[Federal Register Volume 73, Number 146 (Tuesday, July 29, 2008)]
[Proposed Rules]
[Pages 43982-44060]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-16262]



[[Page 43981]]

  
  
  
  
  
  
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Part II





Department of the Treasury





Office of the Comptroller of the Currency



12 CFR Part 3





Federal Reserve System

12 CFR Parts 208 and 225





Federal Deposit Insurance Corporation

12 CFR Part 325





Department of the Treasury





Office of Thrift Supervision

12 CFR Part 567



Risk-Based Capital Guidelines; Capital Adequacy Guidelines: 
Standardized Framework; Proposed Rule

Federal Register / Vol. 73, No. 146 / Tuesday, July 29, 2008 / 
Proposed Rules

[[Page 43982]]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket ID: OCC-2008-0006]
RIN 1557-AD07

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R-1318]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325

RIN 3064-AD29

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 567

[No. 2008-002]
RIN 1550-AC19


Risk-Based Capital Guidelines; Capital Adequacy Guidelines: 
Standardized Framework

AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of 
Governors of the Federal Reserve System; Federal Deposit Insurance 
Corporation; and Office of Thrift Supervision, Treasury.

ACTION: Joint notice of proposed rulemaking.

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SUMMARY: The Office of the Comptroller of the Currency (OCC), Board of 
Governors of the Federal Reserve System (Board), Federal Deposit 
Insurance Corporation (FDIC), and Office of Thrift Supervision (OTS) 
(collectively, the agencies) propose a new risk-based capital framework 
(standardized framework) based on the standardized approach for credit 
risk and the basic indicator approach for operational risk described in 
the capital adequacy framework titled ``International Convergence of 
Capital Measurement and Capital Standards: A Revised Framework'' (New 
Accord) released by the Basel Committee on Banking Supervision. The 
standardized framework generally would be available, on an optional 
basis, to banks, bank holding companies, and savings associations 
(banking organizations) that apply the general risk-based capital 
rules.

DATES: Comments on this joint notice of proposed rulemaking must be 
received by October 27, 2008.

ADDRESSES: Comments should be directed to:
    OCC: Because paper mail in the Washington, DC area and at the OCC 
is subject to delay, commenters are encouraged to submit comments by e-
mail, if possible. Please use the title ``Risk-Based Capital 
Guidelines; Capital Adequacy Guidelines: Standardized Framework; 
Proposed Rule and Notice'' to facilitate the organization and 
distribution of the comments. You may submit comments by any of the 
following methods:
     Federal eRulemaking Portal--``Regulations.gov'': Go to 
http://www.regulations.gov, under the ``More Search Options'' tab click 
next to the ``Advanced Docket Search'' option where indicated, select 
``Comptroller of the Currency'' from the agency drop-down menu, then 
click ``Submit.'' In the ``Docket ID'' column, select OCC-2008-0006 to 
submit or view public comments and to view supporting and related 
materials for this notice of proposed rulemaking. The ``How to Use This 
Site'' link on the Regulations.gov home page provides information on 
using Regulations.gov, including instructions for submitting or viewing 
public comments, viewing other supporting and related materials, and 
viewing the docket after the close of the comment period.
     E-mail: regs.comments@occ.treas.gov.
     Mail: Office of the Comptroller of the Currency, 250 E 
Street, SW., Mail Stop 1-5, Washington, DC 20219.
     Fax: (202) 874-4448.
     Hand Delivery/Courier: 250 E Street, SW., Attn: Public 
Information Room, Mail Stop 1-5, Washington, DC 20219.
    Instructions: You must include ``OCC'' as the agency name and 
``Docket Number OCC-2008-0006'' in your comment. In general, OCC will 
enter all comments received into the docket and publish them on the 
Regulations.gov Web site without change, including any business or 
personal information that you provide such as name and address 
information, e-mail addresses, or phone numbers. Comments received, 
including attachments and other supporting materials, are part of the 
public record and subject to public disclosure. Do not enclose any 
information in your comment or supporting materials that you consider 
confidential or inappropriate for public disclosure.
    You may review comments and other related materials that pertain to 
this [insert type of rulemaking action] by any of the following 
methods:
     Viewing Comments Electronically: Go to http://
www.regulations.gov, under the ``More Search Options'' tab click next 
to the ``Advanced Document Search'' option where indicated, select 
``Comptroller of the Currency'' from the agency drop-down menu, then 
click ``Submit.'' In the ``Docket ID'' column, select ``OCC-2008-0006'' 
to view public comments for this rulemaking action.
     Viewing Comments Personally: You may personally inspect 
and photocopy comments at the OCC's Public Information Room, 250 E 
Street, SW., Washington, DC. For security reasons, the OCC requires 
that visitors make an appointment to inspect comments. You may do so by 
calling (202) 874-5043. Upon arrival, visitors will be required to 
present valid government-issued photo identification and submit to 
security screening in order to inspect and photocopy comments.
     Docket: You may also view or request available background 
documents and project summaries using the methods described above.
    Board: You may submit comments, identified by Docket No. R-1318, by 
any of the following methods:
     Agency Web Site: http://www.federalreserve.gov. Follow the 
instructions for submitting comments at http://www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     E-mail: regs.comments@federalreserve.gov. Include docket 
number in the subject line of the message.
     FAX: (202) 452-3819 or (202) 452-3102.
     Mail: Jennifer J. Johnson, Secretary, Board of Governors 
of the Federal Reserve System, 20th Street and Constitution Avenue, 
NW., Washington, DC 20551.
    All public comments are available from the Board's Web site at 
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, your 
comments will not be edited to remove any identifying or contact 
information. Public comments may also be viewed electronically or in 
paper form in Room MP-500 of the Board's Martin Building (20th and C 
Street, NW.) between 9 a.m. and 5 p.m. on weekdays.
    FDIC: You may submit by any of the following methods:
     Federal eRulemaking Portal: http://www.regulations.gov 
Follow the instructions for submitting comments.

[[Page 43983]]

     Agency Web site: http://www.FDIC.gov/regulations/laws/
federal/propose.html.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th 
Street, NW., Washington, DC 20429.
     Hand Delivered/Courier: The guard station at the rear of 
the 550 17th Street Building (located on F Street), on business days 
between 7 a.m. and 5 p.m.
     E-mail: comments@FDIC.gov.
     Public Inspection: Comments may be inspected and 
photocopied in the FDIC Public Information Center, Room E-1002, 3502 
Fairfax Drive, Arlington, VA 22226, between 9 a.m. and 5 p.m. on 
business days.
    Instructions: Submissions received must include the Agency name and 
title for this notice. Comments received will be posted without change 
to http://www.FDIC.gov/regulations/laws/federal/propose.html, including 
any personal information provided.
    OTS: You may submit comments, identified by OTS-2008-0002, by any 
of the following methods:
     Federal eRulemaking Portal: ``Regulations.gov'': Go to 
http://www.regulations.gov, under the ``more Search Options'' tab click 
next to the ``Advanced Docket Search'' option where indicated, select 
``Office of Thrift Supervision'' from the agency dropdown menu, then 
click ``Submit.'' In the ``Docket ID'' column, select ``OTS-2008-0002'' 
to submit or view public comments and to view supporting and related 
materials for this proposed rulemaking. The ``How to Use This Site'' 
link on the Regulations.gov home page provides information on using 
Regulations.gov, including instructions for submitting or viewing 
public comments, viewing other supporting and related materials, and 
viewing the docket after the close of the comment period.
     Mail: Regulation Comments, Chief Counsel's Office, Office 
of Thrift Supervision, 1700 G Street, NW., Washington, DC 20552, 
Attention: OTS-2008-0002.
     Facsimile: (202) 906-6518.
     Hand Delivery/Courier: Guard's Desk, East Lobby Entrance, 
1700 G Street, NW., from 9 a.m. to 4 p.m. on business days, Attention: 
Regulation Comments, Chief Counsel's Office, Attention: OTS-2008-0002.
     Instructions: All submissions received must include the 
agency name and docket number for this rulemaking.
    All comments received will be entered into the docket and posted on 
Regulations.gov without change, including any personal information 
provided. Comments, including attachments and other supporting 
materials received are part of the public record and subject to public 
disclosure. Do not enclose any information in your comment or 
supporting materials that you consider confidential or inappropriate 
for public disclosure.
     Viewing Comments Electronically: Go to http://
www.regulations.gov, select ``Office of Thrift Supervision'' from the 
agency drop-down menu, then click ``Submit.'' Select Docket ID ``OTS-
2008-0002'' to view public comments for this notice of proposed 
rulemaking.
     Viewing Comments On-Site: You may inspect comments at the 
Public Reading Room, 1700 G Street, NW., by appointment. To make an 
appointment for access, call (202) 906-5922, send an e-mail to 
public.info@ots.treas.gov, or send a facsimile transmission to (202) 
906-6518. (Prior notice identifying the materials you will be 
requesting will assist us in serving you.) We schedule appointments on 
business days between 10 a.m. and 4 p.m. In most cases, appointments 
will be available the next business day following the date we receive a 
request.

FOR FURTHER INFORMATION CONTACT: 
    OCC: Margot Schwadron, Senior Risk Expert, (202) 874-6022, Capital 
Policy Division; Carl Kaminski, Attorney; or Ron Shimabukuro, Senior 
Counsel, Legislative and Regulatory Activities Division, (202) 874-
5090; Office of the Comptroller of the Currency, 250 E Street, SW., 
Washington, DC 20219.
    Board: Barbara Bouchard, Associate Director, (202) 452-3072; or 
William Tiernay, Senior Supervisory Financial Analyst, (202) 872-7579, 
Division of Banking Supervision and Regulation; or Mark E. Van Der 
Weide, Assistant General Counsel, (202) 452-2263; or April Snyder, 
Counsel, (202) 452-3099, Legal Division. For the hearing impaired only, 
Telecommunication Device for the Deaf (TDD), (202) 263-4869.
    FDIC: Nancy Hunt, Senior Policy Analyst, (202) 898-6643; Ryan 
Sheller, Capital Markets Specialist, (202) 898-6614; or Bobby R. Bean, 
Chief, Policy Section, Capital Markets Branch, (202) 898-3575, Division 
of Supervision and Consumer Protection; or Benjamin W. McDonough, 
Senior Attorney, (202) 898-7411, or Michael B. Phillips, Counsel, (202) 
898-3581, Supervision and Legislation Branch, Legal Division, Federal 
Deposit Insurance Corporation, 550 17th Street, NW., Washington, DC 
20429.
    OTS: Michael Solomon, Director, Capital Policy Division, (202) 906-
5654; or Teresa Scott, Senior Project Manager, Capital Policy Division, 
(202) 906-6478, Office of Thrift Supervision, 1700 G Street, NW., 
Washington, DC 20552.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Background
II. Proposed Rule
    A. Applicability of the Standardized Framework
    B. Reservation of Authority
    C. Principle of Conservatism
    D. Merger and Acquisition Transition Provisions
    E. Calculation of Tier 1 and Total Qualifying Capital
    F. Calculation of Risk-Weighted Assets
    1. Total Risk-Weighted Assets
    2. Calculation of Risk-Weighted Assets for General Credit Risk
    3. Calculation of Risk-Weighted Assets for Unsettled 
Transactions, Securitization Exposures, and Equity Exposures
    4. Calculation of Risk-Weighted Assets for Operational Risk
    G. External and Inferred Ratings
    1. Overview
    2. Use of External Ratings
    H. Risk-Weight Categories
    1. Exposures to Sovereign Entities
    2. Exposures to Certain Supranational Entities and Multilateral 
Development Banks (MDBs)
    3. Exposures to Depository Institutions, Foreign Banks, and 
Credit Unions
    4. Exposures to Public Sector Entities (PSEs)
    5. Corporate Exposures
    6. Regulatory Retail Exposures
    7. Residential Mortgage Exposures
    8. Pre-Sold Construction Loans and Statutory Multifamily 
Mortgages
    9. Past Due Loans
    10. Other Assets
    I.Off-Balance Sheet Items
    J. OTC Derivative Contracts
    1. Background
    2. Treatment of OTC Derivative Contracts
    3. Counterparty Credit Risk for Credit Derivatives
    4. Counterparty Credit Risk for Equity Derivatives
    5. Risk Weight for OTC Derivative Contracts
    K. Credit Risk Mitigation (CRM)
    1. Guarantees and Credit Derivatives
    2. Collateralized Transactions
    L. Unsettled Transactions
    M. Risk-Weighted Assets for Securitization Exposures
    1. Securitization Overview and Definitions
    2. Operational Requirements
    3. Hierarchy of Approaches
    4. Ratings-Based Approach (RBA)
    5. Exposures that Do Not Qualify for the RBA
    6. CRM for Securitization Exposures
    7. Risk-Weighted Assets for Early Amortization Provisions
    8. Maximum Capital Requirement
    N. Equity Exposures
    1. Introduction and Exposure Measurement
    2. Hedge Transactions
    3. Measures of Hedge Effectiveness
    4. Simple Risk-Weight Approach (SRWA)
    5. Non-Significant Equity Exposures
    6. Equity Exposures to Investment Funds

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    7. Full Look-Through Approach
    8. Simple Modified Look-Through Approach
    9. Alternative Modified Look-Through Approach
    10. Money Market Fund Approach
    O. Operational Risk
    1. Basic Indicator Approach (BIA)
    2. Advanced Measurement Approach (AMA)
    P. Supervisory Oversight and Internal Capital Adequacy 
Assessment
    Q. Market Discipline
    1. Overview
    2. General Requirements
    3. Frequency/Timeliness
    4. Location of Disclosures and Audit/Certification Requirements
    5. Proprietary and Confidential Information
    6. Summary of Specific Public Disclosure Requirements
III. Regulatory Analysis
    A. Regulatory Flexibility Act Analysis
    B. OCC Executive Order 12866 Determination
    C. OTS Executive Order 12866 Determination
    D. OCC Executive Order 13132 Determination
    E. Paperwork Reduction Act
    F. OCC Unfunded Mandates Reform Act of 1995 Determination
    G. OTS Unfunded Mandates Reform Act of 1995 Determination
    H. Solicitation of Comments on Use of Plain Language

