[Federal Register Volume 73, Number 146 (Tuesday, July 29, 2008)]
[Proposed Rules]
[Pages 43982-44060]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-16262]
[[Page 43981]]
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Part II
Department of the Treasury
Office of the Comptroller of the Currency
12 CFR Part 3
Federal Reserve System
12 CFR Parts 208 and 225
Federal Deposit Insurance Corporation
12 CFR Part 325
Department of the Treasury
Office of Thrift Supervision
12 CFR Part 567
Risk-Based Capital Guidelines; Capital Adequacy Guidelines:
Standardized Framework; Proposed Rule
Federal Register / Vol. 73, No. 146 / Tuesday, July 29, 2008 /
Proposed Rules
[[Page 43982]]
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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 3
[Docket ID: OCC-2008-0006]
RIN 1557-AD07
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-1318]
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AD29
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
12 CFR Part 567
[No. 2008-002]
RIN 1550-AC19
Risk-Based Capital Guidelines; Capital Adequacy Guidelines:
Standardized Framework
AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of
Governors of the Federal Reserve System; Federal Deposit Insurance
Corporation; and Office of Thrift Supervision, Treasury.
ACTION: Joint notice of proposed rulemaking.
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SUMMARY: The Office of the Comptroller of the Currency (OCC), Board of
Governors of the Federal Reserve System (Board), Federal Deposit
Insurance Corporation (FDIC), and Office of Thrift Supervision (OTS)
(collectively, the agencies) propose a new risk-based capital framework
(standardized framework) based on the standardized approach for credit
risk and the basic indicator approach for operational risk described in
the capital adequacy framework titled ``International Convergence of
Capital Measurement and Capital Standards: A Revised Framework'' (New
Accord) released by the Basel Committee on Banking Supervision. The
standardized framework generally would be available, on an optional
basis, to banks, bank holding companies, and savings associations
(banking organizations) that apply the general risk-based capital
rules.
DATES: Comments on this joint notice of proposed rulemaking must be
received by October 27, 2008.
ADDRESSES: Comments should be directed to:
OCC: Because paper mail in the Washington, DC area and at the OCC
is subject to delay, commenters are encouraged to submit comments by e-
mail, if possible. Please use the title ``Risk-Based Capital
Guidelines; Capital Adequacy Guidelines: Standardized Framework;
Proposed Rule and Notice'' to facilitate the organization and
distribution of the comments. You may submit comments by any of the
following methods:
Federal eRulemaking Portal--``Regulations.gov'': Go to
http://www.regulations.gov, under the ``More Search Options'' tab click
next to the ``Advanced Docket Search'' option where indicated, select
``Comptroller of the Currency'' from the agency drop-down menu, then
click ``Submit.'' In the ``Docket ID'' column, select OCC-2008-0006 to
submit or view public comments and to view supporting and related
materials for this notice of proposed rulemaking. The ``How to Use This
Site'' link on the Regulations.gov home page provides information on
using Regulations.gov, including instructions for submitting or viewing
public comments, viewing other supporting and related materials, and
viewing the docket after the close of the comment period.
E-mail: [email protected].
Mail: Office of the Comptroller of the Currency, 250 E
Street, SW., Mail Stop 1-5, Washington, DC 20219.
Fax: (202) 874-4448.
Hand Delivery/Courier: 250 E Street, SW., Attn: Public
Information Room, Mail Stop 1-5, Washington, DC 20219.
Instructions: You must include ``OCC'' as the agency name and
``Docket Number OCC-2008-0006'' in your comment. In general, OCC will
enter all comments received into the docket and publish them on the
Regulations.gov Web site without change, including any business or
personal information that you provide such as name and address
information, e-mail addresses, or phone numbers. Comments received,
including attachments and other supporting materials, are part of the
public record and subject to public disclosure. Do not enclose any
information in your comment or supporting materials that you consider
confidential or inappropriate for public disclosure.
You may review comments and other related materials that pertain to
this [insert type of rulemaking action] by any of the following
methods:
Viewing Comments Electronically: Go to http://www.regulations.gov, under the ``More Search Options'' tab click next
to the ``Advanced Document Search'' option where indicated, select
``Comptroller of the Currency'' from the agency drop-down menu, then
click ``Submit.'' In the ``Docket ID'' column, select ``OCC-2008-0006''
to view public comments for this rulemaking action.
Viewing Comments Personally: You may personally inspect
and photocopy comments at the OCC's Public Information Room, 250 E
Street, SW., Washington, DC. For security reasons, the OCC requires
that visitors make an appointment to inspect comments. You may do so by
calling (202) 874-5043. Upon arrival, visitors will be required to
present valid government-issued photo identification and submit to
security screening in order to inspect and photocopy comments.
Docket: You may also view or request available background
documents and project summaries using the methods described above.
Board: You may submit comments, identified by Docket No. R-1318, by
any of the following methods:
Agency Web Site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: [email protected]. Include docket
number in the subject line of the message.
FAX: (202) 452-3819 or (202) 452-3102.
Mail: Jennifer J. Johnson, Secretary, Board of Governors
of the Federal Reserve System, 20th Street and Constitution Avenue,
NW., Washington, DC 20551.
All public comments are available from the Board's Web site at
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, your
comments will not be edited to remove any identifying or contact
information. Public comments may also be viewed electronically or in
paper form in Room MP-500 of the Board's Martin Building (20th and C
Street, NW.) between 9 a.m. and 5 p.m. on weekdays.
FDIC: You may submit by any of the following methods:
Federal eRulemaking Portal: http://www.regulations.gov
Follow the instructions for submitting comments.
[[Page 43983]]
Agency Web site: http://www.FDIC.gov/regulations/laws/federal/propose.html.
Mail: Robert E. Feldman, Executive Secretary, Attention:
Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th
Street, NW., Washington, DC 20429.
Hand Delivered/Courier: The guard station at the rear of
the 550 17th Street Building (located on F Street), on business days
between 7 a.m. and 5 p.m.
E-mail: [email protected].
Public Inspection: Comments may be inspected and
photocopied in the FDIC Public Information Center, Room E-1002, 3502
Fairfax Drive, Arlington, VA 22226, between 9 a.m. and 5 p.m. on
business days.
Instructions: Submissions received must include the Agency name and
title for this notice. Comments received will be posted without change
to http://www.FDIC.gov/regulations/laws/federal/propose.html, including
any personal information provided.
OTS: You may submit comments, identified by OTS-2008-0002, by any
of the following methods:
Federal eRulemaking Portal: ``Regulations.gov'': Go to
http://www.regulations.gov, under the ``more Search Options'' tab click
next to the ``Advanced Docket Search'' option where indicated, select
``Office of Thrift Supervision'' from the agency dropdown menu, then
click ``Submit.'' In the ``Docket ID'' column, select ``OTS-2008-0002''
to submit or view public comments and to view supporting and related
materials for this proposed rulemaking. The ``How to Use This Site''
link on the Regulations.gov home page provides information on using
Regulations.gov, including instructions for submitting or viewing
public comments, viewing other supporting and related materials, and
viewing the docket after the close of the comment period.
Mail: Regulation Comments, Chief Counsel's Office, Office
of Thrift Supervision, 1700 G Street, NW., Washington, DC 20552,
Attention: OTS-2008-0002.
Facsimile: (202) 906-6518.
Hand Delivery/Courier: Guard's Desk, East Lobby Entrance,
1700 G Street, NW., from 9 a.m. to 4 p.m. on business days, Attention:
Regulation Comments, Chief Counsel's Office, Attention: OTS-2008-0002.
Instructions: All submissions received must include the
agency name and docket number for this rulemaking.
All comments received will be entered into the docket and posted on
Regulations.gov without change, including any personal information
provided. Comments, including attachments and other supporting
materials received are part of the public record and subject to public
disclosure. Do not enclose any information in your comment or
supporting materials that you consider confidential or inappropriate
for public disclosure.
Viewing Comments Electronically: Go to http://www.regulations.gov, select ``Office of Thrift Supervision'' from the
agency drop-down menu, then click ``Submit.'' Select Docket ID ``OTS-
2008-0002'' to view public comments for this notice of proposed
rulemaking.
Viewing Comments On-Site: You may inspect comments at the
Public Reading Room, 1700 G Street, NW., by appointment. To make an
appointment for access, call (202) 906-5922, send an e-mail to
public.info@ots.treas.gov">public.info@ots.treas.gov, or send a facsimile transmission to (202)
906-6518. (Prior notice identifying the materials you will be
requesting will assist us in serving you.) We schedule appointments on
business days between 10 a.m. and 4 p.m. In most cases, appointments
will be available the next business day following the date we receive a
request.
FOR FURTHER INFORMATION CONTACT:
OCC: Margot Schwadron, Senior Risk Expert, (202) 874-6022, Capital
Policy Division; Carl Kaminski, Attorney; or Ron Shimabukuro, Senior
Counsel, Legislative and Regulatory Activities Division, (202) 874-
5090; Office of the Comptroller of the Currency, 250 E Street, SW.,
Washington, DC 20219.
Board: Barbara Bouchard, Associate Director, (202) 452-3072; or
William Tiernay, Senior Supervisory Financial Analyst, (202) 872-7579,
Division of Banking Supervision and Regulation; or Mark E. Van Der
Weide, Assistant General Counsel, (202) 452-2263; or April Snyder,
Counsel, (202) 452-3099, Legal Division. For the hearing impaired only,
Telecommunication Device for the Deaf (TDD), (202) 263-4869.
FDIC: Nancy Hunt, Senior Policy Analyst, (202) 898-6643; Ryan
Sheller, Capital Markets Specialist, (202) 898-6614; or Bobby R. Bean,
Chief, Policy Section, Capital Markets Branch, (202) 898-3575, Division
of Supervision and Consumer Protection; or Benjamin W. McDonough,
Senior Attorney, (202) 898-7411, or Michael B. Phillips, Counsel, (202)
898-3581, Supervision and Legislation Branch, Legal Division, Federal
Deposit Insurance Corporation, 550 17th Street, NW., Washington, DC
20429.
OTS: Michael Solomon, Director, Capital Policy Division, (202) 906-
5654; or Teresa Scott, Senior Project Manager, Capital Policy Division,
(202) 906-6478, Office of Thrift Supervision, 1700 G Street, NW.,
Washington, DC 20552.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
II. Proposed Rule
A. Applicability of the Standardized Framework
B. Reservation of Authority
C. Principle of Conservatism
D. Merger and Acquisition Transition Provisions
E. Calculation of Tier 1 and Total Qualifying Capital
F. Calculation of Risk-Weighted Assets
1. Total Risk-Weighted Assets
2. Calculation of Risk-Weighted Assets for General Credit Risk
3. Calculation of Risk-Weighted Assets for Unsettled
Transactions, Securitization Exposures, and Equity Exposures
4. Calculation of Risk-Weighted Assets for Operational Risk
G. External and Inferred Ratings
1. Overview
2. Use of External Ratings
H. Risk-Weight Categories
1. Exposures to Sovereign Entities
2. Exposures to Certain Supranational Entities and Multilateral
Development Banks (MDBs)
3. Exposures to Depository Institutions, Foreign Banks, and
Credit Unions
4. Exposures to Public Sector Entities (PSEs)
5. Corporate Exposures
6. Regulatory Retail Exposures
7. Residential Mortgage Exposures
8. Pre-Sold Construction Loans and Statutory Multifamily
Mortgages
9. Past Due Loans
10. Other Assets
I.Off-Balance Sheet Items
J. OTC Derivative Contracts
1. Background
2. Treatment of OTC Derivative Contracts
3. Counterparty Credit Risk for Credit Derivatives
4. Counterparty Credit Risk for Equity Derivatives
5. Risk Weight for OTC Derivative Contracts
K. Credit Risk Mitigation (CRM)
1. Guarantees and Credit Derivatives
2. Collateralized Transactions
L. Unsettled Transactions
M. Risk-Weighted Assets for Securitization Exposures
1. Securitization Overview and Definitions
2. Operational Requirements
3. Hierarchy of Approaches
4. Ratings-Based Approach (RBA)
5. Exposures that Do Not Qualify for the RBA
6. CRM for Securitization Exposures
7. Risk-Weighted Assets for Early Amortization Provisions
8. Maximum Capital Requirement
N. Equity Exposures
1. Introduction and Exposure Measurement
2. Hedge Transactions
3. Measures of Hedge Effectiveness
4. Simple Risk-Weight Approach (SRWA)
5. Non-Significant Equity Exposures
6. Equity Exposures to Investment Funds
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7. Full Look-Through Approach
8. Simple Modified Look-Through Approach
9. Alternative Modified Look-Through Approach
10. Money Market Fund Approach
O. Operational Risk
1. Basic Indicator Approach (BIA)
2. Advanced Measurement Approach (AMA)
P. Supervisory Oversight and Internal Capital Adequacy
Assessment
Q. Market Discipline
1. Overview
2. General Requirements
3. Frequency/Timeliness
4. Location of Disclosures and Audit/Certification Requirements
5. Proprietary and Confidential Information
6. Summary of Specific Public Disclosure Requirements
III. Regulatory Analysis
A. Regulatory Flexibility Act Analysis
B. OCC Executive Order 12866 Determination
C. OTS Executive Order 12866 Determination
D. OCC Executive Order 13132 Determination
E. Paperwork Reduction Act
F. OCC Unfunded Mandates Reform Act of 1995 Determination
G. OTS Unfunded Mandates Reform Act of 1995 Determination
H. Solicitation of Comments on Use of Plain Language
I. Background
In 1989, the agencies implemented a risk-based capital framework
for U.S. banking organizations (general risk-based capital rules).\1\
The agencies based the framework on the ``International Convergence of
Capital Measurement and Capital Standards'' (Basel I), released by the
Basel Committee on Banking Supervision (Basel Committee) \2\ in 1988.
The general risk-based capital rules established a uniform risk-based
capital system that was more risk sensitive and addressed several
shortcomings in the capital regimes the agencies used prior to 1989.
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\1\ 12 CFR part 3, Appendix A (OCC); 12 CFR parts 208 and 225,
Appendix A (Board); 12 CFR part 325, Appendix A (FDIC); and 12 CFR
part 567, subpart B (OTS). The risk-based capital rules generally do
not apply to bank holding companies with less than $500 million in
assets. 71 FR 9897 (February 28, 2006).
\2\ The Basel Committee was established in 1974 by central banks
and governmental authorities with bank supervisory responsibilities.
Current member countries are Belgium, Canada, France, Germany,
Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden,
Switzerland, the United Kingdom, and the United States.
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In June 2004, the Basel Committee introduced a new capital adequacy
framework, the New Accord,\3\ that is designed to promote improved risk
measurement and management processes and better align minimum risk-
based capital requirements with risk. The New Accord includes three
options for calculating risk-based capital requirements for credit risk
and three options for operational risk. For credit risk, the three
approaches are: standardized, foundation internal ratings-based, and
advanced internal ratings-based. For operational risk, the three
approaches are: basic indicator (BIA), standardized, and advanced
measurement (AMA). The advanced internal ratings-based approach and the
AMA together are referred to as the ``advanced approaches.''
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\3\ ``International Convergence of Capital Measurement and
Capital Standards, A Revised Framework, Comprehensive Version,'' the
Basel Committee on Banking Supervision, June 2006. The text is
available on the Bank for International Settlements Web site at
http://www.bis.org/publ/bcbs128.htm.
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On September 25, 2006, the agencies issued a notice of proposed
rulemaking to implement the advanced approaches in the United States
(advanced approaches NPR).\4\ Many of the commenters on the advanced
approaches NPR requested that the agencies harmonize certain provisions
of the agencies' proposal with the New Accord and offer the
standardized approach in the United States. A number of these
commenters supported making the standardized approach available for all
U.S. banking organizations.
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\4\ 71 FR 55830 (September 25, 2006).
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On December 7, 2007, the agencies issued a final rule implementing
the advanced approaches (advanced approaches final rule).\5\ The
advanced approaches final rule is mandatory for certain banking
organizations and voluntary for others. In general, the advanced
approaches final rule requires a banking organization that has
consolidated total assets of $250 billion or more, has consolidated on-
balance sheet foreign exposure of $10 billion or more, or is a
subsidiary or parent of an organization that uses the advanced
approaches (core banking organization) to implement the advanced
approaches. The implementation of the advanced approaches has created a
bifurcated regulatory capital framework in the United States: one set
of risk-based capital rules for banking organizations using the
advanced approaches (advanced approaches organizations), and another
set for banking organizations that do not use the advanced approaches
(general banking organizations).
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\5\ 72 FR 69288 (December 7, 2007).
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On December 26, 2006, the agencies issued a notice of proposed
rulemaking (Basel IA NPR), which proposed modifications to the general
risk-based capital rules for general banking organizations.\6\ One
objective of the Basel IA NPR was to enhance the risk sensitivity of
the risk-based capital rules without imposing undue regulatory burden.
Specifically, the agencies proposed to increase the number of risk-
weight categories, expand the use of external ratings for assigning
risk weights, broaden recognition of collateral and guarantors, use
loan-to-value ratios (LTV ratios) to risk weight most residential
mortgages, increase the credit conversion factor for various short-term
commitments, assess a risk-based capital requirement for early
amortizations in securitizations of revolving retail exposures, and
remove the 50 percent risk-weight limit for derivative transactions.
The Basel IA NPR also sought comment on the extent to which certain
advanced approaches organizations should be permitted to use approaches
other than the advanced approaches in the New Accord.
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\6\ 71 FR 77446 (December 26, 2006).
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Most commenters on the Basel IA NPR supported the agencies' goal to
make the general risk-based capital rules more risk sensitive without
adding undue regulatory burden. However, a number of the commenters
representing a broad range of U.S. banking organizations and trade
associations urged the agencies to implement the New Accord's
standardized approach for credit risk in the United States. These
commenters generally stated that the standardized approach is more risk
sensitive than the Basel IA NPR and would more appropriately address
the industry's concerns regarding domestic and international
competitiveness. Most of these commenters requested that the U.S.
implementation of the standardized approach closely follow the New
Accord. Certain commenters also requested that the agencies make some
or all of the other options for credit risk and operational risk in the
New Accord available in the United States. For example, some commenters
preferred implementation of the standardized approach without a
separate capital requirement for operational risk. Other commenters
supported including one or more of the approaches in the New Accord for
operational risk.
II. Proposed Rule
After considering the comments on both the Basel IA and the
advanced approaches NPRs, the agencies have decided not to finalize the
Basel IA NPR and to propose instead a new risk-based capital framework
that would implement the standardized approach for credit risk, the BIA
for operational
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risk, and related disclosure requirements (collectively, this NPR or
this proposal). This NPR generally parallels the relevant approaches in
the New Accord. This NPR, however, diverges from the New Accord where
the U.S. markets have unique characteristics and risk profiles, notably
the proposal for risk weighting residential mortgage exposures. The
agencies have also sought to make this NPR consistent where relevant
with the advanced approaches final rule.
This NPR would not modify how a banking organization that uses the
standardized framework would calculate its leverage ratio
requirement.\7\ Banking organizations face risks other than credit and
operational risks that neither the New Accord nor this NPR addresses.
The leverage ratio is a straightforward measure of solvency that
supplements the risk-based capital requirements. Consequently, the
agencies continue to view the tier 1 leverage ratio and other
prudential safeguards such as Prompt Corrective Action as important
components of the regulatory capital regime.
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\7\ 12 CFR 3.6(b) and (c)(OCC); 12 CFR part 208, Appendix B and
12 CFR part 225, Appendix D (Board); 12 CFR 325.3 (FDIC); and 12 CFR
567.8 (OTS).
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Question 1a: The agencies seek comments on all aspects of this
proposal, including risk sensitivity, regulatory burden, and
competitive impact.
The agencies' general risk-based capital rules permit the use of
external ratings issued by a nationally recognized statistical rating
organization (NRSRO) to assign risk weights to recourse obligations,
direct credit substitutes, certain residual interests, and asset- and
mortgage-backed securities. The New Accord permits a banking
organization to use external ratings to determine risk weights for a
broad range of exposures, including sovereign, bank, corporate, and
securitization exposures. It also provides, within certain limitations,
for the use of both inferred ratings and issuer ratings. As discussed
in more detail later in this preamble, the agencies propose that
external, issuer, and inferred ratings be used to risk weight various
exposures. While the agencies believe that the use of ratings proposed
in this NPR can contribute to a more risk-sensitive framework, they are
aware of the limitations associated with using credit ratings for risk-
based capital purposes and, thus, are particularly interested in
comments on the use of such ratings for those purposes.
Numerous bank supervisory groups and committees, including the
Basel Committee on Banking Supervision, the Financial Stability Forum,
and the Senior Supervisors Group, have undertaken work to better
understand the causes for and possible responses to the recent market
events, discussing, among numerous other issues, the role of credit
ratings. In addition, in March, the President's Working Group on
Financial Markets (PWG) issued its report titled ``Policy Statement on
Financial Market Developments,'' providing an analysis of the
underlying factors contributing to the recent market stress and a set
of recommendations to address identified weaknesses. Among its
recommendations, the PWG encouraged regulators, including the Federal
banking agencies, to review the current use of credit ratings in the
regulation and supervision of financial institutions. In this regard,
the PWG policy statement noted that certain investors and asset
managers failed to obtain sufficient information or to conduct
comprehensive risk assessments, with some investors relying exclusively
on credit ratings for valuation purposes. More generally, the PWG
statement also noted market participants, including originators,
underwriters, asset managers, credit rating agencies, and investors,
failed to obtain sufficient information or to conduct comprehensive
risk assessments on complex instruments, including securitized credits
and their underlying asset pools.
The PWG policy statement also acknowledged the steps already taken
by credit rating agencies to improve the performance of credit ratings
and encouraged additional actions, potentially including the
publication of sufficient information about the assumptions underlying
their credit rating methodologies; changes to the credit rating process
to clearly differentiate ratings for structured products from ratings
for corporate and municipal securities; and ratings performance
measures for structured credit products and other asset-backed
securities readily available to the public in a manner that facilitates
comparisons across products and credit ratings.
Most directly relevant to this NPR, the agencies were encouraged to
reinforce steps taken by the credit rating agencies through revisions
to supervisory policy and regulation, including regulatory capital
requirements that use ratings. At a minimum, regulators were urged to
distinguish, as appropriate, between ratings of structured credit
products and ratings of corporate and municipal bonds in regulatory and
supervisory policies.
Question 1b: The agencies seek comment on the advantages and
disadvantages of the use of external credit ratings in risk-based
capital requirements for banking organizations and whether identified
weakness in the credit rating process suggests the need to change or
enhance any of the proposals in this NPR. The agencies also seek
comment on whether additional refinements to the proposals in the NPR
should be considered to address more broadly the prudent use of credit
ratings by banking organizations. For example, should there be
operational conditions for banking organizations to make use of credit
ratings in determining risk-based capital requirements, enhancements to
minimum capital requirements, or modifications to the supervisory
review process?
The agencies also note that efforts are underway by the BCBS to
review the treatment in the New Accord for certain off-balance sheet
conduits, resecuritizations, such as collateralized debt obligations
referencing asset-backed securities, and other securitization-related
risks. The agencies are fully committed to working with the BCBS in
this regard and also intend to review the agencies' current approach to
securitization transactions to assess whether modifications might be
needed. This review will take into account lessons learned from recent
market-related events and may result in additional proposals for
modification to the risk-based capital rules.
Question 1c: The agencies seek commenters' views on what changes to
the approaches set forth in this NPR, if any, should be considered as a
result of recent market events, particularly with respect to the
securitization framework described in this NPR.
A. Applicability of the Standardized Framework
Most commenters on the Basel IA NPR favored its opt-in approach,
whereby a banking organization could voluntarily decide whether or not
to use the proposed rules. They supported the flexibility of the opt-in
provision and the ability of a general banking organization to remain
under the general risk-based capital rules. Commenters observed that
many banking organizations choose to hold capital well in excess of
regulatory minimums and would not necessarily benefit from a more risk-
sensitive capital rule. For these commenters, limiting regulatory
burden was a higher priority than increasing the risk
[[Page 43986]]
sensitivity of their risk-based capital requirements.
The agencies acknowledge this concern and propose to make the
standardized framework optional for banking organizations that do not
use the advanced approaches final rule to calculate their risk-based
capital requirements.\8\ Under this NPR, a banking organization that
opts to use the standardized framework generally would have to notify
its primary Federal supervisor in writing of its intent to use the new
rules at least 60 days before the beginning of the calendar quarter in
which it first uses the standardized framework. This notice must
include a list of any affiliated depository institutions or bank
holding companies, if applicable, that seek supervisory exemption from
the use of the standardized framework. Before it notifies its primary
Federal supervisor, the banking organization should review its ability
to implement the proposed rule and evaluate the potential impact on its
regulatory capital.
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\8\ The agencies are not proposing in this NPR to make this
standardized framework available to banking organizations for which
the application of the advanced approaches final rule is mandatory,
unless such a banking organization is exempted in writing from the
advanced approaches final rule by its primary Federal supervisor.
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Under this proposal, a banking organization that opts to use this
standardized framework could return to the general risk-based capital
rules by notifying its primary Federal supervisor in writing at least
60 days before the beginning of the calendar quarter in which it
intends to opt out of the standardized framework. The banking
organization would have to include in its notice an explanation of its
rationale for ceasing to use the standardized framework and identify
the risk-based capital framework it intends to use. The primary Federal
supervisor would review this notice to ensure that the use of the
general risk-based capital rules would be appropriate for that banking
organization.\9\ The agencies expect that a banking organization would
not alternate between the general risk-based capital rules and this
standardized framework.
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\9\ The primary Federal supervisor may waive the 60-day notice
period for opting in to the standardized framework and for returning
to the general risk-based capital rules.
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Any general banking organization could generally continue to
calculate its risk-based capital requirements using the general risk-
based capital rules without notifying its primary Federal supervisor.
The primary Federal supervisor would, however, have the authority to
require a general banking organization to use a different risk-based
capital rule if that supervisor determines that a particular capital
rule is appropriate in light of the banking organization's asset size,
level of complexity, risk profile, or scope of operations.
Under section 1(b) of the proposed rule, if a bank holding company
opts in to the standardized framework, its subsidiary depository
institutions also would apply the standardized framework. Similarly, if
a depository institution opts in to the standardized framework, its
parent bank holding company (where applicable) and any subsidiary
depository institutions of the parent holding company generally would
be required to apply the standardized rules as well. Savings and loan
holding companies, however, are not subject to risk-based capital
rules. Accordingly, if a savings association opts in to the proposed
rule, the proposed rule would not apply to the savings and loan holding
company or to a subsidiary depository institution of that holding
company, unless the subsidiary depository institution is directly
controlled by the savings association.
The agencies believe that this approach serves as an important
safeguard against regulatory capital arbitrage among affiliated banking
organizations. The agencies recognize, however, that there may be
infrequent situations where the use of the standardized rules could
create undue burden at individual depository institutions within a
corporate family. Therefore, under section 1(c) of the proposed rule, a
banking organization that would otherwise be required to apply the
standardized rule because a related banking organization has elected to
apply it may instead use the general risk-based capital rules if its
primary Federal supervisor determines in writing that that application
of the standardized framework is not appropriate in light of the
banking organization's asset size, level of complexity, risk profile,
or scope of operations. When seeking such a determination, the banking
organization should provide a rationale for its request. The primary
Federal supervisor may consider potential capital arbitrage issues
within a corporate structure in making its determination.
Question 2: The agencies seek comment on the proposed applicability
of the standardized framework and in particular on the degree of
flexibility that should be provided to individual depository
institutions within a corporate family, keeping in mind regulatory
burden issues as well as ways to minimize the potential for regulatory
capital arbitrage.
In the advanced approaches final rule, the agencies require core
banking organizations to use only the most advanced approaches provided
in the New Accord. As proposed, the standardized framework generally
would be available only for banking organizations that are not core
banking organizations.
Question 3: The agencies seek comment on whether or to what extent
core banking organizations should be able to use the proposed
standardized framework.
B. Reservation of Authority
Under this NPR, a primary Federal supervisor could require a
banking organization to hold an amount of capital greater than would
otherwise be required if that supervisor determines that the risk-based
capital requirements under the standardized framework are not
commensurate with the banking organization's credit, market,
operational, or other risks. In addition, the agencies expect that
there may be instances when the standardized framework would prescribe
a risk-weighted asset amount for one or more exposures that was not
commensurate with the risks associated with the exposures. In such a
case, the banking organization's primary Federal supervisor would
retain the authority to require the banking organization to assign a
different risk-weighted asset amount for the exposures or to deduct the
amount of the exposures from regulatory capital. Similarly, this NPR
proposes to authorize a banking organization's primary Federal
supervisor to require the banking organization to assign a different
risk-weighted asset amount for operational risk if the supervisor were
to find that the risk-weighted asset amount for operational risk
produced by the banking organization under this NPR is not commensurate
with the operational risks of the banking organization.
C. Principle of Conservatism
The agencies believe that in some cases it may be reasonable to
allow a banking organization not to apply a provision of the proposed
rule if not doing so would yield a more conservative result. Under
section 1(f) of the proposed rule, a banking organization may choose
not to apply a provision of the rule to one or more exposures provided
that: (i) The banking organization can demonstrate on an ongoing basis
to the satisfaction of its primary Federal supervisor that not applying
the provision would, in all
[[Page 43987]]
circumstances, unambiguously generate a risk-based capital requirement
for each exposure greater than that which would otherwise be required
under the rule; (ii) the banking organization appropriately manages the
risk of those exposures; (iii) the banking organization provides
written notification to its primary Federal supervisor prior to
applying this principle to each exposure; and (iv) the exposures to
which the banking organization applies this principle are not, in the
aggregate, material to the banking organization.
The agencies emphasize that a conservative capital requirement for
a group of exposures does not reduce the need for appropriate risk
management of those exposures. Moreover, the principle of conservatism
applies to the determination of capital requirements for specific
exposures; it does not apply to the disclosure requirements in section
71 of the proposed rule.
D. Merger and Acquisition Transition Provisions
A banking organization that uses the standardized framework and
that merges with or acquires another banking organization operating
under different risk-based capital rules may not be able to quickly
integrate the acquired organization's exposures into its risk-based
capital system. Under this NPR, a banking organization that uses the
standardized framework and that merges with or acquires a banking
organization that uses the general risk-based capital rules could
continue to use the general risk-based capital rules to calculate the
risk-based capital requirements for the merged or acquired banking
organization's exposures for up to 12 months following the last day of
the calendar quarter during which the merger or acquisition is
consummated. The risk-weighted assets of the merged or acquired company
calculated under the general risk-based capital rules would be included
in the banking organization's total risk-weighted assets. Deductions
associated with the exposures of the merged or acquired company would
be deducted from the banking organization's tier 1 capital and tier 2
capital.
Similarly, where both banking organizations calculate their risk-
based capital requirements under the standardized framework, but the
merged or acquired banking organization uses different aspects of the
framework, the banking organization may continue to use the merged or
acquired banking organization's own systems to determine its
organization's risk-weighted assets for, and deductions from capital
associated with, the merged or acquired banking organization's
exposures for the same time period.
A banking organization that merges with or acquires an advanced
approaches banking organization may use the advanced approaches risk-
based capital rules to determine the risk-weighted asset amounts for,
and deductions from capital associated with, the merged or acquired
banking organization's exposures for up to 12 months after the calendar
quarter during which the merger or acquisition consummates. During the
period when the advanced approaches risk-based capital rules apply to
the merged or acquired company, any allowance for loan and lease losses
(ALLL) associated with the merged or acquired company's exposures must
be excluded from the banking organization's tier 2 capital. Any excess
eligible credit reserves associated with the merged or acquired banking
organization's exposures may be included in that banking organization's
tier 2 capital up to 0.6 percent of that banking organization's risk-
weighted assets. (Excess eligible credit reserves would be determined
according to section 13(a)(2) of the advanced approaches risk-based
capital rules.)
If a banking organization relies on these merger provisions, it
would be required to disclose publicly the amounts of risk-weighted
assets and total qualifying capital calculated under the applicable
risk-based capital rules for the acquiring banking organization and for
the merged or acquired banking organization.
E. Calculation of Tier 1 and Total Qualifying Capital
This NPR would maintain the minimum risk-based capital ratio
requirements of 4.0 percent tier 1 capital to total risk-weighted
assets and 8.0 percent total qualifying capital to total risk-weighted
assets. A banking organization's total qualifying capital is the sum of
its tier 1 (core) capital elements and tier 2 (supplemental) capital
elements, subject to various limits, restrictions, and deductions
(adjustments). The agencies are not restating the elements of tier 1
and tier 2 capital in the proposed rule. Those capital elements
generally would be unchanged from the general risk-based capital
rules.\10\ Deductions or other adjustments would also be unchanged,
except for those provisions discussed below.
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\10\ See 12 CFR part 3, Appendix A, section 2 (national banks);
12 CFR part 208, Appendix A, section II (state member banks); 12 CFR
part 225, Appendix A, section II (bank holding companies); 12 CFR
part 325, Appendix A, section I (state nonmember banks); and 12 CFR
567.5 (savings associations).
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Under this NPR, a banking organization would make certain other
adjustments to determine its tier 1 and total qualifying capital. Some
of these adjustments would be made only to tier 1 capital. Other
adjustments would be made 50 percent to tier 1 capital and 50 percent
to tier 2 capital. If the amount deductible from tier 2 capital exceeds
the banking organization's actual tier 2 capital, the banking
organization would have to deduct the shortfall amount from tier 1
capital. Consistent with the agencies' general risk-based capital
rules, a banking organization would have to have at least 50 percent of
its total qualifying capital in the form of tier 1 capital.
Under this NPR, a banking organization would deduct from tier 1
capital any after-tax gain-on-sale resulting from a securitization.
Gain-on-sale means an increase in a banking organization's equity
capital that results from a securitization, other than an increase in
equity capital that results from the banking organization's receipt of
cash in connection with the securitization. The agencies included this
deduction to offset accounting treatments that produce an increase in a
banking organization's equity capital and tier 1 capital at the
inception of a securitization, for example, a gain attributable to a
credit-enhancing interest-only strip receivable (CEIO) that results
from Financial Accounting Standard (FAS) 140 accounting treatment for
the sale of underlying exposures to a securitization special purpose
entity (SPE).\11\ The agencies expect that the amount of the required
deduction would diminish over time as the banking organization realizes
the increase in equity capital and, thus, tier 1 capital booked at the
inception of the securitization, through actual receipt of cash flows.
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\11\ See Statement of Financial Accounting Standards No. 140,
``Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities'' (September 2000).
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Under the general risk-based capital rules, a banking organization
must deduct CEIOs, whether purchased or retained, from tier 1 capital
to the extent that the CEIOs exceed 25 percent of the banking
organization's tier 1 capital. Under this NPR, a banking organization
would have to deduct CEIOs from tier 1 capital to the extent they
represent after-tax gain-on-sale, and would have to deduct any CEIOs
that do not constitute an after-tax gain-on-sale 50 percent from tier 1
capital and 50 percent from tier 2 capital.
[[Page 43988]]
Under the FDIC, OCC, and Board general risk-based capital rules, a
banking organization must deduct from its tier 1 capital certain
percentages of the adjusted carrying value of its nonfinancial equity
investments. In contrast, OTS general risk-based capital rules require
the deduction of most investments in equity securities from total
capital.\12\ Under this NPR, however, a banking organization would not
deduct these investments. Instead, the banking organization's equity
exposures generally would be subject to the treatment provided in Part
V of this proposed rule.
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\12\ OTS general risk-based capital rules require savings
associations to deduct all ``equity investments'' from total
capital. 12 CFR 567.5(c)(2)(ii). ``Equity investments'' are defined
to include: (i) Investments in equity securities (other than
investments in subsidiaries, equity investments that are permissible
for national banks, indirect ownership interests in certain pools of
assets (for example, mutual funds), Federal Home Loan Bank stock and
Federal Reserve Bank stock); and (ii) investments in certain real
property. 12 CFR 567.1. The proposed treatment of investments in
equity securities is discussed above. Equity investments in real
estate would continue to be deducted to the same extent as under the
general risk-based capital rules.
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A banking organization also would have to deduct from total capital
the amount of certain unsettled transactions and certain securitization
exposures. These deductions are provided in section 21, section 38, and
Part IV of this proposed rule.
Consistent with the advanced approaches final rule, for bank
holding companies with consolidated insurance underwriting subsidiaries
that are functionally regulated (or subject to comparable supervision
and minimum regulatory capital requirements in their home
jurisdiction), the following treatment would apply. The assets and
liabilities of the subsidiary would be consolidated for purposes of
determining the bank holding company's risk-weighted assets. The bank
holding company, however, would deduct 50 percent from tier 1 capital
and 50 percent from tier 2 capital an amount equal to the insurance
underwriting subsidiary's minimum regulatory capital requirement as
determined by its functional (or equivalent) regulator. For U.S.
regulated insurance subsidiaries, this amount generally would be 200
percent of the subsidiary's Authorized Control Level as established by
the appropriate state insurance regulator. Under the general risk-based
capital rules, such subsidiaries typically are fully consolidated with
the bank holding company.
While the elements of tier 1 and tier 2 capital are the same across
the general risk-based capital rules, the advanced approaches final
rule, and this NPR, the deductions from those elements are different
for each of the three risk-based capital frameworks. As a result, each
framework has a distinct definition of tier 1, tier 2, and total
qualifying capital.
Securitization-related deductions create a significant difference
in the calculation of tier 1 and tier 2 capital across the three
frameworks. Under the general risk-based capital rules, only certain
CEIOs must be deducted from capital; all other high-risk exposures for
which dollar-for-dollar capital must be held may be ``grossed-up'' in
accordance with the regulatory reporting instructions, effectively
increasing the denominator of the risk-based capital ratio but not
affecting the numerator. In contrast, under the advanced approaches
final rule and this NPR, certain high risk securitization exposures
must be deducted directly from total capital. Other significant
differences in the definition of tier 1, tier 2, and total qualifying
capital across the three frameworks include the treatment of
nonfinancial equity investments for banks and bank holding companies,
certain equity investments for savings associations, certain unsettled
transactions, consolidated insurance underwriting subsidiaries of bank
holding companies, and the ALLL/eligible credit reserves.
The different definitions of tier 1, tier 2, and total capital
across the risk-based capital frameworks raise a number of issues. The
agencies clarified in the preamble to the advanced approaches rule that
a banking organization's tier 1 capital and tier 2 capital for all non-
regulatory-capital supervisory and regulatory purposes (for example,
lending limits and Regulation W quantitative limits) is the banking
organization's tier 1 capital and tier 2 capital as calculated under
the risk-based capital framework to which it is subject. The agencies
did not specifically state a position regarding the numerator of the
leverage ratio. One potential approach is for each banking organization
to use its applicable risk-based definition of tier 1 capital for
determining both the risk-based and leverage capital ratios. Another
potential approach is to define a numerator for the tier 1 leverage
ratio that would be the same for all banking organizations. This
approach could require banks to calculate one measure of tier 1 capital
for risk-based capital purposes and another measure of tier 1 capital
for leverage ratio purposes.\13\
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\13\ To the extent that the agencies decide to change the
numerator of the leverage ratio, they would propose such changes in
a separate rulemaking. As a related matter, the OTS advanced
approaches final rule incorrectly states that the leverage ratio is
calculated using the revised definition of tier 1 and tier 2
capital. This NPR would remove this provision until the agencies
conclusively resolve this matter.
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Question 4: Given the potential for three separate definitions of
tier 1 capital under the three frameworks, the agencies solicit comment
on all aspects of the tier 1 leverage ratio numerator, including issues
related to burden and competitive equity.
F. Calculation of Risk-Weighted Assets
(1) Total Risk-Weighted Assets
Under this NPR, a banking organization's total risk-weighted assets
would be the sum of its total risk-weighted assets for general credit
risk, unsettled transactions, securitization exposures, equity
exposures, and operational risk. Banking organizations that use the
market risk rule (MRR) would supplement their capital calculations with
those provisions.\14\
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\14\ 12 CFR part 3, Appendix B (national banks); 12 CFR part
208, Appendix E (state member banks); 12 CFR part 225, Appendix E
(bank holding companies); and 12 CFR part 325, Appendix C (state
nonmember banks). OTS intends to codify a market risk capital rule
for savings associations at 12 CFR part 567, Appendix D.
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(2) Calculation of Risk-Weighted Assets for General Credit Risk
For each of its general credit risk exposures (that is, credit
exposures that are not unsettled transactions subject to section 38 of
the proposed rule, securitization exposures, or equity exposures), a
banking organization must first determine the exposure amount and then
multiply that amount by the appropriate risk weight set forth in
section 33 of the proposed rule. General credit risk exposures include
exposures to sovereign entities; exposures to supranational entities
and multilateral development banks; exposures to public sector
entities; exposures to depository institutions, foreign banks, and
credit unions; corporate exposures; regulatory retail exposures;
residential mortgage exposures; pre-sold construction loans; statutory
multifamily mortgage exposures; and other assets.
Generally, the exposure amount for the on-balance sheet component
of an exposure is the banking organization's carrying value for the
exposure. If the exposure is classified as a security available for
sale, however, the exposure amount is the banking organization's
carrying value of the exposure adjusted for unrealized gains and
losses. The exposure amount for the off-balance sheet component of an
exposure is typically determined by multiplying the
[[Page 43989]]
notional amount of the off-balance sheet component by the appropriate
credit conversion factor (CCF) under section 34 of the proposed rule.
The exposure amount for over-the-counter (OTC) derivative contracts is
determined under section 35 of the proposed rule. Exposure amounts for
collateralized OTC derivative contracts, repo-style transactions, or
eligible margin loans may be determined under particular rules in
section 37 of the proposed rule.
(3) Calculation of Risk-Weighted Assets for Unsettled Transactions,
Securitization Exposures, and Equity Exposures
(a) Unsettled Transactions
Risk-weighted assets for specified unsettled and failed securities,
foreign exchange, and commodities transactions are calculated according
to paragraph (f) of section 38 of the proposed rule.\15\
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\15\ Certain transaction types are excluded from the scope of
section 38, as provided in paragraph (b) of section 38.
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(b) Securitization Exposures
Risk-weighted assets for securitization exposures are calculated
according to Part IV of the proposed rule. Generally, a banking
organization would calculate the risk-weighted asset amount of a
securitization exposure by multiplying the amount of the exposure as
determined in section 42 of the proposed rule by the appropriate risk
weight in section 43 of this NPR.
Part IV of the proposed rule provides a hierarchy of approaches for
calculating risk-weighted assets for securitization exposures. Among
the approaches included in Part IV is a ratings-based approach (RBA),
which calculates the risk-weighted asset amount of a securitization
exposure by multiplying the amount of the exposure by risk-weights that
correspond to the applicable external or applicable inferred rating of
the securitization. Part IV provides other treatments for specific
types of securitization exposures including deduction from capital for
certain exposures, and different risk-weighted asset computations for
certain securitizations exposures that do not qualify for the RBA and
for securitizations that have an early amortization provision.
(c) Equity Exposures
Risk-weighted assets for equity exposures are calculated according
to the rules in Part V of the proposed rule. Generally, risk-weighted
assets for equity exposures that are not exposures to investment funds
would be calculated according to the simple risk-weight approach (SRWA)
in section 52 of this proposed rule. Risk-weighted assets for equity
exposures to investment funds would, with certain exceptions, be
calculated according to one of three look-through approaches or, if the
investment fund qualifies, calculated according to the money market
fund approach. These approaches are described in section 53 of the
proposed rule.
(4) Calculation of Risk-Weighted Assets for Operational Risk
Risk-weighted assets for operational risk are calculated under the
BIA provided in section 61 of this proposed rule.
G. External and Inferred Ratings
(1) Overview
The agencies' general risk-based capital rules permit the use of
external ratings issued by a nationally recognized statistical rating
organization (NRSRO) to assign risk weights to recourse obligations,
direct credit substitutes, residual interests (other than a credit-
enhancing interest-only strip), and asset- and mortgage-backed
securities.\16\ Under the ratings-based approach in the general risk-
based capital rules, a banking organization must use the lowest NRSRO
external rating if multiple ratings exist. The approach also requires
one rating for a traded exposure and two ratings for a non-traded
exposure and allows the use of inferred ratings within a securitization
structure. When the agencies revised their general risk-based capital
rules to permit the use of external ratings issued by an NRSRO for
these exposures, the agencies acknowledged that these ratings
eventually could be used to determine the risk-based capital
requirements for other types of debt instruments, such as externally
rated corporate bonds.
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\16\ Some synthetic structures also may be subject to the
external rating approach. For example, certain credit-linked notes
issued from a synthetic securitization are risk weighted according
to the rating given to the notes. 66 FR 59614, 59622 (November 29,
2001).
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The New Accord would permit a banking organization to use external
ratings to determine risk weights for a broad range of exposures. It
also provides for the use of both inferred and, within certain
limitations, issuer ratings, but discourages the use of unsolicited
ratings. Generally consistent with the New Accord, and in response to
favorable comments on the Basel IA NPR's proposal to expand the use of
external ratings, the agencies propose that external, issuer, and
inferred ratings be used to risk weight various exposures.
This proposed use of ratings is a more risk-sensitive approach than
relying on membership in the Organization for Economic Cooperation and
Development (OECD) \17\ to differentiate the risk of exposures to
sovereign entities, depository institutions, foreign banks, and credit
unions. The proposed approach also would use a greater number of risk
weights than the general risk-based capital rules, which would further
improve the risk sensitivity of a banking organization's risk-based
capital requirements.
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\17\ The OECD-based group of countries comprises all full
members of the OECD, as well as countries that have concluded
special lending arrangements with the International Monetary Fund
(IMF) associated with the IMF's General Arrangements to Borrow. The
list of OECD countries is available on the OECD Web site at http://www.oecd.org.
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Consistent with the agencies' general risk-based capital rules and
the advanced approaches final rule, the agencies propose to recognize
only credit ratings that are issued by an NRSRO. For the purposes of
this NPR, NRSRO means an entity registered with the U.S. Securities and
Exchange Commission (SEC) as an NRSRO under section 15E of the
Securities Exchange Act of 1934 (15 U.S.C. 78o-7).\18\
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\18\ See 17 CFR 240.17g-1. On September 29, 2006, the President
signed the Credit Rating Agency Reform Act of 2006 (``Reform Act'')
(Pub. L. 109-291) into law. The Reform Act requires a credit rating
agency that wants to represent itself as an NRSRO to register with
the SEC. The agencies may review their risk-based capital rules,
guidance and proposals from time to time to determine whether any
modification of the agencies' definition of an NRSRO is appropriate.
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(2) Use of External Ratings
Under this NPR, a banking organization would use the applicable
external rating of an exposure (for certain exposures that have
external ratings) to determine its risk weight. Additionally,
consistent with the New Accord, the banking organization would infer a
rating for certain exposures that do not have external ratings from the
issuer rating of the obligor or from the external rating of another
specific issue of the obligor. The agencies' proposal for the use of
external and inferred ratings, however, differs in some respects from
the New Accord, as described below.
(a) External Ratings
Under this NPR, an external rating means a credit rating that is
assigned by an NRSRO to an exposure, provided that the credit rating
fully reflects the entire amount of credit risk with regard to all
payments owed to the holder of the exposure. If, for example, a holder
is
[[Page 43990]]
owed principal and interest on an exposure, the credit rating must
fully reflect the credit risk associated with timely repayment of
principal and interest. If a holder is owed only principal on an
exposure, the credit rating must fully reflect only the credit risk
associated with timely repayment of principal. Furthermore, a credit
rating would qualify as an external rating only if it is published in
an accessible form and is or will be included in the transition
matrices made publicly available by the NRSRO that summarize the
historical performance of positions rated by the NRSRO. An external
rating may be either solicited or unsolicited by the obligor issuing
the rated exposure. This definition is consistent with the definition
of ``external rating'' in the advanced approaches final rule.
Under this NPR, a banking organization would determine the risk
weight for certain exposures with external ratings based on the
applicable external ratings of the exposures. If an exposure to a
sovereign or public sector entity (PSE), a corporate exposure, or a
securitization exposure has only one external rating, that rating is
the applicable external rating. If such an exposure has multiple
external ratings, the applicable external rating would be the lowest
external rating. This approach for determining the applicable external
rating differs from the New Accord. In the New Accord, if an exposure
has two external ratings, a banking organization would apply the lower
rating to the exposure to determine the risk weight. If an exposure has
three or more external ratings, the banking organization would use the
second lowest external rating to risk weight the exposure. The agencies
believe that the proposed approach, which is designed to mitigate the
potential for external ratings arbitrage, more reliably promotes safe
and sound banking practices.
(b) Inferred Ratings
Consistent with the New Accord, the agencies propose that a banking
organization must, subject to certain conditions, infer a rating on an
exposure to a sovereign entity or a PSE or on a corporate exposure that
does not have an applicable external rating (unrated exposure).\19\ An
inferred rating may be based on the issuer rating of the sovereign,
PSE, or corporate obligor or based on another externally rated exposure
of that obligor. Exposures with an inferred rating would be treated the
same as exposures with an identical external rating.
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\19\ The treatment of inferred ratings for securitization
exposures is discussed in section M.(4) of this preamble.
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(i) Determining Inferred Ratings
To determine the risk weight for an unrated exposure to a sovereign
entity or a PSE, or for an unrated corporate exposure, a banking
organization must first determine if, within the framework established
in this NPR, the exposure has one or more inferred ratings. An unrated
exposure may have inferred ratings based both on the issuer ratings of
the obligor and the external ratings of specific issues of the obligor.
A banking organization would not be able to use an external rating
assigned to an obligor or specific issues of the obligor to infer a
rating for an exposure to the obligor's affiliate.
(A) Inferred Rating Based on an Issuer Rating
Under this NPR, a senior unrated exposure to a sovereign entity or
a PSE, or a senior unrated corporate exposure where the corporate
issuer has one or more issuer ratings, has inferred ratings based on
those issuer ratings. For purposes of inferring a rating from an issuer
rating, a senior exposure would be an exposure that ranks at least pari
passu (that is, equal) with the obligor's general creditors in the
event of bankruptcy, insolvency, or other similar proceeding. This NPR
defines an issuer rating as a credit rating assigned by an NRSRO to the
obligor that reflects the obligor's capacity and willingness to satisfy
all of its financial obligations, and is published in an accessible
form and is or will be included in the transition matrices made
publicly available by the NRSRO that summarize the historical
performance of the NRSRO's ratings.
(B) Inferred Rating Based on a Specific Issue Rating
Under this NPR, an unrated exposure to a sovereign entity or a PSE,
or an unrated corporate exposure may have one or more inferred ratings
based on external ratings assigned to another exposure issued by the
obligor. An unrated exposure would have an inferred rating equal to the
external rating of another exposure issued by the same obligor and
secured by the same collateral (if any), if the externally rated
exposure: (i) Ranks pari passu with the unrated exposure (or at the
banking organization's option, is subordinated in all respects to the
unrated exposure); (ii) has a long-term rating; (iii) does not benefit
from any credit enhancement that is not available to the unrated
exposure, (iv) has an effective remaining maturity that is equal to or
longer than that of the unrated exposure, and (v) is denominated in the
same currency as the unrated exposure. The currency requirement would
not apply where the unrated exposure that is denominated in a foreign
currency arises from a participation in a loan extended by a
multilateral development bank or is guaranteed by a multilateral
development bank against convertibility and transfer risk. If the
banking organization's participation is only partially guaranteed
against convertibility and transfer risk, the banking organization
could use the external rating for the portion of the participation that
benefits from the multilateral development bank's participation. If the
externally rated exposure does not meet these requirements, it cannot
be used to infer a rating for the unrated exposure.
The inferred rating approach provides a special treatment for
inferred ratings from low-quality ratings (ratings that correspond to a
risk weight of 100 percent or greater for an exposure to a PSE and 150
percent for an exposure to a sovereign entity or a corporate exposure).
An unrated exposure would have inferred rating(s) equal to the long-
term external rating(s) of exposures with low-quality ratings that are
issued by the same obligor and that are senior in all respects to the
unrated exposure.
This approach for inferred ratings differs from the New Accord,
which would require that any low-quality rating of an exposure issued
by an obligor be assigned to any unrated exposure to the obligor. The
agencies have concluded that this treatment could result in an
inappropriately high capital charge in some circumstances. For example,
an obligor for business reasons may choose to issue subordinated debt
that receives a low-quality rating. The New Accord suggests this low-
quality rating should be assigned to unrated senior exposures of the
obligor, even if the unrated senior exposures are also senior to
exposures with a high-quality rating. Under this NPR, a banking
organization in that situation could assign the high-quality rating to
the unrated senior secured exposure.
(ii) Determining the Applicable Inferred Rating
Once a banking organization has determined all the inferred ratings
for an unrated exposure, it must determine the applicable inferred
rating for the exposure. Under this NPR, the applicable inferred rating
for an exposure that has only one inferred rating would be the inferred
rating. If the unrated exposure has two or more
[[Page 43991]]
inferred ratings, the applicable inferred rating would be the lowest
inferred rating.
The agencies believe that this approach for determining the
applicable inferred rating for an unrated exposure is appropriately
risk sensitive and consistent with the principles for use of external
ratings in this NPR and the advanced approaches final rule. The
agencies are aware, however, that the proposed use of unsolicited
external ratings in this NPR may raise certain issues. The New Accord
suggests that banking organizations generally should use solicited
ratings and expresses concern that NRSROs might potentially use
unsolicited ratings to put pressure on issuers to obtain solicited
ratings.
Question 5: The agencies seek comment on the use of solicited and
unsolicited external ratings as proposed in this NPR.
H. Risk-Weight Categories
(1) Exposures to Sovereign Entities
The agencies' general risk-based capital rules generally assign a
risk weight to an exposure to a sovereign entity based on the type of
exposure and membership of the sovereign in the OECD. Consistent with
the New Accord, the agencies propose to risk weight an exposure to a
sovereign entity based on the exposure's applicable external or
applicable inferred rating (see Table 1).\20\
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\20\ The ratings examples used throughout this document are
illustrative and do not express any preferences or determinations on
any NRSRO.
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For purposes of this NPR, sovereign entity means a central
government (including the U.S. government) or an agency, department,
ministry, or central bank of a central government. In the United
States, this definition would include the twelve Federal Reserve Banks.
The definition would not include commercial enterprises owned by the
central government that are engaged in activities involving trade,
commerce, or profit, which are generally conducted or performed in the
private sector.
Where a sovereign entity's banking supervisor allows a banking
organization under its jurisdiction to apply a lower risk weight to the
same exposure to that sovereign than Table 1 provides, a U.S. banking
organization would be able to assign that lower risk weight to its
exposures to that sovereign entity provided the exposure is denominated
in that sovereign entity's domestic currency, and the banking
organization has at least the equivalent amount of liabilities in that
currency.
Table 1.--Exposures to Sovereign Entities
------------------------------------------------------------------------
Applicable external or applicable
inferred rating for an exposure to Example Risk weight
a sovereign entity (in percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 0
Second-highest investment grade AA................. 0
rating.
Third-highest investment grade A.................. 20
rating.
Lowest investment grade rating..... BBB................ 50
One category below investment grade BB................. 100
Two categories below investment B.................. 100
grade.
Three categories or more below CCC................ 150
investment grade.
No applicable rating............... N/A................ 100
------------------------------------------------------------------------
(2) Exposures to Certain Supranational Entities and Multilateral
Development Banks
Consistent with the New Accord's treatment of exposures to
supranational entities, the agencies propose to assign a zero percent
risk weight to exposures to the Bank for International Settlements, the
European Central Bank, the European Commission, and the International
Monetary Fund.
Generally consistent with the New Accord, the agencies also propose
that an exposure to a multilateral development bank (MDB) receive a
zero percent risk weight. This proposed risk weight would apply only to
those MDBs listed below and is based on the generally high credit
quality of these MDBs, their strong shareholder support, and a
shareholder structure comprised of a significant proportion of
sovereign entities with high quality issuer ratings. In this NPR, MDB
means the International Bank for Reconstruction and Development, the
International Finance Corporation, the Inter-American Development Bank,
the Asian Development Bank, the African Development Bank, the European
Bank for Reconstruction and Development, the European Investment Bank,
the European Investment Fund, the Nordic Investment Bank, the Caribbean
Development Bank, the Islamic Development Bank, the Council of Europe
Development Bank, and any other multilateral lending institution or
regional development bank in which the U.S. government is a shareholder
or contributing member or which the primary Federal supervisor
determines poses comparable credit risk. Exposures to regional
development banks and multilateral lending institutions that do not
meet these requirements would generally be treated as corporate
exposures.
(3) Exposures to Depository Institutions, Foreign Banks, and Credit
Unions
The agencies' general risk-based capital rules assign a risk weight
of 20 percent to all exposures to U.S. depository institutions, foreign
banks, and credit unions incorporated in an OECD country. Short-term
exposures to such entities incorporated in a non-OECD country receive a
20 percent risk weight and long-term exposures to such entities in
these countries receive a 100 percent risk weight.
