Basel III Will Complicate Your Bank’s Deferred Tax Assets

On January 1, 2015, community banks will begin the transition to new Basel III rules. These new capital requirements coming from the Federal Reserve, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency promise to complicate the way that U.S. banks calculate deferred tax assets (DTAs) and deferred tax liabilities (DTLs). Basel III decreases the amount of DTAs that can be used to calculate Tier 1 capital and adds complexity to DTA calculations. A careful comparison of current rules for treatment of DTAs against the new Basel III requirements reveals layers of additional complexity that banks will need to address as they handle tax planning going forward.

Under the new risk-based capital rules required by Basel III, most components of accumulated other comprehensive income (AOCI) are required to be included in bank’s common equity tier one capital (CET1) – unless the financial Institution makes a one-time permanent opt-out election with its March 31, 2015 call report.

Failure to make a timely election will result in the inclusion of unrealized gains on available for sale (AFS) equity securities, unrealized gains and losses on AFS debt securities, and amounts attributed to defined benefit post retirement plans, as CET1 capital. These requirements are likely to increase the volatility of the bank's capital ratios. The current calculation utilizes one overall limit that includes all tax jurisdictions. In contrast, the new regulations require a determination of recoverable taxes on a state-by-state basis. Each state-deferred tax asset will have to be evaluated to determine whether it is realizable based on state specific carryback provisions.

Going forward, multi-state banks will need to balance materiality and precision when evaluating and tracking state-deferred taxes on a jurisdictional basis. Future tax planning should integrate strategies to offset the impact of these new regulatory capital requirements. Banks may need to look for ways to accelerate income generation to reduce deferred tax assets, or consider Accounting Method Changes and certain elections to utilize deferred tax assets. Tracking your deferred items has become more important than ever. HORNE recommends that you start to evaluate the new requirements against your capital ratios now.

How can we help you prepare for and manage the impact of new Basel III capital ratio requirements in your financial institution?