Leverage is a powerful force. With enough leverage, a small force can be used to move a very heavy object. If you’ve ever used a jack to lift a car and change a tire, a crowbar to open a crate, or a spoon to open a stuck lid, you can attest to this power.Leverage is also a force in the banking industry. US banks are required to maintain minimum leverage ratios to be considered well-capitalized by the banking regulators. In 2019, the regulators established a new community banking leverage ratio (CBLR) to simplify leverage compliance for smaller banks. Community banks may qualify for the CBLR if they have less than $10B in total consolidated assets and meet other risk-profile criteria established by the regulators.Encouraging Opt-In by CFIsWhile the CBLR simplifies regulatory capital requirements, only about half of the community banks that qualify have opted into it. This may be due to not believing f that the CBLR provides effective relief from having to comply with the generally applicable capital requirements or that it isn’t well-calibrated as a capital requirement.Regulators have now proposed two key changes to the CBLR designed to address these concerns and encourage more community banks to take advantage of the framework:
- Lowering of the CBLR threshold from 9% to 8% — a decrease of 11% from the current standard. This will allow more community banks to qualify for the CBLR while providing a larger buffer between the actual amount of regulatory capital held and the amount of capital required using the CBLR. It may also decrease the likelihood that stress losses would cause a CFI to fall below the threshold, which could increase commercial and business lending.
- Extending the grace period for community banks that fail to meet the definition of a qualifying community banking organization (QCBO). Currently, banks that fail to meet this definition have two quarters to re-qualify. The proposal would extend this to four quarters if the bank maintains a minimum leverage ratio of at least 7% and hasn’t used the grace period for more than eight of the previous 20 quarters.
According to the Federal Reserve, banks would be required to continue to maintain a level of capital that’s consistent with ensuring the safety and soundness of community banks. The proposal would also maintain a leverage ratio that is double the minimum leverage ratio applicable to community banks that don’t use the CBLR framework.Lowering the Regulatory Burden on Community BanksIf adopted, the proposal would reduce the regulatory burden on community banks and give them greater flexibility and optionality in how they approach capital management. “These tailored modifications represent a necessary step in continuing to focus attention on the unique needs of community banks in today’s financial landscape,” stated the Federal Reserve when announcing the proposal last November.The main benefits of the proposed changes to the CBLR include the following:
- Being able to use more of their capital for lending in order to meet the financing needs of the communities they serve.
- Facing a lower regulatory burden than if they try to comply with the generally applicable capital requirements.
- Institutions failing to meet the definition of a QCBO will have more time to adjust their numbers before further intervention by the regulators.
Important note: While the CBLR threshold would be lowered to 8% if the proposal is adopted, it is still not a requirement to use the CBLR. Each bank that may qualify to use the CBLR should determine what threshold limits make the most sense for them.Industry Advocates Support ProposalThe proposal is expected to be adopted sometime later this year. “These changes demonstrate the agencies’ ongoing commitment to focusing attention on community banks and their vital role in local economies while ensuring appropriate safeguards remain in place,” stated the Federal Reserve when announcing the proposal. Many community banking industry advocates are in favor of the proposed changes to the CBLR framework. For example, the Independent Community Bankers Association’s (ICBA’s) position states: “ICBA supports legislation to allow more community banks to benefit from the CBLR through continued recalibration, including by lowering the range in which regulators may set the CBLR and increasing the asset threshold for institutions eligible to opt into the framework.”In addition, Congress is also considering legislation that would increase the CBLR threshold from $10B to $15B so that even more banks would be able to opt in. PCBB will keep you updated on the status of these proposals as developments occur.