Since this NPR eliminates the OECD/non-OECD distinction, the
agencies propose that exposures to a depository institution, a foreign
bank, or a credit union receive a risk weight based on the lowest
issuer rating of the entity's sovereign of incorporation. In this NPR,
sovereign of incorporation means the country where an entity is
incorporated, chartered, or similarly established. In general,
exposures to a depository institution, foreign bank, or credit union
would receive a risk weight one category higher than the risk weight
assigned to an exposure to the entity's sovereign of incorporation. For
exposures to a depository institution, foreign bank, or credit union
where the sovereign of incorporation is rated one or two categories
below investment grade or is unrated, the risk weight
[[Page 43992]]
would be 100 percent. If the sovereign of incorporation is rated three
or more categories below investment grade, these exposures would
receive a risk weight of 150 percent. Table 2 illustrates the proposed
risk weights for exposures to depository institutions, foreign banks,
and credit unions. A depository institution is defined as in section 3
of the Federal Deposit Insurance Act (12 U.S.C. 1813), and foreign bank
means a foreign bank as defined in section 211.2 of the Federal Reserve
Board's Regulation K (12 CFR 211.2) other than a depository
institution.
Table 2.--Exposures to Depository Institutions, Foreign Banks, and
Credit Unions
------------------------------------------------------------------------
Exposure risk
Lowest issuer rating of the Example weight (in
sovereign of incorporation percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 20
Second-highest investment grade AA................. 20
rating.
Third-highest investment grade A.................. 50
rating.
Lowest investment grade rating..... BBB................ 100
One category below investment grade BB................. 100
Two categories below investment B.................. 100
grade.
Three categories or more below CCC................ 150
investment grade.
No issuer rating................... N/A................ 100
------------------------------------------------------------------------
Consistent with the general risk-based capital rules and the New
Accord, exposures to a depository institution or foreign bank that are
includable in the regulatory capital of that institution would receive
a risk weight no lower than 100 percent unless the exposure is subject
to deduction as a reciprocal holding.\21\
---------------------------------------------------------------------------
\21\ 12 CFR part 3, Appendix A, section 2(c)(6)(ii) (OCC); 12
CFR parts 208 and 225, Appendix A, section II.B.3 (FRB); 12 CFR part
325, Appendix A, I.B.(4) (FDIC); and 12 CFR 567.5(c)(2)(i) (OTS).
---------------------------------------------------------------------------
The proposal outlined above is consistent with one of the two
options available in the New Accord for risk weighting claims on banks.
The alternative approach, which the agencies propose for exposures to
PSEs, risk weights exposures based on the applicable external or
applicable inferred rating of the exposures. This alternative approach
for exposures to PSEs is described below.
Question 6: The agencies seek comment on this proposed approach, as
well as on the appropriateness of applying the alternative approach to
exposures to depository institutions, credit unions, and foreign banks.
(4) Exposures to Public Sector Entities (PSEs)
The agencies' general risk-based capital rules assign a 20 percent
risk weight to general obligations of states and other political
subdivisions of OECD countries.\22\ Exposures to entities that rely on
revenues from specific projects, rather than general revenues (for
example, revenue bonds), receive a risk weight of 50 percent.
Generally, other exposures to state and political subdivisions of OECD
countries (including industrial revenue bonds) and exposures to
political subdivisions of non-OECD countries receive a risk weight of
100 percent.
---------------------------------------------------------------------------
\22\ Political subdivisions of the United States include a
state, county, city, town or other municipal corporation, a public
authority, and generally any publicly owned entity that is an
instrument of a state or municipal corporation.
---------------------------------------------------------------------------
Consistent with the New Accord, the agencies propose that an
exposure to a PSE receive a risk weight based on the applicable
external or applicable inferred rating of the exposure. This approach
would apply to both general obligation and revenue bonds. In no case,
however, may an exposure to a PSE receive a risk weight that is lower
than the risk weight that corresponds to the lowest issuer rating of a
PSE's sovereign of incorporation (see Table 1 for risk weights for
exposures to sovereign entities).
The proposed rule defines a PSE as a state, local authority, or
other governmental subdivision below the level of a sovereign entity.
This definition would not include commercial companies owned by a
government that engage in activities involving trade, commerce, or
profit, which are generally conducted or performed in the private
sector. Table 3 illustrates the risk weights for exposures to PSEs.
Table 3.--Exposures to Public Sector Entities: Long-Term Credit Rating
------------------------------------------------------------------------
Applicable external or applicable
inferred rating of an exposure to a Example Risk weight
PSE (in percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 20
Second-highest investment grade AA................. 20
rating.
Third-highest investment grade A.................. 50
rating.
Lowest investment grade rating..... BBB................ 50
One category below investment grade BB................. 100
Two categories below investment B.................. 100
grade.
Three categories or more below CCC................ 150
investment grade.
No applicable rating............... N/A................ 50
------------------------------------------------------------------------
The New Accord also suggests that a national supervisor may permit
a banking organization to assign a risk weight to an exposure to a PSE
as if it were an exposure to the sovereign entity in whose jurisdiction
the PSE is established. The agencies are not proposing to risk weight
exposures to PSEs in the United States in this manner. In certain
cases, however, the agencies have allowed a banking organization to
rely on the risk weight
[[Page 43993]]
that a foreign banking supervisor assigns to its own PSEs. Therefore,
the agencies propose to allow a banking organization to risk weight an
exposure to a foreign PSE according to the risk weight that the foreign
banking supervisor assigns. In no event, however, could the risk weight
for an exposure to a foreign PSE be lower than the lowest risk weight
assigned to that PSE's sovereign of incorporation.
The New Accord contains an alternative approach to risk weight
exposures to a PSE, which is based on the lowest issuer rating of the
PSE's sovereign of incorporation. The agencies are proposing this
approach for exposures to depository institutions, foreign banks, and
credit unions as described in the previous section.
Question 7: The agencies seek comment on the pros and cons of the
proposed approach for risk weighting exposures to PSEs as well as on
the appropriateness of applying, instead, the approach proposed in this
NPR for depository institutions.
The New Accord does not incorporate the use of short-term ratings
for exposures to PSEs. The agencies recognize, however, that an NRSRO
may assign a short-term municipal rating to an exposure to a PSE that
has a maturity of up to three years (for example, a bond anticipation
note). Further, the agencies understand that there are different
techniques for comparing these short-term ratings to other types of
ratings, both short-term and long-term. The agencies are considering
whether to permit the use of these short-term ratings for risk
weighting short-term exposures to PSEs using the risk weights in Table
4.
Table 4.--Public Sector Entities: Short-Term Ratings
------------------------------------------------------------------------
Applicable external rating of an Risk weight
exposure to a PSE Example (in percent)
------------------------------------------------------------------------
Highest investment grade........... SP-1/MIG-1......... 20
Second-highest investment grade.... SP-2/MIG-2......... 50
Third-highest investment grade..... SP-3/MIG-3......... 100
Below investment grade............. Non-prime.......... 150
No applicable external rating...... N/A................ 50
------------------------------------------------------------------------
Question 8: The agencies solicit comment on the use of short-term
ratings for exposures to PSEs generally and specifically on the ratings
and related risk weights in Table 4.
(5) Corporate Exposures
Under the agencies' general risk-based capital rules, most
corporate exposures receive a risk weight of 100 percent. Exposures to
securities firms incorporated in the United States or in an OECD
country may receive a 20 percent risk weight if they meet certain
requirements, and exposures to U.S. government-sponsored agencies or
entities (GSEs) may also receive a 20 percent risk weight. GSEs include
an agency or corporation originally established or chartered by the
U.S. Government to serve public purposes specified by the U.S.
Congress, but whose obligations are not explicitly guaranteed by the
full faith and credit of the U.S. Government.
In this NPR, corporate exposure means a credit exposure to a
natural person or a company (including an industrial development bond,
an exposure to a GSE, or an exposure to a securities broker or dealer)
that is not an exposure to: a sovereign entity, the Bank for
International Settlements, the European Central Bank, the European
Commission, the International Monetary Fund, an MDB, a depository
institution, a foreign bank, a credit union, or a PSE; a regulatory
retail exposure; a residential mortgage exposure; a pre-sold
construction loan; a statutory multifamily mortgage; a securitization
exposure; or an equity exposure.
Consistent with the New Accord, the agencies propose to permit a
banking organization to elect one of two methods to risk weight
corporate exposures. Regardless of the method a banking organization
chooses, it would have to use that approach consistently for all
corporate exposures. First, a banking organization could risk weight
all of its corporate exposures at 100 percent without regard to
external ratings. Second, a banking organization could risk weight a
corporate exposure based on its applicable external or applicable
inferred rating. Table 5 provides the proposed risk weights for
corporate exposures with applicable external or applicable inferred
ratings based on long-term credit ratings. Table 6 provides the
proposed risk weights for corporate exposures with applicable external
ratings based on short-term credit ratings.
If a corporate exposure has no external rating, that exposure could
not receive a risk weight lower than the risk weight that corresponds
to the lowest issuer rating of the obligor's sovereign of incorporation
in Table 1. In addition, if an obligor has any exposure with a short-
term external rating that corresponds to a risk weight of 150 percent
under Table 6, a banking organization would assign a 150 percent risk
weight to any corporate exposure to that obligor that does not have an
external rating and that ranks pari passu with or is subordinated to
the externally rated exposure.
Table 5.--Corporate Exposures: Long-Term Credit Rating
------------------------------------------------------------------------
Exposure risk
Applicable external or applicable Example weight (in
inferred rating percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 20
Second-highest investment grade AA................. 20
rating.
Third-highest investment grade A.................. 50
rating.
Lowest investment grade rating..... BBB................ 100
One category below investment grade BB................. 100
Two categories below investment B.................. 150
grade.
Three categories or more below CCC................ 150
investment grade.
No applicable rating............... N/A................ 100
------------------------------------------------------------------------
[[Page 43994]]
Table 6.--Corporate Exposures: Short-Term Credit Rating
------------------------------------------------------------------------
Exposure risk
Applicable external rating Example weight (in
percent)
------------------------------------------------------------------------
Highest investment grade........... A-1/P-1............ 20
Second-highest investment grade.... A-2/P-2............ 50
Third-highest investment grade..... A-3/P-3............ 100
Below investment grade............. B, C, and non-prime 150
No applicable external rating...... N/A................ 100
------------------------------------------------------------------------
As provided in the New Accord, this NPR (outside of the
securitization framework) would not allow a banking organization to
infer a rating from an exposure based on a short-term external rating.
Consistent with this position, this NPR does not include the New Accord
provision that assigns a risk weight of at least 100 percent to all
unrated short-term exposures of an obligor if any rated short-term
exposure of that obligor receives a 50 percent risk weight.
Question 9: The agencies seek comment on the appropriateness of
including either or both of these aspects of the New Accord in any
final rule implementing the standardized framework.
The New Accord would treat securities firms that meet certain
requirements like depository institutions. The agencies propose,
however, to risk weight exposures to securities firms as corporate
exposures, parallel with the treatment of bank holding companies and
savings association holding companies.
The agencies also propose that exposures to GSEs be treated as
corporate exposures and risk weighted based on the NRSRO credit
ratings. These ratings on individual GSE exposures are often based in
part on the NRSRO assessments of the extent to which the U.S.
government might come to the financial aid of a GSE. The agencies
believe that risk-weight determinations should not be based on the
possibility of U.S. government financial assistance, except where the
U.S. government has legally committed to provide such assistance.
In addition to the credit ratings on individual GSE exposures, the
NRSROs also publish issuer ratings that evaluate the financial strength
of some GSEs without respect to any implied financial assistance from
the U.S. government. These financial strength ratings are monitored by
the issuing NRSROs but are not included in the NRSROs' transition
matrices. Accordingly, the financial strength ratings would not meet
the definition of an external rating in this NPR. Further, the use of
these ratings is also problematic because NRSROs provide financial
strength ratings for issuers, but not for specific issues, and do not
provide the same level of differentiation between short- and long-term
debt and various levels of subordination as NRSRO ratings of specific
exposures. In addition, NRSROs have not published financial strength
ratings for all GSEs.
Question 10: The agencies seek comment on the use of financial
strength ratings to determine risk weights for exposures to GSEs, and
seek comment on how such ratings might be applied. The agencies also
seek input on how subordination and maturity of exposures could be
embodied in such an approach, and what requirements should be developed
for recognizing ratings assigned to GSEs.
(6) Regulatory Retail Exposures
The general risk-based capital rules generally assign a risk weight
of 100 percent to non-mortgage retail exposures, secured or unsecured,
including personal, auto, and credit card loans. Consistent with the
New Accord, the agencies propose that a banking organization apply a 75
percent risk weight to regulatory retail exposures that meet the
following criteria: (i) A banking organization's aggregate exposure to
a single obligor does not exceed $1 million; (ii) the exposure is part
of a well diversified portfolio; and (iii) the exposure is not an
exposure to a sovereign entity, the Bank for International Settlements,
the European Central Bank, the European Commission, the International
Monetary Fund, an MDB, a PSE, a depository institution, a foreign bank,
or a credit union; an acquisition, development and construction loan; a
residential mortgage exposure; a pre-sold construction loan; a
statutory multifamily mortgage; a securitization exposure; an equity
exposure; or a debt security. Examples of regulatory retail exposures
would include a revolving credit or line of credit (including credit
card and overdraft lines of credit), a personal term loan or lease
(including an installment loan, auto loan or lease, student or
educational loan, personal loan), and a facility or commitment to a
company.
Any retail exposure that does not meet these requirements generally
would be considered a corporate exposure and would receive a risk
weight based on the risk-weight tables for corporate exposures (see
Tables 5 and 6).
Question 11: The agencies seek comment on whether a specific
numerical limit on concentration should be incorporated into the
provisions for regulatory retail exposures. For example, the New Accord
suggests a 0.2 percent limit on an aggregate exposure to one obligor as
a measure of concentration within the regulatory retail portfolio. The
agencies solicit comment on the appropriateness of a 0.2 percent limit
as well as on other types of measures of portfolio concentration that
may be appropriate.
(7) Residential Mortgage Exposures
The general risk-based capital rules assign exposures secured by
one-to-four family residential properties to either the 50 percent or
100 percent risk weight category. Most exposures secured by a first
lien on a one-to-four family residential property meet the criteria to
receive a 50 percent risk weight.\23\ The New Accord applies a
similarly broad treatment to residential mortgages. It provides a risk
weight of 35 percent for most first-lien residential mortgage exposures
that meet prudential criteria such as the existence of a substantial
margin of additional security over the amount of the loan.
---------------------------------------------------------------------------
\23\ 12 CFR part 3, Appendix A, section 3(c)(iii) (OCC); 12 CFR
parts 208 and 225, Appendix A, section III.C.3 (Board); 12 CFR part
325, Appendix A, section II.C.3 (FDIC); and 12 CFR 567.1 (definition
of ``qualifying mortgage loan'') and 12 CFR 567.6(a)(1)(iii)(B) (50
percent risk weight) (OTS).
---------------------------------------------------------------------------
In the Basel IA NPR, the agencies proposed to assign a risk weight
for one-to-four family residential mortgage exposures based on the LTV
ratio. The agencies noted that the LTV ratio is a meaningful indicator
of potential loss and borrower default. Commenters on the Basel IA NPR
generally supported
[[Page 43995]]
this LTV ratio approach. In this NPR, the agencies propose
substantially the same treatment for residential mortgage exposures as
was proposed in the Basel IA NPR. Given the characteristics of the U.S.
residential mortgage market, the agencies believe that the risk weights
in the New Accord do not reflect the appropriate spectrum of risk for
these assets. The agencies believe the wider range of risk weights that
the agencies proposed in the Basel IA NPR is more appropriate for the
U.S. residential mortgage market.
The agencies believe that an LTV ratio approach to residential
mortgage exposures would not impose a significant burden on banking
organizations because LTV information is readily available and is
commonly used in the underwriting process. Use of LTV ratios to assign
risk weights to residential mortgage exposures would not substitute
for, or otherwise release a banking organization from, its
responsibility to have prudent loan underwriting and risk management
practices consistent with the size, type, and risk of its mortgage
business.\24\ Through the supervisory process, the agencies would
continue to assess a banking organization's underwriting and risk
management practices consistent with supervisory guidance and safety
and soundness. The agencies would continue to use their supervisory
authority to require a banking organization to hold additional capital
for residential mortgage exposures where appropriate.
---------------------------------------------------------------------------
\24\ See, for example, ``Interagency Guidance on Nontraditional
Mortgage Product Risks,'' 71 FR 58609 (Oct. 4, 2006) and ``Statement
on Subprime Mortgage Lending,'' 72 FR 37569 (July 10, 2007).
---------------------------------------------------------------------------
The proposed rule defines a residential mortgage exposure as an
exposure (other than a pre-sold construction loan) that is primarily
secured by a one-to-four family residential property. The proposed rule
identifies two types of residential mortgage exposures (first-lien
residential mortgage exposures and junior-lien residential mortgage
exposures), and provides a separate treatment for each type of
exposure. A first-lien residential mortgage exposure is a residential
mortgage exposure secured by a first lien or a residential mortgage
exposure secured by first and junior lien(s) where no other party holds
an intervening lien. This treatment is similar to the treatment of
mortgage exposures under the general risk-based capital rules. A
junior-lien residential mortgage exposure is a residential mortgage
exposure that is secured by a junior lien and that is not a first-lien
residential mortgage exposure.
(a) Exposure Amount
The proposed rule provides that a banking organization would hold
capital for both the funded and the unfunded portions of residential
mortgage exposures. For the funded portion of a residential mortgage
exposure, the banking organization would assign a risk weight to the
carrying value of the exposure (that is, the principal amount of the
exposure). For the unfunded portion of a residential mortgage exposure
(for example, potential exposure from a negative amortization feature
or a home equity line of credit (HELOC)), a banking organization would
risk weight the notional amount of the exposure (that is, the maximum
contractual commitment) multiplied by the appropriate credit conversion
factor. For a residential mortgage exposure that has both funded and
unfunded components, a banking organization would calculate separate
risk-weighted asset amounts for the unfunded and funded portions, based
on separately calculated LTV ratios as discussed below.
(b) Risk Weights
The agencies propose that a banking organization risk weight first-
lien residential mortgage exposures that meet certain qualifying
criteria according to Table 7. The risk weights in Table 7 would apply
only to a first-lien residential mortgage exposure that is secured by
property that is owner-occupied or rented, is prudently underwritten,
is not 90 days or more past due, and is not on nonaccrual. A first-lien
residential mortgage exposure that has been restructured may receive a
risk weight lower than 100 percent, only if the banking organization
updates the LTV ratio at the time of the restructuring and according to
the discussion below and in section 33 of the proposed rule. First-lien
residential mortgage exposures that do not meet these criteria would
receive a 100 percent risk weight if they have an LTV ratio less than
or equal to 90 percent, and would receive a 150 percent risk weight if
they have an LTV ratio greater than 90 percent.
Table 7.--Risk Weights for First-Lien Residential Mortgage Exposures
------------------------------------------------------------------------
Risk weight
Loan-to-value ratio (in percent) (in percent)
------------------------------------------------------------------------
Less than or equal to 60................................ 20
Greater than 60 and less than or equal to 80............ 35
Greater than 80 and less than or equal to 85............ 50
Greater than 85 and less than or equal to 90............ 75
Greater than 90 and less than or equal to 95............ 100
Greater than 95......................................... 150
------------------------------------------------------------------------
Under the general risk-based capital rules, a banking organization
must assign a risk weight to an exposure secured by a junior lien on
residential property at 100 percent, unless the banking organization
also holds the first lien and there are no intervening liens. The New
Accord does not specifically discuss the treatment of exposures secured
by junior liens on residential property.
The agencies continue to believe that stand-alone junior-lien
residential mortgage exposures have a different risk profile than
first-lien residential mortgage exposures and should be risk weighted
accordingly. Under the proposed rule, a banking organization would
compute an LTV ratio as described below for a junior-lien residential
mortgage exposure that is not 90 days or more past due or on nonaccrual
based upon the loan amounts for the junior-lien residential mortgage
exposure and all senior exposures as described below. The banking
organization would then assign a risk weight to the exposure amount of
the junior-lien residential mortgage exposure according to Table 8.
This treatment is similar to the Basel IA NPR and recognizes that
stand-alone junior-lien residential mortgage exposures generally
default at a higher rate than first-lien residential mortgage
exposures. A banking organization would risk weight a junior-lien
residential mortgage exposure that is 90 days or more past due or on
nonaccrual at 150 percent.
Table 8.--Risk Weights for Junior-Lien Residential Mortgage Exposures
------------------------------------------------------------------------
Risk weight
Loan-to-value ratio (in percent) (in percent)
------------------------------------------------------------------------
Less than or equal to 60................................ 75
Greater than 60 and less than or equal to 90............ 100
Greater than 90......................................... 150
------------------------------------------------------------------------
[[Page 43996]]
(c) Loan-to-Value Ratio Calculation
The agencies propose that a banking organization calculate the LTV
ratio on an ongoing basis as described below. The denominator of the
LTV ratio, that is, the value of the property, would be equal to the
lesser of the acquisition cost for the property (for a purchase
transaction) or the estimate of a property's value at the origination
of the exposure or, at the banking organization's option, at the time
of restructuring. The estimate of value would be based on an appraisal
or evaluation of the property in conformance with the agencies'
appraisal regulations \25\ and should conform to the ``Interagency
Appraisal and Evaluation Guidelines'' \26\ and the ``Real Estate
Lending Guidelines.'' \27\ If a banking organization's first-lien
residential mortgage exposure consists of both first and junior liens
on a property, a banking organization could update the estimate of
value at the origination of the junior-lien mortgage.
---------------------------------------------------------------------------
\25\ 12 CFR part 34, subpart C (OCC); 12 CFR part 208, subpart E
and part 225, subpart G (Board); 12 CFR part 323 (FDIC); and 12 CFR
part 564 (OTS).
\26\ ``The Comptroller's Handbook for Commercial Real Estate and
Construction Lending'', Appendix E (OCC); SR 94-55 (Board); FIL-74-
94 (FDIC); and 12 CFR part 564 (OTS).
\27\ 12 CFR part 34, subpart D, Appendix A (OCC); 12 CFR part
208, subpart E, Appendix C and part 225, subpart G (Board); 12 CFR
part 365 (FDIC); and 12 CFR 560.100-101 (OTS).
---------------------------------------------------------------------------
The numerator of the ratio, that is, the loan amount, would depend
on whether the exposure is funded or unfunded, and on whether the
exposure is a first-lien residential mortgage exposure or a junior-lien
residential mortgage exposure. The loan amount of the funded portion of
a first-lien residential mortgage exposure would be the principal
amount of the exposure. The loan amount of the funded portion of a
junior-lien residential mortgage exposure would be the principal amount
of the exposure plus the maximum contractual amounts of all senior
exposures secured by the same residential property. Senior unfunded
commitments may include negative amortization features and HELOCs.
A banking organization would be required to calculate a separate
loan amount and LTV ratio for the unfunded portion of a residential
mortgage exposure. The loan amount of the unfunded portion of a
residential mortgage exposure would be the loan amount of the funded
portion of the exposure, as described above, plus the unfunded portion
of the maximum contractual amount of the commitment.
The agencies believe that a banking organization should be able to
reflect the risk mitigating effects of loan-level private mortgage
insurance (PMI) when calculating the LTV ratio of a residential
mortgage exposure. Loan-level PMI is insurance that protects a lender
in the event of borrower default up to a predetermined portion of the
residential mortgage exposure and that does not have a pool-level cap
that could effectively reduce coverage below the predetermined amount
of the exposure. Under this proposed rule, a banking organization could
reduce the loan amount of a residential mortgage exposure up to the
amount covered by loan-level PMI, provided the PMI issuer is a
regulated mortgage insurance company, is not an affiliate \28\ of the
banking organization, and (i) has long-term senior debt (without credit
enhancement) that has an external rating that is in at least the third-
highest investment grade rating category or (ii) has a claims-paying
rating that is in at least the third-highest investment grade rating
category. The agencies believe that pool-level PMI generally should not
be reflected in the calculation of the LTV ratio, because pool-level
PMI is not structured in such a way that a banking organization can
determine the LTV ratio for a mortgage loan.
---------------------------------------------------------------------------
\28\ An affiliate of a banking organization is defined as any
company that controls, is controlled by, or is under common control
with, the banking organization. A person or company controls a
company if it: (i) Owns, controls, or holds the power to vote 25
percent or more of a class of voting securities of the company, or
(ii) consolidates the company for financial reporting purposes.
---------------------------------------------------------------------------
Question 12: The agencies request comment on all aspects of the
proposed treatment of PMI under this framework.
(d) Example of LTV Ratio Calculation
Assume a banking organization originates a first-lien residential
mortgage exposure with a negative amortization feature; the property is
valued at $100,000; the original and outstanding principal amount of
the exposure is $81,000; and the negative amortization feature has a 10
percent cap and extends for ten years (that is, the mortgage loan
balance can contractually negatively amortize to 110 percent of the
original balance over the next 10 years). The funded loan amount of
$81,000 has an 81 percent LTV ratio, which is risk weighted at 50
percent (based on Table 7). The negative amortization feature is an
unfunded commitment with a maximum contractual amount of $8,100. It
would receive a 50 percent CCF, resulting in an exposure amount of
$4,050. The loan amount of the unfunded portion would be $81,000 funded
amount plus the $8,100 maximum contractual unfunded amount, resulting
in an LTV of 89.1 percent. The unfunded commitment exposure amount of
$4,050 would therefore receive a 75 percent risk weight (based on Table
7). The total risk-weighted assets for the exposure would be $43,538,
as illustrated in Table 9:
Table 9.--Example of Proposed Risk-Based Capital Calculation for First-
Lien Residential Mortgage Exposures With Negative Amortization Features
------------------------------------------------------------------------
------------------------------------------------------------------------
Funded Risk-Weighted Assets Calculation
------------------------------------------------------------------------
(1) Amount to Risk Weight............................... $81,000
(2) Funded LTV Ratio = Funded Loan Amount / Property 81%
Value = $81,000/$100,000 =.............................
(3) Risk Weight based on Table 7........................ 50%
(4) RW Assets for Funded Loan Amount = $81,000 x .50 =.. $40,500
------------------------------------------------------------------------
Unfunded Risk-Weighted Assets Calculation
------------------------------------------------------------------------
(1) Exposure Amount = Unfunded Maximum Amount x CCF = $4,050
$8,100 x .50 =.........................................
(2) Unfunded LTV Ratio = (Funded Amount + Unfunded 89.1%
Amount)/Property Value = ($81,000 + $8,100)/$100,000 =.
(3) Risk Weight based on Table 7........................ 75%
(4) RW Assets for Unfunded Amount = $4,050 x 0.75....... $3,038
------------------------------------------------------------------------
[[Page 43997]]
Total Risk-Weighted Assets for a Loan with Negative Amortizing Features
------------------------------------------------------------------------
RW Assets for Funded Amount + RW for Unfunded Amount = $43,538
$40,500 + $3,038 =.....................................
------------------------------------------------------------------------
Note: The funded and unfunded amount of the loan will change over time
once the loan begins to negatively amortize.
(e) Alternative LTV Ratio Calculation
The agencies are considering an alternative for calculating the LTV
ratio and risk-weighted asset amount for residential mortgage exposures
with unfunded commitments. This alternative is less complex but may
result in different capital implications. Under the alternative, a
banking organization would not calculate a separate risk-weighted asset
amount for the funded and unfunded portion of the residential mortgage
exposure. The alternative calculation would require only the
calculation of a single LTV ratio representing a combined funded and
unfunded amount when calculating the LTV ratio for a given exposure.
Under the alternative, the loan amount of a first-lien residential
mortgage exposure would equal the funded principal amount (or combined
exposures provided there is no intervening lien) plus the exposure
amount of any unfunded commitment (that is, the unfunded amount of the
maximum contractual amount of any commitment multiplied by the
appropriate CCF). The loan amount of a junior-lien residential mortgage
exposure would equal the sum of: (i) The funded principal amount of the
exposure, (ii) the exposure amount of any undrawn commitment associated
with the junior-lien exposure, and (iii) the exposure amount of any
senior exposure held by a third party on the date of origination of the
junior-lien exposure. Where a senior exposure held by a third party
includes an undrawn commitment, such as a HELOC or a negative
amortization feature, the loan amount for a junior-lien residential
mortgage exposure would include the maximum contractual amount of that
commitment multiplied by the appropriate CCF. The denominator of the
LTV ratio would be the same under both alternatives.
Question 13: The agencies seek comment on the pros and cons
associated with the two alternatives for calculating the LTV ratio.
While the agencies believe risk weighting one-to-four family
residential mortgage exposures based on the LTV ratio appropriately
captures a large number of mortgage exposures with differing risk, the
agencies have considered basing the risk weight for these exposures on
other parameters. Examples include using pricing information that the
Home Mortgage Disclosure Act (HMDA) requires many banking organizations
to report, or borrower credit scores.
Question 14: The agencies seek industry views on any other risk-
sensitive methods that could be used to segment residential mortgage
exposures by risk level and solicit comment on how such alternatives
might be applied.
(8) Pre-Sold Construction Loans and Statutory Multifamily Mortgages
The general risk-based capital rules assign 50 percent and 100
percent risk weights to certain one-to-four family residential pre-sold
construction loans and multifamily residential loans. The agencies
adopted these provisions as a result of the Resolution Trust
Corporation Refinancing, Restructuring, and Improvement Act of 1991
(RTCRRI Act). The RTCRRI Act mandates that each agency provide in its
capital regulations (i) a 50 percent risk weight for certain one-to-
four-family residential pre-sold construction loans and multifamily
residential loans that meet specific statutory criteria in the RTCRRI
Act and any other underwriting criteria imposed by the agencies, and
(ii) a 100 percent risk weight for one-to-four-family residential pre-
sold construction loans for residences for which the purchase contract
is cancelled.
Consistent with the RTCRRI Act, a pre-sold construction loan would
be subject to a 50 percent risk weight unless the purchase contract is
cancelled. The NPR defines a pre-sold construction loan as any one-to-
four family residential pre-sold construction loan for a residence
meeting the requirements under section 618(a)(1) or (2) of the RTCRRI
Act and under 12 CFR part 3, Appendix A, section 3(a)(3)(iv) (for
national banks); 12 CFR part 208, Appendix A, section III.C.3. (for
state member banks); 12 CFR part 225, Appendix A, section III.C.3. (for
bank holding companies); 12 CFR part 325, Appendix A, section II.C.
(for state nonmember banks), and that is not 90 days or more past due
or on nonaccrual; or 12 CFR 567.1 (definition of ``qualifying
residential construction loan'') (for savings associations), and that
is not on nonaccrual.
Also consistent with the RTCRRI Act, under the NPR, a statutory
multifamily mortgage would receive a 50 percent risk weight. The NPR
defines statutory multifamily mortgage as any multifamily residential
mortgage meeting the requirements under section 618(b)(1) of the RTCRRI
Act, and under 12 CFR part 3, Appendix A, section 3(a)(3)(v) (for
national banks); 12 CFR part 208, Appendix A, section III.C.3. (for
state member banks); 12 CFR part 225, Appendix A, section III.C.3. (for
bank holding companies); 12 CFR part 325, Appendix A, section II.C.a.
(for state nonmember banks); or 12 CFR 567.1 (definition of
``qualifying multifamily mortgage loan'') and 12 CFR 567.6(a)(1)(iii)
(for savings associations), and that is not on nonaccrual.\29\ A
multifamily mortgage that does not meet the definition of a statutory
mortgage would be treated as a corporate exposure.
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\29\ Under these proposed definitions, a loan that is 90 days or
more past due or on nonaccrual would not qualify as a pre-sold
construction loan or a statutory multifamily mortgage. These loans
would be accorded the treatment described in the next section.
---------------------------------------------------------------------------
(9) Past Due Loans
Under the general risk-based capital rules, the risk weight of a
loan generally does not change if the loan becomes past due, with the
exception of certain residential mortgage loans. The New Accord
provides risk weights ranging from 50 to 150 percent for loans that are
more than 90 days past due, depending on the amount of specific
provisions a banking organization has recorded.
Most banking organizations in the United States do not recognize
specific provisions. Therefore, the treatment of past due exposures in
the New Accord is not applicable for those banking organizations.
Accordingly, to reflect impaired credit quality, the agencies propose
to risk weight most exposures that are 90 days or more past due or on
nonaccrual at 150 percent, except for past due residential mortgage
exposures. A banking organization could reduce the risk weight of the
exposure to reflect financial collateral or eligible guarantees.
[[Page 43998]]
Question 15: The agencies seek comment on whether, for those
banking organizations that are required to maintain specific
provisions, it would be appropriate to follow the New Accord treatment,
that is, the risk weight would vary depending on the amount of specific
provisions the banking organization has recorded.
(10) Other Assets
The agencies propose to use the following risk weights, which are
generally consistent with the risk weights in the general risk-based
capital rules, for other exposures: (i) A banking organization could
assign a zero percent risk weight to cash owned and held in all of its
offices or in transit; to gold bullion held in its own vaults, or held
in another depository institution's vaults on an allocated basis, to
the extent gold bullion assets are offset by gold bullion liabilities;
and to derivative contracts that are publicly traded on an exchange
that requires the daily receipt and payment of cash-variation margin;
(ii) a banking organization could assign a 20 percent risk weight to
cash items in the process of collection; and (iii) a banking
organization would have to apply a 100 percent risk weight to all
assets not specifically assigned a different risk weight under this NPR
(other than exposures that are deducted from tier 1 or tier 2 capital).
I. Off-Balance Sheet Items
Under the general risk-based capital rules, a banking organization
generally determines the risk-based asset amount for an off-balance
sheet exposure using a two-step process. The banking organization
applies a CCF to the off-balance sheet amount to obtain an on-balance
sheet credit equivalent amount and then applies the appropriate risk
weight to that amount.
In general, the agencies propose to calculate the exposure amount
of an off-balance sheet item by multiplying the off-balance sheet
component, which is usually the notional amount, by the applicable CCF.
The agencies also propose to retain most of the CCFs in the general
risk-based capital rules.\30\ Consistent with the New Accord, however,
the agencies propose that a banking organization apply a 20 percent CCF
to all commitments with an original maturity of one year or less
(short-term commitments) that are not unconditionally cancelable rather
than the zero percent in the general risk-based capital rules. The
agencies believe that a 20 percent CCF for these short-term commitments
better reflects the risk of these exposures.
---------------------------------------------------------------------------
\30\ The discussion of the risk-based capital treatment for off-
balance sheet securitization exposures, including liquidity
facilities for asset-backed commercial paper, is presented in Part
IV of the proposed rule. Equity commitments are discussed in Part V
of the proposed rule.
---------------------------------------------------------------------------
For purposes of this NPR, a commitment means any legally binding
arrangement that obligates a banking organization to extend credit or
to purchase assets. In this NPR, unconditionally cancelable means, with
respect to a commitment, that a banking organization may, at any time,
with or without cause, refuse to extend credit under the facility (to
the extent permitted under applicable law). In the case of a
residential mortgage exposure that is a line of credit, a banking
organization is deemed able to unconditionally cancel the commitment if
it can, at its option, prohibit additional extensions of credit, reduce
the credit line, and terminate the commitment to the full extent
permitted by applicable law.
Under this NPR, if a banking organization commits to provide a
commitment on an off-balance sheet item, that is, a commitment to make
a commitment, the agencies propose that a banking organization apply
the lower of the two applicable CCFs. If a banking organization
provides a commitment that is structured as a syndication, it would
only be required to calculate the exposure amount for its pro rata
share of the commitment.
There is no reference to note issuance facilities (NIFs) and
revolving underwriting facilities (RUFs) in the proposed rule as the
agencies are not aware that any such transactions exist in the United
States.
Under the agencies' general risk-based capital rules, capital is
required against any on-balance sheet exposures that arise from
securities financing transactions (that is, repurchase agreements,
reverse repurchase agreements, securities lending transactions, and
securities borrowing transactions); for example, capital is required
against the cash receivable that a banking organization generates when
it borrows a security and posts cash collateral to obtain the security.
A banking organization faces counterparty credit risk on securities
financing transactions, however, regardless of whether the transaction
generates an on-balance sheet exposure. In contrast to the general
risk-based capital rules, this NPR requires a banking organization to
hold risk-based capital against all securities financing transactions.
Similar to other exposures, a banking organization would determine the
exposure amount of a securities financing transaction and then risk
weight that amount based on the counterparty or, if applicable,
collateral or guarantee.
In general, a banking organization must apply a 100 percent CCF to
the off-balance sheet component of a repurchase agreement or securities
lending or borrowing transaction. The off-balance sheet component of a
repurchase agreement equals the sum of the current market values of all
positions the banking organization has sold subject to repurchase. The
off-balance sheet component of a securities lending transaction is the
sum of the current market values of all positions the banking
organization has lent under the transaction. For securities borrowing
transactions, the off-balance sheet component is the sum of the current
market values of all non-cash positions the banking organization has
posted as collateral under the transaction. In certain circumstances, a
banking organization may instead determine the exposure amount of the
transaction as described in the collateralized transaction section of
this preamble and in section 37 of the proposed rule.
J. OTC Derivative Contracts
(1) Background
Under the general risk-based capital rules for over-the-counter
(OTC) derivative contracts, a banking organization must hold risk-based
capital for counterparty credit risk.\31\ To determine the capital
requirement, a banking organization must first compute a credit
equivalent amount for a contract and then apply to that amount a risk
weight based on the obligor, counterparty, eligible guarantor, or
recognized collateral. For an OTC derivative contract that is not
subject to a qualifying bilateral netting contract, the credit
equivalent amount is the sum of (i) the greater of the current exposure
(mark-to-market value) or zero and (ii) an estimate of the potential
future credit exposure (PFE). PFE is the notional principal amount of
the contract multiplied by a credit conversion factor.
---------------------------------------------------------------------------
\31\ OTS rules on the calculation of credit equivalent amounts
for derivative contracts differ from the rules of the other
agencies. That is, OTS rules address only interest rate and foreign
exchange rate contracts and include certain other differences.
Accordingly, the description of the current provisions in this
preamble primarily reflects the other banking agencies' rules.
---------------------------------------------------------------------------
Under the general risk-based capital rules for OTC derivative
contracts subject to a qualifying bilateral netting contract, the
credit equivalent amount is calculated by adding the net current
exposure of the netting contract and the sum of the estimates of PFE
for the individual contracts. The net current
[[Page 43999]]
exposure is the sum of all positive and negative mark-to-market values
of the individual contracts but not less than zero. A banking
organization recognizes the effects of the bilateral netting contract
on the gross potential future exposure of the contracts by calculating
an adjusted add-on amount based on the ratio of net current exposure to
gross current exposure, either on a counterparty-by-counterparty basis
or on an aggregate basis.
(2) Treatment of OTC Derivative Contracts
Consistent with the treatment in the New Accord and the general
risk-based capital rules, the proposed rule defines an OTC derivative
contract as a derivative contract that is not traded on an exchange
that requires the daily receipt and payment of cash-variation margin. A
derivative contract would be defined as a financial contract whose
value is derived from the values of one or more underlying assets,
reference rates, or indices of asset values or reference rates.
Derivative contracts would include interest rate derivative contracts,
exchange rate derivative contracts, equity derivative contracts,
commodity derivative contracts, credit derivatives, and any other
instrument that poses similar counterparty credit risks. The proposed
rule also defines derivative contracts to include unsettled securities,
commodities, and foreign exchange trades with a contractual settlement
or delivery lag that is longer than the normal settlement period (which
the proposed rule defines as the lesser of the market standard for the
particular instrument and five business days). This includes, for
example, mortgage-backed securities transactions that the GSEs conduct
in the To-Be-Announced market.
The current exposure method for determining the exposure amount for
single OTC derivative contracts contained in the New Accord is similar
to the method in the agencies' general risk-based capital rules. The
agencies propose to retain this risk-based capital treatment for OTC
derivative contracts.
Under the agencies' general risk-based capital rules, a banking
organization must obtain a written and well-reasoned legal opinion for
each of its bilateral qualifying master netting agreements that cover
OTC derivative contracts to recognize the netting benefit. In this NPR,
the agencies propose that to use netting treatment for multiple OTC
derivative contracts, the contracts must be subject to a qualifying
master netting agreement.
In this NPR, a qualifying master netting agreement means any
written, legally enforceable bilateral netting agreement, provided that
(i) the agreement creates a single legal obligation for all individual
transactions covered by the agreement upon an event of default,
including bankruptcy, insolvency or similar proceeding, of the
counterparty; (ii) the agreement provides the banking organization the
right to accelerate, terminate, and close out on a net basis all
transactions under the agreement and to liquidate or set off collateral
promptly upon an event of default, including upon an event of
bankruptcy, insolvency, or similar proceeding, of the counterparty,
provided that, in any such case, any exercise of rights under the
agreement will not be stayed or avoided under applicable law in the
relevant jurisdictions; (iii) the banking organization has conducted
sufficient legal review to conclude with a well-founded basis (and
maintain sufficient written documentation of that legal review) that
the agreement meets the requirements of part (ii) of this definition
and that, in the event of legal challenge (including one resulting from
default, bankruptcy, insolvency, or similar proceeding), the relevant
court and administrative authorities would find the agreement to be
legal, valid, binding, and enforceable under the law of the relevant
jurisdictions; (iv) the banking organization establishes and maintains
procedures to monitor possible changes in relevant law and to ensure
that the agreement continues to satisfy the requirements of the
definition of a qualifying master netting agreement; and (v) the
agreement does not contain a walkaway clause.
In some cases, the legal review requirement could be met by
reasoned reliance on a commissioned legal opinion or an in-house
counsel analysis. In other cases, for example, those involving certain
new derivative transactions or derivative counterparties in atypical
jurisdictions, the banking organization would need to obtain an
explicit, written legal opinion from external or internal legal counsel
addressing the particular situation.
If an OTC derivative contract is collateralized by financial
collateral, a banking organization would first determine the exposure
amount of the OTC derivative contract as described above and in section
35 of this proposed rule. To take into account the risk-reducing
effects of the financial collateral, a banking organization could
recognize the credit risk mitigation benefits of the financial
collateral using the simple approach for collateralized transactions
provided in section 37(b) of this proposed rule. Alternatively, a
banking organization could, if the financial collateral is marked-to-
market on a daily basis and subject to a daily margin maintenance
requirement, adjust the exposure amount of the contract using the
collateral haircut approach provided in section 37(c) of this proposed
rule.
(3) Counterparty Credit Risk for Credit Derivatives
A banking organization that purchases a credit derivative that is
recognized under section 36 of the proposed rule as a credit risk
mitigant for an existing exposure that is not a covered position under
the MRR would not have to compute a separate counterparty credit risk
capital requirement for the credit derivative in section 31 of the
proposed rule. If a banking organization chose not to hold risk-based
capital against the counterparty credit risk of such credit derivative
contracts, it would have to do so consistently for all such credit
derivative contracts. Further, where the contracts are subject to a
qualifying master netting agreement, the banking organization would
either include them all or exclude them all from any measure used to
determine counterparty credit risk exposure to all relevant
counterparties for risk-based capital purposes.
Where a banking organization provides protection through a credit
derivative that is not treated as a covered position under the MRR, it
would treat the credit derivative as an exposure to the reference
obligor and compute a risk-weighted asset amount for the credit
derivative under section 31 of the proposed rule. The banking
organization need not compute a counterparty credit risk capital
requirement for the credit derivative, as long as it does so
consistently for all such credit derivatives and either includes all or
excludes all such credit derivatives that are subject to a qualifying
master netting contract from any measure used to determine counterparty
credit risk exposure to all relevant counterparties for risk-based
capital purposes. Where the banking organization provides protection
through a credit derivative treated as a covered position under the
MRR, it would compute a counterparty credit risk capital requirement
using an amount determined under the OTC derivative contracts section
of this NPR. However, the PFE of the protection provider would be
capped at the net present value of the amount of unpaid premiums.
[[Page 44000]]
(4) Counterparty Credit Risk for Equity Derivatives
Under this NPR, a banking organization would be required to treat
an equity derivative contract as an equity exposure and compute a risk-
weighted asset amount for that exposure. A banking organization could
choose not to hold risk-based capital against the counterparty credit
risk of such equity contracts unless the banking organization treats
the contract as a covered position under the MRR. However, it would
have to do so consistently for all such equity derivative contracts.
Furthermore, where the contracts are subject to a qualifying master
netting agreement, the banking organization would have to either
include or exclude all the contracts from any measure used to determine
counterparty credit risk exposure to all relevant counterparties for
risk-based capital purposes. (The approach for equity exposures is
provided in Part V of the proposed rule.)
(5) Risk Weight for OTC Derivative Contracts
Under the general risk-based capital rules, a banking organization
must risk weight the credit equivalent amount of an OTC derivative
exposure by applying the risk weight of the counterparty or, where
applicable, guarantor or collateral, to the credit equivalent amount of
the contract(s). The risk weight is limited to 50 percent even if the
counterparty or guarantor would otherwise receive a higher risk weight.
The agencies limited the risk weight assigned to OTC derivative
contracts to 50 percent when they finalized the derivatives
counterparty credit risk rule in 1995.\32\ At that time, most
derivatives counterparties were highly rated and were generally
financial institutions. The agencies noted, however, that they intended
to monitor the quality of credits in the interest rate and exchange
rate markets to determine whether some transactions might merit a 100
percent risk weight.
---------------------------------------------------------------------------
\32\ 60 FR 46169-46185 (September 5, 1995).
---------------------------------------------------------------------------
Consistent with the New Accord, the agencies propose that the risk
weight for OTC derivative transactions would not be subject to any
specific ceiling. As the market for derivatives has developed, the
types of counterparties acceptable to participants have expanded to
include counterparties that the agencies believe merit a risk weight
greater than 50 percent.
K. Credit Risk Mitigation (CRM)
Banking organizations use a number of techniques to mitigate credit
risks. For example, a banking organization may collateralize exposures
by first-priority claims, in whole or in part, with cash or securities;
a third party may guarantee a loan exposure; or a banking organization
may buy a credit derivative to offset an exposure's credit risk.
Additionally, a banking organization may agree to net exposures to a
counterparty against reciprocal exposures from that counterparty. This
section describes how a banking organization could recognize for risk-
based capital purposes the risk-mitigation effects of guarantees,
credit derivatives, financial collateral, and, in limited cases, non-
financial collateral.
To recognize credit risk mitigants for risk-based capital purposes,
a banking organization should have in place operational procedures and
risk management processes that ensure that all documentation used in
collateralizing or guaranteeing a transaction is legal, valid, binding,
and enforceable under applicable law in the relevant jurisdictions. The
banking organization should have conducted sufficient legal review to
reach a well-founded conclusion that the documentation meets this
standard and should reconduct such a review as necessary to ensure
continuing enforceability.
Although the use of credit risk mitigants may reduce or transfer
credit risk, it simultaneously may increase other risks, including
operational, liquidity, and market risks. Accordingly, it is imperative
that a banking organization employ robust procedures and processes to
control risks, including roll-off risk and concentration risk, arising
from the banking organization's use of credit risk mitigants and to
monitor the implications of using credit risk mitigants for the banking
organization's overall credit risk profile.
(1) Guarantees and Credit Derivatives
(a) Eligibility Requirements
The agencies' general risk-based capital rules generally recognize
third-party guarantees provided by central governments, U.S.
government-sponsored entities, public-sector entities in OECD
countries, multilateral lending institutions and regional development
banks, depository institutions, and qualifying securities firms in OECD
countries. Consistent with the New Accord, the agencies propose to
allow a banking organization to use a substitution approach similar to
the approach in the agencies' general risk-based capital rules and
recognize a wider range of guarantors.
This NPR defines an eligible guarantor as any of the following
entities: (i) a sovereign entity, the Bank for International
Settlements, the International Monetary Fund, the European Central
Bank, the European Commission, a Federal Home Loan Bank, the Federal
Agricultural Mortgage Corporation (Farmer Mac), an MDB, a depository
institution, a foreign bank, a credit union, a bank holding company (as
defined in section 2 of the Bank Holding Company Act (12 U.S.C. 1841)),
or a savings and loan holding company (as defined in 12 U.S.C. 1467a)
provided all or substantially all of the holding company's activities
are permissible for a financial holding company under 12 U.S.C.
1843(k); or (ii) any other entity (other than a securitization special
purpose entity (SPE)) if at the time the entity issued the guarantee or
credit derivative or at any time thereafter, the entity has issued and
has outstanding an unsecured long-term debt security without credit
enhancement that has a long-term applicable external rating.
For recognition under this proposed rule, consistent with the
advanced approaches final rule, guarantees and credit derivatives would
have to meet specific eligibility requirements. This proposed rule
defines an eligible guarantee as a guarantee from an eligible guarantor
that: (i) is written; (ii) is either unconditional, or a contingent
obligation of the United States Government or its agencies, the
validity of which to the beneficiary is dependent upon some affirmative
action on the part of the beneficiary of the guarantee or a third party
(for example, servicing requirements); (iii) covers all or a pro rata
portion of all contractual payments of the obligor on the reference
exposure; (iv) gives the beneficiary a direct claim against the
protection provider; (v) is not unilaterally cancelable by the
protection provider for reasons other than the breach of the contract
by the beneficiary; (vi) is legally enforceable against the protection
provider in a jurisdiction where the protection provider has sufficient
assets against which a judgment may be attached and enforced; (vii)
requires the protection provider to make payment to the beneficiary on
the occurrence of a default (as defined in the guarantee) of the
obligor on the reference exposure in a timely manner without the
beneficiary first having to take legal actions to pursue the obligor
for payment; (viii) does not increase the beneficiary's cost of credit
protection on the guarantee in response to deterioration in the credit
quality of the reference exposure; and (ix) is not provided by an
affiliate of the
[[Page 44001]]
banking organization, unless the affiliate is an insured depository
institution, foreign bank, securities broker or dealer, or insurance
company that does not control the banking organization; and is subject
to consolidated supervision and regulation comparable to that imposed
on U.S. depository institutions, securities brokers or dealers, or
insurance companies (as the case may be).
In this NPR, consistent with the advanced approaches final rule,
eligible credit derivative means a credit derivative in the form of a
credit default swap, nth-to-default swap, total return swap,
or any other form of credit derivative approved by the primary Federal
supervisor, provided that:
(i) The contract meets the requirements of an eligible guarantee
and has been confirmed by the protection purchaser and the protection
provider;
(ii) Any assignment of the contract has been confirmed by all
relevant parties;
(iii) If the credit derivative is a credit default swap or
nth-to-default swap, the contract includes the following
credit events: (A) failure to pay any amount due under the terms of the
reference exposure, subject to any applicable minimal payment threshold
that is consistent with standard market practice and with a grace
period that is closely in line with the grace period of the reference
exposure; and (B) bankruptcy, insolvency, or inability of the obligor
on the reference exposure to pay its debts, or its failure or admission
in writing of its inability generally to pay its debts as they become
due, and similar events;
(iv) The terms and conditions dictating the manner in which the
contract is to be settled are incorporated into the contract;
(v) If the contract allows for cash settlement, the contract
incorporates a robust valuation process to estimate loss reliably and
specifies a reasonable period for obtaining post-credit event
valuations of the reference exposure;
(vi) If the contract requires the protection purchaser to transfer
an exposure to the protection provider at settlement, the terms of at
least one of the exposures that is permitted to be transferred under
the contract must provide that any required consent to transfer may not
be unreasonably withheld;
(vii) If the credit derivative is a credit default swap or nth-to-
default swap, the contract clearly identifies the parties responsible
for determining whether a credit event has occurred, specifies that
this determination is not the sole responsibility of the protection
provider, and gives the protection purchaser the right to notify the
protection provider of the occurrence of a credit event; and
(viii) If the credit derivative is a total return swap and the
banking organization records net payments received on the swap as net
income, the banking organization records offsetting deterioration in
the value of the hedged exposure (through reductions in fair value).
Under this NPR, which is consistent with the advanced approaches
final rule, a banking organization would be permitted to recognize an
eligible credit derivative that hedges an exposure that is different
from the credit derivative's reference exposure used for determining
the derivative's cash settlement value, deliverable obligation, or
occurrence of a credit event only if: (i) The reference exposure ranks
pari passu or subordinated to the hedged exposure and (ii) the
reference exposure and the hedged exposure are exposures to the same
legal entity, and legally enforceable cross-default or cross-
acceleration clauses are in place to assure protection payments under
the credit derivative are triggered when the obligor fails to pay under
the terms of the hedged exposure.
(b) Substitution Approach
Under the substitution approach in this NPR, if the protection
amount (as defined below) of the eligible guarantee or eligible credit
derivative is greater than or equal to the exposure amount of the
hedged exposure, a banking organization could substitute the risk
weight associated with the guarantee or credit derivative for the risk
weight of the hedged exposure. If the protection amount of the eligible
guarantee or eligible credit derivative is less than the exposure
amount of the hedged exposure, the banking organization would have to
treat the hedged exposure as two separate exposures (protected and
unprotected) to recognize the credit risk mitigation benefit of the
guarantee or credit derivative on the protected exposure. A banking
organization would calculate the risk-weighted asset amount for the
protected exposure under section 36 of this NPR (using a risk weight
associated with the guarantee or credit derivative and an exposure
amount equal to the protection amount of the guarantee or credit
derivative). The banking organization would calculate its risk-weighted
asset amount for the unprotected exposure under section 36 of this NPR
(using the risk weight assigned to the exposure and an exposure amount
equal to the exposure amount of the original hedged exposure minus the
protection amount of the guarantee or credit derivative). If the
banking organization determines that substitution of the guarantee or
credit derivative's risk weight would lead to an inappropriate degree
of risk mitigation, it may substitute a higher risk weight.
The protection amount of an eligible guarantee or eligible credit
derivative would be the effective notional amount of the guarantee or
credit derivative reduced by any applicable haircuts for maturity
mismatch, lack of restructuring coverage, and currency mismatch (each
described below). The effective notional amount of an eligible
guarantee or eligible credit derivative would be the lesser of the
contractual notional amount of the credit risk mitigant and the
exposure amount of the hedged exposure, multiplied by the percentage
coverage of the credit risk mitigant. For example, the effective
notional amount of a guarantee that covers, on a pro rata basis, 40
percent of any losses on a $100 bond would be $40.
(c) Maturity Mismatch Haircut
A banking organization that seeks to reduce the risk-weighted asset
amount of an exposure by recognizing an eligible guarantee or eligible
credit derivative would have to adjust the effective notional amount of
the credit risk mitigant downward to reflect any maturity mismatch
between the hedged exposure and the credit risk mitigant. A maturity
mismatch occurs when the residual maturity of a credit risk mitigant is
less than that of the hedged exposure(s). When a banking organization
has a group of hedged exposures with different residual maturities that
are covered by a single eligible guarantee or eligible credit
derivative, a banking organization would treat each hedged exposure as
if it were fully covered by a separate eligible guarantee or eligible
credit derivative. To determine whether any of the hedged exposures has
a maturity mismatch with the eligible guarantee or credit derivative,
the banking organization would assess whether the residual maturity of
the eligible guarantee or eligible credit derivative is less than that
of the hedged exposure.
The residual maturity of a hedged exposure would be the longest
possible remaining time before the obligor is scheduled to fulfill its
obligation on the exposure. Embedded options that may reduce the term
of the credit risk mitigant would be taken into account so that the
shortest possible residual maturity for the credit risk mitigant would
be used to determine the
[[Page 44002]]
potential maturity mismatch. Where a call is at the discretion of the
protection provider, the residual maturity of the eligible guarantee or
eligible credit derivative would be at the first call date. If the call
is at the discretion of the banking organization purchasing the
protection, but the terms of the arrangement at the origination of the
eligible guarantee or eligible credit derivative contain a positive
incentive for the banking organization to call the transaction before
contractual maturity, the remaining time to the first call date would
be the residual maturity of the credit risk mitigant. For example,
where there is a step-up in the cost of credit protection in
conjunction with a call feature or where the effective cost of
protection increases over time even if credit quality remains the same
or improves, the residual maturity of the credit risk mitigant would be
the remaining time to the first call.
Under the proposed rule, a banking organization would only
recognize an eligible guarantee or an eligible credit derivative with a
maturity mismatch if the original maturity is equal to or greater than
one year and the residual maturity is greater than three months.
When a maturity mismatch exists, a banking organization would have
to apply the following maturity mismatch adjustment to the effective
notional amount of the guarantee or credit derivative adjusted for
maturity mismatch:
Pm = E x (t-0.25) / (T-0.25),
Where:
(i) Pm = effective notional amount of the guarantee or credit
derivative adjusted for maturity mismatch;
(ii) E = effective notional amount of the guarantee or credit
derivative;
(iii) t = lesser of T or residual maturity of the guarantee or
credit derivative, expressed in years; and
(iv) T = lesser of 5 or residual maturity of the hedged exposure,
expressed in years.
(d) Restructuring Haircut
A banking organization that seeks to recognize an eligible credit
derivative that does not include a restructuring as a credit event that
triggers payment under the derivative would have to reduce the
recognition of the credit derivative by 40 percent. For these purposes,
a restructuring involves forgiveness or postponement of principal,
interest, or fees that result in a credit loss event (that is, a charge
off, specific provision, or other similar debit to the profit and loss
account).
In other words, the effective notional amount of the credit
derivative adjusted for lack of restructuring credit event (and
maturity mismatch, if applicable) would be:
Pr = Pm x 0.60,
Where:
(i) Pr = effective notional amount of the credit derivative,
adjusted for lack of restructuring credit event (and maturity
mismatch, if applicable); and
(ii) Pm = effective notional amount of the credit derivative
(adjusted for maturity mismatch, if applicable).
