Basel Committee Increases Capital Flexibility & Removes Anti-Coop Statements

Volume 5, Number 3
October 17, 2016

Basel Committee Increases Capital Flexibility & Removes Anti-Coop Statements

The final version of the Basel Committee on Banking Supervision’s Guidance on the application of the Core Principles for Effective Banking Supervision to the regulation and supervision of institutions relevant to financial inclusion issued September 27th increases capital flexibility for credit unions and other mutuals. In addition, the final Basel Committee standard removes numerous, inaccurate claims about the supervision of credit unions and other mutuals that World Council of Credit Unions strongly opposed in our March 31, 2016 comment letter to the Committee. 

Regarding increased capital flexibility for credit unions and other mutuals, at World Council’s request the Committee stated expressly that “[n]ational regulators are encouraged to use their discretion to adjust their capital definitions” so that “[m]ember shares issued by mutual banks and cooperative” financial institutions with sufficient permanence and loss absorbability can qualify as “common equity Tier 1” capital. Common equity Tier 1 capital is the most desirable form of regulatory capital under Basel III and also includes retained earnings.

In addition, the final version of the standard at World Council’s urging removed five inaccurate claims about financial cooperative institutions and other mutuals that the Committee had included in its December 2015 proposal. Specifically, the final standard:

  • Removed inaccurate criticisms of cooperatives’ corporate governance;
  • Removed language saying that cooperatives are subject to “excessive risk-taking” (when in reality credit unions are usually more risk-adverse than joint-stock banks);
  • Removed language saying that undercapitalized cooperatives should not be allowed to add new members;
  • Removed language saying that shares issued by cooperatives and mutuals are not typically eligible for inclusion in regulatory capital; and
  • Clarified that credit unions and other mutual banking institutions are depository institutions.

Basel Committee’s Final Guidance on “Total Loss Absorbing Capacity” (TLAC) Instruments Standard Limited to Global Systemically Important Banks and Investments in Those Banks’ Convertible Bonds

The final version of the Basel Committee’s TLAC [Total Loss Absorbing Capacity] Holdings standard issued October 13th, which amends the Basel III capital accord, will have little or no impact on credit unions and other mutuals. As urged by World Council in our February 2016 comment letter, the final version of the standard only applies to Global-Systemically Important Banks (G-SIBs) and institutions subject to Basel III that invest more than 5 percent of their common equity in convertible bonds or other “Total Loss Absorbing Capacity” (TLAC) instruments issued by G-SIBs. 

Under these new Basel III requirements only G-SIB institutions will be required to issue convertible bonds or other TLAC instruments, which they will need to issue in an amount equal to at least 18 percent of their risk-weighted assets. The standard envisions TLAC as a new type of gone concern capital that will help reduce the need to governmental bail-outs for large banks. Requirements to issue TLAC instruments such as convertible bonds will therefore not apply to credit unions or other mutuals (except for two large French banks that the Financial Stability Board has designated as G-SIBs), as World Council urged in our comments earlier this year.

Currently, there are only 30 G-SIBs in the world, all of which are large banks based in China, the European Union, Japan, and the USA. The French banks Groupe BPCE and Groupe Crédit Agricole are currently the only cooperative financial institutions designated by the Financial Stability Board as G-SIBs.

Credit unions and other mutuals subject to Basel III will therefore only be impacted by this new Basel standard if they invest an amount more than 5 percent of their “common equity Tier 1” capital (i.e. retained earnings and most types of perpetual capital shares) in convertible bonds or other TLAC instruments issued by the 30 G-SIBs. The purpose of the Basel Committee’s deduction approach for investments in G-SIB-issued TLAC instruments is to reduce the chances of financial contagion related to the failure of a G-SIB institution.

Institutions subject to Basel III that invest more than 5 percent of their common equity in G-SIB convertible bonds or other TLAC instruments will be required to deduct the amounts of these investments above 5 percent of their common equity from their Tier 2 capital (e.g., unallocated loss reserves, subordinated debt, and some types of less permanent capital shares). An institution’s investments in TLAC instruments below 5 percent of the institution’s common equity capital will be risk-weighted like most other types of investments, not deducted from capital.

G20 Leaders’ Hangzhou Summit

The leaders of the Group of 20 (G20) nations held their annual summit in Hangzhou, China in September 2016. The G20 sets the financial policy agenda for international standard setting bodies for the coming year, including the policy agendas of the Basel Committee on Banking Supervision, the Financial Stability Board, and the Financial Action Task Force. The “G20 Leader’s Communique” issued at the close of the Summit indicates that the next year will be a busy one in terms of financial rulemaking at the international level, including the finalization of the Basel III capital accord and new international anti-money laundering rules.

Most notably, the G20 Leaders stated that they do not support further significant increases to capital requirements for depository institutions. In the Leaders’ Statements, the G20 urged the Basel Committee to finalize the Basel III capital accord before the end of the year but “without further significantly increasing overall capital requirements across the banking sector, while promoting a level playing field.”

World Council believes that the G20 is against further increasing regulatory capital requirements on banking institutions because lower capital levels typically promote increased lending and economic growth. This G20 statement against increasing capital requirements echoes a similar European Union Council statement made in July to the effect that the final version of Basel III “would not be expected to result in a significant increase in the overall capital requirements for the banking sector, therefore, not resulting in significant differences for specific regions of the world.” Also in July, the Bank of England Financial Policy Committee’s decided to lower the capital requirements of British banks and building societies as a post-Brexit economic stabilization measure “to support lending.”

The G20 Leaders also announced the “Hangzhou Action Plan” for economic stabilization and growth that focuses on “structural reforms” and industrialization that will “address supply side constrains so as to raise productivity sustainably, expand the frontier of production, and increase mid- to long-term potential.” The Hangzhou Action Plan specifically mentions support for continued easy money policies from central banks, fiscal and tax policy changes intended to promote supply side growth, innovation in manufacturing and the digital economy, and “industrialization in developing countries, especially those in Africa and Least Developed Countries.”

Regarding Anti-Money Laundering and Countering the Financing of Terrorism (AML/CFT), the G20 supported the finalization of the Financial Action Task Force’s upcoming guidance on correspondent banking AML/CFT rules on which World Council filed comments in August. In addition, the G20 urged the Task Force to develop new rules on Customer Due Diligence/Know Your Customer requirements and anti-corruption rules. The G20 also urged the International Monetary Fund and World Bank “to intensity support for domestic capacity building to help countries improve their compliance with global [AML/CFT] and prudential standards” and for the Financial Action Task Force to work with its regional affiliates, such as the Caribbean Financial Action Task Force, to “strengthen its traction capacity” for international adoption of AML/CFT rules.

On international development, the Leaders’ Communique officially launched the “G20 Global Platform on Inclusive Business” to support the “important role of inclusive business in development,” as well as the “G20 Initiative on Supporting Industrialization in Africa and [Least Developed Countries].” The Leaders’ Statement also supported “promoting inclusive and sustainable structural transformation,” sustainable agriculture and agribusiness, green energy, and vocational training.  

Michael S. Edwards
VP & General Counsel
World Council of Credit Unions (WOCCU)
601 Pennsylvania Ave., NW, Washington, DC 20004-2601 USA
Office: +1-202-508-6755 | Mobile: +1-215-668-5240 | Fax: +1-202-638-3410 |

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