[Code of Federal Regulations]
[Title 12 Volume 1]
[Revised as of January 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 12CFR3.100]
[Page 18-50]
TITLE 12--BANKS AND BANKING
CHAPTER I--COMPTROLLER OF THE CURRENCY, DEPARTMENT OF THE TREASURY
PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES--Table of Contents
Subpart E--Issuance of a Directive
Sec. 3.100 Capital and surplus.
For purposes of determining statutory limits that are based on the
amount of bank's capital and/or surplus, the provisions of this section
are to be used, rather than the definitions of capital contained in
Sec. 3.2.
(a) Capital. The term capital as used in provisions of law relating
to the capital of national banking associations shall include the amount
of common
[[Page 19]]
stock outstanding and unimpaired plus the amount of perpetual preferred
stock outstanding and unimpaired.
(b) Capital Stock. The term capital stock as used in provisions of
law relating to the capital stock of national banking associations,
other than 12 U.S.C. 101, 177 and 178, shall have the same meaning as
the term capital set forth in paragraph (a) of this section.
(c) Surplus. The term surplus as used in provisions of law relating
to the surplus of national banking associations means the sum of
paragraphs (c) (1), (2), (3) and (4) of this section:
(1) Capital surplus; undivided profits; reserves for contingencies
and other capital reserves (excluding accrued dividends on perpetual and
limited life preferred stock); net worth certificates issued pursuant to
12 U.S.C. 1823(i); minority interests in consolidated subsidiaries; and
allowances for loan and lease losses; minus intangible assets;
(2) Mortgage servicing assets;
(3) Mandatory convertible debt to the extent of 20% of the sum of
paragraphs (a) and (c) (1) and (2) of this section;
(4) Other mandatory convertible debt, limited life preferred stock
and subordinated notes and debentures to the extent set forth in
paragraph (f)(2) of this section.
(d) Unimpaired Surplus Fund. The term unimpaired surplus fund as
used in provisions of law relating to the unimpaired surplus fund of
national banking associations shall have the same meaning as the term
surplus set forth in paragraph (c) of this section.
(e) Definitions. (1) Allowance for loan and lease losses means the
balance of the valuation reserve on December 31, 1968, plus additions to
the reserve charged to operations since that date, less losses charged
against the allowance net of recoveries.
(2) Capital surplus means the total of those accounts reflecting:
(i) Amounts paid in in excess of the par or stated value of capital
stock;
(ii) Amounts contributed to the bank other than for capital stock;
(iii) amounts transferred from undivided profits pursuant to 12
U.S.C. 60; and
(iv) Other amounts transferred from undivided profits.
(3) Intangible assets means those purchased assets that are to be
reported as intangible assets in accordance with the Instructions--
Consolidated Reports of Condition and Income (Call Report).
(4) Limited Life preferred stock means preferred stock which has a
maturity or which may be redeemed at the option of the holder.
(5) Mandatory convertible debt means subordinated debt instruments
which unqualifiedly require the issuer to exchange either common or
perpetual preferred stock for such instruments by a date at or before
the maturity of the instrument. The maturity of these instruments must
be 12 years or less. In addition, the instrument must meet the
requirements of paragraphs (f)(1)(i) through (v) of this section for
subordinated notes and debentures or other requirements published by the
OCC.
(6) Minority interest in consolidated subsidiaries means the portion
of equity capital accounts of all consolidated subsidiaries of the bank
that is allocated to minority shareholders of such subsidiaries.
(7) Mortgage servicing assets means the bank-owned rights to service
for a fee mortgage loans that are owned by others.
(8) Perpetual preferred stock means preferred stock that does not
have a stated maturity date and cannot be redeemed at the option of the
holder.
(f) Requirements and restrictions: Limited life preferred stock,
mandatory convertible debt, and other subordinated debt--(1)
Requirements. Issues of limited life preferred stock and subordinated
notes and debentures (except mandatory convertible debt) shall have
original weighted average maturities of at least five years to be
included in the definition of surplus. In addition, a subordinated note
or debenture must also:
(i) Be subordinated to the claims of depositors;
(ii) State on the instrument that it is not a deposit and is not
insured by the FDIC;
(iii) Be unsecured;
(iv) Be ineligible as collateral for a loan by the issuing bank;
(v) Provide that once any scheduled payments of principal begin, all
scheduled payments shall be made at least annually and the amount repaid
in
[[Page 20]]
each year shall be no less than in the prior year; and
(vi) Provide that no prepayment (including payment pursuant to an
acceleration clause or redemption prior to maturity) shall be made
without prior OCC approval unless the bank remains an eligible bank, as
defined in 12 CFR 5.3(g), after the prepayment.
(2) Restrictions. The total amount of mandatory convertible debt not
included in paragraph (c)(3) of this section, limited life preferred
stock, and subordinated notes and debentures considered as surplus is
limited to 50 percent of the sum of paragraphs (a) and (c) (1), (2) and
(3) of this section.
(3) Reservation of authority. The OCC expressly reserves the
authority to waive the requirements and restrictions set forth in
paragraphs (f) (1) and (2) of this section, in order to allow the
inclusion of other limited life preferred stock, mandatory convertible
notes and subordinated notes and debentures in the capital base of any
national bank for capital adequacy purposes or for purposes of
determining statutory limits. The OCC further expressly reserves the
authority to impose more stringent conditions than those set forth in
paragraphs (f) (1) and (2) of this section to exclude any component of
Tier 1 or Tier 2 capital, in whole or in part, as part of a national
bank's capital and surplus for any purpose.
(g) Transitional rules. (1) Equity commitment notes approved by the
OCC as capital and issued prior to April 15, 1985, may continue to be
included in paragraph (c)(3) of this section. All other instruments
approved by the OCC as capital and issued prior to April 15, 1985, are
to be included in paragraph (c)(4) of this section.
(2) Intangible assets (other than mortgage servicing assets)
purchased prior to April 15, 1985, and accounted for in accordance with
OCC instructions, may continue to be included as surplus up to 25% of
the sum of paragraphs (a) and (c)(1) of this section.
(Approved by the Office of Management and Budget under control number
1557-0166)
[50 FR 10216, Mar. 14, 1985, as amended at 55 FR 38801, Sept. 21, 1990;
60 FR 39229, Aug. 1, 1995; 61 FR 60363, Nov. 27, 1996; 63 FR 42674, Aug.
10, 1998]
Appendix A to Part 3--Risk-Based Capital Guidelines
Section 1. Purpose, Applicability of Guidelines, and Definitions.
(a) Purpose. (1) An important function of the Office of the
Comptroller of the Currency (OCC) is to evaluate the adequacy of capital
maintained by each national bank. Such an evaluation involves the
consideration of numerous factors, including the riskiness of a bank's
assets and off-balance sheet items. This appendix A implements the OCC's
risk-based capital guidelines. The risk-based capital ratio derived from
those guidelines is more systematically sensitive to the credit risk
associated with various bank activities than is a capital ratio based
strictly on a bank's total balance sheet assets. A bank's risk-based
capital ratio is obtained by dividing its capital base (as defined in
section 2 of this appendix A) by its risk-weighted assets (as calculated
pursuant to section 3 of this appendix A). These guidelines were created
within the framework established by the report issued by the Committee
on Banking Regulations and Supervisory Practices in July 1988. The OCC
believes that the risk-based capital ratio is a useful tool in
evaluating the capital adequacy of all national banks, not just those
that are active in the international banking system.
(2) The purpose of this appendix A is to explain precisely (i) how a
national bank's risk-based capital ratio is determined and (ii) how
these risk-based capital guidelines are applied to national banks. The
OCC will review these guidelines periodically for possible adjustments
commensurate with its experience with the risk-based capital ratio and
with changes in the economy, financial markets and domestic and
international banking practices.
(b) Applicability. (1) The risk-based capital ratio derived from
these guidelines is an important factor in the OCC's evaluation of a
bank's capital adequacy. However, since this measure addresses only
credit risk, the 8% minimum ratio should not be viewed as the level to
be targeted, but rather as a floor. The final supervisory judgment on a
bank's capital adequacy is based on an individualized assessment of
numerous factors, including those listed in 12 CFR 3.10. With respect to
the consideration of these factors, the OCC will give particular
attention to any bank with significant exposure to declines in the
economic value of its capital due to changes in interest rates. As a
result, it may differ from the conclusion drawn from an isolated
comparison of a bank's risk-based capital ration to the 8% minimum
specified in these guidelines. In addition to the standards established
by these risk-based capital guidelines, all national banks must maintain
a minimum capital-to-total assets ratio in
[[Page 21]]
accordance with the provisions of 12 CFR part 3.
(2) Effective December 31, 1990, these risk-based capital guidelines
will apply to all national banks. In the interim, banks must maintain
minimum capital-to-total assets ratios as required by 12 CFR part 3, and
should begin preparing for the implementation of these risk-based
capital guidelines. In this regard, each national bank that does not
currently meet the final minimum ratio established in section 4(b)(1) of
this appendix A should begin planning for achieving that standard.
(3) These risk-based capital guidelines will not be applied to
federal branches and agencies of foreign banks.
(c) Definitions. For purposes of this appendix A, the following
definitions apply:
(1) Adjusted carrying value means, for purposes of section 2(c)(5)
of this appendix A, the aggregate value that investments are carried on
the balance sheet of the bank reduced by any unrealized gains on the
investments that are reflected in such carrying value but excluded from
the bank's Tier 1 capital and reduced by any associated deferred tax
liabilities. For example, for investments held as available-for-sale
(AFS), the adjusted carrying value of the investments would be the
aggregate carrying value of the investments (as reflected on the
consolidated balance sheet of the bank) less any unrealized gains on
those investments that are included in other comprehensive income and
that are not reflected in Tier 1 capital, and less any associated
deferred tax liabilities. Unrealized losses on AFS nonfinancial equity
investments must be deducted from Tier 1 capital in accordance with
section 1(c)(8) of this appendix A. The treatment of small business
investment companies that are consolidated for accounting purposes under
generally accepted accounting principles is discussed in section
2(c)(5)(ii) of this appendix A. For investments in a nonfinancial
company that is consolidated for accounting purposes, the bank's
adjusted carrying value of the investment is determined under the equity
method of accounting (net of any intangibles associated with the
investment that are deducted from the bank's Tier 1 capital in
accordance with section 2(c)(2) of this appendix A). Even though the
assets of the nonfinancial company are consolidated for accounting
purposes, these assets (as well as the credit equivalent amounts of the
company's off-balance sheet items) are excluded from the bank's risk-
weighted assets.
(2) Allowances for loan and lease losses means the balance of the
valuation reserve on December 31, 1968, plus additions to the reserve
charged to operations since that date, less losses charged against the
allowance net of recoveries.
(3) Asset-backed commercial paper program means a program that
issues commercial paper backed by assets or other exposures held in a
bankruptcy-remote special purpose entity.
(4) Associated company means any corporation, partnership, business
trust, joint venture, association or similar organization in which a
national bank directly or indirectly holds a 20 to 50 percent ownership
interest.
(5) Banking and finance subsidiary means any subsidiary of a
national bank that engages in banking- and finance-related activities.
(6) Cash items in the process of collection means checks or drafts
in the process of collection that are drawn on another depository
institution, including a central bank, and that are payable immediately
upon presentation in the country in which the reporting bank's office
that is clearing or collecting the check or draft is located; U.S.
Government checks that are drawn on the United States Treasury or any
other U.S. Government or Government-sponsored agency and that are
payable immediately upon presentation; broker's security drafts and
commodity or bill-of-lading drafts payable immediately upon presentation
in the United States or the country in which the reporting bank's office
that is handling the drafts is located; and unposted debits.
(7) Central government means the national governing authority of a
country; it includes the departments, ministries and agencies of the
central government and the central bank. The U.S. Central Bank includes
the 12 Federal Reserve Banks. The definition of central government does
not include the following: State, provincial, or local governments;
commercial enterprises owned by the central government, which are
entities engaged in activities involving trade, commerce, or profit that
are generally conducted or performed in the private sector of the United
States economy; and non-central government entities whose obligations
are guaranteed by the central government.
(8) Commitment means any arrangement that obligates a national bank
to: (i) Purchase loans or securities; or (ii) extend credit in the form
of loans or leases, participations in loans or leases, overdraft
facilities, revolving credit facilities, or similar transactions.
(9) Common stockholders' equity means common stock, common stock
surplus, undivided profits, capital reserves, and adjustments for the
cumulative effect of foreign currency translation, less net unrealized
holding losses on available-for-sale equity securities with readily
determinable fair values.
(10) Conditional guarantee means a contingent obligation of the
United States Government or its agencies, or the central government of
an OECD country, the validity of which to the beneficiary is dependent
upon
[[Page 22]]
some affirmative action--e.g., servicing requirements--on the part of
the beneficiary of the guarantee or a third party.
(11) Deferred tax assets means the tax consequences attributable to
tax carryforwards and deductible temporary differences. Tax
carryforwards are deductions or credits that cannot be used for tax
purposes during the current period, but can be carried forward to reduce
taxable income or taxes payable in a future period or periods. Temporary
differences are financial events or transactions that are recognized in
one period for financial statement purposes, but are recognized in
another period or periods for income tax purposes. Deductible temporary
differences are temporary differences that result in a reduction of
taxable income in a future period or periods.
(12) Derivative contract means generally a financial contract whose
value is derived from the values of one or more underlying assets,
reference rates or indexes of asset values. Derivative contracts include
interest rate, foreign exchange rate, equity, precious metals and
commodity contracts, or any other instrument that poses similar credit
risks.
(13) Depository institution means a financial institution that
engages in the business of banking; that is recognized as a bank by the
bank supervisory or monetary authorities of the country of its
incorporation and the country of its principal banking operations; that
receives deposits to a substantial extent in the regular course of
business; and that has the power to accept demand deposits. In the U.S.,
this definition encompasses all federally insured offices of commercial
banks, mutual and stock savings banks, savings or building and loan
associations (stock and mutual), cooperative banks, credit unions, and
international banking facilities of domestic depository institution.
Bank holding companies are excluded from this definition. For the
purposes of assigning risk weights, the differentiation between OECD
depository institutions and non-OECD depository institutions is based on
the country of incorporation. Claims on branches and agencies of foreign
banks located in the United States are to be categorized on the basis of
the parent bank's country of incorporation.
(14) Equity investment means, for purposes of section 1(c)(19) and
section 2(c)(5) of this appendix A, any equity instrument including
warrants and call options that give the holder the right to purchase an
equity instrument, any equity feature of a debt instrument (such as a
warrant or call option), and any debt instrument that is convertible
into equity. An investment in any other instrument, including
subordinated debt or other types of debt instruments, may be treated as
an equity investment if the OCC determines that the instrument is the
functional equivalent of equity or exposes the bank to essentially the
same risks as an equity instrument.
(15) Exchange rate contracts include: Cross-currency interest rate
swaps; forward foreign exchange rate contracts; currency options
purchased; and any similar instrument that, in the opinion of the OCC,
gives rise to similar risks.
(16) Goodwill means an intangible asset that represents the excess
of the purchase price over the fair market value of tangible and
identifiable intangible assets acquired in purchases accounted for under
the purchase method of accounting.
(17) Intangible assets include mortgage and non-mortgage servicing
assets (but exclude any interest only (IO) strips receivable related to
these mortgage and nonmortgage servicing assets), purchased credit card
relationships, goodwill, favorable leaseholds, and core deposit value.
(18) Interest rate contracts include: Single currency interest rate
swaps; basis swaps; forward rate agreements; interest rate options
purchased; forward forward deposits accepted; and any similar instrument
that, in the opinion of the OCC, gives rise to similar risks, including
when-issued securities.
(19) Multifamily residential property means any residential property
consisting of five or more dwelling units including apartment buildings,
condominiums, cooperatives, and other similar structures primarily for
residential use, but not including hospitals, nursing homes, or other
similar facilities.
(20) Nationally recognized statistical rating organization (NRSRO)
means an entity recognized by the Division of Market Regulation of the
Securities and Exchange Commission (or any successor Division)
(Commission or SEC) as a nationally recognized statistical rating
organization for various purposes, including the Commission's uniform
net capital requirements for brokers and dealers.
(21) Nonfinancial equity investment means any equity investment held
by a bank in a nonfinancial company through a small business investment
company (SBIC) under section 302(b) of the Small Business Investment Act
of 1958 (15 U.S.C. 682(b)) or under the portfolio investment provisions
of Regulation K (12 CFR 211.8(c)(3)). An equity investment made under
section 302(b) of the Small Business Investment Act of 1958 in a SBIC
that is not consolidated with the bank is treated as a nonfinancial
equity investment in the manner provided in section 2(c)(5)(ii)(C) of
this appendix A. A nonfinancial company is an entity that engages in any
activity that has not been determined to be permissible for a bank to
conduct directly or to be financial in nature or incidental to financial
activities under section 4(k) of the Bank Holding Company Act (12 U.S.C.