(e) Currency Mismatch Haircut
Where the eligible guarantee or eligible credit derivative is
denominated in a currency different from that in which any hedged
exposure is denominated, the effective notional amount of the guarantee
or credit derivative adjusted for currency mismatch (and maturity
mismatch and lack of restructuring credit event, if applicable) would
be calculated as:
Pc = Pr x (1-Hfx),
Where:
(i) Pc = effective notional amount of the guarantee or credit
derivative, adjusted for currency mismatch (and maturity mismatch
and lack of restructuring credit event, if applicable);
(ii) Pr = effective notional amount of the guarantee or credit
derivative (adjusted for maturity mismatch and lack of restructuring
credit event, if applicable); and
(iii) Hfx = haircut appropriate for the currency mismatch between
the guarantee or credit derivative and the hedged exposure.
Except as provided below, a banking organization would be required
to use a standard supervisory haircut of 8.0 percent for Hfx (based on
a ten-business day holding period and daily marking-to-market and
remargining). Alternatively, a banking organization could use
internally estimated haircuts for Hfx based on a ten-business day
holding period and daily marking-to-market and remargining if the
banking organization qualifies to use the own-estimates haircuts, or
the simple VaR method as provided in section 37(d) of this NPR. The
banking organization would scale these haircuts up using the square
root of time formula if the banking organization revalues the guarantee
or credit derivative less frequently than once every ten business days.
The applicable haircut (HM) is calculated using the following square
root of time formula:
[GRAPHIC] [TIFF OMITTED] TP29JY08.000
Where:
(i) TM = greater of ten and the number of days between revaluations
of the credit derivative or guarantee;
(ii) TN = holding period used by the banking organization to derive
HN; and
(iii) HN = haircut based on the holding period TN.
(f) Multiple Credit Risk Mitigants
If multiple credit risk mitigants (for example, two eligible
guarantees) cover a single exposure, the CRM section in the New Accord
provides that a banking organization must disaggregate the exposure
into portions covered by each credit risk mitigant (for example, the
portion covered by each guarantee) and must calculate separately the
risk-based capital requirement of each portion.\33\ The New Accord also
indicates that when credit risk mitigants provided by a single
protection provider have differing maturities, the mitigants should be
subdivided into separate layers of protection.\34\ The agencies propose
to permit a banking organization to take this approach.
---------------------------------------------------------------------------
\33\ New Accord, ] 206.
\34\ Id.
---------------------------------------------------------------------------
(2) Collateralized Transactions
The general risk-based capital rules recognize limited types of
collateral: Cash on deposit; securities issued or guaranteed by central
governments of the OECD countries; securities issued or guaranteed by
the U.S. government or its agencies; and securities issued by certain
multilateral development banks.\35\
---------------------------------------------------------------------------
\35\ The agencies' rules for collateral transactions, however,
differ somewhat as described in the agencies' joint report to
Congress. ``Joint Report: Differences in Accounting and Capital
Standards among the Federal Banking Agencies,'' 71 FR 16776 (April
4, 2006).
---------------------------------------------------------------------------
(a) Collateral Proposal
In the past, the banking industry has urged the agencies to
recognize a wider array of collateral types for purposes of reducing
risk-based capital requirements. The agencies agree that their general
risk-based capital rules for collateral are restrictive and, in some
cases, ignore market practice. Accordingly, the agencies propose to
recognize the credit mitigating impact of financial collateral. For
purposes of this NPR, financial collateral means collateral in the form
of any of the following instruments: (i) Cash on deposit with the
banking organization (including cash held for the banking organization
by a third-party custodian or trustee); (ii) gold bullion; (iii) long-
term debt securities that have an applicable external rating of one
category below investment grade or higher (for example, at least BB-);
(iv)
[[Page 44003]]
short-term debt instruments that have an applicable external rating of
at least investment grade (for example, at least A-3); (v) equity
securities that are publicly traded; (vi) convertible bonds that are
publicly traded; (vii) money market mutual fund shares and other mutual
fund shares if a price for the shares is publicly quoted daily; or
(viii) conforming residential mortgage exposures. With the exception of
cash on deposit, the banking organization would have to have a
perfected, first-priority security interest in the collateral or,
outside of the United States, the legal equivalent thereof,
notwithstanding the prior security interest of any custodial agent. A
banking organization could recognize partial collateralization of the
exposure.
The agencies propose to permit a banking organization to recognize
the risk-mitigating effects of financial collateral using the simple
approach, the collateral haircut approach, and the simple VaR approach.
The collateral haircut and simple VaR approaches are the same as the
collateral haircut and simple VaR approaches in the advanced approaches
final rule. The agencies do not propose, however, to include the
internal models method (for example, the expected positive exposure
(EPE) method) in this NPR.
The agencies propose to permit a banking organization to use any
applicable approach to recognize collateral provided the banking
organization uses the same approach for similar exposures. Under this
NPR as under the advanced approaches final rule, a banking organization
could use the collateral haircut approach only for repo-style
transactions, eligible margin loans, collateralized OTC derivative
transactions, and single-product netting sets thereof, and the simple
VaR approach only for single-product netting sets of repo-style
transactions and eligible margin loans.
Table 10 illustrates the CRM methods that would be available for
various types of transactions under the proposed rule.
Table 10.--Applicability of CRM Methods
----------------------------------------------------------------------------------------------------------------
Collateral
Collateralized exposure Simple haircut Simple VaR
approach approach method
----------------------------------------------------------------------------------------------------------------
Any exposure................................................. X ............... ...............
OTC Derivative Contract...................................... X X ...............
Repo-Style Transaction....................................... X X X
Eligible Margin Loan......................................... X X X
----------------------------------------------------------------------------------------------------------------
The proposed rule defines repo-style transaction as a repurchase or
reverse repurchase transaction, or a securities borrowing or securities
lending transaction (including a transaction in which the banking
organization acts as agent for a customer and indemnifies the customer
against loss), provided that:
(i) The transaction is based solely on liquid and readily
marketable securities, cash, gold, or conforming residential mortgage
exposures;
(ii) The transaction is marked-to-market daily and subject to daily
margin maintenance requirements;
(iii)(a) The transaction is a ``securities contract'' or
``repurchase agreement'' under section 555 or 559, respectively, of the
Bankruptcy Code (11 U.S.C. 555 or 559), a qualified financial contract
under section 11(e)(8) of the Federal Deposit Insurance Act (12 U.S.C.
1821(e)(8)), or a netting contract between or among financial
institutions under sections 401-407 of the Federal Deposit Insurance
Corporation Improvement Act of 1991 (12 U.S.C. 4401-4407) or the
Federal Reserve Board's Regulation EE (12 CFR part 231); or (b) if the
transaction does not meet the criteria in paragraph (iii)(a) of this
definition, then: Either the transaction is executed under an agreement
that provides the banking organization the right to accelerate,
terminate, and close out the transaction on a net basis and to
liquidate or set off collateral promptly upon an event of default
(including upon an event of bankruptcy, insolvency, or similar
proceeding) of the counterparty, provided that, in any such case, any
exercise of rights under the agreement will not be stayed or avoided
under applicable law in the relevant jurisdictions; or the transaction
is either overnight or unconditionally cancelable at any time by the
banking organization and is executed under an agreement that provides
the banking organization the right to accelerate, terminate, and close
out the transaction on a net basis and to liquidate or set off
collateral promptly upon an event of counterparty default; and
(iv) The banking organization has conducted sufficient legal review
to conclude with a well-founded basis (and maintains sufficient
documentation of that legal review) that the agreement meets the
requirements of paragraph (iii) of this definition and is legal, valid,
binding, and enforceable under applicable law in the relevant
jurisdictions.
This NPR defines an eligible margin loan as an extension of credit
where: (i) the extension of credit is collateralized exclusively by
liquid and readily marketable debt or equity securities, gold, or
conforming residential mortgage exposures; (ii) the collateral is
marked-to-market daily, and the transaction is subject to daily margin
maintenance requirements; (iii) the extension of credit is conducted
under an agreement that provides the banking organization the right to
accelerate and terminate the extension of credit and to liquidate or
set off collateral promptly upon an event of default (including upon an
event of bankruptcy, insolvency, or similar proceeding) of the
counterparty, provided that, in any such case, any exercise of rights
under the agreement will not be stayed or avoided under applicable law
in the relevant jurisdictions; \36\ and (iv) the banking organization
has conducted sufficient legal review to conclude with a well-founded
basis (and maintains sufficient written documentation of that legal
review) that the agreement meets the requirements of paragraph (iii) of
this definition and is legal, valid, binding, and enforceable under
applicable law in the relevant jurisdictions.
---------------------------------------------------------------------------
\36\ This requirement is met where all transactions under the
agreement are (i) executed under U.S. law and (ii) constitute
``securities contracts'' under section 555 of the Bankruptcy code
(11 U.S.C. 555), qualified financial contracts under section
11(e)(8) of the Federal Deposit Insurance Act (12 U.S.C. 1821(e)(8),
or netting contracts between or among financial institutions under
sections 401-407 of the Federal Deposit Insurance Corporation
Improvement Act of 1991 (12 U.S.C. 4401-4407) or the Federal Reserve
Board's Regulation EE (12 CFR part 231).
---------------------------------------------------------------------------
(b) Risk Management Guidance for Recognizing Collateral
Before relying on the CRM benefits of collateral to risk weight its
exposures, a banking organization should: (i) Conduct sufficient legal
review to ensure, at inception and on an ongoing basis, that all
documentation used in the
[[Page 44004]]
collateralized transaction is binding on all parties and legally
enforceable in all relevant jurisdictions; (ii) consider the
correlation between obligor risk of the underlying direct exposure and
collateral risk in the transaction; and (iii) fully take into account
the time and cost needed to realize the liquidation proceeds and the
potential for a decline in collateral value over this time period.
A banking organization also should ensure that: (i) the legal
mechanism under which the collateral is pledged or transferred ensures
that the banking organization has the right to liquidate or take legal
possession of the collateral in a timely manner in the event of the
default, insolvency, or bankruptcy (or other defined credit event) of
the obligor and, where applicable, the custodian holding the
collateral; (ii) the banking organization has taken all steps necessary
to fulfill legal requirements to secure its interest in the collateral
so that it has and maintains an enforceable security interest; (iii)
the banking organization has clear and robust procedures to ensure
observation of any legal conditions required for declaring the default
of the borrower and prompt liquidation of the collateral in the event
of default; (iv) the banking organization has established procedures
and practices for conservatively estimating, on a regular ongoing
basis, the market value of the collateral, taking into account factors
that could affect that value (for example, the liquidity of the market
for the collateral and obsolescence or deterioration of the
collateral); and (v) the banking organization has in place systems for
promptly requesting and receiving additional collateral for
transactions whose terms require maintenance of collateral values at
specified thresholds.
(c) Simple Approach
The agencies propose to allow a banking organization to apply the
simple approach, which is similar to the approach in the agencies'
general risk-based capital rules, in a manner generally consistent with
the New Accord. Generally, under the simple approach, the
collateralized portion of the exposure would receive the risk weight
applicable to the collateral. Subject to certain exceptions, the risk
weight assigned to the collateralized portion of the exposure may not
be less than 20 percent. In most cases, the collateral would have to be
financial collateral. For repurchase agreements, reverse repurchase
agreements, and securities lending and borrowing transactions, the
collateral is the instruments, gold, and cash the banking organization
has borrowed, purchased subject to resale, or taken as collateral from
the counterparty under the transaction. A banking organization,
however, could recognize any collateral for a repo-style transaction
that is included in the banking organization's VaR-based measure under
the MRR. In all cases, the collateral agreement would have to be for at
least the life of the exposure, a banking organization would have to
revalue the collateral at least every six months, and the exposure and
the collateral (other than gold) would have to be denominated in the
same currency.
In certain cases, collateral may be used to reduce the risk weight
to less than 20 percent for an exposure. The exceptions to the risk-
weight floor of 20 percent are: (i) OTC derivative transactions that
are marked-to-market on a daily basis and subject to a daily margin
maintenance agreement, which could receive (1) a zero percent risk
weight to the extent that they are collateralized by cash on deposit,
and (2) a 10 percent risk weight to the extent that they are
collateralized by a sovereign security or PSE security that qualifies
for a zero percent risk weight under section 33 of this NPR; (ii) the
portion of exposures collateralized by cash on deposit could receive a
zero percent risk weight; and (iii) the portion of exposures
collateralized by a sovereign security or a PSE security denominated in
the same currency could receive a zero percent risk weight provided
that the banking organization discounts the market value of the
collateral by 20 percent.
In the case where a banking organization chooses to recognize
collateral in the form of conforming residential mortgages, the banking
organization must risk weight the portion of the exposure that is
secured by the conforming residential mortgage at 50 percent.
(d) Collateral Haircut and Simple VaR Approaches
The agencies propose to permit a banking organization to use the
collateral haircut approach to recognize the risk mitigating effect of
financial collateral that secures a repo-style transaction, eligible
margin loan, collateralized OTC derivative contract, or single-product
netting set of such transactions through an adjustment to the exposure
amount. The collateral haircut approach contains two methods for
calculating the haircuts: Supervisory haircuts or own-estimates
haircuts. Additionally, the banking organization could use the simple
VaR approach for single-product netting sets of repo-style transactions
or eligible margin loans. In this proposed rule, a netting set means a
group of transactions with a single counterparty that are subject to a
qualifying master netting agreement.
Although a banking organization could use any combination of
supervisory haircuts, own-estimate haircuts, and simple VaR (only for
single-product netting sets of repo-style transactions or eligible
margin loans) to recognize collateral, it would have to use the same
approach for similar exposures. A banking organization could, however,
apply a different method to subsets of repo-style transactions,
eligible margin loans, or OTC derivatives by product type or geographic
location if its application of different methods were designed to
separate transactions that do no have similar risk profiles and was not
designed for arbitrage purposes. For example, a banking organization
could choose to use one method for agency securities lending
transactions, that is, repo-style transactions in which the banking
organization, acting as agent for a customer, lends the customer's
securities and indemnifies the customer against loss, and another
method for all other repo-style transactions. The agencies propose to
require use of the supervisory haircut approach to recognize the risk-
mitigating effect of conforming residential mortgages in exposure
amount. Use of the standard supervisory haircut approach for repo-style
transactions, eligible margin loans, and OTC derivatives collateralized
by conforming mortgages, however, would not preclude a banking
organization's use of own estimates haircuts or the simple VaR approach
for exposures collateralized by other types of financial collateral.
Consistent with the New Accord and the advanced approaches final
rule, a banking organization could also use the collateral haircut
approaches to recognize the benefits of any collateral (not only
financial collateral) mitigating the counterparty credit risk of repo-
style transactions included in a banking organization's VaR-based
measure under the MRR. In this instance, a banking organization would
not need to apply the supervisory haircut approach to conforming
mortgage collateral, but could use one of the other approaches to
recognize that collateral.
(e) Exposure Amount for Repo-Style Transactions, Eligible Margin Loans,
and Collateralized OTC Derivatives
Under the collateral haircut approach, a banking organization would
set the exposure amount equal to the greater of zero and the sum of
three quantities:
[[Page 44005]]
(i) The value of the exposure less the value of the collateral (for
eligible margin loans and repo-style transactions, the value of the
exposure is the sum of the current market values of all instruments,
gold, and cash the banking organization has lent, sold subject to
repurchase, or posted as collateral to the counterparty under the
transaction (or netting set); for collateralized OTC derivative
contracts, the value of the exposure is the exposure amount that is
calculated under section 35(c) or (d) of this proposed rule; the value
of the collateral is the sum of the current market values of all
instruments, gold and cash the banking organization has borrowed,
purchased subject to resale, or taken as collateral from the
counterparty under the transaction (or netting set));
(ii) The absolute value of the net position in a given instrument
or in gold (where the net position in a given instrument or in gold
equals the sum of the current market values of the instrument or gold
the banking organization has lent, sold subject to repurchase, or
posted as collateral to the counterparty minus the sum of the current
market values of that same instrument or gold the banking organization
has borrowed, purchased subject to resale, or taken as collateral from
the counterparty) multiplied by the market price volatility haircut
appropriate to the instrument or gold; and
(iii) The sum of the absolute values of the net position of any
cash or instruments in each currency that is different from the
settlement currency multiplied by the haircut appropriate to each
currency mismatch.
To determine the appropriate haircuts, a banking organization may
choose to use standard supervisory haircuts or, with prior written
approval from its primary Federal supervisor, its own estimates of
haircuts. After determining the exposure amount, the banking
organization would risk weight the exposure amount according to the
obligor or guarantor if applicable.
For purposes of the collateral haircut approach, a given instrument
would include, for example, all securities with a single Committee on
Uniform Securities Identification Procedures (CUSIP) number and would
not include securities with different CUSIP numbers, even if issued by
the same issuer with the same maturity date.
For purposes of this calculation, the net position in a given
currency equals the sum of the current market values of any instruments
or cash in the currency the banking organization has lent, sold subject
to repurchase, or posted as collateral to the counterparty minus the
sum of the current market values of any instruments or cash in the
currency the banking organization has borrowed, purchased subject to
resale, or taken as collateral from the counterparty.
(f) Standard Supervisory Haircuts
Under this NPR, if a banking organization chooses to use standard
supervisory haircuts, it would use an 8.0 percent haircut for each
currency mismatch and use the market price volatility haircut
appropriate to each security in Table 11 below. These haircuts are
based on the ten-business-day holding period for eligible margin loans
and collateralized OTC derivative contracts and may be multiplied by
the square root of \1/2\ to convert the standard supervisory haircuts
to the five-business-day minimum holding period for repo-style
transactions (unless the collateral is conforming residential
mortgages, in which case the banking organization must use a minimum
ten-business-day holding period). A banking organization would adjust
the standard supervisory haircuts upward on the basis of a holding
period longer than ten business days for eligible margin loans and
collateralized OTC derivative contracts or five business days for repo-
style transactions where and as appropriate to take into account the
illiquidity of an instrument.
Table 11.--Standard Supervisory Haircuts Based on Market Price Volatility \1\
----------------------------------------------------------------------------------------------------------------
Applicable external rating grade category Residual maturity for debt Sovereign entity
for debt securities securities issuers \2\ Other issuers
----------------------------------------------------------------------------------------------------------------
Two highest investment grade rating <= 1 year..................... .005 .01
categories for long-term ratings/highest >1 year, <= 5 years........... .02 .04
investment grade rating category for short- >5 years...................... .04 .08
term ratings.
----------------------------------------------------------------------------------------------------------------
Two lowest investment grade rating <= 1 year..................... .01 .02
categories for both short- and long-term >1 year, <= 5 years........... .03 .06
ratings. > 5 years..................... .06 .12
----------------------------------------------------------------------------------------------------------------
One rating category below investment grade. All........................... .15 .25
----------------------------------------------------------------------------------------------------------------
Main index equities \37\ (including convertible bonds) and gold............ .15 .15
----------------------------------------------------------------------------------------------------------------
Other publicly traded equities (including convertible bonds), conforming .25 .25
residential mortgages, and non-financial collateral.
----------------------------------------------------------------------------------------------------------------
Mutual funds.................................(1) Highest haircut applicable to any security in
which the fund can invest.
----------------------------------------------------------------------------------------------------------------
Cash on deposit with the bank (including a certificate of deposit issued by 0 0
the banking organization).
----------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircuts in Table 11 are based on a ten-business-day holding period.
\2\ This column includes the haircuts for MDBs and foreign PSEs that would receive a zero percent risk weight.
As an example, if a banking organization that uses standard
supervisory haircuts has extended an eligible margin loan of $100 that
is collateralized by five-year U.S. Treasury notes with a market value
of $100, the value of the exposure less the value of the collateral
would be zero, and the net position in the security ($100) times the
supervisory haircut (.02) would be $2. There is no currency mismatch.
[[Page 44006]]
Therefore, the exposure amount would be $0 + $2 = $2.
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\37\ The proposed rule defines a ``main index'' as the S&P 500
Index, the FTSE All-World Index, and any other index for which the
bank demonstrates to the satisfaction of its primary Federal
supervisor that the equities represented in the index have
comparable liquidity, depth of market, and size of bid-ask spreads
as equities in the S&P 500 Index and the FTSE All-World Index.
---------------------------------------------------------------------------
(g) Own Estimates of Haircuts
With the prior written approval of the banking organization's
primary Federal supervisor, a banking organization could calculate
market price volatility and currency mismatch haircuts using its own
internal estimates of market price volatility and foreign exchange
volatility. The banking organization's primary Federal supervisor would
base approval to use internally estimated haircuts on the satisfaction
of certain minimum qualitative and quantitative standards. These
standards include: (i) The banking organization would use a 99th
percentile one-tailed confidence interval and a minimum five-business-
day holding period for repo-style transactions and a minimum ten-
business-day holding period for all other transactions; (ii) the
banking organization would adjust holding periods upward where and as
appropriate to take into account the illiquidity of an instrument;
(iii) the banking organization would select a historical observation
period for calculating haircuts of at least one year; and (iv) the
banking organization would update its data sets and compute haircuts no
less frequently than quarterly and would update its data sets and
compute haircuts whenever market prices change materially. A banking
organization would estimate individually the volatilities of the
exposure, the collateral, and foreign exchange rates and may not take
into account the correlations between them.
A banking organization that uses internally estimated haircuts
would have to adhere to the following rules. The banking organization
could calculate internally estimated haircuts for categories of debt
securities that have an applicable external or applicable inferred
rating of at least investment grade. The haircut for a category of
securities would have to be representative of the internal volatility
estimates for securities in that category that the banking organization
has actually lent, sold subject to repurchase, posted as collateral,
borrowed, purchased subject to resale, or taken as collateral. In
determining relevant categories, the banking organization would at a
minimum have to take into account (i) the type of issuer of the
security; (ii) the applicable external rating of the security; (iii)
the maturity of the security; and (iv) the interest rate sensitivity of
the security. A banking organization would calculate a separate
internally estimated haircut for each individual debt security that has
an applicable external rating below investment grade and for each
individual equity security. In addition, a banking organization would
estimate a separate currency mismatch haircut for its net position in
each mismatched currency based on estimated volatilities for foreign
exchange rates between the mismatched currency and the settlement
currency where an exposure or collateral (whether in the form of cash
or securities) is denominated in a currency that differs from the
settlement currency.
When a banking organization calculates an internally estimated
haircut on a TN-day holding period, which is different from
the minimum holding period for the transaction type, the banking
organization would have to calculate the applicable haircut
(HM) using the following square root of time formula:
[GRAPHIC] [TIFF OMITTED] TP29JY08.001
Where:
(i) TM = five for repo-style transactions and ten for eligible
margin loans and OTC derivatives;
(ii) TN = holding period used by the banking organization to derive
HN; and
(iii) HN = haircut based on the holding period TN.
(h) Simple VaR Method
With the prior written approval of its primary Federal supervisor,
a banking organization could estimate the exposure amount for repo-
style transactions and eligible margin loans subject to a single-
product qualifying master netting agreement using a VaR model. Under
the simple VaR method, a banking organization's exposure amount for
transactions subject to such a netting agreement would be equal to the
value of the exposures minus the value of the collateral plus a VaR-
based estimate of the PFE. The value of the exposures would be the sum
of the current market values of all instruments, gold, and cash the
banking organization has lent, sold subject to repurchase, or posted as
collateral to a counterparty under the netting set. The value of the
collateral would be the sum of the current market values of all
instruments, gold, and cash the banking organization has borrowed,
purchased subject to resale, or taken as collateral from a counterparty
under the netting set. The VaR-based estimate of the PFE would be an
estimate of the banking organization's maximum exposure on the netting
set over a fixed time horizon with a high level of confidence.
To qualify for the simple VaR approach, a banking organization's
VaR model would have to estimate the banking organization's 99th
percentile, one-tailed confidence interval for an increase in the value
of the exposures minus the value of the collateral ([Sigma]E -
[Sigma]C) over a five-business-day holding period for repo-style
transactions or over a ten-business-day holding period for eligible
margin loans using a minimum one-year historical observation period of
price data representing the instruments that the banking organization
has lent, sold subject to repurchase, posted as collateral, borrowed,
purchased subject to resale, or taken as collateral. The main ongoing
qualification requirement for using a VaR model is that the banking
organization would have to validate its VaR model by establishing and
maintaining a rigorous and regular backtesting regime. In this NPR,
backtesting means the comparison of a banking organization's internal
estimates with actual outcomes during a sample period not used in model
development.
(i) Zero H Approach
The New Accord includes an additional approach, the Zero H
approach, to recognize the risk mitigating benefits of certain
collateral types in repo-style transactions conducted with a limited
group of counterparties. The Zero H approach permits a banking
organization that uses the collateral haircut approach to apply a
haircut of zero percent to financial collateral in repo-style
transactions that meet the criteria described below and are conducted
with core market participants. Under the New Accord, the definition of
core market participants includes sovereign entities, central banks,
PSEs, banks and securities firms, other financial companies eligible
for a 20 percent risk weight, regulated mutual funds, regulated pension
funds, and recognized clearing organizations. A repo-style transaction
conducted with a core market participant qualifies for the Zero H
approach if: (i) Both the exposure and the collateral are cash or a
sovereign or PSE security that qualifies for a zero percent risk weight
and are denominated in the same currency; (ii) following a
counterparty's failure to remargin, the time required between the last
mark-to-market before the failure to remargin and the liquidation \38\
of the collateral is no more than four business days; (iii) the
[[Page 44007]]
transaction is settled across a settlement system proven for that type
of transaction; (iv) the documentation covering the agreement is
standard market documentation for repo-style transactions in the
securities concerned; (v) the transaction is governed by documentation
specifying that if the counterparty fails to satisfy an obligation to
deliver cash or securities or to deliver margin or otherwise defaults,
then the transaction is immediately terminable; and (vi) upon any
default event, regardless of whether the counterparty is insolvent or
bankrupt, the banking organization has the unfettered, legally
enforceable right to immediately seize and liquidate the collateral for
its benefit.
---------------------------------------------------------------------------
\38\ The banking organization does not have to liquidate the
collateral, but it would have to be able to do so within the time
frame.
---------------------------------------------------------------------------
The New Accord also includes a variation of the Zero H approach for
banking organizations that use the simple approach to recognize
financial collateral. For repo-style transactions that meet the Zero H
criteria and are conducted with core market participants, the banking
organization would assign a risk weight of zero percent. A banking
organization would assign a risk weight of 10 percent to repo-style
transaction exposures that meet the criteria and are conducted with
non-core market participants.
The agencies have decided not to include the Zero H approach and
the variation for the simple approach in this proposal because the
agencies believe that doing so would add unnecessary complexity. In the
New Accord, a banking organization must choose to use either the simple
approach or the comprehensive approach \39\ for all its collateralized
transactions. The agencies have proposed a more flexible treatment that
would permit a banking organization to select its approach to
collateral based on transaction type. This flexibility allows for more
risk sensitivity in the capital calculation for repo-style
transactions. For example, a banking organization could choose the
collateral haircut or simple VaR approach for repo-style transactions
and the simple approach for other transaction types. Additionally, the
agencies question whether the capital requirements prescribed by the
Zero H approach adequately address the credit risk of repo-style
transactions. In both this proposal and the New Accord, banking
organizations would be subject to the operational risk capital
requirement for these transactions.
---------------------------------------------------------------------------
\39\ The comprehensive approach in the New Accord includes the
collateral haircut approaches, the simple VaR approach, and the
internal models approach.
---------------------------------------------------------------------------
Question 16: The agencies seek comment on whether these Zero H
approaches should be included in the standardized framework.
Additionally, the agencies seek comment on whether the Zero H
approaches would adequately address the credit risk of repo-style
transactions that would qualify for those approaches.
(j) Internal Models Methodology
The advanced approaches final rule includes an internal models
methodology for the calculation of the exposure amount for the
counterparty credit exposure for OTC derivatives, eligible margin
loans, and repo-style transactions. This methodology requires a risk
model that captures counterparty credit risk and estimates the exposure
amount at the level of a netting set. A banking organization may use
the internal models methodology for OTC derivatives, eligible margin
loans, and repo-style transactions.
The internal models methodology is fully discussed in the advanced
approaches final rule.\40\ The specific references in the advanced
approaches final rule's preamble and common rule text are: (i)
Preamble; \41\ (ii) section 22(c) and certain other paragraphs in
section 22 of the common rule text,\42\ such as paragraphs (a)(2) and
(3), (i), (j), and (k), which discuss the qualification requirements
for the advanced systems in general and therefore would apply to the
expected positive exposure modeling approach (EPE) as part of the
internal models methodology; (iii) section 32(c) and (d) of the common
rule text; \43\ (iv) applicable definitions in Section 2 of the common
rule text; \44\ and (v) applicable disclosure requirements in Tables
11.6 and 11.7 of the common rule text.\45\
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\40\ See 72 FR 69288 (December 7, 2007).
\41\ Id. at 69346-49 and 69302-21.
\42\ Id. at 69407-08.
\43\ Id. at 69413-16.
\44\ Id. at 69397-405.
\45\ Id. at 69443.
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Although the internal models methodology is not part of this
proposed rule, the standardized approach in the New Accord does
incorporate an internal models methodology for credit risk mitigants.
Therefore, the agencies are considering whether to implement the
internal models methodology in a final rule consistent with the
requirements in the advanced approaches final rule.
Question 17: The agencies request comment on the appropriateness of
including the internal models methodology for calculating exposure
amounts for OTC derivatives, eligible margin loans, and repo-style
transactions in any final rule implementing the standardized framework.
The agencies also requested comment on the extent to which banking
organizations contemplating implementing the standardized framework
believe they can meet the associated advanced modeling and systems
requirements. (For purposes of reviewing the internal models
methodology in the advanced approaches final rule, commenters should
substitute the term ``exposure amount'' for the term ``exposure at
default'' and ``EAD'' each time these terms appear in the advanced
approaches final rule.)
L. Unsettled Transactions
Consistent with the New Accord and the advanced approaches final
rule, the agencies propose to institute a more risk-sensitive risk-
based capital requirement for unsettled and failed securities, foreign
exchange, and commodities transactions.
The proposed capital requirement, however, would not apply to
certain transaction types, including:
(i) Transactions accepted by a qualifying central counterparty \46\
that are subject to daily marking-to-market and daily receipt and
payment of variation margin (which do not have a risk-based capital
requirement);
---------------------------------------------------------------------------
\46\ Qualifying central counterparty would be defined as a
counterparty that: (i) Facilitates trades between counterparties in
one or more financial markets by either guaranteeing trades or
novating contracts; (ii) requires all participants in its
arrangements to be fully collateralized on a daily basis; and (iii)
the banking organization demonstrates to the satisfaction of the
agency is in sound financial condition and is subject to effective
oversight by a national supervisory authority. The agencies consider
a qualifying central counterparty to be the functional equivalent of
an exchange and have long exempted exchange-traded contracts from
risk-based capital requirements.
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(ii) Repo-style transactions;
(iii) One-way cash payments on OTC derivative contracts; and
(iv) Transactions with a contractual settlement period that is
longer than the normal settlement period as defined below. (Such
transactions would be treated as OTC derivative contracts and assessed
a risk-based capital requirement under section 31 of the proposed
rule.) This proposed rule also provides that, in the case of a system-
wide failure of a settlement or clearing system, the banking
organization's primary Federal supervisor could waive risk-based
capital requirements for unsettled and failed transactions until the
situation is rectified.
This NPR contains separate treatments for delivery-versus-payment
[[Page 44008]]
(DvP) and payment-versus-payment (PvP) transactions with a normal
settlement period, and non-DvP/non-PvP transactions with a normal
settlement period. This NPR provides the following definitions of a DvP
transaction, a PvP transaction, and a normal settlement period:
A DvP transaction is a securities or commodities
transaction in which the buyer is obligated to make payment only if the
seller has made delivery of the securities or commodities and the
seller is obligated to deliver the securities or commodities only if
the buyer has made payment.
A PvP transaction is a foreign exchange transaction in
which each counterparty is obligated to make a final transfer of one or
more currencies only if the other counterparty has made a final
transfer of one or more currencies.
A transaction has a normal settlement period if the
contractual settlement period for the transaction is equal to or less
than the market standard for the instrument underlying the transaction
and equal to or less than five business days.
A banking organization would have to hold risk-based capital
against a DvP or PvP transaction with a normal settlement period if the
banking organization's counterparty has not made delivery or payment
within five business days after the settlement date. The banking
organization would determine its risk-weighted asset amount for such a
transaction by multiplying the positive current exposure of the
transaction for the banking organization by the appropriate risk weight
in Table 12. The positive current exposure of a transaction of a
banking organization would be the difference between the transaction
value at the agreed settlement price and the current market price of
the transaction, if the difference results in a credit exposure of the
banking organization to the counterparty.
Table 12.--Risk Weights for Unsettled DvP and PvP Transactions
------------------------------------------------------------------------
Risk weight to
be applied to
Number of business days after contractual settlement positive
date current
exposure (in
percent)
------------------------------------------------------------------------
From 5 to 15........................................... 100.0
From 16 to 30.......................................... 625.0
From 31 to 45.......................................... 937.5
46 or more............................................. 1,250.0
------------------------------------------------------------------------
A banking organization would hold risk-based capital against any
non-DvP/non-PvP transaction with a normal settlement period if the
banking organization delivered cash, securities, commodities, or
currencies to its counterparty but has not received its corresponding
deliverables by the end of the same business day. The banking
organization would continue to hold risk-based capital against the
transaction until the banking organization received its corresponding
deliverables. From the business day after the banking organization made
its delivery until five business days after the counterparty delivery
is due, the banking organization would calculate its risk-based capital
requirement for the transaction by risk weighting the current market
value of the deliverables owed to the banking organization using the
risk weight appropriate for an exposure to the counterparty.
If, in a non-DvP/non-PvP transaction with a normal settlement
period, the banking organization has not received its deliverables by
the fifth business day after the counterparty delivery due date, the
banking organization would deduct the current market value of the
deliverables owed to the banking organization 50 percent from tier 1
capital and 50 percent from tier 2 capital.
M. Risk-Weighted Assets for Securitization Exposures
Under the agencies' general risk-based capital rules, a banking
organization may use external ratings issued by NRSROs to assign risk
weights to certain recourse obligations, residual interests, direct
credit substitutes, and asset- and mortgage-backed securities.
Exposures to securitization transactions may also be subject to capital
requirements that can result in effective risk weights of 1,250
percent, or a dollar-for-dollar capital requirement. A banking
organization must deduct certain CEIOs from tier 1 capital.\47\
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\47\ 12 CFR part 3, Appendix A, section 4 (OCC); 12 CFR parts
208 and 225, Appendix A, section III.B.3 (Board); 12 CFR part 325,
Appendix A section II.B.1 (FDIC); and 12 CFR 567.6(b) (OTS).
---------------------------------------------------------------------------
(1) Securitization Overview and Definitions
The securitization framework in this NPR is designed to address the
credit risk of exposures that involve the tranching of the credit risk
of one or more underlying financial exposures. The agencies believe
that requiring all or substantially all of the underlying exposures for
a securitization to be financial exposures creates an important
boundary between the general credit risk framework and the
securitization framework. Examples of financial exposures are loans,
commitments, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, equity securities, or credit
derivatives. Based on their cash flow characteristics, for purposes of
this proposal, the agencies would also consider asset classes such as
lease residuals and entertainment royalties to be financial assets. The
securitization framework is designed to address the tranching of the
credit risk of financial exposures and is not designed, for example, to
apply to tranched credit exposures to commercial or industrial
companies or nonfinancial assets. Accordingly, under this NPR, a
specialized loan to finance the construction or acquisition of large-
scale projects (for example, airports or power plants), objects (for
example, ships, aircraft, or satellites), or commodities (for example,
reserves, inventories, precious metals, oil, or natural gas) generally
would not be a securitization exposure because the assets backing the
loan typically are nonfinancial assets (the facility, object, or
commodity being financed).
Consistent with the advanced approaches final rule, this NPR would
define a securitization exposure as an on-balance sheet or off-balance
sheet credit exposure that arises from a traditional or synthetic
securitization (including credit-enhancing representations and
warranties). A traditional securitization means a transaction in which:
(i) All or a portion of the credit risk of one or more underlying
exposures is transferred to one or more third parties other than
through the use of credit derivatives or guarantees; (ii) the credit
risk associated with the underlying exposures has been separated into
at least two tranches reflecting different levels of seniority; (iii)
the performance of the securitization exposures depends upon the
performance of the underlying exposures; (iv) all or substantially all
of the underlying exposures are financial exposures (such as loans,
commitments, credit derivatives, guarantees, receivables, asset-backed
securities, mortgage-backed securities, other debt securities, or
equity securities); (v) the underlying exposures are not owned by an
operating company; (vi) the underlying exposures are not owned by a
small business investment company described in section 302 of the Small
Business Investment Act of 1958 (15 U.S.C. 682); and (vii) (a) for
banks and bank holding companies, the underlying exposures are not
owned by a firm an investment in which qualifies as a community
development investment under 12 U.S.C. 24 (Eleventh); or (b) for
[[Page 44009]]
savings associations, the underlying exposures are not owned by a firm
an investment in which is designed primarily to promote community
welfare, including the welfare of low- and moderate-income communities
or families, such as by providing services or employment.
In this proposed rule, operating companies would not fall under the
definition of a traditional securitization (even if substantially all
of their assets are financial exposures). For purposes of this proposed
rule's definition of a traditional securitization, operating companies
generally are companies that produce goods or provide services beyond
the business of investing, reinvesting, holding, or trading in
financial assets. Examples of operating companies are depository
institutions, bank holding companies, securities brokers and dealers,
insurance companies, and non-bank mortgage lenders. Accordingly, an
equity investment in an operating company, such as a bank, generally
would be an equity exposure under the proposed rule. Investment firms,
which generally do not produce goods or provide services beyond the
business of investing, reinvesting, holding, or trading in financial
assets, would not be operating companies for purposes of this proposed
rule and would not qualify for this general exclusion from the
definition of traditional securitization. Examples of investment firms
would include companies that are exempted from the definition of an
investment company under section 3(a) of the Investment Company Act of
1940 (15 U.S.C. 80a-3(a)) by either section 3(c)(1) (15 U.S.C. 80a-
3(c)(1)) or section 3(c)(7) (15 U.S.C. 80a-3(c)(7)) of the Act.
Under this proposed rule, a primary Federal supervisor of a banking
organization would have the discretion to exclude from the definition
of traditional securitization transactions in which the underlying
exposures are owned by investment firms that exercise substantially
unfettered control over the size and composition of their assets,
liabilities, and off-balance sheet transactions. The agencies would
consider a number of factors in the exercise of this discretion,
including the assessment of the investment firm's leverage, risk
profile, and economic substance. This supervisory exclusion would give
the primary Federal supervisor the discretion to distinguish structured
finance transactions, to which the securitization framework was
designed to apply, from those of flexible investment firms such as many
hedge funds and private equity funds. Only investment firms that can
easily change the size and composition of their capital structure, as
well as the size and composition of their assets and off-balance sheet
exposures, would be eligible for the exclusion from the definition of
traditional securitization under this provision. The agencies do not
consider managed collateralized debt obligation vehicles, structured
investment vehicles, and similar structures, which allow considerable
management discretion regarding asset composition but are subject to
substantial restrictions regarding capital structure, to have
substantially unfettered control. Thus, such transactions would meet
the definition of traditional securitization.
The agencies are concerned that the line between securitization
exposures and non-securitization exposures may be difficult to draw in
some circumstances. In addition to the supervisory exclusion from the
definition of traditional securitization described above, a primary
Federal supervisor may scope certain transactions into the
securitization framework if justified by the economics of the
transaction. Similar to the analysis for excluding an investment firm
from treatment as a traditional securitization, the agencies would
consider the economic substance, leverage, and risk profile of
transactions to ensure that the appropriate risk-based capital
classification is made. The agencies would consider a number of factors
when assessing the economic substance of a transaction including, for
example, the amount of equity in the structure, overall leverage
(whether on-or off-balance sheet), whether redemption rights attach to
the equity investor, and the ability of the junior tranches to absorb
losses without interrupting contractual payments to more senior
tranches.
A synthetic securitization means a transaction in which: (i) All or
a portion of the credit risk of one or more underlying exposures is
transferred to one or more third parties through the use of one or more
credit derivatives or guarantees (other than a guarantee that transfers
only the credit risk of an individual retail exposure); (ii) the credit
risk associated with the underlying exposures has been separated into
at least two tranches reflecting different levels of seniority; (iii)
performance of the securitization exposures depends upon the
performance of the underlying exposures; and (iv) all or substantially
all of the underlying exposures are financial exposures (such as loans,
commitments, credit derivatives, guarantees, receivables, asset-backed
securities, mortgage-backed securities, other debt securities, or
equity securities).
Both the designation of exposures as securitization exposures and
the calculation of risk-based capital requirements for securitization
exposures would be guided by the economic substance of a transaction
rather than its legal form. Provided there is a tranching of credit
risk, securitization exposures could include, among other things,
asset-backed and mortgage-backed securities, loans, lines of credit,
liquidity facilities, financial standby letters of credit, credit
derivatives and guarantees, loan servicing assets, servicer cash
advance facilities, reserve accounts, credit-enhancing representations
and warranties, and CEIOs. Securitization exposures also could include
assets sold with retained tranches. Mortgage-backed pass-through
securities, for example, those guaranteed by Fannie Mae or Freddie Mac,
do not meet the proposed definition of securitization exposure because
they do not involve a tranching of credit risk. Rather, only those
mortgage-backed securities that involve tranching of credit risk would
be securitization exposures. Banking organizations are encouraged to
consult with their primary Federal supervisor about transactions that
require additional guidance.
(2) Operational Requirements
(a) Operational Requirements for Traditional Securitizations
In a traditional securitization, an originating banking
organization typically transfers a portion of the credit risk of
exposures to third parties by selling them to a securitization special
purpose entity (SPE). Under this NPR, a banking organization would be
an originating banking organization if it: (i) Directly or indirectly
originated or securitized the underlying exposures included in the
securitization; or (ii) serves as an asset-backed commercial paper
(ABCP) program sponsor to the securitization. Under the proposed rule,
a banking organization that engages in a traditional securitization
would exclude the underlying exposures from the calculation of risk-
weighted assets only if each of the following conditions are met: (i)
the transfer is a sale under GAAP; (ii) the originating banking
organization transfers to one or more third parties credit risk
associated with the underlying exposures; and (iii) any clean-up calls
relating to the securitization are eligible clean-up calls (as
discussed below). An originating banking organization that meets these
[[Page 44010]]
conditions would hold regulatory capital against any securitization
exposures it retains in connection with the securitization. An
originating banking organization that fails to meet these conditions
would instead hold regulatory capital against the transferred exposures
as if they had not been securitized and would deduct from tier 1
capital any after-tax gain-on-sale resulting from the transaction.
Consistent with the general risk-based capital rules, the above
operational requirements refer specifically to GAAP for the purpose of
determining whether a securitization transaction should be treated as
an asset sale or a financing. In contrast, the New Accord stipulates
guiding principles for determining whether sale treatment is warranted.
The agencies believe that the conditions currently outlined under GAAP
to qualify for sale treatment are broadly consistent with the guiding
principles enumerated in the New Accord. However, if GAAP in this area
were to materially change, the agencies would reassess, and possibly
revise, the operational standards.
(b) Clean-Up Calls
To satisfy the operational requirements for securitizations and
enable an originating banking organization to exclude the underlying
exposures from the calculation of its risk-based capital requirements,
any clean-up call associated with a securitization must be an eligible
clean-up call. The proposed rule defines a clean-up call as a
contractual provision that permits an originating banking organization
or servicer to call securitization exposures (for example, asset-backed
securities) before the stated maturity or call date. In the case of a
traditional securitization, a clean-up call is generally accomplished
by repurchasing the remaining securitization exposures once the amount
of underlying exposures or outstanding securitization exposures falls
below a specified level. In the case of a synthetic securitization, the
clean-up call may take the form of a clause that extinguishes the
credit protection once the amount of underlying exposures has fallen
below a specified level.
Under the proposed rule, an eligible clean-up call is a clean-up
call that:
(i) Is exercisable solely at the discretion of the originating
banking organization or servicer;
(ii) Is not structured to avoid allocating losses to securitization
exposures held by investors or otherwise structured to provide credit
enhancement to the securitization (for example, to purchase non-
performing underlying exposures); and
(iii)(a) For a traditional securitization, is only exercisable when
10 percent or less of the principal amount of the underlying exposures
or securitization exposures (determined as of the inception of the
securitization) is outstanding; or
(b) For a synthetic securitization, is only exercisable when 10
percent or less of the principal amount of the reference portfolio of
underlying exposures (determined as of the inception of the
securitization) is outstanding.
Where a securitization SPE is structured as a master trust, a
clean-up call with respect to a particular series or tranche issued by
the master trust would meet criteria (iii)(a) and (iii)(b) as long as
the outstanding principal amount in that series was 10 percent or less
of its original amount at the inception of the series.
(c) Operational Requirements for Synthetic Securitizations
In general, the proposed rule's treatment of synthetic
securitizations is similar to that of traditional securitizations. The
operational requirements for synthetic securitizations, however, are
more rigorous to ensure that the originating banking organization has
truly transferred credit risk of the underlying exposures to one or
more third-party protection providers.
For synthetic securitizations, an originating banking organization
would recognize the use of credit risk mitigation to hedge, or transfer
credit risk associated with, underlying exposures for risk-based
capital purposes only if each of the following conditions were
satisfied:
(i) The credit risk mitigant is financial collateral, an eligible
credit derivative, or an eligible guarantee.
(ii) The banking organization transfers credit risk associated with
the underlying exposures to one or more third parties, and the terms
and conditions in the credit risk mitigants do not include provisions
that:
(a) Allow for the termination of the credit protection due to
deterioration in the credit quality of the underlying exposures;
(b) Require the banking organization to alter or replace the
underlying exposures to improve the credit quality of the underlying
exposures;
(c) Increase the banking organization's cost of credit protection
in response to deterioration in the credit quality of the underlying
exposures;
(d) Increase the yield payable to parties other than the banking
organization in response to a deterioration in the credit quality of
the underlying exposures; or
(e) Provide for increases in a retained first loss position or
credit enhancement provided by the banking organization after the
inception of the securitization.
(iii) The banking organization obtains a well-reasoned opinion from
legal counsel that confirms the enforceability of the credit risk
mitigant in all relevant jurisdictions.
(iv) Any clean-up calls relating to the securitization are eligible
clean-up calls (as discussed above).
Failure to meet the above operational requirements for a synthetic
securitization would prevent the originating banking organization from
using this securitization framework and would require the originating
banking organization to hold risk-based capital against the underlying
exposures as if they had not been synthetically securitized. A banking
organization that provides credit protection to a synthetic
securitization would use the securitization framework to compute risk-
based capital requirements for its exposures to the synthetic
securitization even if the originating banking organization failed to
meet one or more of the operational requirements for a synthetic
securitization.
(3) Hierarchy of Approaches
Under the proposed rule a banking organization generally would
determine the amount of a traditional or synthetic securitization
exposure and then determine the risk-based capital requirement for the
securitization exposure according to two general approaches: A ratings-
based approach (RBA) and an approach for exposures that do not qualify
for the RBA. Although synthetic securitizations typically employ credit
derivatives, a banking organization must first apply the securitization
framework when calculating risk-based capital requirements for a
synthetic securitization exposure. Under this proposed rule, a banking
organization could ultimately be redirected to the securitization CRM
rules to adjust the securitization framework capital requirement for an
exposure to reflect the CRM technique used in the transaction.
(a) Exposure Amount of a Securitization Exposure
Under this proposed rule, the amount of an on-balance sheet
securitization exposure that is not a repo-style transaction, eligible
margin loan, or OTC derivative contract (other than a credit
derivative) would be the banking
[[Page 44011]]
organization's carrying value minus any unrealized gains and plus any
unrealized losses on the exposure if the exposure were a security
classified as available-for-sale, or the banking organization's
carrying value if the exposure were not a security classified as
available-for-sale.
The amount of an off-balance sheet securitization exposure that is
not an eligible ABCP liquidity facility, a repo-style transaction, or
an OTC derivative contract (other than a credit derivative) would be
the notional amount of the exposure.
This NPR defines an eligible ABCP liquidity facility as a liquidity
facility supporting ABCP, in form or in substance, that is subject to
an asset quality test at the time of draw that precludes funding
against assets that are 90 days or more past due or in default. In
addition, if the assets or exposures that an eligible ABCP liquidity
facility is required to fund against are externally rated assets or
exposures at the inception of the facility, the facility can be used to
fund only those assets or exposures with an applicable external rating
of at least investment grade at the time of funding. Notwithstanding
these eligibility requirements, a liquidity facility will be considered
an eligible ABCP liquidity facility if the assets or exposures funded
under the liquidity facility and that do not meet the eligibility
requirements are guaranteed, either conditionally or unconditionally,
by a sovereign entity with an issuer rating in one of the three highest
investment grade rating categories.
Consistent with the New Accord, the exposure amount of an eligible
ABCP liquidity facility would be the notional amount of the exposure
multiplied by (i) a 20 percent CCF, for a facility with an original
maturity of one year or less that does not qualify for the RBA; (ii) a
50 percent CCF, for a facility with an original maturity of over one
year that does not qualify for the RBA; or (iii) 100 percent, for a
facility that qualifies for the RBA. The proposed CCF for eligible ABCP
liquidity facilities with an original maturity of less than one year is
greater than the 10 percent CCF prescribed under the general risk-based
capital rules. The agencies believe the credit risk of eligible ABCP
liquidity facilities is similar to that of other short-term commitments
to lend or purchase assets, and believe that a 20 percent CCF is
appropriate for both eligible ABCP liquidity facilities and non-
securitization commitments with an original maturity of one year or
less.
Under this proposed rule, when a securitization exposure to an ABCP
program is a commitment, such as a liquidity facility, the notional
amount could be reduced to the maximum potential amount that the
banking organization could be required to fund given the ABCP program's
current underlying assets (calculated without regard to the current
credit quality of those assets). Thus, if $100 is the maximum amount
that could be drawn given the current volume and current credit quality
of the program's assets, but the maximum potential draw against these
same assets could increase to as much as $200 under some scenarios if
their credit quality were to deteriorate, then the exposure amount is
$200.
The amount of securitization exposure that is a repo-style
transaction, eligible margin loan, or an OTC derivative (other than a
credit derivative) would be the exposure amount as calculated in
section 35 or 37 of this proposed rule.
(b) Gains-on-Sale and CEIOs
Under the proposed rule, a banking organization would first deduct
from tier 1 capital any after-tax gain-on-sale resulting from a
securitization and would deduct from total capital any portion of a
CEIO that does not constitute an after-tax gain-on-sale, as described
in section 21 of the proposed rule. Thus, if the after-tax gain-on-sale
associated with a securitization equaled $100 while the amount of CEIOs
associated with that same securitization equaled $120, the banking
organization would deduct $100 from tier 1 capital and $20 from total
capital ($10 from tier 1 capital and $10 from tier 2 capital). The
agencies believe these deductions are appropriate given historical
supervisory concerns with the subjectivity involved in valuations of
gains-on-sale and CEIOs. Furthermore, although the treatments of gains-
on-sale and CEIOs can increase an originating banking organization's
risk-based capital requirement following a securitization, the agencies
believe that such anomalies will be rare where a securitization
transfers significant credit risk from the originating banking
organization to third parties.
(c) Ratings-Based Approach
If a securitization exposure is not a gain-on-sale or CEIO, a
banking organization would apply the RBA to a securitization exposure
if the exposure qualifies for the RBA.\48\ Generally, an exposure would
qualify for the RBA if the exposure has an external rating from an
NRSRO or has an inferred rating (that is, the exposure is senior to
another securitization exposure in the transaction that has an external
rating from an NRSRO).
---------------------------------------------------------------------------
\48\A securitization exposure held by an originating bank must
have two or more external ratings or inferred ratings to qualify for
the RBA.
---------------------------------------------------------------------------
(d) Securitization Exposures That Do Not Qualify for the RBA
If a securitization exposure is not a gain-on-sale or CEIO and does
not qualify for the RBA, a banking organization generally would be
required to deduct the exposure from total capital. However, there are
several situations in the approach for unrated exposures described
below and in section 44 of the proposed rule in which an alternative
risk-based capital treatment is permitted.
(e) Exceptions to the General Hierarchy of Approaches
There are four exceptions to the general approach described above
that parallel the agencies' general risk-based capital rules. First, an
interest-only mortgage-backed security would be assigned a risk weight
that is no less than 100 percent. The agencies believe that a minimum
risk weight of 100 percent is prudent in light of the uncertainty
implied by the substantial price volatility of these securities.
Second, a sponsoring banking organization that qualifies as a primary
beneficiary and must consolidate an ABCP program as a variable interest
entity under GAAP could exclude the consolidated ABCP program assets
from risk-weighted assets.\49\ In such cases, the banking organization
would hold risk-based capital against any of its securitization
exposures to the ABCP program. Third, as required by Federal statute, a
special set of rules would continue to apply to transfers of small-
business loans and leases with recourse by well-capitalized depository
institutions.\50\ Finally, under this NPR, if a securitization exposure
is an OTC derivative contract (other than a credit derivative) that has
a first priority claim on the cash flows from the underlying exposures
(notwithstanding amounts due under interest rate or currency derivative
contracts, fees due, or other similar payments), a banking organization
may choose to apply an
[[Page 44012]]
effective 100 percent risk weight to the exposure rather than the
general securitization hierarchy of approaches. This treatment would be
subject to supervisory approval.
---------------------------------------------------------------------------
\49\ See Financial Accounting Standards Board, ``Interpretation
No. 46(R): Consolidation of Certain Variable Interest Entities''
(December 2003).
\50\ See 12 U.S.C. 1835, which places a cap on the risk-based
capital requirement applicable to a well-capitalized depository
institution that transfers small-business loans with recourse. The
final rule does not expressly state that the agencies may permit
adequately capitalized banks to use the small business recourse rule
on a case-by-case basis because the agencies may do this under the
general reservation of authority contained in section 1 of the rule.
---------------------------------------------------------------------------
(f) Overlapping Exposures
This proposal also includes provisions to limit the double counting
of risks in situations involving overlapping securitization exposures.
If a banking organization has multiple securitization exposures that
provide duplicative coverage to the underlying exposures of a
securitization (such as when a banking organization provides a program-
wide credit enhancement and multiple pool-specific liquidity facilities
to an ABCP program), the banking organization is not required to hold
duplicative risk-based capital against the overlapping position.
Instead, the banking organization would apply to the overlapping
position the applicable risk-based capital treatment under the
securitization framework that results in the highest capital
requirement. If different banking organizations have overlapping
exposures to a securitization, however, each banking organization would
hold capital against the entire maximum amount of its exposure.
Although duplication of capital requirements will not occur for an
individual banking organization, some systemic duplication would occur
where multiple banking organizations have overlapping exposures to the
same securitization.
(g) Servicer Cash Advances
A traditional securitization typically employs a servicing banking
organization that, on a day-to-day basis, collects principal, interest,
and other payments from the underlying exposures of the securitization
and forwards such payments to the securitization SPE or to investors in
the securitization. Such servicing banking organizations often provide
a credit facility to the securitization under which the servicing
banking organization could advance cash to ensure an uninterrupted flow
of payments to investors in the securitization (including advances made
to cover foreclosure costs or other expenses to facilitate the timely
collection of the underlying exposures). These servicer cash advance
facilities are securitization exposures.
Under the proposed rule, a servicing banking organization would
determine its risk-based capital requirement for any advances under
such a facility using either the RBA or the approach for securitization
exposures that do not qualify for the RBA as described below. The
treatment of the undrawn portion of the facility would depend on
whether the facility is an ``eligible'' servicer cash advance facility.
An eligible servicer cash advance facility would be defined as a
servicer cash advance facility in which: (i) The servicer is entitled
to full reimbursement of advances (except that a servicer could be
obligated to make non-reimbursable advances for a particular underlying
exposure if any such advance is contractually limited to an
insignificant amount of the outstanding principal balance of that
exposure); (ii) the servicer's right to reimbursement is senior in
right of payment to all other claims on the cash flows from the
underlying exposures of the securitization; and (iii) the servicer has
no legal obligation to, and does not, make advances to the
securitization if the servicer concludes the advances are unlikely to
be repaid. Consistent with the general risk-based capital rules with
respect to residential mortgage servicer cash advances, a servicing
banking organization would not be required to hold risk-based capital
against the undrawn portion of an eligible servicer cash advance
facility. A banking organization that provides a non-eligible servicer
cash advance facility would determine its risk-based capital
requirement for the undrawn portion of the facility in the same manner
as the banking organization would determine its risk-based capital
requirement for any other off-balance sheet securitization exposure.
(h) Implicit Support
The proposed rule also specifies the regulatory capital consequence
if a banking organization provides support to a securitization in
excess of the banking organization's predetermined contractual
obligation. First, consistent with the general risk-based capital
rules, a banking organization that provides such implicit support would
have to hold regulatory capital against all of the underlying exposures
associated with the securitization as if the exposures had not been
securitized, and would deduct from tier 1 capital any after-tax gain-
on-sale resulting from the securitization.\51\ Second, the banking
organization would have to disclose publicly (i) that it has provided
implicit support to the securitization, and (ii) the regulatory capital
impact to the banking organization of providing the implicit support.
The banking organization's primary Federal supervisor also could
require the banking organization to hold regulatory capital against all
the underlying exposures associated with some or all of the banking
organization's other securitizations as if the exposures had not been
securitized, and to deduct from tier 1 capital any after-tax gain-on-
sale resulting from such securitizations.
