount of high-quality capital held 

by banking organizations in the United States was insufficient to absorb losses during periods of severe stress. The effects of having insufficient levels of capital were 

further magnified by the fact that some capital instruments did not absorb losses 

to the extent previously expected. While robust bank capital requirements alone 

cannot ensure the safety and soundness of the banking system, we believe they play 

a key role in protecting the banking system and financial stability more broadly. 

As demonstrated during the recent financial crisis, banking organizations with 

strong capital positions are better equipped to absorb losses from unexpected 

sources. Furthermore, strong capital positions help to ensure that bank losses are 

borne by shareholders, rather than taxpayers. The June 2012 interagency proposal 

to amend the bank regulatory capital framework applies the lessons of the crisis, 

in part, by increasing the quantity and quality of capital held by banks. 1 For all 

banking organizations, the proposal would introduce a new common equity tier 1 

capital requirement, raise existing minimum tier 1 capital requirements, and implement a capital conservation buffer to increase bank resiliency during times of stress. 

The proposal also updates and harmonizes the existing capital rules with a standardized approach for the calculation of risk-weighted assets, incorporating a more 

risk-sensitive treatment for certain asset classes to address weaknesses identified 

in the capital framework in recent years. 

For large, internationally active organizations, the proposal would introduce a 

supplementary leverage ratio, a countercyclical capital buffer, and would effectively 

raise the capital requirement by updating aspects of the advanced approaches riskbased capital rule. These amendments, along with other recent regulatory capital 

enhancements, will require the large, systemically important banking organizations 

to hold significantly higher levels of capital relative to other institutions. Under the 

proposal, savings and loan holding companies would, for the first time, be subject 

to consolidated capital requirements, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). With this proposal, U.S. bank 

capital requirements would reflect international Basel III agreements reached by 

the Basel Committee on Banking Supervision as well as relevant domestic legislative provisions, including sections 171 and 939A of the Dodd-Frank Act. 

In developing this proposal, the Federal Reserve sought to strike the right balance 

between safety and soundness concerns and the regulatory burden associated with 

implementation, including the impact on community banking. It is important to note 

that numerous items in this proposal, and in other recent regulatory reforms, are 

focused on larger institutions and would not be applicable to community banking 

organizations. These items include the countercyclical capital buffer, the supplementary leverage ratio, enhanced disclosure requirements, the advanced approaches 

29 

2See, ‘‘Assessing the Macroeconomic Impact of the Transition to Stronger Capital and Liquidity Requirements’’ (August 2010), www.bis.org/publ/othp10.pdf; and ‘‘An Assessment of the 

Long-Term Economic Impact of Stronger Capital and Liquidity Requirements’’ (August 2010), 

http://www.bis.org/publ/bcbs173.pdf. 3See, Attachment A—‘‘FRB Impact, Methodology, and Assumptions’’. 4See, comment letters, www.federalreserve.gov/apps/foia/ViewComments.aspx?doclid=R1442&doclver=1. 

risk-based capital framework, stress testing requirements, the systemically important financial institution capital surcharge, and market risk capital reforms. 

Impact 

The Federal Reserve has assessed the impact of the changes proposed by this 

rulemaking on banking organizations and the broader financial system through domestic analyses and through its participation in cost-benefit analyses performed by 

the Basel Committee on Banking Supervision. The Macroeconomic Assessment 

Group, a working group of the Basel Committee, found that among internationally 

active banks, the stronger capital standards proposed under Basel III would significantly lower the probability of banking crises and their associated economic losses, 

while having only a modest negative effect on gross domestic product and the cost 

of credit. 2 Furthermore, these modest negative effects can be mitigated by the phase 

in of the standards over time, which is why we have included extensive transition 

periods for several aspects of the proposal. The Federal Reserve believes that the 

benefits of the proposed changes, in terms of the reduction of risk to the U.S. financial system and to the broader economy, outweigh the compliance costs to the financial industry and any costs to the macroeconomy. 

In developing the proposal, each of the Federal banking agencies prepared an impact analysis of the proposed requirements on banking organizations that currently 

meet the minimum regulatory capital requirements, based on each agency’s own key 

assumptions using regulatory reporting data. The Federal Reserve’s analysis and assumptions are included as an attachment to today’s testimony. 3 The overall conclusion of these analyses was that the vast majority of banking organizations would 

not be required to raise additional capital because they already meet, on a fully 

phased-in basis, the proposed higher minimum requirements. In addition, approximately 90 percent of community banking organizations already have sufficient capital to meet or exceed the proposed buffer, thus avoiding restrictions on capital distributions and certain executive bonus payments. While many of the largest banking 

organizations do not already meet the proposed new minimums and the buffer on 

a fully phased-in basis, they are generally making steady progress toward meeting 

these standards before they are phased in. However, the Federal Reserve is mindful 

that other burdens exist for banks, such as systems changes and other compliance 

costs, which were outside the scope of our analysis. 

Public Comments on the Proposed Changes 

The Federal banking agencies released the proposed rulemaking in early June 

with an extended comment period ending on October 22, giving interested parties 

more than 4 months to comment on the proposal rather than the typical 2- or 3- 

month comment period. The agencies have received thousands of comment letters 

from the public, including banking organizations of all sizes, trade groups, academics, public interest advocates, and private individuals. 4 Agency staffs are reviewing these letters carefully and will continue to do so in the coming weeks. Comments include general views on the proposal, including concerns regarding overall 

complexity and burden, as well as suggestions for specific policy changes and technical modifications aimed at better conforming the proposal to market practices. 

The most common specific areas of concern noted by the financial industry, regardless of institution size, relate to the proposed treatments of accumulated other 

comprehensive income, otherwise known as AOCI, and residential mortgage exposures. The proposed treatment of AOCI would require unrealized gains and losses 

on available-for-sale securities to flow through to regulatory capital as opposed to 

the current treatment, which neutralizes such effects. Commenters have expressed 

concern that this treatment would introduce capital volatility, due not only to credit 

risk but also to interest rate risk, and affect the composition of firms’ securities 

holdings. The proposed treatment of AOCI is part of the Basel III Accord and is 

meant to better reflect an institution’s actual loss-absorption capacity; however, we 

are analyzing commenters’ concerns and will be assessing potential ways forward 

in this area as we finalize the rule. 

In light of observed high loss rates for residential mortgages during the crisis, the 

agencies proposed a modified treatment aimed at better differentiating the risks of 

these exposures, which are generally assigned preferential risk weights under our 

30 

5See, ‘‘Community Banking Connections: A Supervision and Regulation Publication’’ (Third 

Quarter, 2012), www.communitybankingconnections.org/articles/2012/Q3/CBCQ32012.pdf. 

current approach. Commenters have expressed concern that the operational burden 

and compliance costs of the proposed methodology for risk weighting residential 

mortgage exposures and the higher risk weights for certain types of mortgage products will increase costs to consumers and reduce their access to mortgage credit. The 

Federal Reserve, along with the other Federal banking agencies, will take these and 

all comments received into consideration as we finalize the rule. 

Community Banks 

The Federal Reserve believes capital requirements that improve the quantity and 

quality of regulatory capital would benefit the resiliency of all banking organizations 

regardless of size. However, as we consider comments from industry participants 

and other interested parties regarding the proposed regulatory capital requirements, 

the Federal Reserve, along with the other Federal banking agencies, will remain 

sensitive to concerns expressed by community banking organizations. The Board 

recognizes the vital role that community banking organizations play in the U.S. financial system. Community bankers typically have deep roots in their communities, 

allowing them to gain insights on their local economies and to forge strong relationships with customers. As a result, they can provide relationship-based lending to 

small businesses, families, and others in their local communities in a manner that 

larger institutions would find difficult to duplicate. 

When the agencies were developing these proposals, we recognized the need to 

carefully assess their impact on community banking organizations. While we conducted internal analysis to estimate the impact of the proposal (as discussed earlier), the Federal Reserve also recognized the importance of soliciting feedback directly from community banking organizations to understand more specifically the 

potential effects on their business activities. To facilitate review of the proposal, the 

agencies provided summaries of the requirements that were most relevant for community banking organizations, provided a tool to help smaller organizations estimate their capital levels under the proposal, and extended the comment period so 

that interested parties would have more time to assess the proposals and submit 

their comments. The Federal Reserve also engaged in substantial industry outreach 

to hear the views of community bankers and encourage submission of comments. 

For example, we held a series of ‘‘Ask the Fed’’ sessions aimed primarily at banking 

organizations supervised by the Federal Reserve that provided an overview of the 

proposals and gave bankers an opportunity to ask us questions. Following these sessions, which were attended by more than 3,000 bankers, we published a summary 

of answers to frequently asked questions in a new Federal Reserve publication for 

community bankers. 5 Throughout the comment process, Board members and staff 

also met with various industry associations to clarify and discuss aspects of the proposal. 

Through outreach efforts and as part of the comment process, community banking 

organizations have expressed concerns about particular elements of the proposed requirements, indicating that they do not adequately take into account the community 

banking business model and that some aspects would have potential disproportionate effects on their organizations. In particular, they have asserted that the proposed treatment of AOCI would have more of an impact on community banks because they have fewer available strategies to address the resultant capital volatility 

relative to larger institutions. In addition, they have expressed concern that the relatively higher risk weights assigned to certain mortgage products would penalize 

loan products that community banking organizations typically provide their customers. We will be mindful of these comments when considering potential refinements to the proposal and will work to appropriately balance the benefits of a revised capital framework against its costs. As we work toward finalizing the rule, we 

will seek to further tailor the requirements as appropriate for community banking 

organizations. 

Insurance Holding Companies 

The proposal would apply consolidated risk-based capital requirements that measure the credit and market risk of all assets owned by a depository institution holding company and its subsidiaries, including assets held by insurance companies. In 

addition, the proposal would capture the risk of insurance underwriting activities 

included in the consolidated holding company capital requirements by requiring deduction of the minimum regulatory capital requirement of the relevant State regulator for insurance companies in the consolidated group. Currently, capital requirements for insurance companies are imposed by State insurance laws on a legal entiVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00034 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
31 

6See, ‘‘Agencies Provide Guidance on Regulatory Capital Rulemakings’’, 

www.federalreserve.gov/newsevents/press/bcreg/20121109a.htm. 

ty basis and there are no State-based, consolidated capital requirements that cover 

the subsidiaries and noninsurance affiliates of insurance companies. 

The proposed capital requirements have been criticized by savings and loan holding companies that are not currently subject to consolidated capital requirements 

and that have significant insurance activities. Before mentioning some of the concerns raised by the industry, I would like to provide some background regarding the 

policy rationale for this proposal. The proposed application of consolidated capital 

requirements to savings and loan holding companies is consistent with the Board’s 

long-standing practice of applying consolidated minimum capital requirements to 

bank holding companies, including those that control functionally regulated subsidiary insurance companies. Importantly, such an approach eliminates incentives 

to engage in capital arbitrage by booking individual exposures in the legal entity 

in which they receive the most favorable capital requirement. 

The proposed requirements are also consistent with the Collins Amendment in 

section 171 of the Dodd-Frank Act, which requires that the agencies establish consolidated minimum risk-based and leverage requirements for depository institution 

holding companies (bank holding companies and savings and loan holding companies) that are no less than the generally applicable risk-based capital and leverage 

requirements that apply to insured depository institutions under the prompt corrective action framework. At the same time, the proposal included provisions assigning 

specific risk weights to assets typically held by insurance companies but not depository institutions, namely policy loans and nonguaranteed separate accounts. These 

provisions were designed to appropriately risk weight assets particular to the insurance industry while at the same time ensuring that the proposals complied with section 171 of the Dodd-Frank Act and fulfilled the policy goals for consistent consolidated capital requirements previously described. 

Through the comment process, depository institution holding companies with insurance activities raised overarching concerns that the proposed regulatory capital 

requirements, which have primarily been developed for banking organizations, are 

not suitable for the insurance business model. In particular, they assert that the 

proposal does not appropriately recognize the longer-term nature of their liabilities 

and their practice of matching asset and liability maturities. They also assert that 

the proposal would disproportionately affect longer term assets held by many insurance companies, thus causing them to fundamentally alter their business strategy. 

These holding companies also have requested a longer transition period to implement consolidated capital requirements for the first time. Currently, those savings 

and loan holding companies that are also insurance companies report financial 

statements to State insurance regulators according to Statutory Accounting Principles and would have to begin reporting under the Generally Accepted Accounting 

Principles to comply with consolidated regulatory capital requirements, a change 

they assert would be unreasonably costly. 

The Federal Reserve takes these comments seriously and will consider them carefully in determining how to appropriately apply regulatory capital requirements to 

depository institution holding companies with significant insurance activities. 

Timeline 

Given the breadth of the proposed changes, many industry participants have expressed general concern that they may be subject to a final regulatory capital rule 

on January 1, 2013, as contemplated in the proposals, and that this would not provide sufficient time to understand the rule or to make the necessary systems 

changes. Therefore, the agencies clarified on Friday that they do not expect to finalize the proposal by January 2013. 6 We are working as quickly as possible to evaluate comments and issue a final rule that would provide the industry with appropriate transition periods to come into compliance. 

Thank you. I would be pleased to take your questions. 

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* Statement Required by 12 U.S.C. §250: The views expressed herein are those of the Office 

of the Comptroller of the Currency and do not necessarily represent the views of the President. 1Testimony of John Walsh, Acting Comptroller of the Currency, before the Committee on 

Banking, Housing, and Urban Affairs, United States Senate (March 22, 2012). 

PREPARED STATEMENT OF JOHN C. LYONS 

CHIEF NATIONAL BANK EXAMINER, OFFICE OF THE COMPTROLLER OF THE CURRENCY

NOVEMBER 14, 2012 

Chairman Johnson, Ranking Member Shelby, and Members of the Committee, 

thank you for your invitation to testify.* I appreciate the opportunity to appear before you today to discuss the three proposed capital rules released by the Federal 

banking agencies (the Office of the Comptroller of the Currency (OCC), the Federal 

Reserve Board, and the Federal Deposit Insurance Corporation) in June, and in particular, the impact of those proposed rules on national banks and Federal savings 

associations and the stability of the U.S. financial system. 

During the public comment period for these proposals that ended on October 22, 

2012, the OCC and the other Federal banking agencies received approximately 

1,500 comment letters from banks and Federal savings associations of all sizes. In 

light of the number of comments received and the important issues raised, the agencies announced last week that we do not expect to finalize the proposals by January 

1, 2013. While we are still in the process of reading and assessing the comments, 

it appears that the most fundamental issues have been raised by small banks and 

Federal savings associations (collectively, community banks) who have raised concerns about the applicability of the standards to them. Large banks have raised 

some of the same concerns as the community banks in terms of specific provisions 

contained in the proposals as well as additional concerns that are more technical 

in nature. Since our comment review process is in early stages, there are some limitations on the views I can express to avoid prejudging the outcome of the rulemaking process. 

We are committed to carefully considering all the comments we received; however, 

my testimony today will focus on some of the overarching concerns raised, and in 

particular, those raised by community bankers. In this regard, I want to assure you 

that we are very cognizant of the special role that smaller banks play in our communities and in providing financing of our country’s small businesses and families. 

It’s important to start by noting that the key reason that we issued the proposals 

was to improve the safety and soundness of our Nation’s banking system. Strong 

capital standards have played an important role in moderating downturns and positioning the banking system to serve as a catalyst for recovery by ensuring that financial institutions stand ready to lend throughout the economic cycle. Access to 

credit by businesses and consumers is critically important to promoting and achieving financial stability. The recent crisis demonstrated the consequences of having 

insufficient capital in the banking system of the U.S. and around the world. 

The international Basel III agreements embraced many of the lessons learned 

during the crisis relating to regulatory capital. As members of the Basel Committee 

on Banking Supervision, the agencies worked to develop these enhanced capital 

standards, and the elements contained in the Basel III international framework are 

reflected in much of what we have proposed to apply in the U.S. As the OCC has 

previously testified, many of the key provisions and objectives of Basel III complement key capital provisions of the Dodd-Frank Act. 1 However, in developing the 

U.S. capital proposals, we did not adopt a ‘‘one-size fits all approach.’’ We carefully 

evaluated each element of the Basel III framework and assessed to which banks it 

should be applied. In making these assessments, the agencies strove to calibrate the 

requirements to reflect the nature and complexity of the financial institutions involved. As a result, and consistent with the higher standards for larger banks required by section 165 of the Dodd-Frank Act, many of the provisions in the proposed 

rules are only for larger banks and those that engage in complex or risky activities; 

community banks with more basic balance sheets are largely or completely exempted. While the international Basel III agreements incorporate many of the lessons 

learned from the crisis, there were other key concerns that were not addressed in 

those standards, but which are important for promoting the resiliency and stability 

of the U.S. banking system—for example, the importance of better differentiating 

risks in mortgage lending. The U.S. proposed rules attempt to address these additional elements as well. 

We recognize that the proposed changes represent a comprehensive reform of regulatory capital standards and that the burden of reviewing and assessing the impact 

of new regulatory proposals can weigh especially heavily on community banks. This 

44 

2 ‘‘Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective Action’’ 

(Basel III NPR), 77 Fed. Reg. 52792; ‘‘Regulatory Capital Rules: Standardized Approach for 

Risk-weighted Assets; Market Discipline and Disclosure Requirements’’ (Standardized Approach 

NPR), 77 Fed. Reg. 52888; and ‘‘Regulatory Capital Rules: Advanced Approaches Risk-based 

Capital Rule; Market Risk Capital Rule’’ (Advanced Approaches NPR) 77 Fed. Reg. 52978. 

is why we have taken several measures to reduce the burden of this rulemaking 

process for these banks—in the way we organized the proposals, in outreach we 

have conducted, and by distributing a tool to help bankers assess the potential impact of the proposals on their capital requirements. 

We also appreciate that the burden for community banks lies not only in reviewing and understanding the proposals, but also in complying with them. In this context, it is important to remember that these are proposed rules, not final rules, and 

we are very interested in feedback on all aspects of these proposals. We posed over 

80 specific questions in the proposals, including questions related to regulatory burden, to elicit comments on all aspects of the proposals. 

