More than a year ago, the American Bankers Association filed a lawsuit to provide relief for community banks from the Volcker Rule. The initial Volcker final rule required banks to divest their trust-preferred securities holdings, forcing thousands of otherwise healthy community banks to sell these assets at depressed prices. About a month later, the banking agencies issued an interim final rule providing relief to community banks that had invested in Trups.
While celebrated, the relief provided to some banks has proven to be short-lived as Basel III starts coming into effect.
Under Basel III, any amount above 10% of a bank's common equity is treated as a loss and deducted from regulatory capital. The Basel III capital deduction strongly encourages the very divestiture of Trups collateralized debt obligations that was overturned in the 2014 interim final Volcker rule. As such, it is unclear how the Basel III treatment is consistent with congressional intent of retaining the "status quo" for the Trups market, as described by all three banking agencies. Is this deduction a means of reinstating the original Volcker Rule's divestiture requirement? Does the Basel Committee carry more weight than Congress?
The harsh capital treatment of Trups holdings under Basel III doesn't make a lot of sense. The purpose is to discourage banks from buying each other's capital instruments and thereby reduce interdependence among banks. However, going forward, banks will not be permitted to buy new Trups under Volcker. As a result, concerns that banks will buy each other's capital instruments and artificially inflate capital levels within the banking sector aren't legitimate.
The harsh capital treatment for existing Trups held by banks is not justified by the potential losses. While some issues in the Trups market warrant higher capital requirements, treating a bank's entire exposure as a loss is beyond the pale.
Trups as an asset class have improved measurably over the last several quarters. It can be demonstrated that the issuing banks making up the collateral bases are becoming more creditworthy. Market values have improved considerably. Therefore the outlook for Trups held in bank investment portfolios has improved. Why encourage divestiture or restrict capital at this point?
Similarities between Volcker and Basel are striking: Both rules weren't intended for community banks, but have had a disproportionate impact on hometown institutions. The difference is that with Volcker, regulators recognized congressional intent and provided relief. They have yet to do so with Basel III.
Regulators should not use international capital rules to compromise the relief provided under Volcker. Why pull the rug out from under a recovering market?
Hugh Carney is vice president of capital policy for the American Bankers Association.