1843(k)).
(22) The OECD-based group of countries comprises all full members of
the Organization
[[Page 23]]
for Economic Cooperation and Development (OECD) regardless of entry
date, 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,\1\ but excludes any country
that has rescheduled its external sovereign debt within the previous
five years. These countries are hereinafter referred to as OECD
countries. A rescheduling of external sovereign debt generally would
include any renegotiation of terms arising from a country's inability or
unwillingness to meet its external debt service obligations, but
generally would not include renegotiations of debt in the normal course
of business, such as a renegotiation to allow the borrower to take
advantage of a decline in interest rates or other change in market
conditions.
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\1\ As of November 1995, the OECD included the following countries:
Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany,
Greece, Iceland, Ireland, Italy, Japan, Luxembourg, Mexico, the
Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland,
Turkey, the United Kingdom, and the United States; and Saudi Arabia had
concluded special lending arrangements with the IMF associated with the
IMF's General Arrangements to Borrow.
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(23) Original maturity means, with respect to a commitment, the
earliest possible date after a commitment is made on which the
commitment is scheduled to expire (i.e., it will reach its stated
maturity and cease to be binding on either party), provided that either:
(i) The commitment is not subject to extension or renewal and will
actually expire on its stated expiration date; or
(ii) If the commitment is subject to extension or renewal beyond its
stated expiration date, the stated expiration date will be deemed the
original maturity only if the extension or renewal must be based upon
terms and conditions independently negotiated in good faith with the
customer at the time of the extension or renewal and upon a new, bona
fide credit analysis utilizing current information on financial
condition and trends.
(24) Preferred stock includes the following instruments: (i)
Convertible preferred stock, which means preferred stock that is
mandatorily convertible into either common or perpetual preferred stock;
(ii) Intermediate-term preferred stock, which means preferred stock with
an original maturity of at least five years, but less than 20 years;
(iii) Long-term preferred stock, which means preferred stock with an
original maturity of 20 years or more; and (iv) Perpetual preferred
stock, which means preferred stock without a fixed maturity date that
cannot be redeemed at the option of the holder, and that has no other
provisions that will require future redemption of the issue. For
purposes of these instruments, preferred stock that can be redeemed at
the option of the holder is deemed to have an original maturity of the
earliest possible date on which it may be so redeemed.
(25) Public-sector entities include states, local authorities and
governmental subdivisions below the central government level in an OECD
country. In the United States, this definition encompasses a state,
county, city, town, or other municipal corporation, a public authority,
and generally any publicly-owned entity that is an instrumentality of a
state or municipal corporation. This definition does not include
commercial companies owned by the public sector.\1a\
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\1a\ See Definition (5), Central government, for further explanation
of commercial companies owned by the public sector.
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(26) Reciprocal holdings of bank capital instruments means cross-
holdings or other formal or informal arrangements in which two or more
banking organizations swap, exchange, or otherwise agree to hold each
other's capital instruments. This definition does not include holdings
of capital instruments issued by other banking organizations that were
taken in satisfaction of debts previously contracted, provided that the
reporting national bank has not held such instruments for more than five
years or a longer period approved by the OCC.
(27) Replacement cost means, with respect to interest rate and
exchange rate contracts, the loss that would be incurred in the event of
a counterparty default, as measured by the net cost of replacing the
contract at the current market value. If default would result in a
theoretical profit, the replacement value is considered to be zero. The
mark-to-market process should incorporate changes in both interest rates
and counterparty credit quality.
(28) Residential properties means houses, condominiums, cooperative
units, and manufactured homes. This definition does not include boats or
motor homes, even if used as a primary residence.
(29) Risk-weighted assets means the sum of total risk-weighted
balance sheet assets and the total of risk-weighted off-balance sheet
credit equivalent amounts. Risk-weighted balance sheet and off-balance
sheet assets are calculated in accordance with section 3 of this
appendix A.
(30) Sponsor means a bank that:
(i) Establishes an asset-backed commercial paper program;
(ii) Approves the sellers permitted to participate in the asset-
backed commercial paper program;
[[Page 24]]
(iii) Approves the asset pools to be purchased by the asset-backed
commercial paper program; or
(iv) Administers the asset-backed commercial paper program by
monitoring the assets, arranging for debt placement, compiling monthly
reports, or ensuring compliance with the program documents and with the
program's credit and investment policy.
(31) State means any one of the several states of the United States
of America, the District of Columbia, Puerto Rico, and the territories
and possessions of the United States.
(32) Subsidiary means any corporation, partnership, business trust,
joint venture, association or similar organization in which a national
bank directly or indirectly holds more than a 50% ownership interest.
This definition does not include ownership interests that were taken in
satisfaction of debts previously contracted, provided that the reporting
bank has not held the interest for more than five years or a longer
period approved by the OCC.
(33) Total capital means the sum of a national bank's core (Tier 1)
and qualifying supplementary (Tier 2) capital elements.
(34) Unconditionally cancelable means, with respect to a commitment-
type lending arrangement, that the bank may, at any time, with or
without cause, refuse to advance funds or extend credit under the
facility. In the case of home equity lines of credit, the bank is deemed
able to unconditionally cancel the commitment if it can, at its option,
prohibit additional extensions of credit, reduce the line, and terminate
the commitment to the full extent permitted by relevant Federal law.
(35) United States Government or its agencies means an
instrumentality of the U.S. Government whose debt obligations are fully
and explicitly guaranteed as to the timely payment of principal and
interest by the full faith and credit of the United States Government.
(36) United States Government-sponsored agency means an agency
originally established or chartered to serve public purposes specified
by the United States Congress, but whose obligations are not explicitly
guaranteed by the full faith and credit of the United States Government.
(37) Walkaway clause means a provision in a bilateral netting
contract that permits a nondefaulting counterparty to make a lower
payment than it would make otherwise under the bilateral netting
contract, 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 bilateral netting contract.
Section 2. Components of Capital.
A national bank's qualifying capital base consists of two types of
capital--core (Tier 1) and supplementary (Tier 2).
(a) Tier 1 Capital. The following elements comprise a national
bank's Tier 1 capital:
(1) Common stockholders' equity;
(2) Noncumulative perpetual preferred stock and related surplus; and
\2\
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\2\ Preferred stock issues where the dividend is reset periodically
based upon current market conditions and the bank's current credit
rating, including but not limited to, auction rate, money market or
remarketable preferred stock, are assigned to Tier 2 capital, regardless
of whether the dividends are cumulative or noncumulative.
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(3) Minority interests in the equity accounts of consolidated
subsidiaries, except that the following are not included in Tier 1
capital or total capital:
(i) Minority interests in a small business investment company or
investment fund that holds nonfinancial equity investments and minority
interests in a subsidiary that is engaged in nonfinancial activities and
is held under one of the legal authorities listed in section 1(c)(21) of
this appendix A.
(ii) Minority interests in consolidated asset-backed commercial
paper programs sponsored by a bank if the consolidated assets are
excluded from risk-weighted assets pursuant to section 4(j)(1) of this
appendix A. This section 2(a)(3)(ii) of this appendix A is effective
from July 1, 2003 to April 1, 2004.
(b) Tier 2 Capital. The following elements comprise a national
bank's Tier 2 capital:
(1) Allowance for loan and lease losses, up to a maximum of 1.25% of
risk-weighted assets,\3\ subject to the transition rules in section
4(a)(2) of this appendix A;
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\3\ The amount of the allowance for loan and lease losses that may
be included in capital is based on a percentage of risk-weighted assets.
The gross sum of risk-weighted assets used in this calculation includes
all risk-weighted assets, with the exception of the assets required to
be deducted under section 3 in establishing risk-weighted assets (i.e.,
the assets required to be deducted from capital under section 2(c)) of
this appendix. A banking organization may deduct reserves for loan and
lease losses in excess of the amount permitted to be included as
capital, as well as allocated transfer risk reserves and reserves held
against other real estate owned, from the gross sum of risk-weighted
assets in computing the denominator of the risk-based capital ratio.
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(2) Cumulative perpetual preferred stock, long-term preferred stock,
convertible preferred stock, and any related surplus, without limit, if
the issuing national bank has the option to defer payment of dividends
on these instruments. For long-term preferred
[[Page 25]]
stock, the amount that is eligible to be included as Tier 2 capital is
reduced by 20% of the original amount of the instrument (net of
redemptions) at the beginning of each of the last five years of the life
of the instrument;
(3) Hybrid capital instruments, without limit. Hybrid capital
instruments are those instruments that combine certain characteristics
of debt and equity, such as perpetual debt. To be included as Tier 2
capital, these instruments must meet the following criteria: \4\
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\4\ Mandatory convertible debt instruments that meet the
requirements of 12 CFR 3.100(e)(5), or that have been previously
approved as capital by the OCC, are treated as qualifying hybrid capital
instruments.
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(i) The instrument must be unsecured, subordinated to the claims of
depositors and general creditors, and fully paid-up;
(ii) The instrument must not be redeemable at the option of the
holder prior to maturity, except with the prior approval of the OCC;
(iii) The instrument must be available to participate in losses
while the issuer is operating as a going concern (in this regard, the
instrument must automatically convert to common stock or perpetual
preferred stock, if the sum of the retained earnings and capital surplus
accounts of the issuer shows a negative balance); and
(iv) The instrument must provide the option for the issuer to defer
principal and interest payments, if
(A) The issuer does not report a net profit for the most recent
combined four quarters, and
(B) The issuer eliminates cash dividends on its common and preferred
stock.
(4) Term subordinated debt instruments, and intermediate-term
preferred stock and related surplus are included in Tier 2 capital, but
only to a maximum of 50% of Tier 1 capital as calculated after
deductions pursuant to section 2(c) of this appendix. To be considered
capital, term subordinated debt instruments shall meet the requirements
of Sec. 3.100(f)(1). However, pursuant to 12 CFR 5.47, the OCC may, in
some cases, require that the subordinated debt be approved by the OCC
before the subordinated debt may qualify as Tier 2 capital or may
require prior approval for any prepayment (including payment pursuant to
an acceleration clause or redemption prior to maturity) of the
subordinated debt. Also, at the beginning of each of the last five years
for the life of either type of instrument, the amount that is eligible
to be included as Tier 2 capital is reduced by 20% of the original
amount of that instrument (net of redemptions).
(5) Up to 45 percent of the pretax net unrealized holding gains
(that is, the excess, if any, of the fair value over historical cost) on
available-for-sale equity securities with readily determinable fair
values.\5\ Unrealized gains (losses) on other types of assets, such as
bank premises and available-for-sale debt securities, are not included
in Tier 2 capital, but the OCC may take these unrealized gains (losses)
into account as additional factors when assessing a bank's overall
capital adequacy.
---------------------------------------------------------------------------
\5\ The OCC reserves the authority to exclude all or a portion of
unrealized gains from Tier 2 capital if the OCC determines that the
equity securities are not prudently valued.
---------------------------------------------------------------------------
(c) Deductions from Capital. The following items are deducted from
the appropriate portion of a national bank's capital base when
calculating its risk-based capital ratio:
(1) Deductions from Tier 1 Capital. The following items are deducted
from Tier 1 capital before the Tier 2 portion of the calculation is
made:
(i) Goodwill;
(ii) Other intangible assets, except as provided in section 2(c)(2)
of this appendix A;
(iii) Deferred tax assets, except as provided in section 2(c)(3) of
this appendix A, that are dependent upon future taxable income, which
exceed the lesser of either:
(A) The amount of deferred tax assets that the bank could reasonably
expect to realize within one year of the quarter-end Call Report, based
on its estimate of future taxable income for that year; or
(B) 10% of Tier 1 capital, net of goodwill and all intangible assets
other than purchased credit card relationships, mortgage servicing
assets and non-mortgage servicing assets; and
(iv) Credit-enhancing interest-only strips (as defined in section
4(a)(3) of this appendix A), as provided in section 2(c)(4).
(v) Nonfinancial equity investments as provided by section 2(c)(5)
of this appendix A.
(2) Qualifying intangible assets. Subject to the following
conditions, mortgage servicing assets, nonmortgage servicing assets \6\
and
[[Page 26]]
purchased credit card relationships need not be deducted from Tier 1
capital:
---------------------------------------------------------------------------
\6\ Intangible assets are defined to exclude IO strips receivable
related to these mortgage and non-mortgage servicing assets. See section
1(c)(14) of this appendix A. Consequently, IO strips receivable related
to mortgage and non-mortgage servicing assets are not required to be
deducted under section 2(c)(2) of this appendix A. However, credit-
enhancing interest-only strips as defined in section 4(a)(3) are
deducted from Tier 1 capital in accordance with section 2(c)(4) of this
appendix A. Any non credit-enhancing IO strips receivable are subject to
a 100% risk weight under section 3(a)(4) of this appendix A.
---------------------------------------------------------------------------
(i) The total of all intangible assets that are included in Tier 1
capital is limited to 100 percent of Tier 1 capital, of which no more
than 25 percent of Tier 1 capital can consist of purchased credit card
relationships and non-mortgage servicing assets in the aggregate.
Calculation of these limitations must be based on Tier 1 capital net of
goodwill and all other identifiable intangibles, other than purchased
credit card relationships, mortgage servicing assets and non-mortgage
servicing assets.
(ii) Banks must value each intangible asset included in Tier 1
capital at least quarterly at the lesser of:
(A) 90 percent of the fair value of each intangible asset,
determined in accordance with section 2(c)(2)(iii) of this appendix A;
or
(B) 100 percent of the remaining unamortized book value.
(iii) The quarterly determination of the current fair value of the
intangible asset must include adjustments for any significant changes in
original valuation assumptions, including changes in prepayment
estimates.
(iv) Banks may elect to deduct disallowed servicing assets on a
basis that is net of any associated deferred tax liability. Deferred tax
liabilities netted in this manner cannot also be netted against deferred
tax assets when determining the amount of deferred tax assets that are
dependent upon future taxable income.
(3) Deferred tax assets--(i) Net unrealized gains and losses on
available-for-sale securities. Before calculating the amount of deferred
tax assets subject to the limit in section 2(c)(1)(iii) of this appendix
A, a bank may eliminate the deferred tax effects of any net unrealized
holding gains and losses on available-for-sale debt securities. Banks
report these net unrealized holding gains and losses in their Call
Reports as a separate component of equity capital, but exclude them from
the definition of common stockholders' equity for regulatory capital
purposes. A bank that adopts a policy to deduct these amounts must apply
that approach consistently in all future calculations of the amount of
disallowed deferred tax assets under section 2(c)(1)(iii) of this
appendix A.
(ii) Consolidated groups. The amount of deferred tax assets that a
bank can realize from taxes paid in prior carryback years and from
reversals of existing taxable temporary differences generally would not
be deducted from capital. However, for a bank that is a member of a
consolidated group (for tax purposes), the amount of carryback potential
a bank may consider in calculating the limit on deferred tax assets
under section 2(c)(1)(iii) of this appendix A, may not exceed the amount
that the bank could reasonably expect to have refunded by its parent
holding company.
(iii) Nontaxable Purchase Business Combination. In calculating the
amount of net deferred tax assets under section 2(c)(1)(iii) of this
appendix A, a deferred tax liability that is specifically associated
with an intangible asset (other than purchased mortgage servicing rights
and purchased credit card relationships) due to a nontaxable purchase
business combination may be netted against that intangible asset. Only
the net amount of the intangible asset must be deducted from Tier 1
capital. Deferred tax liabilities netted in this manner cannot also be
netted against deferred tax assets when determining the amount of net
deferred tax assets that are dependent upon future taxable income.
(iv) Estimated future taxable income. Estimated future taxable
income does not include net operating loss carryforwards to be used
during that year or the amount of existing temporary differences
expected to reverse within the year. A bank may use future taxable
income projections for their closest fiscal year, provided it adjusts
the projections for any significant changes that occur or that it
expects to occur. Such projections must include the estimated effect of
tax planning strategies that the bank expects to implement to realize
net operating losses or tax credit carryforwards that will otherwise
expire during the year.
(4) Credit-enhancing interest-only strips. Credit-enhancing
interest-only strips, whether purchased or retained, that exceed 25% of
Tier 1 capital must be deducted from Tier 1 capital. Purchased and
retained credit-enhancing interest-only strips, on a non-tax adjusted
basis, are included in the total amount that is used for purposes of
determining whether a bank exceeds its Tier 1 capital.