I. Background

    In 1989, the agencies implemented a risk-based capital framework 
for U.S. banking organizations (general risk-based capital rules).\1\ 
The agencies based the framework on the ``International Convergence of 
Capital Measurement and Capital Standards'' (Basel I), released by the 
Basel Committee on Banking Supervision (Basel Committee) \2\ in 1988. 
The general risk-based capital rules established a uniform risk-based 
capital system that was more risk sensitive and addressed several 
shortcomings in the capital regimes the agencies used prior to 1989.
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    \1\ 12 CFR part 3, Appendix A (OCC); 12 CFR parts 208 and 225, 
Appendix A (Board); 12 CFR part 325, Appendix A (FDIC); and 12 CFR 
part 567, subpart B (OTS). The risk-based capital rules generally do 
not apply to bank holding companies with less than $500 million in 
assets. 71 FR 9897 (February 28, 2006).
    \2\ The Basel Committee was established in 1974 by central banks 
and governmental authorities with bank supervisory responsibilities. 
Current member countries are Belgium, Canada, France, Germany, 
Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, 
Switzerland, the United Kingdom, and the United States.
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    In June 2004, the Basel Committee introduced a new capital adequacy 
framework, the New Accord,\3\ that is designed to promote improved risk 
measurement and management processes and better align minimum risk-
based capital requirements with risk. The New Accord includes three 
options for calculating risk-based capital requirements for credit risk 
and three options for operational risk. For credit risk, the three 
approaches are: standardized, foundation internal ratings-based, and 
advanced internal ratings-based. For operational risk, the three 
approaches are: basic indicator (BIA), standardized, and advanced 
measurement (AMA). The advanced internal ratings-based approach and the 
AMA together are referred to as the ``advanced approaches.''
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    \3\ ``International Convergence of Capital Measurement and 
Capital Standards, A Revised Framework, Comprehensive Version,'' the 
Basel Committee on Banking Supervision, June 2006. The text is 
available on the Bank for International Settlements Web site at 
http://www.bis.org/publ/bcbs128.htm.
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    On September 25, 2006, the agencies issued a notice of proposed 
rulemaking to implement the advanced approaches in the United States 
(advanced approaches NPR).\4\ Many of the commenters on the advanced 
approaches NPR requested that the agencies harmonize certain provisions 
of the agencies' proposal with the New Accord and offer the 
standardized approach in the United States. A number of these 
commenters supported making the standardized approach available for all 
U.S. banking organizations.
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    \4\ 71 FR 55830 (September 25, 2006).
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    On December 7, 2007, the agencies issued a final rule implementing 
the advanced approaches (advanced approaches final rule).\5\ The 
advanced approaches final rule is mandatory for certain banking 
organizations and voluntary for others. In general, the advanced 
approaches final rule requires a banking organization that has 
consolidated total assets of $250 billion or more, has consolidated on-
balance sheet foreign exposure of $10 billion or more, or is a 
subsidiary or parent of an organization that uses the advanced 
approaches (core banking organization) to implement the advanced 
approaches. The implementation of the advanced approaches has created a 
bifurcated regulatory capital framework in the United States: one set 
of risk-based capital rules for banking organizations using the 
advanced approaches (advanced approaches organizations), and another 
set for banking organizations that do not use the advanced approaches 
(general banking organizations).
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    \5\ 72 FR 69288 (December 7, 2007).
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    On December 26, 2006, the agencies issued a notice of proposed 
rulemaking (Basel IA NPR), which proposed modifications to the general 
risk-based capital rules for general banking organizations.\6\ One 
objective of the Basel IA NPR was to enhance the risk sensitivity of 
the risk-based capital rules without imposing undue regulatory burden. 
Specifically, the agencies proposed to increase the number of risk-
weight categories, expand the use of external ratings for assigning 
risk weights, broaden recognition of collateral and guarantors, use 
loan-to-value ratios (LTV ratios) to risk weight most residential 
mortgages, increase the credit conversion factor for various short-term 
commitments, assess a risk-based capital requirement for early 
amortizations in securitizations of revolving retail exposures, and 
remove the 50 percent risk-weight limit for derivative transactions. 
The Basel IA NPR also sought comment on the extent to which certain 
advanced approaches organizations should be permitted to use approaches 
other than the advanced approaches in the New Accord.
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    \6\ 71 FR 77446 (December 26, 2006).
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    Most commenters on the Basel IA NPR supported the agencies' goal to 
make the general risk-based capital rules more risk sensitive without 
adding undue regulatory burden. However, a number of the commenters 
representing a broad range of U.S. banking organizations and trade 
associations urged the agencies to implement the New Accord's 
standardized approach for credit risk in the United States. These 
commenters generally stated that the standardized approach is more risk 
sensitive than the Basel IA NPR and would more appropriately address 
the industry's concerns regarding domestic and international 
competitiveness. Most of these commenters requested that the U.S. 
implementation of the standardized approach closely follow the New 
Accord. Certain commenters also requested that the agencies make some 
or all of the other options for credit risk and operational risk in the 
New Accord available in the United States. For example, some commenters 
preferred implementation of the standardized approach without a 
separate capital requirement for operational risk. Other commenters 
supported including one or more of the approaches in the New Accord for 
operational risk.

II. Proposed Rule

    After considering the comments on both the Basel IA and the 
advanced approaches NPRs, the agencies have decided not to finalize the 
Basel IA NPR and to propose instead a new risk-based capital framework 
that would implement the standardized approach for credit risk, the BIA 
for operational

[[Page 43985]]

risk, and related disclosure requirements (collectively, this NPR or 
this proposal). This NPR generally parallels the relevant approaches in 
the New Accord. This NPR, however, diverges from the New Accord where 
the U.S. markets have unique characteristics and risk profiles, notably 
the proposal for risk weighting residential mortgage exposures. The 
agencies have also sought to make this NPR consistent where relevant 
with the advanced approaches final rule.
    This NPR would not modify how a banking organization that uses the 
standardized framework would calculate its leverage ratio 
requirement.\7\ Banking organizations face risks other than credit and 
operational risks that neither the New Accord nor this NPR addresses. 
The leverage ratio is a straightforward measure of solvency that 
supplements the risk-based capital requirements. Consequently, the 
agencies continue to view the tier 1 leverage ratio and other 
prudential safeguards such as Prompt Corrective Action as important 
components of the regulatory capital regime.
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    \7\ 12 CFR 3.6(b) and (c)(OCC); 12 CFR part 208, Appendix B and 
12 CFR part 225, Appendix D (Board); 12 CFR 325.3 (FDIC); and 12 CFR 
567.8 (OTS).
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    Question 1a: The agencies seek comments on all aspects of this 
proposal, including risk sensitivity, regulatory burden, and 
competitive impact.
    The agencies' general risk-based capital rules permit the use of 
external ratings issued by a nationally recognized statistical rating 
organization (NRSRO) to assign risk weights to recourse obligations, 
direct credit substitutes, certain residual interests, and asset- and 
mortgage-backed securities. The New Accord permits a banking 
organization to use external ratings to determine risk weights for a 
broad range of exposures, including sovereign, bank, corporate, and 
securitization exposures. It also provides, within certain limitations, 
for the use of both inferred ratings and issuer ratings. As discussed 
in more detail later in this preamble, the agencies propose that 
external, issuer, and inferred ratings be used to risk weight various 
exposures. While the agencies believe that the use of ratings proposed 
in this NPR can contribute to a more risk-sensitive framework, they are 
aware of the limitations associated with using credit ratings for risk-
based capital purposes and, thus, are particularly interested in 
comments on the use of such ratings for those purposes.
    Numerous bank supervisory groups and committees, including the 
Basel Committee on Banking Supervision, the Financial Stability Forum, 
and the Senior Supervisors Group, have undertaken work to better 
understand the causes for and possible responses to the recent market 
events, discussing, among numerous other issues, the role of credit 
ratings. In addition, in March, the President's Working Group on 
Financial Markets (PWG) issued its report titled ``Policy Statement on 
Financial Market Developments,'' providing an analysis of the 
underlying factors contributing to the recent market stress and a set 
of recommendations to address identified weaknesses. Among its 
recommendations, the PWG encouraged regulators, including the Federal 
banking agencies, to review the current use of credit ratings in the 
regulation and supervision of financial institutions. In this regard, 
the PWG policy statement noted that certain investors and asset 
managers failed to obtain sufficient information or to conduct 
comprehensive risk assessments, with some investors relying exclusively 
on credit ratings for valuation purposes. More generally, the PWG 
statement also noted market participants, including originators, 
underwriters, asset managers, credit rating agencies, and investors, 
failed to obtain sufficient information or to conduct comprehensive 
risk assessments on complex instruments, including securitized credits 
and their underlying asset pools.
    The PWG policy statement also acknowledged the steps already taken 
by credit rating agencies to improve the performance of credit ratings 
and encouraged additional actions, potentially including the 
publication of sufficient information about the assumptions underlying 
their credit rating methodologies; changes to the credit rating process 
to clearly differentiate ratings for structured products from ratings 
for corporate and municipal securities; and ratings performance 
measures for structured credit products and other asset-backed 
securities readily available to the public in a manner that facilitates 
comparisons across products and credit ratings.
    Most directly relevant to this NPR, the agencies were encouraged to 
reinforce steps taken by the credit rating agencies through revisions 
to supervisory policy and regulation, including regulatory capital 
requirements that use ratings. At a minimum, regulators were urged to 
distinguish, as appropriate, between ratings of structured credit 
products and ratings of corporate and municipal bonds in regulatory and 
supervisory policies.
    Question 1b: The agencies seek comment on the advantages and 
disadvantages of the use of external credit ratings in risk-based 
capital requirements for banking organizations and whether identified 
weakness in the credit rating process suggests the need to change or 
enhance any of the proposals in this NPR. The agencies also seek 
comment on whether additional refinements to the proposals in the NPR 
should be considered to address more broadly the prudent use of credit 
ratings by banking organizations. For example, should there be 
operational conditions for banking organizations to make use of credit 
ratings in determining risk-based capital requirements, enhancements to 
minimum capital requirements, or modifications to the supervisory 
review process?
    The agencies also note that efforts are underway by the BCBS to 
review the treatment in the New Accord for certain off-balance sheet 
conduits, resecuritizations, such as collateralized debt obligations 
referencing asset-backed securities, and other securitization-related 
risks. The agencies are fully committed to working with the BCBS in 
this regard and also intend to review the agencies' current approach to 
securitization transactions to assess whether modifications might be 
needed. This review will take into account lessons learned from recent 
market-related events and may result in additional proposals for 
modification to the risk-based capital rules.
    Question 1c: The agencies seek commenters' views on what changes to 
the approaches set forth in this NPR, if any, should be considered as a 
result of recent market events, particularly with respect to the 
securitization framework described in this NPR.

A. Applicability of the Standardized Framework

    Most commenters on the Basel IA NPR favored its opt-in approach, 
whereby a banking organization could voluntarily decide whether or not 
to use the proposed rules. They supported the flexibility of the opt-in 
provision and the ability of a general banking organization to remain 
under the general risk-based capital rules. Commenters observed that 
many banking organizations choose to hold capital well in excess of 
regulatory minimums and would not necessarily benefit from a more risk-
sensitive capital rule. For these commenters, limiting regulatory 
burden was a higher priority than increasing the risk

[[Page 43986]]

sensitivity of their risk-based capital requirements.
    The agencies acknowledge this concern and propose to make the 
standardized framework optional for banking organizations that do not 
use the advanced approaches final rule to calculate their risk-based 
capital requirements.\8\ Under this NPR, a banking organization that 
opts to use the standardized framework generally would have to notify 
its primary Federal supervisor in writing of its intent to use the new 
rules at least 60 days before the beginning of the calendar quarter in 
which it first uses the standardized framework. This notice must 
include a list of any affiliated depository institutions or bank 
holding companies, if applicable, that seek supervisory exemption from 
the use of the standardized framework. Before it notifies its primary 
Federal supervisor, the banking organization should review its ability 
to implement the proposed rule and evaluate the potential impact on its 
regulatory capital.
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    \8\ The agencies are not proposing in this NPR to make this 
standardized framework available to banking organizations for which 
the application of the advanced approaches final rule is mandatory, 
unless such a banking organization is exempted in writing from the 
advanced approaches final rule by its primary Federal supervisor.
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    Under this proposal, a banking organization that opts to use this 
standardized framework could return to the general risk-based capital 
rules by notifying its primary Federal supervisor in writing at least 
60 days before the beginning of the calendar quarter in which it 
intends to opt out of the standardized framework. The banking 
organization would have to include in its notice an explanation of its 
rationale for ceasing to use the standardized framework and identify 
the risk-based capital framework it intends to use. The primary Federal 
supervisor would review this notice to ensure that the use of the 
general risk-based capital rules would be appropriate for that banking 
organization.\9\ The agencies expect that a banking organization would 
not alternate between the general risk-based capital rules and this 
standardized framework.
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    \9\ The primary Federal supervisor may waive the 60-day notice 
period for opting in to the standardized framework and for returning 
to the general risk-based capital rules.
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    Any general banking organization could generally continue to 
calculate its risk-based capital requirements using the general risk-
based capital rules without notifying its primary Federal supervisor. 
The primary Federal supervisor would, however, have the authority to 
require a general banking organization to use a different risk-based 
capital rule if that supervisor determines that a particular capital 
rule is appropriate in light of the banking organization's asset size, 
level of complexity, risk profile, or scope of operations.
    Under section 1(b) of the proposed rule, if a bank holding company 
opts in to the standardized framework, its subsidiary depository 
institutions also would apply the standardized framework. Similarly, if 
a depository institution opts in to the standardized framework, its 
parent bank holding company (where applicable) and any subsidiary 
depository institutions of the parent holding company generally would 
be required to apply the standardized rules as well. Savings and loan 
holding companies, however, are not subject to risk-based capital 
rules. Accordingly, if a savings association opts in to the proposed 
rule, the proposed rule would not apply to the savings and loan holding 
company or to a subsidiary depository institution of that holding 
company, unless the subsidiary depository institution is directly 
controlled by the savings association.
    The agencies believe that this approach serves as an important 
safeguard against regulatory capital arbitrage among affiliated banking 
organizations. The agencies recognize, however, that there may be 
infrequent situations where the use of the standardized rules could 
create undue burden at individual depository institutions within a 
corporate family. Therefore, under section 1(c) of the proposed rule, a 
banking organization that would otherwise be required to apply the 
standardized rule because a related banking organization has elected to 
apply it may instead use the general risk-based capital rules if its 
primary Federal supervisor determines in writing that that application 
of the standardized framework is not appropriate in light of the 
banking organization's asset size, level of complexity, risk profile, 
or scope of operations. When seeking such a determination, the banking 
organization should provide a rationale for its request. The primary 
Federal supervisor may consider potential capital arbitrage issues 
within a corporate structure in making its determination.
    Question 2: The agencies seek comment on the proposed applicability 
of the standardized framework and in particular on the degree of 
flexibility that should be provided to individual depository 
institutions within a corporate family, keeping in mind regulatory 
burden issues as well as ways to minimize the potential for regulatory 
capital arbitrage.
    In the advanced approaches final rule, the agencies require core 
banking organizations to use only the most advanced approaches provided 
in the New Accord. As proposed, the standardized framework generally 
would be available only for banking organizations that are not core 
banking organizations.
    Question 3: The agencies seek comment on whether or to what extent 
core banking organizations should be able to use the proposed 
standardized framework.

