Risk-weighted assets, regulators’ stiff proposal
Written by Shea Dittrich, director at Sageworks
Both domestic and international government organizations began to realize the deficiencies that existed within the financial system. In response, they enacted legislation aimed at preventing a future calamity that would result in further economic challenges while also protecting consumers from unsafe practices and unsound financial institutions.
Despite these efforts, very little action has taken place, and confusion surrounding the implementation and rules for such legislation has left the industry in a stalemate. The potential impacts of the Dodd-Frank Wall Street Reform and Consumer Protection Act and of the guidelines described in Basel III have been felt from large banks to community banks around the country. Both of these regulatory frameworks recognized the need for banks to increase capital levels in order to account for the inherent risk within the respective bank.
Organizations and bankers have lobbied on community banks’ behalf, many of which currently lack the capital that would be required upon implementation. To date, many community banks are encouraged by the response provoked by their questions and comments: the January 1, 2013, implementation for Basel III was delayed and the rulings are not finalized.
Additionally, Dodd-Frank has still released very few rules and guidance around its newly reformed capital frameworks. According to the Davis Polk “Dodd-Frank Progress Report,” as of January 2013, 237 requirements under Dodd-Frank have passed their deadline for implementation; 142 of the rules have been missed, and 31 have not yet had a proposal released.
Despite these delays, it is extremely likely that banks will in the future be required to report appropriately how their institutions’ risk correlates with their given capital. While most of the regulatory concern from bankers has focused on the required common equity Tier 1 capital ratio, which under both legislations is expected to rise significantly, it is critical that banks begin to plan for changes to capital requirements, and a good place to begin planning is with the institutions’ methodology for risk-weighting.