(i) The 25% limitation on credit-enhancing interest-only strips will
be based on Tier 1 capital net of goodwill and all identifiable
intangibles, other than purchased credit card relationships, mortgage
servicing assets and non-mortgage servicing assets.
(ii) Banks must value each credit-enhancing interest-only strip
included in Tier 1 capital at least quarterly. The quarterly
determination of the current fair value of the credit-enhancing
interest-only strip must include adjustments for any significant changes
in original valuation assumptions, including changes in prepayment
estimates.
(iii) Banks may elect to deduct disallowed credit-enhancing
interest-only strips on a basis that is net of any associated deferred
tax liability. Deferred tax liabilities netted in this manner cannot
also be netted against deferred tax assets when determining the
[[Page 27]]
amount of deferred tax assets that are dependent upon future taxable
income.
(5) Nonfinancial equity investments--(i) General. (A) A bank must
deduct from its Tier 1 capital the appropriate percentage, as determined
in accordance with Table A, of the adjusted carrying value of all
nonfinancial equity investments held by the bank and its subsidiaries.
Table A--Deduction for Nonfinancial Equity Investments
------------------------------------------------------------------------
Aggregate adjusted carrying value of all
nonfinancial equity investments held Deduction from Tier 1 Capital
directly or indirectly by banks (as a (as a percentage of the
percentage of the Tier 1 capital of the adjusted carrying value of
bank)\1\ the investment)
------------------------------------------------------------------------
Less than 15 percent..................... 8.0 percent.
Greater than or equal to 15 percent but 12.0 percent.
less than 25 percent.
Greater than or equal to 25 percent...... 25.0 percent.
------------------------------------------------------------------------
\1\ For purposes of calculating the adjusted carrying value of
nonfinancial equity investments as a percentage of Tier 1 capital,
Tier 1 capital is defined as the sum of the Tier 1 capital elements
net of goodwill and net of all identifiable intangible assets other
than mortgage servicing assets, nonmortgage servicing assets and
purchased credit card relationships, but prior to the deduction for
disallowed mortgage servicing assets, disallowed nonmortgage servicing
assets, disallowed purchased credit card relationships, disallowed
credit-enhancing interest only strips (both purchased and retained),
disallowed deferred tax assets, and nonfinancial equity investments.
(B) Deductions for nonfinancial equity investments must be applied
on a marginal basis to the portions of the adjusted carrying value of
nonfinancial equity investments that fall within the specified ranges of
the bank's Tier 1 capital. For example, if the adjusted carrying value
of all nonfinancial equity investments held by a bank equals 20 percent
of the Tier 1 capital of the bank, then the amount of the deduction
would be 8 percent of the adjusted carrying value of all investments up
to 15 percent of the bank's Tier 1 capital, and 12 percent of the
adjusted carrying value of all investments equal to, or in excess of, 15
percent of the bank's Tier 1 capital.
(C) The total adjusted carrying value of any nonfinancial equity
investment that is subject to deduction under section 2(c)(5) of this
appendix A is excluded from the bank's weighted risk assets for purposes
of computing the denominator of the bank's risk-based capital ratio. For
example, if 8 percent of the adjusted carrying value of a nonfinancial
equity investment is deducted from Tier 1 capital, the entire adjusted
carrying value of the investment will be excluded from risk-weighted
assets in calculating the denominator of the risk-based capital ratio.
(D) Banks engaged in equity investment activities, including those
banks with a high concentration in nonfinancial equity investments
(e.g., in excess of 50 percent of Tier 1 capital), will be monitored and
may be subject to heightened supervision, as appropriate, by the OCC to
ensure that such banks maintain capital levels that are appropriate in
light of their equity investment activities, and the OCC may impose a
higher capital charge in any case where the circumstances, such as the
level of risk of the particular investment or portfolio of investments,
the risk management systems of the bank, or other information, indicate
that a higher minimum capital requirement is appropriate.
(ii) Small business investment company investments. (A)
Notwithstanding section 2(c)(5)(i) of this appendix A, no deduction is
required for nonfinancial equity investments that are made by a bank or
its subsidiary through a SBIC that is consolidated with the bank, or in
a SBIC that is not consolidated with the bank, to the extent that such
investments, in the aggregate, do not exceed 15 percent of the Tier 1
capital of the bank. Except as provided in paragraph (c)(5)(ii)(B) of
this section, any nonfinancial equity investment that is held through or
in a SBIC and not deducted from Tier 1 capital will be assigned to the
100 percent risk-weight category and included in the bank's consolidated
risk-weighted assets.
(B) If a bank has an investment in a SBIC that is consolidated for
accounting purposes but the SBIC is not wholly owned by the bank, the
adjusted carrying value of the bank's nonfinancial equity investments
held through the SBIC is equal to the bank's proportionate share of the
SBIC's adjusted carrying value of its equity investments in nonfinancial
companies. The remainder of the SBIC's adjusted carrying value (i.e.,
the minority interest holders' proportionate share) is excluded from the
risk-weighted assets of the bank.
(C) If a bank has an investment in a SBIC that is not consolidated
for accounting purposes and has current information that identifies the
percentage of the SBIC's assets that are equity investments in
nonfinancial companies, the bank may reduce the adjusted carrying value
of its investment in the SBIC proportionately to reflect the percentage
of the adjusted carrying value of the SBIC's assets that are not equity
investments in nonfinancial companies. The amount by which the adjusted
carrying value of the bank's investment in the SBIC
[[Page 28]]
is reduced under this paragraph will be risk weighted at 100 percent and
included in the bank's risk-weighted assets.
(D) To the extent the adjusted carrying value of all nonfinancial
equity investments that the bank holds through a consolidated SBIC or in
a nonconsolidated SBIC equals or exceeds, in the aggregate, 15 percent
of the Tier 1 capital of the bank, the appropriate percentage of such
amounts, as set forth in Table A, must be deducted from the bank's Tier
1 capital. In addition, the aggregate adjusted carrying value of all
nonfinancial equity investments held through a consolidated SBIC and in
a nonconsolidated SBIC (including any nonfinancial equity investments
for which no deduction is required) must be included in determining, for
purposes of Table A the total amount of nonfinancial equity investments
held by the bank in relation to its Tier 1 capital.
(iii) Nonfinancial equity investments excluded. (A) Notwithstanding
section 2(c)(5)(i) and (ii) of this appendix A, no deduction from Tier 1
capital is required for the following:
(1) Nonfinancial equity investments (or portion of such investments)
made by the bank prior to March 13, 2000, and continuously held by the
bank since March 13, 2000.
(2) Nonfinancial equity investments made on or after March 13, 2000,
pursuant to a legally binding written commitment that was entered into
by the bank prior to March 13, 2000, and that required the bank to make
the investment, if the bank has continuously held the investment since
the date the investment was acquired.
(3) Nonfinancial equity investments received by the bank through a
stock split or stock dividend on a nonfinancial equity investment made
prior to March 13, 2000, provided that the bank provides no
consideration for the shares or interests received, and the transaction
does not materially increase the bank's proportional interest in the
nonfinancial company.
(4) Nonfinancial equity investments received by the bank through the
exercise on or after March 13, 2000, of an option, warrant, or other
agreement that provides the bank with the right, but not the obligation,
to acquire equity or make an investment in a nonfinancial company, if
the option, warrant, or other agreement was acquired by the bank prior
to March 13, 2000, and the bank provides no consideration for the
nonfinancial equity investments.
(B) Any excluded nonfinancial equity investments described in
section 2(c)(5)(iii)(A) of this appendix A must be included in
determining the total amount of nonfinancial equity investments held by
the bank in relation to its Tier 1 capital for purposes of Table A. In
addition, any excluded nonfinancial equity investments will be risk
weighted at 100 percent and included in the bank's risk-weighted assets.
(6) Deductions from total capital. The following items are deducted
from total capital:
(i) Investments, both equity and debt, in unconsolidated banking and
finance subsidiaries that are deemed to be capital of the subsidiary;\7\
and
---------------------------------------------------------------------------
\7\ The OCC may require deduction of investments in other
subsidiaries and associated companies, on a case-by-case basis.
---------------------------------------------------------------------------
(ii) Reciprocal holdings of bank capital instruments.
Section 3. Risk Categories/Weights for On-Balance Sheet Assets and Off-
Balance Sheet Items
The denominator of the risk-based capital ratio, i.e., a national
bank's risk-weighted assets,\8\ is derived by assigning that bank's
assets and off-balance sheet items to one of the four risk categories
detailed in section 3(a) of this appendix A. Each category has a
specific risk weight. Before an off-balance sheet item is assigned a
risk weight, it is converted to an on-balance sheet credit equivalent
amount in accordance with section 3(b) of this appendix A. The risk
weight assigned to a particular asset or on-balance sheet credit
equivalent amount determines the percentage of that asset/credit
equivalent that is included in the denominator of the bank's risk-based
capital ratio. Any asset deducted from a bank's capital in computing the
numerator of the risk-based capital ratio is not included as part of the
bank's risk-weighted assets.
---------------------------------------------------------------------------
\8\ The OCC reserves the right to require a bank to compute its
risk-based capital ratio on the basis of average, rather than period-
end, risk-weighted assets when necessary to carry out the purposes of
these guidelines.
---------------------------------------------------------------------------
Some of the assets on a bank's balance sheet may represent an
indirect holding of a pool of assets, e.g., mutual funds, that
encompasses more than one risk weight within the pool. In those
situations, the bank may assign the asset to the risk category
applicable to the highest risk-weighted asset that pool is permitted to
hold pursuant to its stated investment objectives in the fund's
prospectus. Alternatively, the bank may assign the asset on a pro rata
basis to different risk categories according to the investment limits in
the fund's prospectus. In either case, the minimum risk weight that may
be assigned to such a pool is 20%. If a bank assigns the asset on a pro
rata basis, and the sum of the investment limits in the fund's
prospectus exceeds 100%, the bank must assign the highest pro rata
amounts of its total investment to the higher risk category. If, in
[[Page 29]]
order to maintain a necessary degree of liquidity, the fund is permitted
to hold an insignificant amount of its assets in short-term, highly-
liquid securities of superior credit quality (that do not qualify for a
preferential risk weight), such securities generally will not be taken
into account in determining the risk category into which the bank's
holding in the overall pool should be assigned. The prudent use of
hedging instruments by a fund to reduce the risk of its assets will not
increase the risk weighting of the investment in that fund above the 20%
category. However, if a fund engages in any activities that are deemed
to be speculative in nature or has any other characteristics that are
inconsistent with the preferential risk weighting assigned to the fund's
assets, the bank's investment in the fund will be assigned to the 100%
risk category. More detail on the treatment of mortgage-backed
securities is provided in section 3(a)(3)(vi) of this appendix A.
(a) On-Balance Sheet Assets. The following are the risk categories/
weights for on-balance sheet assets.
(1) Zero percent risk weight. (i) Cash, including domestic and
foreign currency owned and held in all offices of a national bank or in
transit. Any foreign currency held by a national bank should be
converted into U.S. dollar equivalents.
(ii) Deposit reserves and other balances at Federal Reserve Banks.
(iii) Securities issued by, and other direct claims on, the United
States Government or its agencies, or the central government of an OECD
country.
(iv) That portion of assets directly and unconditionally guaranteed
by the United States Government or its agencies, or the central
government of an OECD country.\9\
---------------------------------------------------------------------------
\9\ For the treatment of privately-issued mortgage-backed securities
where the underlying pool is comprised solely of mortgage-related
securities issued by GNMA, see infra note 10.
---------------------------------------------------------------------------
(v) That portion of local currency claims on or unconditionally
guaranteed by central governments of non-OECD countries, to the extent
the bank has local currency liabilities in that country. Any amount of
such claims that exceeds the amount of the bank's local currency
liabilities is assigned to the 100% risk category of section 3(a)(4) of
this appendix.
(vi) Gold bullion held in the bank's own vaults or in another bank's
vaults on an allocated basis, to the extent it is backed by gold bullion
liabilities.
(vii) The book value of paid-in Federal Reserve Bank stock.
(viii) That portion of assets and off-balance sheet transactions
\9a\ collateralized by cash or securities issued or directly and
unconditionally guaranteed by the United States Government or its
agencies, or the central government of an OECD country, provided that:
\9b\
---------------------------------------------------------------------------
\9a\ See footnote 22 in section 3(b)(5)(iii) of this appendix A
(collateral held against derivative contracts).
\9b\ Assets and off-balance sheet transactions collateralized by
securities issued or guaranteed by the United States Government or its
agencies, or the central government of an OECD country include, but are
not limited to, securities lending transactions, repurchase agreements,
collateralized letters of credit, such as reinsurance letters of credit,
and other similar financial guarantees. Swaps, forwards, futures, and
options transactions are also eligible, if they meet the collateral
requirements. However, the OCC may at its discretion require that
certain collateralized transactions be risk weighted at 20 percent if
they involve more than a minimal risk.
---------------------------------------------------------------------------
(A) The bank maintains control over the collateral:
(1) If the collateral consists of cash, the cash must be held on
deposit by the bank or by a third-party for the account of the bank;
(2) If the collateral consists of OECD government securities, then
the OECD government securities must be held by the bank or by a third-
party acting on behalf of the bank;
(B) The bank maintains a daily positive margin of collateral fully
taking into account any change in the market value of the collateral
held as security;
(C) Where the bank is acting as a customer's agent in a transaction
involving the loan or sale of securities that is collateralized by cash
or OECD government securities delivered to the bank, any obligation by
the bank to indemnify the customer is limited to no more than the
difference between the market value of the securities lent and the
market value of the collateral received, and any reinvestment risk
associated with the collateral is borne by the customer; and
(D) The transaction involves no more than minimal risk.
(2) 20 percent risk weight. (i) All claims on depository
institutions incorporated in an OECD country, and all assets backed by
the full faith and credit of depository institutions incorporated in an
OECD country. This includes the credit equivalent amount of
participations in commitments and standby letters of credit sold to
other depository institutions incorporated in an OECD country, but only
if the originating bank remains liable to the customer or beneficiary
for the
[[Page 30]]
full amount of the commitment or standby letter of credit. Also included
in this category are the credit equivalent amounts of risk
participations in bankers' acceptances conveyed to other depository
institutions incorporated in an OECD country. However, bank-issued
securities that qualify as capital of the issuing bank are not included
in this risk category, but are assigned to the 100% risk category of
section 3(a)(4) of this appendix A.
(ii) Claims on, or guaranteed by depository institutions, other than
the central bank, incorporated in a non-OECD country, with a residual
maturity of one year or less.
(iii) Cash items in the process of collection.
(iv) That portion of assets collateralized by cash or by securities
issued or directly and unconditionally guaranteed by the United States
Government or its agencies, or the central government of an OECD
country, that does not qualify for the zero percent risk-weight
category.
(v) That portion of assets conditionally guaranteed by the United
States Government or its agencies, or the central government of an OECD
country.
(vi) Securities issued by, or other direct claims on, United States
Government-sponsored agencies.
(vii) That portion of assets guaranteed by United States Government-
sponsored agencies.\10\
---------------------------------------------------------------------------
\10\ Privately issued mortgage-backed securities, e.g., CMOs and
REMICs, where the underlying pool is comprised solely of mortgage-
related securities issued by GNMA, FNMA and FHLMC, will be treated as an
indirect holding of the underlying assets and assigned to the 20% risk
category of this section 3(a)(2). If the underlying pool is comprised of
assets which attract different risk weights, e.g., FNMA securities and
conventional mortgages, the bank should generally assign the security to
the highest risk category appropriate for any asset in the pool.
However, on a case-by-case basis, the OCC may allow the bank to assign
the security proportionately to the various risk categories based on the
proportion in which the risk categories are represented by the
composition cash flows of the underlying pool of assets. Before the OCC
will consider a request to proportionately risk-weight such a security,
the bank must have current information for the reporting date that
details the composition and cash flows of the underlying pool of assets.
Furthermore, before a mortgage-related security will receive a risk
weight lower than 100%, it must meet the criteria set forth in section
3(a)(3)(vi) of this appendix A.
---------------------------------------------------------------------------
(viii) That portion of assets collateralized by the current market
value of securities issued or guaranteed by United States Government-
sponsored agencies.
(ix) Claims representing general obligations of any public-sector
entity in an OECD country, and that portion of any claims guaranteed by
any such public-sector entity. In the U.S., these obligations must meet
the requirements of 12 CFR 1.3(g).
