[Federal Register: October 31, 2007 (Volume 72, Number 210)]
[Proposed Rules]
[Page 61568-61574]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr31oc07-22]
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Proposed Rules
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
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[[Page 61568]]
FARM CREDIT ADMINISTRATION
12 CFR Part 615
RIN 3052-AC25
Funding and Fiscal Affairs, Loan Policies and Operations, and
Funding Operations; Capital Adequacy--Basel Accord
AGENCY: Farm Credit Administration.
ACTION: Advance notice of proposed rulemaking (ANPRM).
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SUMMARY: The Farm Credit Administration (FCA or we) is considering
possible modifications to our risk-based capital rules for Farm Credit
System institutions (FCS or System) that are similar to the
standardized approach delineated in the New Basel Capital Accord. We
are seeking comments to facilitate the development of a proposed rule
that would enhance our regulatory capital framework and more closely
align minimum capital requirements with risks taken by System
institutions. We are also withdrawing our previously published ANPRM.
DATES: You may send comments on or before March 31, 2008.
ADDRESSES: We offer several methods for the public to submit comments.
For accuracy and efficiency reasons, commenters are encouraged to
submit comments by e-mail or through the Agency's Web site or the
Federal eRulemaking Portal. Regardless of the method you use, please do
not submit your comment multiple times via different methods. You may
submit comments by any of the following methods:
E-mail: Send us an e-mail at reg-comm@fca.gov.
Agency Web site: http://www.fca.gov. Select ``Legal
Info,'' then ``Pending Regulations and Notices.''
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Mail: Gary K. Van Meter, Deputy Director, Office of
Regulatory Policy, Farm Credit Administration, 1501 Farm Credit Drive,
McLean, VA 22102-5090.
Fax: (703) 883-4477. Posting and processing of faxes may
be delayed, as faxes are difficult for us to process and achieve
compliance with section 508 of the Rehabilitation Act. Please consider
another means to comment, if possible.
You may review copies of comments we receive at our office in
McLean, Virginia, or on our Web site at http://www.fca.gov. Once you
are in the Web site, select ``Legal Info,'' and then select ``Public
Comments.'' We will show your comments as submitted, but for technical
reasons we may omit items such as logos and special characters.
Identifying information that you provide, such as phone numbers and
addresses, will be publicly available. However, we will attempt to
remove e-mail addresses to help reduce Internet spam.
FOR FURTHER INFORMATION CONTACT: Laurie Rea, Associate Director, Office
of Regulatory Policy, Farm Credit Administration, McLean, VA 22102-
5090, (703) 883-4232, TTY (703) 883-4434, or Wade Wynn, Policy Analyst,
Office of Regulatory Policy, Farm Credit Administration, McLean, VA
22102-5090, (703) 883-4262, TTY (703) 883-4434, or Rebecca S. Orlich,
Senior Counsel, Office of General Counsel, Farm Credit Administration,
McLean, VA 22102-5090, (703) 883-4020, TTY (703) 883-4020.
SUPPLEMENTARY INFORMATION:
I. Objectives
The objective of this ANPRM is to gather information to facilitate
the development of a comprehensive proposal that would:
1. Promote safe and sound banking practices and a prudent level of
regulatory capital for System institutions; \1\
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\1\ The System was created by Congress in 1916 and is the oldest
GSE in the United States. System institutions provide credit and
financially related services to farmers, ranchers, producers or
harvesters of aquatic products, and farmer-owned cooperatives. They
also make credit available for agricultural processing and marketing
activities, rural housing, certain farm-related businesses,
agricultural and aquatic cooperatives, rural utilities, and foreign
and domestic entities in connection with international agricultural
trade.
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2. Improve the risk sensitivity of our regulatory capital
requirements while avoiding undue regulatory burden;
3. To the extent appropriate, minimize differences in regulatory
capital requirements between System institutions and federally
regulated banking organizations; \2\ and
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\2\ Banking organizations include commercial banks, savings
associations, and their respective bank holding companies.
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4. Foster economic growth in agriculture and rural America through
the effective allocation of System capital.
In addition, we are withdrawing our previous ANPRM on capital,
published in the Federal Register on June 21, 2007 (72 FR 34191), as
described more fully below.
II. Background
The FCA's risk-based capital requirements for System institutions
are contained in subparts H and K of part 615 of our regulations.\3\
Our risk-based capital framework is based, in part, on the
``International Convergence of Capital Measurement and Capital
Standards'' (Basel I) as published by the Basel Committee on Banking
Supervision (Basel Committee) \4\ and is broadly consistent with the
capital requirements of the other Federal financial regulatory
agencies.\5\ We first adopted a risk-based capital framework for the
System as part of our 1988 regulatory capital revisions \6\ required by
the Agricultural Credit Act of 1987 \7\ and made subsequent revisions
in 1997,\8\ 1998 \9\ and 2005.\10\ Under the current capital framework,
each on- and off-balance sheet credit exposure is assigned to one of
five broad risk-weighting categories to determine the
[[Page 61569]]
risk-adjusted asset base, which is the denominator for computing the
permanent capital, total surplus, and core surplus ratios.