In my testimony today, I will review briefly the proposed capital rules and then 

discuss three of the major issues raised in the comments we have received. These 

issues are: (1) the overall complexity of the proposals and questions about their applicability to, and appropriateness for, community banks; (2) the proposed treatment 

of unrealized losses (and gains) in regulatory capital; and (3) the treatment of real 

estate lending, particularly residential mortgages. 

The Proposed Capital Rules 

In June, the agencies published three notices of proposed rulemaking (NPRs)— 

the Basel III NPR, the Standardized Approach NPR, and the Advanced Approaches 

NPR. 2 Many, but not all, of the provisions contained in two of these three NPRs— 

the Basel III NPR and the Standardized Approach NPR—would apply to all banks, 

including community banks. 

The Basel III NPR would raise the quantity and quality of capital required to 

meet minimum regulatory standards. The Standardized Approach NPR seeks to address shortcomings in the way capital is aligned with risks in our current rules. The 

Advanced Approaches NPR would require the largest banks, when calculating regulatory capital, to take a more complete and accurate account of their risks, both onand off-balance sheet. The Basel III and Advanced Approaches NPRs would significantly raise capital standards for large banks. Taken together, the three NPRs address the risks that contributed to the recent financial crisis and aim to enhance 

the safety and soundness of the U.S. banking system. 

Turning to the first of the three NPRs, the Basel III NPR concentrates largely 

on improving the reliability with which banks of all sizes can absorb future losses. 

It covers both the definition and the minimum required levels of capital. The NPR 

proposes a new measure for regulatory capital called Common Equity Tier 1 (CET1). 

This measure was introduced because some of the instruments that qualified under 

the broader existing definitions of regulatory capital did not dependably absorb 

losses during the crisis and the subsequent economic downturn. 

The proposed minimum standard for CET1 is 4.5 percent of risk-weighted assets. 

On top of this, the NPR introduces two new capital buffers—the capital conservation 

buffer and the countercyclical buffer. 

The proposed capital conservation buffer is 2.5 percent of risk-weighted assets, 

which would bring the effective CET1 requirement up to 7 percent of risk-weighted 

assets. If a bank’s CET1 ratio were to fall below that level, capital distributions and 

discretionary bonus payments would be restricted. This buffer would apply to banks 

of all sizes. During the recent financial crisis and economic downturn, some banks 

continued to pay dividends and substantial discretionary bonuses even as their financial condition weakened; the capital conservation buffer is intended to limit such 

practices and conserve capital at individual banks and for the banking system as 

a whole. 

The countercyclical capital buffer would apply only to the largest internationally 

active banks with assets in excess of $250 billion or foreign exposures of more than 

$10 billion. If activated by the agencies during the expansionary stage of a credit 

cycle, it could increase the minimum CET1 buffer by as much as another 2.5 percent 

of risk-weighted assets. The intent of the countercyclical capital buffer is to increase 

capital requirements during periods of rapid economic growth to reduce the excesses 

in lending and to protect against the effects of weakened underwriting standards 

during subsequent contractions. 

A separate surcharge on systemically important banks (the so-called ‘‘SIFI surcharge’’), which is to be the subject of a separate rulemaking, could potentially add 

45 

3See the attached impact assessment on OCC-regulated banks and thrifts pursuant to the 

Unfunded Mandates Reform Act. 

another 3.5 percent of risk-weighted assets to the risk-based capital requirements 

of the largest banks. The cumulative effect of the countercyclical buffer and the potential SIFI requirement is that during an upswing in the credit cycle, some large 

U.S. banks may be required to hold CET1 equal to as much as 13 percent of their 

risk-weighted assets. This difference in potential capital requirements—i.e., as much 

as 13 percent for large banks compared with 7 percent for small banks—is intended 

to appropriately distinguish between their relative riskiness. 

In addition to risk-based capital standards, all U.S. financial institutions are subject to a leverage ratio that is designed to limit the overall amount that a bank can 

leverage its capital. In this regard, another way in which the proposals differentiate 

between banks of different sizes is the new supplementary leverage ratio introduced 

in the Basel III NPR. This ratio would be set at 3 percent of adjusted assets and 

would apply only to large internationally active banks. It is a more demanding 

standard than the existing 4 percent leverage requirement that already applies to 

all banks because it would include certain off-balance-sheet exposures. If this proposed change is implemented, small banks would be subject to only one leverage 

ratio requirement whereas large banks would have to meet two requirements. 

While the Basel III NPR focuses on raising the quality and quantity of capital, 

the Standardized Approach NPR seeks to ensure that riskier activities require more 

capital. To accomplish this, the Standardized Approach NPR would revise the capital treatment for exposures to non-U.S. sovereigns, residential mortgages, commercial real estate, securitizations, and equities, and revise and expand the recognition 

of credit risk mitigation through collateral and guarantees. It also would introduce 

new disclosure requirements for banks over $50 billion in assets, as a means to impose additional market discipline. This disclosure requirement would not apply to 

community banks. Finally, the Standardized Approach NPR would remove external 

credit ratings from the capital standards in accordance with section 939A of the 

Dodd-Frank Act. 

The Advanced Approaches NPR applies only to the largest, internationally active 

banks. This NPR includes several changes to the calculation of risk-weighted assets 

for counterparty exposures so that sufficient capital will be required for this source 

of risk that was found to be significant during the recent financial crisis. 

In developing the June proposals, we were keenly aware of their potential impact, 

particularly on smaller banks throughout the country. The proposals include lengthy 

transition provisions and delayed effective dates to reduce the likelihood of adverse 

effects from increases in minimum required regulatory capital. For example, the revised risk weights included in the Standardized Approach NPR would not go into 

effect until 2015, and some of the transitional provisions related to capital instruments in the Basel III NPR extend out to 2022. 

We assessed the potential effects of the proposed rules on banks by using regulatory reporting data and certain key assumptions, which we noted in the preamble 

to the proposals. 3 Our assessments indicate that many community banks hold capital well above both the existing and the proposed regulatory minimums. Many of 

the largest, internationally active banks already have strengthened their regulatory 

capital levels to meet the proposed minimum standards, particularly the new CET1 

standard, in order to meet market participants’ expectations. Establishing higher 

minimum standards for all banks would reinforce the financial strength of the banking sector in the future and the stability of the U.S. financial system. 

While we did consider the potential impact of the proposals on banks and the 

banking system as we were developing them, one of the key purposes of the notice 

and comment process is to gain a better understanding of the potential impact of 

the proposals on banks of all sizes. As previously noted, to foster feedback from community banks on potential effects of the proposals, the agencies developed and posted on their respective Web sites an estimator tool that allowed smaller banks to use 

bank-specific information to assess the likely impact on their individual institution. 

Issues Raised in Comment Letters 

1. Complexity and Applicability 

Commenters have raised an overarching concern about the complexity of the 

rules. More specifically, many comments have stated that the residential mortgage 

provisions in the Standardized Approach NPR are too complex. The NPR would separate mortgages into two risk categories based on product and underwriting characteristics and then, within each category, assign several new risk weights based on 

loan-to-value ratios (LTVs). Commenters were concerned about the costs associated 

46 

4Proposed regulations relate to the definition of ‘‘qualified mortgage’’ under regulations to be 

issued by the Consumer Financial Protection Bureau pursuant to the Truth in Lending Act (as 

revised by section 1412 of the Dodd-Frank Act), as well as the definition of ‘‘qualified residential 

mortgage’’ under the securitization risk retention regulations to be issued jointly by the Federal 

banking agencies, FHFA, SEC, and HUD pursuant to section 941 of the Dodd-Frank Act. 5 Under the existing standards for national banks in 12 CFR Part 3, Appendix A, section 2, 

and for Federal savings associations in 12 CFR 167.5, Tier 1 capital (national banks) and core 

capital (Federal savings associations) include ‘‘common stockholders’ equity.’’ The definition of 

‘‘common stockholders’ equity’’ (listed at 12 CFR Part 3, Appendix A, section 1 for national 

banks and 12 CFR 167.1 for Federal savings associations) does not include unrealized gains or 

losses on AFS debt securities, but it does include unrealized losses on AFS equity securities with 

readily determinable fair values. Additionally, at 12 CFR Part 3, Appendix A, section 2(b)(5) (national banks) and 12 CFR 167.5(b)(5) (Federal savings associations), the current rules also provide that up to 45 percent of pretax net unrealized gains on AFS equity securities can be included in Tier 2 capital. 12 CFR Part 3, Appendix A, section 2(b)(5) (national banks) and 12 

CFR 167.5(b)(5) (Federal savings associations), further provide that unrealized gains and losses 

on other assets, including AFS debt securities, may be taken into account when considering a 

bank’s overall capital adequacy, however, those gains and losses are not specifically included in 

the determination of a bank’s regulatory capital ratios. 6Section 20(a)(1) of the proposal defines the elements that make up common equity tier 1 

capital. Those elements include accumulated other comprehensive income (AOCI). Under U.S. 

GAAP, AOCI is comprised of four elements: (1) unrealized gains and losses on AFS securities 

(ASC Topic 320, Investments—Debt and Equity Securities); (2) gains and losses on derivatives 

held as effective cash flow hedges (ASC Topic 815, Derivatives and Hedging); (3) recognized acwith reviewing the existing book of mortgages and creating new systems to accommodate the more granular treatment of risks under the proposed approach. Under 

today’s standards, all mortgages are assigned just one of two weights based on criteria that are relatively simple to administer. 

Commenters also raised concerns about complexities resulting from these capital 

proposals in combination with other regulatory initiatives. For example, banks of all 

sizes have raised concerns about the interactions between some of the provisions of 

the proposals and certain aspects of the Dodd-Frank Act. In particular, some commenters raised concerns about the interplay and overall effect that the proposed 

treatment for residential mortgages will have on the housing sector and availability 

of mortgage loans when combined with the pending regulations related to the definitions of ‘‘qualified mortgage’’ (QM) and ‘‘qualified residential mortgage’’ (QRM). 4 In 

developing the treatment for residential mortgages, the agencies were mindful of the 

proposed definitions of QM and QRM and specifically requested comment on whether mortgages that meet the QM definition should be included in the lower risk category of residential mortgage. 

Some commenters suggested that, given the complexity of the proposals, the best 

way to reduce regulatory burden on community banks would be to delay the implementation of the Standardized Approach NPR or to exempt community banks altogether from any new capital rules. In this vein, many commenters observed that 

community banks did not cause the crisis, and therefore should be exempted. We 

will carefully consider these comments as well as suggestions for improving the 

NPR. 

As noted earlier, we have taken steps to try to ease the burden of understanding 

the proposed set of rules for community banks. Nevertheless, we recognize that understanding and complying with the proposed rules could still be difficult for community banks. However, it is also important to recognize that the proposed rules 

are lengthy, in part, because they address banks of all shapes and sizes including 

banks involved in complex or risky activities, instruments, or lines of business. 

Banks engaged in these activities are not necessarily only the largest banks in the 

country but also can include smaller banks that engage in one or two complex or 

riskier activities. The proposed rules are comprehensive in their coverage and would 

therefore address such instances. The vast majority of community banks, however, 

will not need to consider many of these provisions. 

Finally, it is important to remember that over 460 smaller banks have failed in 

the aftermath of the financial crisis for a variety of reasons but, ultimately, because 

they did not have enough capital in relation to the risks that they took. The future 

safety and soundness of community banks will depend on their having sufficient 

capital going forward. 

2. Unrealized Losses 

Another major issue raised by commenters is the inclusion of unrealized losses 

(and gains) on available-for-sale (AFS) debt securities in regulatory capital. Under 

our existing standards, such unrealized losses generally do not affect a bank’s regulatory capital. 5 In contrast, under the Basel III NPR, unrealized losses on AFS debt 

securities would directly impact a bank’s regulatory capital. 6 The rationale for the 

47 

tuarial gains and losses on defined benefit plans (ASC Topic 715, Compensation—Retirement 

Benefits); and (4) gains and losses resulting from currency translation of foreign subsidiaries 

financial statements (ASC Topic 830, Foreign Currency Matters). Under the existing capital 

standards, items one through three of AOCI are not included in regulatory capital. 7 Under the proposals, balloon mortgages would receive risk weights between 100 and 200 

percent, depending on the loan’s LTV. 

proposal is that ignoring unrealized losses has the potential to mask the true financial position of a bank. This is particularly true when a bank is under stress and 

when creditors are most likely to be concerned about unrealized losses that could 

inhibit a bank’s ability to meet its obligations. 

Many bankers have commented that the inclusion of unrealized gains and losses 

on AFS debt securities could result in large and volatile changes in capital levels 

and other measures tied to regulatory capital, such as legal lending limits, especially when interest rates rise from the current low levels. Because these gains and 

losses often result from changes in interest rates rather than changes in credit risk, 

commenters also noted that the value of these assets on any particular day might 

not be a good indicator of the value of a security to a bank, given that the bank 

could hold the security until its maturity and realize the amount due in full (assuming no credit related issues). 

There are strategies available to banks to minimize some of these potential adverse effects on regulatory capital. Banks could increase their capital, hedge or reduce the maturities of their AFS securities, or shift securities into the held-to-maturity portfolio at the cost of reducing liquidity. However, commenters have stated 

that these strategies are all expensive and some strategies, such as hedging or raising additional capital, may be especially expensive and difficult for community 

banks. Commenters also have noted that under the proposed approach, offsetting 

changes in the value of other items on a bank’s balance sheet would not be recognized for regulatory capital purposes when interest rates change. As a result, they 

stated that the proposed treatment could greatly overstate the real impact of interest rate changes on the safety and soundness of the bank. 

The agencies anticipated many of the concerns raised by commenters on this issue 

and included a discussion within the Basel III NPR requesting comment on potentially excluding from regulatory capital unrealized gains and losses associated with 

U.S. Treasury and GSE debt that can be expected to be driven solely by interest 

rates. Under such an approach, other unrealized losses and gains—for example, 

those associated with a corporate bond—would be recognized in regulatory capital. 

The OCC recognizes the importance of this issue and the challenges the proposed 

treatment could present to banks, particularly community banks, in managing their 

capital, liquidity, and interest rate risk positions and in affecting their ability to 

lend to their communities. We are committed to reviewing this issue carefully. 

3. Real Estate Lending 

Another major concern of commenters relates to the proposed treatment for residential mortgages, and, to a lesser extent, commercial real estate. These provisions 

in the Standardized Approach NPR attempt to address some of the causes of the 

crisis—the collapse in residential mortgage underwriting standards and the prevalence of higher risk commercial real estate loans in some banks. Under our current 

rules, residential mortgages within a broad spectrum of risk attributes receive identical capital treatment. The treatment of commercial real estate loans is even less 

risk sensitive in that all such loans receive the same capital treatment. The proposed standard would raise the capital requirement for the riskiest mortgages and 

commercial real estate loans while actually lowering the charge on relatively safer 

residential mortgage loans. 

Some of the major issues that commenters have raised relate to: the treatment 

of residential balloon mortgages; recordkeeping issues associated with the proposed 

use of LTV ratios; the treatment of second liens and commercial real estate; and 

the potential impact on the housing market. With respect to residential balloon 

mortgages, the concentration of credit risk in the final balloon payment presents 

more risk to the lender than a loan that is fully amortized over a number of years— 

especially in situations where housing prices are not increasing. Therefore, the NPR 

proposes a relatively high capital charge. 7 Many community bankers have questioned this assumption and noted their good experience with balloons and their wide 

use in managing interest rate risk and providing credit to established customers. 

On the recordkeeping that would be required for LTVs, while higher LTV ratios 

are closely associated with higher risks of default, many community bankers have 

stated that going back through their existing portfolios to determine each loan’s 

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8 Remarks by Thomas J. Curry, Comptroller of the Currency, before the American Bankers 

Association in San Diego, California, October 15, 2012. 

LTV at origination would be a burdensome task. For this reason, some have suggested applying the proposed treatment prospectively. 

Commenters have also raised concerns with the proposed treatments for second 

lien residential mortgages, such as home equity loans, and for certain commercial 

real estate loans. Similar to issues raised with balloon mortgages, commenters have 

expressed concern that the proposed rules do not adequately distinguish between 

prudent and more risky lending in such products. 

With respect to broader implications for the housing market, while the proposal 

would actually lower capital requirements for the safest mortgages, it would also 

raise capital requirements for riskier mortgages, which could raise the incremental 

costs of such mortgages. Commenters have raised concerns about the impact this 

might have on recovery of the housing sector. 

The OCC will pay attention to the unique and intimate knowledge that community banks possess of their customers and their lending relationships as we review 

the range of issues raised by commenters on our proposed treatment of real estate 

lending. 

Conclusion 

Given the attention that the regulatory capital proposals have received recently, 

let me conclude by taking a moment to put these proposals in a broader perspective. 

Specifically, regulatory capital standards are an important component in a larger 

and more comprehensive process of bank supervision. They cannot and should not 

be viewed as a substitute for other assessments of a bank’s financial position, including banks’ internal capital adequacy assessments. They should be viewed as 

complementary to strong supervision of institutions, which requires in-depth and 

bank-specific analysis. 

With this as the context, I want to reemphasize that we are still in the process 

of reviewing the many comment letters that we have received. We will carefully assess the advantages and disadvantages of the alternatives suggested, including assessing regulatory burden against the value of more and better quality capital that 

is better aligned to actual risks. As the Comptroller said last month, ‘‘As we finalize 

the rules, we will be thinking broadly about ways to reduce regulatory burden. As 

well as considering the substance of each provision, we will be taking a fresh look 

at the possible scope for transition arrangements, including the potential for 

grandfathering, to evaluate what we can do to lighten burden without compromising 

our two key principles of raising the quantity and quality of capital and setting minimum standards that generally require more capital for more risk.’’ 8

Given the vital role that banks serve in our national economy and local communities, we are committed to helping ensure that the business model of banks, both 

large and small, remains vibrant and viable. But, as a foundation for their future 

success, their capital has to stay strong too. If we can help ensure that, then we 

will be well along the road in ensuring that there is a stable and competitive banking system meeting household and business credit needs across America in the 

years ahead. 