(x) Claims on, or guaranteed by, official multilateral lending
institutions or regional development institutions in which the United
States Government is a shareholder or contributing member.\11\
---------------------------------------------------------------------------
\11\ These institutions include, but are not limited to, the
International Bank for Reconstruction and Development (World Bank), the
Inter-American Development Bank, the Asian Development Bank, the African
Development Bank, the European Investments Bank, the International
Monetary Fund and the Bank for International Settlements.
---------------------------------------------------------------------------
(xi) That portion of assets collateralized by the current market
value of securities issued by official multilateral lending institutions
or regional development institutions in which the United States
Government is a shareholder or contributing member.
(xii) That portion of local currency claims conditionally guaranteed
by central governments of non-OECD countries, to the extent the bank has
local currency liabilities in that country. Any amount of such claims
that exceeds the amount of the bank's local currency liabilities is
assigned to the 100% risk category of section 3(a)(4) of this appendix.
(xiii) Claims on, or guaranteed by, a securities firm incorporated
in an OECD country, that satisfies the following conditions:
(A) If the securities firm is incorporated in the United States,
then the firm must be a broker-dealer that is registered with the SEC
and must be in compliance with the SEC's net capital regulation (17 CFR
240.15c3(1)).
(B) If the securities firm is incorporated in any other OECD
country, then the bank must be able to demonstrate that the firm is
subject to consolidated supervision and regulation, including its
subsidiaries, comparable to that imposed on depository institutions in
OECD countries; such regulation must include risk-based capital
standards comparable to those applied to depository institutions under
the Basel Capital Accord.\11a\
---------------------------------------------------------------------------
\11a\ See Accord on International Convergence of Capital Measurement
and Capital Standards as adopted by the Basle Committee on Banking
Regulations and Supervisory Practices (renamed as the Basel Committee on
Banking Supervision), dated July 1988 (amended 1998).
---------------------------------------------------------------------------
(C) The securities firm, whether incorporated in the United States
or another OECD country, must also have a long-term credit rating in
accordance with section
[[Page 31]]
3(a)(2)(xiii)(C)(1) of this appendix A; a parent company guarantee in
accordance with section 3(a)(2)(xiii)(C)(2) of this appendix A; or a
collateralized claim in accordance with section 3(a)(2)(xiii)(C)(3) of
this appendix A. Claims representing capital of a securities firm must
be risk weighted at 100 percent in accordance with section 3(a)(4) of
this Appendix A.
(1) Credit rating. The securities firm must have either a long-term
issuer credit rating or a credit rating on at least one issue of long-
term unsecured debt, from a NRSRO that is in one of the three highest
investment-grade categories used by the NRSRO. If the securities firm
has a credit rating from more than one NRSRO, the lowest credit rating
must be used to determine the credit rating under this paragraph.
(2) Parent company guarantee. The claim on, or guaranteed by, the
securities firm must be guaranteed by the firm's parent company, and the
parent company must have either a long-term issuer credit rating or a
credit rating on at least one issue of long-term unsecured debt, from a
NRSRO that is in one of the three highest investment-grade categories
used by the NRSRO.
(3) Collateralized claim. The claim on the securities firm must be
collateralized subject to all of the following requirements:
(i) The claim must arise from a reverse repurchase/repurchase
agreement or securities lending/borrowing contract executed using
standard industry documentation.
(ii) The collateral must consist of debt or equity securities that
are liquid and readily marketable.
(iii) The claim and collateral must be marked-to-market daily.
(iv) The claim must be subject to daily margin maintenance
requirements under standard industry documentation.
(v) The contract from which the claim arises can be liquidated,
terminated, or accelerated immediately in bankruptcy or similar
proceedings, and the security or collateral agreement will not be stayed
or avoided under the applicable law of the relevant jurisdiction. To be
exempt from the automatic stay in bankruptcy in the United States, the
claim must arise from a securities contract or a 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 (912 U.S.C. 4407), or the Regulation EE (12 CFR
part 231).
(3) 50 percent risk weight. (i) Revenue obligations of any public-
sector entity in an OECD country for which the underlying obligor is the
public-sector entity, but which are repayable solely from the revenues
generated by the project financed through the issuance of the
obligations.
(ii) The credit equivalent amount of derivative contracts,
calculated in accordance with section 3(b)(5) of this appendix A, that
do not qualify for inclusion in a lower risk category.
(iii) Loans secured by first mortgages on one-to-four family
residential properties, either owner-occupied or rented, provided that
such loans are not otherwise 90 days or more past due, or on nonaccrual
or restructured. It is presumed that such loans will meet prudent
underwriting standards. If a bank holds a first lien and junior lien on
a one-to-four family residential property and no other party holds an
intervening lien, the transaction is treated as a single loan secured by
a first lien for the purposes of both determining the loan-to-value
ratio and assigning a risk weight to the transaction. Furthermore,
residential property loans made for the purpose of construction
financing are assigned to the 100% risk category of section 3(a)(4) of
this appendix A; however, these loans may be included in the 50% risk
category of this section 3(a)(3) of this appendix A if they are subject
to a legally binding sales contract and satisfy the requirements of
section 3(a)(3)(iv) of this appendix A.
(iv) Loans to residential real estate builders for one-to-four
family residential property construction, if the bank obtains sufficient
documentation demonstrating that the buyer of the home intends to
purchase the home (i.e., a legally binding written sales contract) and
has the ability to obtain a mortgage loan sufficient to purchase the
home (i.e., a firm written commitment for permanent financing of the
home upon completion), subject to the following additional criteria:
(A) The builder must incur at least the first 10% of the direct
costs (i.e., actual costs of the land, labor, and material) before any
drawdown is made under the construction loan and the construction loan
may not exceed 80% of the sales price of the resold home;
(B) The individual purchaser has made a substantial ``earnest money
deposit'' of no less than 3% of the sales price of the home that must be
subject to forfeiture by the individual purchaser if the sales contract
is terminated by the individual purchaser; however, the earnest money
deposit shall not be subject to forfeiture by reason of breach or
termination of the sales contract on the part of the builder;
(C) The earnest money deposit must be held in escrow by the bank
financing the builder or by an independent party in a fiduciary
capacity; the escrow agreement must provide that in the event of default
the escrow funds must be used to defray any cost
[[Page 32]]
incurred relating to any cancellation of the sales contract by the
buyer;
(D) If the individual purchaser terminates the contract or if the
loan fails to satisfy any other criterion under this section, then the
bank must immediately recategorize the loan at a 100% risk weight and
must accurately report the loan in the bank's next quarterly
Consolidated Reports of Condition and Income (Call Report);
(E) The individual purchaser must intend that the home will be
owner-occupied;
(F) The loan is made by the bank in accordance with prudent
underwriting standards;
(G) The loan is not more than 90 days past due, or on nonaccrual;
and
(H) The purchaser is an individual(s) and not a partnership, joint
venture, trust, corporation, or any other entity (including an entity
acting as a sole proprietorship) that is purchasing one or more of the
homes for speculative purposes.
(v) Loans secured by a first mortgage on multifamily residential
properties: \11b\
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\11b\ The portion of multifamily residential property loans that is
sold subject to a pro rata loss sharing arrangement may be treated by
the selling bank as sold to the extent that the sales agreement provides
for the purchaser of the loan to share in any loss incurred on the loan
on a pro rata basis with the selling bank. The portion of multifamily
residential property loans sold subject to any loss sharing arrangement
other than pro rata sharing of the loss shall be accorded the same
treatment as any other asset sold under an agreement to repurchase or
sold with recourse under section 4(b) of this appendix A.
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(A) The amortization of principal and interest occurs in not more
than 30 years;
(B) The minimum original maturity for repayment of principal is not
less than 7 years;
(C) All principal and interest payments have been made on a timely
basis in accordance with the terms of the loan for at least one year
immediately preceding the risk weighting of the loan in the 50% risk
weight category, and the loan is not otherwise 90 days or more past due,
or on nonaccrual status;
(D) The loan is made in accordance with all applicable requirements
and prudent underwriting standards;
(E) If the rate of interest does not change over the term of the
loan:
(I) The current loan amount outstanding does not exceed 80% of the
current value of the property, as measured by either the value of the
property at origination of the loan (which is the lower of the purchase
price or the value as determined by the initial appraisal, or if
appropriate, the initial evaluation) or the most current appraisal, or
if appropriate, the most current evaluation; and
(II) In the most recent fiscal year, the ratio of annual net
operating income generated by the property (before payment of any debt
service on the loan) to annual debt service on the loan is not less than
120%;\11c\
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\11c\ For the purposes of the debt service requirements in sections
3(a)(3)(v)(E)(II) and 3(a)(3)(v)(F)(II) of this appendix A, other forms
of debt service coverage that generate sufficient cash flows to provide
comparable protection to the institution may be considered for (a) a
loan secured by cooperative housing or (b) a multifamily residential
property loan if the purpose of the loan is for the development or
purchase of multifamily residential property primarily intended to
provide low- to moderate-income housing, including special operating
reserve accounts or special operating subsidies provided by federal,
state, local or private sources. However, the OCC reserves the right, on
a case-by-case basis, to review the adequacy of any other forms of
comparable debt service coverage relied on by the bank.
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(F) If the rate of interest changes over the term of the loan:
(I) The current loan amount outstanding does not exceed 75% of the
current value of the property, as measured by either the value of the
property at origination of the loan (which is the lower of the purchase
price or the value as determined by the initial appraisal, or if
appropriate, the initial evaluation) or the most current appraisal, or
if appropriate, the most current evaluation; and
(II) In the most recent fiscal year, the ratio of annual net
operating income generated by the property (before payment of any debt
service on the loan) to annual debt service on the loan is not less than
115%; and
(G) If the loan was refinanced by the borrower:
(I) All principal and interest payments on the loan being refinanced
which were made in the preceding year prior to refinancing shall apply
in determining the one-year timely payment requirement under paragraph
(a)(3)(v)(C) of this section; and
(II) The net operating income generated by the property in the
preceding year prior to refinancing shall apply in determining the
applicable debt service requirements under paragraphs (a)(3)(v)(E) and
(a)(3)(v)(F) of this section.
(vi) Privately-issued mortgage-backed securities, i.e. those that do
not carry the guarantee of a government or government-sponsored agency,
if the privately-issued mortgage-backed securities are at the time the
mortgage-backed securities are originated fully secured by or otherwise
represent a sufficiently secure interest in mortgages
[[Page 33]]
that qualify for the 50% risk weight under paragraphs (a)(3) (iii), (iv)
and (v) of this section,\12\ provided that they meet the following
criteria:
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\12\ If all of the underlying mortgages in the pool do not qualify
for the 50% risk weight, the bank should generally assign the entire
value of the security to the 100% risk category of section 3(a)(4) of
this appendix A; however, on a case-by-case basis, the OCC may allow the
bank to assign only the portion of the security which represents an
interest in, and the cash flows of, nonqualifying mortgages to the 100%
risk category, with the remainder being assigned a risk weight of 50%.
Before the OCC will consider a request to risk weight a mortgage-backed
security on a proportionate basis, the bank must have current
information for the reporting date that details the composition and cash
flows of the underlying pool of mortgages.
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(A) The underlying assets must be held by an independent trustee
that has a first priority, perfected security interest in the underlying
assets for the benefit of the holders of the security;
(B) The holder of the security must have an undivided pro rata
ownership interest in the underlying assets or the trust that issues the
security must have no liabilities unrelated to the issued securities;
(C) The trust that issues the security must be structured such that
the cash flows from the underlying assets fully meet the cash flows
requirements of the security without undue reliance on any reinvestment
income; and
(D) There must not be any material reinvestment risk associated with
any funds awaiting distribution to the holder of the security.
(4) 100 percent risk weight. All other assets not specified above,
\12a\ including:
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\12a\ A bank subject to the market risk capital requirements
pursuant to appendix B of this part 3 may calculate the capital
requirement for qualifying securities borrowing transactions pursuant to
section 3(a)(1)(ii) of appendix B of this part 3.
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(i) Claims on or guaranteed by depository institutions incorporated
in a non-OECD country, as well as claims on the central bank of a non-
OECD country, with a residual maturity exceeding one year.
(ii) All non-local currency claims on non-OECD central governments,
as well as local currency claims on non-OECD central governments that
are not included in section 3(a)(1)(v) of this appendix A.
(iii) Any classes of a mortgage-backed security that can absorb more
than their pro rata share of the principal loss without the whole issue
being in default, e.g., subordinated classes or residual interests,
regardless of the issuer or guarantor.
(iv) All stripped mortgage-backed securities, including interest
only portions (IOs), principal only portions (POs) and other similar
instruments, regardless of the issuer or guarantor.
(v) Obligations issued by any state or any political subdivision
thereof for the benefit of a private party or enterprise where that
party or enterprise, rather than the issuing state or political
subdivision, is responsible for the timely payment of principal and
interest on the obligation, e.g., industrial development bonds.
(vi) Claims on commercial enterprises owned by non-OECD and OECD
central governments.
(vii) Any investment in an unconsolidated subsidiary that is not
required to be deducted from total capital pursuant to section 2(c)(3)
of this appendix A.
(viii) Instruments issued by depository institutions incorporated in
OECD and non-OECD countries that qualify as capital of the issuer.
(ix) Investments in fixed assets, premises, and other real estate
owned.
(x) Claims representing capital of a securities firm notwithstanding
section 3(a)(2)(xiii) of this appendix A.
(b) Off-Balance Sheet Activities. The risk weight assigned to an
off-balance sheet item is determined by a two-step process. First, the
face amount of the off-balance sheet item is multiplied by the
appropriate credit conversion factor specified in this section. This
calculation translates the face amount of an off-balance sheet item into
an on-balance sheet credit equivalent amount. Second, the resulting
credit equivalent amount is then assigned to the proper risk category
using the criteria regarding obligors, guarantors, and collateral listed
in section 3(a) of this appendix A. Collateral and guarantees are
applied to the face amount of an off-balance sheet item; however, with
respect to derivative contracts under section 3(b)(5) of this appendix
A, collateral and guarantees are applied to the credit equivalent
amounts of such derivative contracts. The following are the credit
conversion factors and the off-balance sheet items to which they apply.
However, direct credit substitutes, recourse obligations, and securities
issued in connection with asset securitizations are treated as described
in section 4 of this appendix A.
(1) 100 percent credit conversion factor. (i) [Reserved] \13\
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\13\ [Reserved]
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(ii) Risk participations purchased in bankers' acceptances;
(iii) [Reserved] \14\
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\14\ [Reserved]
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[[Page 34]]
(iv) Contingent obligations with a certain draw down, e.g., legally
binding agreements to purchase assets as a specified future date.
(v) Indemnification of customers whose securities the bank has lent
as agent. If the customer is not indemnified against loss by the bank,
the transaction is excluded from the risk-based capital calculation.\15\
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\15\ When a bank lends its own securities, the transaction is
treated as a loan. When a bank lends its own securities or, acting as
agent, agrees to indemnify a customer, the transaction is assigned to
the risk weight appropriate to the obligor or collateral that is
delivered to the lending or indemnifying institution or to an
independent custodian acting on their behalf.
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(2) 50 percent credit conversion factor. (i) Transaction-related
contingencies including, among other things, performance bonds and
performance-based standby letters of credit related to a particular
transaction.\16\ To the extent permitted by law or regulation,
performance-based standby letters of credit include such things as
arrangements backing subcontractors' and suppliers' performance, labor
and materials contracts, and construction bids;
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\16\ For purposes of this section 3(b)(2)(i), a ``performance-based
standby letter of credit'' is any letter of credit, or similar
arrangement, however named or described, which represents an irrevocable
obligation to the beneficiary on the part of the issuer to make payment
on account of any default by the account party in the performance of a
non-financial or commercial obligation. Participations in performance-
based standby letters of credit are treated in accordance with section 4
of this appendix A.
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(ii) Unused portion of commitments, including home equity lines of
credit, with an original maturity exceeding one year; \17\ and
---------------------------------------------------------------------------
\17\ Participations in commitments are treated in accordance with
section 4 of this appendix A.
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(iii) Revolving underwriting facilities, note issuance facilities,
and similar arrangements pursuant to which the bank's customer can issue
short-term debt obligations in its own name, but for which the bank has
a legally binding commitment to either:
(A) Purchase the obligations the customer is unable to sell by a
stated date; or
(B) Advance funds to its customer, if the obligations cannot be
sold.
(3) 20 percent credit conversion factor. (i) Trade-related
contingencies. These are short-term self-liquidating instruments used to
finance the movement of goods and are collateralized by the underlying
shipment. A commercial letter of credit is an example of such an
instrument.
(4) Zero percent credit conversion factor. (i) Unused portion of
commitments with an original maturing of one year or less;
(ii) Unused portion of commitments with an original maturity of
greater than one year, if they are unconditionally cancelable \18\ at
any time at the option of the bank and the bank has the contractual
right to make, and in fact does make, either--
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\18\ See section 1(c)(26) of appendix A to this part.