B. Reservation of Authority

    Under this NPR, a primary Federal supervisor could require a 
banking organization to hold an amount of capital greater than would 
otherwise be required if that supervisor determines that the risk-based 
capital requirements under the standardized framework are not 
commensurate with the banking organization's credit, market, 
operational, or other risks. In addition, the agencies expect that 
there may be instances when the standardized framework would prescribe 
a risk-weighted asset amount for one or more exposures that was not 
commensurate with the risks associated with the exposures. In such a 
case, the banking organization's primary Federal supervisor would 
retain the authority to require the banking organization to assign a 
different risk-weighted asset amount for the exposures or to deduct the 
amount of the exposures from regulatory capital. Similarly, this NPR 
proposes to authorize a banking organization's primary Federal 
supervisor to require the banking organization to assign a different 
risk-weighted asset amount for operational risk if the supervisor were 
to find that the risk-weighted asset amount for operational risk 
produced by the banking organization under this NPR is not commensurate 
with the operational risks of the banking organization.

C. Principle of Conservatism

    The agencies believe that in some cases it may be reasonable to 
allow a banking organization not to apply a provision of the proposed 
rule if not doing so would yield a more conservative result. Under 
section 1(f) of the proposed rule, a banking organization may choose 
not to apply a provision of the rule to one or more exposures provided 
that: (i) The banking organization can demonstrate on an ongoing basis 
to the satisfaction of its primary Federal supervisor that not applying 
the provision would, in all

[[Page 43987]]

circumstances, unambiguously generate a risk-based capital requirement 
for each exposure greater than that which would otherwise be required 
under the rule; (ii) the banking organization appropriately manages the 
risk of those exposures; (iii) the banking organization provides 
written notification to its primary Federal supervisor prior to 
applying this principle to each exposure; and (iv) the exposures to 
which the banking organization applies this principle are not, in the 
aggregate, material to the banking organization.
    The agencies emphasize that a conservative capital requirement for 
a group of exposures does not reduce the need for appropriate risk 
management of those exposures. Moreover, the principle of conservatism 
applies to the determination of capital requirements for specific 
exposures; it does not apply to the disclosure requirements in section 
71 of the proposed rule.

D. Merger and Acquisition Transition Provisions

    A banking organization that uses the standardized framework and 
that merges with or acquires another banking organization operating 
under different risk-based capital rules may not be able to quickly 
integrate the acquired organization's exposures into its risk-based 
capital system. Under this NPR, a banking organization that uses the 
standardized framework and that merges with or acquires a banking 
organization that uses the general risk-based capital rules could 
continue to use the general risk-based capital rules to calculate the 
risk-based capital requirements for the merged or acquired banking 
organization's exposures for up to 12 months following the last day of 
the calendar quarter during which the merger or acquisition is 
consummated. The risk-weighted assets of the merged or acquired company 
calculated under the general risk-based capital rules would be included 
in the banking organization's total risk-weighted assets. Deductions 
associated with the exposures of the merged or acquired company would 
be deducted from the banking organization's tier 1 capital and tier 2 
capital.
    Similarly, where both banking organizations calculate their risk-
based capital requirements under the standardized framework, but the 
merged or acquired banking organization uses different aspects of the 
framework, the banking organization may continue to use the merged or 
acquired banking organization's own systems to determine its 
organization's risk-weighted assets for, and deductions from capital 
associated with, the merged or acquired banking organization's 
exposures for the same time period.
    A banking organization that merges with or acquires an advanced 
approaches banking organization may use the advanced approaches risk-
based capital rules to determine the risk-weighted asset amounts for, 
and deductions from capital associated with, the merged or acquired 
banking organization's exposures for up to 12 months after the calendar 
quarter during which the merger or acquisition consummates. During the 
period when the advanced approaches risk-based capital rules apply to 
the merged or acquired company, any allowance for loan and lease losses 
(ALLL) associated with the merged or acquired company's exposures must 
be excluded from the banking organization's tier 2 capital. Any excess 
eligible credit reserves associated with the merged or acquired banking 
organization's exposures may be included in that banking organization's 
tier 2 capital up to 0.6 percent of that banking organization's risk-
weighted assets. (Excess eligible credit reserves would be determined 
according to section 13(a)(2) of the advanced approaches risk-based 
capital rules.)
    If a banking organization relies on these merger provisions, it 
would be required to disclose publicly the amounts of risk-weighted 
assets and total qualifying capital calculated under the applicable 
risk-based capital rules for the acquiring banking organization and for 
the merged or acquired banking organization.

E. Calculation of Tier 1 and Total Qualifying Capital

    This NPR would maintain the minimum risk-based capital ratio 
requirements of 4.0 percent tier 1 capital to total risk-weighted 
assets and 8.0 percent total qualifying capital to total risk-weighted 
assets. A banking organization's total qualifying capital is the sum of 
its tier 1 (core) capital elements and tier 2 (supplemental) capital 
elements, subject to various limits, restrictions, and deductions 
(adjustments). The agencies are not restating the elements of tier 1 
and tier 2 capital in the proposed rule. Those capital elements 
generally would be unchanged from the general risk-based capital 
rules.\10\ Deductions or other adjustments would also be unchanged, 
except for those provisions discussed below.
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    \10\ See 12 CFR part 3, Appendix A, section 2 (national banks); 
12 CFR part 208, Appendix A, section II (state member banks); 12 CFR 
part 225, Appendix A, section II (bank holding companies); 12 CFR 
part 325, Appendix A, section I (state nonmember banks); and 12 CFR 
567.5 (savings associations).
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    Under this NPR, a banking organization would make certain other 
adjustments to determine its tier 1 and total qualifying capital. Some 
of these adjustments would be made only to tier 1 capital. Other 
adjustments would be made 50 percent to tier 1 capital and 50 percent 
to tier 2 capital. If the amount deductible from tier 2 capital exceeds 
the banking organization's actual tier 2 capital, the banking 
organization would have to deduct the shortfall amount from tier 1 
capital. Consistent with the agencies' general risk-based capital 
rules, a banking organization would have to have at least 50 percent of 
its total qualifying capital in the form of tier 1 capital.
    Under this NPR, a banking organization would deduct from tier 1 
capital any after-tax gain-on-sale resulting from a securitization. 
Gain-on-sale means an increase in a banking organization's equity 
capital that results from a securitization, other than an increase in 
equity capital that results from the banking organization's receipt of 
cash in connection with the securitization. The agencies included this 
deduction to offset accounting treatments that produce an increase in a 
banking organization's equity capital and tier 1 capital at the 
inception of a securitization, for example, a gain attributable to a 
credit-enhancing interest-only strip receivable (CEIO) that results 
from Financial Accounting Standard (FAS) 140 accounting treatment for 
the sale of underlying exposures to a securitization special purpose 
entity (SPE).\11\ The agencies expect that the amount of the required 
deduction would diminish over time as the banking organization realizes 
the increase in equity capital and, thus, tier 1 capital booked at the 
inception of the securitization, through actual receipt of cash flows.
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    \11\ See Statement of Financial Accounting Standards No. 140, 
``Accounting for Transfers and Servicing of Financial Assets and 
Extinguishments of Liabilities'' (September 2000).
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    Under the general risk-based capital rules, a banking organization 
must deduct CEIOs, whether purchased or retained, from tier 1 capital 
to the extent that the CEIOs exceed 25 percent of the banking 
organization's tier 1 capital. Under this NPR, a banking organization 
would have to deduct CEIOs from tier 1 capital to the extent they 
represent after-tax gain-on-sale, and would have to deduct any CEIOs 
that do not constitute an after-tax gain-on-sale 50 percent from tier 1 
capital and 50 percent from tier 2 capital.

[[Page 43988]]

    Under the FDIC, OCC, and Board general risk-based capital rules, a 
banking organization must deduct from its tier 1 capital certain 
percentages of the adjusted carrying value of its nonfinancial equity 
investments. In contrast, OTS general risk-based capital rules require 
the deduction of most investments in equity securities from total 
capital.\12\ Under this NPR, however, a banking organization would not 
deduct these investments. Instead, the banking organization's equity 
exposures generally would be subject to the treatment provided in Part 
V of this proposed rule.
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    \12\ OTS general risk-based capital rules require savings 
associations to deduct all ``equity investments'' from total 
capital. 12 CFR 567.5(c)(2)(ii). ``Equity investments'' are defined 
to include: (i) Investments in equity securities (other than 
investments in subsidiaries, equity investments that are permissible 
for national banks, indirect ownership interests in certain pools of 
assets (for example, mutual funds), Federal Home Loan Bank stock and 
Federal Reserve Bank stock); and (ii) investments in certain real 
property. 12 CFR 567.1. The proposed treatment of investments in 
equity securities is discussed above. Equity investments in real 
estate would continue to be deducted to the same extent as under the 
general risk-based capital rules.
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    A banking organization also would have to deduct from total capital 
the amount of certain unsettled transactions and certain securitization 
exposures. These deductions are provided in section 21, section 38, and 
Part IV of this proposed rule.
    Consistent with the advanced approaches final rule, for bank 
holding companies with consolidated insurance underwriting subsidiaries 
that are functionally regulated (or subject to comparable supervision 
and minimum regulatory capital requirements in their home 
jurisdiction), the following treatment would apply. The assets and 
liabilities of the subsidiary would be consolidated for purposes of 
determining the bank holding company's risk-weighted assets. The bank 
holding company, however, would deduct 50 percent from tier 1 capital 
and 50 percent from tier 2 capital an amount equal to the insurance 
underwriting subsidiary's minimum regulatory capital requirement as 
determined by its functional (or equivalent) regulator. For U.S. 
regulated insurance subsidiaries, this amount generally would be 200 
percent of the subsidiary's Authorized Control Level as established by 
the appropriate state insurance regulator. Under the general risk-based 
capital rules, such subsidiaries typically are fully consolidated with 
the bank holding company.
    While the elements of tier 1 and tier 2 capital are the same across 
the general risk-based capital rules, the advanced approaches final 
rule, and this NPR, the deductions from those elements are different 
for each of the three risk-based capital frameworks. As a result, each 
framework has a distinct definition of tier 1, tier 2, and total 
qualifying capital.
    Securitization-related deductions create a significant difference 
in the calculation of tier 1 and tier 2 capital across the three 
frameworks. Under the general risk-based capital rules, only certain 
CEIOs must be deducted from capital; all other high-risk exposures for 
which dollar-for-dollar capital must be held may be ``grossed-up'' in 
accordance with the regulatory reporting instructions, effectively 
increasing the denominator of the risk-based capital ratio but not 
affecting the numerator. In contrast, under the advanced approaches 
final rule and this NPR, certain high risk securitization exposures 
must be deducted directly from total capital. Other significant 
differences in the definition of tier 1, tier 2, and total qualifying 
capital across the three frameworks include the treatment of 
nonfinancial equity investments for banks and bank holding companies, 
certain equity investments for savings associations, certain unsettled 
transactions, consolidated insurance underwriting subsidiaries of bank 
holding companies, and the ALLL/eligible credit reserves.
    The different definitions of tier 1, tier 2, and total capital 
across the risk-based capital frameworks raise a number of issues. The 
agencies clarified in the preamble to the advanced approaches rule that 
a banking organization's tier 1 capital and tier 2 capital for all non-
regulatory-capital supervisory and regulatory purposes (for example, 
lending limits and Regulation W quantitative limits) is the banking 
organization's tier 1 capital and tier 2 capital as calculated under 
the risk-based capital framework to which it is subject. The agencies 
did not specifically state a position regarding the numerator of the 
leverage ratio. One potential approach is for each banking organization 
to use its applicable risk-based definition of tier 1 capital for 
determining both the risk-based and leverage capital ratios. Another 
potential approach is to define a numerator for the tier 1 leverage 
ratio that would be the same for all banking organizations. This 
approach could require banks to calculate one measure of tier 1 capital 
for risk-based capital purposes and another measure of tier 1 capital 
for leverage ratio purposes.\13\
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    \13\ To the extent that the agencies decide to change the 
numerator of the leverage ratio, they would propose such changes in 
a separate rulemaking. As a related matter, the OTS advanced 
approaches final rule incorrectly states that the leverage ratio is 
calculated using the revised definition of tier 1 and tier 2 
capital. This NPR would remove this provision until the agencies 
conclusively resolve this matter.
---------------------------------------------------------------------------

    Question 4: Given the potential for three separate definitions of 
tier 1 capital under the three frameworks, the agencies solicit comment 
on all aspects of the tier 1 leverage ratio numerator, including issues 
related to burden and competitive equity.

F. Calculation of Risk-Weighted Assets

(1) Total Risk-Weighted Assets
    Under this NPR, a banking organization's total risk-weighted assets 
would be the sum of its total risk-weighted assets for general credit 
risk, unsettled transactions, securitization exposures, equity 
exposures, and operational risk. Banking organizations that use the 
market risk rule (MRR) would supplement their capital calculations with 
those provisions.\14\
---------------------------------------------------------------------------

    \14\ 12 CFR part 3, Appendix B (national banks); 12 CFR part 
208, Appendix E (state member banks); 12 CFR part 225, Appendix E 
(bank holding companies); and 12 CFR part 325, Appendix C (state 
nonmember banks). OTS intends to codify a market risk capital rule 
for savings associations at 12 CFR part 567, Appendix D.
---------------------------------------------------------------------------

(2) Calculation of Risk-Weighted Assets for General Credit Risk
    For each of its general credit risk exposures (that is, credit 
exposures that are not unsettled transactions subject to section 38 of 
the proposed rule, securitization exposures, or equity exposures), a 
banking organization must first determine the exposure amount and then 
multiply that amount by the appropriate risk weight set forth in 
section 33 of the proposed rule. General credit risk exposures include 
exposures to sovereign entities; exposures to supranational entities 
and multilateral development banks; exposures to public sector 
entities; exposures to depository institutions, foreign banks, and 
credit unions; corporate exposures; regulatory retail exposures; 
residential mortgage exposures; pre-sold construction loans; statutory 
multifamily mortgage exposures; and other assets.
    Generally, the exposure amount for the on-balance sheet component 
of an exposure is the banking organization's carrying value for the 
exposure. If the exposure is classified as a security available for 
sale, however, the exposure amount is the banking organization's 
carrying value of the exposure adjusted for unrealized gains and 
losses. The exposure amount for the off-balance sheet component of an 
exposure is typically determined by multiplying the

[[Page 43989]]

notional amount of the off-balance sheet component by the appropriate 
credit conversion factor (CCF) under section 34 of the proposed rule. 
The exposure amount for over-the-counter (OTC) derivative contracts is 
determined under section 35 of the proposed rule. Exposure amounts for 
collateralized OTC derivative contracts, repo-style transactions, or 
eligible margin loans may be determined under particular rules in 
section 37 of the proposed rule.
(3) Calculation of Risk-Weighted Assets for Unsettled Transactions, 
Securitization Exposures, and Equity Exposures
(a) Unsettled Transactions
    Risk-weighted assets for specified unsettled and failed securities, 
foreign exchange, and commodities transactions are calculated according 
to paragraph (f) of section 38 of the proposed rule.\15\
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    \15\ Certain transaction types are excluded from the scope of 
section 38, as provided in paragraph (b) of section 38.
---------------------------------------------------------------------------

(b) Securitization Exposures
    Risk-weighted assets for securitization exposures are calculated 
according to Part IV of the proposed rule. Generally, a banking 
organization would calculate the risk-weighted asset amount of a 
securitization exposure by multiplying the amount of the exposure as 
determined in section 42 of the proposed rule by the appropriate risk 
weight in section 43 of this NPR.
    Part IV of the proposed rule provides a hierarchy of approaches for 
calculating risk-weighted assets for securitization exposures. Among 
the approaches included in Part IV is a ratings-based approach (RBA), 
which calculates the risk-weighted asset amount of a securitization 
exposure by multiplying the amount of the exposure by risk-weights that 
correspond to the applicable external or applicable inferred rating of 
the securitization. Part IV provides other treatments for specific 
types of securitization exposures including deduction from capital for 
certain exposures, and different risk-weighted asset computations for 
certain securitizations exposures that do not qualify for the RBA and 
for securitizations that have an early amortization provision.
(c) Equity Exposures
    Risk-weighted assets for equity exposures are calculated according 
to the rules in Part V of the proposed rule. Generally, risk-weighted 
assets for equity exposures that are not exposures to investment funds 
would be calculated according to the simple risk-weight approach (SRWA) 
in section 52 of this proposed rule. Risk-weighted assets for equity 
exposures to investment funds would, with certain exceptions, be 
calculated according to one of three look-through approaches or, if the 
investment fund qualifies, calculated according to the money market 
fund approach. These approaches are described in section 53 of the 
proposed rule.
(4) Calculation of Risk-Weighted Assets for Operational Risk
    Risk-weighted assets for operational risk are calculated under the 
BIA provided in section 61 of this proposed rule.

