Capital Rules Aggravate Credit Crunch

Suggestions that banks in the industrialized nations should have a uniform risk-based capital ratio were bandied about for years before the rules were adopted.

When the regulators set the implementation schedule for risk-based capital ratios in January 1989, everyone thought there would be enough time for the banks to adjust.

But before implementation was completed, real estate markets collapsed and the country entered a recession. The losses suffered by banks in their real estate loan portfolios have a doubly negative effect on capital.

First, the losses reduce capital. Second, they lead to lowered stock prices, making it impracticable for many banks to raise capital by selling stock. With so many banks suffering losses or earning minimal profits, few will be able to meet the new capital standards from retained earnings.

Minimum Ratio of 8%

As of Jan. 1, 1993, the minimum ratio of total capital to risk-weighted assets will be 8%. One-half of that amount must be core, or Tier 1, capital consisting of common stockholders' equity, noncumulative perpetual preferred stock and related supluses, and minority interest equity in consolidated subsidiaries.

To meet the risk-based capital requirements, banks are being forced to shrink total assets, change their asset mix, or do both. Economic circumstances require that many banks choose between restructuring commercial real estate loans or foreclosing for full or partial satisfaction of the debt.

Because of the severely depressed real estate markets in many areas, banks often have no opportunity to sell the real estate they have acquired. Similarly, there is little demand for restructured commercial real estate loans.

|Risky' Assets on the Books

This means that many institutions are forced to hold a certain minimum amount of real estate owned and commercial real estate loans. Since such assets are given a 100% risk weight under the new guidelines, it appears that banks are shifting much of their remaining asset portfolio into assets with smaller risk weights.

For example, one- to four-family residential loans, either owner occupied or rented, carry a 50% risk weight, as do certain privately issued mortgage-backed securities. Other privately issued mortgage securities - for which the underlying asset pool is composed solely of mortgage securities issued by the Government National Mortgage Association, Federal National Mortgage Association, and Federal Home Loan Mortgage Corp. - are assigned a 20% risk weight.

And, of course, federal government securities carry a risk weight of zero. Thus banks are shifting toward assets with lower risk weights.

Apples and Oranges

Under this scenario, it should not surprise anyone that a credit crunch has developed. Commercial real estate loans have the same 100% risk weight as loans to prosperous small or large businesses engaged in other commercial activities. Therefore, from a risk-based capital point of view, there is no difference between making a commercial real estate loan and a business loan.

Banks that must shrink assets to meet the risk-based capital requirements will be reluctant to make new loans or renew old loans in the high-risk-weighted categories. Such decisions will continue to be detrimental to the economy to be detrimental to the any real choice?

As the final implementation date for 8% risk-based capital draws near, and as more banks move to shrink their asset size, they will find that they are selling assets into an increasingly weak market.

The risk-based rules are, of course, not the only cause of the credit retrenchment by banks, but they are undoubtedly a factor. With Congress and the regulators urging more and more capital for banks in order to protect the insurance fund, it may be the wrong time to suggest a review of the implementation dates of the risk-based capital rules. However, a review may be in order.

The risk-based capital guidelines look good on paper and are meant to strengthen banks, but they have been overtaken by economic and political events.

Mr. Byrd, who has a private law practice in Washington, is a former attorney for the Office of the Comptroller of the Currency.

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