---------------------------------------------------------------------------
\51\ ``Interagency Guidance on Implicit Recourse in Asset
Securitizations,'' May 23, 2002. OCC Bulletin 2002-20 (OCC); SR02-15
(Board); FIL-52-2002 (FDIC); and CEO Memo No. 162 (OTS).
---------------------------------------------------------------------------
Over the last several years, the agencies have published a
significant amount of supervisory guidance to assist banking
organizations with the capital treatment of securitization exposures.
In general, the agencies expect banking organizations to continue to
use this guidance, most of which would remain applicable to the
standardized securitization framework.
(4) Ratings-Based Approach
Under this NPR, a banking organization would determine the risk-
weighted asset amount for a securitization exposure that is eligible
for the RBA by multiplying the exposure amount by the appropriate risk
weight provided in Table 13 or Table 14. Banking organizations would
deduct from total capital exposures that have applicable long-term
ratings of two categories or more below investment grade and applicable
short-term ratings below the lowest investment grade rating.
Under the proposal, whether a securitization exposure is eligible
for the RBA would depend on whether the banking organization holding
the securitization exposure is an originating banking organization or
an investing banking organization. An originating banking organization
would be required to use the RBA for a securitization exposure if (i)
the exposure has two or more external ratings, or (ii) the exposure has
two or more external or inferred ratings. In contrast, an investing
banking organization would be required to use the RBA for a
securitization exposure if the exposure has one or more external or
inferred ratings.
[[Page 44013]]
Table 13.--Long-Term Credit Rating Risk Weights Under the RBA
------------------------------------------------------------------------
Applicable external rating or
applicable inferred rating of a Example Risk weight (in
securitization exposure percent)
------------------------------------------------------------------------
Highest investment grade rating AAA............... 20.
Second-highest investment grade AA................ 20.
rating.
Third-highest investment grade A................. 50.
rating.
Lowest investment grade rating. BBB............... 100.
One category below investment BB................ 350.
grade.
Two categories below investment B................. Deduction.
grade.
Three categories or more below CCC............... Deduction.
investment grade.
------------------------------------------------------------------------
Table 14.--Short-Term Credit Rating Risk Weights Under the RBA
------------------------------------------------------------------------
Applicable external or
applicable inferred rating of a Example Risk weight (in
securitization exposure percent)
------------------------------------------------------------------------
Highest investment grade rating A-1/P-1........... 20.
Second-highest investment grade A-2/P-2........... 50.
rating.
Lowest investment grade rating. A-3/P-3........... 100.
All other ratings.............. N/A............... Deduction.
------------------------------------------------------------------------
Under the proposed rule, securitization exposures with an inferred
rating are treated the same as securitization exposures with an
identical external rating. However, the proposed rule includes a
different provision for determining inferred ratings for securitization
exposures than for other types of exposures. A securitization exposure
that does not have an external rating (an unrated securitization
exposure) would have an inferred rating equal to the external rating of
a securitization exposure that is issued by the same issuer and secured
by the same underlying exposures and (i) has an external rating; (ii)
is subordinate in all respects to the unrated securitization exposure;
(iii) does not benefit from any credit enhancement that is not
available to the unrated securitization exposure; (iv) has an effective
remaining maturity that is equal to or longer than the unrated
securitization exposure; and (v) is the most immediately subordinated
exposure to the unrated securitization exposure that meets the criteria
in (i) through (iv) above. For example, a securitization might issue
three tranches of securities designated as senior, mezzanine, and
subordinated. If the senior tranche is unrated, the mezzanine tranche
is rated A and meets the criteria in (i) through (iv) above, and the
subordinated tranche is rated BB, the senior tranche could receive an
inferred rating of A based on the rating of the mezzanine tranche,
regardless of the rating of the subordinated tranche. If the mezzanine
tranche has two ratings, the senior tranche could receive an applicable
inferred rating based only on the lowest of the ratings on the
mezzanine tranche. If a securitization exposure has multiple inferred
ratings, the applicable inferred rating is the lowest inferred rating.
Banking organizations would not be permitted to assign an inferred
rating based on the ratings of the underlying exposures in a
securitization, even when the unrated securitization exposure is
secured by a single, externally rated security. Such an approach would
fail to meet the requirements that the rated reference exposure be
issued by the same issuer, secured by the same underlying assets, and
subordinated in all respects to the unrated securitization exposure.
(5) Exposures That Do Not Qualify for the RBA
A banking organization would generally be required to deduct from
total capital securitization exposures that do not qualify for the RBA,
with the following exceptions that apply provided that the banking
organization knows the composition of the underlying exposures at all
times: (i) Eligible ABCP liquidity facilities, (ii) first priority
securitization exposures, and (iii) exposures in a second loss position
or better to an ABCP program.
(a) Eligible ABCP Liquidity Facilities
In this NPR, consistent with the New Accord, the exposure amount of
an eligible ABCP liquidity facility would be assigned to the highest
risk weight applicable to any of the underlying individual exposures
covered by the liquidity facility.
(b) First-Priority Securitization Exposures
If a first-priority securitization exposure does not qualify for
the RBA, a banking organization could determine the risk weight of the
exposure by ``looking through'' the exposure to its underlying assets.
The risk-weighted asset amount would be the weighted-average risk
weight of the underlying exposures multiplied by the exposure amount of
the first-priority securitization exposure. If a banking organization
is unable to determine the risk weights of the underlying credit risk
exposures, the first-priority securitization exposure would be deducted
from total capital.
First-priority securitization exposure would be defined as a
securitization exposure that has a first-priority claim on the cash
flows from the underlying exposures and that is not an eligible ABCP
liquidity facility. When determining whether a securitization exposure
has a first-priority claim on the cash flows from the underlying
exposures, a banking organization would not be required to consider
amounts due under interest rate or currency derivative contracts, fees
due, or other similar payments. Generally, only the most senior tranche
of a securitization would be a first-priority securitization exposure.
(c) Securitization Exposures in a Second Loss Position or Better to an
ABCP Program
This NPR would define an ABCP program as a program that primarily
issues commercial paper that has an external rating and is backed by
underlying exposures held in a bankruptcy-remote securitization SPE. In
this NPR, a banking organization would not be required to deduct from
total capital a securitization exposure to an ABCP program that does
not qualify for the RBA and is not an eligible ABCP
[[Page 44014]]
liquidity facility or a first-priority securitization exposure,
provided that it satisfies the following requirements: (i) The exposure
must be economically in a second loss position or better and the first
loss position must provide significant credit protection to the second
loss position, (ii) the credit risk associated with the exposure must
be the equivalent of investment grade or better,\52\ and (iii) the
banking organization holding the exposure must not retain or provide
the first loss position.
---------------------------------------------------------------------------
\52\ Interagency guidance on assessing whether a banking
organization's internal risk rating system used in measuring risk
exposures in ABCP programs is adequate and reasonably corresponds to
the NRSRO's rating categories is set forth in ``Interagency Guidance
on assisting in the determination of the appropriate risk-based
capital treatment to be applied to direct credit substitutes issued
in connection with asset-backed commercial paper programs.'' March
31, 2005. OCC Bulletin 2005-12 (OCC); SR 05-6 (Board); FIL-26-2005
(FDIC); and CEO Letter 217, dated April 1, 2005 (OTS).
---------------------------------------------------------------------------
If the exposure meets the above requirements, the risk weight would
be the higher of 100 percent or the highest risk weight assigned to any
of the individual exposures covered by the ABCP program. The agencies
believe that this approach, which is consistent with the New Accord,
appropriately and conservatively assesses the credit risk of non-first
loss exposures to ABCP programs.
Under the agencies' general risk-based capital rules, certain
securitization exposures that are not rated by an NRSRO may be risk
weighted based on alternative methods. These methods include internal
risk ratings for ABCP programs, program ratings, and computer program
ratings and are not included in this NPR.
Question 18: The agencies solicit comment on the decision not to
include internal risk ratings for ABCP programs, program ratings, and
computer program ratings in this proposal.
(6) CRM for Securitization Exposures
The proposed treatment of CRM for securitization exposures differs
slightly from the CRM treatment of other exposures. An originating
banking organization that has obtained a credit risk mitigant to hedge
its securitization exposure to a synthetic or traditional
securitization that satisfies the operational criteria in section 41 of
the proposed rule could recognize the credit risk mitigant, but only as
provided in section 45. An investing banking organization that has
obtained a credit risk mitigant to hedge a securitization exposure also
could recognize the credit risk mitigant, but only as provided in
section 45.
In general, to recognize the risk mitigating effects of financial
collateral or an eligible guarantee or an eligible credit derivative
for a securitization exposure, a banking organization could use the
approaches for collateralized transactions or the substitution
treatment for guarantees and credit derivatives described in section
36. However, section 45 of the proposed rule contains specific
provisions a banking organization would have to follow when applying
those approaches to securitization exposures.
In this NPR, a banking organization that determines its risk-based
capital requirement for a securitization exposure based on external or
inferred rating(s) that reflect the benefits of a particular credit
risk mitigant provided to the associated securitization or that
supports some or all of the underlying exposures, could not use the
credit risk mitigation rules to further reduce its risk-based capital
requirement for the exposure based on the credit risk mitigant. For
example, a banking organization that owns an AAA-rated asset-backed
security that benefits, along with all the other securities issued by
the securitization SPE, from an insurance wrap that is part of the
securitization transaction would calculate its risk-based capital
requirement for the security strictly using the RBA. No additional
credit would be given for the presence of the insurance wrap. In
contrast, if a banking organization owns a BBB-rated asset-backed
security and obtains a credit default swap from a AAA-rated
counterparty to protect the banking organization from losses on the
security, the banking organization would be able to apply the
securitization CRM rules to recognize the risk mitigating effects of
the credit default swap and determine the risk-based capital
requirement for the position.
For purposes of this section, a banking organization may only
recognize an eligible guarantee or eligible credit derivative from an
eligible guarantor if the guarantor: (i) Is a sovereign entity, the
Bank for International Settlements, the International Monetary Fund,
the European Central Bank, the European Commission, a Federal Home Loan
Bank, Farmer Mac, an MDB, a depository institution, a foreign bank, a
credit union, a bank holding company, or a savings and loan holding
company; or (ii) has issued and has outstanding an unsecured long-term
debt security without credit enhancement that has a long-term
applicable external rating in one of the three highest investment grade
rating categories.
With respect to eligible guarantees and credit derivatives, in the
context of a synthetic securitization, when an eligible guarantee or
eligible credit derivative covers multiple hedged exposures that have
different residual maturities, the banking organization must use the
longest residual maturity of any of the hedged exposures as the
residual maturity of all the hedged exposures.
(a) Nth-to-Default Credit Derivatives
Credit derivatives that provide credit protection only for the nth
defaulting reference exposure in a group of reference exposures (nth-
to-default credit derivatives) are similar to synthetic securitizations
that provide credit protection only after the first-loss tranche has
defaulted or become a loss. A simplified treatment would be available
to banking organizations that purchase and provide such credit
protection. A banking organization that obtains credit protection on a
group of underlying exposures through a first-to-default credit
derivative would determine its risk-based capital requirement for the
underlying exposures as if the banking organization had synthetically
securitized only the underlying exposure with the lowest capital
requirement and had obtained no credit risk mitigant on the other
(higher capital requirement) underlying exposures. If the banking
organization purchased credit protection on a group of underlying
exposures through an nth-to-default credit derivative (other than a
first-to-default credit derivative), it would only recognize the credit
protection for risk-based capital purposes either if it had obtained
credit protection on the same underlying exposures in the form of
first-through-(n-1)-to-default credit derivatives, or if n-1 of the
underlying exposures have already defaulted. In such a case, the
banking organization would determine its risk-based capital requirement
for the underlying exposures as if the banking organization had only
synthetically securitized the n-1 underlying exposures with the lowest
capital requirement and had obtained no credit risk mitigant on the
other underlying exposures.
A banking organization that provides credit protection on a group
of underlying exposures through a first-to-default credit derivative
would determine its risk-weighted asset amount for the derivative by
applying the risk weights in Table 13 or 14 (if the derivative
qualifies for the RBA) or, by setting its risk-weighted asset amount
[[Page 44015]]
for the derivative equal to the product of (i) the protection amount of
the derivative; and (ii) the sum of the risk weights of the individual
underlying exposures, up to a maximum of 1,250 percent.
If a banking organization provides credit protection on a group of
underlying exposures through an nth-to-default credit derivative (other
than a first-to-default credit derivative), the banking organization
would determine its risk-weighted asset amount for the derivative by
applying the risk weights in Table 13 or 14 (if the derivative
qualifies for the RBA) or, by setting the risk-weighted asset amount
for the derivative equal to the product of (i) the protection amount of
the derivative and (ii) the sum of the risk weights of the individual
underlying exposures (excluding the n-1 underlying exposures with the
lowest risk-based capital requirements), up to a maximum of 1,250
percent.
For example, a banking organization provides credit protection in
the form of a second-to-default credit derivative on a basket of five
reference exposures. The derivative is unrated and the protection
amount of the derivative is $100. The risk weights for the underlying
exposures are 20 percent, 50 percent, 100 percent, 100 percent, and 150
percent. The risk-weighted asset amount of the derivative would be $100
x (50% + 100% + 100% + 150%) or $400. If the derivative were externally
rated one category below investment grade, the risk-weighted asset
amount would be $100 x 350% or $350.
(7) Risk-Weighted Assets for Early Amortization Provisions
Many securitizations of revolving credit facilities (for example,
credit card receivables) contain provisions that require the
securitization to wind down and repay investors if the excess spread
falls below a certain threshold.\53\ This decrease in excess spread
may, in some cases, be caused by deterioration in the credit quality of
the underlying exposures. An early amortization event can increase a
banking organization's capital needs if the banking organization would
have to finance new draws on the revolving credit facilities with on-
balance sheet sources of funding. The payment allocations a banking
organization uses to distribute principal and finance charge
collections during the amortization phase of these transactions also
can expose it to greater risk of loss than in other securitization
transactions. Consistent with the New Accord, this NPR includes a risk-
based capital requirement that, in general, is linked to the likelihood
of an early amortization event to address the risks that early
amortization of a securitization poses to originating banking
organizations.
---------------------------------------------------------------------------
\53\ The NPR defines excess spread for a period as gross finance
charge collections (including market interchange fees) and other
income received by the SPE over the period minus interest paid to
holders of securitization exposures, servicing fees, charge-offs,
and other senior trust similar expenses of the SPE over the period,
all divided by the principal balance of the underlying exposures at
the end of the period.
---------------------------------------------------------------------------
The proposed rule defines an early amortization as a provision in a
securitization's governing documentation that, when triggered, causes
investors in the securitization exposures to be repaid before the
original stated maturity of the securitization exposure, unless the
provision is triggered solely by events not related to the performance
of the underlying exposures or the originating banking organization
(for example, material changes in tax laws or regulations) or leaves
investors exposed to future draws by obligors on the underlying
exposures even after the provision is triggered.
Under the NPR, an originating banking organization would hold
regulatory capital against its own interest and the investors' interest
in a securitization that (i) includes one or more underlying exposures
in which the borrower is permitted to vary the drawn amount within an
agreed line of credit, and (ii) contains an early amortization
provision. Investors' interest means, with respect to a securitization,
the exposure amount of the underlying exposures multiplied by the ratio
of (i) the total amount of securitization exposures issued by the
securitization special purpose entity (SPE); divided by (ii) the
outstanding principal amount of the underlying exposures. A banking
organization would compute the risk-weighted asset amount for its
interest using the hierarchy of approaches for securitization exposures
described above. An originating banking organization would calculate
the risk-weighted asset amount for the investors' interest in the
securitization as the product of (i) the investors' interest, (ii) the
appropriate conversion factor (CF), (iii) the weighted-average risk
weight that would apply under this NPR to the underlying exposure type
if the underlying exposures had not been securitized, and (iv) the
proportion of the underlying exposures in which the borrower is
permitted to vary the drawn amount within an agreed limit under a line
of credit.
The CF would differ according to whether the securitized exposures
are revolving retail credit facilities (for example, credit card
receivables) or other revolving credit facilities (for example,
revolving corporate credit facilities) and whether the early
amortization provision is controlled or non-controlled; and whether the
line is committed or uncommitted. A line would qualify as uncommitted
if it were unconditionally cancelable to the extent permitted under
applicable law.
(a) Controlled Early Amortization
Under the proposed rule, a controlled early amortization provision
would have to meet each of the following conditions: (i) The
originating banking organization has appropriate policies and
procedures to ensure that it has sufficient capital and liquidity
available in the event of an early amortization; (ii) throughout the
duration of the securitization (including the early amortization
period) there is the same pro rata sharing of interest, principal,
expenses, losses, fees, recoveries, and other cash flows from the
underlying exposures, based on the originating banking organizations'
and the investors' relative shares of the underlying exposures
outstanding measured on a consistent monthly basis; (iii) the
amortization period is sufficient for at least 90 percent of the total
underlying exposures outstanding at the beginning of the early
amortization period to have been repaid or recognized as in default;
and (iv) the schedule for repayment of investor principal is not more
rapid than would be allowed by straight-line amortization over an 18-
month period. An early amortization provision that does not meet any of
the above criteria would be a ``non-controlled'' early amortization
provision.
To calculate the appropriate CF for a securitization of uncommitted
revolving retail exposures that contains a controlled early
amortization provision, a banking organization would compare the three-
month average annualized excess spread for the securitization to the
point at which the banking organization has to trap excess spread under
the securitization transaction. In securitizations that do not require
trapping of excess spread, or that specify a trapping point based
primarily on performance measures other than the three-month average
annualized excess spread, the excess spread trapping point would be 4.5
percent. The banking organization would divide the three-month average
excess spread level by the excess spread trapping point and apply the
appropriate CF from Table 15.
A banking organization would apply a 90 percent CF for all other
revolving
[[Page 44016]]
underlying exposures (that is, committed exposures and non-retail
exposures) in securitizations with a controlled early amortization
provision. The proposed CFs for uncommitted revolving retail credit
lines are much lower than for committed retail credit lines or for non-
retail credit lines because banking organizations have demonstrated the
ability to monitor and, when appropriate, to curtail uncommitted retail
credit lines promptly when a customer's credit quality deteriorates.
Such account management tools are unavailable for committed lines, and
banking organizations may be less proactive about using such tools in
the case of uncommitted non-retail credit lines owing to lender
liability concerns and the prominence of broad-based, longer-term
customer relationships.
Table 15.--Conversion Factors for Controlled Early Amortization
------------------------------------------------------------------------
Uncommitted CF Committed CF
3-month average excess spread (in percent) (in percent)
------------------------------------------------------------------------
Retail Credit Lines:
Greater than or equal to 133.33% of 0 90
trapping point.....................
Less than 133.33% to 100% of 1 ..............
trapping point.....................
Less than 100% to 75% of trapping 2 ..............
point..............................
Less than 75% to 50% of trapping 10 ..............
point..............................
Less than 50% to 25% of trapping 20 ..............
point..............................
Less than 25% of trapping point..... 40 ..............
Non-retail credit lines................. 90 90
------------------------------------------------------------------------
(b) Non-Controlled Early Amortization
To calculate the appropriate CF for securitizations of uncommitted
revolving retail exposures that contain a non-controlled early
amortization provision, a banking organization would have to perform
the excess spread calculations described in the controlled early
amortization section above and then apply the CFs in Table 16.
A banking organization would use a 100 percent CF for all other
revolving underlying exposures (that is, committed exposures and non-
retail exposures) in securitizations with a non-controlled early
amortization provision. In other words, no risk transference would be
recognized for these transactions.
Where a securitization contains a mix of retail and non-retail
exposures or a mix of committed and uncommitted exposures, a banking
organization could take a pro-rata approach to determining the risk-
based capital requirement for the securitization's early amortization
provision. If a pro-rata approach were not feasible, a banking
organization would treat a securitization with an underlying exposure
that is non-retail as a securitization of non-retail exposures and
would treat the securitization as a securitization of committed
exposures if a single underlying exposure is a committed exposure.
Table 16.--Conversion Factors for Non-Controlled Early Amortization
------------------------------------------------------------------------
Uncommitted CF Committed CF
3-month average excess spread (in percent) (in percent)
------------------------------------------------------------------------
Retail Credit Lines:
Greater than or equal to 133.33% of 0 100
trapping point.....................
Less than 133.33% to 100% of 5 ..............
trapping point.....................
Less than 100% to 75% of trapping 15 ..............
point..............................
Less than 75% to 50% of trapping 50 ..............
point..............................
Less than 50% of trapping point..... 100 ..............
Non-retail credit lines................. 100 100
------------------------------------------------------------------------
(c) Revolving Residential Mortgage Exposures
Unlike credit card securitizations, HELOC securitizations in the
United States typically do not generate material excess spread and
typically are structured with credit enhancements and early
amortization triggers based on other factors, such as portfolio loss
rates. Under the New Accord, a banking organization would have to hold
capital against the potential early amortization of most U.S. HELOC
securitizations at their inception, rather than only if the credit
quality of the underlying exposures deteriorated. Although the
securitization framework in the New Accord does not provide an
alternative methodology in such cases, the agencies have concluded that
the features of the U.S. HELOC securitization market would warrant an
alternative approach. Accordingly, the proposed rule allows a banking
organization the option of applying either (i) the CFs in Tables 15 and
16, as appropriate, or (ii) a fixed CF of 10 percent to its
securitizations for which all or substantially all of the underlying
exposures are revolving residential mortgage exposures. If a banking
organization chooses the fixed CF of 10 percent, it would have to use
that CF for all securitizations for which all or substantially all of
the underlying exposures are revolving residential mortgage exposures.
(8) Maximum Capital Requirement
The total capital requirement for a banking organization's
exposures to a single securitization with an early amortization
provision is subject to a maximum capital requirement equal to the
greater of (i) the capital requirement for the retained securitization
exposures or (ii) the capital requirement for the underlying exposures
that would apply if the banking organization directly held the
underlying exposures on its balance sheet.
[[Page 44017]]
N. Equity Exposures
(1) Introduction and Exposure Measurement
Under the FDIC, OCC, and Board's general risk-based capital rules,
a banking organization must deduct a portion of non-financial equity
investments from tier 1 capital. This deduction depends upon the
aggregate adjusted carrying value of all non-financial equity
investments held directly or indirectly by the banking organization as
a percentage of its tier 1 capital. By contrast, OTS rules require the
deduction of most equity securities from total capital.\54\
---------------------------------------------------------------------------
\54\ See preamble discussion at section II.E.
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Under this proposed rule, a banking organization would use the
simple risk-weight approach (SRWA) for equity exposures that are not
exposures to an investment fund. This approach is consistent with the
SRWA for equity exposures and investment fund approach provided in the
advanced approaches final rule. A banking organization could use the
various look-through approaches for equity exposures to an investment
fund.
This NPR defines an equity exposure as:
(i) A security or instrument (whether voting or non-voting) that
represents a direct or indirect ownership interest in, and is a
residual claim on, the assets and income of a company, unless:
(a) The issuing company is consolidated with the banking
organization under GAAP;
(b) The banking organization is required to deduct the ownership
interest from tier 1 or tier 2 capital under this appendix;
(c) The ownership interest incorporates a payment or other similar
obligation on the part of the issuing company (such as an obligation to
make periodic payments); or
(d) The ownership interest is a securitization exposure;
(ii) A security or instrument that is mandatorily convertible into
a security or instrument described in paragraph (i) of this definition;
(iii) An option or warrant that is exercisable for a security or
instrument described in paragraph (i) of this definition; or
(iv) Any other security or instrument (other than a securitization
exposure) to the extent the return on the security or instrument is
based on the performance of a security or instrument described in
paragraph (i) of this definition.
Under the proposed SRWA, a banking organization generally would
assign a 300 percent risk weight to publicly traded equity exposures, a
400 percent risk weight to non-publicly traded equity exposures, and a
600 percent risk weight to certain equity exposures to investment firms
as described below. Certain equity exposures to sovereign entities,
supranational entities, MDBs, PSEs, and others would have a risk weight
of zero percent, 20 percent, or 100 percent; and certain community
development equity exposures, the effective portion of hedged pairs,
and, up to certain limits, non-significant equity exposures would
receive a 100 percent risk weight.
The proposed rule defines publicly traded to mean traded on: (i)
Any exchange registered with the SEC as a national securities exchange
under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f);
or (ii) any non-U.S.-based securities exchange that is registered with,
or approved by, a national securities regulatory authority and that
provides a liquid, two-way market for the exposure (that is, there are
enough independent bona fide offers to buy and sell so that a sales
price is reasonably related to the last sales price or current bona
fide competitive bid and offer quotations can be determined promptly
and a trade can be settled at such a price within five business days).
A banking organization using the SRWA would determine the adjusted
carrying value for each equity exposure. The proposed rule defines the
adjusted carrying value of an equity exposure as: (i) For the on-
balance sheet component of an equity exposure, the banking
organization's carrying value of the exposure reduced by any unrealized
gains on the exposure that are reflected in such carrying value but
excluded from the banking organization's tier 1 and tier 2 capital;
\55\ and (ii) for the off-balance sheet component of an equity exposure
that is not an equity commitment, the effective notional principal
amount of the exposure, the size of which is equivalent to a
hypothetical on-balance sheet position in the underlying equity
instrument that would evidence the same change in fair value (measured
in dollars) for a given small change in the price of the underlying
equity instrument, minus the adjusted carrying value of the on-balance
sheet component of the exposure as calculated above in (i).
---------------------------------------------------------------------------
\55\ The potential downward adjustment to the carrying value of
an equity exposure reflects the fact that 100 percent of the
unrealized gains on available-for-sale equity exposures are included
in carrying value but only up to 45 percent of any such unrealized
gains are included in regulatory capital.
---------------------------------------------------------------------------
For an unfunded equity commitment that is unconditional, the
adjusted carrying value is the effective notional principal multiplied
by a 100 percent conversion factor. If the unfunded equity commitment
is conditional, the adjusted carrying value is the effective notional
principal amount of the commitment multiplied by a 20 percent
conversion factor for a commitment with a maturity of one year or less
or multiplied by a 50 percent conversion factor to the effective
notional principal amount for a commitment with a maturity of over one
year.
The agencies created the concept of the effective notional
principal amount of the off-balance sheet portion of an equity exposure
to provide a uniform method for banking organizations to measure the
on-balance sheet equivalent of an off-balance sheet exposure. For
example, if the value of a derivative contract referencing the common
stock of company X changes the same amount as the value of 150 shares
of common stock of company X, for a small (for example, 1.0 percent)
change in the value of the common stock of company X, the effective
notional principal amount of the derivative contract is the current
value of 150 shares of common stock of company X regardless of the
number of shares the derivative contract references. The adjusted
carrying value of the off-balance sheet component of the derivative is
the current value of 150 shares of common stock of company X minus the
adjusted carrying value of any on-balance sheet amount associated with
the derivative.
(2) Hedge Transactions
The agencies are proposing specific rules for recognizing hedged
equity exposures. For purposes of determining risk-weighted assets
under the SRWA, a banking organization may identify hedge pairs, which
would be defined as two equity exposures that form an effective hedge
provided each equity exposure is publicly traded or has a return that
is primarily based on a publicly traded equity exposure. A banking
organization may risk weight only the effective and ineffective
portions of a hedge pair rather than the entire adjusted carrying value
of each exposure that makes up the pair. Two equity exposures form an
effective hedge if the exposures either have the same remaining
maturity or each has a remaining maturity of at least three months; the
hedge relationship is documented formally before the banking
organization acquires at least one of the equity exposures; the
documentation specifies the measure of effectiveness (E) (defined
below) the banking organization would use for the hedge relationship
throughout the life of the transaction; and the hedge relationship
[[Page 44018]]
has an E greater than or equal to 0.8. A banking organization would
measure E at least quarterly and would use one of three alternative
measures of E: The dollar-offset method, the variability-reduction
method, or the regression method.
It is possible that only part of a banking organization's exposure
to a particular equity instrument is part of a hedge pair. For example,
assume a banking organization has an equity exposure A with a $300
adjusted carrying value and chooses to hedge a portion of that exposure
with an equity exposure B with an adjusted carrying value of $100. Also
assume that the combination of equity exposure B and $100 of the
adjusted carrying value of equity exposure A form an effective hedge
with an E of 0.8. In this situation the banking organization would
treat $100 of equity exposure A and $100 of equity exposure B as a
hedge pair, and the remaining $200 of its equity exposure A as a
separate, stand-alone equity position.
The effective portion of a hedge pair would be E multiplied by the
greater of the adjusted carrying values of the equity exposures forming
the hedge pair, and the ineffective portion would be (1-E) multiplied
by the greater of the adjusted carrying values of the equity exposures
forming the hedge pair. In the above example, the effective portion of
the hedge pair would be 0.8 x $100 = $80 and the ineffective portion of
the hedge pair would be (1 - 0.8) x $100 = $20.
(3) Measures of Hedge Effectiveness
Under the dollar-offset method of measuring effectiveness, the
banking organization would determine the ratio of the cumulative sum of
the periodic changes in the value of one equity exposure to the
cumulative sum of the periodic changes in the value of the other equity
exposure, termed the ratio of value change (RVC). If the changes in the
values of the two exposures perfectly offset each other, the RVC would
be -1.0. If RVC is positive, implying that the values of the two equity
exposures move in the same direction, the hedge is not effective and E
= 0. If RVC is negative and greater than or equal to -1.0 (that is,
between zero and -1.0), then E would equal the absolute value of RVC.
If RVC is negative and less than -1.0, then E would equal 2.0 plus RVC.
The variability-reduction method of measuring effectiveness
compares changes in the value of the combined position of the two
equity exposures in the hedge pair (labeled X) to changes in the value
of one exposure as though that one exposure were not hedged (labeled
A). This measure of E expresses the time-series variability in X as a
proportion of the variability of A. As the variability described by the
numerator becomes small relative to the variability described by the
denominator, the measure of effectiveness improves, but is bounded from
above by a value of one. E would be computed as:
[GRAPHIC] [TIFF OMITTED] TP29JY08.002
Where:
Xt = At - Bt
At = the value at time t of the one exposure in a hedge pair, and
Bt = the value at time t of the other exposure in the hedge pair.
The value of t would range from zero to T, where T is the length of
the observation period for the values of A and B, and is comprised of
shorter values each labeled t.
The regression method of measuring effectiveness is based on a
regression in which the change in value of one exposure in a hedge pair
is the dependent variable and the change in value of the other exposure
in the hedge pair is the independent variable. E would equal the
coefficient of determination of this regression, which is the
proportion of the variation in the dependent variable explained by
variation in the independent variable. However, if the estimated
regression coefficient is positive, then the value of E is zero. The
closer the relationship between the values of the two exposures, the
higher E will be.
(4) Simple Risk-Weight Approach (SRWA)
Under the SRWA, a banking organization would determine the risk-
weighted asset amount for each equity exposure, other than an equity
exposure to an investment fund, by multiplying the adjusted carrying
value of the equity exposure, or the effective portion and ineffective
portion of a hedge pair as described above, by the lowest applicable
risk weight in Table 17. A banking organization would determine the
risk-weighted asset amount for an equity exposure to an investment fund
under section 52 of the proposed rule.
The banking organization's aggregate risk-weighted asset amount for
its equity exposures (other than equity exposures to investment funds)
would be equal to the sum of the risk-weighted asset amounts for each
of the banking organization's individual equity exposures.
(5) Non-Significant Equity Exposures
Under the SRWA, a banking organization may apply a 100 percent risk
weight to non-significant equity exposures. The proposed rule defines
non-significant equity exposures as equity exposures \56\ to the extent
that the aggregate adjusted carrying value of the exposures does not
exceed 10 percent of the banking organization's tier 1 capital plus
tier 2 capital.
---------------------------------------------------------------------------
\56\ Excluding exposures to an investment firm that would meet
the definition of traditional securitization were it not for the
primary Federal supervisor's application of paragraph (8) of that
definition and has greater than immaterial leverage.
---------------------------------------------------------------------------
When computing the aggregate adjusted carrying value of a banking
organization's equity exposures for determining non-significance, the
banking organization may exclude (i) equity exposures that receive less
than a 300 percent risk weight under the SRWA (other than equity
exposures determined to be non-significant); (ii) the equity exposure
in a hedge pair with the smaller adjusted carrying value; and (iii) a
proportion of each equity exposure to an investment fund equal to the
proportion of the assets of the investment fund that are not equity
exposures or that qualify as community development equity exposures. If
a banking organization does not know the actual holdings of the
investment fund, the banking organization may calculate the proportion
of the assets of the fund that are not equity exposures based on the
terms of the prospectus, partnership agreement, or similar contract
that defines the fund's permissible investments. If the sum of the
investment limits for all exposure classes within the fund exceeds 100
percent, the banking organization would assume that the investment fund
invests to the maximum extent possible in equity exposures.
When determining which of a banking organization's equity exposures
qualify for a 100 percent risk weight based on non-significance, a
banking organization first would include equity exposures to
unconsolidated small business investment companies, or those held
through consolidated small business investment companies described in
section 302 of the Small Business Investment Act of 1958 (15 U.S.C.
682), then would include publicly traded equity exposures (including
those held indirectly through investment funds), and then would include
non-publicly traded equity exposures (including those held indirectly
through investment funds).
[[Page 44019]]
As discussed above in the Securitization section of this NPR, the
agencies would have discretion under the proposed rule to exclude from
the definition of a traditional securitization those investment firms
that exercise substantially unfettered control over the size and
composition of their assets, liabilities, and off-balance sheet
exposures. Equity exposures to investment firms that would otherwise be
a traditional securitization were it not for the specific agency
exclusion are leveraged exposures to the underlying financial assets of
the investment firm. The agencies believe that equity exposure to such
firms with greater than immaterial leverage warrant a 600 percent risk
weight under the SRWA, due to their particularly high risk. Moreover,
the agencies believe that the 100 percent risk weight assigned to non-
significant equity exposures is inappropriate for equity exposures to
investment firms with greater than immaterial leverage.
The SRWA is summarized in Table 17:
Table 17.--Simple Risk-Weight Approach
------------------------------------------------------------------------
Risk weight (in percent) Equity exposure
------------------------------------------------------------------------
0............................ An equity exposure to a sovereign entity,
the Bank for International Settlements,
the European Central Bank, the European
Commission, the International Monetary
Fund, a MDB, a PSE, and any other entity
whose credit exposures receive a zero
percent risk weight under section 33 of
this proposed rule that may be assigned
a zero percent risk weight.
20........................... An equity exposure to a Federal Home Loan
Bank or Farmer Mac.
100.......................... Community development equity
exposures.\57\
The effective portion of a hedge
pair.
Non-significant equity exposures
to the extent less than 10 percent of
tier 1 plus tier 2 capital.
300.......................... A publicly traded equity exposure (other
than an equity exposure that receives a
600 percent risk weight and including
the ineffective portion of a hedge
pair).
400.......................... An equity exposure that is not publicly
traded (other than an equity exposure
that receives a 600 percent risk
weight).
600.......................... An equity exposure to an investment firm
that (1) would meet the definition of a
traditional securitization were it not
for the primary Federal supervisor's
application of paragraph (8) of that
definition and (2) has greater than
immaterial leverage.
------------------------------------------------------------------------
(6) Equity Exposures to Investment Funds
Under the agencies' general risk-based capital rules, exposures to
investments funds are captured through one of two methods. These
methods are similar to the alternative modified look-through approach
and the simple modified look-through approach described below. The
agencies propose two additional options in this NPR, the full look-
through approach and money market fund approach.
---------------------------------------------------------------------------
\57\ The proposed rule generally defines these exposures as
exposures that would qualify as community development investments
under 12 U.S.C. 24 (Eleventh), excluding equity exposures to an
unconsolidated small business investment company and equity
exposures held through a consolidated small business investment
company described in section 302 of the Small Business Investment
Act of 1958 (15 U.S.C. 682). For savings associations, community
development investments would be defined to mean equity investments
that are designed primarily to promote community welfare, including
the welfare of low- and moderate-income communities or families,
such as by providing services or jobs, and excluding equity
exposures to an unconsolidated small business investment company and
equity exposures held through a consolidated small business
investment company described in section 302 of the Small Business
Investment Act of 1958 (15 U.S.C. 682).
---------------------------------------------------------------------------
The agencies are proposing a separate treatment for equity
exposures to an investment fund to prevent banks from arbitraging the
proposed rule's risk-based capital requirements for certain high-risk
exposures and to ensure that banking organizations do not receive a
punitive risk-based capital requirement for equity exposures to
investment funds that hold only low-risk assets. Under this proposal,
the agencies would define an investment fund as a company (i) all or
substantially all of the assets of which are financial assets and (ii)
that has no material liabilities. As proposed, a banking organization
would determine the risk-weighted asset amount for equity exposures to
investment funds using one of four approaches: The full look-through
approach, the simple modified look-through approach, the alternative
modified look-through approach, or for qualifying investment funds, the
money market fund approach, unless the equity exposure to an investment
fund is a community development equity exposure. Such community
development equity exposures would be subject to a 100 percent risk
weight. If an equity exposure to an investment fund is part of a hedge
pair, a banking organization could use the ineffective portion of the
hedge pair as the adjusted carrying value for the equity exposure to
the investment fund. The risk-weighted asset amount of the effective
portion of the hedge pair would be equal to its adjusted carrying
value. A banking organization could choose to apply a different
approach among the four alternatives to different equity exposures to
investment funds.
(7) Full Look-Through Approach
A banking organization may use the full look-through approach only
if the banking organization is able to compute a risk-weighted asset
amount for each of the exposures held by the investment fund. Under the
proposed rule, a banking organization would be required to calculate
the risk-weighted asset amount for each of the exposures held by the
investment fund as if the exposures were held directly by the banking
organization. Depending on the exposure type, a banking organization
would apply the appropriate proposed rule treatment to an equity
exposure to an investment fund. The banking organization's risk-
weighted asset amount for the fund would be equal to the total risk-
weighted amount for the exposures held by the fund multiplied by the
banking organization's proportional interest in the fund.
(8) Simple Modified Look-Through Approach
Under the proposed simple modified look-through approach, a banking
organization would set the risk-weighted asset amount for its equity
exposure to an investment fund equal to the adjusted carrying value of
the equity exposure multiplied by the highest risk weight that applies
to any exposure the fund is permitted to hold under its prospectus,
partnership agreement, or similar contract that defines the fund's
[[Page 44020]]
permissible investments. The banking organization could exclude
derivative contracts held by the fund that are used for hedging, not
speculative purposes, and do not constitute a material portion of the
fund's exposures.
(9) Alternative Modified Look-Through Approach
Under this approach, a banking organization may assign the adjusted
carrying value of an equity exposure to an investment fund on a pro
rata basis to risk-weight categories based on the investment limits in
the fund's prospectus, partnership agreement, or similar contract that
defines the fund's permissible investments. The risk-weighted amount
for the banking organization's equity exposure to the investment fund
would be equal to the sum of each portion of the adjusted carrying
value assigned to an exposure class multiplied by the applicable risk
weight. If the sum of the investment limits for all exposure classes
within the fund exceeds 100 percent, the banking organization must
assume that the fund invests to the maximum extent permitted under its
investment limits in the exposure class with the highest risk weight in
this proposed rule, and continues to make investments in the order of
the exposure class with the next highest risk weight until the maximum
total investment level is reached. If more than one exposure class
applies to an exposure, the banking organization would use the highest
applicable risk weight. A banking organization could exclude derivative
contracts held by the fund that are used for hedging, not speculative,
purposes and do not constitute a material portion of the fund's
exposures.
(10) Money Market Fund Approach
Under this proposed rule, a banking organization may apply a seven
percent risk weight to an equity exposure to a money market fund that
is subject to SEC rule 2a-7 and that has an applicable external rating
in the highest investment-grade category.
O. Operational Risk
(1) Basic Indicator Approach (BIA)
The general risk-based capital rules do not include an explicit
capital charge for operational risk. Rather, the general risk-based
capital rules were designed to focus on credit risk. However, due to
their broad-brush nature, the rules implicitly cover other types of
risks such as operational risk. The more risk-sensitive treatment under
the standardized approach for credit risk sharpens the capital measure
for that element of the risk-based capital charge and lessens the
implicit capital buffer for other risks.
The agencies recognize that operational risk is an important risk
and that a number of factors are driving increases in operational risk.
These factors include greater use of automated technology;
proliferation of new and highly complex products; growth of e-banking
transactions and related business applications; large-scale
acquisitions, mergers and consolidations; and greater use of
outsourcing arrangements. These factors, and in light of the agencies'
goal to promote improved risk measurement processes support the
inclusion of an explicit capital requirement for operational risk for
those institutions that adopt the proposed rule.
Consistent with the New Accord, the agencies propose to implement
the BIA for determining a banking organization's risk-based capital
requirement for operational risk. The operational risk capital
requirement would cover the risk of loss resulting from inadequate or
failed internal processes, people, and systems or from external events.
Operational risk includes legal risk, which is the risk of loss
(including litigation costs, settlements, and regulatory fines)
resulting from the failure of the banking organization to comply with
laws, regulations, prudent ethical standards, and contractual
obligations in any aspect of the banking organization's business, but
excludes strategic and reputational risks.
Under the BIA, a banking organization's risk-weighted assets for
operational risk would equal 15 percent of its average positive annual
gross income over the previous three years multiplied by 12.5. The
calculation of average positive annual gross income is based on annual
gross income as reported by the banking organization in its regulatory
financial reports over the three most recent calendar years as
discussed below. Gross income is a proxy for the scale of a banking
organization's operational risk exposure and can, in some instances
(for example, for a banking organization with low margins or
profitability) underestimate the banking organization's capital needs
for operational risk. Therefore, a banking organization using the BIA
should manage its operational risk consistent with the Basel
Committee's ``Sound Practices for the Management and Supervision of
Operational Risk'' guidance, which includes a set of principles for the
effective management of operational risk.\58\
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\58\ See the February 2003 BCBS publication entitled ``Sound
Practices for the Management and Supervision of Operational Risk.''
---------------------------------------------------------------------------
The proposed rule defines average positive annual gross income as
the sum of the banking organization's positive annual gross income, as
described below, over the three most recent calendar years. This
calculation would not include any amounts from any year in which annual
gross income is negative or zero; that is, it is the sum of its
positive annual gross income divided by the number of years in which
its annual gross income was positive. Annual gross income would equal:
(i) For a bank, its net interest income plus its total noninterest
income minus its underwriting income from insurance and reinsurance
activities as reported on the bank's year-end Consolidated Reports of
Condition and Income (Call Report).
(ii) For a bank holding company, its net interest income plus its
total noninterest income minus its underwriting income from insurance
and reinsurance activities as reported on the bank holding company's
Consolidated Financial Statements for Bank Holding Companies (Y9-C
Report).
(iii) For a savings association, its net interest income (expense)
before provision for losses on interest-bearing assets, plus total
noninterest income, minus the portion of its other fees and charges
that represents income derived from insurance and reinsurance
underwriting activities, minus (plus) its income (loss) from the sale
of assets held-for-sale and available-for-sale securities to include
only the profit or loss from the disposition of available-for-sale
securities pursuant to FASB Statement No. 115, minus (plus) its income
(loss) from the sale of securities held-to-maturity, all as reported on
the savings association's year-end Thrift Financial Report (TFR).
[[Page 44021]]
Table 18 illustrates the relevant components of average positive
annual gross income from regulatory reports.
Table 18.--Calculation of Gross Income for BIA
----------------------------------------------------------------------------------------------------------------
For Bank FFIEC 031/041, BHC Y-9C, and TFR reporting Call report Y-9C TFR
----------------------------------------------------------------------------------------------------------------
Item No. from
Item No. Schedules RI and Description RIAD BHC K SO
HI
----------------------------------------------------------------------------------------------------------------
1............... 3................ Net interest income... ... 4074 4074 SO312
2............... 5.m.............. Total noninterest + 4079 4079 SO42
income.
3............... 5.d.(4).......... Underwriting income - C386 C386 n/a
from insurance and
reinsurance
activities.
4............... n/a.............. Other fees and charges - n/a n/a \1\ SO420
5............... n/a.............. Sale of assets held- - n/a n/a \2\ SO430
for-sale and of
available-for-sale
securities.
6............... n/a.............. Sale of securities - n/a n/a SO467
held-to-maturity.
7............... n/a.............. Gross income for BIA.. ... .............. .............. ..............
----------------------------------------------------------------------------------------------------------------
\1\ Include only the portion of SO420 that represents income derived from insurance and reinsurance underwriting
activities.
\2\ Include only ``profit or loss from the disposition of available-for-sale securities pursuant to FASB
Statement No. 115'' from SO430.
Question 19: The agencies solicit comment on this proposed
treatment of operational risk, and, in particular, on the
appropriateness of the proposed average positive gross income
calculation.
(2) Advanced Measurement Approaches (AMA)
Under the AMA framework of the New Accord, a banking organization
that meets the qualifying criteria for AMA would use its internal
operational risk quantifications system to calculate its risk-based
capital requirement for operational risk. The AMA framework is fully
discussed in the advanced approaches final rule. The specific
references in the advanced approaches final rule's preamble and common
rule text are: (i) Preamble; \59\ (ii) section 22(c) and certain other
paragraphs in section 22 of the common rule text,\60\ such as (a)(2)
and (3), (i), (j), and (k), which discuss advanced systems in general
and therefore would apply to AMA; (iii) sections 22(h), 61, and 62 of
the common rule text; \61\ (iv) applicable definitions in section 2 of
the common rule text; \62\ and (v) applicable disclosure requirements
in Table 11.9 of the common rule text. \63\
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\59\ See 72 FR 69302-21, 69382-84, and 69293-94 (December 7,
2007).
\60\ Id. at 69407-08.
\61\ Id. at 69407-08 and 69428-29.
\62\ Id. at 69397-405.
\63\ Id. at 69436.
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Under the New Accord, the AMA option may be made available for
banking organizations that apply any of the New Accord's approaches to
credit risk. The agencies are considering whether to implement the AMA
option in a standardized framework final rule consistent with the
requirements in the advanced approaches final rule. Accordingly, the
agencies would like to know whether any banking organizations that
would be eligible to opt in to a standardized framework believe that
they can meet the advance systems requirements that would qualify them
to use the more complex AMA approach for calculating their risk-based
capital requirement for operational risk.
Question 20: The agencies therefore solicit comment on the
appropriateness of including the AMA for calculating the risk-based
capital requirement for operational risk in any final rule implementing
the standardized framework and the extent to which banking
organizations implementing the standardized approach believe they can
meet the associated advanced modeling and systems requirements.
P. Supervisory Oversight and Internal Capital Adequacy Assessment
One of the objectives of the New Accord is to provide incentives
for banking organizations to develop and apply better techniques for
measuring and managing risks and ensuring that capital is adequate to
support those risks, not just to meet minimum regulatory capital
requirements. Consistent with the agencies' general risk-based capital
rules and Pillar 2 of the New Accord, the proposed rule would require a
banking organization to hold capital that is commensurate with the
level and nature of all risks to which the banking organization is
exposed, and to have both a rigorous process for assessing its overall
capital adequacy in relation to its risk profile and a comprehensive
strategy for maintaining appropriate capital levels.
Consistent with existing supervisory practice, a banking
organization's primary Federal supervisor would evaluate a banking
organization's compliance with the minimum capital requirements and
also evaluate how well the banking organization is assessing its
capital needs relative to its risks and capital goals. Also, consistent
with existing supervisory practice, a primary Federal supervisor may
require a banking organization under its jurisdiction to increase its
capital levels or reduce its risk exposures if capital is deemed
inadequate relative to a banking organization's risk profile.
Q. Market Discipline
(1) Overview
The general risk-based capital rules do not require disclosures
beyond the filing of the risk-based capital section of the agencies'
regulatory reports (that is, FR Y9-C, Call Reports, TFR, etc). The
agencies, however, have long supported meaningful public disclosure by
banking organizations to improve market discipline. The agencies
recognize the importance of market discipline in encouraging sound risk
management practices and fostering financial stability.
Pillar 3 of the New Accord, market discipline, complements the
minimum capital requirements and the supervisory review process by
encouraging market discipline through enhanced and meaningful public
disclosure. These proposed public disclosure requirements are intended
to allow market participants to assess key information about a banking
organization's risk profile and its associated level of capital.
[[Page 44022]]
With enhanced transparency, investors can better evaluate a banking
organization's capital structure, risk exposures, and capital adequacy.
With sufficient and relevant information, market participants can
better evaluate a banking organization's risk management performance,
earnings potential, and financial strength.
Improvements in public disclosures come not only from regulatory
standards, but also through efforts by a banking organization's
management to improve communications to public shareholders and other
market participants. In this regard, improvements to risk management
processes and internal reporting systems provide opportunities to
improve significantly public disclosures over time. Accordingly, the
agencies strongly encourage the management of each banking organization
to review regularly its public disclosures and enhance these
disclosures, where appropriate, to identify clearly all significant
risk exposures, whether on- or off-balance sheet, and their effects on
the banking organization's financial condition and performance, cash
flow, and earnings potential.
(2) General Requirements
The proposed public disclosure requirements apply to the top-tier
legal entity that is a banking organization within a consolidated
banking group (that is, the top-tier banking organization). In general,
a banking organization that is a subsidiary of a bank holding company
(BHC) or another banking organization would not be subject to the
disclosure requirements, except that every banking organization would
have to disclose total and tier 1 capital ratios and their components,
similar to current requirements. If a banking organization is not a
subsidiary of a BHC or another banking organization that must make the
full set of disclosures, the banking organization would have to make
these disclosures.
A banking organization's exposure to risk and the techniques that
it uses to identify, measure, monitor, and control those risks are
important factors that market participants consider in their assessment
of the institution. Accordingly, each banking organization that is
subject to the disclosure requirements would have a formal disclosure
policy approved by its board of directors that addresses the banking
organization's approach for determining the disclosures it should make.
The policy should address the associated internal controls and
disclosure controls and procedures. The board of directors and senior
management would have to ensure that appropriate review of the
disclosures takes place and that effective internal controls and
disclosure controls and procedures are maintained.
A banking organization should decide which disclosures are relevant
for it based on a materiality concept. Information would be regarded as
material if its omission or misstatement could change or influence the
assessment or decision of a user relying on that information for the
purpose of making investment decisions.
A banking organization may be able to fulfill some of the proposed
disclosure requirements by relying on similar disclosures made in
accordance with accounting standards or SEC mandates. In these
situations, a banking organization must explain material differences
between the accounting or other disclosures and the disclosures
required under this proposed rule.
(3) Frequency/Timeliness
Consistent with longstanding requirements in the United States for
robust quarterly disclosures in financial and regulatory reports, and
considering the potential for rapid changes in risk profiles, this NPR
would require that quantitative disclosures be made quarterly. However,
qualitative disclosures that provide a general summary of a banking
organization's risk management objectives and policies, reporting
system, and definitions may be disclosed annually, provided any
significant changes to these are disclosed in the interim. The
disclosures must be timely, that is, made by the reporting deadline for
financial reports (for example SEC forms 10-Q and 10-K) or 45 days
after the calendar quarter-end. When these deadlines differ, the later
deadline should be used.
In some cases, management may determine that a significant change
has occurred, such that the most recent reported amounts do not reflect
the banking organization's capital adequacy and risk profile. In those
cases, a banking organization would have to disclose the general nature
of these changes and briefly describe how they are likely to affect
public disclosures going forward. A banking organization would make
these interim disclosures as soon as practicable after the
determination that a significant change has occurred.
(4) Location of Disclosures and Audit/Certification Requirements
The disclosures would have to be publicly available (for example,
included on a public Web site) for each of the last three years or such
shorter time period since the banking organization opted into the
standardized framework. Except as discussed below, management would
have some discretion to determine the appropriate medium and location
of the disclosure. Furthermore, a banking organization would have
flexibility in formatting its public disclosures.
The agencies encourage management to provide all of the required
disclosures in one place on the entity's public Web site. The public
Web site address would be reported in a regulatory report.
Alternatively, banking organizations would be permitted to provide the
disclosures in more than one place, as some of them may be included in
public financial reports (for example, in Management's Discussion and
Analysis included in SEC filings) or other regulatory reports. The
agencies would encourage such banking organizations to provide a
summary table on their public Web site that specifically indicates
where all the disclosures may be found (for example, regulatory report
schedules, pages numbers in annual reports).
Disclosures of tier 1 and total capital ratios would be tested by
external auditors as part of the financial statement audit, if the
banking organization is required to obtain financial statement audits.
Disclosures that are not included in the footnotes to the audited
financial statements are not subject to external audit reports for
financial statements or internal control reports from management and
the external auditor. Due to the importance of reliable disclosures,
the agencies would require one or more senior officers to attest that
the disclosures would meet the proposed disclosure requirements. The
senior officer may be the chief financial officer, the chief risk
officer, an equivalent senior officer, or a combination thereof.
(5) Proprietary and Confidential Information
The agencies believe that the proposed requirements strike an
appropriate balance between the need for meaningful disclosure and the
protection of proprietary and confidential information.\64\
Accordingly, the agencies believe that banking organizations would be
able to provide
[[Page 44023]]
all of these disclosures without revealing proprietary and confidential
information. Only in rare circumstances might disclosure of certain
items of information required by the proposed rule compel a banking
organization to reveal confidential and proprietary information. In
these unusual situations, the agencies propose that if a banking
organization believes that disclosure of specific commercial or
financial information would prejudice seriously the position of the
banking organization by making public information that is either
proprietary or confidential in nature, the banking organization need
not disclose those specific items. Instead, the banking organization
must disclose more general information about the subject matter of the
requirement, together with the fact that, and the reason why, the
specific items of information have not been disclosed. This provision
would apply only to those disclosures included in this NPR and does not
apply to disclosure requirements imposed by accounting standards or
other regulatory agencies.
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\64\ Proprietary information encompasses information that, if
shared with competitors, would render a banking organization's
investment in these products/systems less valuable, and, hence,
could undermine its competitive position. Information about
customers is often confidential, in that it is provided under the
terms of a legal agreement or counterparty relationship.
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Question 21: The agencies seek commenters' views on all of the
elements of the proposed public disclosure requirements. In particular,
the agencies seek comment on the extent to which the proposed
disclosures balance providing market participants with sufficient
information to appropriately assess the risk profile and capital
strength of individual institutions, fostering comparability across
banking organizations, and minimizing burden on the banking
organizations that are reporting the information. The agencies further
request comment on whether certain banking organizations (for example,
those not publicly listed or not required to have audited financial
statements) should be exempt or have more limited disclosure
requirements and, if so, how to preserve competitive equity with
banking organizations required to make a full set of disclosures.
(6) Summary of Specific Public Disclosure Requirements
The public disclosure requirements described in the tables in the
proposed rule provide important information to market participants on
the scope of application, capital, risk exposures, risk assessment
processes, and, hence, the capital adequacy of the banking
organization. The table numbers below refer to the table numbers in the
proposed rule. For each separate risk area described in Table 15.4
through 15.10, the banking organization would be required to describe
its risk management objectives and policies. The agencies expect that
these objectives and policies would include: (i) Strategies and
processes; (ii) the structure and organization of the relevant risk
management function; (iii) the scope and nature of risk reporting and/
or measurement systems; and (iv) policies for hedging and/or mitigating
risk and strategies and processes for monitoring the continuing
effectiveness of hedges/mitigants.
A banking organization should focus on the substantive content of
the tables, not the tables themselves. The proposed disclosures are:
Table 15.1, Scope of Application, would include a
description of the level in the banking organization to which the
disclosures apply and an outline of any differences in consolidation
for accounting and regulatory capital purposes, as well as a
description of any restrictions on the transfer of funds and capital
within the banking organization. These disclosures provide the basic
context underlying regulatory capital calculations.
Table 15.2, Capital Structure, would provide information
on various components of regulatory capital available to absorb losses
and allow for an evaluation of the quality of the capital available to
absorb losses within the banking organization.
Table 15.3, Capital Adequacy, would provide information
about how a banking organization assesses the adequacy of its capital
and set requirements that the banking organization disclose its risk-
weighted asset amounts for various asset categories. The table also
requires disclosure of the regulatory capital ratios of the
consolidated group and each DI subsidiary. Such disclosures provide
insight into the overall adequacy of capital based on the risk profile
of the banking organization.
Tables 15.4 and 15.6, Credit Risk, would provide
information for different types and concentrations of a banking
organization's exposure to credit risk and the techniques the banking
organization uses to measure, monitor, and mitigate that risk.
Table 15.5, General Disclosures for Counterparty Credit
Risk-Related Exposures, would provide information related to
counterparty credit risk-related exposures.
Table 15.7, Securitization, would provide information to
market participants on the amount of credit risk transferred and
retained by the banking organization through securitization
transactions and the types of products securitized by the organization.
These disclosures provide users a better understanding of how
securitization transactions impact the credit risk of the banking
organization.
Table 15.8, Operational Risk, would provide insight into
the banking organization's operational risk exposure.
Table 15.9, Equities Not Subject to the Market Risk Rule,
would provide market participants with an understanding of the types of
equity securities held by the banking organization and how they are
valued. This disclosure also would provide information on the capital
allocated to different equity products and the amount of unrealized
gains and losses.
Table 15.10, Interest Rate Risk in Non-Trading Activities,
would provide information about the potential risk of loss that may
result from changes in interest rates and how the banking organization
measures such risk.
