Fed Declines Basel III Fix for Sub S Banks

Federal Reserve Chairman Janet Yellen yesterday responded to a letter several House members sent last fall urging regulators to resolve a problem for Subchapter S banks posed by Basel III’s capital conservation buffer. Yellen declined to pursue any policy change, stating that the Fed “continues to believe that the capital conservation buffer should be applied equally to all banking organizations.”

As ABA has noted in its own letters and meetings with regulators, Basel III’s capital conservation buffer prevents banks from making distributions to shareholders when capital falls below a threshold — but because federal tax liability passes through a Sub S bank to individual shareholders, Sub S shareholders can face tax liability even when they have not received a distribution. This puts Sub S banks subject to the buffer at a disadvantage to C corporation banks, which pay any taxes due directly out of the bank’s income.

Yellen said the Fed has flexibility to consider individual requests to make a distribution that would not otherwise be permitted under the capital rule. She added that banks holding more than 1.25 percent capital above the minimum regulatory capital requirement can distribute up to 40 percent of their eligible retained earnings. “As a result, shareholders should be able to pay their tax liabilities under most circumstances.”