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\3\ Our regulations can be accessed at http://www.fca.gov/index.html
.
\4\ The Basel Committee on Banking Supervision was established
in 1974 by central banks with bank supervisory authorities in major
industrialized countries. The Basel Committee formulates standards
and guidelines related to banking and recommends them for adoption
by member countries and others. All Basel Committee documents are
available at http://www.bis.org.
\5\ We refer collectively to the Office of the Comptroller of
the Currency, the Board of Governors of the Federal Reserve System,
the Federal Deposit Insurance Corporation, and the Office of Thrift
Supervision as the ``other Federal financial regulatory agencies.''
\6\ See 53 FR 39229 (October 6, 1988).
\7\ Pub. L. 100-233 (January 6, 1988), section 301. The 1987 Act
amended many provisions of the Farm Credit Act of 1971, as amended,
which is codified at 12 U.S.C. 2001 et seq.
\8\ See 62 FR 4429 (January 30, 1997).
\9\ See 63 FR 39219 (July 22, 1998).
\10\ See 70 FR 35336 (June 17, 2005).
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For a number of years, the Basel Committee has worked to develop a
more risk sensitive regulatory capital framework that incorporates
recent innovations in the financial services industry. In June 2004, it
published the ``International Convergence of Capital Measurement and
Capital Standards: A Revised Framework'' (Basel II) to promote improved
risk measurement and management processes and more closely align
capital requirements with risk.\11\ Basel II has three pillars: (1)
Minimum capital requirements for credit risk, operational risk, and
market risk, (2) supervision of capital adequacy, and (3) market
discipline through enhanced public disclosure. Banking organizations
have various options for calculating the minimum capital requirements
for credit and operational risk. For credit risk, the options are the
standardized approach, the foundation internal ratings-based approach,
and the advanced internal ratings-based approach (A-IRB). For
operational risk, the options are the basic indicator approach, the
standardized approach, and the advanced measurement approach (AMA).
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\11\ See http://www.bis.org/publ/bcbsca.htm for the 2004 Basel
II Accord as well as updates in 2005 and 2006.
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In September 2006, the other Federal financial regulatory agencies
issued an interagency notice of proposed rulemaking for implementing
the advanced approaches of Basel II in the United States (the advanced
capital framework).\12\ This advanced capital framework would require
core banks \13\ and permit opt-in banks \14\ to use the A-IRB \15\ to
calculate the regulatory capital requirement for credit risk and the
AMA \16\ to calculate the regulatory capital requirement for
operational risk.\17\
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\12\ See 71 FR 55830 (September 25, 2006). This document is at
http://www.federalreserve.gov/generalinfo/basel2/USImplementation.htm
.
\13\ Core banks are banking organizations that have consolidated
total assets of $250 billion or more or have consolidated on-balance
sheet foreign exposures of $10 billion or more.
\14\ Opt-in banks are banking organizations that do not meet the
definition of a core bank but have the risk management and
measurement capabilities to voluntarily implement the advanced
approaches of Basel II with supervisory approval.
\15\ A banking organization computes internal estimates of
certain key risk parameters for each credit exposure or pool of
exposures and feeds the results into regulatory formulas to
determine the risk-based capital requirement for credit risk.
\16\ Internal operational risk management systems and processes
are used to compute risk-based capital requirements for operational
risk.
\17\ The other Federal financial regulatory agencies also seek
comments on whether core and opt-in banks should be permitted to use
other credit and operational risk approaches.
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Given the small number of core banks and the complexity and cost
associated with voluntarily adopting the advanced approaches, only a
small number of U.S. banking organizations are expected to implement
the advanced capital framework. As a result, a bifurcated regulatory
capital framework will be created in the United States, which could
result in different regulatory capital charges for similar products
offered by those that apply the advanced capital framework and those
that do not. Financial regulators, banking organizations, trade
associations and other interested parties have raised concerns that the
bifurcated structure could create a significant competitive
disadvantage for those that do not apply the advanced capital
framework.
In December 2006, the other Federal financial regulatory agencies
addressed these concerns by issuing an interagency notice of proposed
rulemaking (Basel IA) to improve the risk sensitivity of the existing
Basel I-based capital framework.\18\ Subsequently, the FCA issued an
ANPRM,\19\ published in June 2007, addressing issues similar to those
addressed in Basel IA. Basel IA was intended to help minimize the
potential differences in the regulatory minimum capital requirements of
those banks applying the advanced capital framework and those banks
that would not. The other Federal financial regulatory agencies
received a significant number of comments opposing their Basel IA
proposal. Many commenters argued that the benefits of complying with
Basel IA did not outweigh the burdens, and many questioned why the U.S.
banking agencies were creating a separate rule that had only minor
differences from the standardized approach under Basel II. On July 20,
2007, the other Federal financial regulatory agencies announced that
they intended to replace the Basel IA proposal with a proposed rule
that would provide all non-core banks the option to adopt the
standardized approach under Basel II.\20\ Their stated intent is to
finalize a standardized approach for banks that do not adopt the
advanced approaches before the core (and opt-in) banks begin their
first transition period year under the advanced approaches of Basel II.