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PREPARED STATEMENT OF GEORGE FRENCH 

DEPUTY DIRECTOR, POLICY, DIVISION OF RISK MANAGEMENT SUPERVISION, FEDERAL

DEPOSIT INSURANCE CORPORATION

NOVEMBER 14, 2012 

Chairman Johnson, Ranking Member Shelby, and Members of the Committee, 

thank you for the opportunity to testify today on behalf of the Federal Deposit Insurance Corporation (FDIC) regarding the recently proposed changes to the Federal 

banking agencies’ regulatory capital requirements. The FDIC has had a longstanding concern for stronger bank capital requirements, and we welcome the opportunity to discuss these important proposals. The Federal banking agencies have received and are carefully reviewing a significant number of comments on these proposals. 

Background 

As you know, in June of this year, the Federal banking agencies issued for public 

comment three separate Notices of Proposed Rulemaking, or NPRs, proposing 

changes to the regulatory capital requirements. Two of the NPRs would implement 

the recent Basel III standards developed by the Basel Committee on Banking Supervision and update our regulations in conformity with Section 939A of the DoddFrank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The first 

of these, the Basel III NPR, would strengthen the quality of bank capital and increase its required level for all institutions, including community banks. The Basel 

III NPR also includes selected Basel III capital requirements applicable only to 

banking organizations that use the agencies’ Advanced Approaches capital regulation. The second NPR, the Advanced Approaches NPR, proposes additional requirements from the Basel III agreement and other Basel standards for these large Advanced Approaches organizations. The third NPR, referred to as the Standardized 

Approach NPR, proposes changes to the risk-weighting of assets and replaces credit 

ratings in the agencies’ capital regulations in accordance with Section 939A of the 

Dodd-Frank Act. This NPR would apply to all institutions. The comment period on 

all three NPRs closed on October 22, 2012. Also, in June of this year, the agencies 

finalized regulations that change the way banks with a large volume of trading activity calculate capital requirements for market risk. 

The agencies proposed the NPRs to address deficiencies in bank capital requirements that became evident in the recent banking crisis. A number of banking organizations failed or required Federal assistance during the crisis, and the U.S. Government provided capital, liquidity and guarantees to a significant portion of the financial sector, including depository institution holding companies and their affiliates. Since January 1, 2008, 463 FDIC-insured banks have failed. 

In light of this experience, strengthening bank capital requirements seems to be 

an appropriate and important step. All banks need strong capital to navigate periods of economic turbulence while continuing to serve their important role as financial intermediaries to the economy. The changes proposed in the NPRs are intended 

to address identified deficiencies in the existing capital regime and provide greater 

comfort in the capital adequacy of our banking system. At the same time, reviewing 

the numerous comments received will help us address concerns about the costs and 

potential unintended consequences of various aspects of the proposals. 

My testimony will describe the proposed rules in more detail, along with some of 

the most frequently identified concerns among the more than 1,500 comments we 

have received. It is worth emphasizing that the rulemaking process is ongoing and 

the agencies have not yet reached final decisions regarding how to address the various issues that have been raised with respect to the NPRs. 

The Basel III NPR 

One of the critical lessons learned from the recent financial crisis was that highquality, loss-absorbing capital is essential to ensuring the safety and soundness of 

financial institutions. As such, in the aftermath of the crisis, the FDIC and the 

other U.S. banking agencies participated in an intensive international effort to 

strengthen bank capital standards. The result of these efforts is the Basel III capital 

agreement. In broad terms, the Basel III capital standards aim to improve the quality and increase the required level of bank capital. Collectively, Basel III and other 

standards published by the Basel Committee address a number of features of capital 

regulation that allowed for an excessive use of leverage in the years leading up to 

the crisis. 

The FDIC Board of Directors voted to issue the Basel III NPR for public comment 

on June 12, 2012. The Basel III NPR proposes to strengthen the definition of regulatory capital to better absorb losses than under current rules, and to increase the 

85 

1 Under existing regulations, unrealized gains and losses on AFS debt securities are not included in regulatory Tier 1 capital. Unrealized losses on AFS equity securities with readily determinable fair value are included in Tier 1 capital, while a portion of unrealized gains on AFS 

equity securities can be included in Tier 2 capital. 

required level of capital. These changes are proposed to be phased in over time. The 

NPR also includes selected requirements that apply only to banks using the agencies’ Advanced Approaches capital regulation. 

The Basel III NPR proposes a number of changes to strengthen the definition of 

capital. The most important of these changes are described below. 

• Under current rules, common equity is permitted to comprise as little as half 

of Tier 1 capital, reducing the loss absorbency of, and market confidence in, the 

regulatory capital measure. The Basel III NPR proposes a new risk-based capital requirement for ‘‘common equity Tier 1,’’ a form of regulatory capital that 

would be more reliably available to absorb losses. 

• Intangible assets, except for a limited amount of mortgage servicing rights, are 

deducted from capital in the Basel III NPR. Intangible assets, which are generally difficult to sell in order to absorb losses, are subject to limits in current 

capital rules, but the NPR makes these limits more stringent. 

• Deferred tax assets are subject to stricter limits in the Basel III NPR. These 

assets, as analysts noted during the crisis, may have little value when a bank 

is losing money and capital support is most needed. 

• Investments in the capital instruments of other financial institutions that exceed specified thresholds are deducted from capital in the Basel III NPR. It was 

evident in the recent crisis that inclusion of large amounts of such investments 

in a banking organization’s capital can create a chain of interconnected losses 

that exacerbates a banking crisis. 

• Minority interests in consolidated subsidiaries are subject to stricter limits in 

the Basel III NPR. Minority interests can absorb losses in a specific subsidiary 

but may be unavailable to absorb losses throughout an organization. 

• Trust Preferred Securities (TruPS) are subject to a phase-out from Bank Holding Companies’ (BHC5) Tier 1 capital in the Basel III NPR (a 3-year phase-out 

for large BHCs and a 10-year phase-out for smaller BHCs). TruPS can absorb 

losses in a failure, but do not absorb losses on a going-concern basis. The application of this proposed change to smaller BHCs, and the change to the treatment of accumulated other comprehensive income described below, have been 

frequent subjects of concern from commenters. 

• Accumulated other comprehensive income (AOCI), which includes unrealized 

gains and losses on available-for-sale (AFS) securities, is proposed to be included in the calculation of capital under the Basel III NPR. 1 Incorporating 

these gains and losses as proposed in the NPR may result in a better indicator 

of the bank’s capital strength if it is forced to sell these securities in an adverse 

economic environment. 

We are carefully considering the comments we have received on each of these proposed changes to the definition of capital. 

As noted above, the Basel III NPR proposes to establish a new risk-based capital 

requirement for ‘‘common equity Tier 1’’ capital. Under the NPR, banks would need 

to hold common equity Tier 1 capital in an amount that is at least 4.5 percent of 

risk-weighted assets in order to be considered ‘‘Adequately Capitalized.’’ The NPR 

also proposes to increase by two percentage points the minimum and ‘‘Well Capitalized’’ levels for the Tier 1 risk-based capital ratios that are part of the agencies’ 

Prompt Corrective Action (PCA) regulations. 

The Basel III NPR also proposes a capital buffer incorporating a sliding scale of 

dividend restrictions for banks whose risk-based capital ratios are less than 2.5 percentage points higher than the regulatory minimums. The purpose of the buffer is 

to encourage banks to maintain a cushion of capital above the regulatory minimums 

so they will be able to continue to lend during periods of economic adversity without 

breaching those minimums. The Basel III buffer is similar to the statutory requirement that the agencies’ PCA regulations include a capital ratio threshold for banks 

to be considered ‘‘Well Capitalized.’’ 

In addition, the Basel III NPR requires banks that use the Advanced Approaches 

capital regulation to comply with a supplementary leverage ratio that includes certain off-balance sheet items in the denominator. The FDIC views the leverage ratio 

as a foundational measure of capital, and we are highly supportive of its inclusion 

in the Basel framework. The complexities specific to the Basel III leverage ratio, 

86 

2 ‘‘Calibrating Regulatory Minimum Capital Requirements and Capital Buffers: A Top–Down 

Approach’’, October, 2010, Basel Committee on Bank Supervision; http://www.bis.org/publ/ 

bcbs180.htm. 3 ‘‘An Assessment of the Long-Term Economic Impact of Stronger Capital and Liquidity Requirements’’, August, 2010; Basel Committee on Bank Supervision; http://www.bis.org/publ/ 

bcbsl73.htm, and ‘‘Assessing the Macroeconomic Impact of the Transition to Stronger Capital 

and Liquidity Requirements (MAG Analysis),’’ December, 2010, Financial Stability Board and 

Basel Committee on Bank Supervision; http://www.bis.org/publ/othp12.pdf. 

however, are mainly relevant for very large institutions with extensive off-balance 

sheet activities. For that reason, the agencies have proposed that the Basel III leverage ratio would be a supplementary requirement, and only applied to banks 

using the Advanced Approaches capital regulation. The existing U.S. leverage ratio 

requirements would remain in effect for all U.S. banks. 

The Basel III NPR also requires Advanced Approach banking organizations to 

hold additional capital in the form of a ‘‘countercyclical buffer’’ if the agencies determine that the banking industry is experiencing excessive credit growth. The NPR 

indicated that the countercyclical buffer initially would be set at zero, with the 

agencies acting jointly to raise that level, if and when credit conditions warranted 

putting this buffer into effect. If a determination was made that the buffer was necessary, the amount of the buffer could be as much as 2.5 percent of risk-weighted 

assets. The countercyclical buffer would serve to provide additional capital for the 

losses that often follow a period of excessive credit growth, and may itself serve as 

a check on excessive growth. Again, the NPR indicates that the countercyclical buffer would only be in effect when credit conditions warrant and would be zero at other 

times. 

The minimum capital ratios and capital buffers proposed in the Basel III NPR 

were developed as part of a Basel Committee effort, in which the agencies participated, to estimate the amount of bank capital needed to absorb losses in severe economic scenarios including the losses experienced in banking crises in different countries over time. The results of this analysis were published in October, 2010. 2 The 

results suggest that bank capital ratios at the levels agreed to by the Basel Committee and proposed in the Basel III NPR would provide reasonable assurance that 

banks would be able to absorb losses during a period of economic adversity while 

continuing to be able to lend—and certainly greater assurance than exists under the 

current rules. 

While working as part of the Basel Committee to develop the capital ratios that 

were proposed in the Basel III NPR, the agencies were mindful that while the requirements should be sufficient to enable banks to withstand a period of economic 

adversity, they should not be so high as to choke off prudent lending or normal economic activity. The agencies participated in international efforts to evaluate the potential effect of the higher bank capital requirements on economic activity. This 

work focused on two issues. One issue is the potential costs to the broader economy 

of an insufficiently capitalized banking system. Experience suggests that banking 

crises have consistently been followed by large and long-lasting reductions in economic activity. The other—and competing issue—is the costs that higher capital requirements might impose by increasing the cost of credit and reducing the volume 

of lending. 

The literature reviews and other analysis conducted as part of these international 

efforts generally concluded that within the range of capital requirements being considered, the economic benefits of higher capital requirements from reducing the frequency and severity of banking crises would exceed the economic costs resulting 

from a modest increase in the cost of credit. 3 This analysis supports the overall conclusion that an increase in bank capital requirements from current levels is warranted. Precrisis increases in leverage permitted by the current capital rules did 

stimulate financial institution growth and earnings for a time, but the real economy 

ultimately suffered a significant cost when the financial cycle turned. In addition 

to the financial institution failures and Government assistance mentioned earlier in 

this testimony, the U.S. economy experienced a loss of over eight and a half million 

payroll jobs as a result of the recession, and it suffered a 35 percent decline in home 

prices as well as over 10 million new foreclosures. The decline in employment and 

economic activity reduced revenues at all levels of Government, with fiscal effects 

that reverberate back to the real economy. 

While we view strengthening bank capital requirements as an appropriate goal 

to reduce the likelihood and severity of future banking crises, the agencies also are 

mindful that the proposals in these three NPRs represent significant change. The 

review of comments that is now underway is expected to shed considerable light on 

87 

the potential for unintended consequences associated with specific aspects of these 

proposals. 

Advanced Approaches NPR 

In addition to the Basel III NPR, the FDIC Board of Directors approved a separate NPR on June 12 that proposes a number of enhancements to the calculation 

of risk-weighted assets for the large, complex banks using the Advanced Approaches. This NPR proposes to implement aspects of Basel III that are designed 

to improve and strengthen modeling standards, the treatment of counterparty credit 

risk, credit risks associated with securitization exposures, and disclosure requirements. The proposal also contains alternatives to credit ratings consistent with Section 939A of the Dodd-Frank Act. The proposals in this NPR would strengthen the 

existing Advanced Approaches capital rules, particularly those related to capital requirements for derivatives. 

The FDIC has had a longstanding concern about the reliance in the Advanced Approaches rule on a bank’s own models and risk estimates. Section 171 of the DoddFrank Act (the Collins Amendment) addresses this concern by placing a floor under 

the Advanced Approaches capital requirements that ensures that the Advanced Approaches capital requirements are not less than the requirements that are generally 

applicable to other banks. 

Standardized Approach NPR 

The third NPR, the Standardized Approach proposal, includes a number of proposed changes to the calculation of risk-weighted assets in the agencies’ general 

risk-based capital rules. The proposal also includes alternatives to credit ratings 

consistent with Section 939A of the Dodd-Frank Act. The capital requirements proposed in the Standardized Approach NPR are separate and distinct from those 

under the Basel III framework. 

The Standardized Approach proposal was designed to address shortcomings in the 

measurement of risk-weighted assets that became apparent during the recent financial crisis. In part, this is addressed by implementing certain changes based on the 

Basel II Standardized Approach contained in the Basel international regulatory capital standards and by replacing credit ratings consistent with section 939A of the 

Dodd-Frank Act. The proposed risk-weightings and segmentation methodologies for 

residential mortgages were developed by the Federal banking agencies in response 

to issues observed during the financial crisis. Among other things, the proposed rule 

would: 

• revise risk weights for residential mortgages based on loan-to-value ratios and 

certain product and underwriting features; 

• increase capital requirements for past-due loans, high volatility commercial real 

estate exposures, and certain short-term loan commitments; 

• expand the recognition of collateral and guarantors in determining risk-weighted assets; 

• remove references to credit ratings; and 

• establish due-diligence requirements for securitization exposures. 

We have estimated that the large majority of insured banks would meet the capital requirements resulting from the combined implementation of the Basel III NPR 

and the Standardized Approach NPR. The attachment to this testimony describes 

the methodology for these estimates and the results for banks in different size 

groups. These estimates suggest that for most insured banks, the proposals would 

not result in a need to raise new capital. It should be emphasized that these are 

estimates, and that institutions themselves will have better information about the 

specific factors used in the proposed capital calculations than the agencies currently 

collect in financial reports. In particular, our estimates did not attempt to address 

the extent to which institutions might feel the need to hold additional capital buffers beyond those specifically proposed, for example, to offset future changes in 

AOCI. Our review of the public comments is expected to shed additional light on 

such issues. 

Final Market Risk Rule 

On June 12, the FDIC Board of Directors also approved the final regulation making improvements to the Market Risk Rule. This final regulation, which takes effect 

on January 1, 2013, addresses important weaknesses of the current Market Risk 

Rule to reflect lessons learned in the financial crisis. Leading up to the crisis, low 

capital requirements under the current Market Risk Rule encouraged institutions 

to place illiquid, high-risk assets in their trading books. Large mark-to-market 

losses on these assets played an important role in fueling the financial crisis during 

88 

its early stages. The final regulation requires an appropriate increase in the stringency of the Market Risk Rule that will better address such risks. 

This final rule applies only to the largest institutions that have significant trading 

activities. It is based on reforms that were agreed to internationally with the Basel 

Committee’s 2009 revisions to the Basel II market risk framework. These revisions 

are part of what is generally referred to as the Basel II.5 reforms. 

Concerns have been expressed that the Market Risk Rule, while improved, is still 

too reliant on internal models. The idea of establishing a simple, nonmodeled and 

higher minimum capital floor for all trading book capital requirements is worthy of 

further study, and is in fact being considered as part of a fundamental review of 

trading book capital requirements being conducted by the Basel Committee. 

Outreach and Comments 

As the primary Federal supervisor for the majority of community banks, the FDIC 

is particularly focused on ensuring that community banks are able to properly analyze the capital proposals and assess their impact. Since the Basel III NPR and the 

Standardized Approach NPR would affect all banks, the FDIC undertook an outreach agenda to assist community banks in analyzing the impact of the proposals. 

First, both the Basel III NPR and the Standardized Approach NPR contain a relatively short and concise addendum designed to aid smaller banks in identifying 

and understanding the aspects of the proposal that would apply to them. 

Second, FDIC staff hosted six community bank capital outreach sessions, one in 

each of the FDIC regional offices. Each session included an FDIC staff overview of 

the NPRs that identified the most significant changes for community banking organizations, and a question-and-answer session for the bankers in attendance. 

Third, the FDIC posted an on-demand video on its Web site that contains the 

same information provided by the FDIC in the live outreach sessions. Copies of the 

materials provided to bankers at the live outreach sessions are also posted online. 

Fourth, FDIC staff hosted a national call to address the questions most frequently 

asked by attendees at the live outreach program sessions. 

Finally, the FDIC, along with the other banking agencies, developed a Regulatory 

Capital Estimation Tool designed to assist community banking organizations and 

other interested parties in evaluating the potential effect that the Basel III NPR 

and the Standardized Approach NPR could have on their capital ratios. 

We believe that these outreach efforts have helped many bankers understand 

these proposals and identify the issues that are of concern to them. As of November 

8, the FDIC had received more than 1500 comments. The vast majority of these 

comments are from community banks. Their comments have been highly substantive and provide significant information regarding the possible impact of the 

proposals. 

