Fed Unveils Basel Bank Capital Proposal

The Federal Reserve released a proposal to enact an international agreement on higher capital standards for banks, known as Basel III, that largely rejects pleas by the U.S. banking industry to soften parts of the new standards.

U.S. banks have pushed the Fed to allow them to more heavily count mortgage servicing rights and the unrealized gains and losses of certain securities toward their capital requirements than allowed by Basel III, but the U.S. central bank's draft rule closely follows the international agreement.

The Fed board is scheduled to vote later on Thursday on whether to put the proposal out for public comment. The Federal Deposit Insurance Corp and the Comptroller of the Currency are expected to approve the proposal soon as well.

The Basel agreement is the cornerstone of efforts by international regulators following the 2007-2009 financial crisis to make sure the global banking system is more resilient.

The new standards would force banks to rely more on equity than debt to fund themselves, so that they are able to better withstand significant losses.

It is up to each country to write rules to implement the Basel agreement for its banks.

The accord, which is to be phased in from 2013 through 2019, will require banks to maintain top-quality capital equivalent to 7 percent of their risk-bearing assets, about three times what they are required to hold under existing rules. The Fed proposal adheres to this standard.

Banks have mostly agreed this minimum level is necessary.

The biggest banks, however, have balked at a part of the agreement to have 28 global "systemic" banks hold as much as an additional 2.5 percent capital buffer.

This provision would hit the largest international financial institutions such as JPMorgan Chase & Co, Goldman Sachs Group Inc and Deutsche Bank AG.

The Fed draft proposal released on Thursday does not address the capital buffer for the largest banks; it will be considered at a later date.

The Fed broke up its proposal for implementing the Basel agreement into three separate rules. The first two, which govern capital levels and the types of assets that can count toward the new standards, would apply to all U.S. banks with $500 million or more in assets.

The third rule addresses the models and methods the largest banks, those with more than $250 billion in assets, can use to determine the amount of capital they have to hold based on the risk of their assets.

Also on Thursday, the Fed board is set to vote on a final rule implementing new capital standards regarding risks posed specifically by banks' trading books.

This update for trading books is known as Basel 2.5.

In response to the financial crisis, regulators across the world agreed to update their capital guidelines to better take into account the risks from such things as securities made up of mortgages, which played a key role in the meltdown.

U.S. regulators had delayed putting this rule into place because the 2010 Dodd-Frank financial oversight law bans the use of work done by credit rating agencies in U.S. banking regulations, including those that assess bank capital. The agencies have struggled to find alternatives.

Banks have argued that some of the substitutes for credit ratings included in a proposed rule released in December will not be effective.

For instance, they have questioned whether relying on ratings from the Organisation for Economic Co-operation and Development (OECD) to gauge the riskiness of sovereign debt will work.

In the proposed final rule released on Thursday the Fed rejected this concern and said regulators will use OECD ratings.