On July 2, 2013, the Federal Reserve Board approved a final rule to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. In most respects, the final rule follows the proposed rule from 2012. The proposed rule calls for the following capital requirements, each of which is retained in the final rule:

• A minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5 percent.

• A common equity tier 1 capital conservation buffer of 2.5 percent of risk-weighted assets.

• A minimum ratio of tier 1 capital to risk-weighted assets of 6 percent.

• A minimum leverage ratio of 4 percent.

The final rule, however, makes three changes to the proposed rule that have a beneficial impact on community banks.

First, the proposed rule would have required banking organizations to include accumulated other comprehensive income (AOCI) in common equity tier 1 capital. AOCI includes accumulated unrealized gains and losses on certain assets and liabilities that have not been included in net income. Under existing general risk-based capital rules, most components of AOCI are not included in a banking organization's regulatory capital calculations. If these additional components are included, banking organizations commented that it would create volatility in capital ratios. In response to these comments, the final rule allows community banking organizations to make a one-time election not to include these additional components of AOCI in regulatory capital and instead use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital.

Second, the proposed rule would have modified the risk-weight framework applicable to residential mortgage exposures to require banking organizations to divide residential mortgage exposure into two categories in order to determine the applicable risk weight. In response to this proposal, banking organizations commented that calculating risk weights for existing residential mortgage portfolios would be a burden, and that this proposal could negatively affect credit availability. In response to these comments, the final rule retains the existing treatment for residential mortgage exposures under the general risk-based capital rules.

Third, the proposed rule would have required banking organizations with total consolidated assets of less than $15 billion as of December 31, 2009 to phase out over ten years any trust preferred securities (TruPs) and cumulative perpetual preferred securities as tier 1 capital regulatory capital. Banking organizations commented that this proposal does not account for the difficulties community banking organizations may encounter when issuing new capital instruments or for the importance of community banking lending in local economies. In response to these comments, the final rule permanently grandfathers into tier 1 capital of depository institution holding companies with total consolidated assets of less than $15 billion as of December 31, 2009 any TruPs or cumulative perpetual preferred stock issued before May 19, 2010.

The final rule's phase-in period for community banking organizations will begin in January 2015. The phase-in period for larger institutions (mostly those with $250 billion or more assets) will begin in January 2014.

All banking organizations covered by the final rule will need to continue to prepare for its implementation. In certain instances, this may be easier said than done. The continued improvement of the real estate market and the availability of additional capital remain uncertain, and in coming years we will start to see the end of the applicable period during which stressed banking organizations can defer payment on their TruPs.