The FDIC is in the process of reviewing all of the comments received. To date, 

many commenters have raised concerns about the generally higher level of capital 

requirements for community banks. A number of commenters have requested that 

the agencies not apply the Basel III or Standardized Approach NPRs to community 

banks. Some commenters have requested that the agencies withdraw the Standardized Approach NPR. 

In addition to these general comments, a few more specific topics have been mentioned quite frequently. First, many commenters have expressed concern that the 

Basel III NPR proposes to include AOCI in the calculation of regulatory capital, 

thereby including gains and losses on available-for-sale debt securities. These commenters believe that the inclusion of AOCI will increase the volatility of regulatory 

capital, forcing banks to hold additional capital buffers, and complicate their ability 

to manage interest rate risk and comply with legal lending limits. Also with respect 

to the Basel III NPR, many commenters have expressed concern that trust preferred 

securities issued before May 19, 2010, by community bank holding companies with 

less than $15 billion in assets are proposed to be phased out of Tier 1 capital. 

With respect to the Standardized Approach NPR, many commenters have expressed concern about the increased complexity and systems costs of the proposed 

new methods for asset risk weighting, as well as the proposed increase in risk 

weight for certain exposures, particularly past due exposures and residential mortgages. Many community bank commenters have indicated that the proposed riskweightings for residential mortgages will force them to curtail or exit residential 

mortgage lending because of what they view as the excessively high level of some 

of these risk weights. Commenters also express concern about how the new risk 

weights might interact with a number of pending mortgage regulations whose final 

form remains uncertain. 

89 

Conclusion 

In conclusion, along with our fellow regulators, the FDIC is carefully reviewing 

the comments we have received regarding the NPRs. These are proposed rules and 

we expect to make changes based on the comments. The basic purpose of the Basel 

III framework is to strengthen the long-term quality and quantity of the capital 

base of the U.S. banking system. In light of the recent financial crisis, that would 

appear to be an appropriate and important goal. However, that goal should be 

achieved in a way that is responsive to the concerns expressed by community banks 

about the potential for unintended consequences. 

90 

91 

92 

93 

1See, http://www.federalreserve.gov/newsevents/press/bcreg/20120313a.htm. 

2The Basel III proposals are reflected in three notices of proposed rulemaking. See, 77 Federal Register 52888, 52909, 52958 (August 30, 2012). 3See, ‘‘Calibrating Regulatory Minimum Capital Requirements and Buffers: A Top–Down Approach’’ (BCBC Analysis), available at: http://www.bis.org/publ/bcbs180.pdf. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM MICHAEL S. GIBSON 

Q.1. Is the U.S. banking system currently adequately capitalized? 

Please list any studies or data you relied upon to make this determination. 

A.1. U.S. banking organizations of all sizes have improved their 

capital ratios since the financial crisis. The 19 largest banking organizations in particular have considerably more higher-quality 

capital than they did prior to the financial crisis. The aggregate 

amount of tier 1 common equity, the most loss-absorbing form of 

capital, held by these firms has increased by more than $300 billion since 2009, representing an increase of approximately 80 percent. 1 Implementing the Basel III proposal, along with related reforms such as regular supervisory and company-run stress tests, 

should help solidify these gains to better ensure the resiliency of 

the U.S. banking system. 2

Before developing the Basel III proposal, the Board and the other 

Federal banking agencies participated in the international efforts 

conducted by the Basel Committee on Banking Supervision (BCBS) 

to study the losses experienced in past banking crises in various 

countries to help inform the appropriate levels of capital that banking organizations should maintain. The results of this study were 

made publicly available in October, 2010, and were attached as Attachment A to the letter the Federal banking agencies sent to you 

dated November 13, 2012. 3 As indicated in the BCBS analysis, 

there is no single correct approach for determining adequate capital ratio levels; rather, the analysis provides a variety of different 

perspectives on banking organizations’ loss experiences to help inform what is ultimately a regulatory judgment regarding appropriate levels of minimum capital ratios and other measures of capital adequacy. The minimum ratio levels agreed to by the BCBS, 

which are the same as those in the Basel III proposal, fall within 

the ranges suggested by the BCBS calibration analysis. That analysis focused on information submitted by member countries regarding losses relative to risk-weighted assets incurred over long historical periods. 

If the Basel III proposal were implemented today, the vast majority of top-tier bank holding companies would meet the minimum 

requirements outlined in the proposals. Even after considering the 

capital conservation buffer in addition to the minimum requirements, a substantial majority of institutions would meet the proposed capital standards. Similarly, most banking organizations 

with less than $10 billion in consolidated assets already hold capital that would qualify under the proposals and exceed the proposed minimum risk-based regulatory ratios. 

Q.2. If the proposed Basel III rules were implemented, would your 

agency consider the U.S. banking system to be adequately capitalVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00097 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
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4See, 77 Federal Register 52888, 52909, 52958 (August 30, 2012). 5See, BCBS Analysis, paragraph I.A. 

ized? Please explain how you made that determination and what 

studies and data you relied upon. 

A.2. As detailed in the Federal banking agencies’ letter of November 13, 2012, all banking organizations need a strong capital base 

to enable them to withstand periods of economic adversity yet continue to fulfill their role as a source of credit to the economy. The 

capital standards in the three notices of proposed rulemakings 

(NPRs) related to Basel III each address identified weaknesses in 

the current U.S. regulatory capital regime. 4

Generally, the NPRs can be characterized as both strengthening 

the definition of capital so that banking organizations are better 

able to absorb losses and increasing the required minimum levels 

of capital so that banking organizations can better withstand periods of economic adversity. The NPRs also would modify risk 

weights to better reflect risks inherent in specific assets. Each NPR 

contains extensive discussion of the specific proposed changes and 

why the Board and other Federal banking agencies views these 

proposed changes as appropriate for the banking organizations that 

they supervise. 

As described in the BCBS Analysis noted in the response to 

Question 1, a conceptual framework was established as the starting 

point for the calibration of the capital standards. Under this framework, the minimum requirement for loss-absorbing capital is defined as the amount of capital a banking organization needs to 

maintain so that investors, creditors, and counterparties would 

view it as a viable going concern. Similarly, a buffer above the minimum requirement is defined as an amount of capital sufficient for 

a banking organization to withstand significant downturn events 

while continuing to meet its minimum capital requirements. 5 As 

noted previously, the minimum ratio levels agreed to by the BCBS, 

which are the same as those proposed in the NPRs, fall within the 

ranges suggested by the BCBS Analysis. On this basis, the minimum capital ratios proposed in the NPRs, including the revised 

definition of capital, could serve as an appropriate basis for minimum capital requirements in the United States. 

The Board is currently in the process of reviewing all comments 

on the NPRs and is carefully considering those comments as part 

of the rulemaking process. 

Q.3. At an FDIC meeting in July, FDIC Director Thomas Hoenig 

stated that ‘‘as proposed, the minimum capital ratios will not significantly enhance financial stability.’’ Bank of England Governor 

Mervyn King and several prominent economists have said that 

Basel III capital standards are insufficient to prevent another crisis. Do you disagree with these assertions? If so, why? 

A.3. While there is no single measure that will prevent future crises, the proposed Basel III capital standards would address weaknesses in the current capital standards that were highlighted by 

the recent financial crisis. Most notably, the proposed rules would 

increase both the quantity and quality of capital held and require 

banking organizations to hold more capital for riskier exposures. 

These changes are expected to improve banking organization’s abilVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00098 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
95 

ity to absorb losses. These improvements also would enhance banking organizations’ ability to continue to function as financial intermediaries in future periods of financial and economic stress, thus 

improving the overall resiliency of the U.S. financial system. In 

this way, the NPRs are a substantial step forward toward a more 

stable financial system. 

Q.4. Given the cost and complexity of Basel III, do you have any 

concerns that Basel III will further tilt the competitive landscape 

in favor of big banks to the detriment of small banks? Have you 

studied the impact of Basel III on small institutions as compared 

to their larger counterparts? 

A.4. Many requirements in the Basel III proposal are focused on 

larger organizations and would not be applicable to smaller banks. 

These requirements include the proposed countercyclical capital 

buffer, the supplementary leverage ratio, enhanced disclosure requirements, and enhancements to the advanced approaches riskbased capital framework. These proposed changes, along with other 

recent regulatory capital enhancements such as stress testing requirements and market risk capital reforms would require large, 

systemically important banking organizations to hold significantly 

higher levels of capital relative to other organizations. The BCBS 

has also proposed requiring an additional capital charge for global 

systemically important banks (the Board has not yet proposed such 

a requirement). 

In developing the Basel III-based capital requirements, the 

Board and the other Federal banking agencies conducted an impact 

analysis based on regulatory reporting data to estimate the change 

in capital that banking organizations would be required to hold to 

meet the proposed minimum capital requirements. Based on the 

agencies’ analysis, the vast majority of banking organizations currently would meet the fully phased-in minimum capital requirements, and those organizations that would not meet the proposed 

minimum requirements would have time to adjust their capital levels by the end of the transition period. More specifically with regard to smaller banking organizations, for bank holding companies 

with less than $10 billion in assets that meet the current minimum 

regulatory capital requirements, the analysis indicated that more 

than 90 percent of organizations would meet the proposed 41⁄2 percent minimum common equity tier 1 ratio today. In addition, quantitative analysis by the Macroeconomic Assessment Group (MAG), 

a working group of the BCBS, found that the stronger Basel III 

capital requirements would lower the probability of banking crises 

and their associated economic output losses while having only a 

modest negative impact on gross domestic product and lending 

costs, and that the potential negative impact could be mitigated by 

phasing in the requirements over time. 

With respect to those banking organizations that would not meet 

the proposed requirements, including community banks with more 

limited capital-raising capabilities, the proposal includes lengthy 

transition periods. During the transition periods, banking organizations can accrete capital through the retention of earnings, as well 

as adjust to other elements of the proposal. The Federal banking 

agencies also developed a capital estimation tool to help companies, 

96 

6 5 U.S.C. 801-808 

particularly community banking organizations, gain a further understanding of the possible impact of the proposals on their capital 

ratios. Finally, the Board sought comment on alternatives to the 

proposed requirements applicable to small banking organizations 

that could minimize their impact on those entities. 

The Board is still in the process of reviewing the public comments it has received on the Basel III proposal, including those regarding the likely impact on smaller institutions. In reviewing 

these comments, the Board is mindful about the potential effect of 

the Basel III proposals on community banks. The Board will remain mindful of these comments when considering potential refinements to the proposal and will work to appropriately balance the 

benefits of a revised capital framework against its potential costs, 

including further tailoring the requirements for smaller institutions as appropriate. 

Q.5. Recently, the agencies announced that they are pushing back 

the effective date of the proposed Basel III rules beyond January 

1, 2013. This affords the agencies more time to carefully review 

comment letters, engage in additional outreach and collect additional data. Will the agencies use this extra time to conduct an 

analysis about the impact of the proposed rules on the U.S. economy and a quantitative impact study that covers all banks, regardless of size, before implementing the final rules? 

A.5. As noted above, in developing the Basel III proposal, the 

Board used regulatory reporting data to consider the potential impact of the proposed requirements on banking organizations of all 

sizes. As also noted above, the Board, working with the BCBS, has 

already analyzed the impact of the proposed rules on U.S. economic 

growth and found that the net impact would likely be positive. The 

comment period was extended to allow interested persons more 

time to understand, evaluate, and prepare comments on the proposals, and the Board has to date received over 2,000 public comments on the proposals. The Board is carefully considering the 

commenters’ views on and concerns about the effects of the NPRs 

on the U.S. economy and on banking organizations. 

Before issuing any final rule, the Board will prepare an analysis 

under the Congressional Review Act (CRA). 6 As part of this analysis, the Board will assess whether the final rule is a ‘‘major rule,’’ 

meaning the rule could (1) have an annual effect on the economy 

of $100 million or more; (2) increase significantly costs or prices for 

consumers, individual industries, Federal, State, or local government agencies, or geographic regions; or (3) have significant adverse effects on competition, employment, investment, productivity, 

or innovation. Consistent with the CRA, any such analysis will be 

provided to Congress and the Government Accountability Office. 

In addition, as mentioned previously, the Board sought comment 

on significant alternatives to the proposed requirements applicable 

to covered small banking organizations that would minimize their 

impact on those entities, as well as on all other aspects of its analysis. After consideration of comments received during the public 

comment period and prior to adopting any final rule, the Board will 

97 

7 5 U.S.C. 601 et seq. 

8See, Chairman Bernanke’s speech available at http://www.federalreserve.gov/newsevents/ 

speech/bernanke20100506a.htm. 9See, Chairman Bernanke’s speech available at http://www.federalreserve.gov/newsevents/ 

speech/bernanke20090113a.htm. 10See, ‘‘Assessing the Macroeconomic Impact of the Transition to Stronger Capital and Liquidity Requirements’’ (MAG Analysis), Attachment E, available at: http://www.bis.org/publ/ 

othp12.pdf; see also ‘‘Results of the Comprehensive Quantitative Impact Study’’, Attachment F, 

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

conduct a final regulatory flexibility analysis under the Regulatory 

Flexibility Act. 7

Q.6. What is the estimated impact of the Basel III rules, if finalized as proposed, on: 

a. The U.S. GDP growth? 

b. The probability of bank failure? 

c. Availability and cost of mortgages, auto loans, student loans 

and small business credit? 

d. The compliance costs for small, medium, and large banks? 

e. The cost of insurance for consumers? 

Please provide data to support your conclusions. 

A.6. The recent financial crisis revealed that the amount of highquality capital held by banking organizations in the United States 

was insufficient to absorb losses during periods of severe stress. 

The effects of having insufficient levels of capital were further magnified by the fact that certain regulatory capital instruments did 

not absorb losses to the extent previously expected. The lack of confidence in the banking sector drove up credit spreads on corporate 

bonds issued by banks, impaired banks’ access to short-term funding, and depressed values of bank equities. Concerns about banking 

institutions arose not only because market participants expected 

steep losses on banking assets, but also because of substantial uncertainty surrounding estimated loss rates, and thus future earnings. 8 Further, heightened systemic risks, falling asset values, and 

tightening credit took a heavy toll on business and consumer confidence. 9

The Board believes that the proposals would result in capital requirements that better reflect banking organizations’ risk profiles 

and enhance their ability to continue functioning as financial intermediaries, including during periods of financial stress, thereby improving the overall resiliency of the 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 MAG, as well as its Quantitative Impact Study, the results of which were made publicly available by 

the BCBS upon their completion. 10

This analysis has suggested that stronger capital requirements 

could help reduce the likelihood of banking crises while yielding 

positive net economic benefits. Moreover, the MAG analysis found 

that the requirements would only have a modest negative impact 

on the gross domestic product of member countries, and that any 

such negative impact could be significantly mitigated by phasing in 

the proposed requirements over time. Thus, the benefits of the 

Basel III proposals, as measured by the reduction of risk to the deVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00101 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
98 

posit insurance fund and to the financial system, would outweigh 

the short-term cost of compliance with the new standards and potential impact on economic growth. 

Q.7. Our housing market is currently entirely dependent on taxpayer-funded Government support through FHA and the GSEs. 

The Administration, however, has yet to prepare a housing finance 

reform plan. As a result, the future of the GSEs is still undetermined. One issue that will have to be addressed in housing finance 

reform is ensuring that the Basel rules are properly coordinated 

with the capital requirements for the GSEs in order to avoid creating any adverse incentives. Prior to the crisis, Fannie and 

Freddie had much lower capital requirements than did comparable 

banking institutions. According to one study, from 1992 through 

2007 the GSE leverage ratios were between 20 and 40 (50 and 100 

if MBS credit guarantees are included) whereas commercial banking sector had ratios between 10 and 15. With an implicit Government guarantee, Fannie and Freddie were able to borrow at artificially low interest rates, making it quite profitable for the GSEs to 

purchase mortgages and offer credit default guarantees below market rates. As a result, Fannie and Freddie grew to become institutions that threatened the financial stability of the U.S. economy. In 

devising the proposed Basel capital rules, did your agency consider 

how the rules would interact with the capital requirements of any 

GSE? If yes, please explain whether any changes were made to the 

rules to protect against adverse consequences you identified. 

A.7. The proposal would maintain the banking agencies’ current 

20-percent risk weight for claims of or guaranteed by GSEs that 

are not equity exposures. The proposal would apply a 100 percent 

risk weight to equity securities issued by a GSE, which previously 

was not a uniform treatment among the agencies. As discussed in 

the proposal, although certain GSEs currently are in conservatorship and receive capital support from the U.S. Treasury, they remain privately owned corporations, and their obligations do not 

have the explicit guarantee of the full faith and credit of the 

United States. The agencies have long held the view that obligations of the GSEs should not be assigned the same risk weight as 

obligations that carry the explicit guarantee of the U.S. Government. 

Our proposal would not affect the capital requirements faced by 

GSEs, such as Fannie Mae and Freddie Mac. Those capital requirements are not under the authority of the Federal banking agencies. 

In determining the risk weight for an exposure to a GSE, the Federal banking agencies have considered the potential risk associated 

with such exposures that would be borne by a banking organization 

holding the exposure. Any changes to the capital requirements for 

GSEs, including those that reduce any perceived advantages at the 

expense of private sector entities, would be determined by the 

FHFA and are outside the scope of this rulemaking. 

Q.8. A key concern that must be addressed is ensuring that the 

capital requirements for Fannie and Freddie do not create incentives for banks to excessively transfer risk to the GSEs, like they 

did before the crisis when banks were charged a 4 percent capital 

requirement for holding a portfolio of mortgage loans, but only 1.6 

99 

percent if they held GSE MBS instead. Do you believe that the proposed rules appropriately address that concern, and if so, how? 

What analysis have you done to make that determination? 

A.8. In developing the proposals, the Federal banking agencies 

sought to establish capital requirements and risk weights for exposures in order to ensure that banking organizations hold capital 

commensurate with the risk of their exposures. Thus, under the 

proposed framework, residential mortgages are assigned to riskweight categories based on the relative risk of the exposures as 

measured by product type and underwriting criteria. Similarly, in 

determining the 20-percent risk weight for an exposure to a GSE, 

the Federal banking agencies have considered the potential risk associated with such exposures that would be borne by a banking organization holding the exposure. Further, the proposed rules would 

not affect the capital requirements faced by GSEs, such as Fannie 

Mae and Freddie Mac. Any changes to the capital requirements for 

GSEs, including those that reduce any perceived advantages at the 

expense of private sector entities, would be determined by the 

FHFA and are outside the scope of this rulemaking. 