---------------------------------------------------------------------------
(A) A separate credit decision based upon the borrower's current
financial condition, before each drawing under the lending facility; or
(B) An annual (or more frequent) credit review based upon the
borrower's current financial condition to determine whether or not the
lending facility should be continued; and
(iii) The unused portion of retail credit card lines or other
related plans that are unconditionally cancelable by the bank in
accordance with applicable law.
(5) Derivative contracts--(i) Calculation of credit equivalent
amounts. The credit equivalent amount of a derivative contract equals
the sum of the current credit exposure and the potential future credit
exposure of the derivative contract. The calculation of credit
equivalent amounts must be measured in U.S. dollars, regardless of the
currency or currencies specified in the derivative contract.
(A) Current credit exposure. The current credit exposure for a
single derivative contract is determined by the mark-to-market value of
the derivative contract. If the mark-to-market value is positive, then
the current credit exposure equals that mark-to-market value. If the
mark-to-market is zero or negative, then the current credit exposure is
zero. The current credit exposure for multiple derivative contracts
executed with a single counterparty and subject to a qualifying
bilateral netting contract is determined as provided by section
3(b)(5)(ii)(A) of this appendix A.
(B) Potential future credit exposure. The potential future credit
exposure for a single derivative contract, including a derivative
contract with negative mark-to-market value, is calculated by
multiplying the notional principal \19\ of the derivative contract by
one of
[[Page 35]]
the credit conversion factors in Table A--Conversion Factor Matrix of
this appendix A, for the appropriate category.\20\ The potential future
credit exposure for gold contracts shall be calculated using the foreign
exchange rate conversion factors. For any derivative contract that does
not fall within one of the specified categories in Table A--Conversion
Factor Matrix of this appendix A, the potential future credit exposure
shall be calculated using the other commodity conversion factors.
Subject to examiner review, banks should use the effective rather than
the apparent or stated notional amount in calculating the potential
future credit exposure. The potential future credit exposure for
multiple derivatives contracts executed with a single counterparty and
subject to a qualifying bilateral netting contract is determined as
provided by section 3(b)(5)(ii)(A) of this appendix A.
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\19\ For purposes of calculating either the potential future credit
exposure under section 3(b)(5)(i)(B) of this appendix A or the gross
potential future credit exposure under section 3(b)(5)(ii)(A)(2) of this
appendix A for foreign exchange contracts and other similar contracts in
which the notional principal is equivalent to the cash flows, total
notional principal is the net receipts to each party falling due on each
value date in each currency.
\20\ No potential future credit exposure is calculated for single
currency interest rate swaps in which payments are made based upon two
floating indices, so-called floating/floating or basis swaps; the credit
equivalent amount is measured solely on the basis of the current credit
exposure.
Table B--Conversion Factor Matrix\1\
----------------------------------------------------------------------------------------------------------------
Foreign
Interest exchange Precious Other
Remaining maturity \2\ rate rate and Equity\2\ metals commodity
gold
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0 1.0 6.0 7.0 10.0
Over one to five years......................... 0.5 5.0 8.0 7.0 12.0
Over five years................................ 1.5 7.5 10.0 8.0 15.0
----------------------------------------------------------------------------------------------------------------
\1\ For derivative contracts with multiple exchanges of principal, the conversion factors are multiplied by the
number of remaining payments in the derivative contract.
\2\ For derivative contracts that automatically reset to zero value following a payment, the remaining maturity
equals the time until the next payment. However, interest rate contracts with remaining maturities of greater
than one year shall be subject to a minimum conversion factor of 0.5 percent.
(ii) Derivative contracts subject to a qualifying bilateral netting
contract--(A) Netting calculation. The credit equivalent amount for
multiple derivative contracts executed with a single counterparty and
subject to a qualifying bilateral netting contract as provided by
section (3)(b)(5)(ii)(B) of this appendix A is calculated by adding the
net current credit exposure and the adjusted sum of the potential future
credit exposure for all derivative contracts subject to the qualifying
bilateral netting contract.
(1) Net current credit exposure. The net current credit exposure is
the net sum of all positive and negative mark-to-market values of the
individual derivative contracts subject to a qualifying bilateral
netting contract. If the net sum of the mark-to-market value is
positive, then the net current credit exposure equals that net sum of
the mark-to-market value. If the net sum of the mark-to-market value is
zero or negative, then the net current credit exposure is zero.
(2) Adjusted sum of the potential future credit exposure. The
adjusted sum of the potential future credit exposure is calculated as:
Anet=0.4xAgross+(0.6xNGRxAgross)
Anet is the adjusted sum of the potential future credit
exposure, Agross is the gross potential future credit
exposure, and NGR is the net to gross ratio. Agross is the
sum of the potential future credit exposure (as determined under section
3(b)(5)(i)(B) of this appendix A) for each individual derivative
contract subject to the qualifying bilateral netting contract. The NGR
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 section 3(b)(5)(i)(A) of this appendix A) of all
individual derivative contracts subject to the qualifying bilateral
netting contract.
(B) Qualifying bilateral netting contract. In determining the
current credit exposure for multiple derivative contracts executed with
a single counterparty, a bank may net derivative contracts subject to a
qualifying bilateral netting contract by offsetting positive and
negative mark-to-market values, provided that:
(1) The qualifying bilateral netting contract is in writing.
(2) The qualifying bilateral netting contract is not subject to a
walkaway clause.
(3) The qualifying bilateral netting contract creates a single legal
obligation for all individual derivative contracts covered by the
qualifying bilateral netting contract. In effect, the qualifying
bilateral netting contract must provide that the bank would have a
single claim or obligation either to receive or to pay only the net
amount of the sum of the positive and negative mark-to-market values on
the individual derivative contracts covered by the qualifying bilateral
netting contract. The single legal obligation for the net amount is
operative in the event that a
[[Page 36]]
counterparty, or a counterparty to whom the qualifying bilateral netting
contract has been assigned, fails to perform due to any of the following
events: default, insolvency, bankruptcy, or other similar circumstances.
(4) The bank obtains a written and reasoned legal opinion(s) that
represents, with a high degree of certainty, that in the event of a
legal challenge, including one resulting from default, insolvency,
bankruptcy, or similar circumstances, the relevant court and
administrative authorities would find the bank's exposure to be the net
amount under:
(i) The law of the jurisdiction in which the counterparty is
chartered or the equivalent location in the case of noncorporate
entities, and if a branch of the counterparty is involved, then also
under the law of the jurisdiction in which the branch is located;
(ii) The law of the jurisdiction that governs the individual
derivative contracts covered by the bilateral netting contract; and
(iii) The law of the jurisdiction that governs the qualifying
bilateral netting contract.
(5) The bank establishes and maintains procedures to monitor
possible changes in relevant law and to ensure that the qualifying
bilateral netting contract continues to satisfy the requirement of this
section.
(6) The bank maintains in its files documentation adequate to
support the netting of a derivative contract.\21\
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\21\ By netting individual derivative contracts for the purpose of
calculating its credit equivalent amount, a bank represents that
documentation adequate to support the netting of a set of derivative
contract is in the bank's files and available for inspection by the OCC.
Upon determination by the OCC that a bank's files are inadequate or that
a qualifying bilateral netting contract may not be legally enforceable
in any one of the bodies of law described in section
3(b)(5)(ii)(B)(3)(i) through (iii) of this appendix A, the underlying
derivative contracts may not be netted for the purposes of this section.
---------------------------------------------------------------------------
(iii) Risk weighting. Once the bank determines the credit equivalent
amount for a derivative contract or a set of derivative contracts
subject to a qualifying bilateral netting contract, the bank assigns
that amount to the risk weight category appropriate to the counterparty,
or, if relevant, the nature of any collateral or guarantee.\22\ However,
the maximum weight that will be applied to the credit equivalent amount
of such derivative contract(s) is 50 percent.
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\22\ Derivative contracts are an exception to the general rule of
applying collateral and guarantees to the face value of off-balance
sheet items. The sufficiency of collateral and guarantees is determined
on the basis of the credit equivalent amount of derivative contracts.
However, collateral and guarantees held against a qualifying bilateral
netting contract is not recognized for capital purposes unless it is
legally available for all contracts included in the qualifying bilateral
netting contract.
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(iv) Exceptions. The following derivative contracts are not subject
to the above calculation, and therefore, are not part of the denominator
of a national bank's risk-based capital ratio:
(A) An exchange rate contract with an original maturity of 14
calendar days or less;\23\ and
---------------------------------------------------------------------------
\23\ Notwithstanding section 3(b)(5)(B) of this appendix A, gold
contracts do not qualify for this exception.
---------------------------------------------------------------------------
(B) A derivative contract that is traded on an exchange requiring
the daily payment of any variations in the market value of the contract.
Section 4. Recourse, Direct Credit Substitutes and Positions in
Securitizations
(a) Definitions. For purposes of this section 4 of this appendix A,
the following definitions apply:
(1) Credit derivative means a contract that allows one party (the
protection purchaser) to transfer the credit risk of an asset or off-
balance sheet credit exposure to another party (the protection
provider). The value of a credit derivative is dependent, at least in
part, on the credit performance of a ``reference asset.''
(2) Credit-enhancing interest-only strip means an on-balance sheet
asset that, in form or in substance:
(i) Represents the contractual right to receive some or all of the
interest due on transferred assets; and
(ii) Exposes the bank to credit risk directly or indirectly
associated with the transferred assets that exceeds its pro rata claim
on the assets whether through subordination provisions or other credit
enhancing techniques.
(3) Credit-enhancing representations and warranties means
representations and warranties that are made or assumed in connection
with a transfer of assets (including loan servicing assets) and that
obligate a bank to protect investors from losses arising from credit
risk in the assets transferred or the loans serviced. Credit-enhancing
representations and warranties include promises to protect a party from
losses resulting from the default or nonperformance of another party or
from an insufficiency in the value of the collateral. Credit-enhancing
representations and warranties do not include:
(i) Early-default clauses and similar warranties that permit the
return of, or premium refund clauses covering, 1-4 family residential
first mortgage loans (as described
[[Page 37]]
in section 3(a)(3)(iii) of this appendix A) for a period not to exceed
120 days from the date of transfer. These warranties may cover only
those loans that were originated within 1 year of the date of transfer;
(ii) Premium refund clauses that cover assets guaranteed, in whole
or in part, by the U.S. Government, a U.S. Government agency, or a U.S.
Government-sponsored enterprise, provided the premium refund clauses are
for a period not to exceed 120 days from the date of transfer; or
(iii) Warranties that permit the return of assets in instances of
fraud, misrepresentation or incomplete documentation.
(4) Direct credit substitute means an arrangement in which a bank
assumes, in form or in substance, credit risk associated with an on- or
off-balance sheet asset or exposure that was not previously owned by the
bank (third-party asset) and the risk assumed by the bank exceeds the
pro rata share of the bank's interest in the third-party asset. If a
bank has no claim on the third-party asset, then the bank's assumption
of any credit risk is a direct credit substitute. Direct credit
substitutes include:
(i) Financial standby letters of credit that support financial
claims on a third party that exceed a bank's pro rata share in the
financial claim;
(ii) Guarantees, surety arrangements, credit derivatives and similar
instruments backing financial claims that exceed a bank's pro rata share
in the financial claim;
(iii) Purchased subordinated interests that absorb more than their
pro rata share of losses from the underlying assets;
(iv) Credit derivative contracts under which the bank assumes more
than its pro rata share of credit risk on a third-party asset or
exposure;
(v) Loans or lines of credit that provide credit enhancement for the
financial obligations of a third party;
(vi) Purchased loan servicing assets if the servicer is responsible
for credit losses or if the servicer makes or assumes credit-enhancing
representations and warranties with respect to the loans serviced.
Mortgage servicer cash advances that meet the conditions of section
4(a)(8)(i) and (ii) of this appendix A, are not direct credit
substitutes; and
(vii) Clean-up calls on third-party assets. Clean-up calls that are
10% or less of the original pool balance and that are exercisable at the
option of the bank are not direct credit substitutes.
(5) Externally rated means that an instrument or obligation has
received a credit rating from at least one nationally recognized
statistical rating organization.
(6) Face amount means the notional principal, or face value, amount
of an off-balance sheet item; the amortized cost of an asset not held
for trading purposes; and the fair value of a trading asset.
(7) Financial asset means cash or other monetary instrument,
evidence of debt, evidence of an ownership interest in an entity, or a
contract that conveys a right to receive or exchange cash or another
financial instrument from another party.
(8) Financial standby letter of credit means a letter of credit or
similar arrangement that represents an irrevocable obligation to a
third-party beneficiary:
(i) To repay money borrowed by, or advanced to, or for the account
of, a second party (the account party); or
(ii) To make payment on behalf of the account party, in the event
that the account party fails to fulfill its obligation to the
beneficiary.
(9) Mortgage servicer cash advance means funds that a residential
mortgage servicer advances to ensure an uninterrupted flow of payments,
including advances made to cover foreclosure costs or other expenses to
facilitate the timely collection of the loan. A mortgage servicer cash
advance is not a recourse obligation or a direct credit substitute if:
(i) The servicer is entitled to full reimbursement and this right is
not subordinated to other claims on the cash flows from the underlying
asset pool; or
(ii) For any one loan, the servicer's obligation to make
nonreimbursable advances is contractually limited to an insignificant
amount of the outstanding principal amount of that loan.
(10) Nationally recognized statistical rating organization (NRSRO)
means an entity recognized by the Division of Market Regulation of the
Securities and Exchange Commission (or any successor Division)
(Commission) as a nationally recognized statistical rating organization
for various purposes, including the Commission's uniform net capital
requirements for brokers and dealers.
(11) Recourse means a bank's retention, in form or in substance, of
any credit risk directly or indirectly associated with an asset it has
sold that exceeds a pro rata share of that bank's claim on the asset. If
a bank has no claim on a sold asset, then the retention of any credit
risk is recourse. A recourse obligation typically arises when a bank
transfers assets and retains an explicit obligation to repurchase assets
or to absorb losses due to a default on the payment of principal or
interest or any other deficiency in the performance of the underlying
obligor or some other party. Recourse may also exist implicitly if a
bank provides credit enhancement beyond any contractual obligation to
support assets it has sold. The following are examples of recourse
arrangements:
(i) Credit-enhancing representations and warranties made on
transferred assets;
[[Page 38]]
(ii) Loan servicing assets retained pursuant to an agreement under
which the bank will be responsible for losses associated with the loans
serviced. Mortgage servicer cash advances that meet the conditions of
section 4(a)(8)(i) and (ii) of this appendix A, are not recourse
arrangements;
(iii) Retained subordinated interests that absorb more than their
pro rata share of losses from the underlying assets;
(iv) Assets sold under an agreement to repurchase, if the assets are
not already included on the balance sheet;
(v) Loan strips sold without contractual recourse where the maturity
of the transferred portion of the loan is shorter than the maturity of
the commitment under which the loan is drawn;
(vi) Credit derivatives issued that absorb more than the bank's pro
rata share of losses from the transferred assets; and
(vii) Clean-up calls. Clean-up calls that are 10% or less of the
original pool balance and that are exercisable at the option of the bank
are not recourse arrangements.
(12) Residual interest means any on-balance sheet asset that
represents an interest (including a beneficial interest) created by a
transfer that qualifies as a sale (in accordance with generally accepted
accounting principles) of financial assets, whether through a
securitization or otherwise, and that exposes a bank to any credit risk
directly or indirectly associated with the transferred asset that
exceeds a pro rata share of that bank's claim on the asset, whether
through subordination provisions or other credit enhancement techniques.
Residual interests generally include credit-enhancing interest-only
strips, spread accounts, cash collateral accounts, retained subordinated
interests (and other forms of overcollateralization) and similar assets
that function as a credit enhancement. Residual interests further
include those exposures that, in substance, cause the bank to retain the
credit risk of an asset or exposure that had qualified as a residual
interest before it was sold. Residual interests generally do not include
interests purchased from a third party.
(13) Risk participation means a participation in which the
originating party remains liable to the beneficiary for the full amount
of an obligation (e.g. a direct credit substitute) notwithstanding that
another party has acquired a participation in that obligation.
(14) Securitization means the pooling and repackaging by a special
purpose entity of assets or other credit exposures that can be sold to
investors. Securitization includes transactions that create stratified
credit risk positions whose performance is dependent upon an underlying
pool of credit exposures, including loans and commitments.