III. Regulatory Analysis
A. Regulatory Flexibility Act Analysis
Pursuant to section 605(b) of the Regulatory Flexibility Act, 5
U.S.C. 605(b) (RFA), the regulatory flexibility analysis otherwise
required under section 604 of the RFA is not required if an agency
certifies that the rule will not have a significant economic impact on
a substantial number of small entities (defined for purposes of the RFA
to include banking organizations with assets less than or equal to $165
million) and publishes its certification and a short, explanatory
statement in the Federal Register along with its rule. Pursuant to
section 605(b) of the RFA, the agencies certify that this proposed rule
will not have a significant economic impact on a substantial number of
small entities. Accordingly, a regulatory flexibility analysis is not
needed. The amendments to the agencies' regulations described above are
elective. They will apply only to banking organizations that opt to
take advantage of the proposed revisions to the existing domestic risk-
based capital framework and that will not be required to use the
advanced approaches contained in the advanced approaches final rule.
The agencies believe that banking organizations that elect to adopt
these proposals will generally be able to do so with data they
currently use as part of their credit approval and portfolio management
processes. Banking organizations not exercising this option would
remain subject to the current capital framework. The proposal does not
impose any new mandatory requirements or burdens. Moreover, industry
groups representing small banking organizations that commented on the
Basel IA NPR noted that small banking organizations typically hold
[[Page 44024]]
more capital than is required by the capital rules and would prefer to
remain under the general risk-based capital rules. For these reasons,
the proposal will not result in a significant economic impact on a
substantial number of small entities.
B. OCC Executive Order 12866 Determination
Executive Order 12866 requires federal agencies to prepare a
regulatory impact analysis for agency actions that are found to be
``significant regulatory actions''. Significant regulatory actions
include, among other things, rulemakings that ``have an annual effect
on the economy of $100 million or more or adversely affect in a
material way the economy, a sector of the economy, productivity,
competition, jobs, the environment, public health or safety, or state,
local, or tribal governments or communities.'' \65\ Regulatory actions
that satisfy one or more of these criteria are referred to as
``economically significant regulatory actions.''
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\65\ Executive Order 12866 (September 30, 1993), 58 FR 51735
(October 4, 1993), as amended by Executive Order 13258, 67 FR 9385
(February 28, 2002) and by Executive Order 13422, 72 FR 2763
(January 23, 2007). For the complete text of the definition of
``significant regulatory action,'' see E.O. 12866 at Sec. 3(f). A
``regulatory action'' is ``any substantive action by an agency
(normally published in the Federal Register) that promulgates or is
expected to lead to the promulgation of a final rule or regulation,
including notices of inquiry, advance notices of proposed
rulemaking, and notices of proposed rulemaking.'' E.O. 12866 at
Sec. 3(e).
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Based on the OCC's estimate of the number of national banks likely
to adopt this proposal and the proposal's total cost of approximately
$74 million, the proposed rule would not have an annual effect on the
economy of $100 million or more. In light of certain unique features of
the proposal, the OCC has nevertheless prepared this regulatory impact
analysis. Specifically, this proposal affords most national banks the
option to apply this approach, which results in additional uncertainty
in estimating the total costs.
In conducting the regulatory analysis for an economically
significant regulatory action, Executive Order 12866 requires each
federal agency to provide to the Administrator of the Office of
Management and Budget's Office of Information and Regulatory Affairs
(OIRA):
The text of the draft regulatory action, together with a
reasonably detailed description of the need for the regulatory action
and an explanation of how the regulatory action will meet that need;
An assessment of the potential costs and benefits of the
regulatory action, including an explanation of the manner in which the
regulatory action is consistent with a statutory mandate and, to the
extent permitted by law, promotes the President's priorities and avoids
undue interference with state, local, and tribal governments in the
exercise of their governmental functions;
An assessment, including the underlying analysis, of
benefits anticipated from the regulatory action (such as, but not
limited to, the promotion of the efficient functioning of the economy
and private markets, the enhancement of health and safety, the
protection of the natural environment, and the elimination or reduction
of discrimination or bias) together with, to the extent feasible, a
quantification of those benefits;
An assessment, including the underlying analysis, of costs
anticipated from the regulatory action (such as, but not limited to,
the direct cost both to the government in administering the regulation
and to businesses and others in complying with the regulation, and any
adverse effects on the efficient functioning of the economy, private
markets (including productivity, employment, and competitiveness),
health, safety, and the natural environment), together with, to the
extent feasible, a quantification of those costs; and
An assessment, including the underlying analysis, of costs
and benefits of potentially effective and reasonably feasible
alternatives to the planned regulation, identified by the agencies or
the public (including improving the current regulation and reasonably
viable nonregulatory actions), and an explanation why the planned
regulatory action is preferable to the identified potential
alternatives.
Set forth below is a summary of the OCC's regulatory impact
analysis, which can be found in its entirety at http://www.occ.treas.gov/law/basel.htm under the link of ``Regulatory Impact
Analysis for Risk-Based Capital Guidelines; Capital Adequacy
Guidelines; Capital Maintenance: Standardized Risk-Based Capital Rules
(Basel II: Standardized Option), Office of the Comptroller of the
Currency, International and Economic Affairs (2008)''.
I. The Need for the Regulatory Action
Federal banking law directs federal banking agencies, including the
Office of the Comptroller of the Currency (OCC), to require banking
organizations to hold adequate capital. The law authorizes federal
banking agencies to set minimum capital levels to ensure that banking
organizations maintain adequate capital. The law also gives federal
banking agencies broad discretion with respect to capital regulation by
authorizing them to also use any other methods that they deem
appropriate to ensure capital adequacy.
Capital regulation seeks to address market failures that stem from
several sources. Asymmetric information about the risk in a banking
organization's portfolio creates a market failure by hindering the
ability of creditors and outside monitors to discern a banking
organization's actual risk and capital adequacy. Moral hazard creates
market failure in which the banking organization's creditors fail to
restrain the banking organization from taking excessive risks because
deposit insurance either fully or partially protects them from losses.
Public policy addresses these market failures because individual banks
fail to adequately consider the positive externality or public benefit
that adequate capital brings to financial markets and the economy as a
whole.
Capital regulations cannot be static. Innovation in and
transformation of financial markets require periodic reassessments of
what may count as capital and what amount of capital is adequate.
Continuing changes in financial markets create both a need and an
opportunity to refine capital standards in banking. The proposed
revisions to U.S. risk-based capital rules, ``Risk-Based Capital
Guidelines; Capital Adequacy Guidelines; Capital Maintenance:
Standardized Risk-Based Capital Rules'' (standardized option), which we
address in this impact analysis, provide a new option for determining
risk-based capital for banking organizations not required to operate
under ``Risk-Based Capital Standards: Advanced Capital Adequacy
Framework'' (advanced approaches). The standardized option and the
advanced approaches reflect the implementation in the United States of
the Basel Committee on Banking Supervision's ``International
Convergence of Capital Measurement and Capital Standards: A Revised
Framework'' (New Accord).
II. Regulatory Background
The proposed capital regulation examined in this analysis would
apply to commercial banks and savings associations (collectively,
banks). Three banking agencies, the OCC, the Board of Governors of the
Federal Reserve System (Board), and the Federal Deposit Insurance
Corporation (FDIC) regulate commercial banks, while the Office of
Thrift Supervision (OTS) regulates all federally chartered and many
state-chartered savings associations.
[[Page 44025]]
Throughout this document, the four are jointly referred to as the
federal banking agencies.
The New Accord comprises three mutually reinforcing ``pillars'' as
summarized below.
1. Minimum Capital Requirements (Pillar 1)
The first pillar establishes a method for calculating minimum
regulatory capital. It sets new requirements for assessing credit risk
and operational risk while generally retaining the approach to market
risk as developed in the 1996 amendments to the 1988 Accord.
The New Accord offers banks a choice of three methodologies for
calculating the capital charge for credit risk. The first approach,
called the standardized approach, essentially refines the risk-
weighting framework of the 1988 Accord. The other two approaches are
variations on an internal ratings-based (IRB) approach that leverages
banks' internal credit-rating systems: A ``foundation'' methodology,
whereby banks estimate the probability of borrower or obligor default,
and an ``advanced'' approach, whereby organizations also supply other
inputs needed for the capital calculation. In addition, the new
framework uses more risk-sensitive methods for dealing with collateral,
guarantees, credit derivatives, securitizations, and receivables.
The New Accord also introduces an explicit capital requirement for
operational risk.\66\ The New Accord offers banking organizations a
choice of three methodologies for calculating their capital charge for
operational risk. The first method, called the basic indicator
approach, requires banks to hold capital for operational risk equal to
15 percent of annual gross income (averaged over the most recent three
years). The second option, called the standardized approach, uses a
formula that divides a banking organization's activities into eight
business lines, calculates the capital charge for each business line as
a fixed percentage of gross income (12 percent, 15 percent, or 18
percent depending on the nature of the business, again averaged over
the most recent three years), and then sums across business lines. The
third option, called the advanced measurement approaches (AMA), uses an
institution's internal operational risk measurement system to determine
the capital requirement.
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\66\ Operational risk is the risk of loss resulting from
inadequate or failed processes, people, and systems or from external
events. It includes legal risk but excludes strategic risk and
reputation risk.
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2. Supervisory Review Process (Pillar 2)
The second pillar calls upon banking organizations to have an
internal capital assessment process and banking supervisors to evaluate
each banking organization's overall risk profile as well as its risk
management and internal control processes. This pillar establishes an
expectation that banking organizations hold capital beyond the minimums
computed under Pillar 1, including additional capital for any risks
that are not adequately captured under Pillar 1. It encourages banking
organizations to develop better risk management techniques for
monitoring and managing their risks. Pillar 2 also charges supervisors
with the responsibility to ensure that banking organizations using
advanced Pillar 1 techniques, such as the advanced IRB approach to
credit risk and the AMA for operational risk, comply with the minimum
standards and disclosure requirements of those methods, and take action
promptly if capital is not adequate.
3. Market Discipline (Pillar 3)
The third pillar of the New Accord sets minimum disclosure
requirements for banking organizations. The disclosures, covering the
composition and structure of the banking organization's capital, the
nature of its risk exposures, its risk management and internal control
processes, and its capital adequacy, are intended to improve
transparency and strengthen market discipline. By establishing a common
set of disclosure requirements, Pillar 3 seeks to provide a consistent
and understandable disclosure framework that market participants can
use to assess key pieces of information on the risks and capital
adequacy of a banking organization.
4. U.S. Implementation
The proposed standardized option rule seeks to improve the risk
sensitivity of existing risk-based capital rules. The standardized
option would be voluntary and available to banking organizations not
subject to the advanced approaches rule. Any institution that is not an
advanced approaches bank would be able to remain under the existing
risk-based capital rules or elect to adopt the standardized option. The
standardized option would:
1. Include a capital requirement for operational risk.
2. Use external credit ratings to risk weight sovereign, public
sector entity, corporate, and securitization exposures.
3. Use the risk weight of the appropriate sovereign to assign risk
weights for exposures to banks.
4. Use loan-to-value ratios to risk-weight residential mortgages.
5. Lower the risk weights for some retail exposures and small loans
to businesses.
6. Expand the range of credit risk mitigation techniques that are
recognized for risk-based capital purposes, including expanding the
range of recognized collateral and eligible guarantors.
7. Increase the credit conversion factor for certain commitments
with an original maturity of one year or less that are not
unconditionally cancelable.
8. Revise the risk weights for securitization exposures and assess
a capital charge for early amortizations in securitizations of
revolving exposures.
9. Remove the 50 percent limit on the risk weight for certain
derivative transactions.
10. Revise the risk-based capital treatment for unsettled and
failed trades for securities, foreign exchange, and commodities.
11. Expand the range of methodologies available to banking
organizations for measuring counterparty credit risk.
The Agencies would continue to reserve the authority to require
banking organizations to hold additional capital where appropriate.
III. Cost-Benefit Analysis of the Proposed Rule
A cost-benefit analysis considers the costs and benefits of a
proposal as they relate to society as a whole. The social benefits of a
proposal are benefits that accrue directly to those subject to a
proposal plus benefits that might accrue indirectly to the rest of
society. Similarly, the overall social costs of a proposal are costs
incurred directly by those subject to the rule and costs incurred
indirectly by others. In the case of the Standardized Option, direct
costs and benefits are those that apply to the banking organizations
that are subject to the proposal. Indirect costs and benefits then stem
from banks and other financial institutions that are not subject to the
proposal, bank customers, and, through the safety and soundness
externality, society as a whole.
The broad social and economic benefit that derives from a safe and
sound banking system supported by vigorous and comprehensive
supervision, including ensuring adequate capital, clearly dwarfs any
direct benefits that might accrue to institutions adopting the
Standardized Option. Similarly, the social and economic cost of any
reduction in the safety and soundness of the banking system would
dramatically overshadow
[[Page 44026]]
any cost borne by banking organizations subject to the rule. The
banking agencies are confident that the enhanced risk sensitivity of
the proposed rule could allow banking organizations to more effectively
achieve objectives that are consistent with a safe and sound banking
system.
Beyond this societal benefit from maintaining a safe and sound
banking system, we do not anticipate additional benefits outside of
those accruing directly to the banking organizations that elect to
adopt the Standardized Option. Because many factors besides regulatory
capital requirements affect pricing and lending decisions, we do not
expect the adoption or non-adoption of the Standardized Option to
affect pricing or lending. Hence, we do not anticipate any costs or
benefits affecting the customers or competitors of institutions
adopting the Standardized Option. For these reasons, the cost and
benefit analysis of the Standardized Option is primarily an analysis of
the costs and benefits directly attributable to institutions that might
elect to adopt its capital rules.
A. Organizations Affected by the Proposed Rule \67\
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\67\ Unless otherwise noted, the population of banks and thrifts
used in this analysis consists of all FDIC-insured institutions.
Banking organizations are aggregated to the top holding company
level.
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As of December 31, 2007, twelve banking organizations meet the
criteria that would require them to adopt the U.S. implementation of
the New Accord's advanced approaches. Removing those twelve mandatory
advanced approaches institutions from the 7,415 FDIC-insured banking
organizations active in December 2007 leaves 7,403 organizations that
would be eligible to adopt the Standardized Option. Seven of the twelve
mandatory advanced approaches institutions are national banks. Out of
1,421 banking organizations with national banks, 1,414 national banking
organizations would thus be eligible to adopt the Standardized Option.
B. Benefits of the Proposed Rule
The proposed rule aims to enhance safety and soundness by improving
the risk sensitivity of regulatory capital requirements. The proposed
rule:
1. Enhances the risk sensitivity of capital charges.
2. Facilitates more efficient use of required bank capital.
3. Recognizes new developments in financial markets.
4. Mitigates potential distortions in minimum regulatory capital
requirements between Advanced Approaches banking organizations and
other banking organizations.
5. Better aligns capital and operational risk and encourages
banking organizations to mitigate operational risk.
6. Enhances supervisory feedback.
7. Promotes market discipline through enhanced disclosure.
8. Preserves the benefits of international consistency and
coordination achieved with the 1988 Basel Accord.
9. Offers long-term flexibility to banking organizations by
providing the ability to opt in to the standardized approach.
C. Costs of the Proposed Rule
As with any rule, the costs of the proposal include necessary
expenditures by banks and thrifts necessary to comply with the new
regulation and costs to the federal banking agencies of implementing
the new rules. Because of a lack of cost estimates from banking
organizations, the OCC found it necessary to use a scope-of-work
comparison with the Advanced Approaches in order to arrive at a cost
estimate for the Standardized Option. Based on this rough assessment,
we estimate that implementation costs for the Standardized Option could
range from $200,000 at smaller institutions to $5 million at larger
institutions.
1. Costs to Banking Organizations
Explicit costs of implementing the proposed rule at banking
organizations fall into two categories: Setup costs and ongoing costs.
Setup costs are typically one-time expenses associated with introducing
the new programs and procedures necessary to achieve initial compliance
with the proposed rule. Setup costs may also involve expenses related
to tracking and retrieving data needed to implement the proposed rule.
Ongoing costs are also likely to reflect data costs associated with
retrieving and preserving data.
The total cost of the standardized option depends entirely on the
number and size of institutions that elect to adopt the voluntary rule.
Obviously, if the number of institutions adopting the standardized
option is zero, then the cost to banks will be zero. Based on comment
letters and discussions with bank supervision staff, we sought to
identify national banks that would be most likely to adopt the
standardized option. Because one of the principal changes in the
standardized option affects the risk weighting for residential
mortgages, we selected national banks with significant mortgage
holdings as the more likely adopters of the new rule. In particular,
our list of more likely adopters includes national banks where one-to-
four family first-lien mortgages comprise over 30 percent of all assets
if the institution has less than $1 billion in assets and where the
mortgage to asset ratio is over 20 percent at larger institutions. We
also include the few national banks that do not meet the well-
capitalized threshold for their risk based capital-to-assets ratio as
of December 31, 2007. Using those criteria, we identified 113 national
banks, which if they adopted the standardized option would result in a
total cost to national banks of approximately $74 million. Over time,
the standardized option may become more appealing to a larger number of
banks. The total cost of the proposed rule would consequently increase
to the extent that more institutions opt into the standardized option
over time. At present, it is unclear how many national banks will
ultimately elect to adopt the standardized option. The standardized
option's provision for an explicit charge for operational risk is
another important factor that national banks will undoubtedly consider
in assessing whether to adopt the standardized option. Although we are
unable to estimate how many of our estimated adopters might be
dissuaded from the standardized option because of an operational risk
capital charge, we do believe that the explicit charge for operational
risk could significantly reduce the number of likely adopters.\68\
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\68\ If the advanced measurement approach (AMA) option for
operational risk were to be made available as part of the
standardized option, we believe that its considerable startup
requirements and accompanying costs would dissuade almost all
institutions with less than $10 billion in assets from pursuing the
AMA operational risk option.
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2. Government Administrative Costs
Like the banking organizations subject to new requirements, the
costs to government agencies of implementing the proposed rule also
involve both startup and ongoing costs. Startup costs include expenses
related to the development of the regulatory proposals, costs of
establishing new programs and procedures, and costs of initial training
of bank examiners in the new programs and procedures. Ongoing costs
include maintenance expenses for any additional examiners and analysts
needed to regularly apply the new supervisory processes. In the case of
the standardized option, because modest changes to Call Reports will
capture most of the rule changes, these ongoing costs are likely to be
minor.
OCC expenditures fall into three broad categories: Training,
guidance,
[[Page 44027]]
and supervision. Training includes expenses for workshops and other
training courses and seminars for examiners. Guidance expenses reflect
expenditures on the development of standardized option guidance.
Supervision expenses reflect organization-specific supervisory
activities. We estimate that OCC expenses for the standardized option
will be approximately $4.3 million through 2008. We also expect
expenditures of $1 million per year between 2009 and 2011. Applying a
five percent discount rate to future expenditures, past expenses ($4.3
million) plus the present value of future expenditures ($2.7 million)
equals total OCC expenditures of $7 million on the standardized option.
3. Total Cost Estimate of Proposed Rule
The OCC's estimate of the total cost of the proposed rule includes
expenditures by banking organizations and the OCC from the present
through 2011. Based on our estimate that approximately 113 national
banks will adopt the standardized option at a cost to each institution
of between $200,000 and $5 million depending on the size of the
institution, we estimate that national banks will spend approximately
$74 million on the standardized option. Combining expenditures provides
an estimate of $81 million for the total cost of the proposed rule for
the OCC and national banks.
IV. Analysis of Baseline and Alternatives
In order to place the costs and benefits of the proposed rule in
context, Executive Order 12866 requires a comparison between the
proposed rule, a baseline of what the world would look like without the
proposed rule, and a reasonable alternative to the proposed rule. In
this regulatory impact analysis, we analyze one baseline and one
alternative to the proposed rule. The baseline considers the
possibility that the proposed standardized option rule is not adopted
and current capital standards continue to apply.
The baseline scenario appears in this analysis in order to estimate
the effects of adopting the proposed rule relative to a hypothetical
regulatory regime that might exist without the Standardized Option.
Because the baseline scenario considers costs and benefits as if the
proposed rule never existed, we set the costs and benefits of the
baseline scenario to zero. Obviously, banking organizations face
compliance costs and reap the benefits of a well-capitalized banking
system even under the baseline. However, because we cannot quantify
these costs and benefits, we normalize the baseline costs and benefits
to zero and estimate the costs and benefits of the proposed rule and
alternative as deviations from this zero baseline.
1. Baseline Scenario: Current capital standards based on the 1988
Basel Accord continue to apply.
Description of Baseline Scenario
Under the Baseline Scenario, current capital rules would continue
to apply to all banking organizations in the United States that are not
subject to the U.S. implementation of the advanced approaches. Under
this scenario, the United States would not adopt the proposed
standardized option, but the implementation of the advanced approaches
final rule would continue.
Change in Benefits: Baseline Scenario
Staying with current capital rules instead of adopting the
standardized option proposal would eliminate the nine benefits of the
proposed rule listed above. Under the baseline, banking organizations
not subject to the advanced approaches would not be given the option of
voluntarily selecting the standardized option. Institutions that would
have adopted the standardized option would not be able to take
advantage of the enhanced risk sensitivity of its capital charges and
the more efficient use of bank capital that implies.
Without the standardized option, an institution would have to
choose between the advanced approaches and the status quo. The baseline
without the standardized option would leave a level playing field for
all the non-core banks. However, the absence of an opportunity to
mitigate potential distortions in minimum required capital would likely
diminish this benefit in the eyes of an institution concerned about
potential distortions created by the implementation of the advanced
approaches.
Changes in Costs: Baseline Scenario
Continuing to use current capital rules eliminates the benefits and
the costs of adopting the proposed rule. As discussed above, under the
proposed rule we estimate that organizations would spend up to $74
million on implementation-related expenditures. Retaining current
capital rules would eliminate any costs associated with the proposed
rule, even though banking organizations would only incur those costs if
they elected to do so.
2. Alternative: Require all U.S. banking organizations not subject
to the Advanced Approaches rule to adopt the Standardized Option.
Description of Alternative
The only change between the proposed rule and the alternative is
that adoption of the proposed rule would be mandatory under the
alternative rather than voluntary. Under this alternative, the
provisions of the proposed rule would remain intact and apply to all
national banks that are not subject to the advanced approaches rule,
i.e., mandatory advanced approaches institutions and those institutions
that elect to adopt the advanced approaches framework.
Change in Benefits: Alternative
Because there are no changes to the elements of the proposed rule
under the alternative, the list of benefits remains the same. Among
these benefits, only one benefit is lost by making the proposed rule
mandatory: The benefit derived from the fact that the proposed rule is
voluntary. As for the benefits relating to the enhanced risk
sensitivity of capital charges, because adoption of the standardized
option is mandatory under the alternative, more banks will be subject
to the standardized option provisions and the aggregate level of
benefits will be higher. Because we estimate that 113 national banks
would adopt the standardized option voluntarily, the difference in the
aggregate benefit level could be considerable.
Changes in Costs: Alternative
Clearly the most significant drawback to the alternative is the
dramatically increased cost of applying a new set of capital rules to
almost all U.S. banking organizations. Under the alternative, direct
costs would increase for every U.S. banking organization that would
have elected to continue to use current capital rules under the
proposed rule. The cost estimate for the alternative is the total cost
estimate for a 100 percent adoption rate of the standardized option.
With 1,414 national banking organizations eligible for the standardized
option, we estimate that the cost to national banking organizations of
the alternative is approximately $740 million. The actual cost may be
somewhat less depending on the number of national banks that elect to
adopt the advanced approaches rule, but it is much greater than our
cost estimate of $74 million for the proposed rule.
3. Overall Comparison of Proposed Rule with Baseline and
Alternative.
The New Accord and its U.S. implementation seek to incorporate risk
measurement and risk management advances into capital requirements.
[[Page 44028]]
Risk-sensitive capital requirements are integral to ensuring an
adequate capital cushion to absorb financial losses at financial
institutions. In implementing the standardized option in the United
States, the agencies' intent is to enhance risk sensitivity while
maintaining a regulatory capital regime that is as rigorous as the
current system. Total capital requirements under the standardized
option, including capital for operational risk, will better allocate
capital in the system. A better allocation will occur regardless of
whether the minimum required capital at a particular institution is
greater or less than it would be under current capital rules.
The objective of the proposed rule is to enhance the risk
sensitivity of capital charges for institutions not subject to the
advanced approaches rule. The proposal also seeks to mitigate any
potential distortions in minimum regulatory capital requirements that
the implementation of the advanced approaches rule might create between
large and small banking organizations. Like the Advanced Approaches
rule, the anticipated benefits of the standardized option proposal are
difficult to quantify in dollar terms. Nevertheless, the OCC believes
that the proposed rule provides benefits associated with enhanced risk
sensitivity and preserves the safety and soundness of the banking
industry and the security of the Federal Deposit Insurance system. To
offset the costs of the proposed rule, its voluntary nature offers
regulatory flexibility that will allow institutions to adopt the
standardized option on a bank-by-bank basis when an institution's
anticipated benefits exceed the anticipated costs of adopting this
regulation.
The banking agencies are confident that the proposed rule could
serve to strengthen institutions electing to adopt the standardized
option while the safety and soundness of institutions electing to forgo
the standardized option and the advanced approaches rule will not
diminish. On the basis of our analysis, we believe that the benefits of
the proposed rule are sufficient to offset the costs of implementing
the proposed rule. However, with safety and soundness secure under
either capital rule, we believe it is best to make the proposed rule
voluntary in order to let each national bank decide whether it is in
that institution's best interest to adopt the standardized option. This
will help to ensure that the costs associated with implementation of
the standardized option do not rise precipitously and outweigh the
benefits. Because adoption is voluntary, the proposed rule offers an
improvement over the baseline scenario and the alternative. The
proposed rule offers an important degree of flexibility unavailable
with either the baseline or the alternative. The baseline does not give
banking organizations a way into the standardized option and the
alternative does not offer them a way out. The alternative for
mandatory adoption would compel most banking organizations to follow a
new set of capital rules and require them to undertake the time and
expense of adjusting to these new rules. The proposed rule offers a
better balance between costs and benefits than either the baseline or
the alternative. Overall, the OCC believes that the benefits of the
proposed rule justify its potential costs.
C. OTS Executive Order 12866 Determination
OTS concurs with OCC's RIA. Rather than replicate that analysis,
OTS drafted an RIA incorporating OCC's analysis by reference and adding
appropriate material reflecting unique aspects of the thrift industry.
The full text of OTS's RIA is available at the locations designated for
viewing the OTS docket, which are indicated in the ADDRESSES section
above. OTS believes that its analysis meets the requirements of
Executive Order 12866. The following discussion supplements OCC's
summary of its RIA.
OTS is the primary federal regulator for 826 federal- and state-
chartered savings associations with assets of $1.51 trillion as of
December 31, 2007. OTS-regulated savings association assets are highly
concentrated in residential mortgage-related assets, with approximately
67 percent of total assets in residential mortgage-related assets. By
contrast, OCC-regulated institutions tend to concentrate their assets
in commercial loans, non-interest earning deposits, and other kinds of
non-mortgage loans, with only 35 percent of total assets in residential
mortgage-related assets. Accordingly, OTS's analysis focuses on the
impact on proposed changes to the capital treatment of residential
mortgages.
Benefit-Cost Analysis
Overall, OTS believes that the benefits of the proposed rule
justify its costs. OTS notes, however, that measuring costs and
benefits of changes in minimum capital requirements pose considerable
challenges. Costs can be difficult to attribute to particular
expenditures because institutions are likely to incur some of the costs
as part of their ongoing efforts to improve risk measurement and
management systems. The measurement of benefits is more problematic
because the benefits of the NPR are more qualitative than quantitative.
Further, measurement problems exist even for those factors that
ostensibly may have measurable effects, such as a lower capital
requirement. Savings associations, particularly smaller institutions,
generally hold capital well above regulatory minimums for a variety of
reasons. Thus, the effect of reducing the regulatory capital
requirement is uncertain and likely to vary across regulated savings
associations. Nonetheless, OTS anticipates that a more risk sensitive
allocation of regulatory capital may have a slight marginal effect on
pricing and lending of adopting savings associations, but may not have
a measurable effect on pricing and lending in the market at a whole.
Under OTS's analysis, direct costs and benefits include costs and
benefits to the approximately 180 savings associations that opt in to
the proposed rule.\69\ Direct costs and benefits also include OTS's
costs of implementing the proposed rule.
---------------------------------------------------------------------------
\69\ OTS identified potential opt-in savings associations based
on asset size, asset composition, and complexity. Specifically, OTS
identified savings associations with total assets in excess of $500
million as an appropriate threshold for opting in to the new
framework. It further estimated that savings associations would opt
in to the new framework if the institution has a concentration of
first-lien mortgages equal to 30 percent (for savings associations
with total assets between $500 million and $1 billion) and 20
percent (for savings associations with assets in excess of $1
billion).
---------------------------------------------------------------------------
1. Benefits
OTS concurs with the OCC analysis identifying the benefits
associated with the proposed rule. Among the benefits cited by OCC was
the enhanced risk sensitivity of minimum regulatory capital
requirements. Because savings associations have a greater concentration
of their assets in first-lien mortgages, the most significant change
for savings associations will involve the risk weighting of residential
mortgages. Under the general risk-based capital rules, most prudently
underwritten residential mortgages with LTV ratios at origination of
less than 90 percent are risk weighed at 50 percent. Most other
residential mortgages receive a risk weight of 100 percent. Under the
proposed rule, risk-weights for residential mortgages would increase as
the LTV ratios increase. Thus, the benefits of opting in to the new
rules will be greater for savings associations to the extent that their
lending and portfolio practices include lower LTV mortgages. OTS
believes that this aspect of the proposed rule is likely to be the
[[Page 44029]]
major factor in a savings association's decision to adopt the proposed
rule.
2. Costs
OTS anticipates that the total direct costs of implementing the
proposed rule will be $143.8 million. This estimate includes direct
costs of $137.6 million for approximately 180 savings associations that
would opt in to the proposed rule.\70\ OTS further estimated that the
direct costs for OTS implementation expenses would be $6.2 million.
---------------------------------------------------------------------------
\70\ The estimated cost per institution increased with the size
of the total assets. OTS estimated that savings associations would
have implementation costs of $500,000 (for savings associations with
total assets between $500 million and $1 billion); $1 million (for
savings associations with total assets between $1 billion and $10
billion); and $5 million (for savings associations with total assets
in excess of $10 billion.
---------------------------------------------------------------------------
3. Uncertainty of Costs and Benefits
OTS concurs with the OCC discussion regarding the uncertainty of
costs and benefits. To the extent that undesirable competitive
inequities may emerge, the banking agencies have the power to respond
to them through many channels, including, but not limited to suitable
changes to capital adequacy regulation.
Analysis of Baseline and Alternatives.
The OCC analysis includes a comparison between the NPR, a baseline
scenario of what the world would look like without the NPR, and an
alternative to the NPR. The selected alternative would require all
banking organizations that are not subject to the advanced approaches
rule to apply the NPR. OTS concurs in the OCC analysis and finds
analogous results for savings associations. Specifically, OTS agrees
with the OCC conclusion that the NPR could strengthen savings
associations electing to opt in to the NPR and would not diminish the
safety and soundness of savings associations that elect to forego the
NPR or the advanced approaches.
1. Baseline Scenario
In its analysis of the baseline scenario, which would leave the
current risk-based capital rules unchanged, OCC determines that
national banks could avoid $74 million of implementation-related
expenditures that would otherwise be required by the NPR. As noted
above, OTS estimates that 180 savings associations would spend up to
$137.6 million to implement the NPR. Retaining the current capital
rules without adopting the NPR would permit these savings associations
to avoid these new expenditures.
2. Alternative Scenario
In its analysis of the alternative scenario, OCC concludes that the
aggregate benefits would considerably increase because 1,414 national
banks, rather than 113, would implement the alternative. Under the
alternative scenario, OTS estimates that the aggregate costs to savings
associations would also increase considerably. Specifically, OTS
estimates that these costs would increase from $137.6 million (for 180
savings associations) to $339.8 million (for 820 savings
associations).\71\
---------------------------------------------------------------------------
\71\ Six of the 826 savings associations could not apply the NPR
because they are subject to the advanced approaches rule.
---------------------------------------------------------------------------
D. OCC Executive Order 13132 Determination
The OCC has determined that this proposed rule does not have any
Federalism implications, as required by Executive Order 13132.
E. Paperwork Reduction Act
(1) Request for Comment on Proposed Information Collection
In accordance with the requirements of the Paperwork Reduction Act
of 1995, the agencies may not conduct or sponsor, and the respondent is
not required to respond to, an information collection unless it
displays a currently valid Office of Management and Budget (OMB)
control number. The agencies are requesting comment on a proposed
information collection. The agencies are also giving notice that the
proposed collection of information has been submitted to OMB for review
and approval.
Comments are invited on:
(a) Whether the collection of information is necessary for the
proper performance of the agencies' functions, including whether the
information has practical utility;
(b) The accuracy of the estimates of the burden of the information
collection, including the validity of the methodology and assumptions
used;
(c) Ways to enhance the quality, utility, and clarity of the
information to be collected;
(d) Ways to minimize the burden of the information collection on
respondents, including through the use of automated collection
techniques or other forms of information technology; and
(e) Estimates of capital or startup costs and costs of operation,
maintenance, and purchase of services to provide information.
Commenters may submit comments on aspects of this notice that may
affect reporting and disclosure requirements to the addresses listed in
the ADDRESSES section of this NPR. Paperwork burden comments directed
to the OCC should reference ``OMB Control No. 1557-NEW'' instead of the
Docket ID.
(2) Proposed Information Collection
Title of Information Collection: Risk-Based Capital Guidelines;
Standardized Risk-Based Capital Rules
Frequency of Response: event-generated and quarterly.
Affected Public:
OCC: National banks.
Board: State member banks and bank holding companies.
FDIC: Insured nonmember banks, insured state branches of foreign
banks, and certain subsidiaries of these entities.
OTS: Savings associations and certain of their subsidiaries.
Abstract: The proposed rule sets forth revisions to the agencies'
existing risk-based capital rules based on the provisions in the
Standardized Approach for credit risk and the Basic Indicator Approach
for operational risk contained in the capital adequacy framework titled
``International Convergence of Capital Measurement and Capital
Standards: A Revised Framework'' published by the Basel Committee on
Banking Supervision in June 2004.
The new information collection requirements in the proposed rule
are found in Sections 1, 37, 42, and 71. The collections of information
are necessary in order to implement the proposed standardized capital
adequacy framework.
Section 1 requires banking organizations to provide written
notification prior to using the appendix to calculate their risk-based
capital requirements (opt-in letter) or ceasing its use (opt-out
letter). It also requires written notification prior to applying the
principle of conservatism for a particular exposure. Section 37
requires a banking organization's prior written notification before it
can calculate its own collateral haircuts using its own internal
estimates. It also requires a banking organization's prior written
notification before it can estimate an exposure amount for a single-
product netting set of repo-style transactions and eligible margin
loans when recognizing the risk-mitigating effects of financial
collateral using the simple VaR methodology. The agencies believe that
the notifications in Section 37 would in most cases be included in the
opt-in letter discussed in Section 1. Section 42 requires certain
public disclosures if a banking organization provides support
[[Page 44030]]
to a securitization in excess of its contractual obligation. Section 71
requires a number of qualitative and quantitative disclosures regarding
a banking organization's risk-based capital ratios and their
components.
Estimated Burden: The burden estimates below exclude any regulatory
reporting burden associated with changes to the Consolidated Reports of
Income and Condition for banks (FFIEC 031 and FFIEC 031; OMB Nos. 7100-
0036, 3064-0052, 1557-0081), the Thrift Financial Report for thrifts
(TFR; OMB No. 1550-0023), and the Financial Statements for Bank Holding
Companies (FR Y-9; OMB No. 7100-0128). The agencies are still
considering whether to revise these information collections or to
implement a new information collection for the regulatory reporting
requirements. In either case, a separate notice would be published for
comment on the regulatory reporting requirements.
The burden associated with this collection of information may be
summarized as follows:
OCC
Number of Respondents: 113.
Estimated Burden Per Respondent: Opt-in letter and prior approvals,
3 hours; opt-out letter, 1 hour; and disclosures, 144 hours.
Total Estimated Annual Burden: 16,272 hours.
Board
Number of Respondents: 60.
Estimated Burden Per Respondent: Opt-in letter and prior approvals,
3 hours; opt-out letter, 1 hour; and disclosures, 144 hours.
Total Estimated Annual Burden: 8,880 hours.
FDIC
Number of Respondents: 61.
Estimated Burden Per Respondent: Opt-in letter and prior approvals,
3 hours; opt-out letter, 1 hour; and disclosures, 144 hours.
Total Estimated Annual Burden: 9,032 hours.
OTS
Number of Respondents: 180.
Estimated Burden Per Respondent: Opt-in letter, 0.5 hours; prior
approvals, 2.5 hours; opt-out letter, 1 hour; and disclosures, 144
hours.
Total Estimated Annual Burden: 26,120 hours.
The agencies' estimates represent an average across all respondents
and reflect variations between institutions based on their size,
complexity, and practices. Each agency is responsible for estimating
and reporting to OMB the total paperwork burden for the institutions
for which they have administrative enforcement authority. They may, but
are not required to, use the same methodology to determine their burden
estimates.
F. OCC Unfunded Mandates Reform Act of 1995 Determination
The Unfunded Mandates Reform Act of 1995 (Pub. L. 104-4) (UMRA)
requires cost-benefit and other analyses for a rule that would include
any Federal mandate that may result in the expenditure by state, local,
and tribal governments, in the aggregate, or by the private sector of
$100 million or more (adjusted annually for inflation) in any one year.
The current inflation-adjusted expenditure threshold is $119.6 million.
The requirements of the UMRA include assessing a rule's effects on
future compliance costs; particular regions or state, local, or tribal
governments; communities; segments of the private sector; productivity;
economic growth; full employment; creation of productive jobs; and the
international competitiveness of U.S. goods and services. The proposed
rule qualifies as a significant regulatory action under the UMRA
because its Federal mandates may result in the expenditure by the
private sector of $119.6 or more in any one year. As permitted by
section 202(c) of the UMRA, the required analyses have been prepared in
conjunction with the Executive Order 12866 analysis document titled
Regulatory Impact Analysis for Risk-Based Capital Guidelines; Capital
Adequacy Guidelines; Capital Maintenance: Standardized Risk-Based
Capital Rules (Basel II: Standardized Option). The analysis is
available on the Internet at http://www.occ.treas.gov/law/basel.htm
under the link of ``Regulatory Impact Analysis for Risk-Based Capital
Guidelines; Capital Adequacy Guidelines; Capital Maintenance:
Standardized Risk-Based Capital Rules (Basel II: Standardized Option),
Office of the Comptroller of the Currency, International and Economic
Affairs (2008).''
G. OTS Unfunded Mandates Reform Act of 1995 Determination
The Unfunded Mandates Reform Act of 1995 (Pub. L. 104-4) (UMRA)
requires cost-benefit and other analyses for a rule that would include
any Federal mandate that may result in the expenditure by state, local,
and tribal governments, in the aggregate, or by the private sector of
$100 million or more (adjusted annually for inflation) in any one year.
The current inflation-adjusted expenditure threshold is $119.6 million.
The requirements of the UMRA include assessing a rule's effects on
future compliance costs; particular regions or State, local, or tribal
governments; communities; segments of the private sector; productivity;
economic growth; full employment; creation of productive jobs; and the
international competitiveness of U.S. goods and services. The proposed
rule qualifies as a significant regulatory action under the UMRA
because its Federal mandates may result in the expenditure by the
private sector of $119.6 or more in any one year. As permitted by
section 202(c) of the UMRA, the required analyses have been prepared in
conjunction with the Executive Order 12866 analysis document titled
Regulatory Impact Analysis for Risk-Based Capital Standards: Capital
Adequacy Guidelines; Capital Maintenance; Domestic Capital
Modifications (Basel II: Standardized Option). The analysis is
available at the locations designated for viewing the OTS docket
indicated in the ADDRESSES section above.
H. Solicitation of Comments on Use of Plain Language
Section 722 of the GLBA required the Federal banking agencies to
use plain language in all proposed and final rules published after
January 1, 2000. The Federal banking agencies invite comment on how to
make this proposed rule easier to understand. For example:
Have we organized the material to suit your needs? If not,
how could the rule be more clearly stated?
Are the requirements in the rule clearly stated? If not,
how could the rule be more clearly stated?
Do the regulations contain technical language or jargon
that is not clear? If so, which language requires clarification?
Would a different format (grouping and order of sections,
use of headings, paragraphing) make the regulation easier to
understand? If so, what changes would make the regulation easier to
understand?
Would more, but shorter, sections be better? If so, which
sections should be changed?
What else could we do to make the regulation easier to
understand?
Text of Common Appendix (All Agencies)
The text of the agencies' common appendix appears below:
[[Page 44031]]
Appendix [--] to Part [--]--Capital Adequacy Guidelines for [Banks]:
\72\ Standardized Framework
---------------------------------------------------------------------------
\72\ For simplicity, and unless otherwise noted, this NPR uses
the term [BANK] to include banks, savings associations, and bank
holding companies. The term [agency] refers to the primary Federal
supervisor of the bank applying the rule. The term [the general
risk-based capital rules] refers to each agency's existing non-
internal ratings based capital rules. The term [the advanced
approaches risk-based capital rules] refers to each agency's
existing internal ratings based capital rules. The term [the market
risk rule] refers to the agencies' existing market risk capital
rules.
---------------------------------------------------------------------------
Part I General Provisions
Section 1 Purpose, Applicability, Election Procedures, and
Reservation of Authority
Section 2 Definitions
Section 3 Minimum Risk-Based Capital Requirements and Overall
Capital Adequacy
Section 4 Merger and Acquisition Transitional Arrangements
Part II Qualifying Capital
Section 21 Modifications to Tier 1 and Tier 2 Capital
Part III Risk-Weighted Assets for General Credit Risk
Section 31 Mechanics for Calculating Risk-Weighted Assets for
General Credit Risk
Section 32 Inferred Ratings for General Credit Risk
Section 33 General Risk Weights
Section 34 Off-Balance Sheet Exposures
Section 35 OTC Derivative Contracts
Section 36 Guarantees and Credit Derivatives: Substitution
Treatment
Section 37 Collateralized Transactions
Section 38 Unsettled Transactions
Part IV Risk-Weighted Assets for Securitization Exposures
Section 41 Operational Requirements for Securitization Exposures
Section 42 Risk-Weighted Assets for Securitization Exposures
Section 43 Ratings-Based Approach (RBA)
Section 44 Securitization Exposures That Do Not Qualify for the
RBA
Section 45 Recognition of Credit Risk Mitigants for
Securitization Exposures
Section 46 Risk-Weighted Assets for Securitizations With Early
Amortization Provisions
Part V Risk-Weighted Assets for Equity Exposures
Section 51 Introduction and Exposure Measurement
Section 52 Simple Risk-Weight Approach (SRWA)
Section 53 Equity Exposures to Investment Funds
Part VI Risk-Weighted Assets for Operational Risk
Section 61 Basic Indicator Approach
Part VII Disclosure
Section 71 Disclosure Requirements
Part I. General Provisions
Section 1. Purpose, Applicability, Election Procedures, and
Reservation of Authority
(a) Purpose. This appendix establishes:
(1) Methodologies for the calculation of risk-based capital
requirements for [BANK]s that elect to use this appendix; and
(2) Operational and public disclosure requirements for such
[BANK]s.
(b) Applicability. This appendix applies to a [BANK] that:
(1) Elects to use this appendix to calculate its risk-based
capital requirements;
(2) Must use this appendix based on a determination by the
[agency] under paragraph (c)(3) of this section;
(3) Is a subsidiary of or controls a depository institution that
uses 12 CFR part 3, appendix D; 12 CFR part 208, appendix G; 12 CFR
part 325, appendix E; or 12 CFR part 567, appendix B to calculate it
risk-based capital requirements; or
(4) Is a subsidiary of a bank holding company that uses 12 CFR
part 225, appendix H, to calculate its risk-based capital
requirements.
(c) Election procedures. (1) Opt-in procedures. (i) Except for a
[BANK] that is required under section 1(b)(1) of [the advanced
approaches risk-based capital rules] to use that capital framework
(other than a [BANK] that is exempt under section 1(b)(3) of [the
advanced approaches risk-based capital rules]), any [BANK] may elect
to use this appendix to calculate its risk-based capital
requirements.
(ii) Unless otherwise waived by the [agency], a [BANK] must
notify the [agency] of its intent to use this appendix in writing at
least 60 days before the beginning of the calendar quarter in which
it first uses this appendix. This notice must contain a list of any
affiliated depository institutions or bank holding companies, if
applicable, that seek not to apply this appendix under section
1(c)(2)(iii) of 12 CFR part 3, appendix D; 12 CFR part 208, appendix
G; 12 CFR part 225, appendix H; 12 CFR part 325, appendix E; or 12
CFR part 567, appendix B.
(2) Opt-out procedures. (i) A [BANK] that uses this appendix to
calculate its risk-based capital requirements may instead elect to
use the [the general risk-based capital rules] or [the advanced
approaches risk-based capital rules].
(ii) Unless otherwise waived by the [agency], a [BANK] must
notify the [agency] of its intent to cease the use of this appendix
in writing at least 60 days before the beginning of the calendar
quarter in which it plans to cease the use of this appendix. Such
notice must include an explanation of the [BANK]'s rationale for
ceasing the use of this appendix and a statement regarding the
appendix or rules the [BANK] plans to use to calculate its risk-
based capital requirements.
(iii) A [BANK] that otherwise would be required to apply this
appendix under paragraph (b)(3) or (b)(4) of this section may
continue to use [the general risk-based capital rules] if the
[agency] determines in writing that application of this appendix is
not appropriate in light of the [BANK]'s asset size, level of
complexity, risk profile, or scope of operations.
(3) Supervisory application of this appendix and exclusion. (i)
The [agency] may apply this appendix to any [BANK] if the [agency]
determines that application of this appendix is appropriate in light
of the [BANK]'s asset size, level of complexity, risk profile, or
scope of operations.
(ii) The [agency] may exclude a [BANK] that has opted-in under
paragraph (c)(1) of this section from using this appendix if the
[agency] determines that application of this appendix is not
appropriate in light of the [BANK]'s asset size, level of
complexity, risk profile, or scope of operations.
(d) Reservation of authority. (1) Additional capital in the
aggregate. The [agency] may require a [BANK] to hold an amount of
capital greater than otherwise required under this appendix if the
[agency] determines that the [BANK]'s risk-based capital requirement
under this appendix is not commensurate with the [BANK]'s credit,
market, operational, or other risks.
(2) Risk-weighted asset amounts. (i) If the [agency] determines
that the risk-weighted asset amount calculated under this appendix
by the [BANK] for one or more exposures is not commensurate with the
risks associated with those exposures, the [agency] may require the
[BANK] to assign a different risk-weighted asset amount to the
exposure(s) or to deduct the amount of the exposure from capital.
(ii) If the [agency] determines that the risk-weighted asset
amount for operational risk produced by the [BANK] under this
appendix is not commensurate with the operational risks of the
[BANK], the [agency] may require the [BANK] to assign a different
risk-weighted asset amount for operational risk.
(3) Other supervisory authority. Nothing in this appendix limits
the authority of the [agency] under any other provision of law or
regulation to take supervisory or enforcement action, including
action to address unsafe or unsound practices or conditions,
deficient capital levels, or violations of law.
(e) Notice and response procedures. In making a determination
under paragraph (c)(2)(iii), (c)(3), or (d) of this section, the
[agency] will apply notice and response procedures in the same
manner as the notice and response procedures in 12 CFR 3.12 (for
national banks), 12 CFR 263.202 (for bank holding companies and
state member banks), 12 CFR 325.6(c) (for state nonmember banks),
and 12 CFR 567.3(d) (for savings associations).
(f) Principle of conservatism. Notwithstanding the requirements
of this appendix, a [BANK] may choose not to apply a provision of
this appendix to one or more exposures, provided that:
(1) The [BANK] can demonstrate on an ongoing basis to the
satisfaction of the [agency] that not applying the provision would,
in all circumstances, unambiguously generate a risk-based capital
requirement for each such exposure greater than that which would
otherwise be required under this appendix;
(2) The [BANK] appropriately manages the risk of each such
exposure;
(3) The [BANK] notifies the [agency] in writing prior to
applying this principle to each such exposure; and
(4) The exposures to which the [BANK] applies this principle are
not, in the aggregate, material to the [BANK].
[[Page 44032]]
Section 2. Definitions
For the purposes of this appendix, the following definitions
apply:
Affiliate with respect to a company means any company that
controls, is controlled by, or is under common control with, the
company.
Applicable external rating. (1) With respect to an exposure,
applicable external rating means:
(i) If the exposure has a single external rating, the external
rating; and
(ii) If the exposure has multiple external ratings, the lowest
external rating.
(2) See also external rating.
Applicable inferred rating. (1) With respect to an exposure,
applicable inferred rating means:
(i) If the exposure has a single inferred rating, the inferred
rating; and
(ii) If the exposure has multiple inferred ratings, the lowest
inferred rating.
(2) See also external rating, inferred rating.
Asset-backed commercial paper (ABCP) program means a program
that primarily issues commercial paper that:
(1) Has an external rating; and
(2) Is backed by underlying exposures held in a bankruptcy-
remote securitization special purpose entity (SPE).
Asset-backed commercial paper (ABCP) program sponsor means a
[BANK] that:
(1) Establishes an ABCP program;
(2) Approves the sellers permitted to participate in an ABCP
program;
(3) Approves the exposures to be purchased by an ABCP program;
or
(4) Administers the ABCP program by monitoring the underlying
exposures, underwriting or otherwise arranging for the placement of
debt or other obligations issued by the program, compiling monthly
reports, or ensuring compliance with the program documents and with
the program's credit and investment policy.
Carrying value means, with respect to an asset, the value of the
asset on the balance sheet of the [BANK] determined in accordance
with generally accepted accounting principles (GAAP).
Clean-up call means a contractual provision that permits an
originating [BANK] or servicer to call securitization exposures
before their stated maturity or call date. (See also eligible clean-
up call.)
Commitment means any legally binding arrangement that obligates
a [BANK] to extend credit or to purchase assets.
Commodity derivative contract means a commodity-linked swap,
purchased commodity-linked option, forward commodity-linked
contract, or any other instrument linked to commodities that gives
rise to similar counterparty credit risks.
Company means a corporation, partnership, limited liability
company, business trust, special purpose entity, depository
institution, association, or similar organization.
Control. A person or company controls a company if it:
(1) Owns, controls, or holds with power to vote 25 percent or
more of a class of voting securities of the company; or
(2) Consolidates the company for financial reporting purposes.
Controlled early amortization provision means an early
amortization provision that meets all the following conditions:
(1) The originating [BANK] has appropriate policies and
procedures to ensure that it has sufficient capital and liquidity
available in the event of an early amortization;
(2) Throughout the duration of the securitization (including the
early amortization period), there is the same pro rata sharing of
interest, principal, expenses, losses, fees, recoveries, and other
cash flows from the underlying exposures based on the originating
[BANK]'s and the investors' relative shares of the underlying
exposures outstanding measured on a consistent monthly basis;
(3) The amortization period is sufficient for at least 90
percent of the total underlying exposures outstanding at the
beginning of the early amortization period to be repaid or
recognized as in default; and
(4) The schedule for repayment of investor principal is not more
rapid than would be allowed by straight-line amortization over an
18-month period.
Corporate exposure means a credit exposure to a natural person
or a company (including an industrial development bond, an exposure
to a government-sponsored entity (GSE), or an exposure to a
securities broker or dealer) that is not:
(1) An exposure to a sovereign entity, the Bank for
International Settlements, the European Central Bank, the European
Commission, the International Monetary Fund, a multilateral
development bank (MDB), a depository institution, a foreign bank, a
credit union, or a public sector entity (PSE);
(2) A regulatory retail exposure;
(3) A residential mortgage exposure;
(4) A pre-sold construction loan;
(5) A statutory multifamily mortgage;
(6) A securitization exposure; or
(7) An equity exposure.
Credit derivative means a financial contract executed under
standard industry credit derivative documentation that allows one
party (the protection purchaser) to transfer the credit risk of one
or more exposures (reference exposure) to another party (the
protection provider). (See also eligible credit derivative.)
Credit-enhancing interest-only strip (CEIO) means an on-balance
sheet asset that, in form or in substance:
(1) Represents a contractual right to receive some or all of the
interest and no more than a minimal amount of principal due on the
underlying exposures of a securitization; and
(2) Exposes the holder to credit risk directly or indirectly
associated with the underlying exposures that exceeds a pro rata
share of the holder's claim on the underlying exposures, whether
through subordination provisions or other credit-enhancement
techniques.
Credit-enhancing representations and warranties means
representations and warranties that are made or assumed in
connection with a transfer of underlying exposures (including loan
servicing assets) and that obligate a [BANK] to protect another
party from losses arising from the credit risk of the underlying
exposures. Credit-enhancing representations and warranties include
provisions to protect a party from losses resulting from the default
or nonperformance of the obligors of the underlying exposures or
from an insufficiency in the value of the collateral backing the
underlying exposures. Credit-enhancing representations and
warranties do not include:
(1) Early default clauses and similar warranties that permit the
return of, or premium refund clauses that cover, loans secured by a
first lien on one-to-four family residential property for a period
not to exceed 120 days from the date of transfer, provided that the
date of transfer is within one year of origination of the
residential mortgage exposure;
(2) Premium refund clauses that cover underlying exposures
guaranteed, in whole or in part, by the U.S. Government, a U.S.
Government Agency, or a GSE, provided that the clauses are for a
period not to exceed 120 days from the date of transfer; or
(3) Warranties that permit the return of underlying exposures in
instances of misrepresentation, fraud, or incomplete documentation.
Credit risk mitigant means collateral, a credit derivative, or a
guarantee.
Depository institution means a depository institution as defined
in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813).
Derivative contract means a financial contract whose value is
derived from the values of one or more underlying assets, reference
rates, or indices of asset values or reference rates. Derivative
contracts include interest rate derivative contracts, exchange rate
derivative contracts, equity derivative contracts, commodity
derivative contracts, credit derivative contracts, and any other
instrument that poses similar counterparty credit risks. Derivative
contracts also include unsettled securities, commodities, and
foreign exchange transactions with a contractual settlement or
delivery lag that is longer than the lesser of the market standard
for the particular instrument or five business days.
Early amortization provision means a provision in the
documentation governing a securitization that, when triggered,
causes investors in the securitization exposures to be repaid before
the original stated maturity of the securitization exposures, unless
the provision:
(1) Is triggered solely by events not directly related to the
performance of the underlying exposures or the originating [BANK]
(such as material changes in tax laws or regulations); or
(2) Leaves investors fully exposed to future draws by obligors
on the underlying exposures even after the provision is triggered.
(See also controlled early amortization provision.)
Effective notional amount means, for an eligible guarantee or
eligible credit derivative, the lesser of the contractual notional
amount of the credit risk mitigant or the exposure amount of the
hedged exposure, multiplied by the percentage coverage of the credit
risk mitigant. For example, the effective notional amount of an
eligible
[[Page 44033]]
guarantee that covers, on a pro rata basis, 40 percent of any losses
on a $100 bond would be $40.
Eligible asset-backed commercial paper (ABCP) liquidity facility
means a liquidity facility supporting ABCP, in form or in substance,
that is subject to an asset quality test at the time of draw that
precludes funding against assets that are 90 days or more past due
or in default. If the assets or exposures that an eligible ABCP
liquidity facility is required to fund against are externally rated
at the inception of the facility, the facility can be used to fund
only those assets or exposures with an applicable external rating of
at least investment grade at the time of funding. Notwithstanding
the two preceding sentences, a liquidity facility is an eligible
ABCP liquidity facility if the assets or exposures funded under the
liquidity facility that do not meet the eligibility requirements are
guaranteed by a sovereign entity with an issuer rating in one of the
three highest investment grade rating categories.
Eligible clean-up call means a clean-up call that:
(1) Is exercisable solely at the discretion of the originating
[BANK] or servicer;
(2) Is not structured to avoid allocating losses to
securitization exposures held by investors or otherwise structured
to provide credit enhancement to the securitization; and
(3)(i) For a traditional securitization, is only exercisable
when 10 percent or less of the principal amount of the underlying
exposures or securitization exposures (determined as of the
inception of the securitization) is outstanding; or
(ii) For a synthetic securitization, is only exercisable when 10
percent or less of the principal amount of the reference portfolio
of underlying exposures (determined as of the inception of the
securitization) is outstanding.
Eligible credit derivative means a credit derivative in the form
of a credit default swap, nth-to-default swap, total return swap, or
any other form of credit derivative approved by the [agency],
provided that:
(1) The contract meets the requirements of an eligible guarantee
and has been confirmed by the protection purchaser and the
protection provider;
(2) Any assignment of the contract has been confirmed by all
relevant parties;
(3) If the credit derivative is a credit default swap or nth-to-
default swap, the contract includes the following credit events:
(i) Failure to pay any amount due under the terms of the
reference exposure, subject to any applicable minimal payment
threshold that is consistent with standard market practice and with
a grace period that is closely in line with the grace period of the
reference exposure; and
(ii) Bankruptcy, insolvency, or inability of the obligor on the
reference exposure to pay its debts, or its failure or admission in
writing of its inability generally to pay its debts as they become
due, and similar events;
(4) The terms and conditions dictating the manner in which the
contract is to be settled are incorporated into the contract;
(5) If the contract allows for cash settlement, the contract
incorporates a robust valuation process to estimate loss reliably
and specifies a reasonable period for obtaining post-credit event
valuations of the reference exposure;
(6) If the contract requires the protection purchaser to
transfer an exposure to the protection provider at settlement, the
terms of at least one of the exposures that is permitted to be
transferred under the contract provide that any required consent to
transfer may not be unreasonably withheld;
(7) If the credit derivative is a credit default swap or nth-to-
default swap, the contract clearly identifies the parties
responsible for determining whether a credit event has occurred,
specifies that this determination is not the sole responsibility of
the protection provider, and gives the protection purchaser the
right to notify the protection provider of the occurrence of a
credit event; and
(8) If the credit derivative is a total return swap and the
[BANK] records net payments received on the swap as net income, the
[BANK] records offsetting deterioration in the value of the hedged
exposure (through reductions in fair value).