Q.9. Mr. Gibson, does the Federal Reserve have in-house capacity 

to conduct an adequate Quantitative Impact Study (QIS) for the 

U.S. financial institutions, including holding companies, based on 

their size and asset class? 

A.9. The Federal Reserve has the capacity to conduct QIS exercises 

and previously has conducted impact analyses of banks and bank 

holding companies of varying sizes. For example, on an annual 

basis, the Federal Reserve analyzes data from the 19 large bank 

holding companies that have participated in the Federal Reserve’s 

Comprehensive Capital Analysis and Review exercises, particularly 

with regard to those bank holding companies’ ability to maintain 

adequate capital under stressed conditions and meet future capital 

requirements. These entities generally are on a transition path to 

meet the proposed capital requirements. Further, as described 

more fully below, we performed a domestic analysis of the impact 

of the proposals on banks and bank holding companies of varying 

sizes in June 2012. 

Q.10. In your prepared remarks, you stated that ‘‘staff from the 

interagency group used both qualitative measures (such as discussions with banks) as well as quantitative measures (such as QIS 

data) to create the assumptions used to estimate capital as proposed.’’ Is the QIS that you refer to a domestic study conducted by 

the Federal Reserve or the global study done by the Basel Committee? If it is a global study, why did the Federal Reserve rely on 

a global study? 

A.10. The analysis I referred to in my prepared remarks is a domestic analysis that was conducted by Federal Reserve staff in 

June, 2012. In particular, staff considered the potential impact of 

the proposed requirements on banking organizations using regulatory reporting data, supplemented by certain assumptions where 

data needed to calculate the capital requirements was not reported. 

The results of the study, as well as related assumptions, and descriptions of methodologies used for the analyses were made available to the public as part of my November 14, 2012, testimony beVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00103 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
100 

fore the Committee on Banking, Housing, and Urban Affairs. These 

documents are available at: http://www.federalreserve.gov/ 

newsevents/testimony/gibson20121114a.htm. 

Q.11. The data for the global QIS done by the Basel Committee 

was collected as of December 31, 2009, almost 3 years ago. Would 

the results of that QIS differ if the same data were collected now? 

If so, how? 

A.11. The Basel Committee publishes regular updates to the QIS 

as it tracks how global banks are affected by their implementation 

of the changes proposed by Basel III. Based on QIS data as of December 31, 2011, banks globally are in a stronger capital position 

than in 2009 and are closer to meeting the Basel III standards. We 

anticipate that future updates to the QIS using current data will 

show additional strengthening as banks continue their efforts to 

meet the fully phased-in Basel III standards. 

Q.12. In response to a question on Basel that I asked Chairman 

Bernanke after a hearing in 2010, he stated that the Federal Reserve began conducting QIS in February 2010 and ‘‘has contributed 

data from the domestic QIS on a confidential basis to the global 

QIS.’’ What were the results of the domestic QIS? Are you prepared 

to make those results publicly available? From how many banks 

did you collect data? How many small and community banks contributed data to that study? 

A.12. Your letter specifically references the quantitative impact 

study (QIS) that the agencies participated in with other members 

of the Basel Committee on Banking Supervision (BCBS), and requests the specific U.S. findings. Although the BCBS found that, 

based on the QIS, the proposed changes would require surveyed 

banking organizations to hold more regulatory capital to meet the 

proposed minimum requirements, the agencies are unable to provide the specific survey information submitted by U.S. institutions 

as it was collected on a confidential basis, conditioned on the assurance that it would only be distributed anonymously to the BCBS 

for purposes of the QIS. The domestic QIS did not include data 

from small and community banks. 

Q.13. Traditionally, insurance companies have been regulated at 

the State level. The proposed Basel III rules, however, will apply 

to thrift holding companies that own insurers. In devising the capital requirements for financial holding companies that own insurance businesses, how much did the Federal Reserve rely on State 

insurance capital requirements? If significantly, please explain the 

collaborative process that the Federal Reserve engaged in with 

State insurance commissioners. If not significantly, please explain 

why not and whether the Federal Reserve believes that capital levels for insurance enterprises as currently required by State regulators are insufficient? 

A.13. Board staff met with industry representatives and the National Association of Insurance Commissioners (NAIC) on several 

occasions to discuss insurance-related issues, including those relating to the proposed regulatory capital framework. Board staff also 

consulted with the Federal Insurance Office in the context of capital requirements and stress testing. 

101 

As explained in the proposed rulemaking, the capital requirements would be consistent with section 171 of the Dodd-Frank Wall 

Street Reform and Consumer Protection Act (Dodd-Frank Act), 

which requires the Board to establish consolidated minimum capital requirements for depository institution holding companies 

(bank holding companies and savings and loan holding companies) 

that are no less than the generally applicable capital requirements 

that apply to insured depository institutions. The proposals would 

apply consolidated risk-based capital requirements that measure 

the credit risk of all assets owned by a depository institution holding company and its subsidiaries, including assets held by insurance companies. Currently, capital requirements for insurance companies are imposed by State insurance laws on a legal entity basis 

and there are no State-based, consolidated capital requirements 

that cover subsidiaries and noninsurance affiliates of insurance 

companies. As such, the proposed consolidated capital requirements 

do not rely directly on the State-based regulatory capital requirements. However, the proposal would require depository institution 

holding companies to consolidate and deduct the minimum regulatory capital requirement of insurance underwriting subsidiaries 

from total capital to reflect the capital needed to cover insurance 

risks. The proposed deduction treatment recognizes that capital requirements imposed by the functional regulator to cover the various risks that insurance risk-based capital captures reflect capital 

needs a the particular subsidiary and that this capital is therefore 

not generally available to absorb the losses in other parts of the organization. 

The Board continues to consider the comments received on the 

proposed Basel III framework, including those focused on insurance 

activities of depository institution holding companies, as it works 

with the other Federal banking agencies through the rulemaking 

process. 

Q.14. The Federal Reserve and the National Association of Insurance Commissions (NAIC) joined efforts in 2002 to study the adequacy of capital requirements for banks and insurance companies. 

In a joint working paper, the Federal Reserve and NAIC concluded 

that ‘‘the effective regulatory capital requirements for assets, liabilities, and various business risks for insurers are not the same as 

those for banks . . . [and] effective capital charges cannot be harmonized simply by changing the nominal capital charges on individual assets.’’ Does the Federal Reserve still agree with the conclusion of the 2002 study? How does the Federal Reserve tailor or 

otherwise recognize in the proposed rules the differences in business models, funding characteristics and general risk profile between banks and insurance companies with respect to capital requirements? 

A.14. In 2002, the National Association of Insurance Commissioners (NAIC) and the Federal Reserve System Joint Subgroup on 

Risk-Based Capital and Regulatory Arbitrage prepared a report 

that explored the similarities and differences between risk-based 

capital frameworks of the insurance sector and the banking sector. 

The report noted that the two frameworks differ fundamentally in 

the treatment and assignment of certain risks and that the effecVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00105 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
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tive capital charges cannot be harmonized simply by changing the 

nominal capital charges on individual assets. 

In June 2012, the Board proposed to revise the regulatory capital 

requirements and to apply consolidated regulatory capital minimums to savings and loan holding companies. In developing the 

proposed capital rules, the Board sought to meet legal requirements and policy objectives while including flexibility for depository 

institution holding companies that are primarily engaged in the insurance business. As explained in the response to Question 5 

above, the proposed rules are consistent with the requirements of 

section 171 of the Dodd-Frank Act. The proposed rules are also consistent with the Board’s long-standing practice of applying consolidated capital requirements to bank holding companies, including 

those that include functionally regulated subsidiary insurance companies. This approach helps to eliminate regulatory capital arbitrage opportunities when a company has an incentive to book its 

risky exposures in legal entities in which the exposures would receive a more favorable regulatory capital treatment. 

In developing the proposal, the Board also considered assets typically held by insurance companies but not depository institutions 

and accordingly tailored the proposed capital requirements with respect to certain insurance-related assets. The proposals would 

apply specific risk weights for policy loans and nonguaranteed separate accounts, which are typically held by insurance companies 

but not banks. These risk weights were developed after a careful 

review of the characteristics of these assets. 

The Board has received numerous comments from the public on 

the proposals with respect to depository institution holding companies that have significant insurance activities and will carefully 

consider all of the comments raised over the course of the rulemaking. 

Q.15. The Senate Banking Committee Report on the Dodd-Frank 

Wall Street Reform and Consumer Protection Act made it clear 

that the law did not mandate insurers use GAAP accounting. However, the proposed rules would require insurance enterprises to 

switch to GAAP. What analysis has the Federal Reserve conducted 

to justify such change? How will this mandated change in accounting provide more useful information about the financial health of 

insurance companies? How will this change impact insurance companies, both practically and financially? 

A.15. As noted above, section 171 of the Dodd-Frank Act requires 

that the Board establish minimum consolidated risk-based and leverage capital requirements for savings and loan holding companies that are not less than the ‘‘generally applicable’’ risk-based 

and leverage capital requirements for insured depository institutions. The ‘‘generally applicable’’ capital requirements for insured 

depository institutions are calculated and reported based on U.S. 

generally accepted accounting principles (GAAP). This is consistent 

with section 37 of the Federal Deposit Insurance Act, which requires that accounting principles applicable to reports or statements that insured depository institutions file with their Federal 

regulators be ‘‘uniform and consistent’’ with GAAP. If an alterVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00106 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
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native accounting standard is required by the Federal regulator, it 

must be ‘‘no less stringent’’ than GAAP. 

The proposed requirement that savings and loan holding companies calculate their capital standards on a consolidated basis using 

a framework that is based on GAAP standards is consistent with 

section 171 of the Dodd-Frank Act and would facilitate comparability across institutions. In contrast, the statutory accounting 

principles (SAP) framework for insurance companies is a legal entity-based framework and does not provide a consolidated basis for 

applying regulatory capital requirements. 

In developing the proposals, the Board took into account the public comments received in response to a notice of intent (published 

on April 22, 2011) regarding the application of the regulatory capital requirements to savings and loan holding companies. Board 

staff also met with a number of industry representatives to discuss 

challenges associated with applying consolidated capital requirements to savings and loan holding companies, including those challenges related to GAAP. 

Following the publication of the proposals, the Board received additional comments on the application of the consolidated capital requirements for savings and loan holding companies, including on 

cost and burden considerations for those firms that currently prepare financial statements based solely on SAP. The Board is carefully evaluating these concerns and will consider all the comments 

received as part of the rulemaking process. 

Q.16. Under the proposals, mortgages will be assigned to two risk 

categories and several subcategories, but the agencies did not explain how risk weights for those subcategories are determined and 

why they are appropriate. How did the Federal Reserve determine 

the appropriate range for those subcategories? Will the Federal Reserve release the underlying research and analysis to the public? 

A.16. The proposed modified mortgage treatment is designed to 

better differentiate and align the risks of these exposures with the 

appropriate category. The mortgage categories were largely informed by the historical loss-rate data of various residential mortgage products during the crisis. The proposed treatment is, therefore, designed to more accurately reflect the risk characteristics of 

a loan. For instance a fixed-rate, first-lien mortgage that exhibits 

low risk because it has a low loan-to-value ratio and has product 

characteristics that qualify it as a category 1 residential mortgage 

exposure is eligible for a preferential risk weight. Mortgages with 

a riskier credit profile based on product type or loan-to-value ratio 

would be assigned a higher risk weight. 

When developing the proposed requirements, the agencies considered their various potential effects on the business activities of 

community banking organizations. The Board is evaluating comments from the industry that provide further clarity on potential 

burdens and unintended consequences of the proposed requirements and will consider the concerns raised in these comments as 

it works with the other Federal banking agencies through the rulemaking process. 

Q.17. How does the Federal Reserve plan to integrate its capital 

planning requirements for the CCAR process with the Basel III 

104 

proposals now that the effective date of the Basel III final rule has 

been delayed? 

A.17. As indicated in the Board’s rule regarding capital plans, the 

Federal Reserve requires a U.S.-domiciled, top-tier bank holding 

company with total consolidated assets of $50 billion (large bank 

holding companies) or more to submit a capital plan on an annual 

basis. In connection with the Board’s capital plan rule (12 CFR 

225.8), 19 of the largest bank holding companies are required to 

participate in the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR). CCAR involves a detailed assessment of 

a bank holding company’s capital plan. The capital plan must include projections of a bank holding company’s pro forma capital levels over a nine-quarter forward-looking planning horizon under 

both expected and stressful conditions. Furthermore, in the capital 

plan, the bank holding company must demonstrate an ability to 

maintain its regulatory capital ratios and at least a 5 percent tier 

1 common ratio under both expected and stressful conditions. 

Currently, the capital plan rule defines regulatory capital ratios 

as any minimum regulatory capital ratio that the Federal Reserve 

may require of a large bank holding company, by regulation or 

order, including the bank holding company’s leverage ratio and tier 

1 and total risk-based capital ratios as calculated under 12 CFR 

part 225, Appendices A, D, E, and G, or any successor regulation. 

In the future, the Board may propose to modify the existing minimum regulatory capital requirements. In particular, if the Basel 

III proposals are finalized, the minimum regulatory ratios under 

the capital plan rule would include any revised risk-based capital 

and leverage ratio, including the common equity tier 1 ratio, which, 

if finalized, would replace the existing tier 1 common requirement. 

Finally, consistent with prior CCAR exercises, the Federal Reserve 

will continue to assess bank holding companies’ strategies for addressing the proposed Basel III revisions to the regulatory capital 

framework. 

RESPONSES TO WRITTEN QUESTIONS OF 

SENATOR MENENDEZ FROM MICHAEL S. GIBSON 

Q.1. A fundamental objective of Dodd-Frank was to reduce systemic risk. I am concerned that the Fed’s Basel III proposal could 

result in bank clearing members having to hold significantly more 

capital when their customers use less-risky instruments. Some 

argue that this incentive will make it more expensive to use exchange-traded futures than bespoke swaps. Should the rule be designed to encourage the use of lower risk profile products, rather 

than potentially discourage it? 

A.1. The Basel III proposals were designed to incentivize the use 

of lower risk profile products by assigning a lower risk weight to 

centrally cleared derivatives relative to the risk weight assigned to 

over-the-counter (OTC) derivatives, which are generally considered 

less transparent and frequently more complex. While the proposed 

treatment under the proposals is a departure from the zero percent 

risk weight assigned to exchange-traded derivatives or futures 

under the Board’s current rules, the proposed risk weight of generally 2 percent for qualifying cleared transactions is not signifiVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00108 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
105 

cantly higher than the current treatment and is substantially lower 

than risk weights that would be applied to OTC derivative transactions. Furthermore, the risk weighting of OTC derivatives is 

structured so that riskier asset classes, as well as products with 

longer-dated tenors, receive a higher risk weight than those asset 

classes that are less risky and shorter-dated. 

Q.2. With the proposed use of Loan-to-Value (LTV) ratios on home 

mortgages in Basel III, community banks would be required to 

recordkeep (or keep records of) the LTVs of future and existing 

mortgages. Some have argued that going back through their existing portfolios and determining each individual loan’s LTV at origination would be burdensome and costly. Have you considered applying this standard prospectively for smaller banks and what 

thoughts have gone into that? 

A.2. The Federal banking agencies sought comment on the proposed treatment of residential mortgage exposures, including on 

the use of loan-to-value amounts in order to assign risk-based capital requirements to these exposures. In response, many commenters stated that it would be difficult for banking organizations, 

especially community banking organizations, to determine and 

track the required data on existing loan portfolios. Some commenters proposed alternatives that would reduce implementation 

burden, such as allowing existing mortgages to remain subject to 

the current risk-based capital requirements or phasing in the new 

requirements over time for existing portfolios. The Federal Reserve 

will take the commenters’ concerns and alternatives into consideration as it works with the other Federal banking agencies to finalize the proposal. 

Q.3. Elizabeth Duke recently said that in her discussions with community bankers, more of them report that they are reducing or 

eliminating their mortgage lending due to regulatory burdens than 

are expanding their mortgage business. In fact, she says that even 

if the specific issues in capital proposals can be addressed, the 

lending regulations might still ‘‘seriously impair’’ the ability of community banks to offer traditional mortgages. How or what are you 

going to do to ensure that the fragile housing market does not take 

another hit as it relates to capital requirements and Basel implementation? 

A.3. In developing the proposals, the Federal banking agencies 

sought to better differentiate risks of mortgage exposures and ensure that banking organizations, regardless of size, hold capital 

commensurate with the risk of these exposures. As proposed, mortgage exposures with greater risks based on product characteristics 

and loan-to-value ratios would be subject to higher capital requirements. 

In the proposals, the Federal banking agencies also sought to 

promote financial stability while avoiding undue burden on the 

economy as well as unintended consequences. The Federal Reserve 

recognizes the vital role that community banking organizations 

play in the U.S. mortgage market. The Federal Reserve is carefully 

reviewing comments from the public on the proposed risk weights 

for mortgages, including those from community banking organizations and will be mindful of the concerns raised in these comments 

106 

as it works with the other Federal banking agencies in moving forward on the proposed capital rules. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER 

FROM MICHAEL S. GIBSON 

Q.1. I, and many other Members, have brought up concerns about 

the need to tailor rules to the size and type of entity. However, I 

recognize the U.S.’s leadership role on the Basel Committee, and 

the need to move through this period of regulatory uncertainty so 

that businesses can make investment decisions. How can the Committee provide regulated entities more certainty about the timeline 

of rules being reproposed or finalized in the future? 

