Basel Committee Proposes Strengthening Bank Capital and Liquidity Regulation

by H. Rodgin Cohen,  for The Harvard Law School Forum at Harvard Law School, January 7, 2010.

On December 17, 2009, the Basel Committee issued two consultative documents proposing reforms to bank capital and liquidity regulation, which are intended to address lessons learned from the financial crisis that began in 2007. [1] The document titled Strengthening the Resilience of the Banking Sector proposes fundamental, although in many respects anticipated, changes to bank capital requirements. The document titled International Framework for Liquidity Risk Measurement, Standards and Monitoring proposes specific liquidity tests that, although similar in many respects to tests historically applied by banks and regulators for management and supervisory purposes, going forward would be required by regulation.

The proposals in the first document, which we refer to as the “capital proposals”, would significantly revise – and, as described by the consultative document, simplify – the definitions of Tier 1 Capital and Tier 2 Capital, with the most significant changes being to Tier 1 Capital. Among other things, the proposals would disqualify innovative capital instruments – including U.S.-style trust preferred securities and other instruments that effectively pay cumulative distributions, and in many cases are debt for tax purposes – from Tier 1 Capital status. They would also re-emphasize that Common Equity is the “predominant” component of Tier 1 Capital by (i) adding a minimum Common Equity to risk-weighted assets ratio, with the ratio itself to be determined based on the outcome of an impact study that the Committee is conducting, and (ii) requiring that goodwill, general intangibles and certain other items that currently must be deducted from Tier 1 Capital instead be deducted from Common Equity as a component of Tier 1 Capital. This approach could have a significant impact on acquisitions in which goodwill arises…(continue reading)

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