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\18\ 71 FR 77446 (December 26, 2006). This document is at http://www.federalreserve.gov/generalinfo/basel2/USImplementation.htm
.
\19\ 72 FR 34191 (June 21, 2007).
\20\ Joint Press Release, ``Banking Agencies Reach Agreement On
Basel II Implementation,'' (July 20, 2007). This document is at
http://www.occ.gov/ftp/release/2007-77.htm.
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The other Federal financial regulatory agencies plan to replace
Basel IA with a proposed rule patterned after the standardized approach
under Basel II. Consequently, we are withdrawing our previous ANPRM and
replacing it with one that is also consistent with the standardized
approach. We intend to develop a proposed rule that is similar to the
capital requirements of the other Federal financial regulatory agencies
where appropriate but also tailored to fit the System's distinct
borrower-owned lending cooperative structure and Government-sponsored
enterprise (GSE) mission.
The questions posed in this ANPRM are, for the most part, similar
to the questions we asked in our previous ANPRM.\21\ We have revised
the technical material in most places to conform to the standardized
approach of Basel II. For example, we replaced the risk-weight
categories that were in the Basel IA proposed rule with the risk-weight
categories that are contained in the standardized approach under Basel
II. We ask commenters to consider the revised material when answering
the following questions. We seek comments from all interested parties
to help us develop a comprehensive proposal that would enhance our
regulatory capital framework and increase the risk sensitivity of our
risk-based capital rules without unduly increasing regulatory burden.
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\21\ Questions 1, 3, 4, 5, 9 and 10 in this ANPRM are identical
to those numbered questions posed in our previous ANPRM. Questions
2, 6 and 11 are slightly different. Question 7 in this ANPRM
replaces Questions 7 and 8 in our previous ANPRM. Questions 8, 12,
and 16 are new to this ANPRM. Questions 13 through 15 are identical
to Questions 12 through 14 in our previous ANPRM. Question 17 is
identical to Question 15 in our previous ANPRM.
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III. Questions
When addressing the following questions, we ask commenters to
consider the overarching objectives of Basel II to more closely align
capital with the specific risks taken by the financial institution
rather than relying on a ``one-size-fits-all'' approach for determining
regulatory minimum risk-based capital requirements. Our objective is to
develop a more dynamic risk-based capital framework that is more
sensitive to the relative risks inherent in System lending and other
mission-related activities. We seek comments on specific criteria that
might be used to determine appropriate risk weights that meet this
objective without
[[Page 61570]]
creating undue burden. Specifically, we ask that you support your
comments with data, to the extent possible, in response to our
questions.\22\
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\22\ Please note that any data you submit will be made available
to the public in our rulemaking file.
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A. Increase the Number of Risk-Weight Categories
Our existing risk-based capital rules assign exposures to one of
five risk-weight categories: 0, 20, 50, 100, and 200 percent.\23\ The
standardized approach of Basel II adds risk-weight categories of 35,
75, and 150 percent and replaces the 200-percent risk-weight category
with a 350-percent risk-weight category.\24\ The 35-percent risk-weight
category would apply to certain residential mortgages. The 75-percent
risk-weight category would apply to certain retail claims (e.g., small
business loans). The 150-percent and 350-percent risk-weight categories
would apply to certain higher risk externally rated exposures (e.g.,
those below investment grade).
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\23\ FCA's risk-weight categories are set forth in 12 CFR
615.5211.
\24\ Basel IA proposed adding risk-weight categories of 35, 75,
and 150 percent.
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Question 1: We seek comment on what additional risk-weight
categories, if any, we should consider for assigning risk weights to
System institutions' on- and off-balance sheet exposures. If additional
risk-weight categories are added, what assets should be included in
each new risk-weight category?
B. Use of External Credit Ratings To Assign Risk-Weight Exposures
1. Direct Exposures
In recent years, the FCA has permitted System institutions to use
external ratings to assign risk weights to certain credit exposures
linked to nationally recognized statistical rating organizations
(NRSROs) ratings.\25\ For example, in March 2003, we adopted an interim
final rule that permitted System institutions to use NRSRO ratings to
place highly rated investments in non-agency asset-backed securities
(ABS) and mortgage-backed securities (MBS) in the 20-percent risk-
weight category.\26\ In April 2004, we expanded the use of NRSRO
ratings to assign risk weights to loans to other financing
institutions.\27\ In June 2005, we adopted a ratings-based approach to
assign risk weights to recourse obligations, direct credit substitutes
(DCS), residual interests (other than credit-enhancing interest-only
strips), and other ABS and MBS investments.\28\ Furthermore, we
recently permitted the use of NRSRO ratings to assign risk weights to
certain electric cooperative credit exposures.\29\
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\25\ A NRSRO is a credit rating organization that is recognized
by and registered with the Securities and Exchange Commission (SEC)
as a nationally recognized statistical rating organization. See 12
CFR 615.5201. See also Pub. L. 109-291.
\26\ See 68 FR 15045 (March 28, 2003).
\27\ Other financing institutions are non-System financial
institutions that borrow from System banks. See 69 FR 29852 (May 26,
2004).
