Discover 2010 Annual Report Download - page 74

In September 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee,
announced minimum capital ratios and transition periods and endorsed the statements the Committee released in July
2010. Following endorsement of the Basel III reform package by the Group of Twenty Finance Ministers and Central Bank
Governors (“G-20”) in November 2010, in December 2010 the Basel Committee released the Basel III rules text.
Basel III provides that: (i) the minimum requirement for the Tier 1 common equity ratio will be increased from the
current 2% level to 4.5%, to be phased in by January 1, 2015, and (ii) the minimum requirement for the Tier 1 capital
ratio will be increased from 4% to 6%, to be phased in by January 1, 2015. The Tier 1 common equity ratio will be
calculated after applying certain regulatory deductions, including for deferred tax assets above prescribed limitations that
arise from timing differences.
In addition, Basel III includes a “capital conservation buffer” that requires banking organizations to maintain an
additional 2.5% of Tier 1 common equity to total risk weighted assets on top of the minimum requirement, which will be
phased in between January 1, 2016 and January 1, 2019. The capital conservation buffer is designed to absorb losses
in periods of financial and economic distress and, while banks are allowed to draw on the buffer during periods of stress,
if a bank’s regulatory capital ratios approach the minimum requirement, the bank will be subject to constraints on
earnings distributions. In addition, Basel III includes a countercyclical buffer within a range of 0% – 2.5%, which would be
implemented according to a particular nation’s circumstances.
These capital requirements are supplemented under Basel III by a non-risk-based leverage ratio. A minimum Tier 1
leverage ratio of 3% will be tested during the parallel run period starting January 1, 2013. Based on the results of the
parallel run period, any final adjustments would be carried out in the first half of 2017.
Basel III states that systemically important banks should have higher “loss absorbing capacity” than required by the
Basel III standards. The Committee will complete a study of the magnitude of additional loss absorbency that global
systemically important banks should have by mid-2011. Basel III also reaffirms the Basel Committee’s intention to
introduce higher capital requirements on securitization and trading activities at the end of 2011.
The Basel III liquidity proposals have three main elements: (i) a “liquidity coverage ratio” designed to ensure that a
bank maintains an adequate level of unencumbered high-quality assets sufficient to meet the bank’s liquidity needs over a
30-day time horizon under an acute liquidity stress scenario, (ii) a “net stable funding ratio” designed to promote more
medium and long-term funding of the assets and activities of banks over a one-year time horizon, and (iii) a set of
monitoring tools that the Basel Committee indicates should be considered as the minimum types of information that banks
should report to supervisors. After an observation period beginning in 2011, the liquidity coverage ratio will become
effective on January 1, 2015. The revised net stable funding ratio will become effective January 1, 2018.
Implementation of Basel III in the U.S. will require implementing regulations and guidelines by U.S. banking regulators,
which may differ in significant ways from the recommendations published by the Basel Committee. It is unclear how U.S.
banking regulators will define “well-capitalized” in their implementation of Basel III.
The Reform Act also includes provisions related to increased capital and liquidity requirements. Such provisions would
establish minimum leverage and risk-based capital requirements on a consolidated basis for all depository institution
holding companies and insured depository institutions that cannot be less than the strictest requirements in effect for
depository institutions as of the date of enactment of the Reform Act (i.e., July 21, 2010).
We are not able to predict at this time the precise content of capital and liquidity guidelines or regulations that may be
adopted by regulatory agencies having authority over us and our subsidiaries or the impact that any changes in
regulation would have on us. However, we expect that the new standards will generally require us or our banking
subsidiaries to maintain more capital, with common equity as a more predominant component, or manage the
configuration of our assets and liabilities in order to comply with formulaic liquidity requirements, which could
significantly impact our return on equity, financial condition, operations, capital position and ability to pursue business
opportunities.
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