WASHINGTON - Under a long-awaited proposal to change the capital rules governing nearly all U.S. banks, residential mortgages and small-business loans under $1 million would become more attractive while commercial real estate loans would cost more.
These and dozens of other changes are part of an advanced notice of proposed rulemaking issued Thursday by federal bank regulators. Known as Basel IA because it amends the 1988 Basel capital accord, it would apply risk-based standards to thousands of U.S. banks that will not implement the more complex Basel II capital standards.
The Federal Reserve Board, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, and Office of Thrift Supervision expect the revisions to allay concerns that the larger banks adopting Basel II would gain a competitive advantage over smaller banks.
"We recognize that a number of banks and industry groups are concerned that banks operating under Basel II might gain a competitive edge over banks that would not be governed by the Basel II framework," Comptroller of the Currency John Dugan said at the FDIC's public meeting Thursday morning. "That is an issue that will remain of great concern to us as we more fully develop any proposals that might stem from this ANPR, as well as proposals for Basel II implementation."
The public will have three months to comment on the advanced notice after it is published in the Federal Register. Regulators plan to move to the next step on both Basel IA and Basel II - formal proposals - in the first quarter. Basel II is not scheduled to take effect until 2009; no implementation deadline has been set for Basel IA.
Under the 35-page advanced notice, regulators would add four new risk weights, also known as "buckets," to the five in use today. These risk weights determine how much capital a bank must hold against various types of assets.
For example, currently almost all mortgages are assigned a 50% risk weight.
Under the plan unveiled Thursday, mortgages would be split into four categories with more capital required behind loans with higher loan-to-value ratios.
For example, mortgage loans with 91% to 100% loan-to-value ratios would require 8% capital, which would mean a 100% risk weighting. The 50% risk weight would apply to loans with ratios between 81% and 90%. A 35% risk weight would hit loans with ratios of 61% to 80%, and loans with ratios below 60% would require just a 20% risk weighting, or 1.6% capital.
Regulators are also considering adjusting the risk weighting on mortgages based on "the borrower's credit assessment or debt-to-income ratio." That could require banks to hold more capital against loans to subprime borrowers.
Creditworthiness and debt-to-income ratios also could affect how much capital must be held behind credit card lines and automobile loans.
Though regulators did not give specific numbers, capital requirements for some commercial real estate loans are expected to increase.
The advanced notice said acquisition, development, and construction loans that do not have a "substantial amount of borrower equity" would probably require more than the 8% called for under current rules. Regulators are soon expected to release guidelines on the risks posed by these types of loans.
Past-due loans, loans with maturities of less than one year, and low-rated commercial exposures, such as junk bonds, could face higher capital levels.
At a public meeting, Fed Governor Susan Bies described some changes as "long-overdue maintenance." She also said a bank's overall capital level, under either Basel IA or Basel II, would not be allowed to fall below the 5% equity-to-assets leverage ratio.
"So we are wearing a belt and a pair of suspenders from a regulatory point of view," Fed Governor Mark Olson said.
Though the vote to issue the advanced notice was unanimous, the process could still hit bumps. At both the Fed and FDIC meetings, regulators welcomed critical feedback from bankers.
For example, FDIC Chairman Don Powell said he expects community banks to object to a proposal to lower capital requirements on some loans that have a third-party rating. He said that many smaller banks do not get third-party ratings on their loans, and that they may complain this would put them at a disadvantage.
With the specifics of Basel IA released for the first time Thursday, an open question is how much the new standard might lower the industry's overall regulatory capital. Chris Spoth, the FDIC's acting director of the division of supervision and consumer protection, said he expected a slight decline.
Regulators said they are considering allowing banks to opt out of making any changes, essentially creating a three-tiered capital framework, with close to 20 banks using Basel II, the majority using Basel IA, and the rest continuing to use the existing Basel I standards.
Agency officials briefed House Financial Services Committee staff on the proposed changes Thursday and are scheduled to meet with Senate Banking Committee staff today.