A.1. The Basel Committee on Banking Supervision provides a 

forum for regular cooperation on banking supervisory matters and 

promotes improvements in bank capital adequacy and risk management practices, in part, through the adoption of international 

standards that member countries then may implement through domestic regulation. Therefore, the Basel Committee itself is not in 

a position to provide certainty about the timeline regarding the 

U.S. domestic rulemaking process. The Federal Reserve, along with 

the other Federal banking agencies, is currently reviewing the 

thousands of comment letters received on the notices of proposed 

rulemaking that would revise the U.S. regulatory capital framework. The Federal Reserve is mindful of the concerns regarding uncertainty for banking organizations and is working with the other 

Federal banking agencies to finalize the proposals as expeditiously 

as possible after considering the public comments. 

Q.2. I’ve heard concerns that the proposed rules require unrealized 

gains and losses on available for sale assets to be recognized within 

AOCI. Insurers that are Savings & Loan Holding Companies are 

especially apprehensive about managing increased asset-liability 

mismatches. Can you discuss your broader goals to encourage a 

long-term focus in capital management, and address these AOCI 

concerns? 

A.2. The recent financial crisis revealed that the amount of highquality capital held by banking organizations in the United States 

was insufficient to absorb losses during periods of severe stress. 

The effects of having insufficient levels of capital were further magnified by the fact that certain regulatory capital instruments did 

not absorb losses to the extent previously expected. The June 2012 

proposal to amend the U.S. banking agencies’ regulatory capital 

framework applies the lessons of the crisis, in part, by increasing 

the quantity and quality of capital held by banking organizations. 

In addition, the proposed application of consolidated capital requirements to savings and loan holding companies is consistent 

with section 171 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which requires the Board 

to establish consolidated minimum capital requirements for depository institution holding companies (bank holding companies and 

savings and loan holding companies) that are no less than the generally applicable capital requirements that apply to insured depository institutions. The proposal is also consistent with the Board’s 

107 

long-standing practice of applying consolidated minimum capital 

requirements to bank holding companies, including those that control functionally regulated subsidiary insurance companies. 

The proposed treatment of AOCI, which would require unrealized 

gains and losses on available-for-sale securities to flow through to 

regulatory capital, would better reflect an institution’s actual lossabsorption capacity. Commenters on the proposal have expressed 

concern that this treatment would introduce capital volatility, due 

not only to credit risk but also to interest rate risk, and would affect the composition of firms’ securities holdings. In particular, depository institution holding companies with insurance activities 

have asserted that the proposal does not appropriately recognize 

the longer-term nature of their liabilities and their practice of 

matching asset and liability maturities. They also assert that the 

proposal would disproportionately affect longer term assets held by 

many insurance companies, thus causing them to fundamentally 

alter their business strategy. The Federal Reserve is evaluating 

these and all of the comments received and will consider them 

carefully as it works with the other Federal banking agencies to determine how to treat AOCI in regulatory capital. 

Q.3. We’ve seen some recent sales of MSRs from banks to 

nonbanks since the proposal was released saying that MSRs may 

only be counted for up to 10 percent of CET1, and additional MSR 

holdings will be weighted at 250 percent. This is a significant 

change from allowing MSRs to be counted up to the equivalent of 

100 percent of Tier 1 capital. The MSRs change comes in combination with more sophisticated risk-weights for mortgages that will 

require more capital for nonstandard and high LTV mortgages. We 

also have QM and QRM on the way, which will have distinct definitions from Basel rules. I am supportive of a more nuanced approach to holding capital for mortgages, but is the panel concerned 

that the limited overlap in these regulations could cause much 

greater compliance difficulty for small institutions and negatively 

affect access to credit among low-to-middle income borrowers? 

A.3. In developing the proposed treatment for mortgage servicing 

assets, the Federal banking agencies considered the specific characteristics and risks of these assets and the potential safety and 

soundness benefits that could result from their proposed treatment. 

The Federal banking agencies requested comments and supporting 

data on the proposed treatment for MSRs. Likewise, in developing 

the proposed risk weights for mortgage exposures, the agencies 

were mindful of the proposed standards for the QM and QRM and 

have requested comment from the public on all aspects of the proposed changes to the regulatory capital framework. Moreover, the 

agencies specifically requested comment on whether mortgages 

that meet the QM definition (which had not yet been finalized at 

the time of the proposal) should be included in category 1 residential mortgage exposures. 

During the comment period, the Federal Reserve and the other 

banking agencies also participated in various outreach efforts, such 

as engaging community banking organizations and trade associations, among others, to better understand industry participants’ 

concerns about the proposals and to gather information on their poVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00111 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
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1See, BCBS, ‘‘Treatment of Trade Finance Under the Basel Capital Framework’’, (October 

2011), available at http://www.bis.org/publ/bcbs205.pdf. 2See, i.d. 

tential effects, including with respect to MSRs and the proposed 

risk weighting of mortgages. These efforts have provided valuable 

additional information. The Federal Reserve will carefully consider 

all comments on the proposals in determining, along with the other 

Federal banking agencies, how to move forward with the rulemaking. 

Q.4. Trade finance transactions rely on letters of credit and other 

off-balance sheet items, and lenders will have to set aside 100 percent capital for these items if current proposals are implemented. 

This transition requires 5 times more capital compared to Basel II. 

Do you believe that these changes are likely to affect smaller companies and emerging countries to a much greater extent? Can you 

respond to concerns that these proposals, as they are written, could 

constrict trade finance opportunities? 

A.4. In 2011, the Basel Committee on Banking Supervision (BCBS) 

revised the Basel framework regarding trade finance transactions. 1

The BCBS revised the standardized approach to remove the sovereign floor, permitting a 20-percent risk-weighting for short-term 

exposure to banks in lower-income countries. The advanced approach was revised to remove the 1-year maturity floor for trade 

finance instruments. The U.S. banking agencies’ Basel III NPR is 

consistent with these revisions, which would likely result in reduced capital requirements for trade finance transactions that meet 

certain conditions. 

In addition, trade finance exposures would impact the calculation 

of the proposed ‘‘Basel III’’ supplementary leverage ratio. 2 The 

Basel III proposals would require companies that use the advanced 

approaches rules to calculate their capital requirements to maintain a minimum supplementary leverage ratio of 3 percent of total 

assets. This ratio’s denominator calculation requires inclusion of 

the notional amount (effectively a 100 percent credit conversion factor) of trade finance exposures the banking organization cannot unconditionally cancel. For trade finance commitments that are unconditionally cancellable by the banking organization, they would 

be included in the denominator calculation at 10 percent of the notional amount. 

As a general matter, the Basel Committee has indicated that it 

will continue to assess the supplementary leverage ratio, including 

through supervisory monitoring during a parallel run period in 

which the proposed design and calibration of the Basel III leverage 

ratio will be evaluated. A final decision by the Committee on the 

measure of exposure for certain transactions and calibration of the 

leverage ratio is not expected until closer to 2018. Further, the 

agencies have requested specific comment on the supplementary leverage ratio and are evaluating these comments, including those 

relating to trade finance. 

109 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR WICKER 

FROM MICHAEL S. GIBSON 

Q.1. In comment letters to Federal regulators, the Conference of 

State Banking Supervisors raised concerns regarding the complexity of the approach proposed by Federal banking agencies for 

implementing the Basel III capital accords. How has this input influenced your approach to the rulemaking process? 

A.1. The Board is mindful of potential burdens that may arise from 

the proposed requirements. To this end, the agencies sought specific comment in the proposal regarding potential burden as well as 

alternatives to decrease the burden of the proposal’s requirements, 

while still addressing safety and soundness concerns. Board staff is 

carefully considering all comments received on the proposal, including those provided by the Conference of State Banking Supervisors. 

Q.2. In applying Basel III to community banks, did the regulators 

consider that most privately held community banks have fewer options for sources of capital than large banks, making it especially 

challenging for them to raise additional capital in the current economic climate, and that the Basel III proposal could disproportionately impact such community banks? 

A.2. Before issuing the proposal, the agencies evaluated the potential impact of the proposed requirements on banking organizations 

by size and asset class, and determined that the vast majority of 

banking organizations, including community banks, already would 

meet the proposed minimum requirements on a fully phased-in 

basis and would also have capital sufficient to exceed the proposed 

capital buffer threshold. With respect to those banking organizations that would not meet the requirements, including community 

banks with more limited capital-raising capabilities, the proposal 

includes lengthy transition periods. During the transition period, 

banking organizations can accrete capital through the retention of 

earnings, as well as adjust to other elements of the proposal. The 

agencies have also developed a capital estimation tool to help companies, particularly community banking organizations, gain a further understanding of the possible impact of the proposals. The 

Board is carefully considering all the comments received on the 

proposed changes, including comments that address how to address 

burdens on community banks. 

Q.3. Will the implementation of the proposed Standardized Approach and the mandate that mortgage loan-to-values (LTVs) be 

tracked require many of the Nation’s smaller banks to make costly 

software upgrades? If so, have you considered the cost impact of 

such a requirement on community banks? 

A.3. In developing the standardized approach proposal, the Federal 

banking agencies generally sought to balance increased risk sensitivity with the potential regulatory and compliance burden on 

banking organizations. The Board is sensitive to concerns expressed by commenters that the requirement to track loan-to-value 

ratio information as part of the framework to assign risk weights 

to mortgage exposures would represent additional burden for banking organizations, especially smaller banking organizations that 

may need to upgrade their data systems. As it works to finalize the 

110 

proposal with the other agencies, the Board will be taking into account these comments as well as proposed alternatives to reduce 

the burden of implementation on banking organizations under the 

proposed framework. 

Q.4. Did the regulators consider the effect on the economy and consumers if community banks reduce mortgage lending significantly 

due to Basel III? 

A.4. The agencies have considered the costs and benefits of the various proposed treatments of the Basel proposals, specifically seeking to balance the need to promote financial stability while minimizing the impact on economic growth and credit availability. The 

agencies also included several specific questions in the proposal regarding the mortgage treatment. The Board is sensitive to concerns 

that higher risk weights and increased compliance cost may lead 

to more expensive mortgages and reduce access to credit and will 

carefully consider community bankers’ as well as all other comments on the proposal as it works with the other Federal banking 

agencies on the rulemaking. 

Q.5. Please explain whether or not the proposed higher capital requirements for past due loans are a form of ‘‘double accounting,’’ 

given that banks already are supposed to reserve for these losses. 

A.5. The proposed 150 percent risk weight for past-due loans reflects the increased risk of loss associated with an exposure that is 

90 days or more past due or on nonaccrual status. By contrast, the 

allowance for loan and lease losses (ALLL) addresses losses that 

have been incurred, which is defined under U.S. GAAP as probable 

of occurring (based on historical loss statistics). Thus, the 150 percent risk weight for past-due loans complements rather than duplicates the ALLL. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM JOHN C. LYONS 

Q.1. Is the U.S. banking system currently adequately capitalized? 

Please list any studies or data you relied upon to make this determination. 

A.1. Generally speaking, national banks and Federal thrifts of all 

sizes are better capitalized today than they were prior to the crisis. 

The Call Report data below show national bank and Federal thrift 

capital ratios before the crisis and the ratios in the middle of 2012. 

111 

Q.2. If the proposed Basel III rules were implemented, would your 

agency consider the U.S. banking system to be adequately capitalized? Please explain how you made that determination and what 

studies and data you relied upon. 

A.2. While capital positions have improved based on current capital 

metrics, the proposed changes to our capital standards should help 

to cement these improved capital positions and ensure that banks 

are in a better position to deal with future financial market turbulence. In addition, the proposed changes are intended to provide a 

better metric by which to measure each bank’s capital position as 

they should enhance the risk sensitivity of the existing capital 

framework. 

Q.3. At an FDIC meeting in July, FDIC Director Thomas Hoenig 

stated that ‘‘as proposed, the minimum capital ratios will not significantly enhance financial stability.’’ Bank of England Governor 

Mervyn King and several prominent economists have said that 

Basel III capital standards are insufficient to prevent another crisis. Do you disagree with these assertions? If so, why? 

A.3. We believe that the proposed enhancements to our capital 

standards will help to strengthen the banking system’s resiliency 

and will enhance financial stability through higher levels and quality of capital and through improved risk sensitivity. Banking crises 

have occurred for as long as there have been banks, and we do not, 

therefore, believe that the proposed standards would necessarily 

succeed in preventing another crisis. However, we expect that 

banks would be better positioned to navigate any future crisis 

under the proposed rules than under the current rules. 

Q.4. Given the cost and complexity of Basel III, do you have any 

concerns that Basel III will further tilt the competitive landscape 

in favor of big banks to the detriment of small banks? Have you 

112 

studied the impact of Basel III on small institutions as compared 

to their larger counterparts? 

A.4. We do not anticipate that small banks will be disadvantaged 

under the proposed rules relative to large banks for a number of 

reasons. First, large banks will be subject to essentially two capital 

regimes under section 171 of the Dodd-Frank Act. Under this provision, the largest banks are required to not only comply with the 

capital standards that have been developed specifically for large, 

internationally active banks, but they are also required to comply 

with the standards that are ‘‘generally applicable’’, i.e., those that 

are applied to smaller institutions. In addition, there are several 

aspects of the proposals that would apply only to the largest banks. 

For example, smaller banks can ignore the advanced approaches 

NPR in its entirety, which contains changes from Basel III that 

only apply to the largest U.S. banks. In addition, the countercyclical buffer, which is meant to make banks hold more capital 

during periods of excessive credit growth, is a Basel III provision 

that would apply only to the largest banks. Similarly, enhanced 

disclosures would apply only to banks with total consolidated assets of $50 billion or more. While not included as part of this set 

of proposals, the largest banks will also have to hold an additional 

cushion of capital under the Global Systemically Important Bank 

(G–SIB) surcharge, which could be up to 3.5 percent of additional 

common equity. 

To measure the potential impact of the proposals, the OCC conducted burden and cost estimates for all OCC-supervised banks 

consistent with the Unfunded Mandates Reform Act and for OCCsupervised small banks pursuant to the Regulatory Flexibility Act. 

Our analysis showed that the majority of banks, including community banks, will meet the new higher capital requirements without 

raising additional capital. For those banks that might need to raise 

additional capital, the proposals include a number of transition provisions to ease the burden. However, for a substantial number of 

the smallest banks (i.e., those with assets of $175 million or less), 

our initial analysis determined that the compliance costs likely 

could be significant. These costs include additional recordkeeping 

and systems costs associated with implementing the alternatives to 

credit ratings. 

The Comptroller has stated publicly that he is aware of the concerns of community bankers and is very interested in looking at 

ways to reduce the potential burden on small banks without compromising the OCC’s goal of raising the quantity and quality of 

capital and setting minimum standards that require more capital 

for more risk. To help facilitate community bank comments, the 

Federal banking agencies provided an estimator tool so that community bankers could give us more specific empirical data on the 

potential impact of the proposals. The agencies will consider any 

such empirical analysis that community banks provide. 

For any final rule, the OCC will complete final assessments 

under both the Unfunded Mandates Reform Act and the Regulatory 

Flexibility Act. Also, for any final rule, the OCC will determine 

whether the rule is a ‘‘major rule’’ for purposes of the Congressional Review Act (e.g., whether it will have an annual effect on 

the economy of $100 million or more). 

113 

Q.5. Recently, the agencies announced that they are pushing back 

the effective date of the proposed Basel III rules beyond January 

1, 2013. This affords the agencies more time to carefully review 

comment letters, engage in additional outreach and collect additional data. Will the agencies use this extra time to conduct an 

analysis about the impact of the proposed rules on the U.S. economy and a quantitative impact study that covers all banks, regardless of size, before implementing the final rules? 

A.5. The OCC is required to complete a final assessment of the rule 

under the Regulatory Flexibility Act, and we plan to complete an 

assessment under the Unfunded Mandates Reform Act. We will 

take into account any comments received on the costs and benefits 

of the NPRs in fulfilling these statutory mandates. Additionally, at 

the final rule stage, the OCC will prepare an analysis under the 

Congressional Review Act. As part of this analysis we will assess 

whether the final rule is a ‘‘major rule,’’ meaning the rule could (1) 

effect the economy by $100 million or more; (2) increase significantly costs or prices for consumers, individual industries, Federal, 

State, or local government agencies, or geographic regions; or (3) 

have significant adverse effects on competition, employment, investment, productivity, or innovation. The analysis will be provided 

to the Congress and the Government Accountability Office (GAO). 

Q.6. What is the estimated impact of the Basel III rules, if finalized as proposed, on: 

a. The U.S. GDP growth? 

b. The probability of bank failure? 

c. Availability and cost of mortgages, auto loans, student loans 

and small business credit? 

d. The compliance costs for small, medium, and large banks? 

e. The cost of insurance for consumers? 

Please provide data to support your conclusions. 

A.6. If finalized as proposed, we estimate that the overall cost of the proposed capital rules would be approximately $145.1 million. 

This estimate reflects one-time systems costs of approximately 

$46.5 million and ongoing capital costs of $98.6 million per year 

once banks fully implement the new rule. The overall estimate reflects the cost of capital some banks would need to raise to meet 

the new minimum capital standards, compliance costs associated 

with establishing the infrastructure to determine correct risk 

weights using the new alternative measures of creditworthiness, 

and compliance costs associated with new disclosure requirements. 

The vast majority of banks in the United States already hold 

capital that would satisfy even the highest new capital standard 

set to take effect on January 1, 2019. Table 1 shows our estimates 

of the cumulative number of OCC-regulated banking organizations 

that would fall short of the new minimum capital standards if the 

banks took no action and held their capital at December 31, 2011, 

levels. We estimate that those 195 institutions would have to raise 

approximately $84 billion in new capital, which is approximately 

nine percent of the amount of capital currently held by OCC-regulated banking organizations. Because most banks in the United 

States already meet the new Basel III capital standards and those 

114 

1See, for instance, Arturo Estrella, Sangkyun Park, and Stavros Perlstlanl, ‘‘Capital Ratios 

as Predictors of Bank Failure’’, Economic Policy Review, Federal Reserve Bank of New York, 

July 2000, pp. 33–52. 

institutions that do need to raise capital have 6 years in which to 

do it, we estimate that the proposed rule will not affect U.S. GDP 

growth. Most of the dampening effect on GDP growth that can 

occur when banks reduce lending to increase capital would have occurred in the past when banks increased their capital levels in response to the financial crisis. 