Eligible guarantee means a guarantee from an eligible guarantor
that:
(1) Is written;
(2) Is either unconditional, or a contingent obligation of the
United States Government or its agencies, the validity of which to
the beneficiary is dependent upon some affirmative action on the
part of the beneficiary of the guarantee or a third party (for
example, servicing requirements);
(3) Covers all or a pro rata portion of all contractual payments
of the obligor on the reference exposure;
(4) Gives the beneficiary a direct claim against the protection
provider;
(5) Is not unilaterally cancelable by the protection provider
for reasons other than the breach of the contract by the
beneficiary;
(6) Is legally enforceable against the protection provider in a
jurisdiction where the protection provider has sufficient assets
against which a judgment may be attached and enforced;
(7) Requires the protection provider to make payment to the
beneficiary on the occurrence of a default (as defined in the
guarantee) of the obligor on the reference exposure in a timely
manner without the beneficiary first having to take legal actions to
pursue the obligor for payment;
(8) Does not increase the beneficiary's cost of credit
protection on the guarantee in response to deterioration in the
credit quality of the reference exposure; and
(9) Is not provided by an affiliate of the [BANK], unless the
affiliate is an insured depository institution, foreign bank,
securities broker or dealer, or insurance company that:
(i) Does not control the [BANK]; and
(ii) Is subject to consolidated supervision and regulation
comparable to that imposed on U.S. depository institutions,
securities brokers or dealers, or insurance companies (as the case
may be).
Eligible guarantor means:
(1) A sovereign entity, the Bank for International Settlements,
the International Monetary Fund, the European Central Bank, the
European Commission, a Federal Home Loan Bank, the Federal
Agricultural Mortgage Corporation (Farmer Mac), an MDB, a depository
institution, a foreign bank, a credit union, a bank holding company
(as defined in section 2 of the Bank Holding Company Act (12 U.S.C.
1841)), or a savings and loan holding company (as defined in 12
U.S.C. 1467a) provided all or substantially all of the holding
company's activities are permissible for a financial holding company
under 12 U.S.C. 1843(k); or
(2) Any other entity (other than a SPE) if at the time the
entity issued the guarantee or credit derivative or any time
thereafter, the entity has issued and outstanding an unsecured debt
security without credit enhancement that has an applicable external
rating based on a long-term rating.
Eligible margin loan means an extension of credit where:
(1) The extension of credit is collateralized exclusively by
liquid and readily marketable debt or equity securities, gold, or
conforming residential mortgage exposures;
(2) The collateral is marked-to-market daily, and the
transaction is subject to daily margin maintenance requirements;
(3) The extension of credit is conducted under an agreement that
provides the [BANK] the right to accelerate and terminate the
extension of credit and to liquidate or set off collateral promptly
upon an event of default (including upon an event of bankruptcy,
insolvency, or similar proceeding) of the counterparty, provided
that, in any such case, any exercise of rights under the agreement
will not be stayed or avoided under applicable law in the relevant
jurisdictions; \73\ and
---------------------------------------------------------------------------
\73\ This requirement is met where all transactions under the
agreement are (i) executed under U.S. law and (ii) constitute
``securities contracts'' under section 555 of the Bankruptcy Code
(11 U.S.C. 555), qualified financial contracts under section
11(e)(8) of the Federal Deposit Insurance Act (12 U.S.C.
1821(e)(8)), or netting contracts between or among financial
institutions under sections 401-407 of the Federal Deposit Insurance
Corporation Improvement Act of 1991 (12 U.S.C. 4401-4407) or the
Federal Reserve Board's Regulation EE (12 CFR part 231).
---------------------------------------------------------------------------
(4) The [BANK] has conducted sufficient legal review to conclude
with a well-founded basis (and maintains sufficient written
documentation of that legal review) that the agreement meets the
requirements of paragraph (3) of this definition and is legal,
valid, binding, and enforceable under applicable law in the relevant
jurisdictions.
Eligible servicer cash advance facility means a servicer cash
advance facility in which:
(1) The servicer is entitled to full reimbursement of advances,
except that a servicer may be obligated to make non-reimbursable
advances for a particular underlying exposure if any such advance is
contractually limited to an insignificant amount of the outstanding
principal balance of that exposure;
(2) The servicer's right to reimbursement is senior in right of
payment to all other claims on the cash flows from the underlying
exposures of the securitization; and
(3) The servicer has no legal obligation to, and does not, make
advances to the
[[Page 44034]]
securitization if the servicer concludes the advances are unlikely
to be repaid.
Equity derivative contract means an equity-linked swap,
purchased equity-linked option, forward equity-linked contract, or
any other instrument linked to equities that gives rise to similar
counterparty credit risks.
Equity exposure means:
(1) A security or instrument (whether voting or non-voting) that
represents a direct or indirect ownership interest in, and is a
residual claim on, the assets and income of a company, unless:
(i) The issuing company is consolidated with the [BANK] under
GAAP;
(ii) The [BANK] is required to deduct the ownership interest
from tier 1 or tier 2 capital under this appendix;
(iii) The ownership interest incorporates a payment or other
similar obligation on the part of the issuing company (such as an
obligation to make periodic payments); or
(iv) The ownership interest is a securitization exposure;
(2) A security or instrument that is mandatorily convertible
into a security or instrument described in paragraph (1) of this
definition;
(3) An option or warrant that is exercisable for a security or
instrument described in paragraph (1) of this definition; or
(4) Any other security or instrument (other than a
securitization exposure) to the extent the return on the security or
instrument is based on the performance of a security or instrument
described in paragraph (1) of this definition.
Exchange rate derivative contract means a cross-currency
interest rate swap, forward foreign-exchange contract, currency
option purchased, or any other instrument linked to exchange rates
that gives rise to similar counterparty credit risks.
Exposure amount means:
(1) For the on-balance sheet component of an exposure (other
than an OTC derivative contract; a repo-style transaction or an
eligible margin loan for which the [BANK] determines the exposure
amount under paragraph (c) or (d) of section 37 of this appendix; or
a securitization exposure), exposure amount means:
(i) If the exposure is a security classified as available-for-
sale, the [BANK]'s carrying value of the exposure, less any
unrealized gains on the exposure, plus any unrealized losses on the
exposure.
(ii) If the exposure is not a security classified as available-
for-sale, the [BANK]'s carrying value of the exposure.
(2) For the off-balance sheet component of an exposure (other
than an OTC derivative contract; a repo-style transaction or an
eligible margin loan for which the [BANK] calculates the exposure
amount under paragraph (c) or (d) of section 37 of this appendix; or
a securitization exposure), exposure amount means the notional
amount of the off-balance sheet component multiplied by the
appropriate credit conversion factor (CCF) in section 34 of this
appendix.
(3) If the exposure is an OTC derivative contract, the exposure
amount determined under section 35 or 37 of this appendix.
(4) If the exposure is an eligible margin loan or repo-style
transaction for which the [BANK] calculates the exposure amount as
provided in paragraph (c) or (d) of section 37 of this appendix, the
exposure amount determined under section 37.
(5) If the exposure is a securitization exposure, the exposure
amount determined under section 42 of this appendix.
External rating means a credit rating that is assigned by a
nationally recognized statistical rating organization (NRSRO) to an
exposure, provided:
(1) The credit rating fully reflects the entire amount of credit
risk with regard to all payments owed to the holder of the exposure.
If a holder is owed principal and interest on an exposure, the
credit rating must fully reflect the credit risk associated with
timely repayment of principal and interest. If a holder is owed only
principal on an exposure, the credit rating must fully reflect only
the credit risk associated with timely repayment of principal; and
(2) The credit rating is published in an accessible form and is
or will be included in the transition matrices made publicly
available by the NRSRO that summarize the historical performance of
positions rated by the NRSRO. (See also applicable external rating,
applicable inferred rating, inferred rating, issuer rating.)
Financial collateral means collateral:
(1) In the form of:
(i) Cash on deposit with the [BANK] (including cash held for the
[BANK] by a third-party custodian or trustee);
(ii) Gold bullion;
(iii) Long-term debt securities that have an applicable external
rating of one category below investment grade or higher;
(iv) Short-term debt instruments that have an applicable
external rating of at least investment grade;
(v) Equity securities that are publicly traded;
(vi) Convertible bonds that are publicly traded;
(vii) Money market mutual fund shares and other mutual fund
shares if a price for the shares is publicly quoted daily; or
(viii) Conforming residential mortgage exposures; and
(2) In which the [BANK] has a perfected, first priority security
interest or, outside of the United States, the legal equivalent
thereof (with the exception of cash on deposit and notwithstanding
the prior security interest of any custodial agent).
Financial standby letter of credit means a letter of credit or
similar arrangement that represents an irrevocable obligation of a
[BANK] to a third-party beneficiary:
(1) To repay money borrowed by, or advanced to, or for the
account of, a second party (the account party); or
(2) To make payment on behalf of the account party, in the event
that the account party fails to fulfill its financial obligation to
the beneficiary.
First-lien residential mortgage exposure means a residential
mortgage exposure secured by a first lien or a residential mortgage
exposure secured by first and junior lien(s) where no other party
holds an intervening lien. (See also residential mortgage exposure.)
Foreign bank means a foreign bank as defined in Sec. 211.2 of
the Federal Reserve Board's Regulation K (12 CFR 211.2) other than a
depository institution. (See also depository institution.)
GAAP means generally accepted accounting principles as used in
the United States.
Gain-on-sale means an increase in the equity capital (as
reported on Schedule RC of the Consolidated Statement of Condition
and Income (Call Report), Schedule HC of the FR Y-9C Report, or
Schedule SC of the Thrift Financial Report) of a [BANK] that results
from a securitization (other than an increase in equity capital that
results from the [BANK]'s receipt of cash in connection with the
securitization). (See also securitization.)
Guarantee means a financial guarantee, letter of credit,
insurance, or other similar financial instrument (other than a
credit derivative) that allows one party (beneficiary) to transfer
the credit risk of one or more specific exposures (reference
exposure) to another party (protection provider). (See also eligible
guarantee.)
Inferred rating. (1) Securitization exposures. A securitization
exposure has an inferred rating equal to the external rating of the
securitization exposure referenced in paragraph (1)(ii) of this
definition if:
(i) The securitization exposure does not have an external
rating; and
(ii) Another securitization exposure issued by the same obligor
and secured by the same underlying exposures:
(A) Has an external rating;
(B) Is subordinated in all respects to the exposure with no
external rating;
(C) Does not benefit from any credit enhancement that is not
available to the exposure with no external rating;
(D) Has an effective remaining maturity that is equal to or
longer than that of the exposure with no external rating; and
(E) Is the most immediately subordinated exposure to the
exposure with no external rating that meets the requirements of
paragraph (1)(ii)(A) through (1)(ii)(D) of this definition.
(2) Other exposures. With respect to an exposure to a sovereign
entity, an exposure to a PSE, or a corporate exposure, inferred
rating means an inferred rating based on an issuer rating and an
inferred rating based on a specific issue as determined under
section 32 of this appendix. (See also applicable external rating,
applicable inferred rating, external rating, issuer rating.)
Interest rate derivative contract means a single-currency
interest rate swap, basis swap, forward rate agreement, purchased
interest rate option, when-issued securities, or any other
instrument linked to interest rates that gives rise to similar
counterparty credit risks.
Investing [BANK] means, with respect to a securitization, a
[BANK] that assumes the credit risk of a securitization exposure
(other than an originating [BANK] of the securitization). In a
typical synthetic securitization, the investing [BANK] sells credit
protection on a pool of underlying exposures to the originating
[BANK].
Investment fund means a company:
(1) All or substantially all of the assets of which are
financial assets; and
(2) That has no material liabilities.
[[Page 44035]]
Issuer rating means a credit rating that is assigned by an NRSRO
to an entity, provided:
(1) The credit rating reflects the entity's capacity and
willingness to satisfy all of its financial obligations; and
(2) The credit rating is published in an accessible form and is
or will be included in the transition matrices made publicly
available by the NRSRO that summarize the historical performance of
the NRSRO's ratings. (See also applicable external rating,
applicable inferred rating.)
Junior-lien residential mortgage exposure means a residential
mortgage exposure that is not a first-lien residential mortgage
exposure. (See also first-lien residential mortgage exposure,
residential mortgage exposure.)
Main index means the Standard & Poor's 500 Index, the FTSE All-
World Index, and any other index for which the [BANK] can
demonstrate to the satisfaction of the [agency] that the equities
represented in the index have comparable liquidity, depth of market,
and size of bid-ask spreads as equities in the Standard & Poor's 500
Index and FTSE All-World Index.
Multi-lateral development bank (MDB) means the International
Bank for Reconstruction and Development, the International Finance
Corporation, the Inter-American Development Bank, the Asian
Development Bank, the African Development Bank, the European Bank
for Reconstruction and Development, the European Investment Bank,
the European Investment Fund, the Nordic Investment Bank, the
Caribbean Development Bank, the Islamic Development Bank, the
Council of Europe Development Bank, and any other multilateral
lending institution or regional development bank in which the U.S.
government is a shareholder or contributing member or which the
[agency] determines poses comparable credit risk.
Nationally recognized statistical rating organization (NRSRO)
means an entity registered with the Securities and Exchange
Commission (SEC) as a nationally recognized statistical rating
organization under section 15E of the Securities Exchange Act of
1934 (15 U.S.C. 78o-7).
Netting set means a group of transactions with a single
counterparty that is subject to a qualifying master netting
agreement.
Nth-to-default credit derivative means a credit derivative that
provides credit protection only for the nth-defaulting reference
exposure in a group of reference exposures.
Operational risk means the risk of loss resulting from
inadequate or failed internal processes, people, and systems or from
external events (including legal risk but excluding strategic and
reputational risk).
Original maturity with respect to an off-balance sheet
commitment means the length of time between the date a commitment is
issued and:
(1) For a commitment that is not subject to extension or
renewal, the stated expiration date of the commitment; or
(2) For a commitment that is subject to extension or renewal,
the earliest date on which the [BANK] can, at its option,
unconditionally cancel the commitment.
Originating [BANK], with respect to a securitization, means a
[BANK] that:
(1) Directly or indirectly originated or securitized the
underlying exposures included in the securitization; or
(2) Serves as an ABCP program sponsor to the securitization.
Over-the-counter (OTC) derivative contract means a derivative
contract that is not traded on an exchange that requires the daily
receipt and payment of cash-variation margin.
Performance standby letter of credit (or performance bond) means
an irrevocable obligation of a [BANK] to pay a third-party
beneficiary when a customer (account party) fails to perform on any
contractual nonfinancial or commercial obligation. To the extent
permitted by law or regulation, performance standby letters of
credit include arrangements backing, among other things,
subcontractors' and suppliers' performance, labor and materials
contracts, and construction bids.
Pre-sold construction loan means any one-to-four family
residential pre-sold construction loan for a residence meeting the
requirements under section 618(a)(1) or (2) of the Resolution Trust
Corporation Refinancing, Restructuring, and Improvement Act of 1991
(RTCRRI Act) and under 12 CFR part 3, appendix A, section
3(a)(3)(iv) (for national banks); 12 CFR part 208, appendix A,
section III.C.3. (for state member banks); 12 CFR part 225, appendix
A, section III.C.3. (for bank holding companies); 12 CFR part 325,
appendix A, section II.C. (for state nonmember banks), and that is
not 90 days or more past due or on nonaccrual; or 12 CFR 567.1
(definition of ``qualifying residential construction loan'') (for
savings associations), and that is not on nonaccrual.
Protection amount (P) means, with respect to an exposure hedged
by an eligible guarantee or eligible credit derivative, the
effective notional amount of the guarantee or credit derivative as
reduced to reflect any currency mismatch, maturity mismatch, or lack
of restructuring coverage (as provided in section 36 of this
appendix).
Publicly traded means traded on:
(1) Any exchange registered with the SEC as a national
securities exchange under section 6 of the Securities Exchange Act
of 1934 (15 U.S.C. 78f); or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities
regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in
question, meaning that there are enough independent bona fide offers
to buy and sell so that a sales price reasonably related to the last
sales price or current bona fide competitive bid and offer
quotations can be determined promptly and a trade can be settled at
such a price within five business days.
Public sector entity (PSE) means a state, local authority, or
other governmental subdivision below the sovereign entity level.
Qualifying master netting agreement means any written, legally
enforceable bilateral netting agreement, provided that:
(1) The agreement creates a single legal obligation for all
individual transactions covered by the agreement upon an event of
default, including bankruptcy, insolvency, or similar proceeding, of
the counterparty;
(2) The agreement provides the [BANK] the right to accelerate,
terminate, and close out on a net basis all transactions under the
agreement and to liquidate or set off collateral promptly upon an
event of default, including upon an event of bankruptcy, insolvency,
or similar proceeding, of the counterparty, provided that, in any
such case, any exercise of rights under the agreement will not be
stayed or avoided under applicable law in the relevant
jurisdictions;
(3) The [BANK] has conducted sufficient legal review to conclude
with a well-founded basis (and has maintained sufficient written
documentation of that legal review) that:
(i) The agreement meets the requirements of paragraph (2) of
this definition; and
(ii) In the event of a legal challenge (including one resulting
from default or from bankruptcy, insolvency, or similar proceeding)
the relevant court and administrative authorities would find the
agreement to be legal, valid, binding, and enforceable under the law
of the relevant jurisdictions;
(4) The [BANK] establishes and maintains procedures to monitor
possible changes in relevant law and to ensure that the agreement
continues to satisfy the requirements of this definition; and
(5) The agreement does not contain a walkaway clause (that is, a
provision that permits a non-defaulting counterparty to make a lower
payment than it would make otherwise under the agreement, or no
payment at all, to a defaulter or the estate of a defaulter, even if
the defaulter or the estate of the defaulter is a net creditor under
the agreement).
Regulatory retail exposure means an exposure that meets the
following requirements:
(1) The [BANK]'s aggregate exposure to a single obligor does not
exceed $1 million;
(2) The exposure is part of a well diversified portfolio; and
(3) The exposure is not:
(i) An exposure to a sovereign entity, the Bank for
International Settlements, the European Central Bank, the European
Commission, the International Monetary Fund, an MDB, a depository
institution, a foreign bank, a credit union, or a PSE;
(ii) An acquisition, development, and construction loan;
(iii) A residential mortgage exposure;
(iv) A pre-sold construction loan;
(v) A statutory multifamily mortgage;
(vi) A securitization exposure;
(vii) An equity exposure; or
(viii) A debt security.
Repo-style transaction means a repurchase or reverse repurchase
transaction, or a securities borrowing or securities lending
transaction, including a transaction in which the [BANK] acts as
agent for a customer and indemnifies the customer against loss,
provided that:
(1) The transaction is based solely on liquid and readily
marketable securities, cash, gold, or conforming residential
mortgage exposures;
(2) The transaction is marked-to-market daily and subject to
daily margin maintenance requirements;
[[Page 44036]]
(3)(i) The transaction is a ``securities contract'' or
``repurchase agreement'' under section 555 or 559, respectively, of
the Bankruptcy Code (11 U.S.C. 555 or 559), a qualified financial
contract under section 11(e)(8) of the Federal Deposit Insurance Act
(12 U.S.C. 1821(e)(8)), or a netting contract between or among
financial institutions under sections 401-407 of the Federal Deposit
Insurance Corporation Improvement Act of 1991 (12 U.S.C. 4401-4407)
or the Federal Reserve Board's Regulation EE (12 CFR part 231); or
(ii) If the transaction does not meet the criteria in paragraph
(3)(i) of this definition, then either:
(A) The transaction is executed under an agreement that provides
the [BANK] the right to accelerate, terminate, and close out the
transaction on a net basis and to liquidate or set off collateral
promptly upon an event of default (including upon an event of
bankruptcy, insolvency, or similar proceeding) of the counterparty,
provided that, in any such case, any exercise of rights under the
agreement will not be stayed or avoided under applicable law in the
relevant jurisdictions; or
(B) The transaction is:
(I) Either overnight or unconditionally cancelable at any time
by the [BANK]; and
(II) Executed under an agreement that provides the [BANK] the
right to accelerate, terminate, and close out the transaction on a
net basis and to liquidate or set off collateral promptly upon an
event of counterparty default; and
(4) The [BANK] has conducted sufficient legal review to conclude
with a well-founded basis (and maintains sufficient written
documentation of that legal review) that the agreement meets the
requirements of paragraph (3) of this definition and is legal,
valid, binding, and enforceable under applicable law in the relevant
jurisdictions.
Residential mortgage exposure means an exposure (other than a
pre-sold construction loan) that is primarily secured by one-to-four
family residential property. (See also first-lien residential
mortgage exposure, junior-lien residential mortgage exposure.)
Securities and Exchange Commission (SEC) means the U.S.
Securities and Exchange Commission.
Securitization means a traditional securitization or a synthetic
securitization.
Securitization exposure means an on-balance sheet or off-balance
sheet credit exposure that arises from a traditional or synthetic
securitization (including credit-enhancing representations and
warranties). (See also synthetic securitization, traditional
securitization.)
Securitization special purpose entity (securitization SPE) means
a corporation, trust, or other entity organized for the specific
purpose of holding underlying exposures of a securitization, the
activities of which are limited to those appropriate to accomplish
this purpose, and the structure of which is intended to isolate the
underlying exposures held by the entity from the credit risk of the
seller of the underlying exposures to the entity.
Servicer cash advance facility means a facility under which the
servicer of the underlying exposures of a securitization may advance
cash to ensure an uninterrupted flow of payments to investors in the
securitization, including advances made to cover foreclosure costs
or other expenses to facilitate the timely collection of the
underlying exposures. (See also eligible servicer cash advance
facility.)
Sovereign entity means a central government (including the U.S.
Government) or an agency, department, ministry, or central bank of a
central government.
Sovereign of incorporation means the country where an entity is
incorporated, chartered, or similarly established.
Statutory multifamily mortgage means any multifamily residential
mortgage that:
(1) Meets the requirements under section 618(b)(1) of the RTCRRI
Act, and under 12 CFR part 3, appendix A, section 3(a)(3)(v) (for
national banks); 12 CFR part 208, appendix A, section III.C.3. (for
state member banks); 12 CFR part 225, appendix A, section III.C.3.
(for bank holding companies); 12 CFR part 325, appendix A, section
II.C. (for state nonmember banks); or 12 CFR 567.1 (definition of
``qualifying multifamily mortgage loan'') and 12 CFR
567.6(a)(1)(iii) (for savings associations); and
(2) Is not on nonaccrual.
Subsidiary means, with respect to a company, a company
controlled by that company.
Synthetic securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more
underlying exposures is transferred to one or more third parties
through the use of one or more credit derivatives or guarantees
(other than a guarantee that transfers only the credit risk of an
individual retail exposure);
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different
levels of seniority;
(3) Performance of the securitization exposures depends upon the
performance of the underlying exposures; and
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities).
Tier 1 capital has the same meaning as in [the general risk-
based capital rules], except as modified in part II of this
appendix.
Tier 2 capital has the same meaning as in [the general risk-
based capital rules], except as modified in part II of this
appendix.
Total qualifying capital means the sum of tier 1 capital and
tier 2 capital, after all deductions required in this appendix.
Total risk-weighted assets means the sum of a [BANK]'s:
(1) Total risk-weighted assets for general credit risk as
calculated under section 31 of this appendix;
(2) Total risk-weighted assets for unsettled transactions as
calculated under paragraph (f) of section 38 of this appendix;
(3) Total risk-weighted assets for securitization exposures as
calculated under paragraph (b) of section 42 of this appendix;
(4) Total risk-weighted assets for equity exposures as
calculated under paragraph (a) of section 52 of this appendix; and
(5) Risk-weighted assets for operational risk as calculated
under section 61 of this appendix.
Traditional securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more
underlying exposures is transferred to one or more third parties
other than through the use of credit derivatives or guarantees.
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different
levels of seniority.
(3) Performance of the securitization exposures depends upon the
performance of the underlying exposures.
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities).
(5) The underlying exposures are not owned by an operating
company.
(6) The underlying exposures are not owned by a small business
investment company described in section 302 of the Small Business
Investment Act of 1958 (15 U.S.C. 682).
(7)(i) For banks and bank holding companies, the underlying
exposures are not owned by a firm an investment in which qualifies
as a community development investment under 12 U.S.C. 24 (Eleventh);
or
(ii) For savings associations, the underlying exposures are not
owned by a firm an investment in which is designed primarily to
promote community welfare, including the welfare of low- and
moderate-income communities or families, such as by providing
services or employment.
(8) The [agency] may determine that a transaction in which the
underlying exposures are owned by an investment firm that exercises
substantially unfettered control over the size and composition of
its assets, liabilities, and off-balance sheet exposures is not a
traditional securitization based on the transaction's leverage, risk
profile, or economic substance.
(9) The [agency] may deem a transaction that meets the
definition of a traditional securitization, notwithstanding
paragraph (5), (6), or (7) of this definition, to be a traditional
securitization based on the transaction's leverage, risk profile, or
economic substance.
Unconditionally cancelable means with respect to a commitment
that a [BANK] may, at any time, with or without cause, refuse to
extend credit under the facility (to the extent permitted under
applicable law).
Underlying exposures means one or more exposures that have been
securitized in a securitization transaction.
Value-at-Risk (VaR) means the estimate of the maximum amount
that the value of one or more exposures could decline due to market
price or rate movements during a fixed holding period within a
stated confidence interval.
[[Page 44037]]
Section 3. Minimum Risk-Based Capital Requirements and Overall
Capital Adequacy
(a) Except as modified by paragraph (c) of this section, each
[BANK] must meet a minimum ratio of:
(1) Total qualifying capital to total risk-weighted assets of
8.0 percent; and
(2) Tier 1 capital to total risk-weighted assets of 4.0 percent.
(b) Each [BANK] must hold capital commensurate with the level
and nature of all risks to which the [BANK] is exposed.
(c) When a [BANK] subject to [the market risk rule] calculates
its risk-based capital requirements under this appendix, the [BANK]
must also refer to [the market risk rule] for supplemental rules to
calculate risk-based capital requirements adjusted for market risk.
(d) A [BANK] must have a rigorous process for assessing its
overall capital adequacy in relation to its risk profile and a
comprehensive strategy for maintaining an appropriate level of
capital.
Section 4. Merger and Acquisition Transitional Arrangements
(a) Mergers and acquisitions of companies that use the general
risk-based capital rules. If a [BANK] that uses this appendix merges
with or acquires a company that uses the general risk-based capital
rules (12 CFR part 3, appendix A; 12 CFR part 208, appendix A; 12
CFR part 225, appendix A; 12 CFR part 325, appendix A; or 12 CFR
part 567, subpart B), the [BANK] may use the general risk-based
capital rules to calculate the risk-weighted asset amounts for, and
the deductions from capital associated with, the merged or acquired
company's exposures for up to 12 months after the last day of the
calendar quarter during which the merger or acquisition consummates.
The risk-weighted assets of the merged or acquired company
calculated under the general risk-based capital rules are included
in the [BANK]'s total risk-weighted assets. Deductions associated
with the exposures of the merged or acquired company are deducted
from the [BANK]'s tier 1 capital and tier 2 capital. If a [BANK]
relies on this paragraph, the [BANK] separately must disclose
publicly the amounts of risk-weighted assets and total qualifying
capital calculated under this appendix for the acquiring [BANK] and
under the general risk-based capital rules for the acquired company.
(b) Mergers and acquisitions of companies that use the
standardized risk-based capital rules. If a [BANK] that uses this
appendix merges with or acquires a company that uses different
aspects of the standardized risk-based capital rules (12 CFR part 3,
appendix D; 12 CFR part 208, appendix G; 12 CFR part 225, appendix
H; 12 CFR part 325, appendix E; or 12 CFR part 567, appendix B), the
[BANK] may continue to use the merged or acquired company's systems
to determine the risk-weighted asset amounts for, and deductions
from capital associated with, the merged or acquired company's
exposures for up to 12 months after the last day of the calendar
quarter during which the merger or acquisition consummates. The
risk-weighted assets of the merged or acquired company are included
in the [BANK]'s total risk-weighted assets. Deductions associated
with the exposures of the merged or acquired company are deducted
from the [BANK]'s tier 1 capital and tier 2 capital. If a [BANK]
relies on this paragraph, the [BANK] separately must disclose
publicly the amounts of risk-weighted assets and total qualifying
capital for the acquiring [BANK] and for the merged or acquired
company under the standardized risk-based capital rules.
(c) Mergers and acquisitions of companies that use the advanced
approaches risk-based capital rules. If a [BANK] that uses this
appendix merges with or acquires a company that uses the advanced
approaches risk-based capital rules (12 CFR part 3, appendix C; 12
CFR part 208, appendix F; 12 CFR part 225, appendix G; 12 CFR part
325, appendix D; or 12 CFR part 567, appendix C), the [BANK] may use
the advanced approaches risk-based capital rules to determine the
risk-weighted asset amounts for, and deductions from capital
associated with, the merged or acquired company's exposures for up
to 12 months after the last day of the calendar quarter during which
the merger or acquisition consummates. During the period when the
advanced approaches risk-based capital rules apply to the merged or
acquired company, any ALLL associated with the merged or acquired
company's exposures must be excluded from the [BANK]'s tier 2
capital. Any excess eligible credit reserves associated with the
merged or acquired company's exposures may be included in the
acquiring [BANK]'s tier 2 capital up to 0.6 percent of the acquired
company's risk-weighted assets. (Excess eligible credit reserves
must be determined according to paragraph (a)(2) of section 13 of
the advanced approaches risk-based capital rules.) If a [BANK]
relies on this paragraph, the [BANK] separately must disclose
publicly the amounts of risk-weighted assets and qualifying capital
calculated under this appendix for the acquiring [BANK] and under
the advanced approaches risk-based capital rules for the acquired
company.
Part II. Qualifying Capital
Section 21. Modifications to Tier 1 and Tier 2 Capital
(a) Modifications to tier 1 and tier 2 capital. A [BANK] that
uses this appendix must make the same deductions from its tier 1
capital and tier 2 capital required in [the general risk-based
capital rules], except that:
(1) A [BANK] is not required to make the deductions from capital
for CEIOs in 12 CFR part 3, appendix A, section 2(c)(1)(iv) (for
national banks); 12 CFR part 208, appendix A, section II.B.1.e. (for
state member banks); 12 CFR part 225, appendix A, section II.B.1.e.
(for bank holding companies); 12 CFR part 325, appendix A, section
II.B.5. (for state nonmember banks); and 12 CFR 567.5(a)(2)(iii) and
567.12(e) (for savings associations);
(2)(i) A bank or bank holding company is not required to make
the deductions from capital for nonfinancial equity investments in
12 CFR part 3, appendix A, section 2(c)(1)(v) (for national banks);
12 CFR part 208, appendix A, section II.B.5. (for state member
banks); 12 CFR part 225, appendix A, section II.B.5. (for bank
holding companies); and 12 CFR part 325, appendix A, section II.B.
(for state nonmember banks);
(ii) A savings association is not required to deduct investments
in equity securities from capital under 12 CFR 567.5(c)(2)(ii).
However, it must continue to deduct equity investments in real
estate under that section. See 12 CFR 567.1, which defines equity
investments, including equity securities and equity investments in
real estate; and
(3) A [BANK] must make the additional deductions from capital
required by paragraphs (b) and (c) of this section.
(b) Deductions from tier 1 capital. In accordance with paragraph
(a) of section 41 and paragraph (a)(1) of section 42, a [BANK] must
deduct any after-tax gain-on-sale resulting from a securitization
from tier 1 capital.
(c) Deductions from tier 1 and tier 2 capital. A [BANK] must
deduct the exposures specified in paragraphs (c)(1) through (c)(3)
in this section 50 percent from tier 1 capital and 50 percent from
tier 2 capital. If the amount deductible from tier 2 capital exceeds
the [BANK]'s actual tier 2 capital, however, the [BANK] must deduct
the excess amount from tier 1 capital.
(1) Credit-enhancing interest-only strips (CEIOs). In accordance
with paragraphs (a)(1) and (c) of section 42, any CEIO that does not
constitute after-tax gain-on-sale.
(2) Certain securitization exposures. In accordance with
paragraphs (a)(3) and (c) of section 42 and sections 43 and 44,
certain securitization exposures that are required to be deducted
from capital.
(3) Certain unsettled transactions. In accordance with paragraph
(e)(3) of section 38, the [BANK]'s exposure on certain unsettled
transactions.
Part III. Risk-Weighted Assets for General Credit Risk
Section 31. Mechanics for Calculating Risk-Weighted Assets for
General Credit Risk
A [BANK] must risk weight its assets and exposures as follows:
(a) A [BANK] must determine the exposure amount of each on-
balance sheet asset, each OTC derivative contract, and each off-
balance sheet commitment, trade and transaction-related contingency,
guarantee, repurchase agreement, securities lending and borrowing
transaction, financial standby letter of credit, forward agreement,
or other similar transaction that is not:
(1) An unsettled transaction subject to section 38;
(2) A securitization exposure; or
(3) An equity exposure (other than an equity derivative
contract).
(b) A [BANK] must multiply each exposure amount identified under
paragraph (a) of this section by the risk weight appropriate to the
exposure based on the obligor or exposure type, eligible guarantor,
or financial collateral to determine the risk-weighted asset amount
for each exposure.
(c) Total risk-weighted assets for general credit risk equals
the sum of the risk-weighted asset amounts calculated under
paragraph (b) of this section.
[[Page 44038]]
Section 32. Inferred Ratings for General Credit Risk
(a) General. This section describes two kinds of inferred
ratings, an inferred rating based on an issuer rating and an
inferred rating based on a specific issue. This section applies to
an exposure to a sovereign entity, an exposure to a PSE, and a
corporate exposure, except as otherwise provided in this appendix.
(b) Inferred rating based on an issuer rating. If a senior
exposure to an obligor (that is, an exposure that ranks pari passu
with an obligor's general creditors in the event of bankruptcy,
insolvency, or other similar proceeding) has no external rating and
the obligor has one or more issuer ratings, the senior exposure has
inferred rating(s) equal to the issuer rating(s) of the obligor that
reflects the currency in which the exposure is denominated.
(c) Inferred rating based on a specific issue. (1) An exposure
with no external rating (the unrated exposure) has inferred
rating(s) based on a specific issue equal to the external rating in
paragraph (c)(1)(ii), if another exposure issued by the same obligor
and secured by the same collateral (if any):
(i) Ranks pari passu with the unrated exposure (or at the
[BANK]'s option, is subordinated in all respects to the unrated
exposure);
(ii) Has an external rating based on a long-term rating;
(iii) Does not benefit from any credit enhancement that is not
available to the unrated exposure;
(iv) Has an effective remaining maturity that is equal to or
longer than that of the unrated exposure; and
(v) Is denominated in the same currency as the unrated exposure.
This requirement does not apply where the unrated exposure is
denominated in a foreign currency that arises from a [BANK]'s
participation in a loan extended or guaranteed by an MDB against
convertibility and transfer risk. If the [BANK]'s participation is
only partially guaranteed against convertibility and transfer risk
by an MDB, the [BANK] may only use the external rating denominated
in the foreign currency for the portion of the participation that
benefits from the MDB's guarantee.
(2) An unrated exposure has inferred rating(s) equal to the
external rating(s) based on any long-term rating of low-quality
exposure(s) that are issued by the same obligor and that are senior
in all respects to the unrated exposure. For the purposes of this
paragraph, a low-quality exposure is an exposure that would receive
a risk weight of 150 percent (for an exposure to a sovereign entity
or a corporate exposure) or 100 percent or greater (for an exposure
to a PSE) under section 33.
Section 33. General Risk Weights
(a) Exposures to sovereign entities. (1) A [BANK] must assign a
risk weight to an exposure to a sovereign entity using the risk
weight that corresponds to its applicable external or applicable
inferred rating in Table 1.
(2) Notwithstanding paragraph (a)(1) of this section, a [BANK]
may assign a risk weight that is lower than the applicable risk
weight in Table 1 to an exposure to a sovereign entity if:
(i) The exposure is denominated in the sovereign entity's
currency;
(ii) The [BANK] has at least an equivalent amount of liabilities
in that currency; and
(iii) The sovereign entity allows banks under its jurisdiction
to assign the lower risk weight to the same exposures to the
sovereign entity.
Table 1.--Exposures to Sovereign Entities
------------------------------------------------------------------------
Applicable external or applicable
inferred rating of an exposure to a Example Risk weight
sovereign entity (in percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 0
Second-highest investment grade AA................. 0
rating.
Third-highest investment grade A.................. 20
rating.
Lowest investment grade rating..... BBB................ 50
One category below investment grade BB................. 100
Two categories below investment B.................. 100
grade.
Three categories or more below CCC................ 150
investment grade.
No applicable rating............... N/A................ 100
------------------------------------------------------------------------
(b) Certain supranational entities and multilateral development
banks. A [BANK] may assign a zero percent risk weight to an exposure
to the Bank for International Settlements, the European Central
Bank, the European Commission, the International Monetary Fund, or
an MDB.
(c) Exposures to depository institutions, foreign banks, and
credit unions. (1) Except as provided in paragraph (c)(2) of this
section, a [BANK] must assign a risk weight to an exposure to a
depository institution, a foreign bank, or a credit union using the
risk weight that corresponds to the lowest issuer rating of the
entity's sovereign of incorporation in Table 2.
(2) A [BANK] must assign a risk weight of at least 100 percent
to an exposure to a depository institution or a foreign bank that is
includable in the depository institution's or foreign bank's
regulatory capital and that is not subject to deduction as a
reciprocal holding pursuant to 12 CFR part 3, appendix A, section
2(c)(6)(ii) (national banks); 12 CFR part 208, appendix A, section
II.B.3 (state member banks); 12 CFR part 225, appendix A, section
II.B.3 (bank holding companies); 12 CFR part 325, appendix A,
section I.B.(4) (state nonmember banks); and 12 CFR part
567.5(c)(2)(i) (savings associations).
Table 2.--Exposures to Depository Institutions, Foreign Banks, and
Credit Unions
------------------------------------------------------------------------
Lowest issuer rating of the Risk weight
sovereign of incorporation Example (in percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 20
Second-highest investment grade AA................. 20
rating.
Third-highest investment grade A.................. 50
rating.
Lowest investment grade rating..... BBB................ 100
One category below investment grade BB................. 100
Two categories below investment B.................. 100
grade.
Three categories or more below CCC................ 150
investment grade.
No issuer rating................... N/A................ 100
------------------------------------------------------------------------
(d) Exposures to public sector entities. (1) Subject to the
limitation in paragraph (d)(2) of this section, a [BANK]:
(i) Must risk weight an exposure to a PSE with an applicable
external or applicable inferred rating based on a long-term rating
using the risk weight that corresponds to the applicable external or
applicable inferred
[[Page 44039]]
rating based on a long-term rating in Table 3.
(ii) Must assign a 50 percent risk weight to an exposure to a
PSE with no applicable external rating based on a long-term rating
and no applicable inferred rating based on a long-term rating.
(iii) May assign a lower risk weight than would otherwise apply
under Table 3 to an exposure to a foreign PSE if:
(A) The PSE's sovereign of incorporation allows banks under its
jurisdiction to assign the lower risk weight; and
(B) The risk weight is not lower than the risk weight that
corresponds to the lowest issuer rating of the PSE's sovereign of
incorporation in Table 1.
(2) A [BANK] may not assign an exposure to a PSE with no
external rating a risk weight that is lower than the risk weight
that corresponds to the lowest issuer rating of the PSE's sovereign
of incorporation in Table 1.
Table 3.--Exposures to Public Sector Entities: Long-Term Credit Rating
------------------------------------------------------------------------
Applicable external or applicable
inferred rating of an exposure to a Example Risk weight
PSE (in percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 20
Second-highest investment grade AA................. 20
rating.
Third-highest investment grade A.................. 50
rating.
Lowest investment grade rating..... BBB................ 50
One category below investment grade BB................. 100
Two categories below investment B.................. 100
grade.
Three categories or more below CCC................ 150
investment grade.
No applicable rating............... N/A................ 50
------------------------------------------------------------------------
(e) Corporate exposures. A [BANK] must use one of the following
approaches to assign risk weights to corporate exposures:
(1) 100 percent risk weight approach. A [BANK] that chooses this
approach must assign a 100 percent risk weight to all corporate
exposures.
(2) Ratings approach. (i) Subject to the limitations in
paragraph (e)(2)(ii) of this section, a [BANK] that chooses this
approach:
(A) Must assign a risk weight to a corporate exposure with an
applicable external or applicable inferred rating based on a long-
term rating using the risk weight that corresponds to the applicable
external or applicable inferred rating based on a long-term rating
in Table 4.
(B) Must assign a risk weight to a corporate exposure with an
applicable external rating based on a short-term rating using the
risk weight that corresponds to the applicable external rating based
on a short-term rating in Table 5.
(C) Must assign a 100 percent risk weight to all corporate
exposures with no external rating and no inferred rating.
(ii) Limitations. (A) A [BANK] may not assign a corporate
exposure with no external rating a risk weight that is lower than
the risk weight that corresponds to the lowest issuer rating of the
obligor's sovereign of incorporation in Table 1.
(B) If an obligor has any exposure with an external rating based
on a short-term rating that corresponds to a risk weight of 150
percent under Table 5, a [BANK] must assign a 150 percent risk
weight to a corporate exposure to that obligor with no external
rating and that ranks pari passu with or is subordinated to the
externally rated exposure.
Table 4.--Corporate Exposures: Long-Term Credit Rating
------------------------------------------------------------------------
Applicable external or applicable
inferred rating of the corporate Example Risk weight
exposure (in percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 20
Second-highest investment grade AA................. 20
rating.
Third-highest investment grade A.................. 50
rating.
Lowest investment grade rating..... BBB................ 100
One category below investment grade BB................. 100
Two categories below investment B.................. 150
grade.
Three categories or more below CCC................ 150
investment grade.
No applicable rating............... N/A................ 100
------------------------------------------------------------------------
Table 5.--Corporate Exposures: Short-Term Credit Rating
------------------------------------------------------------------------
Applicable external rating of the Risk weight
corporate exposure Example (in percent)
------------------------------------------------------------------------
Highest investment grade rating.... A-1/P-1............ 20
Second-highest investment grade A-2/P-2............ 50
rating.
Third-highest investment grade A-3/P-3............ 100
rating.
Below investment grade............. B, C and non-prime. 150
No applicable external rating...... N/A................ 100
------------------------------------------------------------------------
(f) Regulatory retail exposures. A [BANK] must assign a 75
percent risk weight to a regulatory retail exposure.
(g) Residential mortgage exposures. (1) First-lien residential
mortgage exposures. (i) A [BANK] must assign the applicable risk
weight in Table 6, using the loan-to-value ratio (LTV ratio) as
described in paragraph (g)(3) of this section, to a first-lien
residential mortgage exposure that is secured by property that is
owner-occupied or rented, is prudently underwritten, is not 90 days
or more past due, and is not on nonaccrual. A first-lien residential
mortgage exposure that has been restructured may receive a risk
weight lower than 100 percent only if the [BANK] updates the LTV
ratio at the time of restructuring as provided under paragraph
(g)(3) of this section.
(ii) If a first-lien residential mortgage exposure does not
satisfy these requirements, the [BANK] must assign a 100 percent
risk weight to the exposure if the LTV ratio is 90 percent or less,
and must assign a 150 percent risk weight if the LTV ratio is
greater than 90 percent.
[[Page 44040]]
Table 6.--Risk Weights for First-Lien Residential Mortgage Exposures
------------------------------------------------------------------------
Risk weight
Loan-to-value ratio (in percent) (in percent)
------------------------------------------------------------------------
Less than or equal to 60................................ 20
Greater than 60 and less than or equal to 80............ 35
Greater than 80 and less than or equal to 85............ 50
Greater than 85 and less than or equal to 90............ 75
Greater than 90 and less than or equal to 95............ 100
Greater than 95......................................... 150
------------------------------------------------------------------------
(2) Junior-lien residential mortgage exposures. (i) A [BANK]
must assign the applicable risk weight in Table 7, using the LTV
ratio described in paragraph (g)(3) of this section, to a junior-
lien residential mortgage exposure that is not 90 days or more past
due or on nonaccrual.
(ii) If a junior-lien residential mortgage exposure is 90 days
or more past due or on nonaccrual, a [BANK] must assign a 150
percent risk weight to the exposure.
Table 7.--Risk Weights for Junior-Lien Residential Mortgage Exposures
------------------------------------------------------------------------
Risk weight
Loan-to-value ratio (in percent) (in percent)
------------------------------------------------------------------------
Less than or equal to 60................................ 75
Greater than 60 and less than or equal to 90............ 100
Greater than 90......................................... 150
------------------------------------------------------------------------
(3) LTV ratio calculation. To determine the appropriate risk
weight for a residential mortgage exposure under this paragraph (g),
a [BANK] must calculate the LTV ratio (that is, the loan amount of
the exposure divided by the value of the property) as described in
this paragraph. A [BANK] must calculate a separate LTV ratio for the
funded and unfunded portions of a residential mortgage exposure and
must assign a risk weight to the exposure amount of each portion
according to its respective LTV ratio.
(i) Loan amount for calculating the LTV ratio of the funded
portion of a residential mortgage exposure.
(A) First-lien residential mortgage exposure. The loan amount of
the funded portion of a first-lien residential mortgage exposure is
the principal amount of the exposure.
(B) Junior-lien residential mortgage exposure. The loan amount
of the funded portion of a junior-lien residential mortgage exposure
is the principal amount of the exposure plus the principal amounts
of all senior exposures secured by the same residential property on
the date of origination of the junior-lien residential mortgage
exposure plus the unfunded portion of the maximum contractual amount
of any senior exposure(s) secured by the same residential property.
(ii) Loan amount for calculating the LTV ratio of the unfunded
portion of a residential mortgage exposure. The loan amount of the
unfunded portion of a residential mortgage exposure is:
(A) The amount calculated under paragraph (g)(3)(i) of this
section; plus
(B) The unfunded portion of the maximum contractual amount of
the exposure.
(iii) PMI. A [BANK] may reduce the loan amount in the LTV ratio
up to the amount covered by loan-level private mortgage insurance
(PMI). The loan-level PMI must protect the [BANK] in the event of
borrower default up to a predetermined amount of the residential
mortgage exposure, and may not have a pool-level cap that would
effectively reduce coverage below the predetermined amount of the
exposure. Loan-level PMI must be provided by a regulated mortgage
insurance company that is not an affiliate of the [BANK], and that:
(A) Has issued long-term senior debt (without credit
enhancement) that has an external rating that is in at least the
third-highest investment grade rating category; or
(B) Has a claims-paying rating that is in at least the third-
highest investment grade rating category.
(iv) Value. (A) The value of the property is the lesser of the
actual acquisition cost (for a purchase transaction) or the estimate
of the property's value at the origination of the loan or, at the
[BANK]'s option, at the time of restructuring.
(B) A [BANK] must base all estimates of a property's value on an
appraisal or evaluation of the property that satisfies subpart C of
12 CFR part 34 (national banks); subpart E of 12 CFR part 208 (state
member banks); 12 CFR part 323 (state nonmember banks); and 12 CFR
part 564 (savings associations).
(h) Pre-sold residential construction loans. A [BANK] must
assign a 50 percent risk weight to a pre-sold construction loan
unless the purchase contract is cancelled. A [BANK] must assign a
100 percent risk weight to such loan if the purchase contract is
cancelled.
(i) Statutory multifamily mortgages. A [BANK] must assign a 50
percent risk weight to a statutory multifamily mortgage.
(j) Past due exposures. Except for a residential mortgage
exposure, if an exposure is 90 days or more past due or on
nonaccrual:
(1) A [BANK] must assign a 150 percent risk weight to the
portion of the exposure that does not have a guarantee or that is
unsecured.
(2) A [BANK] may assign a risk weight to the collateralized
portion of the exposure based on the risk weight of the collateral
under this section if the collateral meets the requirements of
paragraph (b)(1) of section 37 of this appendix.
(3) A [BANK] may assign a risk weight to the guaranteed portion
of the exposure based on the risk weight that would apply under
section 36 of this appendix if the guarantee or credit derivative
meets the requirements of that section.
(k) Other assets. (1) A [BANK] may assign a zero percent risk
weight to cash owned and held in all offices of the [BANK] or in
transit; to gold bullion held in the [BANK]'s own vaults or held in
another depository institution's vaults on an allocated basis, to
the extent the gold bullion assets are offset by gold bullion
liabilities; and to derivative contracts that are publicly traded on
an exchange that requires the daily receipt and payment of cash-
variation margin.
(2) A [BANK] may assign a 20 percent risk weight to cash items
in the process of collection.
(3) A [BANK] must apply a 100 percent risk weight to all assets
not specifically assigned a different risk weight under this
appendix (other than exposures that are deducted from tier 1 or tier
2 capital).
Section 34. Off-Balance Sheet Exposures
(a) General. (1) A [BANK] must calculate the exposure amount of
an off-balance sheet exposure using the credit conversion factors
(CCFs) in paragraph (b) of this section.
(2) Where a [BANK] commits to provide a commitment, the [BANK]
may apply the lower of the two applicable CCFs.
(3) Where a [BANK] provides a commitment structured as a
syndication or participation, the [BANK] is only required to
calculate the exposure amount for its pro rata share of the
commitment.
(b) Credit conversion factors. (1) Zero percent CCF. A [BANK]
must apply a zero percent CCF to the unused portion of commitments
that are unconditionally cancelable.
(2) 20 percent CCF. A [BANK] must apply a 20 percent CCF to the
following off-balance-sheet exposures:
(i) Commitments with an original maturity of one year or less
that are not unconditionally cancelable.
(ii) Self-liquidating, trade-related contingent items that arise
from the movement of goods, with an original maturity of one year or
less.
(3) 50 percent CCF. A [BANK] must apply a 50 percent CCF to the
following off-balance-sheet exposures:
(i) Commitments with an original maturity of more than one year
that are not unconditionally cancelable by the [BANK].
(ii) Transaction-related contingent items, including performance
bonds, bid bonds, warranties, and performance standby letters of
credit.
(4) 100 percent CCF. A [BANK] must apply a 100 percent CCF to
the following off-balance-sheet items and other similar
transactions:
(i) Guarantees;
(ii) Repurchase agreements (the off-balance sheet component of
which equals the sum of the current market values of all positions
the [BANK] has sold subject to repurchase);
(iii) Off-balance sheet securities lending transactions (the
off-balance sheet component of which equals the sum of the current
market values of all positions the [BANK] has lent under the
transaction);
(iv) Off-balance sheet securities borrowing transactions (the
off-balance sheet component of which equals the sum of the current
market values of all non-cash positions the [BANK] has posted as
collateral under the transaction);
(v) Financial standby letters of credit; and
(vi) Forward agreements. Forward agreements are legally binding
contractual
[[Page 44041]]
obligations to purchase assets with certain drawdown at a specified
future date. Such obligations do not include commitments to make
residential mortgage loans or forward foreign exchange contracts.
Section 35. OTC Derivative Contracts
A [BANK] must calculate the exposure amount of an OTC derivative
contract under this section.
(a) A [BANK] must determine the exposure amount for an OTC
derivative contract that is not subject to a qualifying master
netting agreement using the single OTC derivative contract
calculation in paragraph (c) of this section.
(b) A [BANK] must determine the exposure amount for multiple OTC
derivative contracts that are subject to a qualifying master netting
agreement using the multiple OTC derivative contracts calculation in
paragraph (d) of this section.
(c) Single OTC derivative contract. Except as modified by
paragraph (e) of this section, the exposure amount for a single OTC
derivative contract that is not subject to a qualifying master
netting agreement is equal to the sum of the [BANK]'s current credit
exposure and potential future credit exposure (PFE) on the
derivative contract.
(1) Current credit exposure. The current credit exposure for a
single OTC derivative contract is the greater of the mark-to-market
value of the derivative contract or zero.
(2) PFE. The PFE for a single OTC derivative contract, including
an OTC derivative contract with a negative mark-to-market value, is
calculated by multiplying the notional principal amount of the
derivative contract by the appropriate conversion factor in Table 8.
For purposes of calculating either the PFE under this paragraph or
the gross PFE under paragraph (d) of this section for exchange rate
contracts and other similar contracts in which the notional
principal amount is equivalent to the cash flows, notional principal
amount is the net receipts to each party falling due on each value
date in each currency. For any OTC derivative contract that does not
fall within one of the specified categories in Table 8, the PFE must
be calculated using the appropriate ``other'' conversion factor. A
[BANK] must use an OTC derivative contract's effective notional
principal amount (that is, its apparent or stated notional principal
amount multiplied by any multiplier in the OTC derivative contract)
rather than its apparent or stated notional principal amount in
calculating PFE. PFE of the protection provider of a credit
derivative is capped at the net present value of the amount of
unpaid premiums.
Table 8.--Conversion Factor Matrix for OTC Derivative Contracts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Credit Credit (non-
Foreign (investment- investment- Precious
Remaining maturity \2\ Interest rate exchange rate grade grade Equity metals (except Other
and gold reference reference gold)
obligor) \3\ obligor)
--------------------------------------------------------------------------------------------------------------------------------------------------------
One year or less........................ 0.00 0.01 0.05 0.10 0.06 0.07 0.10
Greater than one year and less than or 0.005 0.05 0.05 0.10 0.08 0.07 0.12
equal to five years....................
Greater than five years................. 0.015 0.075 0.05 0.10 0.10 0.08 0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ For an OTC derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the
derivative contract.
\2\ For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that
the market value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract
with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005.
\3\ A [BANK] must use the column labeled ``Credit (investment-grade reference obligor)'' for a credit derivative whose reference obligor has an
outstanding unsecured debt security that has an applicable external rating based on a long-term rating of at least investment grade without credit
enhancement. A [BANK] must use the column labeled ``Credit (non-investment grade reference obligor)'' for all other credit derivatives.
(d) Multiple OTC derivative contracts subject to a qualifying
master netting agreement. Except as modified by paragraph (e) of
this section, the exposure amount for multiple OTC derivative
contracts subject to a qualifying master netting agreement is equal
to the sum of the net current credit exposure and the adjusted sum
of the PFE for all OTC derivative contracts subject to the
qualifying master netting agreement.
(1) Net current credit exposure. The net current credit exposure
is the greater of the net sum of all positive and negative mark-to-
market values of the individual OTC derivative contracts subject to
the qualifying master netting agreement or zero.
(2) Adjusted sum of the PFE. The adjusted sum of the PFE, Anet,
is calculated as
Anet = (0.4 x Agross) + (0.6 x NGR x Agross),
Where:
(i) Agross = the gross PFE (that is, the sum of the PFE amounts (as
determined under paragraph (c)(2) of this section) for each
individual OTC derivative contract subject to the qualifying master
netting agreement); and
(ii) NGR = the net to gross ratio (that is, the ratio of the net
current credit exposure to the gross current credit exposure). In
calculating the NGR, the gross current credit exposure equals the
sum of the positive current credit exposures (as determined under
paragraph (c)(1) of this section) of all individual OTC derivative
contracts subject to the qualifying master netting agreement.
(e) Collateralized OTC derivative contracts. A [BANK] may
recognize the credit risk mitigation benefits of financial
collateral that secures an OTC derivative contract or multiple OTC
derivatives subject to a qualifying master netting agreement
(netting set) by using the simple approach in paragraph (b) of
section 37 of this appendix. Alternatively, a [BANK] may recognize
the credit risk mitigation benefits of financial collateral that
secures such a contract or netting set if the financial collateral
is marked-to-market on a daily basis and subject to a daily margin
maintenance requirement by applying a risk weight to the exposure as
if it is uncollateralized and adjusting the exposure amount
calculated under paragraph (c) or (d) of this section using the
collateral haircut approach in paragraph (c) of section 37 of this
appendix. The [BANK] must substitute the exposure amount calculated
under paragraph (c) or (d) of this section for [Sigma]E in the
equation in paragraph (c)(3) of section 37 and must use a 10-
business-day minimum holding period (TM = 10).
(f) Counterparty credit risk for credit derivatives. (1) A
[BANK] that purchases a credit derivative that is recognized under
section 36 of this appendix as a credit risk mitigant for an
exposure that is not a covered position under [the market risk rule]
is not required to compute a separate counterparty credit risk
capital requirement under section 31 of this appendix provided that
the [BANK] does so consistently for all such credit derivatives and
either includes all or excludes all such credit derivatives that are
subject to a qualifying master netting agreement from any measure
used to determine counterparty credit risk exposure to all relevant
counterparties for risk-based capital purposes.