(15) Structured finance program means a program where receivable
interests and asset-backed securities issued by multiple participants
are purchased by a special purpose entity that repackages those
exposures into securities that can be sold to investors. Structured
finance programs allocate credit risks, generally, between the
participants and credit enhancement provided to the program.
(16) Traded position means a position retained, assumed or issued in
connection with a securitization that is externally rated, where there
is a reasonable expectation that, in the near future, the rating will be
relied upon by:
(i) Unaffiliated investors to purchase the position; or
(ii) An unaffiliated third party to enter into a transaction
involving the position, such as a purchase, loan or repurchase
agreement.
(b) Credit equivalent amounts and risk weights of recourse
obligations and direct credit substitutes--(1) Credit-equivalent amount.
Except as otherwise provided, the credit-equivalent amount for a
recourse obligation or direct credit substitute is the full amount of
the credit-enhanced assets for which the bank directly or indirectly
retains or assumes credit risk multiplied by a 100% conversion factor.
(2) Risk-weight factor. To determine the bank's risk-weighted assets
for off-balance sheet recourse obligations and direct credit
substitutes, the credit equivalent amount is assigned to the risk
category appropriate to the obligor in the underlying transaction, after
considering any associated guarantees or collateral. For a direct credit
substitute that is an on-balance sheet asset (e.g., a purchased
subordinated security), a bank must calculate risk-weighted assets using
the amount of the direct credit substitute and the full amount of the
assets it supports, i.e., all the more senior positions in the
structure.
(c) Credit equivalent amount and risk weight of participations in,
and syndications of, direct credit substitutes. The credit equivalent
amount for a participation interest in, or syndication of, a direct
credit substitute is calculated and risk weighted as follows:
(1) In the case of a direct credit substitute in which a bank has
conveyed a risk participation, the full amount of the assets that are
supported by the direct credit substitute is converted to a credit
equivalent amount using a 100% conversion factor. The pro rata share of
the credit equivalent amount that has been conveyed through a risk
participation is then assigned to whichever risk-weight category is
lower: the risk-weight category appropriate to the obligor in the
underlying transaction, after considering any associated guarantees or
collateral, or the risk-weight category appropriate to the party
acquiring the participation. The pro rata share of the credit equivalent
amount
[[Page 39]]
that has not been participated out is assigned to the risk-weight
category appropriate to the obligor after considering any associated
guarantees or collateral.
(2) In the case of a direct credit substitute in which the bank has
acquired a risk participation, the acquiring bank's pro rata share of
the direct credit substitute is multiplied by the full amount of the
assets that are supported by the direct credit substitute and converted
using a 100% credit conversion factor. The resulting credit equivalent
amount is then assigned to the risk-weight category appropriate to the
obligor in the underlying transaction, after considering any associated
guarantees or collateral.
(3) In the case of a direct credit substitute that takes the form of
a syndication where each bank or participating entity is obligated only
for its pro rata share of the risk and there is no recourse to the
originating entity, each bank's credit equivalent amount will be
calculated by multiplying only its pro rata share of the assets
supported by the direct credit substitute by a 100% conversion factor.
The resulting credit equivalent amount is then assigned to the risk-
weight category appropriate to the obligor in the underlying
transaction, after considering any associated guarantees or collateral.
(d) Externally rated positions: credit-equivalent amounts and risk
weights.--(1) Traded positions. With respect to a recourse obligation,
direct credit substitute, residual interest (other than a credit-
enhancing interest-only strip) or asset- or mortgage-backed security
that is a ``traded position'' and that has received an external rating
on a long-term position that is one grade below investment grade or
better or a short-term position that is investment grade, the bank may
multiply the face amount of the position by the appropriate risk weight,
determined in accordance with Tables C or D of this Appendix A.\24\ If a
traded position receives more than one external rating, the lowest
single rating will apply.
---------------------------------------------------------------------------
\24\ Stripped mortgage-backed securities or other similar
instruments, such as interest-only or principal-only strips, that are
not credit enhancing must be assigned to the 100% risk category.
Table C
------------------------------------------------------------------------
Risk weight
Long-term rating category Examples (In percent)
------------------------------------------------------------------------
Highest or second highest AAA, AA............. 20
investment grade.
Third highest investment grade.... A................... 50
Lowest investment grade........... BBB................. 100
One category below investment BB.................. 200
grade.
------------------------------------------------------------------------
Table D
------------------------------------------------------------------------
Risk weight
Short-term rating category Examples (In percent)
------------------------------------------------------------------------
Highest investment grade.......... A-1, P-1............ 20
Second highest investment grade... A-2, P-2............ 50
Lowest investment grade........... A-3, P-3............ 100
------------------------------------------------------------------------
(2) Non-traded positions. A recourse obligation, direct credit
substitute, residual interest (but not a credit-enhancing interest-only
strip) or asset- or mortgage-backed security extended in connection with
a securitization that is not a ``traded position'' may be assigned a
risk weight in accordance with section 4(d)(1) of this appendix A if:
(i) It has been externally rated by more than one NRSRO;
(ii) It has received an external rating on a long-term position that
is one category below investment grade or better or a short-term
position that is investment grade by all NRSROs providing a rating;
(iii) The ratings are publicly available; and
(iv) The ratings are based on the same criteria used to rate traded
positions.
If the ratings are different, the lowest rating will determine the risk
category to which the recourse obligation, residual interest or direct
credit substitute will be assigned.
(e) Senior positions not externally rated. For a recourse
obligation, direct credit substitute, residual interest or asset- or
mortgage-backed security that is not externally rated but is senior or
preferred in all features to a traded position (including
collateralization and maturity), a bank may apply a risk weight to the
face amount of the senior position in accordance with section 4(d)(1) of
this appendix A, based upon the traded position, subject to any current
or prospective supervisory guidance and the bank satisfying the OCC that
this treatment is appropriate. This section will apply only if
[[Page 40]]
the traded position provides substantive credit support to the unrated
position until the unrated position matures.
(f) Residual Interests--(1) Concentration limit on credit-enhancing
interest-only strips. In addition to the capital requirement provided by
section 4(f)(2) of this appendix A, a bank must deduct from Tier 1
capital all credit-enhancing interest-only strips in excess of 25
percent of Tier 1 capital in accordance with section 2(c)(2)(iv) of this
appendix A.
(2) Credit-enhancing interest-only strip capital requirement. After
applying the concentration limit to credit-enhancing interest-only
strips in accordance with section (f)(1), a bank must maintain risk-
based capital for a credit-enhancing interest-only strip equal to the
remaining amount of the credit-enhancing interest-only strip (net of any
existing associated deferred tax liability), even if the amount of risk-
based capital required to be maintained exceeds the full risk-based
capital requirement for the assets transferred. Transactions that, in
substance, result in the retention of credit risk associated with a
transferred credit-enhancing interest-only strip will be treated as if
the credit-enhancing interest-only strip was retained by the bank and
not transferred.
(3) Other residual interests capital requirement. Except as provided
in sections (d) or (e) of this section, a bank must maintain risk-based
capital for a residual interest (excluding a credit-enhancing interest-
only strip) equal to the face amount of the residual interest that is
retained on the balance sheet (net of any existing associated deferred
tax liability), even if the amount of risk-based capital required to be
maintained exceeds the full risk-based capital requirement for the
assets transferred. Transactions that, in substance, result in the
retention of credit risk associated with a transferred residual interest
will be treated as if the residual interest was retained by the bank and
not transferred.
(4) Residual interests and other recourse obligations. Where the
aggregate capital requirement for residual interests (including credit-
enhancing interest-only strips) and recourse obligations arising from
the same transfer of assets exceed the full risk-based capital
requirement for those assets, a bank must maintain risk-based capital
equal to the greater of the risk-based capital requirement for the
residual interest as calculated under sections 4(f)(1) through (3) of
this appendix A or the full risk-based capital requirement for the
assets transferred.
(g) Positions that are not rated by an NRSRO. A position (but not a
residual interest) extended in connection with a securitization and that
is not rated by an NRSRO may be risk-weighted based on the bank's
determination of the credit rating of the position, as specified in
Table E of this appendix A, multiplied by the face amount of the
position. In order to qualify for this treatment, the bank's system for
determining the credit rating of the position must meet one of the three
alternative standards set out in section 4(g)(1)through (3) of this
appendix A.
Table E
------------------------------------------------------------------------
Risk weight
Rating category Examples (In percent)
------------------------------------------------------------------------
Investment grade.................. BBB, or better...... 100
One category below investment BB.................. 200
grade.
------------------------------------------------------------------------
(1) Internal risk rating used for asset-backed programs. A direct
credit substitute (but not a purchased credit-enhancing interest-only
strip) is assumed by a bank in connection with an asset-backed
commercial paper program sponsored by the bank and the bank is able to
demonstrate to the satisfaction of the OCC, prior to relying upon its
use, that the bank's internal credit risk rating system is adequate.
Adequate internal credit risk rating systems usually contain the
following criteria:
(i) The internal credit risk system is an integral part of the
bank's risk management system that explicitly incorporates the full
range of risks arising from a bank's participation in securitization
activities;
(ii) Internal credit ratings are linked to measurable outcomes, such
as the probability that the position will experience any loss, the
position's expected loss given default, and the degree of variance in
losses given default on that position;
(iii) The bank's internal credit risk system must separately
consider the risk associated with the underlying loans or borrowers, and
the risk associated with the structure of a particular securitization
transaction;
(iv) The bank's internal credit risk system must identify gradations
of risk among ``pass'' assets and other risk positions;
(v) The bank must have clear, explicit criteria that are used to
classify assets into each internal risk grade, including subjective
factors;
(vi) The bank must have independent credit risk management or loan
review personnel assigning or reviewing the credit risk ratings;
(vii) An internal audit procedure should periodically verify that
internal risk ratings
[[Page 41]]
are assigned in accordance with the bank's established criteria.
(viii) The bank must monitor the performance of the internal credit
risk ratings assigned to nonrated, nontraded direct credit substitutes
over time to determine the appropriateness of the initial credit risk
rating assignment and adjust individual credit risk ratings, or the
overall internal credit risk ratings system, as needed; and
(ix) The internal credit risk system must make credit risk rating
assumptions that are consistent with, or more conservative than, the
credit risk rating assumptions and methodologies of NRSROs.
(2) Program Ratings. A direct credit substitute or recourse
obligation (but not a residual interest) is assumed or retained by a
bank in connection with a structured finance program and a NRSRO has
reviewed the terms of the program and stated a rating for positions
associated with the program. If the program has options for different
combinations of assets, standards, internal credit enhancements and
other relevant factors, and the NRSRO specifies ranges of rating
categories to them, the bank may apply the rating category applicable to
the option that corresponds to the bank's position. In order to rely on
a program rating, the bank must demonstrate to the OCC's satisfaction
that the credit risk rating assigned to the program meets the same
standards generally used by NRSROs for rating traded positions. The bank
must also demonstrate to the OCC's satisfaction that the criteria
underlying the NRSRO's assignment of ratings for the program are
satisfied for the particular position. If a bank participates in a
securitization sponsored by another party, the OCC may authorize the
bank to use this approach based on a program rating obtained by the
sponsor of the program.
(3) Computer Program. The bank is using an acceptable credit
assessment computer program to determine the rating of a direct credit
substitute or recourse obligation (but not a residual interest) extended
in connection with a structured finance program. A NRSRO must have
developed the computer program and the bank must demonstrate to the
OCC's satisfaction that ratings under the program correspond credibly
and reliably with the rating of traded positions.
(h) Limitations on risk-based capital requirements--(1) Low-level
exposure rule. If the maximum contractual exposure to loss retained or
assumed by a bank is less than the effective risk-based capital
requirement, as determined in accordance with section 4(b) of this
appendix A, for the asset supported by the bank's position, the risk
based capital required under this appendix A is limited to the bank's
contractual exposure, less any recourse liability account established in
accordance with generally accepted accounting principles. This
limitation does not apply when a bank provides credit enhancement beyond
any contractual obligation to support assets that it has sold.
(2) Related on-balance sheet assets. If an asset is included in the
calculation of the risk-based capital requirement under this section 4
of this appendix A and also appears as an asset on a bank's balance
sheet, the asset is risk-weighted only under this section 4 of this
appendix A, except in the case of loan servicing assets and similar
arrangements with embedded recourse obligations or direct credit
substitutes. In that case, both the on-balance sheet servicing assets
and the related recourse obligations or direct credit substitutes must
both be separately risk weighted and incorporated into the risk-based
capital calculation.
(i) Alternative Capital Calculation for Small Business Obligations.
(1) Definitions. For purposes of this section 4(i):
(i) Qualified bank means a bank that:
(A) Is well capitalized as defined in 12 CFR 6.4 without applying
the capital treatment described in this section 4(i), or
(B) Is adequately capitalized as defined in 12 CFR 6.4 without
applying the capital treatment described in this section 4(i) and has
received written permission from the appropriate district office of the
OCC to apply the capital treatment described in this section 4(i).
(ii) Recourse has the meaning given to such term under generally
accepted accounting principles.
(iii) Small business means a business that meets the criteria for a
small business concern established by the Small Business Administration
in 13 CFR part 121 pursuant to 15 U.S.C. 632.
(2) Capital and reserve requirements. Notwithstanding the risk-based
capital treatment outlined in section 2(c)(4) and any other subsection
(other than subsection (i)) of this section 4, with respect to a
transfer of a small business loan or a lease of personal property with
recourse that is a sale under generally accepted accounting principles,
a qualified bank may elect to apply the following treatment:
(i) The bank establishes and maintains a non-capital reserve under
generally accepted accounting principles sufficient to meet the
reasonable estimated liability of the bank under the recourse
arrangement; and
(ii) For purposes of calculating the bank's risk-based capital
ratio, the bank includes only the face amount of its recourse in its
risk-weighted assets.
(3) Limit on aggregate amount of recourse. The total outstanding
amount of recourse retained by a qualified bank with respect to
transfers of small business loans and leases of personal property and
included in the risk-weighted assets of the bank as described in section
4(i)(2) of this appendix A may not exceed 15 percent of the bank's total
capital
[[Page 42]]
after adjustments and deductions, unless the OCC specifies a greater
amount by order.
(4) Bank that ceases to be qualified or that exceeds aggregate
limit. If a bank ceases to be a qualified bank or exceeds the aggregate
limit in section 4(i)(3) of this appendix A, the bank may continue to
apply the capital treatment described in section 4(i)(2) of this
appendix A to transfers of small business loans and leases of personal
property that occurred when the bank was qualified and did not exceed
the limit.
(5) Prompt Corrective Action not affected. (i) A bank shall compute
its capital without regard to this section 4(i) for purposes of prompt
corrective action (12 U.S.C. 1831o and 12 CFR part 6) unless the bank is
an adequately or well capitalized bank (without applying the capital
treatment described in this section 4(i)) and, after applying the
capital treatment described in this section 4(i), the bank would be well
capitalized.
(ii) A bank shall compute its capital without regard to this section
4(i) for purposes of 12 U.S.C. 1831o(g) regardless of the bank's capital
level.
(j) Asset-backed commercial paper programs subject to consolidation.
(1) A bank that qualifies as a primary beneficiary and must consolidate
an asset-backed commercial paper program as a variable interest entity
under generally accepted accounting principles may exclude the
consolidated asset-backed commercial paper program assets from risk-
weighted assets if the bank is the sponsor of the consolidated asset-
backed commercial paper program.
(2) If a bank excludes such consolidated asset-backed commercial
paper program assets from risk-weighted assets, the bank must assess the
appropriate risk-based capital charge against any risk exposures of the
bank arising in connection with such asset-backed commercial paper
programs, including direct credit substitutes, recourse obligations,
residual interests, liquidity facilities, and loans, in accordance with
sections 3 and 4(b) of this appendix A.
(3) If a bank either elects not to exclude such consolidated asset-
backed commercial paper program assets from its risk-weighted assets in
accordance with section 4(j)(1) of this appendix A, or is not permitted
to exclude consolidated asset-backed commercial paper program assets,
the bank must assess risk-based capital charge based on the appropriate
risk weight of the consolidated asset-backed commercial paper program
assets in accordance with section 3(a) of this appendix A. In such case,
direct credit substitutes and recourse obligations (including residual
interests), and loans that sponsoring banks provide to such asset-backed
commercial paper programs are not subject to any capital charge under
section 4 of this appendix A.
(4) This section (4)(j) of this appendix A is effective from July 1,
2003 until April 1, 2004.
(k) Other variable interest entities subject to consolidation. (1)
If a bank that is required to consolidated the assets of a variable
interest entity under generally accepted accounting principles, the bank
must assess risk-based capital charge based on the appropriate risk
weight of the consolidated assets in accordance with section 3(a) of
this appendix A. In such case, direct credit substitutes and recourse
obligations (including residual interests), and loans that sponsoring
banks provide to such asset-backed commercial paper programs are not
subject to any capital charge under section 4 of this appendix A.