\28\ These changes are consistent with those of the other
Federal financial regulatory agencies. See 70 FR 35336 (June 17,
2005).
\29\ See ``Revised Regulatory Capital Treatment for Certain
Electric Cooperatives Assets,'' FCA Bookletter BL-053 (February 12,
2007).
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The standardized approach of Basel II expands the use of NRSRO
ratings to determine the risk-based capital charge for long-term
exposures to sovereign entities, non-central government public sector
entities (PSEs), banks,\30\ corporate entities, and securitizations as
displayed in Table 1 set forth below.\31\
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\30\ Banks include multilateral development banks and securities
firms.
\31\ Basel IA proposed the categories sovereign entities, non-
sovereign entities, and securitizations with different risk-weight
categories.
Table 1.--The Standardized Approach Risk Weights Based on External Ratings for Long-Term Exposures
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PSE and bank * risk
Sovereign weights (in Corporate
Credit assessment risk weight percent) risk weight Securitization ** risk
(in percent) ---------------------- (in percent) weight (in percent)
Option 1 Option 2
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AAA to AA-.................... 0 20 20 20 20.
A+ to A-...................... 20 50 50 50 50.
BBB+ to BBB-.................. 50 100 50 100 100.
BB+ to BB-.................... 100 100 100 100 350.
B+ to B-...................... 100 100 100 150 Deduction.***
Below B-...................... 150 150 150 150 Deduction.***
Unrated....................... 100 100 50 100 Deduction.***
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* The Standardized Approach provides two options for PSEs and bank exposures: (1) Option 1 assigns a risk weight
one category below that of sovereigns; (2) Option 2 assigns a risk weight based on the individual bank rating.
Option 2 also provides risk weights for short-term claims as follows: (1) AAA to BBB- and unrated = 20
percent; (2) BB+ to B-= 50 percent; and (3) Below B-= 150 percent.
** Short-term rating categories are as follows: (1) A-1/P-1 = 20 percent; (2) A-2/P-2 = 50 percent; (3) A-3/P-3
= 100 percent; and (4) All other ratings or unrated = Deduction.
*** Banks must deduct the entire amount from capital. However, if banks originate a securitization and the most
senior exposure is unrated, the bank may use the ``look through'' treatment, which is the average risk weight
of the underlying exposures subject to supervisory review.
System institutions provide financing to agriculture and rural
America through a variety of lending \32\ and investment \33\ products.
They also hold highly rated liquid investments to manage liquidity,
short-term surplus funds, and interest rate risk. Our existing risk-
based capital rules assign most agricultural and rural business \34\
loans and mission-related investment assets to the 100-percent risk-
weight category unless the risk exposure is mitigated by an acceptable
guarantee or collateral. The FCA is considering the expanded use of
NRSRO ratings to assign risk weights to other externally rated credit
exposures in the System, such as corporate debt securities and loans.
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\32\ The Farm Credit Banks provide wholesale funding to their
affiliated associations who, in turn, make retail loans to eligible
borrowers. CoBank, ACB, provides both wholesale funding to its
affiliated associations and retail loans to cooperatives and other
eligible borrowers.
\33\ System banks and associations are permitted to make
mission-related investments to agriculture and rural America. See
``Investments in Rural America-Pilot Investment Programs,'' FCA
Informational Memorandum (January 11, 2005).
\34\ Agricultural businesses include farmer-owned cooperatives,
food and fiber processors and marketers, manufacturers and
distributors of agricultural inputs and services, and other
agricultural-related businesses. Rural businesses include electric
utilities and other energy-related businesses, communication
companies, water and waste disposal businesses, ethanol plants, and
other rural-related businesses.
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Question 2: We seek comments on all aspects of the appropriateness
of using NRSRO ratings to assign risk weights to
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credit exposures. If we expand the use of external ratings, how should
we align the risk-weight categories with NRSRO ratings to determine the
appropriate capital charge for externally rated credit exposures?
Should any externally rated positions be excluded from this new
ratings-based approach? We ask commenters to consider the substantial
reliance on NRSRO ratings as a means of evaluating the quality of debt
investments in view of recent events in the subprime mortgage market.
2. Recognized Financial Collateral
Our current risk-based capital rules assign lower risk weights to
exposures collateralized by: (1) Cash held by a System institution or
its funding bank; (2) securities issued or guaranteed by the U.S.
Government, its agencies or Government-sponsored agencies; (3)
securities issued or guaranteed by central governments in other OECD
\35\ countries; (4) securities issued by certain multilateral lending
or regional development institutions; or (5) securities issued by
qualifying securities firms.
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\35\ OECD stands for the Organization for Economic Cooperation
and Development. The OECD is an international organization of
countries that are committed to democratic government and the market
economy. An up-to-date listing of member countries is available at
http://www.oecd.org or http://www.oecdwash.org._____________________________________-
The standardized approach of Basel II has two methods for
recognizing a wider variety of collateral types for risk-weighting
purposes.\36\ Under the simple approach, the collateralized portion of
the exposure would be assigned a risk weight (as listed in Table 1)
according to the external rating of the collateral. The remainder of
the exposure would be assigned a risk weight appropriate to the
counterparty. Collateral would be subject to a 20-percent floor unless
the collateral is cash, certain government securities or repurchase
agreements, and it would be marked-to-market and revalued every 6
months. Securities issued by sovereigns or PSEs must be rated at least
BB-or its equivalent by a NRSRO. Securities issued by other entities
must be rated at least BBB-or its equivalent by an NRSRO. Short-term
debt instruments used as collateral must be rated at least A-3/P-3 or
its equivalent by an NRSRO.