(2) A [BANK] that is the protection provider in a credit
derivative must treat the credit derivative as an exposure to the
reference obligor and is not required to compute a counterparty
credit risk capital requirement for the credit derivative under
section 31 of this appendix provided that it does so consistently
for all such credit derivatives and either includes all or excludes
all such credit derivatives that are
[[Page 44042]]
subject to a qualifying master netting agreement from any measure
used to determine counterparty credit risk exposure to all relevant
counterparties for risk-based capital purposes (unless the [BANK] is
treating the credit derivative as a covered position under [the
market risk rule], in which case the [BANK] must compute a
supplemental counterparty credit risk capital requirement under this
section).
(g) Counterparty credit risk for equity derivatives. (1) A
[BANK] must treat an equity derivative contract as an equity
exposure and compute a risk-weighted asset amount for the equity
derivative contract under part V of this appendix (unless the [BANK]
is treating the contract as a covered position under [the market
risk rule]).
(2) In addition, the [BANK] must also calculate a risk-based
capital requirement for the counterparty credit risk of an equity
derivative contract under this part if the [BANK] is treating the
contract as a covered position under [the market risk rule].
(3) If the [BANK] risk weights the contract under the Simple
Risk-Weight Approach (SRWA) in section 52 of this appendix, a [BANK]
may choose not to hold risk-based capital against the counterparty
credit risk of the equity derivative contract, as long as it does so
for all such contracts. Where the equity derivative contracts are
subject to a qualified master netting agreement, a [BANK] using the
SRWA must either include all or exclude all of the contracts from
any measure used to determine counterparty credit risk exposure.
Section 36. Guarantees and Credit Derivatives: Substitution
Treatment
(a) Scope. (1) General. A [BANK] may recognize the credit risk
mitigation benefits of an eligible guarantee or eligible credit
derivative by substituting the risk weight associated with a
protection provider for the risk weight assigned to an exposure, as
provided under this section.
(2) This section applies to exposures for which:
(i) Credit risk is fully covered by an eligible guarantee or
eligible credit derivative; or
(ii) Credit risk is covered on a pro rata basis (that is, on a
basis in which the [BANK] and the protection provider share losses
proportionately) by an eligible guarantee or eligible credit
derivative.
(3) Exposures on which there is a tranching of credit risk
(reflecting at least two different levels of seniority) generally
are securitization exposures subject to the securitization framework
in part IV of this appendix.
(4) If multiple eligible guarantees or eligible credit
derivatives cover a single exposure described in paragraph (a)(2) of
this section, a [BANK] may treat the hedged exposure as multiple
separate exposures each covered by a single eligible guarantee or
eligible credit derivative and may calculate a separate risk-
weighted asset amount for each separate exposure as described in
paragraph (c) of this section.
(5) If a single eligible guarantee or eligible credit derivative
covers multiple hedged exposures described in paragraph (a)(2) of
this section, a [BANK] must treat each hedged exposure as covered by
a separate eligible guarantee or eligible credit derivative and must
calculate a separate risk-weighted asset amount for each exposure as
described in paragraph (c) of this section.
(6) If a [BANK] calculates the risk-weighted asset amount under
section 31 for an exposure whose applicable external or applicable
inferred rating reflects the benefits of a credit risk mitigant
provided to the exposure, the [BANK] may not use the credit risk
mitigation rules in this section to further reduce the risk-weighted
asset amount for the exposure to reflect that credit risk mitigant.
(b) Rules of recognition. (1) A [BANK] may only recognize the
credit risk mitigation benefits of eligible guarantees and eligible
credit derivatives.
(2) A [BANK] may only recognize the credit risk mitigation
benefits of an eligible credit derivative to hedge an exposure that
is different from the credit derivative's reference exposure used
for determining the derivative's cash settlement value, deliverable
obligation, or occurrence of a credit event if:
(i) The reference exposure ranks pari passu with or is
subordinated to the hedged exposure; and
(ii) The reference exposure and the hedged exposure are to the
same legal entity, and legally enforceable cross-default or cross-
acceleration clauses are in place to assure payments under the
credit derivative are triggered when the obligor fails to pay under
the terms of the hedged exposure.
(c) Substitution approach. (1) Full coverage. If an eligible
guarantee or eligible credit derivative meets the conditions in
paragraphs (a) and (b) of this section and the protection amount (P)
of the guarantee or credit derivative is greater than or equal to
the exposure amount of the hedged exposure, a [BANK] may recognize
the guarantee or credit derivative in determining the risk-weighted
asset amount for the hedged exposure by substituting the risk weight
applicable to the guarantee or credit derivative under section 33
for the risk weight assigned to the exposure. If the [BANK]
determines that full substitution under this paragraph leads to an
inappropriate degree of risk mitigation, the [BANK] may substitute a
higher risk weight than that applicable to the guarantee or credit
derivative.
(2) Partial coverage. If an eligible guarantee or eligible
credit derivative meets the conditions in paragraphs (a) and (b) of
this section and the protection amount (P) of the guarantee or
credit derivative is less than the exposure amount of the hedged
exposure, the [BANK] must treat the hedged exposure as two separate
exposures (protected and unprotected) in order to recognize the
credit risk mitigation benefit of the guarantee or credit
derivative.
(i) The [BANK] may calculate the risk-weighted asset amount for
the protected exposure under section 31 of this appendix, where the
applicable risk weight is the risk weight applicable to the
guarantee or credit derivative. If the [BANK] determines that full
substitution under this paragraph leads to an inappropriate degree
of risk mitigation, the [BANK] may use a higher risk weight than
that applicable to the guarantee or credit derivative.
(ii) The [BANK] must calculate the risk-weighted asset amount
for the unprotected exposure under section 31 of this appendix,
where the applicable risk weight is that of the hedged exposure.
(iii) The treatment in this paragraph (c)(2) is applicable when
the credit risk of an exposure is covered on a partial pro rata
basis and may be applicable when an adjustment is made to the
effective notional amount of the guarantee or credit derivative
under paragraph (d), (e), or (f) of this section.
(d) Maturity mismatch adjustment. (1) A [BANK] that recognizes
an eligible guarantee or eligible credit derivative in determining
the risk-weighted asset amount for a hedged exposure must adjust the
effective notional amount of the credit risk mitigant to reflect any
maturity mismatch between the hedged exposure and the credit risk
mitigant.
(2) A maturity mismatch occurs when the residual maturity of a
credit risk mitigant is less than that of the hedged exposure(s).
(3) The residual maturity of a hedged exposure is the longest
possible remaining time before the obligor is scheduled to fulfil
its obligation on the exposure. If a credit risk mitigant has
embedded options that may reduce its term, the [BANK] (protection
purchaser) must use the shortest possible residual maturity for the
credit risk mitigant. If a call is at the discretion of the
protection provider, the residual maturity of the credit risk
mitigant is at the first call date. If the call is at the discretion
of the [BANK] (protection purchaser), but the terms of the
arrangement at origination of the credit risk mitigant contain a
positive incentive for the [BANK] to call the transaction before
contractual maturity, the remaining time to the first call date is
the residual maturity of the credit risk mitigant. For example,
where there is a step-up in cost in conjunction with a call feature
or where the effective cost of protection increases over time even
if credit quality remains the same or improves, the residual
maturity of the credit risk mitigant will be the remaining time to
the first call.
(4) A credit risk mitigant with a maturity mismatch may be
recognized only if its original maturity is greater than or equal to
one year and its residual maturity is greater than three months.
(5) When a maturity mismatch exists, the [BANK] must apply the
following adjustment to reduce the effective notional amount of the
credit risk mitigant:
Pm = E x (t-0.25)/(T-0.25),
where:
(i) Pm = effective notional amount of the credit risk
mitigant, adjusted for maturity mismatch;
(ii) E = effective notional amount of the credit risk mitigant;
(iii) t = the lesser of T or the residual maturity of the credit
risk mitigant, expressed in years; and
(iv) T = the lesser of five or the residual maturity of the hedged
exposure, expressed in years.
(e) Adjustment for credit derivatives without restructuring as a
credit event. If a [BANK] recognizes an eligible credit
[[Page 44043]]
derivative that does not include as a credit event a restructuring
of the hedged exposure involving forgiveness or postponement of
principal, interest, or fees that results in a credit loss event
(that is, a charge-off, specific provision, or other similar debit
to the profit and loss account), the [BANK] must apply the following
adjustment to reduce the effective notional amount of the credit
derivative:
Pr = Pm x 0.60,
where:
(1) Pr = effective notional amount of the credit risk
mitigant, adjusted for lack of restructuring event (and maturity
mismatch, if applicable); and
(2) Pm = effective notional amount of the credit risk
mitigant (adjusted for maturity mismatch, if applicable).
(f) Currency mismatch adjustment. (1) If a [BANK] recognizes an
eligible guarantee or eligible credit derivative that is denominated
in a currency different from that in which the hedged exposure is
denominated, the [BANK] must apply the following formula to the
effective notional amount of the guarantee or credit derivative:
Pc = Pr x (1-HFX),
where:
(i) Pc = effective notional amount of the credit risk
mitigant, adjusted for currency mismatch (and maturity mismatch and
lack of restructuring event, if applicable);
(ii) Pr = effective notional amount of the credit risk
mitigant (adjusted for maturity mismatch and lack of restructuring
event, if applicable); and
(iii) HFX = haircut appropriate for the currency mismatch
between the credit risk mitigant and the hedged exposure.
(2) A [BANK] must set HFX equal to eight percent
unless it qualifies for the use of and uses its own internal
estimates of foreign exchange volatility based on a 10-business-day
holding period and daily marking-to-market and remargining. A [BANK]
qualifies for the use of its own internal estimates of foreign
exchange volatility if it qualifies for:
(i) The own-estimates haircuts in paragraph (c)(5) of section
37; or
(ii) The simple VaR methodology in paragraph (d) of section 37.
(3) A [BANK] must adjust HFX calculated in paragraph
(f)(2) of this section upward if the [BANK] revalues the guarantee
or credit derivative less frequently than once every 10 business
days using the following square root of time formula:
[GRAPHIC] [TIFF OMITTED] TP29JY08.003
where:
(i) TM equals the greater of 10 or the number of days
between revaluation;
(ii) TN equals the holding period used by the [BANK] to
derive HN; and
(iii) HN equals the haircut based on the holding period
TN.
Section 37. Collateralized Transactions
(a) General. (1) This section provides three approaches that a
[BANK] may use to recognize the risk-mitigating effects of financial
collateral:
(i) The simple approach. A [BANK] may use the simple approach
for any exposure.
(ii) The collateral haircut approach. A [BANK] may use the
collateral haircut approach for repo-style transactions, eligible
margin loans, collateralized OTC derivative contracts, and single-
product netting sets of such transactions.
(iii) The simple VaR methodology. A [BANK] may use the simple
VaR methodology for single-product netting sets of repo-style
transactions and eligible margin loans.
(2) A [BANK] may use any approach described in this section that
is valid for a particular type of exposure or transaction; however,
it must use the same approach for similar exposures or transactions.
(3) If a [BANK] calculates its risk-weighted asset amount under
section 31 for an exposure whose applicable external or applicable
inferred rating reflects the benefits of financial collateral to the
exposure, the [BANK] may not use the credit risk mitigation rules in
this section to further reduce the risk-weighted asset amount for
the exposure to reflect that financial collateral.
(b) The simple approach. (1) General requirements. (i) A [BANK]
may recognize the credit risk mitigation benefits of financial
collateral that secures any exposure or any collateral that secures
a repo-style transaction that is included in the [BANK]'s VaR-based
measure under [the market risk rule].
(ii) To qualify for the simple approach the collateral must meet
the following requirements:
(A) The collateral must be subject to a collateral agreement for
at least the life of the exposure;
(B) The collateral must be revalued at least every six months;
and
(C) The collateral (other than gold) and the exposure must be
denominated in the same currency.
(2) Risk weight substitution. (i) A [BANK] may risk weight the
portion of an exposure that is secured by the market value of
collateral (that meets the requirements of paragraph (b)(1) of this
section) based on the risk weight assigned to the collateral under
this appendix. For repurchase agreements, reverse repurchase
agreements, and securities lending and borrowing transactions, the
collateral is the instruments, gold, and cash the [BANK] has
borrowed, purchased subject to resale, or taken as collateral from
the counterparty under the transaction. Except as provided in
paragraph (b)(3) of this section, the risk weight assigned to the
collateralized portion of the exposure may not be less than 20
percent.
(ii) A [BANK] must risk weight the unsecured portion of the
exposure based on the risk weight assigned to the exposure under
this appendix.
(3) Exceptions to the 20 percent risk-weight floor and other
requirements. Notwithstanding paragraph (b)(2)(i) of this section:
(i) A [BANK] may assign a zero percent risk weight to an
exposure to an OTC derivative contract that is marked-to-market on a
daily basis and subject to a daily margin maintenance requirement,
to the extent the contract is collateralized by cash on deposit.
(ii) A [BANK] may assign a 10 percent risk weight to an exposure
to an OTC derivative contract that is marked-to-market on a daily
basis and subject to a daily margin maintenance requirement, to the
extent that the contract is collateralized by a sovereign security
or a PSE security that qualifies for a zero percent risk weight
under section 33 of this appendix.
(iii) A [BANK] may assign a zero percent risk weight to the
collateralized portion of an exposure where:
(A) The financial collateral is cash on deposit; or
(B) The financial collateral is a sovereign security or a PSE
security, the security qualifies for a zero percent risk weight
under section 33, and the [BANK] has discounted the market value of
the collateral by 20 percent.
(iv) If a [BANK] recognizes collateral in the form of a
conforming residential mortgage, the [BANK] must risk weight the
portion of the exposure that is secured by the conforming
residential mortgage at 50 percent.
(c) Collateral haircut approach. (1) General. A [BANK] may
recognize the credit risk mitigation benefits of financial
collateral that secures an eligible margin loan, repo-style
transaction, collateralized OTC derivative contract, or single-
product netting set of such transactions, and of any collateral that
secures a repo-style transaction that is included in the [BANK]'s
VaR-based measure under [the market risk rule] by using the
collateral haircut approach in this paragraph (c).
(2) Approaches for the calculation of collateral haircuts. There
are two ways to calculate collateral haircuts: the standard
supervisory haircuts approach and the own internal estimates for
haircuts approach. For exposures other than repo-style transactions
included in the [BANK]'s VaR-based measure under the [the market
risk rule], a [BANK] must use the standard supervisory haircut
approach with a minimum 10-business-day holding period if it chooses
to recognize in the exposure amount the benefits of collateral in
the form of a conforming residential mortgage.
(3) Exposure amount equation. Under either collateral haircut
approach, a [BANK] must determine the exposure amount for an
eligible margin loan, repo-style transaction, collateralized OTC
derivative contract, or a single-product netting set of such
transactions by setting the exposure amount equal to max 0,
[([Sigma]E-[Sigma]C) + [Sigma](Es x Hs) + [Sigma](Efx x Hfx)] ,
where:
(i)(A) For eligible margin loans and repo-style transactions,
[Sigma]E equals the value of the exposure (the sum of the current
market values of all instruments, gold, and cash the [BANK] has
lent, sold subject to repurchase, or posted as collateral to the
counterparty under the transaction (or netting set)); and
(B) For collateralized OTC derivative contracts and netting sets
thereof, [Sigma]E equals the exposure amount of the OTC derivative
contract (or netting set) calculated under paragraph (c) or (d) of
section 35 of this appendix;
[[Page 44044]]
(ii) [Sigma]C equals the value of the collateral (the sum of the
current market values of all instruments, gold and cash the [BANK]
has borrowed, purchased subject to resale, or taken as collateral
from the counterparty under the transaction (or netting set));
(iii) Es equals the absolute value of the net position in a
given instrument or in gold (where the net position in a given
instrument or in gold equals the sum of the current market values of
the instrument or gold the [BANK] has lent, sold subject to
repurchase, or posted as collateral to the counterparty minus the
sum of the current market values of that same instrument or gold the
[BANK] has borrowed, purchased subject to resale, or taken as
collateral from the counterparty);
(iv) Hs equals the market price volatility haircut appropriate
to the instrument or gold referenced in Es;
(v) Efx equals the absolute value of the net position of
instruments and cash in a currency that is different from the
settlement currency (where the net position in a given currency
equals the sum of the current market values of any instruments or
cash in the currency the [BANK] has lent, sold subject to
repurchase, or posted as collateral to the counterparty minus the
sum of the current market values of any instruments or cash in the
currency the [BANK] has borrowed, purchased subject to resale, or
taken as collateral from the counterparty); and
(vi) Hfx equals the haircut appropriate to the mismatch between
the currency referenced in Efx and the settlement currency.
(4) Standard supervisory haircuts. Under the standard
supervisory haircuts approach:
(i) A [BANK] must use the haircuts for market price volatility
(Hs) in Table 9, as adjusted in certain circumstances as provided
under in paragraph (c)(4)(iii) and (iv) of this section:
Table 9.--Standard Supervisory Market Price Volatility Haircuts \1\
----------------------------------------------------------------------------------------------------------------
Applicable external rating grade category for Residual maturity for debt Sovereign
debt securities securities entities \2\ Other issuers
----------------------------------------------------------------------------------------------------------------
Two highest investment-grade rating categories <= 1 year....................... 0.005 0.01
for long-term ratings/highest investment- > 1 year, <= 5 years............ 0.02 0.04
grade rating category for short-term ratings. > 5 years....................... 0.04 0.08
----------------------------------------------------------------------------------------------------------------
Two lowest investment-grade rating categories <= 1 year....................... 0.01 0.02
for both short- and long-term ratings. > 1 year, <= 5 years............ 0.03 0.06
> 5 years....................... 0.06 0.12
----------------------------------------------------------------------------------------------------------------
One rating category below investment grade.... All............................. 0.15 0.25
----------------------------------------------------------------------------------------------------------------
Main index equities (including convertible bonds) and gold...........0.15.......
----------------------------------------------------------------------------------------------------------------
Other publicly traded equities (including convertible bonds), conform0.25
residential mortgages, and nonfinancial collateral.
----------------------------------------------------------------------------------------------------------------
Mutual funds....................................Highest haircut applicable to any security in
which the fund can invest.
----------------------------------------------------------------------------------------------------------------
Cash on deposit with the [BANK] (including a certificate of deposit iss0ed by
the [BANK]).
----------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircuts in Table 9 are based on a 10-business-day holding period.
\2\ This column includes the haircuts for MDBs and foreign PSEs that receive a zero percent risk weight under
section 33 of this appendix.
(ii) For currency mismatches, a [BANK] must use a haircut for
foreign exchange rate volatility (Hfx) of 8.0 percent, as adjusted
in certain circumstances as provided under paragraph (c)(4)(iii) and
(iv) of this section.
(iii) For repo-style transactions, a [BANK] may multiply the
standard supervisory haircuts provided in paragraphs (c)(4)(i) and
(ii) of this section by the square root of \1/2\ (which equals
0.707107).
(iv) A [BANK] must adjust the standard supervisory haircuts
provided in paragraphs (c)(4)(i) and (ii) of this section upward on
the basis of a holding period longer than 10 business days (for
eligible margin loans and OTC derivative contracts) or five business
days (for repo-style transactions) where and as appropriate to take
into account the illiquidity of an instrument.
(5) Own internal estimates for haircuts. With the prior written
approval of the [agency], a [BANK] may calculate haircuts (Hs and
Hfx) using its own internal estimates of the volatilities of market
prices and foreign exchange rates.
(i) To receive [agency] approval to use its own internal
estimates, a [BANK] must satisfy the following minimum quantitative
standards:
(A) A [BANK] must use a 99th percentile one-tailed confidence
interval.
(B) The minimum holding period for a repo-style transaction is
five business days and for an eligible margin loan or OTC derivative
contract is 10 business days. When a [BANK] calculates an own-
estimates haircut on a TN-day holding period, which is
different from the minimum holding period for the transaction type,
the applicable haircut (HM) is calculated using the
following square root of time formula:
[GRAPHIC] [TIFF OMITTED] TP29JY08.004
where:
(1) TM equals 5 for repo-style transactions and 10 for
eligible margin loans and OTC derivative contracts;
(2) TN equals the holding period used by the [BANK] to
derive HN; and
(3) HN equals the haircut based on the holding period
TN.
(C) A [BANK] must adjust holding periods upward where and as
appropriate to take into account the illiquidity of an instrument.
(D) The historical observation period must be at least one year.
(E) A [BANK] must update its data sets and recompute haircuts no
less frequently than quarterly and must also reassess data sets and
haircuts whenever market prices change materially.
(ii) With respect to debt securities that have an applicable
external rating of investment grade, a [BANK] may calculate haircuts
for categories of securities. For a category of securities, the
[BANK] must calculate the haircut on the basis of internal
volatility estimates for securities in that category that are
representative of the securities in that category that the [BANK]
has lent, sold subject to repurchase, posted as collateral,
borrowed, purchased subject to resale, or taken as collateral. In
determining relevant categories, the [BANK] must at a minimum take
into account:
(A) The type of issuer of the security;
(B) The applicable external rating of the security;
(C) The maturity of the security; and
(D) The interest rate sensitivity of the security.
(iii) With respect to debt securities that have an applicable
external rating of below investment grade and equity securities, a
[BANK] must calculate a separate haircut for each individual
security.
(iv) Where an exposure or collateral (whether in the form of
cash or securities) is denominated in a currency that differs from
the settlement currency, the [BANK] must
[[Page 44045]]
calculate a separate currency mismatch haircut for its net position
in each mismatched currency based on estimated volatilities of
foreign exchange rates between the mismatched currency and the
settlement currency.
(v) A [BANK]'s own estimates of market price and foreign
exchange rate volatilities may not take into account the
correlations among securities and foreign exchange rates on either
the exposure or collateral side of a transaction (or netting set) or
the correlations among securities and foreign exchange rates between
the exposure and collateral sides of the transaction (or netting
set).
(d) Simple VaR methodology. (1) With the prior written approval
of the [agency], a [BANK] may estimate the exposure amount for a
single-product netting set of repo-style-transactions or eligible
margin loans using a VaR model that meets the requirements in
paragraph (d)(3) of this section. However, a [BANK] may not use the
VaR model described below to recognize in the exposure amount the
benefits of collateral in the form of a conforming residential
mortgage (other than for repo-style transactions included in the
[BANK]'s VaR-based measure under [the market risk rule]).
(2) The [BANK] must set the exposure amount equal to max
0, [([Sigma]E - [Sigma]C) + PFE] ,
where:
(i) [Sigma]E equals the value of the exposure (the sum of the
current market values of all instruments, gold, and cash the [BANK]
has lent, sold subject to repurchase, or posted as collateral to the
counterparty under the netting set);
(ii) [Sigma]C equals the value of the collateral (the sum of the
current market values of all instruments, gold, and cash the [BANK]
has borrowed, purchased subject to resale, or taken as collateral
from the counterparty under the netting set); and
(iii) PFE equals the [BANK]'s empirically based best estimate of the
99th percentile, one-tailed confidence interval for an increase in
the value of ([Sigma]E - [Sigma]C) over a five-business-day holding
period for repo-style transactions or over a 10-business-day holding
period for eligible margin loans using a minimum one-year historical
observation period of price data representing the instruments that
the [BANK] has lent, sold subject to repurchase, posted as
collateral, borrowed, purchased subject to resale, or taken as
collateral.
(3) The [BANK] must validate its VaR model, including by
establishing and maintaining a rigorous and regular backtesting
regime. For the purposes of this section, backtesting means a
comparison of a [BANK]'s internal estimates with actual outcomes
during a sample period not used in model development.
Section 38. Unsettled Transactions
(a) Definitions. For purposes of this section:
(1) Delivery-versus-payment (DvP) transaction means a securities
or commodities transaction in which the buyer is obligated to make
payment only if the seller has made delivery of the securities or
commodities and the seller is obligated to deliver the securities or
commodities only if the buyer has made payment.
(2) Payment-versus-payment (PvP) transaction means a foreign
exchange transaction in which each counterparty is obligated to make
a final transfer of one or more currencies only if the other
counterparty has made a final transfer of one or more currencies.
(3) Qualifying central counterparty means a counterparty (for
example, a clearing house) that:
(i) Facilitates trades between counterparties in one or more
financial markets by either guaranteeing trades or novating
contracts;
(ii) Requires all participants in its arrangements to be fully
collateralized on a daily basis; and
(iii) The [BANK] demonstrates to the satisfaction of the
[agency] is in sound financial condition and is subject to effective
oversight by a national supervisory authority.
(4) Normal settlement period. A transaction has a normal
settlement period if the contractual settlement period for the
transaction is equal to or less than the market standard for the
instrument underlying the transaction and equal to or less than five
business days.
(5) Positive current exposure. The positive current exposure of
a [BANK] for a transaction is the difference between the transaction
value at the agreed settlement price and the current market price of
the transaction, if the difference results in a credit exposure of
the [BANK] to the counterparty.
(b) Scope. This section applies to all transactions involving
securities, foreign exchange instruments, and commodities that have
a risk of delayed settlement or delivery. This section does not
apply to:
(1) Transactions accepted by a qualifying central counterparty
that are subject to daily marking-to-market and daily receipt and
payment of variation margin;
(2) Repo-style transactions, including unsettled repo-style
transactions;
(3) One-way cash payments on OTC derivative contracts; or
(4) Transactions with a contractual settlement period that is
longer than the normal settlement period (which are treated as OTC
derivative contracts as provided in section 35).
(c) System-wide failures. In the case of a system-wide failure
of a settlement or clearing system, the [agency] may waive risk-
based capital requirements for unsettled and failed transactions
until the situation is rectified.
(d) Delivery-versus-payment (DvP) and payment-versus-payment
(PvP) transactions. A [BANK] must hold risk-based capital against
any DvP or PvP transaction with a normal settlement period if the
[BANK]'s counterparty has not made delivery or payment within five
business days after the settlement date. The [BANK] must determine
its risk-weighted asset amount for such a transaction by multiplying
the positive current exposure of the transaction for the [BANK] by
the appropriate risk weight in Table 10.
Table 10.--Risk Weights for Unsettled DvP and PvP Transactions
------------------------------------------------------------------------
Risk weight to
be applied to
Number of business days after contractual settlement positive
date current
exposure (in
percent)
------------------------------------------------------------------------
From 5 to 15............................................ 100.0
From 16 to 30........................................... 625.0
From 31 to 45........................................... 937.5
46 or more.............................................. 1,250.0
------------------------------------------------------------------------
(e) Non-DvP/non-PvP (non-delivery-versus-payment/non-payment-
versus-payment) transactions. (1) A [BANK] must hold risk-based
capital against any non-DvP/non-PvP transaction with a normal
settlement period if the [BANK] has delivered cash, securities,
commodities, or currencies to its counterparty but has not received
its corresponding deliverables by the end of the same business day.
The [BANK] must continue to hold risk-based capital against the
transaction until the [BANK] has received its corresponding
deliverables.
(2) From the business day after the [BANK] has made its delivery
until five business days after the counterparty delivery is due, the
[BANK] must calculate the risk-weighted asset amount for the
transaction by treating the current market value of the deliverables
owed to the [BANK] as an exposure to the counterparty and using the
applicable counterparty risk weight in section 33 of this appendix.
(3) If the [BANK] has not received its deliverables by the fifth
business day after counterparty delivery was due, the [BANK] must
deduct the current market value of the deliverables owed to the
[BANK] 50 percent from tier 1 capital and 50 percent from tier 2
capital.
(f) Total risk-weighted assets for unsettled transactions. Total
risk-weighted assets for unsettled transactions is the sum of the
risk-weighted asset amounts of all DvP, PvP, and non-DvP/non-PvP
transactions.
Part IV. Risk-Weighted Assets for Securitization Exposures
Section 41. Operational Requirements for Securitization Exposures
(a) Operational criteria for traditional securitizations. A
[BANK] that transfers exposures it has originated or purchased to a
securitization SPE or other third party in connection with a
traditional securitization may exclude the exposures from the
calculation of its risk-weighted assets only if each condition in
this paragraph (a) is satisfied. A [BANK] that meets these
conditions must hold risk-based capital against any securitization
exposures it retains in connection with the securitization. A [BANK]
that fails to meet these conditions must instead hold risk-based
capital against the transferred exposures as if they had not been
securitized and must deduct from tier 1 capital any after-tax gain-
on-sale resulting from the transaction. The conditions are:
(1) The transfer is considered a sale under GAAP;
[[Page 44046]]
(2) The [BANK] has transferred to one or more third parties
credit risk associated with the underlying exposures; and
(3) Any clean-up calls relating to the securitization are
eligible clean-up calls.
(b) Operational criteria for synthetic securitizations. For
synthetic securitizations, a [BANK] may recognize for risk-based
capital purposes the use of a credit risk mitigant to hedge
underlying exposures only if each condition in this paragraph (b) is
satisfied. A [BANK] that fails to meet these conditions must instead
hold risk-based capital against the underlying exposures as if they
had not been synthetically securitized. The conditions are:
(1) The credit risk mitigant is financial collateral, an
eligible credit derivative, or an eligible guarantee;
(2) The [BANK] transfers credit risk associated with the
underlying exposures to one or more third parties, and the terms and
conditions in the credit risk mitigants employed do not include
provisions that:
(i) Allow for the termination of the credit protection due to
deterioration in the credit quality of the underlying exposures;
(ii) Require the [BANK] to alter or replace the underlying
exposures to improve the credit quality of the pool of underlying
exposures;
(iii) Increase the [BANK]'s cost of credit protection in
response to deterioration in the credit quality of the underlying
exposures;
(iv) Increase the yield payable to parties other than the [BANK]
in response to a deterioration in the credit quality of the
underlying exposures; or
(v) Provide for increases in a retained first loss position or
credit enhancement provided by the [BANK] after the inception of the
securitization;
(3) The [BANK] obtains a well-reasoned opinion from legal
counsel that confirms the enforceability of the credit risk mitigant
in all relevant jurisdictions; and
(4) Any clean-up calls relating to the securitization are
eligible clean-up calls.
Section 42. Risk-Weighted Assets for Securitization Exposures
(a) Hierarchy of approaches. Except as provided elsewhere in
this section or in section 41:
(1) A [BANK] must deduct from tier 1 capital any after-tax gain-
on-sale resulting from a securitization and must deduct from total
capital in accordance with paragraph (c) of this section the portion
of any CEIO that does not constitute after-tax gain-on-sale.
(2) If a securitization exposure does not require deduction
under paragraph (a)(1) of this section and qualifies for the
Ratings-Based Approach (RBA) in section 43 of this appendix, a
[BANK] must apply the RBA to the exposure.
(3) If a securitization exposure does not require deduction
under paragraph (a)(1) of this section and does not qualify for the
RBA, a [BANK] must apply the treatments in section 44.
(4) If a securitization exposure is an OTC derivative contract
(other than a credit derivative) that has a first priority claim on
the cash flows from the underlying exposures (notwithstanding
amounts due under interest rate or currency derivative contracts,
fees due, or other similar payments), with approval of the [agency],
a [BANK] may choose to set the risk-weighted asset amount of the
exposure equal to the amount of the exposure as determined in
paragraph (d) of this section rather than apply the hierarchy of
approaches described in paragraphs (a)(1) through (3) of this
section.
(b) Total risk-weighted assets for securitization exposures. A
[BANK]'s total risk-weighted assets for securitization exposures
equals the sum of the risk-weighted asset amount for securitization
exposures that the [BANK] risk weights under section 43, 44, or 45
of this appendix plus any risk-weighted asset amount calculated
under section 46 of this appendix, as modified by paragraphs (e)
through (k) of this section.
(c) Deductions. (1) If a [BANK] must deduct a securitization
exposure from total capital, the [BANK] must take the deduction 50
percent from tier 1 capital and 50 percent from tier 2 capital. If
the amount deductible from tier 2 capital exceeds the [BANK]'s tier
2 capital, the [BANK] must deduct the excess from tier 1 capital.
(2) A [BANK] may calculate any deduction from tier 1 capital and
tier 2 capital for a securitization exposure net of any deferred tax
liabilities associated with the securitization exposure.
(d) Exposure amount of a securitization exposure. (1) On-balance
sheet securitization exposures. The exposure amount of an on-balance
sheet securitization exposure that is not a repo-style transaction,
eligible margin loan, or OTC derivative contract (other than a
credit derivative) is:
(i) The [BANK]'s carrying value minus any unrealized gains and
plus any unrealized losses on the exposure, if the exposure is a
security classified as available-for-sale; or
(ii) The [BANK]'s carrying value, if the exposure is not a
security classified as available-for-sale.
(2) Off-balance sheet securitization exposures. (i) The exposure
amount of an off-balance sheet securitization exposure that is not a
repo-style transaction or an OTC derivative contract (other than a
credit derivative) is the notional amount of the exposure. For an
off-balance sheet securitization exposure to an ABCP program, such
as a liquidity facility, the notional amount may be reduced to the
maximum potential amount that the [BANK] could be required to fund
given the ABCP program's current underlying assets (calculated
without regard to the current credit quality of those assets).
(ii) A [BANK] must determine the exposure amount of an eligible
ABCP liquidity facility by multiplying the notional amount of the
exposure by the appropriate CCF:
(A) 20 percent, for an eligible ABCP liquidity facility with an
original maturity of one year or less that does not qualify for the
RBA.
(B) 50 percent, for an eligible ABCP liquidity facility with an
original maturity of over one year that does not qualify for the
RBA.
(C) 100 percent, for an eligible ABCP liquidity facility that
qualifies for the RBA.
(3) Repo-style transactions, eligible margin loans, and OTC
derivative contracts. The exposure amount of a securitization
exposure that is a repo-style transaction, eligible margin loan, or
OTC derivative contract (other than a credit derivative) is the
exposure amount of the transaction as calculated under section 35 or
37 of this appendix.
(e) Overlapping exposures. If a [BANK] has multiple
securitization exposures that provide duplicative coverage to the
underlying exposures of a securitization (such as when a [BANK]
provides a program-wide credit enhancement and multiple pool-
specific liquidity facilities to an ABCP program), the [BANK] is not
required to hold duplicative risk-based capital against the
overlapping position. Instead, the [BANK] may apply to the
overlapping position the applicable risk-based capital treatment
that results in the highest risk-based capital requirement.
(f) Implicit support. If a [BANK] provides support to a
securitization in excess of the [BANK]'s contractual obligation to
provide credit support to the securitization (implicit support):
(1) The [BANK] must hold regulatory capital against all of the
underlying exposures associated with the securitization as if the
exposures had not been securitized and must deduct from tier 1
capital any after-tax gain-on-sale resulting from the
securitization; and
(2) The [BANK] must disclose publicly:
(i) That it has provided implicit support to the securitization;
and
(ii) The regulatory capital impact to the [BANK] of providing
such implicit support.
(g) Undrawn portion of an eligible servicer cash advance
facility. Regardless of any other provision of this part, a [BANK]
is not required to hold risk-based capital against the undrawn
portion of an eligible servicer cash advance facility.
(h) Interest-only mortgage-backed securities. Regardless of any
other provisions of this part, the risk weight for a non-credit-
enhancing interest-only mortgage-backed security may not be less
than 100 percent.
(i) Small-business loans and leases on personal property
transferred with recourse. (1) Regardless of any other provisions of
this appendix, a [BANK] that has transferred small-business loans
and leases on personal property (small-business obligations) with
recourse must include in risk-weighted assets only the contractual
amount of retained recourse if all the following conditions are met:
(i) The transaction is a sale under GAAP.
(ii) The [BANK] establishes and maintains, pursuant to GAAP, a
non-capital reserve sufficient to meet the [BANK]'s reasonably
estimated liability under the recourse arrangement.
(iii) The loans and leases are to businesses that meet the
criteria for a small-business concern established by the Small
Business Administration under section 3(a) of the Small Business Act
(15 U.S.C. 632).
(iv) The [BANK] is well capitalized, as defined in the
[agency]'s prompt corrective action regulation--12 CFR part 6 (for
national banks); 12 CFR part 208, subpart D (for state
[[Page 44047]]
member banks or bank holding companies); 12 CFR part 325, subpart B
(for state nonmember banks); and 12 CFR part 565 (for savings
associations). For purposes of determining whether a [BANK] is well
capitalized for purposes of this paragraph, the [BANK]'s capital
ratios must be calculated without regard to the capital treatment
for transfers of small-business obligations with recourse specified
in this paragraph (i)(1).
(2) The total outstanding amount of recourse retained by a
[BANK] on transfers of small-business obligations receiving the
capital treatment specified in paragraph (i)(1) of this section
cannot exceed 15 percent of the [BANK]'s total qualifying capital.
(3) If a [BANK] ceases to be well capitalized or exceeds the 15
percent capital limitation, the capital treatment specified in
paragraph (i)(1) of this section will continue to apply to any
transfers of small-business obligations with recourse that occurred
during the time that the [BANK] was well capitalized and did not
exceed the capital limit.
(4) The risk-based capital ratios of the [BANK] must be
calculated without regard to the capital treatment for transfers of
small-business obligations with recourse specified in paragraph
(i)(1) of this section as provided in 12 CFR part 3, appendix A (for
national banks); 12 CFR part 208, appendix A (for state member
banks); 12 CFR part 225, appendix A (for bank holding companies); 12
CFR part 325, appendix A (for state nonmember banks); and 12 CFR
567.6(b)(5)(v) (for savings associations).
(j) Consolidated ABCP programs. (1) A [BANK] that qualifies as a
primary beneficiary and must consolidate an ABCP program as a
variable interest entity under GAAP may exclude the consolidated
ABCP program assets from risk-weighted assets if the [BANK] is the
sponsor of the ABCP program. If a [BANK] excludes such consolidated
ABCP program assets from risk-weighted assets, the [BANK] must hold
risk-based capital against any securitization exposures of the
[BANK] to the ABCP program in accordance with this part.
(2) If a [BANK] either is not permitted, or elects not, to
exclude consolidated ABCP program assets from its risk-weighted
assets, the [BANK] must hold risk-based capital against the
consolidated ABCP program assets in accordance with this appendix
but is not required to hold risk-based capital against any
securitization exposures of the [BANK] to the ABCP program.
(k) Nth-to-default credit derivatives. (1) First-to-default
credit derivatives. (i) Protection purchaser. A [BANK] that obtains
credit protection on a group of underlying exposures through a
first-to-default credit derivative must determine its risk-based
capital requirement for the underlying exposures as if the [BANK]
synthetically securitized the underlying exposure with the lowest
risk-based capital requirement and had obtained no credit risk
mitigant on the other underlying exposures.
(ii) Protection provider. A [BANK] that provides credit
protection on a group of underlying exposures through a first-to-
default credit derivative must determine its risk-weighted asset
amount for the derivative by applying the RBA or, if the derivative
does not qualify for the RBA, by setting its risk-weighted asset
amount for the derivative equal to the product of:
(A) The protection amount of the derivative; and
(B) The sum of the risk weights of the individual underlying
exposures, up to a maximum of 1,250 percent.
(2) Second-or-subsequent-to-default credit derivatives. (i)
Protection purchaser. (A) A [BANK] that obtains credit protection on
a group of underlying exposures through an nth-to-default credit
derivative (other than a first-to-default credit derivative) may
recognize the credit risk mitigation benefits of the derivative only
if:
(1) The [BANK] also has obtained credit protection on the same
underlying exposures in the form of first-through-(n-1)-to-default
credit derivatives; or
(2) If n-1 of the underlying exposures have already defaulted.
(B) If a [BANK] satisfies the requirements of paragraph
(k)(2)(i)(A) of this section, the [BANK] must determine its risk-
based capital requirement for the underlying exposures as if the
[BANK] had only synthetically securitized the underlying exposure
with the nth lowest risk-based capital requirement and had obtained
no credit risk mitigant on the other underlying exposures.
(ii) Protection provider. A [BANK] that provides credit
protection on a group of underlying exposures through an nth-to-
default credit derivative (other than a first-to-default credit
derivative) must determine its risk-weighted asset amount for the
derivative by applying the RBA in section 43 of this appendix (if
the derivative qualifies for the RBA) or, if the derivative does not
qualify for the RBA, by setting its risk-weighted asset amount for
the derivative equal to the product of:
(A) The protection amount of the derivative; and
(B) The sum of the risk weights of the individual underlying
exposures (excluding the n-1 underlying exposures with the lowest
risk-based capital requirement), up to a maximum of 1,250 percent.
Section 43. Ratings-Based Approach (RBA)
(a) Eligibility requirements for use of the RBA. (1) Originating
[BANK]. An originating [BANK] must use the RBA to calculate its
risk-based capital requirement for a securitization exposure if the
exposure has two or more external or inferred ratings (and may not
use the RBA if the exposure has fewer than two external or inferred
ratings).
(2) Investing [BANK]. An investing [BANK] must use the RBA to
calculate the risk-based capital requirement for a securitization
exposure if the exposure has one or more external or inferred
ratings (and may not use the RBA if the exposure has no external
rating or inferred rating).
(b) Ratings-based approach. (1) A [BANK] must determine its
risk-based capital requirement for a securitization exposure not
required to be deducted under Table 11 or 12 by multiplying the
exposure amount (as determined in paragraph (d) of section 42) by
the risk weight that corresponds to the applicable external or
applicable inferred rating provided in Table 11 or 12. If the
applicable table requires deduction, the exposure amount must be
deducted from total capital in accordance with paragraph (c) of
section 42 of this appendix.
(2) A [BANK] must apply the risk weights in Table 11 when the
securitization exposure's applicable external or applicable inferred
rating represents a long-term credit rating, and must apply the risk
weights in Table 12 when the securitization exposure's applicable
external or applicable inferred rating represents a short-term
credit rating.
Table 11.--Long-term Credit Rating Risk Weights Under the RBA
------------------------------------------------------------------------
Applicable external or applicable
inferred rating of a Example Risk weight (in
securitization exposure percent)
------------------------------------------------------------------------
Highest investment grade rating.. AAA.............. 20.
Second-highest investment grade AA............... 20.
rating.
Third-highest investment grade A................ 50.
rating.
Lowest investment grade rating... BBB.............. 100.
One category below investment BB............... 350.
grade.
Two categories below investment B................ Deduction.
grade.
Three categories or more below CCC.............. Deduction.
investment grade.
------------------------------------------------------------------------
[[Page 44048]]
Table 12.--Short-term Credit Rating Risk Weights Under the RBA
------------------------------------------------------------------------
Applicable external or applicable
inferred rating of a Example Risk Weight (in
securitization exposure percent)
------------------------------------------------------------------------
Highest investment grade rating.. A-1/P-1.......... 20.
Second-highest investment grade A-2/P-2.......... 50.
rating.
Third-highest investment grade A-3/P-3.......... 100.
rating.
All other ratings................ N/A.............. Deduction.
------------------------------------------------------------------------
Section 44. Securitization Exposures That Do Not Qualify for the
RBA
A [BANK] must deduct from total capital all securitization
exposures that do not qualify for the RBA in section 43 of this
appendix with the following exceptions, provided that the [BANK]
knows the composition of the underlying exposures at all times:
(a) An eligible ABCP liquidity facility. A [BANK] may determine
the risk-weighted asset amount of an eligible ABCP liquidity
facility by multiplying the exposure amount by the highest risk
weight applicable to any of the individual underlying exposures
covered by the facility.
(b) A first priority securitization exposure. A [BANK] may
determine the risk-weighted asset amount of a first priority
securitization exposure by multiplying the exposure amount by the
weighted-average risk weight of the underlying exposures. For
purposes of this section, a first priority securitization exposure
is a securitization exposure that has a first priority claim on the
cash flows from the underlying exposures and that is not an eligible
ABCP liquidity facility. When determining whether a securitization
exposure has a first priority claim on the cash flows from the
underlying exposures, a [BANK] is not required to consider amounts
due under interest rate or currency derivative contracts, fees due,
or other similar payments.
(c) A securitization exposure in a second loss position or
better in an ABCP program. (1) A [BANK] may determine the risk-
weighted asset amount of a securitization exposure that is in a
second loss position or better in an ABCP program that meets the
requirements of paragraph (c)(2) of this section by multiplying the
exposure amount by the higher of the following risk weights:
(i) 100 percent; or
(ii) The highest risk weight applicable to any of the individual
underlying exposures of the ABCP program.
(2) Requirements. (i) The exposure is not a first priority
securitization exposure or an eligible ABCP liquidity facility;
(ii) The exposure must be economically in a second loss position
or better, and the first loss position must provide significant
credit protection to the second loss position;
(iii) The credit risk of the exposure must be the equivalent of
investment grade or better; and
(iv) The [BANK] holding the exposure must not retain or provide
the first loss position.
Section 45. Recognition of Credit Risk Mitigants for Securitization
Exposures
(a) General. (1) An originating [BANK] that has obtained a
credit risk mitigant to hedge its securitization exposure to a
synthetic or traditional securitization that satisfies the
operational criteria in section 41 of this appendix may recognize
the credit risk mitigant under section 36 or 37 of this appendix,
but only as provided in this section.
(2) An investing [BANK] that has obtained a credit risk mitigant
to hedge a securitization exposure may recognize the credit risk
mitigant under section 36 or 37 of this appendix, but only as
provided in this section.
(3) A [BANK] that has used section 43 or section 44 to calculate
its risk-based capital requirement for a securitization exposure
based on external or inferred ratings that reflect the benefits of a
credit risk mitigant provided to the associated securitization or
that supports some or all of the underlying exposures may not use
the credit risk mitigation rules in this section to further reduce
its risk-based capital requirement for the exposure to reflect that
credit risk mitigant.
(b) Eligible guarantors for securitization exposures. A [BANK]
may only recognize an eligible guarantee or eligible credit
derivative from an eligible guarantor that:
(1) Is described in paragraph (1) of the definition of eligible
guarantor; or
(2) Has issued and outstanding an unsecured debt security
without credit enhancement that has an applicable external rating
based on a long-term rating in one of the three highest investment
grade rating categories.
(c) Mismatches. A [BANK] must make applicable adjustments to the
protection amount of an eligible guarantee or credit derivative as
required in paragraphs (d), (e), and (f) of section 36 of this
appendix for any hedged securitization exposure. In the context of a
synthetic securitization, when an eligible guarantee or eligible
credit derivative covers multiple hedged exposures that have
different residual maturities, the [BANK] must use the longest
residual maturity of any of the hedged exposures as the residual
maturity of all the hedged exposures.
Section 46. Risk-Weighted Assets for Securitizations with Early
Amortization Provisions
(a) General. (1) An originating [BANK] must hold risk-based
capital against the sum of the originating [BANK]'s interest and the
investors' interest in a securitization that:
(i) Includes one or more underlying exposures in which the
borrower is permitted to vary the drawn amount within an agreed
limit under a line of credit; and
(ii) Contains an early amortization provision.
(2) The total capital requirement for a [BANK]'s exposures to a
single securitization with an early amortization provision is
subject to a maximum capital requirement equal to the greater of:
(i) The capital requirement for retained securitization
exposures, or
(ii) The capital requirement for the underlying exposures that
would apply if the [BANK] directly held the underlying exposures.
(3) For securitizations described in paragraph (a)(1) of this
section, an originating [BANK] must calculate the risk-based capital
requirement for the originating [BANK]'s interest under sections 42
through 45 of this appendix, and the risk-weighted asset amount for
the investors' interest under paragraph (c) of this section.
(b) Definitions. For purposes of this section:
(1) Investors' interest means, with respect to a securitization,
the exposure amount of the underlying exposures multiplied by the
ratio of:
(i) The total amount of securitization exposures issued by the
securitization SPE; divided by
(ii) The outstanding principal amount of the underlying
exposures.
(2) Excess spread for a period means:
(i) Gross finance charge collections and other income received
by a securitization SPE (including market interchange fees) over a
period minus interest paid to the holders of the securitization
exposures, servicing fees, charge-offs, and other senior trust or
similar expenses of the SPE over the period; divided by
(ii) The principal balance of the underlying exposures at the
end of the period.
(c) Risk-weighted asset amount for investors' interest. The
originating [BANK]'s risk-weighted asset amount for the investors'
interest in the securitization is equal to the product of the
following four quantities:
(1) The investors' interest;
(2) The appropriate conversion factor in paragraph (d) of this
section;
(3) The weighted-average risk weight that would apply under this
appendix to the underlying exposures if the underlying exposures had
not been securitized; and
(4) The proportion of the underlying exposures in which the
borrower is permitted to vary the drawn amount within an agreed
limit under a line of credit.
(d) Conversion factors. (1)(i) Except as provided in paragraph
(d)(2) of this section, to calculate the appropriate conversion
factor, a [BANK] must use Table 13 for a securitization that
contains a controlled early amortization provision and must use
Table 14 for a securitization that contains a non-controlled early
amortization provision. In
[[Page 44049]]
circumstances where a securitization contains a mix of retail and
nonretail exposures or a mix of committed and uncommitted exposures,
a [BANK] may take a pro rata approach to determining the conversion
factor for the securitization's early amortization provision. If a
pro rata approach is not feasible, a [BANK] must treat the mixed
securitization as a securitization of nonretail exposures if a
single underlying exposure is a nonretail exposure and must treat
the mixed securitization as a securitization of committed exposures
if a single underlying exposure is a committed exposure.
(ii) To find the appropriate conversion factor in the tables, a
[BANK] must divide the three-month average annualized excess spread
of the securitization by the excess spread trapping point in the
securitization structure. In securitizations that do not require
excess spread to be trapped, or that specify trapping points based
primarily on performance measures other than the three-month average
annualized excess spread, the excess spread trapping point is 4.5
percent.
Table 13.--Controlled Early Amortization Provisions
------------------------------------------------------------------------
Uncommitted CF Committed CF
3-month average annualized excess spread (in percent) (in percent)
------------------------------------------------------------------------
Retail Credit Lines:
Greater than or equal to 133.33% of 0 90
trapping point.....................
Less than 133.33% to 100% of 1 ..............
trapping point.....................
Less than 100% to 75% of trapping 2 ..............
point..............................
Less than 75% to 50% of trapping 10 ..............
point..............................
Less than 50% to 25% of trapping 20 ..............
point..............................
Less than 25% of trapping point..... 40 ..............
Non-retail credit lines................. 90 90
------------------------------------------------------------------------
Table 14.--Non-controlled Early Amortization Provisions
------------------------------------------------------------------------
Uncommitted CF Committed CF
3-month average annualized excess spread (in percent) (in percent)
------------------------------------------------------------------------
Retail Credit Lines:
Greater than or equal to 133.33% of 0 100
trapping point.....................
Less than 133.33% to 100% of 5 ..............
trapping point.....................
Less than 100% to 75% of trapping 15 ..............
point..............................
Less than 75% to 50% of trapping 50 ..............
point..............................
Less than 50% of trapping point..... 100 ..............
Non-retail credit lines................. 100 100
------------------------------------------------------------------------
(2) For a securitization for which all or substantially all of
the underlying exposures are secured by liens on one-to-four family
residential property, a [BANK] may calculate the appropriate
conversion factor discussed in paragraph (c)(2) of this section
using paragraph (d)(1) of this section or may use a conversion
factor of 10 percent. If the [BANK] chooses to use a conversion
factor of 10 percent, it must use that conversion factor for all
securitizations for which all or substantially all of the underlying
exposures are secured by liens on one-to-four family residential
property.
Part V. Risk-Weighted Assets for Equity Exposures
Section 51. Introduction and Exposure Measurement
(a) General. To calculate its risk-weighted asset amounts for
equity exposures that are not equity exposures to investment funds,
a [BANK] must use the Simple Risk-Weight Approach (SRWA) in section
52. A [BANK] must use the look-through approaches in section 53 to
calculate its risk-weighted asset amounts for equity exposures to
investment funds.
(b) Adjusted carrying value. For purposes of this part, the
adjusted carrying value of an equity exposure is:
(1) For the on-balance sheet component of an equity exposure,
the [BANK]'s carrying value of the exposure reduced by any
unrealized gains on the exposure that are reflected in such carrying
value but excluded from the [BANK]'s tier 1 and tier 2 capital; and
(2) For the off-balance sheet component of an equity exposure
that is not an equity commitment, the effective notional principal
amount of the exposure, the size of which is equivalent to a
hypothetical on-balance sheet position in the underlying equity
instrument that would evidence the same change in fair value
(measured in dollars) for a given small change in the price of the
underlying equity instrument, minus the adjusted carrying value of
the on-balance sheet component of the exposure as calculated in
paragraph (b)(1) of this section.
(3) For a commitment to acquire an equity exposure (an equity
commitment), the effective notional principal amount of the exposure
multiplied by the following conversion factors (CFs):
(i) Conditional equity commitments with an original maturity of
one year or less receive a CF of 20 percent.
(ii) Conditional equity commitments with an original maturity of
over one year receive a CF of 50 percent.
(iii) Unconditional equity commitments receive a CF of 100
percent.
Section 52. Simple Risk-Weight Approach (SRWA)
(a) General. Under the SRWA, a [BANK]'s total risk-weighted
assets for equity exposures equals the sum of the risk-weighted
asset amounts for each of the [BANK]'s individual equity exposures
(other than equity exposures to an investment fund) as determined in
this section and the risk-weighted asset amounts for each of the
[BANK]'s individual equity exposures to an investment fund as
determined in section 53.
(b) SRWA computation for individual equity exposures. A [BANK]
must determine the risk-weighted asset amount for an individual
equity exposure (other than an equity exposure to an investment
fund) by multiplying the adjusted carrying value of the equity
exposure or the effective portion and ineffective portion of a hedge
pair (as defined in paragraph (c) of this section) by the lowest
applicable risk weight in this paragraph (b).
(1) Zero percent risk weight equity exposures. An equity
exposure to a sovereign entity, the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, an MDB, a PSE, and any other entity
whose credit exposures receive a zero percent risk weight under
section 33 may be assigned a zero percent risk weight.
(2) 20 percent risk weight equity exposures. An equity exposure
to a Federal Home Loan Bank or Federal Agricultural Mortgage
Corporation (Farmer Mac) is assigned a 20 percent risk weight.
(3) 100 percent risk weight equity exposures. The following
equity exposures are assigned a 100 percent risk weight:
[[Page 44050]]
(i) Community development equity exposures. (A) For banks and
bank holding companies, an equity exposure that qualifies as a
community development investment under 12 U.S.C. 24 (Eleventh),
excluding equity exposures to an unconsolidated small business
investment company and equity exposures held through a consolidated
small business investment company described in section 302 of the
Small Business Investment Act of 1958 (15 U.S.C. 682).
(B) For savings associations, an equity exposure that is
designed primarily to promote community welfare, including the
welfare of low- and moderate-income communities or families, such as
by providing services or employment, and excluding equity exposures
to an unconsolidated small business investment company and equity
exposures held through a small business investment company described
in section 302 of the Small Business Investment Act of 1958 (15
U.S.C. 682).
(ii) Effective portion of hedge pairs. The effective portion of
a hedge pair.
(iii) Non-significant equity exposures. Equity exposures,
excluding exposures to an investment firm that would meet the
definition of a traditional securitization were it not for the
[agency]'s application of paragraph (8) of that definition and has
greater than immaterial leverage, to the extent that the aggregate
adjusted carrying value of the exposures does not exceed 10 percent
of the [BANK]'s tier 1 capital plus tier 2 capital.
(A) To compute the aggregate adjusted carrying value of a
[BANK]'s equity exposures for purposes of this paragraph
(b)(3)(iii), the [BANK] may exclude equity exposures described in
paragraphs (b)(1), (b)(2), (b)(3)(i), and (b)(3)(ii) of this
section, the equity exposure in a hedge pair with the smaller
adjusted carrying value, and a proportion of each equity exposure to
an investment fund equal to the proportion of the assets of the
investment fund that are not equity exposures or that meet the
criterion of paragraph (b)(3)(i) of this section. If a [BANK] does
not know the actual holdings of the investment fund, the [BANK] may
calculate the proportion of the assets of the fund that are not
equity exposures based on the terms of the prospectus, partnership
agreement, or similar contract that defines the fund's permissible
investments. If the sum of the investment limits for all exposure
classes within the fund exceeds 100 percent, the [BANK] must assume
for purposes of this paragraph (b)(3)(iii) that the investment fund
invests to the maximum extent possible in equity exposures.
(B) When determining which of a [BANK]'s equity exposures
qualify for a 100 percent risk weight under this paragraph, a [BANK]
first must include equity exposures to unconsolidated small business
investment companies or held through consolidated small business
investment companies described in section 302 of the Small Business
Investment Act of 1958 (15 U.S.C. 682), then must include publicly
traded equity exposures (including those held indirectly through
investment funds), and then must include non-publicly traded equity
exposures (including those held indirectly through investment
funds).
(4) 300 percent risk weight equity exposures. A publicly traded
equity exposure (other than an equity exposure described in
paragraph (b)(6) of this section and including the ineffective
portion of a hedge pair) is assigned a 300 percent risk weight.
(5) 400 percent risk weight equity exposures. An equity exposure
(other than an equity exposure described in paragraph (b)(6) of this
section) that is not publicly traded is assigned a 400 percent risk
weight.
(6) 600 percent risk weight equity exposures. An equity exposure
to an investment firm that:
(i) Would meet the definition of a traditional securitization
were it not for the [agency]'s application of paragraph (8) of that
definition, and
(ii) Has greater than immaterial leverage is assigned a 600
percent risk weight.
(c) Hedge transactions. (1) Hedge pair. A hedge pair is two
equity exposures that form an effective hedge so long as each equity
exposure is publicly traded or has a return that is primarily based
on a publicly traded equity exposure.