G. External and Inferred Ratings

(1) Overview
    The agencies' general risk-based capital rules permit the use of 
external ratings issued by a nationally recognized statistical rating 
organization (NRSRO) to assign risk weights to recourse obligations, 
direct credit substitutes, residual interests (other than a credit-
enhancing interest-only strip), and asset- and mortgage-backed 
securities.\16\ Under the ratings-based approach in the general risk-
based capital rules, a banking organization must use the lowest NRSRO 
external rating if multiple ratings exist. The approach also requires 
one rating for a traded exposure and two ratings for a non-traded 
exposure and allows the use of inferred ratings within a securitization 
structure. When the agencies revised their general risk-based capital 
rules to permit the use of external ratings issued by an NRSRO for 
these exposures, the agencies acknowledged that these ratings 
eventually could be used to determine the risk-based capital 
requirements for other types of debt instruments, such as externally 
rated corporate bonds.
---------------------------------------------------------------------------

    \16\ Some synthetic structures also may be subject to the 
external rating approach. For example, certain credit-linked notes 
issued from a synthetic securitization are risk weighted according 
to the rating given to the notes. 66 FR 59614, 59622 (November 29, 
2001).
---------------------------------------------------------------------------

    The New Accord would permit a banking organization to use external 
ratings to determine risk weights for a broad range of exposures. It 
also provides for the use of both inferred and, within certain 
limitations, issuer ratings, but discourages the use of unsolicited 
ratings. Generally consistent with the New Accord, and in response to 
favorable comments on the Basel IA NPR's proposal to expand the use of 
external ratings, the agencies propose that external, issuer, and 
inferred ratings be used to risk weight various exposures.
    This proposed use of ratings is a more risk-sensitive approach than 
relying on membership in the Organization for Economic Cooperation and 
Development (OECD) \17\ to differentiate the risk of exposures to 
sovereign entities, depository institutions, foreign banks, and credit 
unions. The proposed approach also would use a greater number of risk 
weights than the general risk-based capital rules, which would further 
improve the risk sensitivity of a banking organization's risk-based 
capital requirements.
---------------------------------------------------------------------------

    \17\ The OECD-based group of countries comprises all full 
members of the OECD, as well as countries that have concluded 
special lending arrangements with the International Monetary Fund 
(IMF) associated with the IMF's General Arrangements to Borrow. The 
list of OECD countries is available on the OECD Web site at http://
www.oecd.org.
---------------------------------------------------------------------------

    Consistent with the agencies' general risk-based capital rules and 
the advanced approaches final rule, the agencies propose to recognize 
only credit ratings that are issued by an NRSRO. For the purposes of 
this NPR, NRSRO means an entity registered with the U.S. Securities and 
Exchange Commission (SEC) as an NRSRO under section 15E of the 
Securities Exchange Act of 1934 (15 U.S.C. 78o-7).\18\
---------------------------------------------------------------------------

    \18\ See 17 CFR 240.17g-1. On September 29, 2006, the President 
signed the Credit Rating Agency Reform Act of 2006 (``Reform Act'') 
(Pub. L. 109-291) into law. The Reform Act requires a credit rating 
agency that wants to represent itself as an NRSRO to register with 
the SEC. The agencies may review their risk-based capital rules, 
guidance and proposals from time to time to determine whether any 
modification of the agencies' definition of an NRSRO is appropriate.
---------------------------------------------------------------------------

(2) Use of External Ratings
    Under this NPR, a banking organization would use the applicable 
external rating of an exposure (for certain exposures that have 
external ratings) to determine its risk weight. Additionally, 
consistent with the New Accord, the banking organization would infer a 
rating for certain exposures that do not have external ratings from the 
issuer rating of the obligor or from the external rating of another 
specific issue of the obligor. The agencies' proposal for the use of 
external and inferred ratings, however, differs in some respects from 
the New Accord, as described below.
(a) External Ratings
    Under this NPR, an external rating means a credit rating that is 
assigned by an NRSRO to an exposure, provided that the credit rating 
fully reflects the entire amount of credit risk with regard to all 
payments owed to the holder of the exposure. If, for example, a holder 
is

[[Page 43990]]

owed principal and interest on an exposure, the credit rating must 
fully reflect the credit risk associated with timely repayment of 
principal and interest. If a holder is owed only principal on an 
exposure, the credit rating must fully reflect only the credit risk 
associated with timely repayment of principal. Furthermore, a credit 
rating would qualify as an external rating only if it is published in 
an accessible form and is or will be included in the transition 
matrices made publicly available by the NRSRO that summarize the 
historical performance of positions rated by the NRSRO. An external 
rating may be either solicited or unsolicited by the obligor issuing 
the rated exposure. This definition is consistent with the definition 
of ``external rating'' in the advanced approaches final rule.
    Under this NPR, a banking organization would determine the risk 
weight for certain exposures with external ratings based on the 
applicable external ratings of the exposures. If an exposure to a 
sovereign or public sector entity (PSE), a corporate exposure, or a 
securitization exposure has only one external rating, that rating is 
the applicable external rating. If such an exposure has multiple 
external ratings, the applicable external rating would be the lowest 
external rating. This approach for determining the applicable external 
rating differs from the New Accord. In the New Accord, if an exposure 
has two external ratings, a banking organization would apply the lower 
rating to the exposure to determine the risk weight. If an exposure has 
three or more external ratings, the banking organization would use the 
second lowest external rating to risk weight the exposure. The agencies 
believe that the proposed approach, which is designed to mitigate the 
potential for external ratings arbitrage, more reliably promotes safe 
and sound banking practices.
(b) Inferred Ratings
    Consistent with the New Accord, the agencies propose that a banking 
organization must, subject to certain conditions, infer a rating on an 
exposure to a sovereign entity or a PSE or on a corporate exposure that 
does not have an applicable external rating (unrated exposure).\19\ An 
inferred rating may be based on the issuer rating of the sovereign, 
PSE, or corporate obligor or based on another externally rated exposure 
of that obligor. Exposures with an inferred rating would be treated the 
same as exposures with an identical external rating.
---------------------------------------------------------------------------

    \19\ The treatment of inferred ratings for securitization 
exposures is discussed in section M.(4) of this preamble.
---------------------------------------------------------------------------

(i) Determining Inferred Ratings
    To determine the risk weight for an unrated exposure to a sovereign 
entity or a PSE, or for an unrated corporate exposure, a banking 
organization must first determine if, within the framework established 
in this NPR, the exposure has one or more inferred ratings. An unrated 
exposure may have inferred ratings based both on the issuer ratings of 
the obligor and the external ratings of specific issues of the obligor. 
A banking organization would not be able to use an external rating 
assigned to an obligor or specific issues of the obligor to infer a 
rating for an exposure to the obligor's affiliate.
(A) Inferred Rating Based on an Issuer Rating
    Under this NPR, a senior unrated exposure to a sovereign entity or 
a PSE, or a senior unrated corporate exposure where the corporate 
issuer has one or more issuer ratings, has inferred ratings based on 
those issuer ratings. For purposes of inferring a rating from an issuer 
rating, a senior exposure would be an exposure that ranks at least pari 
passu (that is, equal) with the obligor's general creditors in the 
event of bankruptcy, insolvency, or other similar proceeding. This NPR 
defines an issuer rating as a credit rating assigned by an NRSRO to the 
obligor that reflects the obligor's capacity and willingness to satisfy 
all of its financial obligations, and is published in an accessible 
form and is or will be included in the transition matrices made 
publicly available by the NRSRO that summarize the historical 
performance of the NRSRO's ratings.
(B) Inferred Rating Based on a Specific Issue Rating
    Under this NPR, an unrated exposure to a sovereign entity or a PSE, 
or an unrated corporate exposure may have one or more inferred ratings 
based on external ratings assigned to another exposure issued by the 
obligor. An unrated exposure would have an inferred rating equal to the 
external rating of another exposure issued by the same obligor and 
secured by the same collateral (if any), if the externally rated 
exposure: (i) Ranks pari passu with the unrated exposure (or at the 
banking organization's option, is subordinated in all respects to the 
unrated exposure); (ii) has a long-term rating; (iii) does not benefit 
from any credit enhancement that is not available to the unrated 
exposure, (iv) has an effective remaining maturity that is equal to or 
longer than that of the unrated exposure, and (v) is denominated in the 
same currency as the unrated exposure. The currency requirement would 
not apply where the unrated exposure that is denominated in a foreign 
currency arises from a participation in a loan extended by a 
multilateral development bank or is guaranteed by a multilateral 
development bank against convertibility and transfer risk. If the 
banking organization's participation is only partially guaranteed 
against convertibility and transfer risk, the banking organization 
could use the external rating for the portion of the participation that 
benefits from the multilateral development bank's participation. If the 
externally rated exposure does not meet these requirements, it cannot 
be used to infer a rating for the unrated exposure.
    The inferred rating approach provides a special treatment for 
inferred ratings from low-quality ratings (ratings that correspond to a 
risk weight of 100 percent or greater for an exposure to a PSE and 150 
percent for an exposure to a sovereign entity or a corporate exposure). 
An unrated exposure would have inferred rating(s) equal to the long-
term external rating(s) of exposures with low-quality ratings that are 
issued by the same obligor and that are senior in all respects to the 
unrated exposure.
    This approach for inferred ratings differs from the New Accord, 
which would require that any low-quality rating of an exposure issued 
by an obligor be assigned to any unrated exposure to the obligor. The 
agencies have concluded that this treatment could result in an 
inappropriately high capital charge in some circumstances. For example, 
an obligor for business reasons may choose to issue subordinated debt 
that receives a low-quality rating. The New Accord suggests this low-
quality rating should be assigned to unrated senior exposures of the 
obligor, even if the unrated senior exposures are also senior to 
exposures with a high-quality rating. Under this NPR, a banking 
organization in that situation could assign the high-quality rating to 
the unrated senior secured exposure.
(ii) Determining the Applicable Inferred Rating
    Once a banking organization has determined all the inferred ratings 
for an unrated exposure, it must determine the applicable inferred 
rating for the exposure. Under this NPR, the applicable inferred rating 
for an exposure that has only one inferred rating would be the inferred 
rating. If the unrated exposure has two or more

[[Page 43991]]

inferred ratings, the applicable inferred rating would be the lowest 
inferred rating.
    The agencies believe that this approach for determining the 
applicable inferred rating for an unrated exposure is appropriately 
risk sensitive and consistent with the principles for use of external 
ratings in this NPR and the advanced approaches final rule. The 
agencies are aware, however, that the proposed use of unsolicited 
external ratings in this NPR may raise certain issues. The New Accord 
suggests that banking organizations generally should use solicited 
ratings and expresses concern that NRSROs might potentially use 
unsolicited ratings to put pressure on issuers to obtain solicited 
ratings.
    Question 5: The agencies seek comment on the use of solicited and 
unsolicited external ratings as proposed in this NPR.

H. Risk-Weight Categories

(1) Exposures to Sovereign Entities
    The agencies' general risk-based capital rules generally assign a 
risk weight to an exposure to a sovereign entity based on the type of 
exposure and membership of the sovereign in the OECD. Consistent with 
the New Accord, the agencies propose to risk weight an exposure to a 
sovereign entity based on the exposure's applicable external or 
applicable inferred rating (see Table 1).\20\
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    \20\ The ratings examples used throughout this document are 
illustrative and do not express any preferences or determinations on 
any NRSRO.
---------------------------------------------------------------------------

    For purposes of this NPR, sovereign entity means a central 
government (including the U.S. government) or an agency, department, 
ministry, or central bank of a central government. In the United 
States, this definition would include the twelve Federal Reserve Banks. 
The definition would not include commercial enterprises owned by the 
central government that are engaged in activities involving trade, 
commerce, or profit, which are generally conducted or performed in the 
private sector.
    Where a sovereign entity's banking supervisor allows a banking 
organization under its jurisdiction to apply a lower risk weight to the 
same exposure to that sovereign than Table 1 provides, a U.S. banking 
organization would be able to assign that lower risk weight to its 
exposures to that sovereign entity provided the exposure is denominated 
in that sovereign entity's domestic currency, and the banking 
organization has at least the equivalent amount of liabilities in that 
currency.