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\36\ Basel IA proposed assigning lower risk weights to exposures
collateralized by securities issued by sovereigns or non-sovereigns
that were externally rated at least investment grade.
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Under the comprehensive approach, the banking organization adjusts
the value of the exposure by the discounted value of the collateral.
Discount values, known as supervisory haircuts, are displayed in Table
2 set forth below. For example, sovereign debt rated A+ with a 5-year
maturity used as collateral is discounted by 3 percent, and corporate
debt rated A+ with a 5-year maturity is discounted at 6 percent.
Table 2.--Standard Supervisory Haircuts in the Comprehensive Approach
for Credit Mitigation
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Sovereigns Other
Issue rating for debt Residual and PSEs * issuers **
securities maturity (in (in
percent) percent)
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AAA to AA- or A-............. < = 1 year...... 0.5 1
> 1 year, <= 5 2 4
years.
> 5 years...... 4 8
A+ to BBB- or A-2/A-3/P-3.... < = 1 year...... 1 2
> 1 year, <= 5 3 6
years.
> 5 years...... 6 12
BB+ to BB-................... All............ 15 ...........
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* Includes PSEs treated as sovereigns.
** Includes PSEs not treated as sovereigns.
Question 3: We seek comment on whether recognizing additional types
of eligible collateral would improve the risk sensitivity of our risk-
based capital rules without being overly burdensome. We also seek
comment on what additional types of collateral, if any, we should
consider and what effect the collateral should have on the risk
weighting of System exposures.
3. Eligible Guarantors
Our existing capital rules permit the use of third party guarantees
to lower the risk weight of certain exposures. Guarantors include: (1)
The U.S. Government, its agencies or Government-sponsored agencies; (2)
U.S. state and local governments; (3) central governments and banks in
OECD countries; (4) central governments in non-OECD countries (local
currency exposures only); (5) banks in non-OECD countries (short-term
claims only); (6) certain multilateral lending and regional development
institutions; and (7) qualifying securities firms.
The standardized approach of Basel II expands the range of eligible
guarantors to include sovereign entities, PSEs, banks and securities
firms that have a lower risk weight than the counterparty.\37\ All
other guarantors must be rated A- (or its equivalent) or better by a
NRSRO. The guarantee must: (1) Represent a direct claim on the
protection provider, (2) be explicitly referenced to specific exposures
or pools of exposures, (3) be irrevocable, and (4) unconditional. The
guarantor's risk weight would be substituted for the risk weight
assigned to the exposure. Non-guaranteed portions of the exposure would
be assigned to the external rating of the exposure.
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\37\ Basel IA proposed to include guarantees from any entity
that had long-term senior debt rated at least investment grade (or
issuer rating if a sovereign).
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Question 4: We seek comment on what additional types of third party
guarantees, if any, we should recognize and what effect such guarantees
should have on the risk weighting of System exposures.
C. Direct Loans to System Associations
The FCA is considering ways to better align our risk-based capital
requirements for direct loans with System associations. System banks
make direct loans to their affiliated associations who, in turn, make
retail loans to eligible borrowers. Our current risk-based capital
rules assign a 20-percent risk weight to direct loans at the bank level
and another risk weight (depending upon the type of loan) to retail
loans at the association level.\38\ The 20-percent risk weight is
intended to recognize the risks to the banks associated with lending to
their
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affiliated associations. We are exploring methods to improve the risk
sensitivity of our risk-based capital rules by assigning different risk
weights to direct loan exposures based on the System association's
distinct risk profile.
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\38\ Our risk-based capital rules also assign a 20-percent risk
weight to similar GSE and OECD depository institution exposures.
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Question 5: We seek comment on what evaluative criteria or methods
we should use to assign risk weights to direct loans to System
associations. How should the criteria be used to adjust the risk weight
as the quality of the direct loan changes over time?
D. Small Agricultural and Rural Business Loans
Our existing risk-based capital rules assign small agricultural and
rural business loans to the 100-percent risk-weight category unless the
credit risk is mitigated by an acceptable guarantee or acceptable
collateral. The standardized approach of Basel II applies a 75-percent
risk weight to certain retail claims \39\ provided: (1) The exposure is
to an individual person or persons or to a small business, (2) the
exposure is in the form of a revolving credit, line of credit, personal
term loan or lease, or small business facility or commitment, (3) the
regulatory supervisor is satisfied that the retail portfolio is
sufficiently diversified to warrant such a risk weight, and (4) the
total credit exposure to the borrower does not exceed approximately
$1.4 million.\40\
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\39\ The other Federal financial regulatory agencies stated in
Basel IA that they were exploring options to permit certain small
business loans to qualify for a 75-percent risk weight.
