Community Bank Leverage Ratio: Will it Become the New Standard?
The new Community Bank Leverage Ratio (CBLR) included in Senate Bill S.2155 was designed to simplify the calculation of regulatory capital for community banks. But the process of actually getting the bill implemented since it passed thirteen months ago has been a long one. What appears to be the final round of public comment periods on the CBLR has just ended so we are anticipating that the final rule will finally be issued.
New Capital Ratio
Regulators have clearly indicated that the CBLR is not designed to reduce the amount of regulatory capital that community banks are required to hold. If anything, it may increase regulator expectations. It is instead designed to simplify the calculation of regulatory capital by scrapping the requirement to risk weight assets and off balance sheet liabilities. It instead requires banks to calculate a more streamlined leverage ratio that is similar, though not quite identical, to the current Tier 1 leverage ratio.
Banks that exceed the 9% CBLR ratio will automatically be considered well capitalized under the new framework.
Qualifying for the CBLR
Under the proposed rule, community banks with less than $10 billion in total assets can qualify to skip the existing regulatory capital rules and use the CBLR if they meet certain criteria including:
- Having an initial Community Bank Leverage Ratio that exceeds 9%
- Having off balance sheet exposures of 25% or less than total assets
- Having mortgage servicing assets of 25% or less of tangible equity
- Having deferred tax assets related to timing differences of 25% or less of tangible equity
Opt In or Opt Out?
The CBLR framework was designed by regulators to be optional. Banks are supposed to be able to opt in or opt out depending on what best meets their needs.
Under the proposal, banks that fall below the 9% threshold will be given a two quarter “cure period” to return to a well-capitalized position before being forced to go back to the old Schedule RC-R and risk weighted capital requirements.
Though the new proposal is considered to be optional, regulators have indicated that they expect that most eligible banks will opt in.
A New Minimum Capital Requirement?
There are clear advantages of the new CBLR that go beyond fewer lines to complete on the call report. This new ratio will be more comparable from bank to bank, easier for management and the board to understand, and it will eliminate the worry surrounding the capital conservation buffer included in Basel III.
But since the CBLR is more straight forward and easier to understand, commentators have also feared that the 9% Community Bank Leverage Ratio may become the new standard by which all banks are judged. As regulators adapt to the new rule, I certainly could see situations where they may gravitate toward the 9% standard especially if most of the banks they are examining are using the CBLR.
It is already common today to see a 9% leverage ratio used for purposes of merger and acquisition discussions. It is not a stretch to worry that regulators may move further in that direction. For institutions that have historically been tight on capital or are in a high growth period, this could make long term capital planning more challenging.
Next Steps
There have been many comments about the CBLR proposal and many calls by banks and banking associations to reduce the required capital ratio from 9% to 8%, the minimum required under the Congressional law. Since the regulators have already released draft call report forms related to the proposal and reviewed multiple rounds of banker comments, it seems unlikely to me that the required ratio will be reduced though I’ve been surprised before.
If the final rule on the CBLR is released in the next 30 to 90 days, I anticipate that it could go into effect as early as December 31, 2019 or, perhaps more likely, in the first or second quarter of 2020.
We a number of other capital provisions also in the pipeline, banks will want to carefully review their capital plans and ensure that they have adequate contingent capital sources should the need arise.
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Amanda Garnett is a principal in the financial institutions practice of CliftonLarsonAllen (CLA) from Peoria, Illinois. She currently leads the firm’s Midwest financial institution tax team and serves institutions ranging in size from $15 million to $3.5 billion in total assets. In addition to tax compliance, Amanda assists clients in the areas of tax consulting, mergers and acquisitions, and regulatory reporting. She also routinely teaches courses for banking associations across the country.
Great article, Amanda. I would be interested in hearing your thoughts on the tax implications, or non-implications, of the adoption of CBLR. Would this be a change in method of accounting?