                Table 1.--Exposures to Sovereign Entities
------------------------------------------------------------------------
 Applicable external or applicable
 inferred rating for an exposure to        Example          Risk weight
         a sovereign entity                                (in percent)
------------------------------------------------------------------------
Highest investment grade rating....  AAA................               0
Second-highest investment grade      AA.................               0
 rating.
Third-highest investment grade       A..................              20
 rating.
Lowest investment grade rating.....  BBB................              50
One category below investment grade  BB.................             100
Two categories below investment      B..................             100
 grade.
Three categories or more below       CCC................             150
 investment grade.
No applicable rating...............  N/A................             100
------------------------------------------------------------------------

(2) Exposures to Certain Supranational Entities and Multilateral 
Development Banks
    Consistent with the New Accord's treatment of exposures to 
supranational entities, the agencies propose to assign a zero percent 
risk weight to exposures to the Bank for International Settlements, the 
European Central Bank, the European Commission, and the International 
Monetary Fund.
    Generally consistent with the New Accord, the agencies also propose 
that an exposure to a multilateral development bank (MDB) receive a 
zero percent risk weight. This proposed risk weight would apply only to 
those MDBs listed below and is based on the generally high credit 
quality of these MDBs, their strong shareholder support, and a 
shareholder structure comprised of a significant proportion of 
sovereign entities with high quality issuer ratings. In this NPR, MDB 
means the International Bank for Reconstruction and Development, the 
International Finance Corporation, the Inter-American Development Bank, 
the Asian Development Bank, the African Development Bank, the European 
Bank for Reconstruction and Development, the European Investment Bank, 
the European Investment Fund, the Nordic Investment Bank, the Caribbean 
Development Bank, the Islamic Development Bank, the Council of Europe 
Development Bank, and any other multilateral lending institution or 
regional development bank in which the U.S. government is a shareholder 
or contributing member or which the primary Federal supervisor 
determines poses comparable credit risk. Exposures to regional 
development banks and multilateral lending institutions that do not 
meet these requirements would generally be treated as corporate 
exposures.
(3) Exposures to Depository Institutions, Foreign Banks, and Credit 
Unions
    The agencies' general risk-based capital rules assign a risk weight 
of 20 percent to all exposures to U.S. depository institutions, foreign 
banks, and credit unions incorporated in an OECD country. Short-term 
exposures to such entities incorporated in a non-OECD country receive a 
20 percent risk weight and long-term exposures to such entities in 
these countries receive a 100 percent risk weight.
    Since this NPR eliminates the OECD/non-OECD distinction, the 
agencies propose that exposures to a depository institution, a foreign 
bank, or a credit union receive a risk weight based on the lowest 
issuer rating of the entity's sovereign of incorporation. In this NPR, 
sovereign of incorporation means the country where an entity is 
incorporated, chartered, or similarly established. In general, 
exposures to a depository institution, foreign bank, or credit union 
would receive a risk weight one category higher than the risk weight 
assigned to an exposure to the entity's sovereign of incorporation. For 
exposures to a depository institution, foreign bank, or credit union 
where the sovereign of incorporation is rated one or two categories 
below investment grade or is unrated, the risk weight

[[Page 43992]]

would be 100 percent. If the sovereign of incorporation is rated three 
or more categories below investment grade, these exposures would 
receive a risk weight of 150 percent. Table 2 illustrates the proposed 
risk weights for exposures to depository institutions, foreign banks, 
and credit unions. A depository institution is defined as in section 3 
of the Federal Deposit Insurance Act (12 U.S.C. 1813), and foreign bank 
means a foreign bank as defined in section 211.2 of the Federal Reserve 
Board's Regulation K (12 CFR 211.2) other than a depository 
institution.

   Table 2.--Exposures to Depository Institutions, Foreign Banks, and
                              Credit Unions
------------------------------------------------------------------------
                                                           Exposure risk
    Lowest issuer rating of the            Example          weight  (in
     sovereign of incorporation                              percent)
------------------------------------------------------------------------
Highest investment grade rating....  AAA................              20
Second-highest investment grade      AA.................              20
 rating.
Third-highest investment grade       A..................              50
 rating.
Lowest investment grade rating.....  BBB................             100
One category below investment grade  BB.................             100
Two categories below investment      B..................             100
 grade.
Three categories or more below       CCC................             150
 investment grade.
No issuer rating...................  N/A................             100
------------------------------------------------------------------------

    Consistent with the general risk-based capital rules and the New 
Accord, exposures to a depository institution or foreign bank that are 
includable in the regulatory capital of that institution would receive 
a risk weight no lower than 100 percent unless the exposure is subject 
to deduction as a reciprocal holding.\21\
---------------------------------------------------------------------------

    \21\ 12 CFR part 3, Appendix A, section 2(c)(6)(ii) (OCC); 12 
CFR parts 208 and 225, Appendix A, section II.B.3 (FRB); 12 CFR part 
325, Appendix A, I.B.(4) (FDIC); and 12 CFR 567.5(c)(2)(i) (OTS).
---------------------------------------------------------------------------

    The proposal outlined above is consistent with one of the two 
options available in the New Accord for risk weighting claims on banks. 
The alternative approach, which the agencies propose for exposures to 
PSEs, risk weights exposures based on the applicable external or 
applicable inferred rating of the exposures. This alternative approach 
for exposures to PSEs is described below.
    Question 6: The agencies seek comment on this proposed approach, as 
well as on the appropriateness of applying the alternative approach to 
exposures to depository institutions, credit unions, and foreign banks.
(4) Exposures to Public Sector Entities (PSEs)
    The agencies' general risk-based capital rules assign a 20 percent 
risk weight to general obligations of states and other political 
subdivisions of OECD countries.\22\ Exposures to entities that rely on 
revenues from specific projects, rather than general revenues (for 
example, revenue bonds), receive a risk weight of 50 percent. 
Generally, other exposures to state and political subdivisions of OECD 
countries (including industrial revenue bonds) and exposures to 
political subdivisions of non-OECD countries receive a risk weight of 
100 percent.
---------------------------------------------------------------------------

    \22\ Political subdivisions of the United States include a 
state, county, city, town or other municipal corporation, a public 
authority, and generally any publicly owned entity that is an 
instrument of a state or municipal corporation.
---------------------------------------------------------------------------

    Consistent with the New Accord, the agencies propose that an 
exposure to a PSE receive a risk weight based on the applicable 
external or applicable inferred rating of the exposure. This approach 
would apply to both general obligation and revenue bonds. In no case, 
however, may an exposure to a PSE receive a risk weight that is lower 
than the risk weight that corresponds to the lowest issuer rating of a 
PSE's sovereign of incorporation (see Table 1 for risk weights for 
exposures to sovereign entities).
    The proposed rule defines a PSE as a state, local authority, or 
other governmental subdivision below the level of a sovereign entity. 
This definition would not include commercial companies owned by a 
government that engage in activities involving trade, commerce, or 
profit, which are generally conducted or performed in the private 
sector. Table 3 illustrates the risk weights for exposures to PSEs.

 Table 3.--Exposures to Public Sector Entities: Long-Term Credit Rating
------------------------------------------------------------------------
 Applicable external or applicable
inferred rating of an exposure to a        Example          Risk weight
                PSE                                        (in percent)
------------------------------------------------------------------------
Highest investment grade rating....  AAA................              20
Second-highest investment grade      AA.................              20
 rating.
Third-highest investment grade       A..................              50
 rating.
Lowest investment grade rating.....  BBB................              50
One category below investment grade  BB.................             100
Two categories below investment      B..................             100
 grade.
Three categories or more below       CCC................             150
 investment grade.
No applicable rating...............  N/A................              50
------------------------------------------------------------------------

    The New Accord also suggests that a national supervisor may permit 
a banking organization to assign a risk weight to an exposure to a PSE 
as if it were an exposure to the sovereign entity in whose jurisdiction 
the PSE is established. The agencies are not proposing to risk weight 
exposures to PSEs in the United States in this manner. In certain 
cases, however, the agencies have allowed a banking organization to 
rely on the risk weight

[[Page 43993]]

that a foreign banking supervisor assigns to its own PSEs. Therefore, 
the agencies propose to allow a banking organization to risk weight an 
exposure to a foreign PSE according to the risk weight that the foreign 
banking supervisor assigns. In no event, however, could the risk weight 
for an exposure to a foreign PSE be lower than the lowest risk weight 
assigned to that PSE's sovereign of incorporation.
    The New Accord contains an alternative approach to risk weight 
exposures to a PSE, which is based on the lowest issuer rating of the 
PSE's sovereign of incorporation. The agencies are proposing this 
approach for exposures to depository institutions, foreign banks, and 
credit unions as described in the previous section.
    Question 7: The agencies seek comment on the pros and cons of the 
proposed approach for risk weighting exposures to PSEs as well as on 
the appropriateness of applying, instead, the approach proposed in this 
NPR for depository institutions.
    The New Accord does not incorporate the use of short-term ratings 
for exposures to PSEs. The agencies recognize, however, that an NRSRO 
may assign a short-term municipal rating to an exposure to a PSE that 
has a maturity of up to three years (for example, a bond anticipation 
note). Further, the agencies understand that there are different 
techniques for comparing these short-term ratings to other types of 
ratings, both short-term and long-term. The agencies are considering 
whether to permit the use of these short-term ratings for risk 
weighting short-term exposures to PSEs using the risk weights in Table 
4.

          Table 4.--Public Sector Entities: Short-Term Ratings
------------------------------------------------------------------------
  Applicable external rating of an                          Risk weight
         exposure to a PSE                 Example         (in percent)
------------------------------------------------------------------------
Highest investment grade...........  SP-1/MIG-1.........              20
Second-highest investment grade....  SP-2/MIG-2.........              50
Third-highest investment grade.....  SP-3/MIG-3.........             100
Below investment grade.............  Non-prime..........             150
No applicable external rating......  N/A................              50
------------------------------------------------------------------------

    Question 8: The agencies solicit comment on the use of short-term 
ratings for exposures to PSEs generally and specifically on the ratings 
and related risk weights in Table 4.
(5) Corporate Exposures
    Under the agencies' general risk-based capital rules, most 
corporate exposures receive a risk weight of 100 percent. Exposures to 
securities firms incorporated in the United States or in an OECD 
country may receive a 20 percent risk weight if they meet certain 
requirements, and exposures to U.S. government-sponsored agencies or 
entities (GSEs) may also receive a 20 percent risk weight. GSEs include 
an agency or corporation originally established or chartered by the 
U.S. Government to serve public purposes specified by the U.S. 
Congress, but whose obligations are not explicitly guaranteed by the 
full faith and credit of the U.S. Government.
    In this NPR, corporate exposure means a credit exposure to a 
natural person or a company (including an industrial development bond, 
an exposure to a GSE, or an exposure to a securities broker or dealer) 
that is not an exposure to: a sovereign entity, the Bank for 
International Settlements, the European Central Bank, the European 
Commission, the International Monetary Fund, an MDB, a depository 
institution, a foreign bank, a credit union, or a PSE; a regulatory 
retail exposure; a residential mortgage exposure; a pre-sold 
construction loan; a statutory multifamily mortgage; a securitization 
exposure; or an equity exposure.
    Consistent with the New Accord, the agencies propose to permit a 
banking organization to elect one of two methods to risk weight 
corporate exposures. Regardless of the method a banking organization 
chooses, it would have to use that approach consistently for all 
corporate exposures. First, a banking organization could risk weight 
all of its corporate exposures at 100 percent without regard to 
external ratings. Second, a banking organization could risk weight a 
corporate exposure based on its applicable external or applicable 
inferred rating. Table 5 provides the proposed risk weights for 
corporate exposures with applicable external or applicable inferred 
ratings based on long-term credit ratings. Table 6 provides the 
proposed risk weights for corporate exposures with applicable external 
ratings based on short-term credit ratings.
    If a corporate exposure has no external rating, that exposure could 
not receive a risk weight lower than the risk weight that corresponds 
to the lowest issuer rating of the obligor's sovereign of incorporation 
in Table 1. In addition, if an obligor has any exposure with a short-
term external rating that corresponds to a risk weight of 150 percent 
under Table 6, a banking organization would assign a 150 percent risk 
weight to any corporate exposure to that obligor that does not have an 
external rating and that ranks pari passu with or is subordinated to 
the externally rated exposure.

         Table 5.--Corporate Exposures: Long-Term Credit Rating
------------------------------------------------------------------------
                                                           Exposure risk
 Applicable external or applicable         Example          weight  (in
          inferred rating                                    percent)
------------------------------------------------------------------------
Highest investment grade rating....  AAA................              20
Second-highest investment grade      AA.................              20
 rating.
Third-highest investment grade       A..................              50
 rating.
Lowest investment grade rating.....  BBB................             100
One category below investment grade  BB.................             100
Two categories below investment      B..................             150
 grade.
Three categories or more below       CCC................             150
 investment grade.
No applicable rating...............  N/A................             100
------------------------------------------------------------------------


[[Page 43994]]


         Table 6.--Corporate Exposures: Short-Term Credit Rating
------------------------------------------------------------------------
                                                           Exposure risk
     Applicable external rating            Example          weight  (in
                                                             percent)
------------------------------------------------------------------------
Highest investment grade...........  A-1/P-1............              20
Second-highest investment grade....  A-2/P-2............              50
Third-highest investment grade.....  A-3/P-3............             100
Below investment grade.............  B, C, and non-prime             150
No applicable external rating......  N/A................             100
------------------------------------------------------------------------