\40\ We present a comparable threshold in terms of U.S. dollars.
The standardized approach of Basel II has a threshold of [euro]1
million.
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Question 6: We seek comment on what approaches we should use to
improve the risk sensitivity of our risk-based capital rules for small
agricultural and rural business loans. More specifically, what criteria
should we use to classify an agricultural or rural business as a small
business? What criteria should we use to assign risk-weights of less
than 100 percent to these types of loans?
E. Loans Secured by Liens on Real Estate
The FCA is considering ways to use loan-to-value ratios (LTV) and
other criteria to determine the risk-based capital charges for farm
real estate and qualified residential loans. Our existing capital rules
assign farm real estate loans to the 100-percent risk-weight category
and qualified residential loans \41\ to the 50-percent risk-weight
category. The standardized approach of Basel II assigns a 35-percent
risk weight to all prudently underwritten residential mortgages. Basel
IA had proposed to risk-weight loans secured by first and second liens
on residential real estate based on LTV. We continue to believe that
LTV is a viable option for determining appropriate risk-weights for
farm real estate and qualified residential loans. We are also
considering approaches that would combine borrower creditworthiness and
other loan characteristics in conjunction with LTV.
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\41\ Qualified residential loans are rural home loans (as
defined by 12 CFR 613.3030) and single-family residential loans to
bona fide farmers, ranchers, or producers or harvesters of aquatic
products that meet the requirements listed in 12 CFR 615.5201.
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Question 7: We seek comment on all aspects of using LTV to
determine the appropriate risk-weight for farm real estate, qualified
residential loans, or any other asset class. We also welcome comments
on other methods that could be used to improve the risk sensitivity of
our risk-based capital rules for these types of loans.
F. Loans 90 Days or More Past Due or in Nonaccrual \42\
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\42\ This section was not in the previous ANPRM.
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Our existing risk-based capital rules assign most loans to the 100-
percent risk-weight category unless the credit risk is mitigated by an
acceptable guarantee or collateral. When exposures reach 90 days or
more past due or are in nonaccrual status, there is a higher
probability that the financial institution might incur a loss. The
standardized approach of Basel II addresses this potentially higher
risk of loss by assigning the unsecured portion of a loan that is 90
days or more past due (net of specific provisions) as follows:
150-percent risk weight when specific provisions are less
than 20 percent of the outstanding amount of the loan;
100-percent risk weight when specific provisions are 20
percent or more of the outstanding amount of the loan;
When specific provisions are 50 percent or more of the
outstanding amount of the loan, the supervisor has the discretion to
reduce the risk weight to 50 percent.
Question 8: We seek comment on all aspects related to risk-
weighting exposures that reach 90 days or more past due or are in
nonaccrual status.
G. Short- and Long-Term Commitments
Under Sec. 615.5212, off-balance sheet commitments are generally
risk-weighted in two steps: (1) The off-balance sheet commitment is
multiplied by a credit conversion factor (CCF) \43\ to determine its
on-balance sheet credit equivalent; and (2) the on-balance sheet credit
equivalent is assigned to the appropriate risk-weight category in Sec.
615.5211 according to the obligor, after considering any applicable
collateral and guarantees.\44\ The standardized approach of Basel II
assigns a 0-percent CCF to unconditionally cancelable commitments,\45\
a 20-percent CCF to short-term commitments, and a 50-percent CCF to
long-term commitments.\46\
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\43\ A CCF is a number by which an off-balance sheet item is
multiplied to obtain a credit equivalent before placing the item in
a risk-weight category.
\44\ Our existing regulations assign a 0-percent CCF to unused
commitments with an original maturity of 14 months or less. Unused
commitments with an original maturity of greater than 14 months can
also receive a 0-percent CCF provided the commitment is
unconditionally cancelable and the System institution has the
contractual right to make a separate credit decision before each
drawing under the lending arrangement. All other unused commitments
with an original maturity of greater than 14 months are assigned a
50-percent CCF.
\45\ An unconditionally cancelable commitment is one that can be
canceled for any reason at any time without prior notice.
\46\ Basel IA proposed to retain the 0-percent CCF for all
unconditionally cancelable commitments, apply a 10-percent CCF to
all other short-term commitments, and retain the 50-percent CCF for
all long-term commitments.
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Question 9: We seek comment on what approaches we should use to
risk weight short- and long-term commitments that are not
unconditionally cancelable.
H. Adjusting Risk Weights on Exposures Over Time
The FCA welcomes comment on additional approaches or criteria that
might be used to adjust the risk weight of exposures throughout the
life of the asset. Our existing risk-based capital rules assign a
static risk weight to assets within a given asset class without
providing for risk-weight adjustments as asset quality improves or
deteriorates. For example, most loans to System borrowers are risk-
weighted at 100 percent throughout the life of the loan without making
risk-weight adjustments based on credit classifications or other credit
performance factors.
Question 10: We seek comment on what methods we should use to
adjust the risk weight of credit exposures as the asset quality or
default probability changes over time.
