Boards Take Note: The CBLR Mandates a Thorough Exploration of Capital Impact

As third-quarter 10-Qs roll into the Securities and Exchange Commission, one thing stands out:  Most public banks are contemplating whether it makes sense to opt into the new community bank leverage ratio framework. The new rule, which requires banks with less than $10 billion to maintain at least a 9 percent leverage ratio if they join the framework, goes into effect in January.

All qualifying public bank boards have a fiduciary duty to their shareholders to explore the ramifications of opting into the new capital process. While it will allow banks to forgo risk-weighting requirements, the new rules will lock in the 9 percent capital requirement — even for banks that can prove they can safely operate with lower levels.

And that should give boards pause.

As Invictus CEO Adam Mustafa explained in “Simpler is Not Always Better: The Community Bank Leverage Ratio Playbook,” management of every community bank must calculate its unique minimum capital requirement, commensurate with the bank’s risk profile.

“Blindly opting into the CBLR is a disservice to shareholders. For most banks, this will result in unnecessary capital being encumbered when it should be available to deploy to generate a return for shareholders,” the white paper noted.

At the same time, if a community bank decides NOT to opt into the CBLR, it must be prepared to support and defend that requirement to its board of directors and regulators, ideally with a customized capital analysis.

“Choosing not to opt into the CBLR but not having a customized capital requirement calculated and backed by data and analytics is also unacceptable,” Mustafa explains. “It will give your regulator cause for concern because you do not have strong command over how your capital is allocated.”

At a time of industry consolidation, the need for banks to optimize their capital is at an all-time high and may ultimately be the determining factor in remaining independent. The ability for banks to generate sufficient returns on equity for shareholders in a low-growth/low-rate environment is becoming increasingly difficult.

Most banks cannot afford to have any amount of precious capital unnecessarily encumbered and generating zero percent return for shareholders, which is exactly the scenario the CBLR will solidify for most community banks.

The law firm of Alston & Bird noted in a client note earlier this month that qualifying banks that opt into the new framework will raise their “well-capitalized leverage ratio requirements under the PCA Rules from 5% to 9%.” The law firm cautioned banks that opting into the new rules might reduce regulatory burdens, but “its adoption does not come without risk, and such a decision should be made after careful consideration.”

In addition, the Hinshaw law firm advises bank holding companies with less than $3 billion in total consolidated assets that “it may not make sense” for them to opt into the framework as well.

The only way public banks can fully vet whether they should opt into the framework is to conduct a CCAR-like stress test that analyzes the bank’s loans, earnings and entire balance sheet, assessing whether the bank has enough capital to survive an economic downtown.  The results of the stress test can be quickly translated to a customized capital requirement for each bank that is commensurate with its unique risk profile.

Lisa Getter is the publisher of Bank Insights