While higher capital levels reduce the probability of bank failure, 1 we did not estimate how Basel III rules will affect these probabilities. The probability of bank failure will vary from bank to 

bank and will depend on capital and a variety of other factors, best 

summarized in regulatory CAMELS ratings. These CAMELS factors include capital adequacy, asset quality, management quality, 

earnings, liquidity, and sensitivity to market risk. 

Because the proposed rules would change the risk weights for 

residential mortgages, we do expect the increased risk sensitivity 

could have some effect on the cost and availability of residential 

mortgages. Indeed, one of the objectives of the proposed rule is to 

use variations in risk weights to differentiate between high-risk 

and low-risk mortgages, securitizations, and sovereign debt. In particular, for residential mortgages with a lower risk weight under 

the proposed rule, namely category one mortgages with loan-tovalue ratios less than or equal to 60 percent, costs may decrease 

and availability may increase. For residential mortgages with higher risk weights under the proposed rules, for example, mortgages 

with loan-to-value ratios greater than 90 percent, we expect that 

costs may increase and availability decrease. There are, however, 

a large number of factors beyond risk weights that affect the cost 

and availability of mortgages and other loans. The interaction of 

these factors along with possible changes in bank behavior towards 

risk makes it difficult to arrive at an accurate estimate of the proposed rules’ impact on mortgage cost and availability. The risk 

weights for auto loans, student loans, and small business loans do 

not change under the proposed rules. 

Table 2 shows our estimates of compliance costs associated with 

determining new risk weights under the proposed rule. As shown 

in Table 2, we estimate compliance costs of approximately $36,000 

per institution for small- and medium-sized banks. For large banks, 

we estimate compliance costs of approximately $111,000 per institution. We did not attempt to estimate the cost of insurance for 

consumers. 

115 

Q.7. Our housing market is currently entirely dependent on taxpayer-funded Government support through FHA and the GSEs. 

The Administration, however, has yet to prepare a housing finance 

reform plan. As a result, the future of the GSEs is still undetermined. One issue that will have to be addressed in housing finance 

reform is ensuring that the Basel rules are properly coordinated 

with the capital requirements for the GSEs in order to avoid creating any adverse incentives. Prior to the crisis, Fannie and 

Freddie had much lower capital requirements than did comparable 

banking institutions. According to one study, from 1992 through 

2007 the GSE leverage ratios were between 20 and 40 (50 and 100 

if MBS credit guarantees are included) whereas commercial banking sector had ratios between 10 and 15. With an implicit Government guarantee, Fannie and Freddie were able to borrow at artificially low interest rates, making it quite profitable for the GSEs to 

purchase mortgages and offer credit default guarantees below market rates. As a result, Fannie and Freddie grew to become institutions that threatened the financial stability of the U.S. economy. In 

devising the proposed Basel capital rules, did your agency consider 

how the rules would interact with the capital requirements of any 

GSE? If yes, please explain whether any changes were made to the 

rules to protect against adverse consequences you identified. 

116 

A.7. In developing our proposed capital standards, we focused on 

the institutions that we regulate, although we did consider the potential impact of the proposals on the broader economy. We did not 

explicitly consider the regulatory capital requirements for Fannie 

Mae and Freddie Mac as set forth by their regulator, the Federal 

Housing Finance Agency. 

Q.8. A key concern that must be addressed is ensuring that the 

capital requirements for Fannie and Freddie do not create incentives for banks to excessively transfer risk to the GSEs, like they 

did before the crisis when banks were charged a 4 percent capital 

requirement for holding a portfolio of mortgage loans, but only 1.6 

percent if they held GSE MBS instead. Do you believe that the proposed rules appropriately address that concern, and if so, how? 

What analysis have you done to make that determination? 

A.8. While the proposed rules attempt to provide for a more risk 

sensitive approach to mortgage loans held by banks, the proposed 

treatment for exposures to Fannie Mae and Freddie Mac are carried over from the existing rules. This was partly due to the explicit Government support that has been provided to these institutions. If and when the two housing entities are restructured, we 

will consider the risks that exposures to the firms present to banks 

and will revise the capital treatment for such exposures accordingly. However, given the uncertainty as to what the ultimate 

structure and risks of these entities might look like, we believed it 

was premature to make significant changes to the capital standards at this time. 

Q.9. Mr. Lyons, how do the proposed rules address the diverse 

landscape of our financial system, including mid-size banks, community banks, regional banks, and other market participants? 

Please provide specific examples. What analysis did OCC conduct 

to determine that the Basel III model should be applied to those 

market participants? How did OCC determine that the proposed 

capital regime is adequate for institutions based on their size or 

asset class? 

A.9. As I noted in my testimony, in developing the U.S. capital proposals we did not adopt a ‘‘one-size fits all approach.’’ Rather, we 

carefully evaluated each element of the Basel III framework and 

assessed to which banks it should be applied. In making these assessments, the Federal banking agencies strove to calibrate the requirements to reflect the nature and complexity of the financial institutions involved. As a result, and consistent with the higher 

standards for larger banks required by section 165 of the DoddFrank Act, many of the provisions in the proposed rules are only 

for larger banks and those that engage in complex or risky activities: community banks with more basic balance sheets are largely 

or completely exempted. For example, smaller banks can ignore the 

advanced approaches NPR in its entirety, which contains changes 

from Basel III that only apply to the largest U.S. banks. In addition, the countercyclical buffer, which is meant to make banks hold 

more capital during periods of excessive credit growth, is a Basel 

III provision that would apply only to the largest banks. Similarly, 

enhanced disclosures would apply only to banks with total consolidated assets of $50 billion or more. While not included as part of 

117 

this set of proposals, the largest banks will also have to hold an 

additional cushion of capital under the Global Systemically Important Bank (G–SIB) surcharge, which could be up to 3.5 percent of 

additional common equity. 

There are areas, however, where we believe a more uniform regulatory capital approach across banks is warranted. For example, 

the proposals include a consistent definition of what counts as regulatory capital for banks of all sizes. A consistent definition helps 

to limit the complexity of having multiple definitions for banks of 

varying size and also helps to reduce opportunities for regulatory 

capital arbitrage. 

The regulatory capital standards set forth in the proposals are 

meant to be minimum requirements that are appropriate for banks 

of various sizes and with varying business models. These standards 

do not obviate the need for more tailored analysis of each bank’s 

capital adequacy, which is part of our overall supervisory process. 

RESPONSES TO WRITTEN QUESTIONS OF 

SENATOR MENENDEZ FROM JOHN C. LYONS 

Q.1. A fundamental objective of Dodd-Frank was to reduce systemic risk. I am concerned that the Fed’s Basel III proposal could 

result in bank clearing members having to hold significantly more 

capital when their customers use less-risky instruments. Some 

argue that this incentive will make it more expensive to use exchange-traded futures than bespoke swaps. Should the rule be designed to encourage the use of lower risk profile products, rather 

than potentially discourage it? 

A.1. While the use of central counterparties improves the safety 

and soundness of both cleared OTC and exchange-traded products 

through the multilateral netting of exposures and market transparency, the increased use of central counterparties also has the 

potential for increased systemic risk as counterparty credit risk is 

concentrated in these entities. The proposed rules introduce a capital requirement for banks’ exposure to this risk. The proposed capital requirement takes into account the margin provided to the central counterparty by its members as well as the capital of the central counterparty itself. We are still reviewing the comments received on this issue to determine the ultimate resolution of this 

topic. 

Q.2. With the proposed use of Loan-to-Value (LTV) ratios on home 

mortgages in Basel III, community banks would be required to 

recordkeep (or keep records of) the LTVs of future and existing 

mortgages. Some have argued that going back through their existing portfolios and determining each individual loan’s LTV at origination would be burdensome and costly. Have you considered applying this standard prospectively for smaller banks and what 

thoughts have gone into that? 

A.2. These changes are part of the Standardized Approach proposal. As proposed, they would be applicable to all mortgages with 

no grandfathering provisions; however this treatment would not 

come into effect until 2015. This proposed delayed implementation 

was intended to provide sufficient time for banks to adapt to the 

118 

new standards. Several commenters have suggested that we apply 

the proposed mortgage treatment on a prospective basis, and that 

is something that we will carefully consider as we move forward. 

Q.3. Elizabeth Duke recently said that in her discussions with community bankers, more of them report that they are reducing or 

eliminating their mortgage lending due to regulatory burdens than 

are expanding their mortgage business. In fact, she says that even 

if the specific issues in capital proposals can be addressed, the 

lending regulations might still ‘‘seriously impair’’ the ability of community banks to offer traditional mortgages. How or what are you 

going to do to ensure that the fragile housing market does not take 

another hit as it relates to capital requirements and Basel implementation? 

A.3. Our goal with the proposed modifications to our regulatory 

capital framework is to create a more robust and stronger banking 

system that is better positioned to withstand financial market 

stresses. Ultimately, this would help to ensure that access to financing can flow more efficiently to all sectors of the economy, including housing. In addition, the proposed rules included long transition provisions to allow banks to more easily adjust to the higher 

capital standards. Nevertheless, we recognize the concerns that 

commenters have raised with our proposals, particularly as they relate to the housing market, the multitude of regulatory reforms 

that are underway in this sector of the economy, and the burden 

the proposals may pose to community banks. We are committed to 

carefully considering all of these comments in deciding how to best 

move forward. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER 

FROM JOHN C. LYONS 

Q.1. I, and many other Members, have brought up concerns about 

the need to tailor rules to the size and type of entity. However, I 

recognize the U.S.’s leadership role on the Basel Committee, and 

the need to move through this period of regulatory uncertainty so 

that businesses can make investment decisions. How can the Committee provide regulated entities more certainty about the timeline 

of rules being reproposed or finalized in the future? 

A.1. While we are dedicated to the Basel process of developing and 

promulgating globally consistent standards for the largest internationally active banks, our ultimate goal is to ensure the safety 

and soundness of the U.S. banking system. Fortunately, standards 

advanced by the Basel Committee are generally consistent with our 

domestic priorities and objectives, and if they are not, we will make 

adjustments as necessary. 

While we are constantly seeking to improve both the international and domestic processes for proposing and finalizing standards and regulations, there are limits to our ability to provide certainty during the rulemaking process. We continue to strive to provide as much information as possible, both at the domestic rulemaking stage and on an international level as part of the Basel 

Committee, to ensure that our proposals can be understood and assessed by industry participants so that meaningful comment can be 

119 

1See, OCC Bulletin 2012-16, ‘‘Guidance for Evaluating Capital Planning and Adequacy’’. 

provided. Nevertheless, certainty in terms of the structure of rules 

and when those rules might be finalized is difficult given that we 

are open to revising our proposals based on the feedback that we 

receive. The Basel Committee and the Federal banking agencies attempted to mitigate some of this uncertainty by providing for long 

transition periods over which banks could adjust and adapt to any 

new regulations. 

As I noted in my testimony, in developing the U.S. capital proposals we did attempt to tailor our proposals. We carefully evaluated each element of the Basel III framework and assessed to 

which banks it should be applied. In making these assessments, 

the Federal banking agencies strove to calibrate the requirements 

to reflect the nature and complexity of the financial institutions involved. As a result, and consistent with the higher standards for 

larger banks required by section 165 of the Dodd-Frank Act, many 

of the provisions in the proposed rules would affect only larger 

banks and those that engage in complex or risky activities; community banks with more basic balance sheets are largely or completely 

exempted from such provisions. 

Q.2. I’ve heard concerns that the proposed rules require unrealized 

gains and losses on available for sale assets to be recognized within 

AOCI. Insurers that are Savings & Loan Holding Companies are 

especially apprehensive about managing increased asset-liability 

mismatches. Can you discuss your broader goals to encourage a 

long-term focus in capital management, and address these AOCI 

concerns? 

A.2. The OCC is committed to ensuring banks maintain adequate 

capital, and, as I noted in my testimony, regulatory capital standards are but one component in a larger and more comprehensive 

process of bank supervision. For example, we recently issued guidance for national banks and federally chartered thrifts (the Federal 

Reserve Board regulates Savings and Loan holding companies) that 

focuses on the need for these institutions to assess their capital 

adequacy. 1 Part of this process, as well as part of our examination 

process of assessing the strength of a bank’s capital position, involves evaluating a bank’s unrealized gains and losses. 

The rationale for the proposed AOCI treatment is that ignoring 

unrealized losses has the potential to mask the true financial position of a bank. This is particularly true when a bank is under 

stress and when creditors are most likely to be concerned about unrealized losses that could inhibit a bank’s ability to meet its obligations. Nonetheless, this is an issue that numerous commenters 

flagged as a concern and is one that we are carefully reviewing. Because our review and rulemaking process have not been completed, 

it would be difficult to comment on the ultimate resolution of this 

topic without prejudging the process. 

Q.3. We’ve seen some recent sales of MSRs from banks to 

nonbanks since the proposal was released saying that MSRs may 

only be counted for up to 10 percent of CET1, and additional MSR 

holdings will be weighted at 250 percent. This is a significant 

change from allowing MSRs to be counted up to the equivalent of 

120 

100 percent of Tier 1 capital. The MSRs change comes in combination with more sophisticated risk-weights for mortgages that will 

require more capital for nonstandard and high LTV mortgages. We 

also have QM and QRM on the way, which will have distinct definitions from Basel rules. I am supportive of a more nuanced approach to holding capital for mortgages, but is the panel concerned 

that the limited overlap in these regulations could cause much 

greater compliance difficulty for small institutions and negatively 

affect access to credit among low-to-middle income borrowers? 

A.3. We recognize the concerns about regulatory burden, including 

concerns about overlap with other regulatory initiatives related to 

residential mortgages, and we take these concerns very seriously. 

Our intention is not to negatively affect credit access to low-to-middle income borrowers, and we will carefully consider the comments 

we have received in deciding on the best way forward. 

Q.4. Trade finance transactions rely on letters of credit and other 

off-balance sheet items, and lenders will have to set aside 100 percent capital for these items if current proposals are implemented. 

This transition requires 5 times more capital compared to Basel II. 

Do you believe that these changes are likely to affect smaller companies and emerging countries to a much greater extent? Can you 

respond to concerns that these proposals, as they are written, could 

constrict trade finance opportunities? 

A.4. One of the main effects of the proposed rules on trade finance 

relates to the treatment of off-balance sheet trade-related transactions such as letters of credit under the supplementary leverage 

ratio. The supplementary leverage ratio is proposed to apply only 

to the largest, internationally active banking organizations, some of 

which are active in the trade finance arena. Commenters have 

raised concerns with this treatment as well as some concerns with 

other technical aspects of the proposals as they relate to trade finance. We will review these comments carefully to assess whether 

any changes to the proposals are warranted. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR WICKER 

FROM JOHN C. LYONS 

Q.1. In comment letters to Federal regulators, the Conference of 

State Banking Supervisors raised concerns regarding the complexity of the approach proposed by Federal banking agencies for 

implementing the Basel III capital accords. How has this input influenced your approach to the rulemaking process? 

A.1. We are carefully reviewing all of the comments we received on 

the proposals, including those submitted by the Conference of State 

Bank Supervisors. Given that the rulemaking process has not been 

completed and that we are still reviewing comments, it would be 

difficult to speak to how particular comments have shaped our 

views at this time. 

Q.2. In applying Basel III to community banks, did the regulators 

consider that most privately held community banks have fewer options for sources of capital than large banks, making it especially 

challenging for them to raise additional capital in the current ecoVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00124 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
121 

nomic climate, and that the Basel III proposal could disproportionately impact such community banks? 

A.2. Yes. The proposed transition period, which in some cases extends to 2022, was intended to allow banks time to adjust to the 

heightened capital standards. Nevertheless, concerns related to the 

ability of community banks to access capital markets has been 

raised by many commenters, and we will weigh these issues as we 

decide how to move forward. 

Q.3. Will the implementation of the proposed Standardized Approach and the mandate that mortgage loan-to-values (LTVs) be 

tracked require many of the Nation’s smaller banks to make costly 

software upgrades? If so, have you considered the cost impact of 

such a requirement on community banks? 

A.3. For a substantial number of the smallest banks (i.e., those 

with total assets of $175 million or less), our initial analysis determined that the compliance costs could be significant. These costs 

include additional recordkeeping and systems costs associated with 

implementing the alternatives to credit ratings. The Comptroller 

has stated publicly that he is aware of the concerns of community 

bankers and is very interested in looking at ways to reduce the potential burden on small banks without compromising the OCC’s 

goal of raising the quantity and quality of capital and setting minimum standards that require more capital for more risk. The Federal banking agencies requested comment on their costs and burden estimates and on ways to reduce cost and burden without sacrificing safety and soundness. As I noted in my testimony, the Federal banking agencies received a substantial number of comments, 

and as we move forward with any final rules, we will consider the 

comments and empirical analysis that community banks provided 

in their comments. 

Q.4. Did the regulators consider the effect on the economy and consumers if community banks reduce mortgage lending significantly 

due to Basel III? 

A.4. Because the proposed rules will change the risk weights for 

residential mortgages, we do expect that increased risk sensitivity 

could have some effect on the cost and availability of residential 

mortgages. Indeed, one objective of the proposed rule is to use variations in risk weights to differentiate between high-risk and lowrisk mortgages, securitizations, and sovereign debt. In particular, 

for residential mortgages with a lower risk weight under the proposed rule, namely category one mortgages with loan-to-value ratios less than or equal to 60 percent, costs may decrease and availability may increase. For residential mortgages with higher risk 

weights under the proposed rule, for example, mortgages with loanto-value ratios greater than 90 percent, we expect that costs may 

increase and availability decrease. There are, however, a large 

number of factors beyond risk weights that affect the cost and 

availability of mortgages and other loans. The interaction of these 

factors along with possible changes in bank behavior towards risk 

makes it difficult to arrive at an accurate estimate of the proposed 

rules’ impact on mortgage cost and availability. 

122 

Q.5. Please explain whether or not the proposed higher capital requirements for past due loans are a form of ‘‘double accounting,’’ 

given that banks already are supposed to reserve for these losses. 