I. Capital Charge for Operational Risk
The FCA welcomes comments on possible approaches for determining a
capital charge for operational risk. The broad risk-weighting
categories under our existing capital rules are primarily
[[Page 61573]]
designed to protect against credit or counterparty risk. As we move
toward a more risk-sensitive capital framework, it may be appropriate
to apply an explicit capital charge for operational risk, especially to
cover risks associated with off-balance sheet activity.
Basel II defines operational risk as the risk of loss resulting
from inadequate or failed internal processes, people, systems, or from
external events. This definition includes legal risk but excludes
strategic and reputational risk. As previously mentioned, Basel II has
three methods for applying a capital charge for operational risk. Under
the basic indicator approach, the operational capital charge is equal
to 15 percent of the 3-year average of positive annual gross income.
Under the standardized approach, the operational capital charge is
equal to the sum of a fixed percentage of the 3-year average of the
gross income of eight business lines.\47\ Under the AMA, the
operational capital charge is derived from a bank's internal
operational risk management systems and processes.
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\47\ Each business line is multiplied by a fixed percentage and
then summed together to determine the annual gross income. The eight
lines of business are corporate finance (18 percent), trading and
sales (18 percent), retail banking (12 percent), commercial banking
(15 percent), payment and settlement (18 percent), agency services
(15 percent), asset management (12 percent), and retail brokerage
(12 percent).
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Question 11: We seek comment on what approach we should consider,
if any, in determining a risk-based capital charge for operational
risk.
J. Disclosure \48\
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\48\ This section was not in the previous ANPRM.
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The FCA recognizes that market discipline contributes to a safe and
sound banking environment and enhances risk management practices.
Pillar III of Basel II is designed to complement the minimum capital
requirements and supervisory review process by encouraging market
discipline through meaningful public disclosure. The disclosure
requirements are intended to allow market participants to assess key
information about an institution's risk profile and associated level of
capital to better evaluate risk management performance, earnings
potential and financial strength.
Pillar III of Basel II presents the following general disclosure
requirements: (1) Banks should have a formal disclosure policy approved
by the board of directors that addresses the institution's approach for
determining the disclosures it should make; \49\ (2) banks should
implement a process for assessing the appropriateness of their
disclosures, including validation and frequency of them; (3) banks
should decide which disclosures are relevant based on the materiality
concept; \50\ and (4) the disclosures should be made on a semi-annual
basis, subject to certain exceptions.\51\
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\49\ Disclosure is a qualifying criterion under Pillar I to
obtain lower risk weightings and/or to apply specific methodologies.
\50\ Pillar III of Basel II provides minimum disclosure
requirements on capital structure and adequacy, and risk exposure
and assessment on credit risk, market risk, operational risk,
equities, and interest rate risk in the banking book.
\51\ Disclosure of key capital ratios should be made on a
quarterly basis. Qualitative disclosures providing a general summary
of a bank's risk management objective and policies, reporting system
and definitions may be published on an annual basis.
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The other Federal financial regulatory agencies have proposed the
following additional requirements in the advanced capital framework:
(1) The disclosures would follow U.S. generally accepted accounting
principles, SEC mandates, and existing regulatory reporting
requirements; (2) the banks would be required to disclose quantitative
information on a quarterly basis following SEC deadlines; (3) the
disclosures would be made publicly available (for example, on a Web
site) for each of the last 3 years (that is, 12 quarters); \52\ (4)
disclosure of key financial ratios must be provided in the footnotes to
the year-end audited financial statements; \53\ (5) the chief financial
officer must certify that the disclosures are appropriate; and (6) the
board of directors and senior management are responsible for
establishing the internal control structure over financial reporting.
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\52\ U.S. Basel II banks are encouraged to provide this
information in one place on the entity's public Web site.
\53\ These disclosures would be tested by external auditors as
part of the financial statement audit.
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Question 12: We seek comment on all aspects of the Basel II public
disclosure requirements. Specifically, how would the System apply the
public disclosure requirements of Pillar III given its unique
cooperative structure?
K. Capital Leverage Ratio
We are considering whether we should supplement our existing risk-
based capital rules with a minimum capital leverage ratio requirement
for all FCS institutions to further promote the safety and soundness of
the System. Our existing capital regulations require System banks to
maintain a minimum net collateral ratio (NCR) \54\ of 103 percent \55\
but do not impose a capital leverage ratio on System associations. The
NCR provides a level of protection for operating and other forms of
risk at System banks, but it does not differentiate higher quality from
lower quality capital. The other Federal financial regulatory agencies
currently supplement their risk-based capital rules with a leverage
ratio of Tier 1 capital to total assets (Tier 1 leverage ratio).\56\
The Tier 1 leverage ratio consists of only the most reliable and
permanent forms of capital such as common stock, non-cumulative
perpetual preferred stock, and retained earnings.
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\54\ The net collateral ratio is a bank's net collateral as
defined in 12 CFR 615.5301(c) divided by the bank's adjusted total
liabilities.
\55\ See 12 CFR 615.5335(a).
