Credit

Community Bank Leverage Ratio (CBLR) Opportunity and Challenges

February 11, 2020

Under existing capital rules, community banks are required to report a Common Equity Tier 1 (CET1) ratio, a Tier 1 risk-based capital ratio, a total risk-based capital ratio, and a Tier 1 leverage ratio in order to hold their well-capitalized status.   

The simplified CBLR calculation of Tier 1 capital over average assets treats all assets the same, whereas a risk-weighted ratio assigns assets in the denominator an increasing risk weight to account for unique risk of that asset class.

Key CBLR Rule Components: 

  • Community banks can now qualify as “well-capitalized” by simply reporting a Tier 1 leverage ratio that exceeds 9%.
  • Banks with total assets above $10 Billon, advanced approaches banks, or those having outsized unused commitments or trading assets are disqualified from using the CBLR. The rule will go into effect from 2Q2020, although banks implement capital simplifications rules from the start of 2020.
  • A CBLR bank that ceases to meet criteria will be allowed two consecutive quarters to satisfy such criteria or follow general capital rules.
  • Banks using the CBLR will be subject to simplified reporting requirements that the agencies intend to propose at a later date.

Based on 3Q19 call reports, SRA analysis shows that over 87% of all banks across asset size spectrum will be able to opt into CBLR frame work as they maintain leverage ratio above 9%


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Key CBLR Considerations: 

  • While simplifying the rules, the CBLR still requires community banks to hold as much, if not more, capital than before and will incentivize them to maintain strong capital position.
  • An informal "buffer" between the required ratio and a bank's actual ratio may be expected. This may deter banks with a leverage ratio ranging from 9% to 10% from utilizing the simpler ratio.
  • CBLR banks will forego—for regulatory capital purposes—the use of their outstanding Tier 2 subordinated debt.
  • Additionally-strong growth, or planned merger acquisitions could create a conflict between managing to a leverage ratio above 9% and strategic capital efficiency plans. Risk-weighted calculations are relatively complex and difficult to restart once a bank exceeds the $10 Billion guidelines.
  • Current Expected Credit Loss (CECL) adoption could also impact capital as any increase in the loss reserves upon transition will be charged against capital.  For some institutions, this amount could be significant.

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Thus, banks that qualify for the CBLR may still choose not to opt in because of asset requirements, internal guidelines or external capital expectations.

We view the CBLR as a favorable option for community banks, relieving main street institutions from compliance rules that are best borne and appropriately designed for the larger banks. However, high capital levels do not alleviate the necessary strategic focus on credit risk management, stress testing and vigilant risk governance. Choosing whether or not to “opt-in” to the CBLR frame work should be done only after a careful assessment and consideration of your institution’s specific circumstances.

Amitabh Bhargava
Senior Managing Director
Strategic Risk Associates
Abhargava@srabank.com

Bert Knotts
Partner and Chief Credit Officer
Strategic Risk Associates
aknotts@srabank.com

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