Issues : Regulation

Key Considerations with the Community Bank Leverage Ratio

Banking regulators have adopted a final rule offering community banks the ability to opt in to a new, simplified community bank leverage ratio. The CBLR is intended to eliminate the burden associated with risk-based capital ratios, and became effective on Jan. 1, 2020.

Congress amended provisions of the Dodd-Frank Act to provide community banks with regulatory relief from the complexities and burdens of the risk-based capital rules. Agencies including the Office of the Comptroller of the Currency, Federal Reserve and Federal Deposit Insurance Corp. were directed to promulgate rules providing for a CBLR between 8% and 10% for qualifying community banking organizations (QCBO). These banks may opt-in to the framework by completing a CBLR reporting schedule in their call reports or Form FR Y-9Cs.

In response to public comments, the final rule includes a few important changes from the proposed one, including:

  • The adoption of Tier 1 capital, instead of tangible equity, as the leverage ratio numerator.
  • A provision allowing a bank that elects the CBLR framework to continue to be considered “well capitalized” for prompt corrective action (PCA) purposes during a two-quarter grace period, if its leverage ratio is 9% or less but greater than 8%. At the end of the grace period, the bank must return to compliance with the QCBO criteria to qualify for the CBLR framework; otherwise, it must comply with and report under the generally applicable capital rules.

To be eligible, a QCBO cannot have elected to be treated as an advanced approaches banking organization. It must have: (1) a leverage ratio (equal to Tier 1 capital divided by average total consolidated assets) greater than 9%; (2) total consolidated assets of less than $10 billion; (3) total off-balance sheet exposures of 25% or less of total consolidated assets; and (4) a sum of total trading assets and trading liabilities 5% or less of total consolidated assets.

If a QCBO maintains a leverage ratio of greater than 9%, it will be considered to have satisfied the generally applicable risk-based and leverage capital requirements, the “well capitalized” ratio requirements for purposes of the PCA rules and any other capital or leverage requirements applicable to the institution.

QCBOs may subsequently opt-out of the CBLR framework by completing their call report or Form FR Y-9C and reporting the capital ratios required under the generally applicable capital rules. A QCBO that has opted out of the leverage ratio framework can opt back in by meeting the discussed qualifying criteria discussed above.

The leverage ratio provides significant regulatory relief to QCBOs that would otherwise report under the risk-based capital rules. Opting-in to the CBLR allows a qualifying bank to be considered “well capitalized” under the PCA rules through one simple calculation (assuming the organization is not also subject to any written agreement, order, capital directive or PCA directive). Additionally, calculating the community bank leverage ratio involves a measure already used by banks for calculating leverage: Tier 1 capital.

The cost of adoption is low as well. If qualified, a bank simply has to adopt the new leverage ratio in its call reports or Form FR Y-9C. And the two-quarter grace period offers further flexibility. For instance, if a QCBO engages in a major transaction or has an unexpected event that impacts the 9% leverage ratio, the bank will be able to reestablish compliance with the CBLR without having to revert to the generally applicable risk-based capital rules. Since the CBLR is voluntary, it is within each qualifying bank’s discretion whether the benefits are sufficient enough to adopt the new rule.

Qualifying banks should be aware that opting in to the community bank leverage ratio essentially raises its well-capitalized leverage ratio requirements under the PCA rules from 5% to 9%. These banks must ensure their leverage ratios are above 9% or find themselves attempting to comply with both the CBLR and the risk-based capital rules.

It has been suggested that the CBLR may create a de facto expectation from the agencies that a properly capitalized qualifying bank should have a leverage ratio greater than 9%. Though the agencies emphasized that the CBLR is voluntary, community banks eligible to adopt the rule should be thoughtful in their decision to use it. While qualifying banks can opt in and out of the new leverage ratio, the agencies noted that they expect such changes to be rare and typically driven by significant changes, such as an acquisition or divestiture of a business. The agencies further indicated that a bank electing to opt out of the CBLR framework may need to provide a rationale for opting out, if requested.

While the community bank leverage ratio will be useful in reducing regulatory burdens for qualifying community banking organizations, its adoption does not come without risk.