The Federal Reserve has approved the Basel III final rule.

When last we reported on Basel III, there was much consternation among smaller, community banks with less capital reserves than the big banks. Their primary concern was that Basel’s capital reserve requirements would push them out of the mortgage industry since the new rules required too much skin in the game.

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Little banks, big problems

It appears as though Chairman Bernanke and Co. have heeded the cries of the lowly community branch managers. Basel III will still affect the smaller banks ($10 billion or less in assets). The blow, however, will not be as hard as expected.

Among the most significant changes to the current rules is the total capital ratio the small banks must hold. Previously, small banks were required to have a 4% Tier 1 capital ratio. This ratio will be increased to 6% under Basel III.

Tier 1 capital is essentially a bank’s main capital holdings, including declared reserves and common stock. The increased capital ratio means they will now need to hold more capital in relation to their assets. This is essentially a way to force banks to have more skin in the game, inhibiting them from running too lean and taking on excessive risk.

The little guys will also receive more time to comply with the new rule. The rules will take effect for the big banks beginning January 2014. Smaller community banks will have an additional year to comply.

first tuesday insight

The gist of this news is a simple heads-up that your local community bank mortgage lender is not going to go belly-up due to Basel III.

Change is scary for everyone, especially banks. But the fact is all the rhetoric about new regulations squashing the little guy is the same old line espoused by even the biggest, best capitalized banks on the block.

Banks make money by taking risks. Limit their risk, limit their profit.

Hopefully the trend of government-imposed risk aversion will continue. With the institution of both the qualified mortgage (QM) and the qualified residential mortgage (QRM), combined with capital requirements and stress tests, it seems our government is making a good faith effort at stabilizing the financial sector and thus the unstable real estate market.

What we’d like to see is the return of Glass-Steagall. Separating retail banks from investment banks is truly the only way to eliminate the kind of risk that led to the present Lesser Depression. Otherwise, regardless of capital requirements and strict underwriting standards, your bank can gamble with your deposit — and if they lose, the government still picks up the tab.

Re: “Federal Reserve Board of Governors Press Release