Regulators Target 2013 Start for Basel III Rules on Capital, Liquidity

Regulators Target 2013 Start for Basel III Rules on Capital, Liquidity

[Editor's Note: This narrative is derived from Taxation of Financial Institutions § 1.12 (Matthew Bender).]

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Basel III is a global regulatory standard on the adequacy of bank capital and market liquidity requirements agreed upon by members of the Basel Committee on Banking Supervision.  Basel I's goal of minimum capital standards was to strengthen the international banking system as well as provide a consistent framework to be applied to banks in different countries to diminish competitive inequalities.

Essentially, Basel II was designed to permit banks, subject to regulatory review, to substitute internal standards of the capital needed to cover credit risk for the objective "one size fits all" standards employed in Basel I.

In late 2009, the Basel Committee issued two consultative documents proposing reforms to the bank capital and liquidity regulations. The proposals in these documents have been dubbed by people in the financial services industry as Basel III. These proposals were modified and then adopted as modified late in 2010.

Under Basel III, the focus is on the amount of common equity that banks will be required to maintain. Some consideration also may be given to a requirement for banks to issue "bail-in" debt. This debt functions as debt until the point where a bank hits a predetermined decline in the amount of its capital or becomes "nonviable".  The new capital rules are to be phased in over a period of five years, commencing in 2013.

In addition to the enhanced capital requirements, the Basel III proposals have stringent new rules dealing with the liquidity ratios a bank must maintain.  Generally, they require banks to hold a significant quantity of government securities to provide for liquidity in periods of financial distress.  This has led most banks to treat the cost of holding these securities (which typically yield less than the interest expense to carry them on their books) as a "liquidity premium."

Basel III also creates new rules for the treatment of deferred tax assets when a bank makes its capital calculations. The new rules are concerned with the ability of the bank to realize these assets in cash in the event it becomes financially distressed. In comparison with the current bank regulatory rules, the new rules are likely to make it more difficult for banks to give credit to all of their deferred tax assets in making their capital calculations.

The Basel III rules must be adopted by countries participating in the Basel Committee on Banking Supervision. The goal is to have all participating countries adopt their form of the new rules by the beginning of 2013.

On June 7, 2012, the Federal Reserve, the OCC and the FDIC issued three proposed rulemakings under the Basel III proposals.  The Basel III rules are expected to be adopted by participating countries by the beginning of 2013.  The adoption of the Basel III rules will have far-reaching effects, many of which will have related tax consequences.  Taken together, the newly proposed rules are intended to create a new, integrated regulatory framework.  The bank regulators hope these rules adopted in final form to take effect on January 1, 2013.

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