September 5, 2023

CRS Examines How Basel III Would Change the Capital Treatment of Unrealized Losses

In a two-part Insight report, the Congressional Research Service ("CRS") reviewed (i) how proposed amendments to bank capital rules ("Basel III") would change the capital treatment of unrealized losses on the debt securities that large banks hold as assets and (ii) policy considerations on unrealized capital losses post the collapse of Silicon Valley Bank ("SVB").

Impact of "Basel III Endgame" Proposal

In Part 1, CRS examined the impact of recognizing unrealized losses on debt securities held by banks as assets. CRS stated that the proposal would extend the accumulated other comprehensive income ("AOCI") requirement to any U.S. bank with over $100 billion in assets; currently it applies to banks with at least $250 billion in assets. CRS concluded that the number of banks subject to the AOCI requirement would be increased from nine to 36. CRS added that the proposal would "only partially" address the current problem regarding unrealized losses because it would not apply to "held-to-maturity" securities, which "account for over half of banks' unrealized losses."

Unrealized Losses of SVB

In Part 2, CRS called the SVB collapse a "cautionary tale" and stated that the Federal Reserve Board ("FRB") failed to downgrade SVB's interest rate risk management to "less than satisfactory" before the bank's collapse. CRS said that like many banks in 2022, SVB faced unrealized losses on its securities due to rising interest rates, but that SVB might have "changed its behavior" sooner had AOCI been included in its regulatory capital. CRS restated the FRB's findings that SVB was "unusually vulnerable to unrealized losses" and that SVB's total securities holdings were more than double that of peer banks. CRS highlighted that SVB invested over half of its assets in long-term Treasuries and Agency securities with maturity rates greater than 10 years.

CRS concluded that "regulators could manage interest rate risk through supervision instead of capital requirements, but that depends on effective supervision."

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