WASHINGTON — Community bankers won a critical battle on Friday after regulators agreed to indefinitely delay implementation of Basel III capital and liquidity rules until various issues with the proposal could be worked out.

The Federal Reserve Board, the Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency said that they would miss a global deadline of Jan. 1, and did not provide a new timeline for when the rules would go into effect.

Industry representatives took the delay as a positive sign that regulators were listening to the objections raised by lawmakers and thousands of bankers.

 “It demonstrates that the message is getting through that this is not a simple issue or small proposal, but a really big deal that affects people back home,” said Wayne Abernathy, executive vice president of financial institutions policy and regulatory affairs for the American Bankers Association. “I think what the regulators are recognizing is they need to be more than usually careful in making sure they take into account the various comments that are being made.”

In a joint statement, regulators acknowledged that small banks had raised significant issues with their June proposal and that they simply didn’t have time to work through those concerns by the Jan. 1 deadline.

 “Many industry participants have expressed concern that they may be subject to a final regulatory capital rule on Jan. 1, 2013, without sufficient time to understand the rule or to make necessary systems changes,” the agencies said.

Bankers and others have filed more than 2,000 comment letters on the proposal, with many arguing it’s too complicated and could effectively wipe out small banks.

Regulators did not offer a new timeline for when Basel III would go into effect.

 “It's still far too early in the process to know where we and the other agencies are going to come out on these and other issues, or when the final rules may be released,” said Fed Gov. Elizabeth Duke, speaking to community bankers in Chicago on Friday.

“But what I can promise you is that 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.”

Andrew Gladin, a partner at Sullivan & Cromwell, who works for the firm's financial institutions practice, said regulators acted wisely in delaying Basel III.

"Today's joint announcement appears to confirm that the federal banking agencies recognize the implementation of Basel III in the U.S. raises significant and complicated issues on a variety of fronts as evidenced by the many comment letters that have been submitted," said Gladin. "Given the potential impact of these rules not only on banks, but also for the broader economy, this announcement is an encouraging sign that the agencies will be taking the necessary time to work through these issues."

Observers predicted earlier this week that regulators would be forced to delay implementation of Basel, noting that it was already near the mid-way point of the fourth quarter and there were simply too many issues to be resolved. After issuing the initial proposal this summer, regulators extended the comment deadline to Oct. 22, a sign of growing unrest around the plan.

Community banks used that time to successfully raise the stakes for regulators by enlisting the help of Congress. A majority of the Senate, including lawmakers from both political parties, sent a letter to the heads of agencies in September arguing that the proposal was too complex and expensive for community banks.

“We have felt since the time they extended the comment period that the Jan. 1 deadline would be difficult for them to make because we knew there would be an avalanche of comments,” said Camden Fine, president of the Independent Community Bankers of America, who has spearheaded the community banks grassroots efforts against the proposal. “And frankly, I think the fact that Congress also weighed in … convinced the regulatory authorities that they needed to take a more deliberative approach to these Basel proposals.”

In their letters, community bankers stressed the complexity of regulators' proposal, while also arguing they needed to ease up on provisions establishing new risk-based capital requirements for residential mortgages, and keep a filter that impacts how much capital have to hold against certain instruments.

Duke said Fed officials are closely reviewing all of the comment letters that were submitted.

“We take these comments very seriously, and we will be working with our colleagues at the OCC and FDIC to understand and analyze the many issues that have been raised,” said Duke, who chairs a subcommittee on the Fed Board specifically on supervision of community banks.

Micheal Stevens, senior executive vice president for the Conference of State Bank Supervisors, which also objected to the initial Basel proposal, said it was a clear signal that small banks were getting their voices heard by regulators.

“I think the industry should take heart in that the agencies are listening and the comments will be considered,” said Stevens. “Still, there is a long way to go, but I think there's reason for optimism as what the final outcome will be.”

Community bankers had mostly expected the majority of the Basel III plan, which dictates the quality and quantity of capital that institutions must hold, to apply to them, including a core requirement that banks hold 7% in common Tier 1 capital.

But to their surprise, the proposal upped the ante for the roughly 7,000 smaller institutions by changing the risk-weighting calculation for certain assets, including foreign government securities, corporate exposures and residential mortgages.

Duke specifically addressed one area of concern mentioned repeatedly by bankers — the impact the capital proposal would have on residential lending for smaller-sized institutions.

“I am now concerned that, even if the specific issues in the capital proposals can be addressed, the totality of new mortgage lending regulations might still seriously impair the ability of community banks to continue to offer their traditional mortgage products,” said Duke, who noted that many bankers have conveyed plans to reduce or eliminate their mortgage lending business because of regulatory burdens. “I think this represents a real concern, both for mortgage availability and for the viability of community banking.”

Even before the release of the proposal, the Fed has tried to work closely with institutions to hear out their concerns, including holding four teleconference calls with more than 3,200 bankers as well as in-person meetings in Chicago and Kansas City, Mo., over the summer.

Members of the Fed Board, including Chairman Ben Bernanke and Duke, have met with roughly 150 bankers from June through September on the proposal. Most recently, regulators released a calculator so that banks could estimate the amount of capital they may need to hold under the proposed requirements.

Based on earlier analysis, regulators had anticipated that many smaller banks would already meet the new capital requirements, stressing that the new rules were intended to strengthen the quality of capital held by these institutions.

“Before the proposals were issued, our staff of economists and analysts conducted research to estimate the potential impact of the proposed rules,” said Duke. “Their analysis indicated that the vast majority of community banks would already meet the new standards.”

According to staff at the Fed, based on pro forma analysis, 90% of bank holding companies under $10 billion of assets would meet the 4.5% minimum common equity Tier 1 ratio. More than 80% would meet the 7% common equity Tier 1 ratio, including a 2.5% capital conservation buffer. The total shortfall for those firms that don't meet the 7% plus buffer would be roughly $3.6 billion.

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