(2) This section 4(k) of this appendix A is effective from July 1,
2003 until April 1, 2004.
Section 5. Implementation, Transition Rules, and Target Ratios
(a) December 31, 1990 to December 30, 1992. During this time period:
(1) All national banks are expected to maintain a minimum ratio of
total capital (after deductions) to risk-weighted assets of 7.25%.
(i) Fifty percent of this 7.25% must be made up of Tier 1 capital;
however, up to 10% of Tier 1 capital can be comprised of Tier 2 capital
elements, before any deductions for goodwill. The amount of Tier 2
elements included in Tier 1 will not be subject to the sublimits on the
amount of such elements in Tier 2 capital, with the exception of the
allowance for loan and lease losses.
(ii) Goodwill that national banks have been allowed to count as
capital as a result of the transition rules contained in 12 CFR 3.3 is
grandfathered until December 31, 1992, but will be deducted from Tier 1
capital after that date.
(2) The allowance for loan and lease losses can be included in total
capital up to a maximum of 1.5% of a bank's risk-weighted assets,
including the portion that can be borrowed to make up Tier 1.
(3) Tier 2 capital elements that are not used as part of Tier 1
capital will qualify as part of a national bank's total capital base up
to a maximum of 100% of the bank's Tier 1 capital.
(4) In addition to the standards established by these risk-based
capital guidelines, all national banks must maintain a minimum capital-
to-total assets ratio in accordance with the provisions of 12 CFR part
3.
(b) On December 31, 1992. (1) All national banks are expected to
maintain a minimum ratio of total capital (after deductions) to risk-
weighted assets of 8.0%.
(2) Tier 2 capital elements qualify as part of a national bank's
total capital base up to a maximum of 100% of that bank's Tier 1
capital.
[[Page 43]]
(3) In addition to the standards established by these risk-based
capital guidelines, all national banks must maintain a minimum capital-
to-total assets ratio in accordance with the provisions of 12 CFR part
3.
Table 1--Summary of Risk Weights and Risk Categories
Category 1: Zero Percent
1. Cash (domestic and foreign).
2. Balances due from, and claims on, Federal Reserve Banks and
central banks in other OECD countries.
3. Claims on, or unconditionally guaranteed by, the U.S. Government
or its agencies, or other OECD central governments.\1\
---------------------------------------------------------------------------
\1\ For the purpose of calculating the risk-based capital ratio, a
U.S. Government agency is defined as an instrumentality of the U.S.
Government whose obligations are fully and explicitly guaranteed as to
the timely repayment of principal and interest by the full faith and
credit of the U.S. Government.
---------------------------------------------------------------------------
4. That portion of local currency claims on or unconditionally
guaranteed by non-OECD central governments to the extent the bank has
local currency liabilities in that country.
5. Gold bullion held in the bank's own vaults or in another bank's
vaults on an allocated basis, to the extent it is backed by gold bullion
liabilities.
6. Federal Reserve Bank stock.
Category 2: 20 Percent
1. Portions of loans and other assets collateralized by securities
issued or guaranteed by the U.S. Government or its agencies, or other
OECD central governments.\2\
---------------------------------------------------------------------------
\2\ Degree of collateralization is determined by current market
value.
---------------------------------------------------------------------------
2. Portions of loans and other assets conditionally guaranteed by
the U.S. Government or its agencies, or other OECD central governments.
3. Portions of loans and other assets collateralized by cash on
deposit in the lending institution.
4. All claims (long- and short-term) on, or guaranteed by, OECD
depository institutions.
5. Claims on, or guaranteed by, non-OECD depository institutions
with a residual maturity of one year or less.
6. Cash items in the process of collection.
7. Securities and other claims on, or guaranteed by, U.S.
Government-sponsored agencies.\3\
---------------------------------------------------------------------------
\3\ For the purpose of calculating the risk-based capital ratio, a
U.S. Government-sponsored agency is defined as an agency originally
established or chartered 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.
---------------------------------------------------------------------------
8. Portions of loans and other assets collateralized by securities
issued by, or guaranteed by, U.S. Government-sponsored agencies.\4\
---------------------------------------------------------------------------
\4\ Degree of collateralization is determined by current market
value.
---------------------------------------------------------------------------
9. Claims that represent general obligations of, and portions of
claims guaranteed by, public-sector entities in OECD countries, below
the level of central government.
10. Claims on or guaranteed by official multilateral lending
institutions or regional development institutions in which the U.S.
Government is a shareholder or a contributing member.
11. Portions of loans and other assets collateralized with
securities issued by official multilateral lending institutions or
regional development institutions in which the U.S. Government is a
shareholder or a contributing member.
12. That portion of local currency claims conditionally guaranteed
by central governments of non-OECD countries, to the extent the bank has
local currency liabilities in that country.
Category 3: 50 Percent
1. Revenue bonds or similar obligations, including loans and leases,
that are obligations of public sector entities in OECD countries, but
for which the government entity is committed to repay the debt only out
of revenues from the facilities financed.
2. Credit equivalent amounts of interest rate and exchange rate
related contracts, except for those assigned to a lower risk category.
3. Assets secured by a first mortgage on a one-to-four family
residential property that are not more than 90 days past due, on
nonaccrual or restructured.
4. Loans to residential real estate builders for one-to-four family
residential property construction that have been presold pursuant to
legally binding written sales contract.
5. Assets secured by a first mortgage on multifamily residential
properties.
Category 4: 100 Percent
1. All other claims on private obligors.
2. Claims on non-OECD financial institutions with a residual
maturity exceeding one year. Claims on non-OECD central banks with a
residual maturity exceeding one year are included in this category
unless they qualify for item 4 of Category 1.
3. Claims on non-OECD central governments that are not included in
item 4 of Category 1.
4. Obligations issued by state or local governments (including
industrial development
[[Page 44]]
authorities and similar entities) repayable solely by a private party or
enterprise.
5. Premises, plant, and equipment; other fixed assets; and other
real estate owned.
6. Investments in unconsolidated subsidiaries, joint ventures, or
associated companies (unless deducted from capital).
7. Capital instruments issued by other banking organizations.
8. All other assets (including claims on commercial firms owned by
the public sector).
Table 2--Credit Conversion Factors for Off-Balance Sheet Items
------------------------------------------------------------------------
100 Percent Conversion Factor
-------------------------------------------------------------------------
1. [Reserved]
------------------------------------------------------------------------
50 Percent Conversion Factor
1. Transaction-related contingencies (e.g., bid bonds, performance
bonds, warranties, and standby letters of credit related to particular
transactions).
2. Unused portion of commitments with an original maturity exceeding
one year.
3. Revolving underwriting facilities (RUFs), note issuance
facilities (NIFs) and other similar arrangements.
20 Percent Conversion Factor
1. Short-term, self-liquidating trade-related contingencies,
including commercial letters of credit.
Zero Percent Conversion Factor
1. Unused portion of commitments with an original maturity of one
year or less.
2. Unused portion of commitments which are unconditionally
cancelable at any time, regardless of maturity.
Table 3--Treatment of Derivative Contracts
1. The current exposure method is used to calculate the credit
equivalent amounts of derivative contracts. These amounts are assigned a
risk weight appropriate to the obligor or any collateral or guarantee.
However, the maximum risk weight is limited to 50 percent. Multiple
derivative contracts with a single counterparty may be netted if those
contracts are subject to a qualifying bilateral netting contract.
Conversion Factor Matrix \1\
[Percent]
----------------------------------------------------------------------------------------------------------------
Foreign
Interest exchange Precious Other
Remaining maturity \2\ rate rate and Equity \2\ metals commodity
gold
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0 1.0 6.0 7.0 10.0
Over one to five years......................... 0.5 5.0 8.0 7.0 12.0
Over five years................................ 1.5 7.5 10.0 8.0 15.0
----------------------------------------------------------------------------------------------------------------
\1\ For derivative contracts with multiple exchanges of principal, the conversion factors are multiplied by the
number of remaining payments in the derivative contract.
\2\ For derivative contracts that automatically reset to zero value following a payment, the remaining maturity
equals the time until the next payment. However, interest rate contracts with remaining maturities of greater
than one year shall be subject to a minimum conversion factor of 0.5 percent.
2. The following derivative contracts will be excluded:
a. Exchange rate contract with an original maturity of 14 calendar
days or less; and
b. Derivative contract traded on exchanges and subject to daily
margin requirements.
Table 4--Definition of Capital
Capital components are distributed between two categories (Tier 1
and Tier 2). Tier 2 capital elements will qualify as part of a bank's
total capital base up to a maximum of 100% of that bank's Tier 1
capital. Beginning December 31, 1992, the minimum risk-based capital
standard will be 8.0%.
Definition of Capital
Tier 1:
Common stockholders' equity;
Noncumulative perpetual preferred stock and any
related surplus; and
Minority interests in the equity accounts of
consolidated subsidiaries.
Tier 2:
Cumulative perpetual, long-term and convertible
preferred stock, and any related surplus; \5\
---------------------------------------------------------------------------
\5\ The amount of long-term and intermediate-term preferred stock,
as well as term subordinated debt that is eligible to be included as
Tier 2 capital is reduced by 20% of the original amount of the
instrument at the beginning of each of the last five years of the life
of the instrument.
---------------------------------------------------------------------------
Perpetual debt and other hybrid debt/equity
instruments;
Intermediate-term preferred stock and term
subordinated debt (to a maximum of 50% of Tier 1 capital); and
Loan loss reserves (to a maximum of 1.25% of
risk-weighted assets).
[[Page 45]]
Deductions from Capital:
From Tier 1:
Goodwill and other intangibles, with the
exception of identified intangibles that satisfy the criteria included
in the guidelines.
From Total Capital:
Investments in unconsolidated banking and finance
subsidiaries;
Reciprocal holdings of capital instruments
Transitional Definition
During a transition period beginning December 31, 1990, all national
banks are expected to maintain a capital to risk-weighted asset ratio of
7.25%, of which at least 3.25 percentage points must consist of Tier 1
capital. In other words, during this period upon to approximately 4
percentage points of the 7.25% capital ratio may consist of Tier 2
capital. Also during this period, the sublimit on loan loss reserves
will be 1.5% of risk-weighted assets.Q04
[54 FR 4177, Jan. 27, 1989]
Editorial Note: For Federal Register citations affecting Appendix A
to part 3 of title 12, see the List of CFR Sections Affected, which
appears in the Finding Aids section of the printed volume and on GPO
Access.
Effective Date Notes: 1. At 68 FR 70128, Dec. 17, 2003, appendix A
to part 3 was amended in section 3, in paragraph (a)(2)(ix) by removing
``12 CFR 1.3(g)'' and adding in its place ``12 CFR 1.2(b)''; and in
section 4, in paragraph (a)(11)(ii) by removing, ``section (4)(a)(8)(i)
and (ii)'' and adding in its place ``section (4)(a)(9)(i) and (ii)'',
effective Jan. 16, 2004.
2. At 68 FR 74467, Dec. 24, 2003, appendix A was corrected on page
70128, in the third column, instruction 2.b. should read as follows:
b. In section 4, amend paragraph (a)(11)(ii) by removing ``section
4(a)(8)(i) and (ii)'' and adding in its place ``section 4(a)(9)(i) and
(ii)'', effective Jan. 16, 2004.
Appendix B to Part 3--Risk-Based Capital Guidelines; Market Risk
Adjustment
Section 1. Purpose, Applicability, Scope, and Effective Date
(a) Purpose. The purpose of this appendix is to ensure that banks
with significant exposure to market risk maintain adequate capital to
support that exposure.\1\ This appendix supplements and adjusts the
risk-based capital ratio calculations under appendix A of this part with
respect to those banks.
---------------------------------------------------------------------------
\1\ This appendix is based on a framework developed jointly by
supervisory authorities from the countries represented on the Basle
Committee on Banking Supervision and endorsed by the Group of Ten
Central Bank Governors. The framework is described in a Basle Committee
paper entitled ``Amendment to the Capital Accord to Incorporate Market
Risk,'' January 1996.
---------------------------------------------------------------------------
(b) Applicability. (1) This appendix applies to any national bank
whose trading activity \2\ (on a worldwide consolidated basis) equals:
---------------------------------------------------------------------------
\2\ Trading activity means the gross sum of trading assets and
liabilities as reported in the bank's most recent quarterly Consolidated
Report of Condition and Income (Call Report).
---------------------------------------------------------------------------
(i) 10 percent or more of total assets; \3\ or
---------------------------------------------------------------------------
\3\ Total assets means quarter-end total assets as reported in the
bank's most recent Call Report.
---------------------------------------------------------------------------
(ii) $1 billion or more.
(2) The OCC may apply this appendix to any national bank if the OCC
deems it necessary or appropriate for safe and sound banking practices.
(3) The OCC may exclude a national bank otherwise meeting the
criteria of paragraph (b)(1) of this section from coverage under this
appendix if it determines the bank meets such criteria as a consequence
of accounting, operational, or similar considerations, and the OCC deems
it consistent with safe and sound banking practices.
(c) Scope. The capital requirements of this appendix support market
risk associated with a bank's covered positions.
(d) Effective date. This appendix is effective as of January 1,
1997. Compliance is not mandatory until January 1, 1998. Subject to
supervisory approval, a bank may opt to comply with this appendix as
early as January 1, 1997.\4\
---------------------------------------------------------------------------
\4\ A bank that voluntarily complies with the final rule prior to
January 1, 1998, must comply with all of its provisions.
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Section 2. Definitions
For purposes of this appendix, the following definitions apply:
(a) Covered positions means all positions in a bank's trading
account, and all foreign exchange \5\ and commodity positions, whether
or not in the trading account.\6\ Positions include on-balance-sheet
assets and liabilities and off-balance-sheet items. Securities subject
to repurchase and lending agreements are included as if they are still
owned by the lender.
---------------------------------------------------------------------------
\5\ Subject to supervisory review, a bank may exclude structural
positions in foreign currencies from its covered positions.
\6\ The term trading account is defined in the instructions to the
Call Report.
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(b) Market risk means the risk of loss resulting from movements in
market prices.
[[Page 46]]
Market risk consists of general market risk and specific risk
components.
(1) General market risk means changes in the market value of covered
positions resulting from broad market movements, such as changes in the
general level of interest rates, equity prices, foreign exchange rates,
or commodity prices.
(2) Specific risk means changes in the market value of specific
positions due to factors other than broad market movements and includes
default and event risk as well as idiosyncratic variations.
(c) Tier 1 and Tier 2 capital are the same as defined in appendix A
of this part.
(d) Tier 3 capital is subordinated debt that is unsecured; is fully
paid up; has an original maturity of at least two years; is not
redeemable before maturity without prior approval by the OCC; includes a
lock-in clause precluding payment of either interest or principal (even
at maturity) if the payment would cause the issuing bank's risk-based
capital ratio to fall or remain below the minimum required under
appendix A of this part; and does not contain and is not covered by any
covenants, terms, or restrictions that are inconsistent with safe and
sound banking practices.
(e) Value-at-risk (VAR) means the estimate of the maximum amount
that the value of covered positions could decline during a fixed holding
period within a stated confidence level, measured in accordance with
section 4 of this appendix.
Section 3. Adjustments to the Risk-Based Capital Ratio Calculations
(a) Risk-based capital ratio denominator. A bank subject to this
appendix shall calculate its risk-based capital ratio denominator as
follows:
(1) Adjusted risk-weighted assets. (i) Covered positions. Calculate
adjusted risk-weighted assets, which equal risk-weighted assets (as
determined in accordance with appendix A of this part), excluding the
risk-weighted amount of all covered positions (except foreign exchange
positions outside the trading account and over-the-counter derivatives
positions).\7\
(ii) Securities borrowing transactions. In calculating adjusted
risk-weighted assets, a bank also may exclude a receivable that results
from the bank's posting of cash collateral in a securities borrowing
transaction to the extent that the receivable is collateralized by the
market value of the borrowed securities and subject to the following
conditions:
(A) The borrowed securities must be includable in the trading
account and must be liquid and readily marketable;
(B) The borrowed securities must be marked to market daily;
(C) The receivable must be subject to a daily margining requirement;
and
(D) The securities borrowing transaction must be a securities
contract for purposes of section 555 of the Bankruptcy Code (11 U.S.C.
555741(7)), a qualified financial contract for purposes of 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, for purposes
of sections 401-407 of the Federal Deposit Insurance Corporation
Improvement Act of 1991 (12 U.S.C. 4401-4407) or Regulation EE (12 CFR
Part 231).
