WASHINGTON – The Federal Reserve on Friday issued a final rule laying out how its regulatory capital rules would apply to banks with nontraditional institutional investors – such as limited liability corporations or partnerships – that hold controlling interests.
The Fed's 2013 revised regulatory capital framework requires state member banks, bank holding companies and some savings and loan companies to hold specified ratios of capital and of specified quality.
Among those requirements was a mandate that banks hold common equity Tier 1 capital equivalent or greater than 4.5% of risk-weighted assets. In a stress event, that common equity stock is highly absorbent and is generally absorbed by investors according to a subordination plan, with some investors taking losses before other investors.
But partnerships and LLCs do not issue common stock, so if an institution with that kind of structure has a controlling stake in a bank, that CET1 requirement would not apply. However, partnerships and LLCs can issue other capital instruments that could act like common equity stock, and the rule lays out the standards that such instruments would have to meet in order to qualify as CET1 equivalent.
The Fed issued a proposal last December to clarify this point, effectively saying that such an instrument could qualify as CET1 "provided that all ownership classes shared equally in losses, even if all ownership classes do not share equally in profits." The proposal also noted that certain conditions like mandatory capital distribution or unequal sharing of losses "could prevent a capital instrument from qualifying as CET1." The final rule affirmed those basic requirements and clarified some additional contingencies if CET1 capital absorbed losses.
The final rule goes into effect Jan. 1, 2016, and the Fed noted that it would apply to only a relatively small number of firms.
The final rule also said that the Fed will make a separate regulation that would clarify how the CET1 requirement will apply to savings and loan holding companies that are personal or family trusts and to clarify how employee-owned stock treatment plans at depository institutions would be considered under the capital rules.