Banking in the 21st Century: Navigating Uncharted Waters

Even though the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed over 3.5 years ago, its likely effects on commercial banking are only now starting to take shape.¹ Although the Commodity Futures Trading Commission has made material progress in implementing Title VII of the Dodd-Frank Act and the Consumer Financial Protection Bureau has made its mark on retail financial services, the specifics of the new regulatory environment for commercial banking have been slow to emerge. In 2013, that began to change as greater certainty emerged for regulatory capital requirements and the Volcker Rule was finalized.² In early 2014, enhanced prudential standards for larger banking institutions under §165 of the Dodd-Frank Act also were finalized.³ Although a number of shoes are still to drop, including risk-based capital surcharges for the largest banking institutions, possible changes to the supplemental leverage ratio, possible minimum levels of long-term debt, and final liquidity standards, the new regulatory environment for banking in the 21st century is starting to take shape. What is still unclear, however, is how the different regulatory requirements will interact to shape bank balance sheets and how they will affect access to financial services for banks’ commercial customers. It is clear that these requirements will have significant impacts on how banks finance, how they invest, the business that they conduct, and their willingness to lend.

In July 2013, the U.S. banking agencies approved a broad and comprehensive revision of the regulatory capital rules applicable to all U.S. banks and bank holding companies (except those with less than $500 million in total consolidated assets).⁴ The new rules, which will be phased in from 2014 to 2019, introduce Basel III standards for the components of, adjustments to, and deductions from, regulatory capital, as well as new minimum ratios under the U.S. prompt correction action framework. U.S. banks and bank holding companies are subject to the following minimum regulatory capital requirements: a common equity Tier 1 capital ratio of 4.5 percent (a newly introduced requirement), a Tier 1 capital ratio of 6 percent (increased from the current 4 percent), a total capital ratio of 8 percent of total risk-weighted assets (unchanged from the current requirement), a Tier 1 leverage ratio of 4 percent, and, for those U.S. banks and bank holding companies subject to the advanced approaches rule, an additional leverage ratio of Tier 1 capital to total leverage exposure of 3 percent. The rules also introduce regulatory capital buffers above the minimum common equity Tier 1 ratio, including a capital conservation buffer of a further 2.5 percent of common equity Tier 1 capital to risk-weighted assets and, for those U.S. banks and bank holding companies subject to the advanced approaches rule, a countercyclical buffer of up to 2.5 percent of common equity Tier 1 capital to risk-weighted assets that may be deployed as an extension of the capital conservation buffer.