Banking Regulators Reduce Capital Charges for PPP Loans
Commentary by Steven Lofchie
The OCC, Federal Reserve Board ("FRB") and FDIC (collectively, the "Regulators") adopted an interim final rule that will neutralize the regulatory capital effects of participating in the Paycheck Protection Program Lending Facility (or the "PPPL Facility") for financial institutions.
As previously covered, the PPPL Facility was implemented by the Small Business Administration ("SBA") following the adoption of the Coronavirus, Aid, Relief and Economic Security Act (the "CARES Act"). The PPPL Facility offers (i) non-recourse loans to certain qualified small businesses, in order to encourage the retention of employees during the pandemic, and (ii) loan forgiveness under certain conditions.
Without a rule amendment, the Regulators observed, a financial institution's participation in the PPPL Facility would affect its balance sheet, since PPP covered loans must be originated and held by the financial institution. As a result, such financial institutions would be subject to greater regulatory capital requirements. However, the Regulators stated, due to the "non-recourse nature" of the FRB's extension of credit, a PPP covered loan does not expose a financial institution to credit or market risk. Therefore, under the interim final rule, a financial institution will be allowed to exclude PPPL Facility-related exposure from its (i) total leverage exposure, (ii) average total consolidated assets, (iii) advanced approaches total risk-weighted assets and (iv) standardized total risk-weighted assets.
In accordance with Section 1102 (Paycheck Protection Program), the regulators also clarified that PPP covered loans will receive a zero percent risk weight if they are originated by a financial institution under PPP.
Comments on the interim final rule must be submitted within 30 days following its publication in the Federal Register.
Commentary
From an economic perspective, this rule proposal is quite similar to the FRB's emergency rule change to modify the Supplementary Leverage Ratio so as to exclude from the calculation riskless assets. While both of these measures are a response to what is becoming an economic crisis, they also reflect that leverage ratios and capital requirements that do not take account of the actual risk of assets make very little sense. While the banking regulators instituted such measures in the wake of Dodd-Frank, the coronavirus is causing them to be revisited. The lesson is that measures meant to control risk must take account of risk; a measure that does not distinguish between a riskless asset and a high yield asset is likely to be worthless, and, in this situation, counterproductive as it discourages banks from investing in risk-free assets.