\56\ See 12 CFR 3.6(b) and (c); 12 CFR part 208, appendix B and
12 CFR part 225, appendix D; 12 CFR 325.3; and 12 CFR 567.8.
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Question 13: We seek comment on whether our capital rules should
include a minimum capital leverage ratio requirement for all System
institutions. We also seek comment on changes, if any, that should be
made to the existing regulatory minimum NCR requirement applicable to
System banks that would make it more comparable to the Tier 1 ratio
used by the other Federal financial regulatory agencies.
L. Regulatory Capital Directives \57\
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\57\ 12 CFR part 615, subpart M.
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We are considering whether we should modify our capital rules to
specify potential early intervention criteria for the issuance of
capital directives. Currently, FCA has the discretion to issue a
capital directive \58\ when an institution's capital is insufficient.
The FCA, however, has not defined capital or other financial early
intervention thresholds to require an institution to take corrective
action as described in Sec. 615.5355. Early intervention approaches
have been used in other contexts, including the System's Market Access
Agreement and the statutory requirements applicable to other regulated
financial institutions.\59\ An early intervention capital directive
framework could provide a clearer
[[Page 61574]]
indication of when we would impose additional and increasing
supervisory oversight on an institution to address continuing
deterioration in its financial condition and capital position from
credit, interest rate, or other financial risks.
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\58\ A capital directive is defined in Sec. 615.5355(a) as an
order issued to an institution that does not have or maintain
capital at or greater than the minimum ratios set forth in 12 CFR
615.5205, 615.5330, and 615.5335, or established under subpart L of
part 615, or by a written agreement under an enforcement or
supervisory action, or as a condition of approval of an application.
The FCA's authority is set forth in sections 4.3(b)(2) and 4.3A(e)
of the Farm Credit Act (12 U.S.C. 2154(b)(2) and 2154a(e)).
\59\ See 12 U.S.C. 1831o for the prompt corrective action
provisions that apply to commercial banks and savings associations.
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Question 14: We seek comment on revising our current capital
directive regulations to include an early intervention framework. We
also seek comment on potential financial thresholds, such as capital
ratios or risk measures, that would trigger an FCA capital directive
action.
M. Multi-Dimensional Regulatory Structure
As stated above, one of FCA's objectives is to implement a revised
capital framework that improves the risk sensitivity of our capital
rules while avoiding undue regulatory burden. There are currently five
banks and 95 associations in the System with varying degrees of asset
size, complexity of operations, and sophistication in their risk
management practices. Some System institutions have the risk management
capabilities to apply more complex, risk-sensitive regulatory capital
requirements than other System institutions. It may be appropriate for
the FCA to adopt more than one set of capital rules to account for
these differences. However, this approach could result in different
capital requirements for the same type of transaction and increase
examination and oversight costs.
As described above, the other Federal financial regulatory agencies
are in the process of proposing two sets of capital rules for the
financial institutions they regulate. The implementation of the
advanced capital framework would be limited, for the most part, to the
largest, internationally active banks that meet certain infrastructure
requirements. Other banks would implement a simpler capital framework
patterned after the standardized approach of Basel II.
While our expectation is to implement a revised capital framework
similar to the standardized approach of Basel II, we also recognize
that some aspects of the advanced approaches may be appropriate for the
larger, more complex System institutions. However, we are still
reviewing the advanced approaches of Basel II and its potential
application to the System. Therefore, we are not seeking comments on
specific aspects of the advanced approaches at this time. Rather, we
are considering the overall regulatory capital framework for the System
in light of the changes occurring in the financial services industry
and recent best practices for economic capital modeling.
Question 15: We seek comment on the most appropriate risk-based
capital framework for the System and the reasons we should implement
one framework over another. Should we consider creating a uniform
regulatory capital structure for the System or a multi-dimensional
regulatory structure and allow each System institution the option of
choosing which capital framework it will apply? How might this new
risk-based capital framework increase the costs or regulatory burden to
the System? Would the increased costs be justified by improved risk
sensitivity, risk management, and more efficient capital allocation?
N. Reporting Requirements and Transition Period 60
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\60\ This section was not in the previous ANPRM.
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The other Federal financial regulatory agencies have announced that
they will be replacing Basel IA with a proposed rule that would provide
all non-core banks the option of adopting the standardized approach
under Basel II. Their stated intent is to finalize a standardized
approach for non-core banks before the core banks begin their first
transition period year under the advanced capital framework. Our
objective is to minimize, to the extent possible, the time interval
between the issuance of their final rule and ours. We also need a
transition period to make appropriate modifications to the Call
Reporting System to track the new risk-based capital requirements.
Question 16: We seek comment on an appropriate timetable for
implementing our new risk-based capital rules. Specifically, what is an
appropriate time interval between the issuance of the other Federal
financial regulatory agencies' final rule on the standardized approach
of Basel II and ours? How long should the transition period be to allow
System institutions to adjust to the new risk-based capital rules?
Question 17: Additionally, we seek comment on any other methods
that may be used to increase the risk sensitivity of our risk-based
capital rules.
Dated: October 25, 2007.
Roland E. Smith,
Secretary, Farm Credit Administration Board.
[FR Doc. E7-21422 Filed 10-30-07; 8:45 am]
BILLING CODE 6705-01-P