Pub. 10 2020-2021 Issue 4

O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S — H E L P I N G C O L O R A D A N S R E A L I Z E D R E A M S www.coloradobankers.org 10 FEATURE ARTICLE Changes to Eligible Retained Income BY JOHN S. BERTEAU SERVES AS ASSOCIATE GENERAL COUNSEL FOR COMPLIANCE ALLIANCE, WHERE HE IS ONE OF OUR HOTLINE ADVISORS AND FEATURED CONTRIBUTORS. I n response to the coronavirus’s potential economic effects, the OCC, FRB and FDIC (“the agencies”) published an interim final rule on March 20, 2020, proposing to revise the definition of eligible retained income. On March 26, 2020, the FRB published an interim final rule which revised the definition of eligible retained income for institutions subject to the FRB’s total loss-absorbing (TLAC) rule. The agencies recently published a final rule which made final both of these interim final rules without changes. This final rule aims to help strengthen the ability of banks and TLAC institutions to continue lending and conducting other financial intermediation activities during stress periods by making distribution limitations more gradual, as intended by the agencies. Banks must maintain a buffer of regulatory capital above their required minimum risk-based capital and leverage ra - tio requirements to avoid restrictions on capital distributions under the capital rule. The agencies established the capital buffer requirements to encourage better capital conservation and enhance the banking system’s resilience during stress pe - riods. As initially implemented, capital buffer requirements were intended to gradually limit banks’ ability to distribute capital if their capital ratios fell below certain levels. Banks under the capital rule were generally subject to a fixed capital conservation buffer requirement, composed solely of common equity tier 1 capital, of greater than 2.5% of risk-weighted assets. On March 4, 2020, the FRB introduced a stress capital buffer requirement, which provides that a cov - ered holding company will receive a new stress capital buffer requirement on an annual basis, which replaced the existing greater than 2.5% capital conservation buffer requirement. Under the capital rule, if a banking organization’s capital ratios fall within its applicable minimum-plus-buffer require - ments, the maximum amount of capital distributions it can make is a function of its eligible retained income. Before the issuance of the March 20, 2020, interim final rule, the cap - ital rule generally defined eligible retained income as four quarters of net income, net of distributions and associated tax effects not already reflected in net income. The interim final rule revised the definition to be: “(i) The eligible retained income of a national bank or Fed - eral savings association is the greater of: (A) The national bank’s or Federal savings association’s net in - come, calculated following the instructions to the Call Re- port, for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income; and (B) The average of the national bank’s or Federal savings asso - ciation’s net income, calculated following the instructions to the Call Report, for the four calendar quarters preced - ing the current calendar quarter.” The revised definition of “eligible retained income” under this final rule applies to all of an organization’s buffer require - ments, including the fixed greater than 2.5% capital conser - vation buffer and the countercyclical capital buffer. Once the stress capital buffer requirements apply on Oct. 1, 2020, the revised definition would also apply to all parts of a covered holding company’s buffer requirements. Having one definition of “eligible retained income” for all organizations under the capital rule should simplify the regulatory capital framework and ensures fairness across organizations of all sizes. The requirements in the total loss-absorbing capacity (TLAC) rule build on and complement the capital rule. In 2016, the FRB issued the TLAC rule to require the largest and most important bank holding companies (U.S. based) and foreign banking organizations (U.S. operations) to maintain a minimum TLAC amount, consisting of minimum amounts of long-term debt and tier 1 capital. The TLAC rule prescribed buffer require - ments above the minimum TLAC amount that institutions must maintain to avoid restrictions on capital distributions. As with the capital rule, the TLAC buffer requirements were established to encourage better capital conservation and enhance the resilience of the banking system during