Community Bank Leverage Ratio (CBLR): Background and Analysis of Bank Data

Summary

Capital allows banks to withstand losses (to a point) without failing, and regulators require banks to hold certain minimum amounts. These requirements are generally expressed as ratios between balance sheet items, and banks (particularly small banks) indicate that reporting those ratios can be difficult. Capital ratios fall into one of two main types—simpler leverage ratios and more complex risk-weighted ratios. A leverage ratio treats all assets the same, whereas a risk-weighted ratio assigns assets a risk weight to account for the likelihood of losses.

In response to concerns that small banks faced unnecessarily burdensome capital requirements, Congress mandated further tailoring of capital rules in Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (P.L. 115-174) and created the Community Bank Leverage Ratio (CBLR). Under the provision, a bank with less than $10 billion in assets that meets certain risk-profile criteria will have the option to meet a CBLR requirement instead of the existing, more complex risk-weighted requirements. Because most small banks currently hold enough capital to meet the CBLR option, Section 201 will allow many small banks to opt out of requirements to meet and report more complex ratios.

Section 201 grants the federal bank regulatory agencies—the Federal Reserve (the Fed), the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC)—discretion over certain aspects of CBLR implementation, including setting the exact ratio; the provision mandated a range between 8% and 10%. In November 2018, the regulators proposed 9%, arguing this threshold supports safety and stability while providing regulatory relief to small banks. Bank proponents criticized this decision and advocated an 8% threshold, arguing that 9% is too high and withholds the exemption’s benefits from banks with appropriately small risks. Despite the criticism, the bank regulators announced in a joint press release on October 29, 2019, they had finalized the rule with a 9% threshold.

Questions related to how much riskier bank portfolios will be if they are only subject to a leverage ratio (rather than a combination of leverage and risk-based ratios) and how high the threshold must be to mitigate those risks are matters of debate. Riskier assets generally offer greater rates of return to compensate investors for bearing more risk. Without risk weighting, banks would have an incentive to hold riskier assets to earn higher returns. In addition, a leverage ratio alone may not fully reflect a bank’s riskiness because a bank with a high concentration of very risky assets could have a similar ratio to a bank with a high concentration of very safe assets. Risk-based ratios can address these problems, however, they can create misallocations across asset classes and involve complexity related to compliance.

Of the 5,352 FDIC-insured depository institutions in the United States at the end of the second quarter of 2019, the Congressional Research Service (CRS) estimates that 5,078 (about 95%) would meet the size and risk-profile criteria necessary to qualify for the CBLR option. Under the regulator-set risk-profile criteria, nonqualifying banks are on average larger, have larger off-balance-sheet exposures, and have risk-based capital ratios that are about a quarter lower than qualifying banks.

Of the 5,078 banks that qualify based on size and risk criteria, CRS estimates 4,440 (or 83% of all U.S. banks) would exceed a 9% threshold and would be eligible to enter the CBLR regime without having to hold additional capital. If the threshold were set at 8%, an additional 515 banks (9.6%) would exceed the lower threshold. Thus, the difference between 8% or 9% would, depending on perspective, provide appropriate regulatory relief to or remove important safeguards from almost 10% of the nation’s banks, which collectively hold about 2% of total U.S. banking industry assets. Banks that would be CBLR compliant at a 9% threshold are similar in size, activities, and off-balance-sheet exposures to 8% threshold banks. However, the latter group’s risk-based ratios are about half the level of the former’s.