Banks are calling on federal agencies to revamp and delay implementation of a package of proposals that will transform financial regulation. In more than 700 letters to the banking regulators, both large and small banks protested a June proposal that would implement the Basel III accord by forcing financial institutions to hold more and higher-quality capital. While smaller institutions continue to push for an exemption from some of its requirements, the largest institutions are seeking a litany of other changes. Those include easing up on new risk-based capital requirements for residential mortgages; keeping a filter that would affect how much capital banks must hold against certain instruments; narrowing a definition of "financial institution"; and removing duplicative requirements that force certain banks to comply with up to 11 different ratios, including two leverage ratios. One of big banks' largest complaints is also their simplest: timing. Bankers argue that with the plan scheduled to go into effect Jan. 1, it is simply not enough time to come into compliance. "A first glimpse at fundamental changes to the bank capital framework six months before compliance is unprecedented," three financial trade groups said in a joint comment letter. "Fundamental fairness requires that all U.S. banking organizations have a lead-time of more than a few months to bring themselves into compliance with the new capital rules, both substantially and operationally." The letter was signed by Wayne Abernathy, executive vice president of financial institutions policy and regulatory affairs for the American Bankers Association; Kenneth Bentsen, executive vice president of public policy and advocacy for Securities Industry and Financial Markets Association; and Richard Whiting, executive director and general counsel for the Financial Services Roundtable. The trade groups said large banks should not have to comply with the rules until at least a year after the final rule is published, while smaller institutions should have until July 21, 2015. While they agree with the intent of making capital standards more robust, they argue that implementing the proposal now without significant changes could undermine long-term economic growth. "Many aspects of the proposals … would likely hinder credit availability, dampen economic growth and harm the competiveness of the U.S. banking system and the U.S. financial sector," the trade group letter said. But bankers are also seeking far more specific changes. Topping their list is a provision that would require banks to account for unrealized gains and losses of available-for-sale securities when calculating capital requirements, because it eliminates a filter for accumulated other comprehensive income, or AOCI. Such an approach would be "ill-advised because it created inaccurate reports of actual capital strength and the volatility of capital ratios," wrote David Wagner, senior vice president of finance affairs for the Clearing House, and Tom Deutsch, executive director for the American Securitization Forum, in a joint letter. They said it would also undermine the banks' ability to hedge "effectively and economically" against interest rate changes, making them more inclined to take on debt instruments with shorter-term maturities in their securities portfolio. That would cause banks to overstate capital in low rate environments and understate capital when rates lifted -- leading to an inaccurate predictor of a firm's real financial strength. "The removal of the AOCI filter will have the opposite effect and will result in either over or understated ratios that no longer represent a bank's true ability to absorb losses," wrote Matthew Zames, co-chief operating officer for JPMorgan Chase. "This will likely be confusing to the investing community." Gerald Hassell, chairman, president and CEO of BNY Mellon, wrote that eliminating the filter would "encourage some banks to make important risk management decisions based on accounting methodology differences and not liquidity and interest rate management best practices." He warned that a bank would be required to hold more than twice as much capital against a 10-year Treasury note than a 10-year, fixed-rate, private commercial and industrial loan. Banks also pointed to cases where unrealized losses are unlikely to be actualized on highly liquid debt securities with no credit risk. As a result, the plan would wind up imposing a capital charge on banks based on nothing other than interest rate movements. The Clearing House and the securitization group said a filter should only be applied to securities whose changes in fair value are due to interest rates and not credit risk. Separately, they recommend that a filter be kept for higher-quality assets like U.S. and agency securities and mortgage-backed securities. Another critical aspect of regulators' proposal, which would apply to all banks of all sizes, will effectively revamp how much risk-based capital banks must hold against certain assets, such as foreign sovereign securities, corporate exposures and residential mortgages. Under the plan, bankers would be expected to make a significant change in how they measure risk. Currently they use four categories of risk weightings 0%, 20%, 50% and 100%. The new proposals, which would take effect in January 2015, would expand the number of categories that could apply depending on the kind of assets. U.S. government securities, for example, would retain a risk weighting of 0%, while residential mortgage exposure, which is currently assigned a 50% risk weight for high-quality mortgages, could be assigned a risk weight of up to 200% based on the mortgages' loan-to-value ratio and other criteria. The proposal would also automatically assign a 150% risk weighting to certain commercial real estate exposures. Banks argue such changes could have a devastating impact. "The importance of properly calibrating capital requirements to reflect the true economic risk of the underlying assets cannot be emphasized enough," Zames of JPMorgan wrote. "Risk weight misalignment would reduce our ability to provide appropriate and competitively priced mortgage products to our customers, thereby reducing available credit to borrowers, limiting borrower choices, and increasing borrower costs." Bankers are pushing for a delay on this aspect of the plan in order to provide additional time to study the effect the changes in risk weighting would have on capital, especially given other separate rules designed to tighten mortgage underwriting standards. "The associations believe the empirical analysis of actual and relative risks in the residential mortgage market is especially important because the proposed risk weights deviate significantly from international capital standards and would have substantial, detrimental effects on the U.S. housing market, the relationship between banks and government-sponsored entities and the competitiveness of the U.S. banking system," Abernathy, Bentsen and Whiting wrote in their joint letter. Additionally, financial firms took issue with how broadly regulators' proposal would define "financial institution" in order to limit "significant" and "non-significant investments" in capital instruments of unconsolidated financial institutions. They argue the definition should be revised to cover only "regulated financial institutions," such as banking, securities, and insurance firms. It should also exclude "covered funds" as defined by the Volcker Rule, a Dodd-Frank provision that bans proprietary trading. If regulators use a broader definition, it could end up capturing a diverse group of entities that don't perform critical operations in the U.S. financial system. "Investment funds, commodity pools and Erisa plans may engage in some financial activities, but these activities are not central to the global financial system and each set of entities is subject to an extensive regulatory regime," wrote Candice Koederitz, managing director of Morgan Stanley. "These institutions are fundamentally different than large, internationally active banking, securities and insurance companies, where interconnections may magnify systemic risk in a crisis." Separately, the industry argued against part of the proposal that would in certain circumstances make banks subject to duplicative ratios - including a new supplementary leverage ratio that will create "market confusion as to the interrelationships among ratios and which ratio is the binding constraint for an individual bank," Wagner and Deutsch wrote. Banks with extensive off-balance-sheet activities will be required to meet an additional leverage ratio of 3%. Those institutions would be expected to calculate and report their supplementary leverage ratios starting on Jan.1, 2015 and meet the requirement starting in 2018. "Stated bluntly, if the market cannot tell which out of a multiplicity of ratios is the 'right' one, a natural tendency will be to treat them all as lacking credibility," Wagner and Deutsch wrote. "This will also entail substantial duplication and expense." They recommended that the agencies not apply the supplementary leverage ratio to any U.S. bank any earlier than the Jan. 1, 2018, deadline.
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