A.5. The capital requirements for past due loans is not a form of 

double counting or ‘‘double accounting.’’ Allowance for loan losses 

(reserves) under accounting standards and regulatory capital serve 

fundamentally different roles. Under existing U.S. GAAP, accounting reserves represent the estimated amount needed to recognize 

losses that have been incurred as of the balance sheet date. In contrast, the role of regulatory capital is to protect a bank from unexpected (and thus unreserved) losses. For example, if a loss has been 

incurred on a past due loan, an accounting reserve should be established in a sufficient amount to recognize the estimated loss. There 

is no automatic requirement that an accounting allowance be established for all past due loans. Nevertheless, the ultimate loss on 

that past due loan is not known with certainty, and it is this uncertainty that the capital charge is meant to cover. It is also worth 

noting that the existing capital rules require capital for past due 

loans, even though these loans generally already have accounting 

reserves established. The difference between the existing and proposed treatment, therefore, is more a matter of the amount of capital that must be set aside, rather than whether capital should be 

set aside or not. 

123 

1 Created by Congress in 1932, the FHLBanks are 12 regional banks, cooperatively owned and 

used to finance housing and economic development. More than 7,700 lenders nationwide are 

members of the FHLBank System, representing approximately 80 percent of America’s insured 

lending institutions. The FHLBanks and their members have been the largest and most reliable 

source of funding for community lending for nearly eight decades. 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

STATEMENT SUBMITTED BY JOHN VON SEGGERN, PRESIDENT AND 

CHIEF EXECUTIVE OFFICER, COUNCIL OF FEDERAL HOME LOAN 

BANKS 

The Council of Federal Home Loan Banks (Council), appreciates this opportunity 

to submit a written statement for the Committee’s consideration in connection with 

the hearing entitled ‘‘Oversight of Basel III: Impact of Proposed Capital Rules’’. The 

Council is a trade association whose members are the 12 Federal Home Loan Banks 

(FHLBanks), 1 and the proposed rules will have a significant impact on FHLBank 

member institutions as well as the mortgage markets as a whole. The Council is 

therefore very interested in the Basel III rulemaking proposals and the congressional oversight of their development. 

The Council agrees that the capital rules need to be revisited, and that a strong 

capital buffer is an important safeguard for both individual institutions and our financial system as a whole. Accordingly, the Council supports the underlying goals 

of the Basel III accord to strengthen the capital base of depository institutions and 

their holding companies; to provide a buffer against systemic risk; and to better correlate the required amount of capital and the risks presented by particular assets 

and financial activities. However, for the reasons described below, we are unable to 

support the rules as proposed. We have attached to this statement a copy of the 

comment letter we submitted to the regulatory agencies concerning these proposed 

rules. 

I. Risk Weight for Mortgages Held in Portfolio 

We are concerned that the proposed capital treatment of mortgage loans held in 

portfolio by community-based institutions is excessive. Under the proposal there 

would be a significant increase in the minimum capital requirements for both first 

and second mortgages, up to twice the current requirements, unless the loan-tovalue ratio of the mortgage loan is 80 percent or less. As a result, unless a home 

buyer can put down at least 20 percent of the cost of the home, plus closing costs, 

the cost of mortgage credit will increase as the mandated capital increases. This will 

harm both the consumer and the overall economy. 

Today, and for the foreseeable future, mortgage underwriting standards are very 

stringent. Under recent statutory reforms, the Federal banking agencies and the 

Consumer Financial Protection Bureau (CFPB) have many new tools that will significantly raise the credit standards utilized in the extension of mortgage credit by 

regulated financial institutions without the need for across the board higher capital 

requirements. Mortgages being made today, and that will be made under these new 

rules, will look much more like the traditional mortgages that were originated prior 

to 2005. These mortgages have proven to be safe with very low default and foreclosure rates. Burdening these loans with excessive capital requirements will unnecessarily impede the availability of mortgage credit, increase costs to consumers, and 

hurt our economic recovery. Especially hard hit will be first-time home buyers, who 

often require high loan-to-value (LTV) lending. 

LTV ratio is an important factor in loan performance. A significant cash investment in a home purchase clearly lowers the risk of default and the loss given a default. However, further analysis needs to be undertaken regarding the impact of 

lower downpayments when other factors indicate that the borrower is creditworthy. 

When other factors indicate that the borrower is a prime credit, the fact that the 

downpayment is less than 20 percent should not automatically push the loan into 

a higher capital category. 

II. Effect of Other Laws and Regulations and Market Conditions 

Another concern in the proposal is that it fails to recognize the impact of all of 

the statutory and regulatory changes that have been adopted or that are expected 

to be adopted shortly. The CFPB is currently promulgating regulations to implement the requirement of the Dodd-Frank Act that prohibits a creditor from making 

a mortgage loan without considering the ability of the borrower to repay. These regulations will effectively require that lenders use very conservative mortgage underwriting standards, or face potential liability for failure to consider adequately repayment ability when originating the loan. The Dodd-Frank Act also requires reguVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00127 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
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lators to implement new rules relating to the securitization of mortgage loans. These 

regulations will define a ‘‘qualified residential mortgage’’ which will likely become 

the standard for all new mortgages that are going to be placed into securitization 

vehicles. These regulations will also require stringent loan underwriting. The CFPB 

is given broad powers to regulate mortgage originators, including restrictions on incentive compensation. All of these new mandates will significantly raise the credit 

standards utilized in the extension of mortgage credit by regulated financial institutions. In establishing new capital rules, it is critically important to consider these 

new laws and regulations, both in terms of the quality of mortgages that will be 

originated going forward, and also in the cumulative impact these new rules will 

have on mortgage availability and cost. We are concerned that the cumulative effect 

of the proposed capital requirements coupled with the other new statutory and regulatory requirements could result in an adverse impact on mortgage availability and 

affordability. 

III. Balloon Payments 

Under the proposal, loans that have balloon payment features are subject to more 

onerous capital requirements. Many of our member institutions, including community financial institution members, view balloon loans as an effective way to provide 

low cost mortgages to their customers. Many customers desire these loans because 

they know in advance that they will be moving within a prescribed number of years, 

or for other legitimate reasons. For community-based lenders, the use of these products has not been problematic. We also note that from an asset-liability management perspective, community banks are more readily able to retain balloon mortgages on their balance sheet, reducing the need for securitization. Retention of the 

mortgages on balance sheet also provides a strong incentive for community banks 

to effectively and prudently underwrite and manage the risks in these loans. 

Congress specifically recognized the importance of these loans in rural and agricultural communities and created an exception in the Dodd-Frank Act’s qualified 

mortgage standard for balloon loans made by lenders in these communities. We urge 

that any final capital rule treat well underwritten balloon loans like any other first 

mortgages, especially if such loans are written by lenders in rural or agricultural 

areas. 

IV. Home Equity Lines of Credit and Second Liens 

During the past decade, some borrowers avoided making any meaningful downpayment towards the purchase of the home by using a second loan. These so-called 

‘‘piggy back’’ loans increased the risk to the lender. However, home equity lines of 

credit (HELOC) and second liens that are not used for the purpose of funding 

downpayments are an important source of financing for home improvement projects, 

medical expenses, educational payments, and paying off more expensive credit card 

debt. Under the proposal, junior liens are subject to more stringent capital requirements, which can double the capital required under current rules. 

V. Commercial Real Estate 

The proposal would increase the risk weight of certain commercial real estate 

loans from 100 percent to 150 percent. The increased risk weight would apply to 

so-called High Volatility Commercial Real Estate (HVCRE) exposures: loans for the 

acquisition, development and construction of multifamily residential properties and 

commercial buildings. The higher risk weight would not apply to loans made for the 

development and construction of 1-4 family residential units. 

Commercial real estate lending is very important to our community bank members to support their local communities. We understand that this can be a volatile 

asset, and that during the financial crisis these loans deteriorated, but not across 

the board for every community bank. Recent indications are that this market is recovering, underwriting standards have improved, and there is a significant need for 

credit in this sector. The regulators have numerous tools to prevent a deterioration 

in underwriting standards, and the use of these tools would be a more effective 

means of addressing the potential risks in this type of asset than raising the capital 

charge for these loans without regard to the quality of the loan. Further, it makes 

little sense to have a higher capital charge for a secured loan (150 percent) than 

the capital charge that would result from making an unsecured loan to the same 

builder. 

VI. Mortgage Servicing Rights 

Another area of our concern is the treatment of mortgage servicing rights (MSRs). 

These are valuable assets that produce a stream of income that can contribute to 

the health of our financial institutions. Under current rules the value of these assets 

is marked to market quarterly, and the market value is then haircut by 10 percent. 

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We understand that MSRs are sensitive to changes in interest rates, prepayment 

rates and foreclosure rates. However, they are nevertheless a valuable asset that 

can be sold in a liquid market. Under the proposal these assets would essentially 

be driven out of the banking system, to the detriment of both consumers and insured institutions and their holding companies. We believe that the proposed treatment needs to be reevaluated to ensure that it will not result in harming our institutions rather than protecting them. 

We recommend that the agencies’ concerns with regard to MSRs focus on the 

quality of the loans associated with the servicing rights, and not lump all MSRs together. If the underlying loans are prudently underwritten the associated MSRs 

should be allowed to count as an asset for up to 100 percent of Tier 1 capital. If 

the underlying loan does not meet this standard, a more stringent limit on the associated MSRs may be appropriate. 

VII. Securitization Issues 

The proposal does not change the treatment of MBS that are issued or backed 

by a U.S. agency (zero-percent risk weight), or MBS that are issued or backed by 

Fannie Mae or Freddie Mac (20-percent risk weight). However, the proposal makes 

significant changes in the treatment of private label MBS, that will make it much 

more difficult for community banks to purchase private label MBS, and increase the 

capital charge for those that do. This result will unnecessarily impede the return 

of private capital to the mortgage markets. 

VIII. Inclusion of AOCI in Calculation of Tier 1 Capital 

The ‘‘minimum regulatory capital ratios, capital adequacy’’ proposal would require 

that unrealized gains and losses on securities held as ‘‘available for sale’’ (AFS) be 

reflected in a banking organization’s capital account. The inclusion of these unrealized gains and losses creates the potential for several unintended consequences. 

Community banks holding interest rate sensitive securities for asset-liability management or other sound business reasons, would see changes to their capital ratios 

based solely on interest rate movements rather than changes from credit quality, 

without commensurate change in capital ratios resulting from movements in the 

market price for other assets classes or long term or structured liabilities. 

Community banks would be incented to hold short term or floating rate securities 

to minimize the impact on their capital ratios from changes in interest rates. Although there could be beneficial reasons for holding longer term fixed rate assets 

such as municipal or mortgage securities, banks could be hesitant to do so realizing 

the long term, fixed rate nature of these investments would subject them to increased price sensitivity and impact on their Tier 1 capital. 

Community banks would be incented to hold their securities in ‘‘held to maturity’’ 

category rather than available for sale to avoid the impact on their capital ratios. 

This would adversely affect a bank’s ability to manage its balance sheet to respond 

to growing loan demand or changing economic fundamentals. 

The inclusion of unrealized gains and losses in AFS securities would diminish the 

relevance and transparency of the Tier 1 capital measure due to institutions receiving inflated levels of Tier 1 capital from declining interest rates (and hence) rising 

market values of fixed rate, noncallable securities. This change in capital could overstate the amount of Tier 1 capital if the subject bank had no intention of monetizing 

the gain on the securities; this could be the case in a scenario where economic activity is stagnant resulting in falling interest rates. 

IX. Disparate Competitive Impacts 

As discussed above, we believe that the proposal will impose capital charges that 

are far in excess of the actual risks presented, especially for mortgages written since 

the financial crisis of 2008. As a result, nonregulated lenders will be able to gain 

market share at the expense of regulated banking institutions. Making this problem 

more severe, the bifurcated capital approach (standardized vs. advanced) creates the 

potential for significant disparate competitive impacts across the two approaches. 

The significant differences in capital requirements across the advanced and standardized approaches will almost certainly negatively impact community financial institutions as they compete with larger institutions in low credit risk portfolios like 

traditional mortgages. 

X. Conclusion 

The Council supports the efforts of the Federal regulators to enhance regulatory 

capital requirements for insured depository institutions and their holding companies. However, overall we are unable to support these rules as proposed. We believe 

that any increased risk weight must be appropriately aligned with the actual risk 

presented by the asset. High capital for nontraditional or poorly underwritten loans 

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makes sense, and we support that policy. However, applying higher capital charges 

for traditional and prudently underwritten mortgages would be extremely counterproductive to our economy and to the American consumer. 

Thank you for the opportunity to include our views in the hearing record. If you 

have any questions, please contact me at the Council’s Washington office. 

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STATEMENT SUBMITTED BY THE INDEPENDENT COMMUNITY BANKS 

OF AMERICA 

Basel III Should Exempt Community Banks 

On behalf of its nearly 5,000 community bank members, ICBA is pleased to submit this statement for the record for the Senate Banking Committee hearing titled: 

‘‘Oversight of Basel III: Impact of Proposed Capital Rules.’’ We appreciate the opportunity to share the community bank perspective on this issue. ICBA urges the banking regulators to exempt all banks with less than $50 billion in assets from the proposed rules in order to avoid significant unintended consequences including further 

industry consolidation that would harm small business lending, consumers, and 

small communities. 

ICBA supports strong capital requirements that will make the banking system 

more resilient and help deter another global financial crisis. However, Basel III and 

the standardized approach introduce drastic changes to both the definition and calculation of regulatory capital that will negatively impact a fragile housing recovery 

and the overall economy. For community banks, Basel III and the standardized approach are regulatory overkill and will have a devastating impact on small communities and rural areas. 

ICBA strongly believes the complex risk weights and capital requirements of 

Basel III and the standardized approach should not be applied to financial institutions in the United States with consolidated assets of $50 billion or less. These institutions are not deemed to be systemically important financial institutions (SIFIs) 

under the Dodd-Frank Act and are not subject to enhanced prudential standards. 

Applying Basel III and the standardized approach to banks beneath this threshold 

will lead to large scale consolidation in an industry already overly concentrated. 

Without a vibrant community banking system, consumers will be left with fewer 

choices and communities and rural areas across the country will be deprived of the 

credit needed to sustain and grow local economies. 

Absent a total exemption, ICBA strongly favors the following modifications to 

Basel III to simplify the rule and better align the proposed capital standards to the 

unique strengths and risks of community banking: 

• Banks under $50 billion in assets should be exempt from the standardized approach for risk-weighted assets. The standardized approach’s complex and punitive risk weighting for residential mortgages could force community banks out 

of this line of business. 

• Unless it can be empirically shown that these assets are risky, the proposed 

substantially higher risk weights for balloon mortgages and second mortgages 

should be reduced to their current Basel I levels. Basel I risk weighting better 

reflects the high-quality nature of this asset class. 

• Accumulated other comprehensive income (AOCI) should continue to be excluded from the calculation of regulatory capital for banks under $50 billion in 

assets to avoid harmful and unnecessary volatility in capital adequacy. 

• If AOCI is not excluded from the calculation of regulatory capital for community 

banks, then changes in the fair value of all obligations of the U.S. Government, 

mortgage-backed securities issued by Fannie Mae and Freddie Mac, and all municipal securities should be exempt. 

• Consistent with the Collins Amendment of the Dodd-Frank Act, bank regulators 

should continue the current Tier 1 regulatory capital treatment of TruPS issued 

by bank holding companies with consolidated assets between $500 million and 

$15 billion. This change would reflect Congressional intent and reduce the capital burden for community banks. 

• Consistent with the proposal for bank holding companies, the Federal Reserve 

should exempt all thrift holding companies with assets of $500 million or less 

from Basel III and the standardized approach or provide a policy rationale for 

why they are not exempt. 

• The allowance for loan and lease losses (ALLL) should be included in Tier 1 

capital in an amount up to 1.25 percent of risk-weighted assets and the remaining balance of ALLL should qualify for inclusion in Tier 2 capital so that the 

entire ALLL will be included in a community bank’s total capital. This treatment will give proper recognition to the loss-absorbing capacity of the ALLL. 

• Mortgage servicing assets should be subject to the current higher deduction 

thresholds because they do not pose a risk to community bank capital. 

• Community banks should be exempt from the provisions of the capital conservation buffer. This is particularly important for Subchapter S banks. AlterVerDate Nov 24 2008 15:49 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00146 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\11-14 OVERSIGHT OF BASEL III -- IMPACT OF PROPOSED CAPITAL 
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natively, the phase-in period for the capital conservation buffer should be extended by at least 3 years to January 1, 2022, to provide community banks with 

enough time to meet the new regulatory minimums. 

• The proposed risk weights for equity investments should be substantially simplified so community banks will not be discouraged from investing in other financial institutions such as banker’s banks, which are key business partners in 

community bank lending. 

• In the absence of a full exemption from the standardized approach, any changes 

to the risk weights should be applied prospectively to give community banks 

enough time to comply. 

• Regulators should make accommodations to ensure Basel III and the standardized approach do not negatively impact the Nation’s minority banks and the diverse communities they serve. Minority banks should be preserved and promoted. 

• If Basel III and the standardized approach are to apply to community banks, 

then they should also apply to credit unions to limit their competitive advantage. 

Again, the most sensible and prudent policy, the policy that would avoid severe 

unintended consequences, would be an outright exemption for financial institutions 

with assets of less than $50 billion. Basel III was originally intended to apply only 

to large, complex, and internationally active institutions. Applying Basel III more 

broadly in a one-size-fits-all manner would harm all consumers and businesses that 

rely on credit and the impact would be especially harsh in small communities and 

rural areas not served by larger institutions. 

ICBA encourages this Committee to consult our October 22 comment letter to the 

banking regulators for more detail substantiating the above views. (The ICBA letter 

is available at: http://www.icba.org/files/ICBASites/PDFs/cl102212.pdf.) 

ICBA thanks this Committee for convening this important hearing and helping 

to raise the profile of a significant economic policy issue with far reaching implications. We appreciate the opportunity to present the views of the community banking 

industry.