    As provided in the New Accord, this NPR (outside of the 
securitization framework) would not allow a banking organization to 
infer a rating from an exposure based on a short-term external rating. 
Consistent with this position, this NPR does not include the New Accord 
provision that assigns a risk weight of at least 100 percent to all 
unrated short-term exposures of an obligor if any rated short-term 
exposure of that obligor receives a 50 percent risk weight.
    Question 9: The agencies seek comment on the appropriateness of 
including either or both of these aspects of the New Accord in any 
final rule implementing the standardized framework.
    The New Accord would treat securities firms that meet certain 
requirements like depository institutions. The agencies propose, 
however, to risk weight exposures to securities firms as corporate 
exposures, parallel with the treatment of bank holding companies and 
savings association holding companies.
    The agencies also propose that exposures to GSEs be treated as 
corporate exposures and risk weighted based on the NRSRO credit 
ratings. These ratings on individual GSE exposures are often based in 
part on the NRSRO assessments of the extent to which the U.S. 
government might come to the financial aid of a GSE. The agencies 
believe that risk-weight determinations should not be based on the 
possibility of U.S. government financial assistance, except where the 
U.S. government has legally committed to provide such assistance.
    In addition to the credit ratings on individual GSE exposures, the 
NRSROs also publish issuer ratings that evaluate the financial strength 
of some GSEs without respect to any implied financial assistance from 
the U.S. government. These financial strength ratings are monitored by 
the issuing NRSROs but are not included in the NRSROs' transition 
matrices. Accordingly, the financial strength ratings would not meet 
the definition of an external rating in this NPR. Further, the use of 
these ratings is also problematic because NRSROs provide financial 
strength ratings for issuers, but not for specific issues, and do not 
provide the same level of differentiation between short- and long-term 
debt and various levels of subordination as NRSRO ratings of specific 
exposures. In addition, NRSROs have not published financial strength 
ratings for all GSEs.
    Question 10: The agencies seek comment on the use of financial 
strength ratings to determine risk weights for exposures to GSEs, and 
seek comment on how such ratings might be applied. The agencies also 
seek input on how subordination and maturity of exposures could be 
embodied in such an approach, and what requirements should be developed 
for recognizing ratings assigned to GSEs.
(6) Regulatory Retail Exposures
    The general risk-based capital rules generally assign a risk weight 
of 100 percent to non-mortgage retail exposures, secured or unsecured, 
including personal, auto, and credit card loans. Consistent with the 
New Accord, the agencies propose that a banking organization apply a 75 
percent risk weight to regulatory retail exposures that meet the 
following criteria: (i) A banking organization's aggregate exposure to 
a single obligor does not exceed $1 million; (ii) the exposure is part 
of a well diversified portfolio; and (iii) the exposure is not an 
exposure to a sovereign entity, the Bank for International Settlements, 
the European Central Bank, the European Commission, the International 
Monetary Fund, an MDB, a PSE, a depository institution, a foreign bank, 
or a credit union; an acquisition, development and construction loan; a 
residential mortgage exposure; a pre-sold construction loan; a 
statutory multifamily mortgage; a securitization exposure; an equity 
exposure; or a debt security. Examples of regulatory retail exposures 
would include a revolving credit or line of credit (including credit 
card and overdraft lines of credit), a personal term loan or lease 
(including an installment loan, auto loan or lease, student or 
educational loan, personal loan), and a facility or commitment to a 
company.
    Any retail exposure that does not meet these requirements generally 
would be considered a corporate exposure and would receive a risk 
weight based on the risk-weight tables for corporate exposures (see 
Tables 5 and 6).
    Question 11: The agencies seek comment on whether a specific 
numerical limit on concentration should be incorporated into the 
provisions for regulatory retail exposures. For example, the New Accord 
suggests a 0.2 percent limit on an aggregate exposure to one obligor as 
a measure of concentration within the regulatory retail portfolio. The 
agencies solicit comment on the appropriateness of a 0.2 percent limit 
as well as on other types of measures of portfolio concentration that 
may be appropriate.
(7) Residential Mortgage Exposures
    The general risk-based capital rules assign exposures secured by 
one-to-four family residential properties to either the 50 percent or 
100 percent risk weight category. Most exposures secured by a first 
lien on a one-to-four family residential property meet the criteria to 
receive a 50 percent risk weight.\23\ The New Accord applies a 
similarly broad treatment to residential mortgages. It provides a risk 
weight of 35 percent for most first-lien residential mortgage exposures 
that meet prudential criteria such as the existence of a substantial 
margin of additional security over the amount of the loan.
---------------------------------------------------------------------------

    \23\ 12 CFR part 3, Appendix A, section 3(c)(iii) (OCC); 12 CFR 
parts 208 and 225, Appendix A, section III.C.3 (Board); 12 CFR part 
325, Appendix A, section II.C.3 (FDIC); and 12 CFR 567.1 (definition 
of ``qualifying mortgage loan'') and 12 CFR 567.6(a)(1)(iii)(B) (50 
percent risk weight) (OTS).
---------------------------------------------------------------------------

    In the Basel IA NPR, the agencies proposed to assign a risk weight 
for one-to-four family residential mortgage exposures based on the LTV 
ratio. The agencies noted that the LTV ratio is a meaningful indicator 
of potential loss and borrower default. Commenters on the Basel IA NPR 
generally supported

[[Page 43995]]

this LTV ratio approach. In this NPR, the agencies propose 
substantially the same treatment for residential mortgage exposures as 
was proposed in the Basel IA NPR. Given the characteristics of the U.S. 
residential mortgage market, the agencies believe that the risk weights 
in the New Accord do not reflect the appropriate spectrum of risk for 
these assets. The agencies believe the wider range of risk weights that 
the agencies proposed in the Basel IA NPR is more appropriate for the 
U.S. residential mortgage market.
    The agencies believe that an LTV ratio approach to residential 
mortgage exposures would not impose a significant burden on banking 
organizations because LTV information is readily available and is 
commonly used in the underwriting process. Use of LTV ratios to assign 
risk weights to residential mortgage exposures would not substitute 
for, or otherwise release a banking organization from, its 
responsibility to have prudent loan underwriting and risk management 
practices consistent with the size, type, and risk of its mortgage 
business.\24\ Through the supervisory process, the agencies would 
continue to assess a banking organization's underwriting and risk 
management practices consistent with supervisory guidance and safety 
and soundness. The agencies would continue to use their supervisory 
authority to require a banking organization to hold additional capital 
for residential mortgage exposures where appropriate.
---------------------------------------------------------------------------

    \24\ See, for example, ``Interagency Guidance on Nontraditional 
Mortgage Product Risks,'' 71 FR 58609 (Oct. 4, 2006) and ``Statement 
on Subprime Mortgage Lending,'' 72 FR 37569 (July 10, 2007).
---------------------------------------------------------------------------

    The proposed rule defines a residential mortgage exposure as an 
exposure (other than a pre-sold construction loan) that is primarily 
secured by a one-to-four family residential property. The proposed rule 
identifies two types of residential mortgage exposures (first-lien 
residential mortgage exposures and junior-lien residential mortgage 
exposures), and provides a separate treatment for each type of 
exposure. A first-lien residential mortgage exposure is a residential 
mortgage exposure secured by a first lien or a residential mortgage 
exposure secured by first and junior lien(s) where no other party holds 
an intervening lien. This treatment is similar to the treatment of 
mortgage exposures under the general risk-based capital rules. A 
junior-lien residential mortgage exposure is a residential mortgage 
exposure that is secured by a junior lien and that is not a first-lien 
residential mortgage exposure.
(a) Exposure Amount
    The proposed rule provides that a banking organization would hold 
capital for both the funded and the unfunded portions of residential 
mortgage exposures. For the funded portion of a residential mortgage 
exposure, the banking organization would assign a risk weight to the 
carrying value of the exposure (that is, the principal amount of the 
exposure). For the unfunded portion of a residential mortgage exposure 
(for example, potential exposure from a negative amortization feature 
or a home equity line of credit (HELOC)), a banking organization would 
risk weight the notional amount of the exposure (that is, the maximum 
contractual commitment) multiplied by the appropriate credit conversion 
factor. For a residential mortgage exposure that has both funded and 
unfunded components, a banking organization would calculate separate 
risk-weighted asset amounts for the unfunded and funded portions, based 
on separately calculated LTV ratios as discussed below.
(b) Risk Weights
    The agencies propose that a banking organization risk weight first-
lien residential mortgage exposures that meet certain qualifying 
criteria according to Table 7. The risk weights in Table 7 would apply 
only to a first-lien residential mortgage exposure that is secured by 
property that is owner-occupied or rented, is prudently underwritten, 
is not 90 days or more past due, and is not on nonaccrual. A first-lien 
residential mortgage exposure that has been restructured may receive a 
risk weight lower than 100 percent, only if the banking organization 
updates the LTV ratio at the time of the restructuring and according to 
the discussion below and in section 33 of the proposed rule. First-lien 
residential mortgage exposures that do not meet these criteria would 
receive a 100 percent risk weight if they have an LTV ratio less than 
or equal to 90 percent, and would receive a 150 percent risk weight if 
they have an LTV ratio greater than 90 percent.

  Table 7.--Risk Weights for First-Lien Residential Mortgage Exposures
------------------------------------------------------------------------
                                                            Risk weight
            Loan-to-value ratio  (in percent)              (in percent)
------------------------------------------------------------------------
Less than or equal to 60................................              20
Greater than 60 and less than or equal to 80............              35
Greater than 80 and less than or equal to 85............              50
Greater than 85 and less than or equal to 90............              75
Greater than 90 and less than or equal to 95............             100
Greater than 95.........................................             150
------------------------------------------------------------------------

    Under the general risk-based capital rules, a banking organization 
must assign a risk weight to an exposure secured by a junior lien on 
residential property at 100 percent, unless the banking organization 
also holds the first lien and there are no intervening liens. The New 
Accord does not specifically discuss the treatment of exposures secured 
by junior liens on residential property.
    The agencies continue to believe that stand-alone junior-lien 
residential mortgage exposures have a different risk profile than 
first-lien residential mortgage exposures and should be risk weighted 
accordingly. Under the proposed rule, a banking organization would 
compute an LTV ratio as described below for a junior-lien residential 
mortgage exposure that is not 90 days or more past due or on nonaccrual 
based upon the loan amounts for the junior-lien residential mortgage 
exposure and all senior exposures as described below. The banking 
organization would then assign a risk weight to the exposure amount of 
the junior-lien residential mortgage exposure according to Table 8. 
This treatment is similar to the Basel IA NPR and recognizes that 
stand-alone junior-lien residential mortgage exposures generally 
default at a higher rate than first-lien residential mortgage 
exposures. A banking organization would risk weight a junior-lien 
residential mortgage exposure that is 90 days or more past due or on 
nonaccrual at 150 percent.

  Table 8.--Risk Weights for Junior-Lien Residential Mortgage Exposures
------------------------------------------------------------------------
                                                            Risk weight
            Loan-to-value ratio  (in percent)              (in percent)
------------------------------------------------------------------------
Less than or equal to 60................................              75
Greater than 60 and less than or equal to 90............             100
Greater than 90.........................................             150
------------------------------------------------------------------------


[[Page 43996]]

(c) Loan-to-Value Ratio Calculation
    The agencies propose that a banking organization calculate the LTV 
ratio on an ongoing basis as described below. The denominator of the 
LTV ratio, that is, the value of the property, would be equal to the 
lesser of the acquisition cost for the property (for a purchase 
transaction) or the estimate of a property's value at the origination 
of the exposure or, at the banking organization's option, at the time 
of restructuring. The estimate of value would be based on an appraisal 
or evaluation of the property in conformance with the agencies' 
appraisal regulations \25\ and should conform to the ``Interagency 
Appraisal and Evaluation Guidelines'' \26\ and the ``Real Estate 
Lending Guidelines.'' \27\ If a banking organization's first-lien 
residential mortgage exposure consists of both first and junior liens 
on a property, a banking organization could update the estimate of 
value at the origination of the junior-lien mortgage.
---------------------------------------------------------------------------

    \25\ 12 CFR part 34, subpart C (OCC); 12 CFR part 208, subpart E 
and part 225, subpart G (Board); 12 CFR part 323 (FDIC); and 12 CFR 
part 564 (OTS).
    \26\ ``The Comptroller's Handbook for Commercial Real Estate and 
Construction Lending'', Appendix E (OCC); SR 94-55 (Board); FIL-74-
94 (FDIC); and 12 CFR part 564 (OTS).
    \27\ 12 CFR part 34, subpart D, Appendix A (OCC); 12 CFR part 
208, subpart E, Appendix C and part 225, subpart G (Board); 12 CFR 
part 365 (FDIC); and 12 CFR 560.100-101 (OTS).
---------------------------------------------------------------------------

    The numerator of the ratio, that is, the loan amount, would depend 
on whether the exposure is funded or unfunded, and on whether the 
exposure is a first-lien residential mortgage exposure or a junior-lien 
residential mortgage exposure. The loan amount of the funded portion of 
a first-lien residential mortgage exposure would be the principal 
amount of the exposure. The loan amount of the funded portion of a 
junior-lien residential mortgage exposure would be the principal amount 
of the exposure plus the maximum contractual amounts of all senior 
exposures secured by the same residential property. Senior unfunded 
commitments may include negative amortization features and HELOCs.
    A banking organization would be required to calculate a separate 
loan amount and LTV ratio for the unfunded portion of a residential 
mortgage exposure. The loan amount of the unfunded portion of a 
residential mortgage exposure would be the loan amount of the funded 
portion of the exposure, as described above, plus the unfunded portion 
of the maximum contractual amount of the commitment.
    The agencies believe that a banking organization should be able to 
reflect the risk mitigating effects of loan-level private mortgage 
insurance (PMI) when calculating the LTV ratio of a residential 
mortgage exposure. Loan-level PMI is insurance that protects a lender 
in the event of borrower default up to a predetermined portion of the 
residential mortgage exposure and that does not have a pool-level cap 
that could effectively reduce coverage below the predetermined amount 
of the exposure. Under this proposed rule, a banking organization could 
reduce the loan amount of a residential mortgage exposure up to the 
amount covered by loan-level PMI, provided the PMI issuer is a 
regulated mortgage insurance company, is not an affiliate \28\ of the 
banking organization, and (i) has long-term senior debt (without credit 
enhancement) that has an external rating that is in at least the third-
highest investment grade rating category or (ii) has a claims-paying 
rating that is in at least the third-highest investment grade rating 
category. The agencies believe that pool-level PMI generally should not 
be reflected in the calculation of the LTV ratio, because pool-level 
PMI is not structured in such a way that a banking organization can 
determine the LTV ratio for a mortgage loan.
---------------------------------------------------------------------------

    \28\ An affiliate of a banking organization is defined as any 
company that controls, is controlled by, or is under common control 
with, the banking organization. A person or company controls a 
company if it: (i) Owns, controls, or holds the power to vote 25 
percent or more of a class of voting securities of the company, or 
(ii) consolidates the company for financial reporting purposes.
---------------------------------------------------------------------------

    Question 12: The agencies request comment on all aspects of the 
proposed treatment of PMI under this framework.
(d) Example of LTV Ratio Calculation
    Assume a banking organization originates a first-lien residential 
mortgage exposure with a negative amortization feature; the property is 
valued at $100,000; the original and outstanding principal amount of 
the exposure is $81,000; and the negative amortization feature has a 10 
percent cap and extends for ten years (that is, the mortgage loan 
balance can contractually negatively amortize to 110 percent of the 
original balance over the next 10 years). The funded loan amount of 
$81,000 has an 81 percent LTV ratio, which is risk weighted at 50 
percent (based on Table 7). The negative amortization feature is an 
unfunded commitment with a maximum contractual amount of $8,100. It 
would receive a 50 percent CCF, resulting in an exposure amount of 
$4,050. The loan amount of the unfunded portion would be $81,000 funded 
amount plus the $8,100 maximum contractual unfunded amount, resulting 
in an LTV of 89.1 percent. The unfunded commitment exposure amount of 
$4,050 would therefore receive a 75 percent risk weight (based on Table 
7). The total risk-weighted assets for the exposure would be $43,538, 
as illustrated in Table 9:

 Table 9.--Example of Proposed Risk-Based Capital Calculation for First-
 Lien Residential Mortgage Exposures With Negative Amortization Features
------------------------------------------------------------------------
 
------------------------------------------------------------------------
                 Funded Risk-Weighted Assets Calculation
------------------------------------------------------------------------
(1) Amount to Risk Weight...............................         $81,000
(2) Funded LTV Ratio = Funded Loan Amount / Property                 81%
 Value = $81,000/$100,000 =.............................
(3) Risk Weight based on Table 7........................             50%
(4) RW Assets for Funded Loan Amount = $81,000 x .50 =..         $40,500
------------------------------------------------------------------------
                Unfunded Risk-Weighted Assets Calculation
------------------------------------------------------------------------
(1) Exposure Amount = Unfunded Maximum Amount x CCF =             $4,050
 $8,100 x .50 =.........................................
(2) Unfunded LTV Ratio = (Funded Amount + Unfunded                 89.1%
 Amount)/Property Value = ($81,000 + $8,100)/$100,000 =.
(3) Risk Weight based on Table 7........................             75%
(4) RW Assets for Unfunded Amount = $4,050 x 0.75.......          $3,038
------------------------------------------------------------------------

[[Page 43997]]

 
 Total Risk-Weighted Assets for a Loan with Negative Amortizing Features
------------------------------------------------------------------------
RW Assets for Funded Amount + RW for Unfunded Amount =          $43,538
 $40,500 + $3,038 =.....................................
------------------------------------------------------------------------
Note: The funded and unfunded amount of the loan will change over time
  once the loan begins to negatively amortize.

