A capital requirement is considered as standardized requirement for the financial institutions and other depository institutions which actually determine how much liquidity is required to be maintained for certain level of assets. Regulatory agencies are responsible to set requirements for these such as Bank for International Settlements, Federal Deposit Insurance Corporation, and Federal Reserve Board. These requirements actually stated for the purpose of ensuring that banks and other depositories does not holds the investment which increase the risk related to default. They must ensure that banks and depository institutions have enough capital to sustain losses related to operating at the time of withdrawals. Capital requirement is also determined as regulatory capital. In the United States, capital requirement for banks is clearly based on number of factors but these factors are mainly based on the weighted risks which are actually based on assets held by bank. Generally capital requirements are used for the purpose of creating capital ratios which then used to evaluate and compare lending institutions based on their relative strength and safety. Any adequate capitalized institution which is based on the Federal Deposit Insurance Act must have a Tier 1 capital-to-risk weighted assets ratio of at least 4%, and those institutions with a ratio below 4% are considered undercapitalized, and those below 3% are significantly undercapitalized.
Safety and protection of US banking system consist of central bank loans to solvent but liquidity strained banks and other insurance related to Federal deposit was developed in the early period of 1900 for the purpose of protecting the commercial banks. The safety net originally limited to commercially banks because this net is critical to the economy overall health and growth. The main activities included making loans which are funded by shorter deposits and also provide essential payment, liquidity, and credit intermediation services. Therefore, these services make banks inherently unstable because in such case depositors will run if they come to know that their bank is in financial trouble. However, this safety net solves the instability problem and it also helps in create incentives to take excessive risk because it subsidizes banks. With other safety net protection, depositor and other creditors which are protected are willing to lend to banks at lower interest rates for the purpose of given accurate amount of risk. This cheaper funding and reduced market discipline creates incentives for banks to make riskier investments and increase leverage.
- Prompt Corrective Action framework describes five levels of trigger points which are clearly based on capital measures that are total risk-based capital ratio, Tier 1 risk-based capital ratio, and leverage ratio for the purpose of insured state-chartered non-members banks. These ratios are also described on the basis of pledged assets and eligible assets, and clarification on this is described below.
PCA is divided into five categories are:
- Well capitalized:
- Total risk-based capital ratio of 10%or greater.
- Tier 1 risk-based ratio of 6% or greater.
- Leverage ratio of 5% or greater.
- Adequately capitalized:
- Total risk-based capital ratio of 8% or greater.
- Tier 1 risk-based ratio of 4% or greater.
- Leverage ratio of 4% or greater, and it must be noted that leverage ratio of 3% or greater in case bank is rated composite 1 under CAMELS rating system.
- Total risk-based capital ratio of less than 8%.
- Tier 1 risk-based ratio of less than 4%.
- Leverage ratio of less than 4%, and it must be noted that leverage ratio of less than 3% in case bank is rated composite 1 under CAMELS rating system.
- Significantly undercapitalized
- Total risk-based capital ratio of less than 6%.
- Tier 1 risk-based ratio of less than 3%.
- Leverage ratio of less than 3%.
- Critically undercapitalized:
- When tangible equity to total assets (leverage ratio) is equal to or less than 2%.
- Consequences of bank reaching the levels of undercapitalized, or significantly undercapitalized, or critically undercapitalized:
In case bank reach the level or fall below the level of undercapitalized, or significantly undercapitalized, or critically undercapitalized, then some automatic restrictions stated in section 38 of FDI act are imposed on that bank. These restrictions are related to:
- Payment related to capital distributions and management fees.
- Growth of assets.
- Banks require prior approval related to certain expansion proposals.
- FDIC monitors the bank’s condition on regular basis.
- Bank requires submitting the capital restoration plan.
As stated above, some other additional restrictions are also imposed on significantly undercapitalized and critically undercapitalized banks and that is they are restricted to pay compensation to their senior executive officers of the institution, and in case of critically undercapitalized bank there is one more addition that is they have to take approval from FDIC related to entering into any material transaction other than ordinary operations of business such as operations related to investment, expansion, acquisition, and sale of assets or any other similar operations. They can also conduct operations like they can extend the credit for any transactions which is highly leveraged, amend the charter and laws of the institution, they can amend the methods related to accounting, can pay excessive compensation or bonus, paying high interest significantly on new or renewed liabilities. They can also make payment of amount or interest on any subordinated debt which is beginning within the period of 60 days from critically undercapitalized, and also engaged in any covered transaction. Additionally, FDIC also imposed some additional restrictions on the activities of the critically undercapitalized bank.
Camels rating: Camels rating is supervisory rating system which actually developed in US for the purpose of classifying the overall condition of bank. Generally, it is applied to every bank and also credit institution in US and outside also through various regulators. In case of Adequately capitalized: Leverage ratio of 4% or greater, and it must be noted that leverage ratio of 3% or greater in case bank is rated composite 1 under CAMELS rating system, and in case of Undercapitalized: Leverage ratio of less than 4%, and it must be noted that leverage ratio of less than 3% in case bank is rated composite 1 under CAMELS rating system.
The comptroller of the currency of United States of America conducts examinations of U.S. Bank National Association with the help or through his examiners of his national bank and other staff of the Office of the Comptroller of the Currency. Deficiencies in the bank’s overall program are identified from OCC for the purpose of bank secrecy act/anti money laundering compliance and they also provide information to the Bank related to the findings which conducted from the examinations. Through this process banks and other institutions related to credit elected and acting Board of Directors (“Board”), has executed a Stipulation and Consent to the Issuance of a Consent Order, and that is accepted by the Comptroller (“Stipulation”). By this Stipulation, which is incorporated herein by reference, the Bank has consented to the issuance of this Consent Cease and Desist Order (“Order”) by the Comptroller.
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