---------------------------------------------------------------------------
\7\ Foreign exchange positions outside the trading account and all
over-the-counter derivative positions, whether or not in the trading
account, must be included in adjusted risk-weighted assets as determined
in appendix A of this part.
---------------------------------------------------------------------------
(2) Measure for market risk. Calculate the measure for market risk,
which equals the sum of the VAR-based capital charge, the specific risk
add-on (if any), and the capital charge for de minimis exposure (if
any).
(i) VAR-based capital charge. The VAR-based capital charge equals
the higher of:
(A) The previous day's VAR measure; or
(B) The average of the daily VAR measures for each of the preceding
60 business days multiplied by three, except as provided in section 4(e)
of this appendix;
(ii) Specific risk add-on. The specific risk add-on is calculated in
accordance with section 5 of this appendix; and
(iii) Capital charge for de minimis exposure. The capital charge for
de minimis exposure is calculated in accordance with section 4(a) of
this appendix.
(3) Market risk equivalent assets. Calculate market risk equivalent
assets by multiplying the measure for market risk (as calculated in
paragraph (a)(2) of this section) by 12.5.
(4) Denominator calculation. Add market risk equivalent assets (as
calculated in paragraph (a)(3) of this section) to adjusted risk-
weighted assets (as calculated in paragraph (a)(1) of this section). The
resulting sum is the bank's risk-based capital ratio denominator.
(b) Risk-based capital ratio numerator. A bank subject to this
appendix shall calculate its risk-based capital ratio numerator by
allocating capital as follows:
(1) Credit risk allocation. Allocate Tier 1 and Tier 2 capital equal
to 8.0 percent of adjusted risk-weighted assets (as calculated in
paragraph (a)(1) of this section).\8\
---------------------------------------------------------------------------
\8\ A bank may not allocate Tier 3 capital to support credit risk
(as calculated under appendix A).
---------------------------------------------------------------------------
(2) Market risk allocation. Allocate Tier 1, Tier 2, and Tier 3
capital equal to the measure for market risk as calculated in paragraph
(a)(2) of this section. The sum of Tier 2 and Tier 3 capital allocated
for market risk must not exceed 250 percent of Tier 1 capital allocated
for market risk. (This requirement means that Tier 1 capital allocated
in this paragraph (b)(2) must equal at least 28.6 percent of the measure
for market risk.)
(3) Restrictions. (i) The sum of Tier 2 capital (both allocated and
excess) and Tier 3 capital
[[Page 47]]
(allocated in paragraph (b)(2) of this section) may not exceed 100
percent of Tier 1 capital (both allocated and excess).\9\
---------------------------------------------------------------------------
\9\ Excess Tier 1 capital means Tier 1 capital that has not been
allocated in paragraphs (b)(1) and (b)(2) of this section. Excess Tier 2
capital means Tier 2 capital that has not been allocated in paragraph
(b)(1) and (b)(2) of this section, subject to the restrictions in
paragraph (b)(3) of this section.
---------------------------------------------------------------------------
(ii) Term subordinated debt (and intermediate-term preferred stock
and related surplus) included in Tier 2 capital (both allocated and
excess) may not exceed 50 percent of Tier 1 capital (both allocated and
excess).
(4) Numerator calculation. Add Tier 1 capital (both allocated and
excess), Tier 2 capital (both allocated and excess), and Tier 3 capital
(allocated under paragraph (b)(2) of this section). The resulting sum is
the bank's risk-based capital ratio numerator.
Section 4. Internal Models
(a) General. For risk-based capital purposes, a bank subject to this
appendix must use its internal model to measure its daily VAR, in
accordance with the requirements of this section.\10\ The OCC may permit
a bank to use alternative techniques to measure the market risk of de
minimis exposures so long as the techniques adequately measure
associated market risk.
---------------------------------------------------------------------------
\10\ A bank's internal model may use any generally accepted
measurement techniques, such as variance-covariance models, historical
simulations, or Monte Carlo simulations. However, the level of
sophistication and accuracy of a bank's internal model must be
commensurate with the nature and size of its covered positions. A bank
that modifies its existing modeling procedures to comply with the
requirements of this appendix for risk-based capital purposes should,
nonetheless, continue to use the internal model it considers most
appropriate in evaluating risks for other purposes.
---------------------------------------------------------------------------
(b) Qualitative requirements. A bank subject to this appendix must
have a risk management system that meets the following minimum
qualitative requirements:
(1) The bank must have a risk control unit that reports directly to
senior management and is independent from business trading units.
(2) The bank's internal risk measurement model must be integrated
into the daily management process.
(3) The bank's policies and procedures must identify, and the bank
must conduct, appropriate stress tests and backtests.\11\ The bank's
policies and procedures must identify the procedures to follow in
response to the results of such tests.
---------------------------------------------------------------------------
\11\ Stress tests provide information about the impact of adverse
market events on a bank's covered positions. Backtests provide
information about the accuracy of an internal model by comparing a
bank's daily VAR measures to its corresponding daily trading profits and
losses.
---------------------------------------------------------------------------
(4) The bank must conduct independent reviews of its risk
measurement and risk management systems at least annually.
(c) Market risk factors. The bank's internal model must use risk
factors sufficient to measure the market risk inherent in all covered
positions. The risk factors must address interest rate risk,\12\ equity
price risk, foreign exchange rate risk, and commodity price risk.
---------------------------------------------------------------------------
\12\ For material exposures in the major currencies and markets,
modeling techniques must capture spread risk and must incorporate enough
segments of the yield curve--at least six--to capture differences in
volatility and less than perfect correlation of rates along the yield
curve.
---------------------------------------------------------------------------
(d) Quantitative requirements. For regulatory capital purposes, VAR
measures must meet the following quantitative requirements:
(1) The VAR measures must be calculated on a daily basis using a 99
percent, one-tailed confidence level with a price shock equivalent to a
ten-business day movement in rates and prices. In order to calculate VAR
measures based on a ten-day price shock, the bank may either calculate
ten-day figures directly or convert VAR figures based on holding periods
other than ten days to the equivalent of a ten-day holding period (for
instance, by multiplying a one-day VAR measure by the square root of
ten).
(2) The VAR measures must be based on an historical observation
period (or effective observation period for a bank using a weighting
scheme or other similar method) of at least one year. The bank must
update data sets at least once every three months or more frequently as
market conditions warrant.
(3) The VAR measures must include the risks arising from the non-
linear price characteristics of options positions and the sensitivity of
the market value of the positions to changes in the volatility of the
underlying rates or prices. A bank with a large or complex options
portfolio must measure the volatility of options positions by different
maturities.
(4) The VAR measures may incorporate empirical correlations within
and across risk categories, provided that the bank's process for
measuring correlations is sound. In the event that the VAR measures do
not incorporate empirical correlations across risk categories, then the
bank must add the separate VAR measures for the four major risk
categories to determine its aggregate VAR measure.
[[Page 48]]
(e) Backtesting. (1) Beginning one year after a bank starts to
comply with this appendix, a bank must conduct backtesting by comparing
each of its most recent 250 business days' actual net trading profit or
loss \13\ with the corresponding daily VAR measures generated for
internal risk measurement purposes and calibrated to a one-day holding
period and a 99 percent, one-tailed confidence level.
---------------------------------------------------------------------------
\13\ Actual net trading profits and losses typically include such
things as realized and unrealized gains and losses on portfolio
positions as well as fee income and commissions associated with trading
activities.
---------------------------------------------------------------------------
(2) Once each quarter, the bank must identify the number of
exceptions, that is, the number of business days for which the magnitude
of the actual daily net trading loss, if any, exceeds the corresponding
daily VAR measure.
(3) A bank must use the multiplication factor indicated in Table 1
of this appendix in determining its capital charge for market risk under
section 3(a)(2)(i)(B) of this appendix until it obtains the next
quarter's backtesting results, unless the OCC determines that a
different adjustment or other action is appropriate.
Table 1--Multiplication Factor Based on Results of Backtesting
------------------------------------------------------------------------
Multiplication
Number of exceptions factor
------------------------------------------------------------------------
4 or fewer.............................................. 3.00
5....................................................... 3.40
6....................................................... 3.50
7....................................................... 3.65
8....................................................... 3.75
9....................................................... 3.85
10 or more.............................................. 4.00
------------------------------------------------------------------------
Section 5. Specific Risk
(a) Specific risk surcharge. For purposes of section 3(a)(2)(ii) of
this appendix, a bank shall calculate its specific risk surcharge as
follows:
(1) Internal models that incorporate specific risk. (i) No specific
risk surcharge required for qualifying internal models. A bank that
incorporates specific risk in its internal model has no specific risk
surcharge for purposes of section 3(a)(2)(ii) of this appendix if the
bank demonstrates to the OCC that its internal model adequately measures
all aspects of specific risk, including default and event risk, of
covered debt and equity positions. In evaluating a bank's internal model
the OCC will take into account the extent to which the internal model:
(A) Explains the historical price variation in the trading
portfolio; and
(B) Captures concentrations.
(ii) Specific risk surcharge for modeled specific risk that fails to
adequately measure default or event risk. A bank that incorporates
specific risk in its internal model but fails to demonstrate that its
internal model adequately measures all aspects of specific risk,
including default and event risk, as provided by this section 5(a)(1),
must calculate its specific risk surcharge in accordance with one of the
following methods:
(A) If the bank's internal model separates the VAR measure into a
specific risk portion and a general market risk portion, then the
specific risk surcharge equals the previous day's specific risk portion.
(B) If the bank's internal model does not separate the VAR measure
into a specific risk portion and a general market risk portion, then the
specific risk surcharge equals the sum of the previous day's VAR measure
for subportfolios of covered debt and equity positions.
(2) Specific risk surcharge for specific risk not modeled. If a bank
does not model specific risk in accordance with section 5(a)(1) of this
appendix, then the bank shall calculate its specific risk surcharge
using the standard specific risk capital charge in accordance with
section 5(c) of this appendix.
(b) Covered debt and equity positions. If a model includes the
specific risk of covered debt positions but not covered equity positions
(or vice versa), then the bank may reduce its specific risk charge for
the included positions under section 5(a)(1)(ii) of this appendix. The
specific risk charge for the positions not included equals the standard
specific risk capital charge under paragraph (c) of this section.
(c) Standard specific risk capital charge. The standard specific
risk capital charge equals the sum of the components for covered debt
and equity positions as follows:
(1) Covered debt positions. (i) For purposes of this section 5,
covered debt positions means fixed-rate or floating-rate debt
instruments located in the trading account and instruments located in
the trading account with values that react primarily to changes in
interest rates, including certain non-convertible preferred stock,
convertible bonds, and instruments subject to repurchase and lending
agreements. Also included are derivatives (including written and
purchased options) for which the underlying instrument is a covered debt
instrument that is subject to a non-zero specific risk capital charge.
(A) For covered debt positions that are derivatives, a bank must
risk-weight (as described in paragraph (c)(1)(iii) of this section) the
market value of the effective notional amount of the underlying debt
instrument or index portfolio. Swaps must be included as the notional
position in the underlying debt instrument or index portfolio,
[[Page 49]]
with a receiving side treated as a long position and a paying side
treated as a short position; and
(B) For covered debt positions that are options, whether long or
short, a bank must risk-weight (as described in paragraph (c)(1)(iii) of
this section) the market value of the effective notional amount of the
underlying debt instrument or index multiplied by the option's delta.
(ii) A bank may net long and short covered debt positions (including
derivatives) in identical debt issues or indices.
(iii) A bank must multiply the absolute value of the current market
value of each net long or short covered debt position by the appropriate
specific risk weighting factor indicated in Table 2 of this appendix.
The specific risk capital charge component for covered debt positions is
the sum of the weighted values.
Table 2--Specific Risk Weighting Factors for Covered Debt Positions
------------------------------------------------------------------------
Weighting
Remaining maturity factor
Category (contractual) (in
percent)
------------------------------------------------------------------------
Government \1\...................... N/A.................... 0.00
Qualifying \2\...................... 6 months or less....... 0.25
Over 6 months to 24 1.00
months.
Over 24 months......... 1.60
Other \3\........................... N/A.................... 8.00
------------------------------------------------------------------------
\1\ The ``government'' category includes all debt instruments of central
governments of OECD countries (as defined in appendix A of this part)
including bonds, Treasury bills, and other short-term instruments, as
well as local currency instruments of non-OECD central governments to
the extent the bank has liabilities booked in that currency.
\2\ The ``qualifying'' category includes debt instruments of U.S.
government-sponsored agencies (as defined in appendix A of this part),
general obligation debt instruments issued by states and other
political subdivisions of OECD countries, multilateral development
banks (as defined in appendix A of this part), and debt instruments
issued by U.S. depository institutions or OECD-banks (as defined in
appendix A of this part) that do not qualify as capital of the issuing
institution. This category also includes other debt instruments,
including corporate debt and revenue instruments issued by states and
other political subdivisions of OECD countries, that are: (1) Rated
investment grade by at least two nationally recognized credit rating
services; (2) rated investment grade by one nationally recognized
credit rating agency and not rated less than investment grade by any
other credit rating agency; or (3) unrated, but deemed to be of
comparable investment quality by the reporting bank and the issuer has
instruments listed on a recognized stock exchange, subject to review
by the OCC.
\3\ The ``other'' category includes debt instruments that are not
included in the government or qualifying categories.
(2) Covered equity positions. (i) For purposes of this section 5,
covered equity positions means equity instruments located in the trading
account and instruments located in the trading account with values that
react primarily to changes in equity prices, including voting or non-
voting common stock, certain convertible bonds, and commitments to buy
or sell equity instruments. Also included are derivatives (including
written and purchased options) for which the underlying is a covered
equity position.
(A) For covered equity positions that are derivatives, a bank must
risk weight (as described in paragraph (c)(2)(iii) of this section) the
market value of the effective notional amount of the underlying equity
instrument or equity portfolio. Swaps must be included as the notional
position in the underlying equity instrument or index portfolio, with a
receiving side treated as a long position and a paying side treated as a
short position; and
(B) For covered equity positions that are options, whether long or
short, a bank must risk weight (as described in paragraph (c)(2)(iii) of
this section) the market value of the effective notional amount of the
underlying equity instrument or index multiplied by the option's delta.
(ii) A bank may net long and short covered equity positions
(including derivatives) in identical equity issues or equity indices in
the same market.\14\
---------------------------------------------------------------------------
\14\ A bank may also net positions in depository receipts against an
opposite position in the underlying equity or identical equity in
different markets, provided that the bank includes the costs of
conversion.
---------------------------------------------------------------------------
(iii)(A) A bank must multiply the absolute value of the current
market value of each net long or short covered equity position by a risk
weighting factor of 8.0 percent, or by 4.0 percent if the equity is held
in a portfolio that is both liquid and well-diversified.\15\ For covered
equity positions that are index contracts comprising a well-diversified
portfolio of equity instruments, the net long or short position is
multiplied by a risk weighting factor of 2.0 percent.
---------------------------------------------------------------------------
\15\ A portfolio is liquid and well-diversified if: (1) It is
characterized by a limited sensitivity to price changes of any single
equity issue or closely related group of equity issues held in the
portfolio; (2) the volatility of the portfolio's value is not dominated
by the volatility of any individual equity issue or by equity issues
from any single industry or economic sector; (3) it contains a large
number of individual equity positions, with no single position
representing a substantial portion of the portfolio's total market
value; and (4) it consists mainly of issues traded on organized
exchanges or in well-established over-the-counter markets.
---------------------------------------------------------------------------
(B) For covered equity positions from the following futures-related
arbitrage strategies, a bank may apply a 2.0 percent risk weighting
factor to one side (long or short) of each position with the opposite
side exempt from charge:
(1) Long and short positions in exactly the same index at different
dates or in different market centers; or
(2) Long and short positions in index contracts at the same date in
different but similar indices.
[[Page 50]]
(C) For futures contracts on broadly-based indices that are matched
by offsetting positions in a basket of stocks comprising the index, a
bank may apply a 2.0 percent risk weighting factor to the futures and
stock basket positions (long and short), provided that such trades are
deliberately entered into and separately controlled, and that the basket
of stocks comprises at least 90 percent of the capitalization of the
index.
(iv) The specific risk capital charge component for covered equity
positions is the sum of the weighted values.
Section 6. Reservation of Authority
The OCC reserves the authority to modify the application of any of
the provisions in this appendix to any bank, upon reasonable
justification.
[61 FR 47367, Sept. 6, 1996, as amended at 62 FR 68067, Dec. 30, 1997;
65 FR 75858, Dec. 5, 2000]