(2) Effective hedge. Two equity exposures form an effective
hedge if the exposures either have the same remaining maturity or
each has a remaining maturity of at least three months; the hedge
relationship is formally documented in a prospective manner (that
is, before the [BANK] acquires at least one of the equity
exposures); the documentation specifies the measure of effectiveness
(E) the [BANK] will use for the hedge relationship throughout the
life of the transaction; and the hedge relationship has an E greater
than or equal to 0.8. A [BANK] must measure E at least quarterly and
must use one of three alternative measures of E:
(i) Under the dollar-offset method of measuring effectiveness,
the [BANK] must determine the ratio of value change (RVC). The RVC
is the ratio of the cumulative sum of the periodic changes in value
of one equity exposure to the cumulative sum of the periodic changes
in the value of the other equity exposure. If RVC is positive, the
hedge is not effective and E equals 0. If RVC is negative and
greater than or equal to -1 (that is, between zero and -1), then E
equals the absolute value of RVC. If RVC is negative and less than -
1, then E equals 2 plus RVC.
(ii) Under the variability-reduction method of measuring
effectiveness:
[GRAPHIC] [TIFF OMITTED] TP29JY08.005
where:
(A) Xt = At - Bt;
(B) At = the value at time t of one exposure in a hedge pair; and
(C) Bt = the value at time t of the other exposure in a hedge pair.
(iii) Under the regression method of measuring effectiveness, E
equals the coefficient of determination of a regression in which the
change in value of one exposure in a hedge pair is the dependent
variable and the change in value of the other exposure in a hedge
pair is the independent variable. However, if the estimated
regression coefficient is positive, then the value of E is zero.
(3) The effective portion of a hedge pair is E multiplied by the
greater of the adjusted carrying values of the equity exposures
forming a hedge pair.
(4) The ineffective portion of a hedge pair is (1-E) multiplied
by the greater of the adjusted carrying values of the equity
exposures forming a hedge pair.
Section 53. Equity Exposures to Investment Funds
(a) Available approaches. (1) Unless the exposure meets the
requirements for a community development equity exposure in
paragraph (b)(3)(i) of section 52, a [BANK] must determine the risk-
weighted asset amount of an equity exposure to an investment fund
under the Full Look-Through Approach in paragraph (b) of this
section, the Simple Modified Look-Through Approach in paragraph (c)
of this section, the Alternative Modified Look-Through Approach in
paragraph (d) of this section, or, if the investment fund qualifies
for the Money Market Fund Approach, the Money Market Fund Approach
in paragraph (e) of this section.
(2) The risk-weighted asset amount of an equity exposure to an
investment fund that meets the requirements for a community
development equity exposure in paragraph (b)(3)(i) of section 52 is
its adjusted carrying value.
(3) If an equity exposure to an investment fund is part of a
hedge pair and the [BANK] does not use the Full Look-Through
Approach, the [BANK] may use the ineffective portion of the hedge
pair as determined under paragraph (c) of section 52 as the adjusted
carrying value for the equity exposure to the investment fund. The
risk-weighted asset amount of the effective portion of the hedge
pair is equal to its adjusted carrying value.
(b) Full Look-Through Approach. A [BANK] that is able to
calculate a risk-weighted asset amount for its proportional
ownership share of each exposure held by the investment fund (as
calculated under this appendix as if the proportional ownership
share of each exposure were held directly by the [BANK]) may set the
risk-weighted asset amount of the [BANK]'s exposure to the fund
equal to the product of:
(1) The aggregate risk-weighted asset amounts of the exposures
held by the fund as if they were held directly by the [BANK]; and
(2) The [BANK]'s proportional ownership share of the fund.
(c) Simple Modified Look-Through Approach. Under this approach,
the risk-weighted asset amount for a [BANK]'s equity exposure to an
investment fund equals the adjusted carrying value of the equity
exposure multiplied by the highest risk weight that applies to any
exposure the fund is permitted to hold under its prospectus,
partnership agreement, or similar contract that defines the fund's
permissible
[[Page 44051]]
investments (excluding derivative contracts that are used for
hedging rather than speculative purposes and that do not constitute
a material portion of the fund's exposures).
(d) Alternative Modified Look-Through Approach. Under this
approach, a [BANK] may assign the adjusted carrying value of an
equity exposure to an investment fund on a pro rata basis to
different risk weight categories under this appendix based on the
investment limits in the fund's prospectus, partnership agreement,
or similar contract that defines the fund's permissible investments.
The risk-weighted asset amount for the [BANK]'s equity exposure to
the investment fund equals the sum of each portion of the adjusted
carrying value assigned to an exposure class multiplied by the
applicable risk weight under this appendix. If the sum of the
investment limits for exposure classes within the fund exceeds 100
percent, the [BANK] must assume that the fund invests to the maximum
extent permitted under its investment limits in the exposure class
with the highest applicable risk weight under this appendix and
continues to make investments in order of the exposure class with
the next highest applicable risk weight under this appendix until
the maximum total investment level is reached. If more than one
exposure class applies to an exposure, the [BANK] must use the
highest applicable risk weight. A [BANK] may exclude derivative
contracts held by the fund that are used for hedging rather than for
speculative purposes and do not constitute a material portion of the
fund's exposures.
(e) Money Market Fund Approach. The risk-weighted asset amount
for a [BANK]'s equity exposure to an investment fund that is a money
market fund subject to 17 CFR 270.2a-7 and that has an applicable
external rating in the highest investment-grade rating category
equals the adjusted carrying value of the equity exposure multiplied
by seven percent.
Part VI. Risk-Weighted Assets for Operational Risk
Section 61. Basic Indicator Approach
(a) Risk-weighted assets for operational risk. Risk-weighted
assets for operational risk equals 15 percent of a [BANK]'s average
positive annual gross income multiplied by 12.5.
(b) Average positive annual gross income. A [BANK]'s average
positive annual gross income equals the sum of the [BANK]'s positive
annual gross income, as described below, over the three most recent
calendar years divided by the number of those years in which its
annual gross income is positive. A [BANK] must exclude from this
calculation amounts from any year in which the annual gross income
is negative or zero.
(c) Annual gross income equals:
(1) For a [BANK], its net interest income plus its total
noninterest income minus its underwriting income from insurance and
reinsurance activities as reported on the [BANK]'s Call Report.
(2) For a bank holding company, its net interest income plus its
total noninterest income minus its underwriting income from
insurance and reinsurance activities as reported on the bank holding
company's Y9-C Report.
(3) For a savings association, its net interest income (expense)
before provision for losses on interest-bearing assets, plus total
noninterest income, minus the portion of its other fees and charges
that represents income derived from insurance and reinsurance
underwriting activities, minus (plus) its income (loss) from the
sale of assets held for sale and available-for-sale securities to
include only the profit or loss from the disposition of available-
for-sale securities pursuant to FASB Statement No. 115, minus (plus)
its income (loss) from the sale of securities held-to-maturity, all
as reported on the savings association's year-end Thrift Financial
Report.
Part VII. Disclosure
Section 71. Disclosure Requirements
(a) Each [BANK] must publicly disclose each quarter its total
and tier 1 risk-based capital ratios and their components (that is,
tier 1 capital, tier 2 capital, total qualifying capital, and total
risk-weighted assets).\74\
---------------------------------------------------------------------------
\74\ Other public disclosure requirements continue to apply--for
example, Federal securities law and regulatory reporting
requirements.
---------------------------------------------------------------------------
(b) A [BANK] must comply with paragraph (c) of this section
unless it is a consolidated subsidiary of a bank holding company or
depository institution that is subject to these disclosure
requirements.
(c) (1) Each [BANK] that is not a subsidiary of a non-U.S.
banking organization that is subject to comparable public disclosure
requirements in its home jurisdiction must provide timely public
disclosures each calendar quarter of the information in tables 15.1-
15.10 below. If a significant change occurs, such that the most
recent reported amounts are no longer reflective of the [BANK]'s
capital adequacy and risk profile, then a brief discussion of this
change and its likely impact must be provided as soon as practicable
thereafter. Qualitative disclosures that typically do not change
each quarter (for example, a general summary of the [BANK]'s risk
management objectives and policies, reporting system, and
definitions) may be disclosed annually, provided any significant
changes to these are disclosed in the interim. Management is
encouraged to provide all of the disclosures required by this
appendix in one place on the [BANK]'s public Web site.\75\ The
[BANK] must make these disclosures publicly available for each of
the last three years (that is, twelve quarters) or such shorter
period [beginning on the effective date of a [BANK]'s election to
use this appendix].
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\75\ Alternatively, a [BANK] may provide the disclosures in more
than one place, as some of them may be included in public financial
reports (for example, in Management's Discussion and Analysis
included in SEC filings) or other regulatory reports. The [BANK]
must publicly provide a summary table that specifically indicates
where all the disclosures may be found (for example, regulatory
report schedules, page numbers in annual reports).
---------------------------------------------------------------------------
(2) Each [BANK] is required to have a formal disclosure policy
approved by the board of directors that addresses its approach for
determining the disclosures it makes. The policy must address the
associated internal controls and disclosure controls and procedures.
The board of directors and senior management are responsible for
establishing and maintaining an effective internal control structure
over financial reporting, including the disclosures required by this
appendix, and must ensure that appropriate review of the disclosures
takes place. One or more senior officers of the [BANK] must attest
that the disclosures meet the requirements of this appendix.
(3) If a [BANK] believes that disclosure of specific commercial
or financial information would prejudice seriously its position by
making public information that is either proprietary or confidential
in nature, the [BANK] need not disclose those specific items, but
must disclose more general information about the subject matter of
the requirement, together with the fact that, and the reason why,
the specific items of information have not been disclosed.
Table 15.1.--Scope of Application
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures...... (a) The name of the top corporate entity
in the group to which the appendix
applies.
(b) An outline of differences in the
basis of consolidation for accounting
and regulatory purposes, with a brief
description of the entities \1\ within
the group:
(1) that are fully consolidated;
(2) that are deconsolidated and
deducted;
(3) for which the regulatory capital
requirement is deducted; and
(4) that are neither consolidated nor
deducted (for example, where the
investment is risk weighted).
(c) Any restrictions, or other major
impediments, on transfer of funds or
regulatory capital within the group.
Quantitative Disclosures..... (d) The aggregate amount of surplus
capital of insurance subsidiaries
included in the regulatory capital of
the consolidated group.
[[Page 44052]]
(e) The aggregate amount by which actual
regulatory capital is less than the
minimum regulatory capital requirement
in all subsidiaries with regulatory
capital requirements and the name(s) of
the subsidiaries with such deficiencies.
------------------------------------------------------------------------
\1\ Entities include securities, insurance and other financial
subsidiaries, commercial subsidiaries (where permitted), significant
minority equity investments in insurance, financial and commercial
entities.
Table 15.2.--Capital Structure
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures...... (a) Summary information on the terms and
conditions of the main features of all
capital instruments, especially in the
case of innovative, complex or hybrid
capital instruments.
Quantitative Disclosures..... (b) The amount of tier 1 capital, with
separate disclosure of:
(1) common stock/surplus;
(2) retained earnings;
(3) minority interests in the equity
of subsidiaries;
(4) restricted core capital elements
as defined in [the general risk-based
capital rules];
(5) amounts deducted from tier 1
capital, including goodwill and
certain intangibles.
(c) The total amount of tier 2 capital,
with a separate disclosure of amounts
deducted from tier 2 capital.
(d) Other deductions from capital.
(e) Total eligible capital.
------------------------------------------------------------------------
Table 15.3.--Capital Adequacy
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures...... (a) A summary discussion of the [BANK]'s
approach to assessing the adequacy of
its capital to support current and
future activities.
Quantitative Disclosures..... (b) Risk-weighted assets for:
(1) Exposures to sovereign entities;
(2) Exposures to certain supranational
entities and MDBs;
(3) Exposures to depository
institutions, foreign banks, and
credit unions;
(4) Exposures to PSEs;
(5) Corporate exposures;
(6) Regulatory retail exposures;
(7) Residential mortgage exposures;
(8) Statutory multifamily mortgages
and pre-sold construction loans;
(9) Past due loans;
(10) Other assets;
(11) Securitization exposures; and
(12) Equity exposures.
(c) Risk-weighted assets for market risk
as calculated under [the market risk
rule]: \1\
(1) Standardized specific risk charge;
and
(2) Internal models approach for
specific risk.
(d) Risk-weighted assets for operational
risk.
(e) Total and tier 1 risk-based capital
ratios:
(1) For the top consolidated group;
and
(2) For each [BANK] subsidiary.
(f) Total risk-weighted assets.
------------------------------------------------------------------------
\1\ Risk-weighted assets determined under [the market risk rule] are to
be disclosed only for the approaches used.
General qualitative disclosure requirement
For each separate risk area described in tables 15.4 through
15.10, the [BANK] must describe its risk management objectives and
policies.
Table 15.4.\1\--Credit Risk: General Disclosures
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures...... (a) The general qualitative disclosure
requirement with respect to credit risk
(excluding counterparty credit risk
disclosed in accordance with Table
16.5), including:
(1) Definitions of past due and
impaired (for accounting purposes);
(2) Description of approaches followed
for allowances, including statistical
methods used where applicable;
(3) Discussion of the [BANK]'s credit
risk management policy.
Quantitative Disclosures..... (b) Total gross credit risk exposures and
average credit risk exposures, after
accounting offsets in accordance with
GAAP,\2\ and without taking into account
the effects of credit risk mitigation
techniques (for example, collateral and
netting), over the period broken down by
major types of credit exposure. For
example, [BANK]s could apply a breakdown
similar to that used for accounting
purposes. Such a breakdown might, for
instance, be loans, off-balance sheet
commitments, and other non-derivative
off-balance sheet exposures; debt
securities; and OTC derivatives
(c) Geographic \3\ distribution of
exposures, broken down in significant
areas by major types of credit exposure.
(d) Industry or counterparty type
distribution of exposures, broken down
by major types of credit exposure.
(e) Remaining contractual maturity
breakdown (for example, one year or
less) of the whole portfolio, broken
down by major types of credit exposure.
(f)(1) By major industry or counterparty
type:
[[Page 44053]]
(2) Amount of impaired loans;
(3) Amount of past due loans; \4\
(4) Allowances; and
(5) Charge-offs during the period.
(g) Amount of impaired loans and, if
available, the amount of past due loans
broken down by significant geographic
areas including, if practical, the
amounts of allowances related to each
geographical area.\5\
(h) Reconciliation of changes in the
allowance for loan and lease losses.\6\
------------------------------------------------------------------------
\1\ Table 15.4 does not include equity exposures.
\2\ For example, FASB Interpretations 39 and 41.
\3\ Geographical areas may comprise individual countries, groups of
countries, or regions within countries. A [BANK] might choose to
define the geographical areas based on the way the [BANK]'s portfolio
is geographically managed. The criteria used to allocate the loans to
geographical areas must be specified.
\4\ A [BANK] is encouraged also to provide an analysis of the aging of
past-due loans.
\5\ The portion of general allowance that is not allocated to a
geographical area should be disclosed separately.
\6\ The reconciliation should include the following: a description of
the allowance; the opening balance of the allowance; charge-offs taken
against the allowance during the period; amounts provided (or
reversed) for estimated probable loan losses during the period; any
other adjustments (for example, exchange rate differences, business
combinations, acquisitions and disposals of subsidiaries), including
transfers between allowances; and the closing balance of the
allowance. Charge-offs and recoveries that have been recorded directly
to the income statement should be disclosed separately.
Table 15.5.--General Disclosure for Counterparty Credit Risk-Related
Exposures
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures...... (a) The general qualitative disclosure
requirement with respect to OTC
derivatives, eligible margin loans, and
repo-style transactions, including:
(1) Discussion of methodology used to
assign economic capital and credit
limits for counterparty credit
exposures;
(2) Discussion of policies for
securing collateral, valuing and
managing collateral, and establishing
credit reserves;
(3) Discussion of the primary types of
collateral taken;
(4) Discussion of policies with
respect to wrong-way risk exposures;
and
(5) Discussion of the impact of the
amount of collateral the [BANK] would
have to provide given a credit rating
downgrade.
Quantitative Disclosures..... (b) Gross positive fair value of
contracts, netting benefits, netted
current credit exposure, collateral held
(including type, for example, cash,
government securities), and net
unsecured credit exposure.\1\ Also
report the notional value of credit
derivative hedges purchased for
counterparty credit risk protection and
the distribution of current credit
exposure by types of credit exposure.\2\
(c) Notional amount of purchased and sold
credit derivatives, segregated between
use for the [BANK]'s own credit
portfolio, as well as in its
intermediation activities, including the
distribution of the credit derivative
products used, broken down further by
protection bought and sold within each
product group.
------------------------------------------------------------------------
\1\ Net unsecured credit exposure is the credit exposure after
considering both the benefits from legally enforceable netting
agreements and collateral arrangements without taking into account
haircuts for price volatility, liquidity, etc.
\2\ This may include interest rate derivative contracts, foreign
exchange derivative contracts, equity derivative contracts, credit
derivatives, commodity or other derivative contracts, repo-style
transactions, and eligible margin loans.
Table 15.6.--Credit Risk Mitigation \1\, \2\, \3\
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures...... (a) The general qualitative disclosure
requirement with respect to credit risk
mitigation including:
(1) policies and processes for, and an
indication of the extent to which the
[BANK] uses, on- and off-balance
sheet netting;
(2) policies and processes for
collateral valuation and management;
(3) a description of the main types of
collateral taken by the [BANK];
(4) the main types of guarantors/
credit derivative counterparties and
their creditworthiness; and
(5) information about (market or
credit) risk concentrations within
the mitigation taken.
Quantitative Disclosures..... (b) For each separately disclosed
portfolio, the total exposure (after,
where applicable, on-or off-balance
sheet netting) that is covered by
guarantees/credit derivatives and the
risk-weighted asset amount associated
with that exposure.
------------------------------------------------------------------------
\1\ At a minimum, a [BANK] must give the disclosures in Table 15.6 in
relation to credit risk mitigation that has been recognized for the
purposes of reducing capital requirements under this appendix. Where
relevant, [BANK]s are encouraged to give further information about
mitigants that have not been recognized for that purpose.
\2\ Credit derivatives that are treated, for the purposes of this
appendix, as synthetic securitization exposures should be excluded
from the credit risk mitigation disclosures and included within those
relating to securitization.
\3\ Counterparty credit risk-related exposures disclosed pursuant to
Table 15.5 should be excluded from the credit risk mitigation
disclosures in Table 15.6.
Table 15.7.--Securitization
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures...... (a) The general qualitative disclosure
requirement with respect to
securitization (including synthetic
securitizations), including a discussion
of:
(1) the [BANK]'s objectives relating
to securitization activity, including
the extent to which these activities
transfer credit risk of the
underlying exposures away from the
[BANK] to other entities;
(2) the roles played by the [BANK] in
the securitization process \1\ and an
indication of the extent of the
[BANK]'s involvement in each of them.
(b) Summary of the [BANK]'s accounting
policies for securitization activities,
including:
[[Page 44054]]
(1) whether the transactions are
treated as sales or financings;
(2) recognition of gain-on-sale;
(3) key assumptions for valuing
retained interests, including any
significant changes since the last
reporting period and the impact of
such changes; and
(4) treatment of synthetic
securitizations.
(c) Names of NRSROs used for
securitizations and the types of
securitization exposure for which each
organization is used.
Quantitative Disclosures..... (d) The total outstanding exposures
securitized by the [BANK] in
securitizations that meet the operation
criteria in Section 41 (broken down into
traditional/synthetic), by underlying
exposure type.2 3 4
(e) For exposures securitized by the
[BANK] in securitizations that meet the
operational criteria in Section 41:
(1) amount of securitized assets that
are impaired/past due; and
(2) losses recognized by the [BANK]
during the current period \5\ broken
down by exposure type.
(f) Aggregate amount of securitization
exposures broken down by underlying
exposure type.
(g) Aggregate amount of securitization
exposures and the associated capital
charges for these exposures by risk-
weight category. Exposures that have
been deducted from capital should be
disclosed separately by type of
underlying asset.
(h) For securitizations subject to the
early amortization treatment, the
following items by underlying asset type
for securitized facilities:
(1) the aggregate drawn exposures
attributed to the seller's and
investors' interests; and
(2) the aggregate capital charges
incurred by the [BANK] against the
investor's shares of drawn balances
and undrawn lines.
(i) Summary of current year's
securitization activity, including the
amount of exposures securitized (by
exposure type), and recognized gain-or
loss-on-sale by asset type.
------------------------------------------------------------------------
\1\ For example: originator, investor, servicer, provider of credit
enhancement, sponsor of asset-backed commercial paper facility,
liquidity provider, swap provider.
\2\ Underlying exposure types may include, for example, mortgage loans
secured by liens on one-to-four family residential property, home
equity lines, credit card receivables, and auto loans.
\3\ Securitization transactions in which the originating [BANK] does not
retain any securitization exposure should be shown separately but need
only be reported for the year of inception.
\4\ Where relevant, a [BANK] is encouraged to differentiate between
exposures resulting from activities in which they act only as
sponsors, and exposures that result from all other [BANK]
securitization activities.
\5\ For example, charge-offs/allowances (if the assets remain on the
[BANK]'s balance sheet) or write-downs of I/O strips and other
residual interests.
Table 15.8.--Operational Risk
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures...... (a) The general qualitative disclosure
requirement for operational risk.
(b) A description of the use of insurance
for the purpose of mitigating
operational risk.
------------------------------------------------------------------------
Table 15.9.--Equities Not Subject to Market Risk Rule
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures...... (a) The general qualitative disclosure
requirement with respect to equity risk,
including:
(1) differentiation between holdings
on which capital gains are expected
and those taken under other
objectives including for relationship
and strategic reasons; and
(2) discussion of important policies
covering the valuation of and
accounting for equity holdings in the
banking book. This includes the
accounting techniques and valuation
methodologies used, including key
assumptions and practices affecting
valuation as well as significant
changes in these practices.
Quantitative Disclosures..... (b) Value disclosed in the balance sheet
of investments, as well as the fair
value of those investments; for quoted
securities, a comparison to publicly-
quoted share values where the share
price is materially different from fair
value.
(c) The types and nature of investments,
including the amount that is:
(1) Publicly traded; and
(2) Non-publicly traded.
(d) The cumulative realized gains
(losses) arising from sales and
liquidations in the reporting period.
(e)(1) Total unrealized gains (losses)
\1\
(2) Total latent revaluation gains
(losses) \2\
(3) Any amounts of the above included
in tier 1 and/or tier 2 capital.
(f) Capital requirements broken down by
appropriate equity groupings, consistent
with the [BANK]'s methodology, as well
as the aggregate amounts and the type of
equity investments subject to any
supervisory transition regarding
regulatory capital requirements.
------------------------------------------------------------------------
\1\ Unrealized gains (losses) recognized in the balance sheet but not
through earnings.
\2\ Unrealized gains (losses) not recognized either in the balance sheet
or through earnings.
Table 15.10.--Interest Rate Risk for Non-trading Activities
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures...... (a) The general qualitative disclosure
requirement, including the nature of
interest rate risk for non-trading
activities and key assumptions,
including assumptions regarding loan
prepayments and behavior of non-maturity
deposits, and frequency of measurement
of interest rate risk for non-trading
activities.
Quantitative disclosures..... (b) The increase (decline) in earnings or
economic value (or relevant measure used
by management) for upward and downward
rate shocks according to management's
method for measuring interest rate risk
for non-trading activities, broken down
by currency (as appropriate).
------------------------------------------------------------------------
[[Page 44055]]
END OF COMMON RULE.
[END OF COMMON TEXT]
List of Subjects
12 CFR Part 3
Administrative practices and procedure, Capital, National banks,
Reporting and recordkeeping requirements, Risk.
12 CFR Part 208
Confidential business information, Crime, Currency, Federal Reserve
System, Mortgages, Reporting and recordkeeping requirements,
Securities.
12 CFR Part 225
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
12 CFR Part 325
Administrative practice and procedure, Banks, banking, Capital
Adequacy, Reporting and recordkeeping requirements, Savings
associations, State nonmember banks.
12 CFR Part 567
Capital, Reporting and recordkeeping requirements, Savings
associations.
Proposed Adoption of Common Appendix
The proposed adoption of the common rules by the agencies, as
modified by agency-specific text, is set forth below:
Department of the Treasury
Office of the Comptroller of the Currency
12 CFR Chapter I
Authority and Issuance
For the reasons stated in the common preamble, the Office of the
Comptroller of the Currency amends Part 3 of chapter I of Title 12,
Code of Federal Regulations as follows:
PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES
1. The authority citation for part 3 continues to read as follows:
Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n
note, 1835, 3907, and 3909.
2. New Appendix D to part 3 is added as set forth at the end of the
common preamble.
3. Appendix D to part 3 is amended as set forth below:
a. Remove ``[agency]'' and add ``OCC'' in its place wherever it
appears.
b. Remove ``[BANK]'' and add ``bank'' in its place wherever it
appears, and remove ``[Banks]'' and add ``Banks'' in its place wherever
it appears.
c. Remove ``[Appendix--to Part--]'' and add ``Appendix D to Part
3'' in its place wherever it appears.
d. Remove ``[the general risk-based capital rules]'' and add ``12
CFR part 3, appendix A'' in its place wherever it appears.
e. Remove ``[the market risk rule]'' and add ``12 CFR part 3,
appendix B'' in its place wherever it appears.
f. Remove ``[the advanced approaches risk-based capital rules]''
and add ``12 CFR part 3, appendix C'' in its place wherever it appears.
g. In section 1, revise paragraph (e) to read as follows:
Section 1. Purpose, Applicability, Election Procedures, and Reservation
of Authority
* * * * *
(e) Notice and response procedures. In making a determination
under paragraphs (c)(3) or (d) of this section, the OCC will apply
notice and response procedures in the same manner as the notice and
response procedures in 12 CFR 3.12.
* * * * *
h. In section 2, revise the definitions of gain-on-sale, pre-sold
construction loan, statutory multifamily mortgage, and paragraph (7) of
the definition of traditional securitization to read as follows:
Section 2. Definitions
* * * * *
Gain-on-sale means an increase in the equity capital (as
reported on Schedule RC of the Consolidated Statement of Condition
and Income (Call Report)) of a bank that results from a
securitization (other than an increase in equity capital that
results from the bank's receipt of cash in connection with the
securitization). (See also securitization.)
* * * * *
Pre-sold construction loan means any one-to-four family
residential pre-sold construction loan for a residence meeting the
requirements under section 618(a)(1) or (2) of the Resolution Trust
Corporation Refinancing, Restructuring, and Improvement Act of 1991
(RTCRRI Act) and under 12 CFR part 3, appendix A, section
3(a)(3)(iv).
* * * * *
Statutory multifamily mortgage means any multifamily residential
mortgage meeting the requirements under section 618(b)(1) of the
RTCRRI Act, and under 12 CFR part 3, appendix A, section 3(a)(3)(v).
* * * * *
Traditional securitization * * *
(7) The underlying exposures are not owned by a firm an
investment in which qualifies as a community development investment
under 12 U.S.C. 24(Eleventh);
* * * * *
i. In section 21, revise paragraph (a)(1) and (a)(2) to read as
follows:
Section 21. Modifications to Tier 1 and Tier 2 Capital
(a) * * *
(1) A bank is not required to make the deductions from capital
for CEIOs in 12 CFR part 3, appendix A, section 2(c)(1)(iv).
(2) A bank is not required to make the deductions from capital
for nonfinancial equity investments in 12 CFR part 3, appendix A,
section 2(c)(1)(v).
* * * * *
j. In section 33, revise paragraphs (c)(2) and (g)(3)(iv)(B) to
read as follows:
Section 33. General Risk Weights
* * * * *
(c)* * *
(2) A bank must assign a risk weight of at least 100 percent to
an exposure to a depository institution or a foreign bank that is
includable in the depository institution's or foreign bank's
regulatory capital and that is not subject to deduction as a
reciprocal holding pursuant to 12 CFR part 3, appendix A, section
2(c)(6)(ii).
* * * * *
(g) * * *
(3) * * *
(iv) * * *
(B) A bank must base all estimates of a property's value on an
appraisal or evaluation of the property that satisfies subpart C of
12 CFR part 34.
* * * * *
k. Revise paragraph (i)(1)(iv) and paragraph (i)(4) of section 42
to read as follows:
Section 42. Risk-Weighted Assets for Securitization Exposures
* * * * *
(i) * * *
(1) * * *
(iv) The bank is well capitalized, as defined in the OCC's
prompt corrective action regulation at 12 CFR part 6. For purposes
of determining whether a bank is well capitalized for purposes of
this paragraph, the bank's capital ratios must be calculated without
regard to the capital treatment for transfers of small-business
obligations with recourse specified in paragraph (i)(1) of this
section.
* * * * *
(4) The risk-based capital ratios of the bank must be calculated
without regard to the capital treatment for transfers of small-
business obligations with recourse specified in paragraph (i)(1) of
this section as provided in 12 CFR part 3, appendix A.
* * * * *
l. In section 52, revise paragraph (b)(3)(i) to read as follows:
Section 52. Simple Risk-Weight Approach (SRWA)
* * * * *
(b) * * *
(3) * * *
(i) Community development exposures. An equity exposure that
qualifies as a community development investment under 12 U.S.C.
24(Eleventh), excluding equity exposures to an unconsolidated small
[[Page 44056]]
business investment company and equity exposures held through a
consolidated small business investment company described in section
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *
m. In section 61, revise paragraph (c) to read as follows:
Section 61. Basic Indicator Approach
* * * * *
(c) Annual gross income. A bank's annual gross income equals its
net interest income plus its total noninterest income minus its
underwriting income from insurance and reinsurance activities as
reported on the bank's Call Report.
* * * * *
n. In section 71, revise paragraph (b) to read as follows:
Section 71. Disclosure Requirements
* * * * *
(b) A bank must comply with paragraph (c) of section 71 of
appendix H to the Federal Reserve Board's Regulation Y (12 CFR part
225, appendix H), including Tables 15.1--15.10, unless it is a
consolidated subsidiary of a bank holding company or depository
institution that is subject to these requirements.
* * * * *
o. In section 71, remove paragraph (c) and Tables 15.1-15.10.
Board of Governors of the Federal Reserve System
12 CFR Chapter II
Authority and Issuance
For the reasons stated in the common preamble, the Board of
Governors of the Federal Reserve System amends parts 208 and 225 of
chapter II of title 12 of the Code of Federal Regulations as follows:
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)
1. The authority citation for part 208 continues to read as
follows:
Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-338a,
371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9), 1823(j),
1828(o), 1831, 1831o, 1831p-1, 1831r-1, 1835a, 1882, 2901-2907,
3105, 3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b, 78l(b), 78l(g),
78l(i), 78o-4(c)(5), 78q, 78q-1, and 78w, 6801, and 6805; 31 U.S.C.
5318; 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128.
2. New Appendix G to part 208 is added as set forth at the end of
the common preamble.
3. Appendix G to part 208 is amended as set forth below:
a. Remove ``[agency]'' and add ``Federal Reserve'' in its place
wherever it appears.
b. Remove ``[BANK]'' and add ``bank'' in its place wherever it
appears, and remove ``[Banks]'' and add ``Banks'' in its place wherever
it appears.
c. Remove ``[Appendix -- to Part --]'' and add ``Appendix G to Part
208'' in its place wherever it appears.
d. Remove ``[the general risk-based capital rules]'' and add ``12
CFR part 208, appendix A'' in its place wherever it appears.
e. Remove ``[the market risk rule]'' and add ``12 CFR part 208,
appendix E'' in its place wherever it appears.
f. Remove ``[the advanced approaches risk-based capital rules]''
and add ``12 CFR part 208, appendix F'' in its place wherever it
appears.
g. In section 1, revise paragraph (e) to read as follows:
Section 1. Purpose, Applicability, Election Procedures, and Reservation
of Authority
* * * * *
(e) Notice and response procedures. In making a determination
under paragraphs (c)(3) or (d) of this section, the Federal Reserve
will apply notice and response procedures in the same manner as the
notice and response procedures in 12 CFR 263.202.
* * * * *
h. In section 2, revise the definitions of gain-on-sale, pre-sold
construction loan, statutory multifamily mortgage, and paragraph (7) of
the definition of traditional securitization to read as follows:
Section 2. Definitions
* * * * *
Gain-on-sale means an increase in the equity capital (as
reported on Schedule RC of the Consolidated Statement of Condition
and Income (Call Report)) of a bank that results from a
securitization (other than an increase in equity capital that
results from the bank's receipt of cash in connection with the
securitization). (See also securitization.)
* * * * *
Pre-sold construction loan means any one-to-four family
residential pre-sold construction loan for a residence meeting the
requirements under section 618(a)(1) or (2) of the Resolution Trust
Corporation Refinancing, Restructuring, and Improvement Act of 1991
(RTCRRI Act) and under 12 CFR part 208, appendix A, section III.C.3.
* * * * *
Statutory multifamily mortgage means any multifamily residential
mortgage meeting the requirements under section 618(b)(1) of the
RTCRRI Act and under 12 CFR part 208, appendix A, section III.C.3.
* * * * *
Traditional securitization * * *
(7) The underlying exposures are not owned by a firm an
investment in which qualifies as a community development investment
under 12 U.S.C. 24 (Eleventh);
* * * * *
i. In section 21, revise paragraphs (a)(1) and (2) to read as
follows:
Section 21. Modifications to Tier 1 and Tier 2 Capital
(a) * * *
(1) A bank is not required to make the deductions from capital
for CEIOs in 12 CFR part 208, appendix A, section II.B.1.e.
(2) A bank is not required to make the deductions from capital
for nonfinancial equity investments in 12 CFR part 208, appendix A,
section II.B.5.
* * * * *
j. In section 33, revise paragraphs (c)(2) and (g)(3)(iv)(B) to
read as follows:
Section 33. General Risk Weights
* * * * *
(c) * * *
(2) A bank must assign a risk weight of at least 100 percent to
an exposure to a depository institution or a foreign bank that is
includable in the depository institution's or foreign bank's
regulatory capital and that is not subject to deduction as a
reciprocal holding pursuant to 12 CFR part 208, appendix A, section
II.B.3.
* * * * *
(g) * * *
(3) * * *
(iv) * * *
(B) A bank must base all estimates of a property's value on an
appraisal or evaluation of the property that satisfies subpart E of
12 CFR part 208.
* * * * *
k. Revise paragraph (i)(1)(iv) and paragraph (i)(4) of section 42
to read as follows:
Section 42. Risk-Weighted Assets for Securitization Exposures
* * * * *
(i) * * *
(1) * * *
(iv) The bank is well capitalized, as defined in the Federal
Reserve's prompt corrective action regulation at 12 CFR part 208,
Subpart D. For purposes of determining whether a bank is well
capitalized for purposes of this paragraph, the bank's capital
ratios must be calculated without regard to the capital treatment
for transfers of small-business obligations with recourse specified
in paragraph (i)(1) of this section.
* * * * *
(4) The risk-based capital ratios of the bank must be calculated
without regard to the capital treatment for transfers of small-
business obligations with recourse specified in paragraph (i)(1) of
this section as provided in 12 CFR part 208, appendix A.
* * * * *
l. In section 52, revise paragraph (b)(3)(i) to read as follows:
Section 52. Simple Risk-Weight Approach (SRWA)
* * * * *
(b) * * *
(3) * * *
(i) Community development exposures. An equity exposure that
qualifies as a community development investment under 12 U.S.C. 24
(Eleventh), excluding equity exposures to an unconsolidated small
[[Page 44057]]
business investment company and equity exposures held through a
consolidated small business investment company described in section
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *
m. In section 61, revise paragraph (c) to read as follows:
Section 61. Basic Indicator Approach
* * * * *
(c) Annual gross income. A bank's annual gross income equals its
net interest income plus its total noninterest income minus its
underwriting income from insurance and reinsurance activities as
reported on the bank's Call Report.
* * * * *
n. In section 71, revise paragraph (b) to read as follows:
Section 71. Disclosure Requirements
* * * * *
(b) A bank must comply with paragraph (c) of section 71 of
appendix H to the Federal Reserve Board's Regulation Y (12 CFR part
225, appendix H), including Tables 15.1-15.10, unless it is a
consolidated subsidiary of a bank holding company or depository
institution that is subject to these requirements.
* * * * *
o. In section 71, remove paragraph (c) and remove Tables 15.1-
15.10.
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
1. The authority citation for part 225 continues to read as
follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-1,
1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, and
3909; 15 U.S.C. 6801 and 6805.
2. New Appendix H to part 225 is added as set forth at the end of
the common preamble.
3. Appendix H to part 225 is amended as set forth below:
a. Remove ``[agency]'' and add ``Federal Reserve'' in its place
wherever it appears.
b. Remove ``[BANK]'' and add in its place ``bank holding company''
wherever it appears, and remove ``[Banks]'' and add ``Bank Holding
Companies'' in its place wherever it appears.
c. Remove ``[Appendix -- to Part --]'' and add ``Appendix H to Part
225'' in its place wherever it appears.
d. Remove ``[the general risk-based capital rules]'' and add ``12
CFR part 225, appendix A'' in its place wherever it appears.
e. Remove ``[the market risk rule]'' and add ``12 CFR part 225,
appendix E'' in its place wherever it appears.
f. Remove ``[the advanced approaches risk-based capital rules]''
and add ``12 CFR part 225, appendix G'' in its place wherever it
appears.
g. In section 1, revise paragraphs (b) and (e) to read as follows:
Section 1. Purpose, Applicability, Election Procedures, and Reservation
of Authority
* * * * *
(b) Applicability. This appendix applies to a bank holding
company that elects to use this appendix to calculate its risk-based
capital requirements and that is not a consolidated subsidiary of
another bank holding company that uses this appendix to calculate
its risk-based capital requirements.
* * * * *
(e) Notice and response procedures. In making a determination
under paragraphs (c)(3) or (d) of this section, the Federal Reserve
will apply notice and response procedures in the same manner as the
notice and response procedures in 12 CFR 263.202.
* * * * *
h. In section 2, revise the definitions of gain-on-sale, pre-sold
construction loan, statutory multifamily mortgage, and paragraph (7) of
the definition of traditional securitization to read as follows:
Section 2. Definitions
* * * * *
Gain-on-sale means an increase in the equity capital (as
reported on Schedule HC of the FR Y-9C Report) of a bank holding
company that results from a securitization (other than an increase
in equity capital that results from the bank holding company's
receipt of cash in connection with the securitization). (See also
securitization.)
* * * * *
Pre-sold construction loan means any one-to-four family
residential pre-sold construction loan for a residence meeting the
requirements under section 618(a)(1) or (2) of the Resolution Trust
Corporation Refinancing, Restructuring, and Improvement Act of 1991
(RTCRRI Act) and under 12 CFR part 225, appendix A, section III.C.3.
* * * * *
Statutory multifamily mortgage means any multifamily residential
mortgage meeting the requirements under section 618(b)(1) of the
RTCRRI Act and under 12 CFR part 225, appendix A, section III.C.3.
* * * * *
Traditional securitization * * *
(7) The underlying exposures are not owned by a firm an
investment in which qualifies as a community development investment
under 12 U.S.C. 24(Eleventh);
* * * * *
i. In section 21, revise paragraphs (a)(1) and (2) and add a new
paragraph (c)(4) to read as follows:
Section 21. Modifications to Tier 1 and Tier 2 Capital
(a) * * *
(1) A bank holding company is not required to make the
deductions from capital for CEIOs in 12 CFR part 225, appendix A,
section II.B.1.e.
(2) A bank holding company is not required to make the
deductions from capital for nonfinancial equity investments in 12
CFR part 225, appendix A, section II.B.5.
* * * * *
(c) * * *
(4) A bank holding company must also deduct an amount equal to
the minimum regulatory capital requirement established by the
regulator of any insurance underwriting subsidiary of the holding
company. For U.S.-based insurance underwriting subsidiaries, this
amount generally would be 200 percent of the subsidiary's Authorized
Control Level as established by the appropriate state regulator of
the insurance company.
j. In section 33, revise paragraph (c)(2) to read as follows:
Section 33. General Risk Weights
* * * * *
(c) * * *
(2) A bank holding company must assign a risk weight of at least
100 percent to an exposure to a depository institution or a foreign
bank that is includable in the depository institution's or foreign
bank's regulatory capital and that is not subject to deduction as a
reciprocal holding pursuant to 12 CFR part 225, appendix A, section
II.B.3.
* * * * *
k. In paragraph (k)(1) of section 33, remove ``A [BANK] may assign
a zero percent risk weight to cash owned and held in all offices of the
[BANK] or in transit; to gold bullion held in the [BANK]'s own vaults,
or held in another depository institution's vaults on an allocated
basis, to the extent the gold bullion assets are offset by gold bullion
liabilities;'' and add in its place ``A bank holding company may assign
a zero percent risk weight to cash owned and held in all offices of
subsidiary depository institutions or in transit; to gold bullion held
in either a subsidiary depository institution's own vaults, or held in
another depository institution's vaults on an allocated basis, to the
extent the gold bullion assets are offset by gold bullion
liabilities;''
* * * * *
l. Revise paragraph (i)(1)(iv) and revise paragraph (i)(4) of
section 42 to read as follows:
Section 42. Risk-Weighted Assets for Securitization Exposures
* * * * *
(i) * * *
(1) * * *
(iv) The bank holding company is well capitalized, as defined in
the Federal Reserve's prompt corrective action regulation at 12 CFR
part 208, Subpart D. For purposes of determining whether a bank
holding company is well capitalized for purposes of this paragraph,
the bank holding company's capital ratios must be calculated without
regard to the capital treatment for transfers of
[[Page 44058]]
small-business obligations with recourse specified in paragraph
(i)(1) of this section.
* * * * *
(4) The risk-based capital ratios of the bank holding company
must be calculated without regard to the capital treatment for
transfers of small-business obligations with recourse specified in
paragraph (i)(1) of this section as provided in 12 CFR part 225,
appendix A.
* * * * *
m. In section 52, revise paragraph (b)(3)(i) to read as follows:
Section 52. Simple Risk-Weight Approach (SRWA)
* * * * *
(b) * * *
(3) * * *
(i) Community development exposures. An equity exposure that
qualifies as a community development investment under 12 U.S.C.
24(Eleventh), excluding equity exposures to an unconsolidated small
business investment company and equity exposures held through a
consolidated small business investment company described in section
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *
n. In section 61, revise paragraph (c) to read as follows:
Section 61. Basic Indicator Approach
* * * * *
(c) Annual gross income. A bank holding company's annual gross
income equals its net interest income plus its total noninterest
income minus its underwriting income from insurance and reinsurance
activities as reported on the bank holding company's Y-9C Report.
* * * * *
Federal Deposit Insurance Corporation
12 CFR Chapter III
Authority and Issuance
For the reasons stated in the common preamble, the Federal Deposit
Insurance Corporation amends part 325 of chapter III of Title 12, Code
of Federal Regulations as follows:
PART 325--CAPITAL MAINTENANCE
1. The authority citation for part 325 continues to read as
follows:
Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b),
1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n), 1828(o),
1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat. 1761, 1789, 1790
(12 U.S.C. 1831n, note); Pub. L. 102-242, 105 Stat. 2236, 2355, 2386
(12 U.S.C. 1828 note).
2. New Appendix E to part 325 is added as set forth at the end of
the common preamble.
3. Appendix E to part 325 is amended as set forth below:
a. Remove ``[agency]'' and add ``FDIC'' in its place wherever it
appears.
b. Remove ``[BANK]'' and add ``bank'' in its place wherever it
appears, and remove ``[Banks]'' and add ``Banks'' in its place wherever
it appears.
c. Remove ``[Appendix -- to Part --]'' and add ``Appendix E to Part
325'' in its place wherever it appears.
d. Remove ``[the general risk-based capital rules]'' and add ``12
CFR part 325, appendix A'' in its place wherever it appears.
e. Remove ``[the market risk rule]'' and add ``12 CFR part 325,
appendix C'' in its place wherever it appears.
f. Remove ``[the advanced approaches risk-based capital rules]''
and add ``12 CFR part 325, appendix D'' in its place wherever it
appears.
g. In section 1, revise paragraph (e) to read as follows:
Section 1. Purpose, Applicability, Election Procedures, and Reservation
of Authority
* * * * *
(e) Notice and response procedures. In making a determination
under paragraphs (c)(3) or (d) of this section, the FDIC will apply
notice and response procedures in the same manner as the notice and
response procedures in 12 CFR 325.6(c).
* * * * *
h. In section 2, revise the definitions of gain-on-sale, pre-sold
construction loan, statutory multifamily mortgage, and paragraph (7) of
the definition of traditional securitization to read as follows:
Section 2. Definitions
* * * * *
Gain-on-sale means an increase in the equity capital (as
reported on Schedule RC of the Consolidated Statement of Condition
and Income (Call Report)) of a bank that results from a
securitization (other than an increase in equity capital that
results from the bank's receipt of cash in connection with the
securitization). (See also securitization.)
* * * * *
Pre-sold construction loan means any one-to-four family
residential pre-sold construction loan for a residence meeting the
requirements under section 618(a)(1) or (2) of the Resolution Trust
Corporation Refinancing, Restructuring, and Improvement Act of 1991
(RTCRRI Act) and under 12 CFR part 325, appendix A, section II.C,
and that is not 90 days or more past due or on nonaccrual.
* * * * *
Statutory multifamily mortgage means any multifamily residential
mortgage meeting the requirements under section 618(b)(1) of the
RTCRRI Act and under 12 CFR part 325, appendix A, section II.C.
* * * * *
Traditional securitization * * *
(7) The underlying exposures are not owned by a firm an
investment in which qualifies as a community development investment
under 12 U.S.C. 24(Eleventh);
* * * * *
i. In section 21, revise paragraph (a)(1) and (a)(2) to read as
follows:
Section 21. Modifications to Tier 1 and Tier 2 Capital
(a) * * *
(1) A bank is not required to make the deductions from capital
for CEIOs in 12 CFR part 325, appendix A, section II.B.5.
(2) A bank is not required to make the deductions from capital
for nonfinancial equity investments in 12 CFR part 325, appendix A,
section II.B.
* * * * *
j. In section 33, revise paragraphs (c)(2) and (g)(3)(iv)(B) to
read as follows:
Section 33. General Risk Weights
* * * * *
(c) * * *
(2) A bank must assign a risk weight of at least 100 percent to
an exposure to a depository institution or a foreign bank that is
includable in the depository institution's or foreign bank's
regulatory capital and that is not subject to deduction as a
reciprocal holding pursuant to 12 CFR part 325, appendix A, section
I.B.(4).
* * * * *
(g) * * *
(3) * * *
(iv) * * *
(B) A bank must base all estimates of a property's value on an
appraisal or evaluation of the property that satisfies 12 CFR part
323.
* * * * *
k. Revise paragraph (i)(1)(iv) and paragraph (i)(4) of section 42
to read as follows:
Section 42. Risk-Weighted Assets for Securitization Exposures
* * * * *
(i) * * *
(1) * * *
(iv) The bank is well capitalized, as defined in the FDIC's
prompt corrective action regulation at 12 CFR part 325, subpart B.
For purposes of determining whether a bank is well capitalized for
purposes of this paragraph, the bank's capital ratios must be
calculated without regard to the capital treatment for transfers of
small-business obligations with recourse specified in paragraph
(i)(1) of this section.
* * * * *
(4) The risk-based capital ratios of the bank must be calculated
without regard to the capital treatment for transfers of small-
business obligations with recourse specified in paragraph (i)(1) of
this section as provided in 12 CFR part 325, appendix A.
* * * * *
l. In section 52, revise paragraph (b)(3)(i) to read as follows:
Section 52. Simple Risk-Weight Approach (SRWA)
* * * * *
(b) * * *
(3) * * *
(i) Community development exposures. An equity exposure that
qualifies as a community development investment under 12 U.S.C.
24(Eleventh), excluding equity exposures to an unconsolidated small
[[Page 44059]]
business investment company and equity exposures held through a
consolidated small business investment company described in section
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *
m. In section 61, revise paragraph (c) to read as follows:
Section 61. Basic Indicator Approach
* * * * *
(c) Annual gross income. A bank's annual gross income equals its
net interest income plus its total noninterest income minus its
underwriting income from insurance and reinsurance activities as
reported on the bank's Call Report.
* * * * *
n. In section 71, revise paragraph (b) to read as follows:
Section 71. Disclosure Requirements
* * * * *
(b) A bank must comply with paragraph (c) of section 71 of
appendix H to the Federal Reserve Board's Regulation Y (12 CFR part
225, appendix H), including Tables 15.1-15.10, unless it is a
consolidated subsidiary of a bank holding company or depository
institution that is subject to these requirements.
* * * * *
o. In section 71, remove paragraph (c) and Tables 15.1-15.10.
Department of the Treasury
Office of Thrift Supervision
12 CFR Chapter V
Authority and Issuance
For the reasons stated in the common preamble, the Office of Thrift
Supervision amends Part 567 of chapter V of Title 12, Code of Federal
Regulations as follows:
PART 567--CAPITAL
1. The authority citation for part 567 continues to read as
follows:
Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1467a, 1828(note).
2. In Sec. 567.0, revise paragraph (a), redesignate paragraph (b)
as paragraph (c), add new paragraph (b), and amend redesignated
paragraph (c) by adding a new heading and by revising paragraph
(c)(2)(ii) to read as follows:
Sec. 567.0 Scope.
(a) General. This part prescribes the minimum regulatory capital
requirements for savings associations. Subpart B of this part applies
to all savings associations, except as described in paragraphs (b) and
(c) of this section.
(b) Savings associations using the standardized approach rule. (1)
A savings association that uses Appendix B of this part must utilize
the methodologies in that appendix to calculate their risk based
capital requirement and make the required disclosures described in that
appendix.
(2) Subpart B of this part does not apply to the computation of
risk-based capital requirements by a savings association that uses
Appendix B of this part. However, these savings associations:
(i) Must compute the components of capital under Sec. 567.5
subject to the modifications in section 21 of Appendix B of this part.
(ii) Must meet the leverage ratio requirement described at
Sec. Sec. 567.2(a)(2) and 567.8. Notwithstanding paragraph (b)(2)(i)
of this section, the savings association must compute core (tier 1)
capital under section 567.5.
(iii) Must meet the tangible capital requirement described at
Sec. Sec. 567.2(a)(3) and 567.9.
(iv) Are subject to Sec. Sec. 567.3 (individual minimum capital
requirement), 567.4 (capital directives); and 567.10 (consequences of
failure to meet capital requirements).
(v) Are subject to the reservations of authority at Sec. 567.11,
which supplement the reservations of authority at section 1 of Appendix
B of this part.
(c) Savings associations using the advanced approaches rule.
* * * * *
(2) * * *
(ii) Must meet the leverage ratio requirement described at
Sec. Sec. 567.2(a)(2) and 567.8. Notwithstanding paragraph (c)(2)(i)
of this section, the savings association must compute core (tier 1)
capital under section 567.5.
* * * * *
2. Appendix B is added to part 567 as set forth at the end of the
common preamble.
3. Amend Appendix B of part 567 as follows:
a. Revise the heading of Appendix B to read as follows:
Appendix B to Part 567--Risk-Based Capital Requirements--Standardized
Framework
b. Remove [agency] and add ``OTS'' in its place wherever it
appears.
c. Remove ``[BANK]'' and add ``savings association'' in its place
wherever it appears, and remove ``[Banks]'' and add ``Savings
Associations'' in its place wherever it appears.
d. Remove ``[Appendix -- to Part --]'' and add ``Appendix B to Part
567'' in its place wherever it appears.
e. Remove ``[the general risk-based capital rules]'' and add
``subpart B of part 567'' in its place wherever it appears.
f. Remove ``[the market risk rule]'' and add ``any applicable
market risk rule'' in its place wherever it appears.
g. Remove ``[the advanced approaches risk-based capital rules] and
add ``Appendix C to Part 567'' in its place wherever it appears.
h. In section 1, revise paragraph (e) to read as follows:
Section 1. Purpose, Applicability, Election Procedures, and Reservation
of Authority
* * * * *
(e) Notice and response procedures. In making a determination
under paragraphs (c)(3) or (d) of this section, the [agency] will
apply notice and response procedures in the same manner as the
notice and response procedures in 12 CFR 567.3(d).
* * * * *
i. In section 2, revise the definitions of gain-on-sale, pre-sold
construction loan, statutory multifamily loan, and paragraph (7) of the
definition of traditional securitization to read as follows:
Section 2. Definitions
* * * * *
Gain-on-sale means an increase in the equity capital (as
reported on Schedule SC of the Thrift Financial Report) of a savings
association that results from a securitization (other than an
increase in equity capital that results from the savings
association's receipt of cash in connection with the
securitization). (See also securitization.)
* * * * *
Pre-sold construction loan means any one-to-four family
residential pre-sold construction loan for a residence meeting the
requirements under section 618(a)(1) or (2) of the Resolution Trust
Corporation Refinancing, Restructuring, and Improvement Act of 1991
(RTCRRI Act) and 12 CFR 567.1 (definition of ``qualifying
residential construction loan''), and that is not on nonaccrual.
* * * * *
Statutory multifamily mortgage means any multifamily residential
mortgage that:
(1) Meets the requirements under section 618(b)(1) of the RTCRRI
Act and under 12 CFR 567.1 (definition of ``qualifying multifamily
mortgage loan'') and 12 CFR 567.6(a)(1)(iii); and
(2) Is not on nonaccrual.
* * * * *
Traditional securitization * * *
(7) The underlying exposures are not owned by a firm an
investment in which is designed primarily to promote community
welfare, including the welfare of low- and moderate-income
communities or families, such as by providing services or jobs.
* * * * *
j. Revise paragraphs (a)(1) and (2) of section 21 to read as
follows:
Section 21. Modifications to Tier 1 and Tier 2 Capital
* * * * *
(a) * * *
[[Page 44060]]
(1) A savings association is not required to make the deductions
from capital for CEIOs in 12 CFR 567.5(a)(2)(iii) and 567.12(e);
(2) A savings association is not required to deduct equity
securities from capital under 12 CFR 567.5(c)(2)(ii). However, it
must continue to deduct equity investments in real estate under that
section. See 12 CFR 567.1, which defines equity investments,
including equity securities and equity investments in real estate.
* * * * *
k. Revise paragraphs (c)(2) and (g)(3)(iv)(B) of section 33 to read
as follows:
Section 33. General Risk Weights
* * * * *
(c) * * *
(2) A savings association must assign a risk weight of at least
100 percent to an exposure to a depository institution or a foreign
bank that is includable in the depository institution's or foreign
bank's regulatory capital and that is not subject to deduction as a
reciprocal holding pursuant to 12 CFR part 567.5(c)(2)(i).
* * * * *
(g) * * *
(3) * * *
(iv) * * *
(B) A savings association must base all estimates of a
property's value on an appraisal or evaluation of the property that
satisfies 12 CFR part 564.
* * * * *
l. Revise the first sentence of paragraph (i)(1)(iv) and paragraph
(i)(4) of section 42 to read as follows:
Section 42. Risk-Weighted Assets for Securitization Exposures
* * * * *
(i) * * *
(1) * * *
(iv) The savings association is well capitalized, as defined in
the OTS 's prompt corrective action regulation at 12 CFR part 565. *
* *
* * * * *
(4) The risk-based capital ratios of the savings association
must be calculated without regard to the capital treatment for
transfers of small-business obligations with recourse specified in
paragraph (i)(1) of this section as provided in 12 CFR
567.6(b)(5)(v).
* * * * *
m. Revise paragraph (b)(3)(i) of section 52 to read as follows:
Section 52. Simple Risk-Weight Approach (SRWA)
* * * * *
(b) * * *
(3) * * *
(i) Community development equity exposures. An equity exposure
that is designed primarily to promote community welfare, including
the welfare of low- and moderate-income communities or families,
such as by providing services or jobs, excluding equity exposures to
an unconsolidated small business investment company and equity
exposures held through a consolidated small business investment
company described in section 302 of the Small Business Investment
Act of 1958 (15 U.S.C. 682).
* * * * *
n. Revise paragraph (c) in section 61 to read as follows:
Section 61. Basic Indicator Approach
* * * * *
(c) Annual gross income. Annual gross income equals a savings
association's net interest income (expense) before provision for
losses on interest-bearing assets, plus total noninterest income,
minus the portion of its other fees and charges that represents
income derived from insurance and reinsurance underwriting
activities, minus (plus) its net income (loss) from the sale of
assets held for sale and available-for-sale securities to include
only the profit or loss from the disposition of available-for-sale
securities pursuant to FASB Statement No. 115, minus (plus) its net
income (loss) from the sale of securities held-to-maturity, all as
reported on the savings association's year-end Thrift Financial
Report.
* * * * *
o. In section 71, revise paragraph (b) to read as follows:
Section 71. Disclosure Requirements
* * * * *
(b) A savings association must comply with paragraph (c) of this
section, unless it is a consolidated subsidiary of a bank holding
company or depository institution that is subject to these
requirements.
* * * * *
Dated: July 2, 2008.
John C. Dugan,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System, July 10, 2008.
Jennifer J. Johnson,
Secretary of the Board.
Dated at Washington, DC, this 25th day of June 2008.
By order of the Board of Directors. Federal Deposit Insurance
Corporation.
Robert E. Feldman,
Executive Secretary.
Dated: July 2, 2008.
By the Office of Thrift Supervision.
John M. Reich,
Director.
[FR Doc. E8-16262 Filed 7-28-08; 8:45 am]
BILLING CODE 4810-33-P, 6210-01-P, 6714-01-P, 6720-01-P