(e) Alternative LTV Ratio Calculation
    The agencies are considering an alternative for calculating the LTV 
ratio and risk-weighted asset amount for residential mortgage exposures 
with unfunded commitments. This alternative is less complex but may 
result in different capital implications. Under the alternative, a 
banking organization would not calculate a separate risk-weighted asset 
amount for the funded and unfunded portion of the residential mortgage 
exposure. The alternative calculation would require only the 
calculation of a single LTV ratio representing a combined funded and 
unfunded amount when calculating the LTV ratio for a given exposure. 
Under the alternative, the loan amount of a first-lien residential 
mortgage exposure would equal the funded principal amount (or combined 
exposures provided there is no intervening lien) plus the exposure 
amount of any unfunded commitment (that is, the unfunded amount of the 
maximum contractual amount of any commitment multiplied by the 
appropriate CCF). The loan amount of a junior-lien residential mortgage 
exposure would equal the sum of: (i) The funded principal amount of the 
exposure, (ii) the exposure amount of any undrawn commitment associated 
with the junior-lien exposure, and (iii) the exposure amount of any 
senior exposure held by a third party on the date of origination of the 
junior-lien exposure. Where a senior exposure held by a third party 
includes an undrawn commitment, such as a HELOC or a negative 
amortization feature, the loan amount for a junior-lien residential 
mortgage exposure would include the maximum contractual amount of that 
commitment multiplied by the appropriate CCF. The denominator of the 
LTV ratio would be the same under both alternatives.
    Question 13: The agencies seek comment on the pros and cons 
associated with the two alternatives for calculating the LTV ratio.
    While the agencies believe risk weighting one-to-four family 
residential mortgage exposures based on the LTV ratio appropriately 
captures a large number of mortgage exposures with differing risk, the 
agencies have considered basing the risk weight for these exposures on 
other parameters. Examples include using pricing information that the 
Home Mortgage Disclosure Act (HMDA) requires many banking organizations 
to report, or borrower credit scores.
    Question 14: The agencies seek industry views on any other risk-
sensitive methods that could be used to segment residential mortgage 
exposures by risk level and solicit comment on how such alternatives 
might be applied.
(8) Pre-Sold Construction Loans and Statutory Multifamily Mortgages
    The general risk-based capital rules assign 50 percent and 100 
percent risk weights to certain one-to-four family residential pre-sold 
construction loans and multifamily residential loans. The agencies 
adopted these provisions as a result of the Resolution Trust 
Corporation Refinancing, Restructuring, and Improvement Act of 1991 
(RTCRRI Act). The RTCRRI Act mandates that each agency provide in its 
capital regulations (i) a 50 percent risk weight for certain one-to-
four-family residential pre-sold construction loans and multifamily 
residential loans that meet specific statutory criteria in the RTCRRI 
Act and any other underwriting criteria imposed by the agencies, and 
(ii) a 100 percent risk weight for one-to-four-family residential pre-
sold construction loans for residences for which the purchase contract 
is cancelled.
    Consistent with the RTCRRI Act, a pre-sold construction loan would 
be subject to a 50 percent risk weight unless the purchase contract is 
cancelled. The NPR defines a pre-sold construction loan as any one-to-
four family residential pre-sold construction loan for a residence 
meeting the requirements under section 618(a)(1) or (2) of the RTCRRI 
Act and under 12 CFR part 3, Appendix A, section 3(a)(3)(iv) (for 
national banks); 12 CFR part 208, Appendix A, section III.C.3. (for 
state member banks); 12 CFR part 225, Appendix A, section III.C.3. (for 
bank holding companies); 12 CFR part 325, Appendix A, section II.C. 
(for state nonmember banks), and that is not 90 days or more past due 
or on nonaccrual; or 12 CFR 567.1 (definition of ``qualifying 
residential construction loan'') (for savings associations), and that 
is not on nonaccrual.
    Also consistent with the RTCRRI Act, under the NPR, a statutory 
multifamily mortgage would receive a 50 percent risk weight. The NPR 
defines statutory multifamily mortgage as any multifamily residential 
mortgage meeting the requirements under section 618(b)(1) of the RTCRRI 
Act, and under 12 CFR part 3, Appendix A, section 3(a)(3)(v) (for 
national banks); 12 CFR part 208, Appendix A, section III.C.3. (for 
state member banks); 12 CFR part 225, Appendix A, section III.C.3. (for 
bank holding companies); 12 CFR part 325, Appendix A, section II.C.a. 
(for state nonmember banks); or 12 CFR 567.1 (definition of 
``qualifying multifamily mortgage loan'') and 12 CFR 567.6(a)(1)(iii) 
(for savings associations), and that is not on nonaccrual.\29\ A 
multifamily mortgage that does not meet the definition of a statutory 
mortgage would be treated as a corporate exposure.
---------------------------------------------------------------------------

    \29\ Under these proposed definitions, a loan that is 90 days or 
more past due or on nonaccrual would not qualify as a pre-sold 
construction loan or a statutory multifamily mortgage. These loans 
would be accorded the treatment described in the next section.
---------------------------------------------------------------------------

(9) Past Due Loans
    Under the general risk-based capital rules, the risk weight of a 
loan generally does not change if the loan becomes past due, with the 
exception of certain residential mortgage loans. The New Accord 
provides risk weights ranging from 50 to 150 percent for loans that are 
more than 90 days past due, depending on the amount of specific 
provisions a banking organization has recorded.
    Most banking organizations in the United States do not recognize 
specific provisions. Therefore, the treatment of past due exposures in 
the New Accord is not applicable for those banking organizations. 
Accordingly, to reflect impaired credit quality, the agencies propose 
to risk weight most exposures that are 90 days or more past due or on 
nonaccrual at 150 percent, except for past due residential mortgage 
exposures. A banking organization could reduce the risk weight of the 
exposure to reflect financial collateral or eligible guarantees.

[[Page 43998]]

    Question 15: The agencies seek comment on whether, for those 
banking organizations that are required to maintain specific 
provisions, it would be appropriate to follow the New Accord treatment, 
that is, the risk weight would vary depending on the amount of specific 
provisions the banking organization has recorded.
(10) Other Assets
    The agencies propose to use the following risk weights, which are 
generally consistent with the risk weights in the general risk-based 
capital rules, for other exposures: (i) A banking organization could 
assign a zero percent risk weight to cash owned and held in all of its 
offices or in transit; to gold bullion held in its own vaults, or held 
in another depository institution's vaults on an allocated basis, to 
the extent gold bullion assets are offset by gold bullion liabilities; 
and to derivative contracts that are publicly traded on an exchange 
that requires the daily receipt and payment of cash-variation margin; 
(ii) a banking organization could assign a 20 percent risk weight to 
cash items in the process of collection; and (iii) a banking 
organization would have to apply a 100 percent risk weight to all 
assets not specifically assigned a different risk weight under this NPR 
(other than exposures that are deducted from tier 1 or tier 2 capital).

I. Off-Balance Sheet Items

    Under the general risk-based capital rules, a banking organization 
generally determines the risk-based asset amount for an off-balance 
sheet exposure using a two-step process. The banking organization 
applies a CCF to the off-balance sheet amount to obtain an on-balance 
sheet credit equivalent amount and then applies the appropriate risk 
weight to that amount.
    In general, the agencies propose to calculate the exposure amount 
of an off-balance sheet item by multiplying the off-balance sheet 
component, which is usually the notional amount, by the applicable CCF. 
The agencies also propose to retain most of the CCFs in the general 
risk-based capital rules.\30\ Consistent with the New Accord, however, 
the agencies propose that a banking organization apply a 20 percent CCF 
to all commitments with an original maturity of one year or less 
(short-term commitments) that are not unconditionally cancelable rather 
than the zero percent in the general risk-based capital rules. The 
agencies believe that a 20 percent CCF for these short-term commitments 
better reflects the risk of these exposures.
---------------------------------------------------------------------------

    \30\ The discussion of the risk-based capital treatment for off-
balance sheet securitization exposures, including liquidity 
facilities for asset-backed commercial paper, is presented in Part 
IV of the proposed rule. Equity commitments are discussed in Part V 
of the proposed rule.
---------------------------------------------------------------------------

    For purposes of this NPR, a commitment means any legally binding 
arrangement that obligates a banking organization to extend credit or 
to purchase assets. In this NPR, unconditionally cancelable means, with 
respect to a commitment, that a banking organization may, at any time, 
with or without cause, refuse to extend credit under the facility (to 
the extent permitted under applicable law). In the case of a 
residential mortgage exposure that is a line of credit, a banking 
organization is deemed able to unconditionally cancel the commitment if 
it can, at its option, prohibit additional extensions of credit, reduce 
the credit line, and terminate the commitment to the full extent 
permitted by applicable law.
    Under this NPR, if a banking organization commits to provide a 
commitment on an off-balance sheet item, that is, a commitment to make 
a commitment, the agencies propose that a banking organization apply 
the lower of the two applicable CCFs. If a banking organization 
provides a commitment that is structured as a syndication, it would 
only be required to calculate the exposure amount for its pro rata 
share of the commitment.
    There is no reference to note issuance facilities (NIFs) and 
revolving underwriting facilities (RUFs) in the proposed rule as the 
agencies are not aware that any such transactions exist in the United 
States.
    Under the agencies' general risk-based capital rules, capital is 
required against any on-balance sheet exposures that arise from 
securities financing transactions (that is, repurchase agreements, 
reverse repurchase agreements, securities lending transactions, and 
securities borrowing transactions); for example, capital is required 
against the cash receivable that a banking organization generates when 
it borrows a security and posts cash collateral to obtain the security. 
A banking organization faces counterparty credit risk on securities 
financing transactions, however, regardless of whether the transaction 
generates an on-balance sheet exposure. In contrast to the general 
risk-based capital rules, this NPR requires a banking organization to 
hold risk-based capital against all securities financing transactions. 
Similar to other exposures, a banking organization would determine the 
exposure amount of a securities financing transaction and then risk 
weight that amount based on the counterparty or, if applicable, 
collateral or guarantee.
    In general, a banking organization must apply a 100 percent CCF to 
the off-balance sheet component of a repurchase agreement or securities 
lending or borrowing transaction. The off-balance sheet component of a 
repurchase agreement equals the sum of the current market values of all 
positions the banking organization has sold subject to repurchase. The 
off-balance sheet component of a securities lending transaction is the 
sum of the current market values of all positions the banking 
organization has lent under the transaction. For securities borrowing 
transactions, the off-balance sheet component is the sum of the current 
market values of all non-cash positions the banking organization has 
posted as collateral under the transaction. In certain circumstances, a 
banking organization may instead determine the exposure amount of the 
transaction as described in the collateralized transaction section of 
this preamble and in section 37 of the proposed rule.

J. OTC Derivative Contracts

(1) Background
    Under the general risk-based capital rules for over-the-counter 
(OTC) derivative contracts, a banking organization must hold risk-based 
capital for counterparty credit risk.\31\ To determine the capital 
requirement, a banking organization must first compute a credit 
equivalent amount for a contract and then apply to that amount a risk 
weight based on the obligor, counterparty, eligible guarantor, or 
recognized collateral. For an OTC derivative contract that is not 
subject to a qualifying bilateral netting contract, the credit 
equivalent amount is the sum of (i) the greater of the current exposure 
(mark-to-market value) or zero and (ii) an estimate of the potential 
future credit exposure (PFE). PFE is the notional principal amount of 
the contract multiplied by a credit conversion factor.
---------------------------------------------------------------------------

    \31\ OTS rules on the calculation of credit equivalent amounts 
for derivative contracts differ from the rules of the other 
agencies. That is, OTS rules address only interest rate and foreign 
exchange rate contracts and include certain other differences. 
Accordingly, the description of the current provisions in this 
preamble primarily reflects the other banking agencies' rules.
---------------------------------------------------------------------------

    Under the general risk-based capital rules for OTC derivative 
contracts subject to a qualifying bilateral netting contract, the 
credit equivalent amount is calculated by adding the net current 
exposure of the netting contract and the sum of the estimates of PFE 
for the individual contracts. The net current

[[Page 43999]]

exposure is the sum of all positive and negative mark-to-market values 
of the individual contracts but not less than zero. A banking 
organization recognizes the effects of the bilateral netting contract 
on the gross potential future exposure of the contracts by calculating 
an adjusted add-on amount based on the ratio of net current exposure to 
gross current exposure, either on a counterparty-by-counterparty basis 
or on an aggregate basis.
(2) Treatment of OTC Derivative Contracts
    Consistent with the treatment in the New Accord and the general 
risk-based capital rules, the proposed rule defines an OTC derivative 
contract as a derivative contract that is not traded on an exchange 
that requires the daily receipt and payment of cash-variation margin. A 
derivative contract would be defined as a financial contract whose 
value is derived from the values of one or more underlying assets, 
reference rates, or indices of asset values or reference rates. 
Derivative contracts would include interest rate derivative contracts, 
exchange rate derivative contracts, equity derivative contracts, 
commodity derivative contracts, credit derivatives, and any other 
instrument that poses similar counterparty credit risks. The proposed 
rule also defines derivative contracts to include unsettled securities, 
commodities, and foreign exchange trades with a contractual settlement 
or delivery lag that is longer than the normal settlement period (which 
the proposed rule defines as the lesser of the market standard for the 
particular instrument and five business days). This includes, for 
example, mortgage-backed securities transactions that the GSEs conduct 
in the To-Be-Announced market.
    The current exposure method for determining the exposure amount for 
single OTC derivative contracts contained in the New Accord is similar 
to the method in the agencies' general risk-based capital rules. The 
agencies propose to retain this risk-based capital treatment for OTC 
derivative contracts.
    Under the agencies' general risk-based capital rules, a banking 
organization must obtain a written and well-reasoned legal opinion for 
each of its bilateral qualifying master netting agreements that cover 
OTC derivative contracts to recognize the netting benefit. In this NPR, 
the agencies propose that to use netting treatment for multiple OTC 
derivative contracts, the contracts must be subject to a qualifying 
master netting agreement.
    In this NPR, a qualifying master netting agreement means any 
written, legally enforceable bilateral netting agreement, provided that 
(i) the agreement creates a single legal obligation for all individual 
transactions covered by the agreement upon an event of default, 
including bankruptcy, insolvency or similar proceeding, of the 
counterparty; (ii) the agreement provides the banking organization the 
right to accelerate, terminate, and close out on a net basis all 
transactions under the agreement and to liquidate or set off collateral 
promptly upon an event of default, including upon an event of 
bankruptcy, insolvency, or similar proceeding, of the counterparty, 
provided that, in any such case, any exercise of rights under the 
agreement will not be stayed or avoided under applicable law in the 
relevant jurisdictions; (iii) the banking organization has conducted 
sufficient legal review to conclude with a well-founded basis (and 
maintain sufficient written documentation of that legal review) that 
the agreement meets the requirements of part (ii) of this definition 
and that, in the event of legal challenge (including one resulting from 
default, bankruptcy, insolvency, or similar proceeding), the relevant 
court and administrative authorities would find the agreement to be 
legal, valid, binding, and enforceable under the law of the relevant 
jurisdictions; (iv) the banking organization establishes and maintains 
procedures to monitor possible changes in relevant law and to ensure 
that the agreement continues to satisfy the requirements of the 
definition of a qualifying master netting agreement; and (v) the 
agreement does not contain a walkaway clause.
    In some cases, the legal review requirement could be met by 
reasoned reliance on a commissioned legal opinion or an in-house 
counsel analysis. In other cases, for example, those involving certain 
new derivative transactions or derivative counterparties in atypical 
jurisdictions, the banking organization would need to obtain an 
explicit, written legal opinion from external or internal legal counsel 
addressing the particular situation.
    If an OTC derivative contract is collateralized by financial 
collateral, a banking organization would first determine the exposure 
amount of the OTC derivative contract as described above and in section 
35 of this proposed rule. To take into account the risk-reducing 
effects of the financial collateral, a banking organization could 
recognize the credit risk mitigation benefits of the financial 
collateral using the simple approach for collateralized transactions 
provided in section 37(b) of this proposed rule. Alternatively, a 
banking organization could, if the financial collateral is marked-to-
market on a daily basis and subject to a daily margin maintenance 
requirement, adjust the exposure amount of the contract using the 
collateral haircut approach provided in section 37(c) of this proposed 
rule.
(3) Counterparty Credit Risk for Credit Derivatives
    A banking organization that purchases a credit derivative that is 
recognized under section 36 of the proposed rule as a credit risk 
mitigant for an existing exposure that is not a covered position under 
the MRR would not have to compute a separate counterparty credit risk 
capital requirement for the credit derivative in section 31 of the 
proposed rule. If a banking organization chose not to hold risk-based 
capital against the counterparty credit risk of such credit derivative 
contracts, it would have to do so consistently for all such credit 
derivative contracts. Further, where the contracts are subject to a 
qualifying master netting agreement, the banking organization would 
either include them all or exclude them all from any measure used to 
determine counterparty credit risk exposure to all relevant 
counterparties for risk-based capital purposes.
    Where a banking organization provides protection through a credit 
derivative that is not treated as a covered position under the MRR, it 
would treat the credit derivative as an exposure to the reference 
obligor and compute a risk-weighted asset amount for the credit 
derivative under section 31 of the proposed rule. The banking 
organization need not compute a counterparty credit risk capital 
requirement for the credit derivative, as long as it does so 
consistently for all such credit derivatives and either includes all or 
excludes all such credit derivatives that are subject to a qualifying 
master netting contract from any measure used to determine counterparty 
credit risk exposure to all relevant counterparties for risk-based 
capital purposes. Where the banking organization provides protection 
through a credit derivative treated as a covered position under the 
MRR, it would compute a counterparty credit risk capital requirement 
using an amount determined under the OTC derivative contracts section 
of this NPR. However, the PFE of the protection provider would be 
capped at the net present value of the amount of unpaid premiums.

[[Page 44000]]

(4) Counterparty Credit Risk for Equity Derivatives
    Under this NPR, a banking organization would be required to treat 
an equity derivative contract as an equity exposure and compute a risk-
weighted asset amount for that exposure. A banking organization could 
choose not to hold risk-based capital against the counterparty credit 
risk of such equity contracts unless the banking organization treats 
the contract as a covered position under the MRR. However, it would 
have to do so consistently for all such equity derivative contracts. 
Furthermore, where the contracts are subject to a qualifying master 
netting agreement, the banking organization would have to either 
include or exclude all the contracts from any measure used to determine 
counterparty credit risk exposure to all relevant counterparties for 
risk-based capital purposes. (The approach for equity exposures is 
provided in Part V of the proposed rule.)
(5) Risk Weight for OTC Derivative Contracts
    Under the general risk-based capital rules, a banking organization 
must risk weight the credit equivalent amount of an OTC derivative 
exposure by applying the risk weight of the counterparty or, where 
applicable, guarantor or collateral, to the credit equivalent amount of 
the contract(s). The risk weight is limited to 50 percent even if the 
counterparty or guarantor would otherwise receive a higher risk weight.
    The agencies limited the risk weight assigned to OTC derivative 
contracts to 50 percent when they finalized the derivatives 
counterparty credit risk rule in 1995.\32\ At that time, most 
derivatives counterparties were highly rated and were generally 
financial institutions. The agencies noted, however, that they intended 
to monitor the quality of credits in the interest rate and exchange 
rate markets to determine whether some transactions might merit a 100 
percent risk weight.
---------------------------------------------------------------------------

    \32\ 60 FR 46169-46185 (September 5, 1995).
---------------------------------------------------------------------------

    Consistent with the New Accord, the agencies propose that the risk 
weight for OTC derivative transactions would not be subject to any 
specific ceiling. As the market for derivatives has developed, the 
types of counterparties acceptable to participants have expanded to 
include counterparties that the agencies believe merit a risk weight 
greater than 50 percent.

K. Credit Risk Mitigation (CRM)

    Banking organizations use a number of techniques to mitigate credit 
risks. For example, a banking organization may collateralize exposures 
by first-priority claims, in whole or in part, with cash or securities; 
a third party may guarantee a loan exposure; or a banking organization 
may buy a credit derivative to offset an exposure's credit risk. 
Additionally, a banking organization may agree to net exposures to a 
counterparty against reciprocal exposures from that counterparty. This 
section describes how a banking organization could recognize for risk-
based capital purposes the risk-mitigation effects of guarantees, 
credit derivatives, financial collateral, and, in limited cases, non-
financial collateral.
    To recognize credit risk mitigants for risk-based capital purposes, 
a banking organization should have in place operational procedures and 
risk management processes that ensure that all documentation used in 
collateralizing or guaranteeing a transaction is legal, valid, binding, 
and enforceable under applicable law in the relevant jurisdictions. The 
banking organization should have conducted sufficient legal review to 
reach a well-founded conclusion that the documentation meets this 
standard and should reconduct such a review as necessary to ensure 
continuing enforceability.
    Although the use of credit risk mitigants may reduce or transfer 
credit risk, it simultaneously may increase other risks, including 
operational, liquidity, and market risks. Accordingly, it is imperative 
that a banking organization employ robust procedures and processes to 
control risks, including roll-off risk and concentration risk, arising 
from the banking organization's use of credit risk mitigants and to 
monitor the implications of using credit risk mitigants for the banking 
organization's overall credit risk profile.
(1) Guarantees and Credit Derivatives
(a) Eligibility Requirements
    The agencies' general risk-based capital rules generally recognize 
third-party guarantees provided by central governments, U.S. 
government-sponsored entities, public-sector entities in OECD 
countries, multilateral lending institutions and regional development 
banks, depository institutions, and qualifying securities firms in OECD 
countries. Consistent with the New Accord, the agencies propose to 
allow a banking organization to use a substitution approach similar to 
the approach in the agencies' general risk-based capital rules and 
recognize a wider range of guarantors.
    This NPR defines an eligible guarantor as any of the following 
entities: (i) a sovereign entity, the Bank for International 
Settlements, the International Monetary Fund, the European Central 
Bank, the European Commission, a Federal Home Loan Bank, the Federal 
Agricultural Mortgage Corporation (Farmer Mac), an MDB, a depository 
institution, a foreign bank, a credit union, a bank holding company (as 
defined in section 2 of the Bank Holding Company Act (12 U.S.C. 1841)), 
or a savings and loan holding company (as defined in 12 U.S.C. 1467a) 
provided all or substantially all of the holding company's activities 
are permissible for a financial holding company under 12 U.S.C. 
1843(k); or (ii) any other entity (other than a securitization special 
purpose entity (SPE)) if at the time the entity issued the guarantee or 
credit derivative or at any time thereafter, the entity has issued and 
has outstanding an unsecured long-term debt security without credit 
enhancement that has a long-term applicable external rating.
    For recognition under this proposed rule, consistent with the 
advanced approaches final rule, guarantees and credit derivatives would 
have to meet specific eligibility requirements. This proposed rule 
defines an eligible guarantee as a guarantee from an eligible guarantor 
that: (i) is written; (ii) is either unconditional, or a contingent 
obligation of the United States Government or its agencies, the 
validity of which to the beneficiary is dependent upon some affirmative 
action on the part of the beneficiary of the guarantee or a third party 
(for example, servicing requirements); (iii) covers all or a pro rata 
portion of all contractual payments of the obligor on the reference 
exposure; (iv) gives the beneficiary a direct claim against the 
protection provider; (v) is not unilaterally cancelable by the 
protection provider for reasons other than the breach of the contract 
by the beneficiary; (vi) is legally enforceable against the protection 
provider in a jurisdiction where the protection provider has sufficient 
assets against which a judgment may be attached and enforced; (vii) 
requires the protection provider to make payment to the beneficiary on 
the occurrence of a default (as defined in the guarantee) of the 
obligor on the reference exposure in a timely manner without the 
beneficiary first having to take legal actions to pursue the obligor 
for payment; (viii) does not increase the beneficiary's cost of credit 
protection on the guarantee in response to deterioration in the credit 
quality of the reference exposure; and (ix) is not provided by an 
affiliate of the

[[Page 44001]]

banking organization, unless the affiliate is an insured depository 
institution, foreign bank, securities broker or dealer, or insurance 
company that does not control the banking organization; and is subject 
to consolidated supervision and regulation comparable to that imposed 
on U.S. depository institutions, securities brokers or dealers, or 
insurance companies (as the case may be).
    In this NPR, consistent with the advanced approaches final rule, 
eligible credit derivative means a credit derivative in the form of a 
credit default swap, nth-to-default swap, total return swap, 
or any other form of credit derivative approved by the primary Federal 
supervisor, provided that:
    (i) The contract meets the requirements of an eligible guarantee 
and has been confirmed by the protection purchaser and the protection 
provider;
    (ii) Any assignment of the contract has been confirmed by all 
relevant parties;
    (iii) If the credit derivative is a credit default swap or 
nth-to-default swap, the contract includes the following 
credit events: (A) failure to pay any amount due under the terms of the 
reference exposure, subject to any applicable minimal payment threshold 
that is consistent with standard market practice and with a grace 
period that is closely in line with the grace period of the reference 
exposure; and (B) bankruptcy, insolvency, or inability of the obligor 
on the reference exposure to pay its debts, or its failure or admission 
in writing of its inability generally to pay its debts as they become 
due, and similar events;
    (iv) The terms and conditions dictating the manner in which the 
contract is to be settled are incorporated into the contract;
    (v) If the contract allows for cash settlement, the contract 
incorporates a robust valuation process to estimate loss reliably and 
specifies a reasonable period for obtaining post-credit event 
valuations of the reference exposure;
    (vi) If the contract requires the protection purchaser to transfer 
an exposure to the protection provider at settlement, the terms of at 
least one of the exposures that is permitted to be transferred under 
the contract must provide that any required consent to transfer may not 
be unreasonably withheld;
    (vii) If the credit derivative is a credit default swap or nth-to-
default swap, the contract clearly identifies the parties responsible 
for determining whether a credit event has occurred, specifies that 
this determination is not the sole responsibility of the protection 
provider, and gives the protection purchaser the right to notify the 
protection provider of the occurrence of a credit event; and
    (viii) If the credit derivative is a total return swap and the 
banking organization records net payments received on the swap as net 
income, the banking organization records offsetting deterioration in 
the value of the hedged exposure (through reductions in fair value).
    Under this NPR, which is consistent with the advanced approaches 
final rule, a banking organization would be permitted to recognize an 
eligible credit derivative that hedges an exposure that is different 
from the credit derivative's reference exposure used for determining 
the derivative's cash settlement value, deliverable obligation, or 
occurrence of a credit event only if: (i) The reference exposure ranks 
pari passu or subordinated to the hedged exposure and (ii) the 
reference exposure and the hedged exposure are exposures to the same 
legal entity, and legally enforceable cross-default or cross-
acceleration clauses are in place to assure protection payments under 
the credit derivative are triggered when the obligor fails to pay under 
the terms of the hedged exposure.
(b) Substitution Approach
    Under the substitution approach in this NPR, if the protection 
amount (as defined below) of the eligible guarantee or eligible credit 
derivative is greater than or equal to the exposure amount of the 
hedged exposure, a banking organization could substitute the risk 
weight associated with the guarantee or credit derivative for the risk 
weight of the hedged exposure. If the protection amount of the eligible 
guarantee or eligible credit derivative is less than the exposure 
amount of the hedged exposure, the banking organization would have to 
treat the hedged exposure as two separate exposures (protected and 
unprotected) to recognize the credit risk mitigation benefit of the 
guarantee or credit derivative on the protected exposure. A banking 
organization would calculate the risk-weighted asset amount for the 
protected exposure under section 36 of this NPR (using a risk weight 
associated with the guarantee or credit derivative and an exposure 
amount equal to the protection amount of the guarantee or credit 
derivative). The banking organization would calculate its risk-weighted 
asset amount for the unprotected exposure under section 36 of this NPR 
(using the risk weight assigned to the exposure and an exposure amount 
equal to the exposure amount of the original hedged exposure minus the 
protection amount of the guarantee or credit derivative). If the 
banking organization determines that substitution of the guarantee or 
credit derivative's risk weight would lead to an inappropriate degree 
of risk mitigation, it may substitute a higher risk weight.
    The protection amount of an eligible guarantee or eligible credit 
derivative would be the effective notional amount of the guarantee or 
credit derivative reduced by any applicable haircuts for maturity 
mismatch, lack of restructuring coverage, and currency mismatch (each 
described below). The effective notional amount of an eligible 
guarantee or eligible credit derivative would be the lesser of the 
contractual notional amount of the credit risk mitigant and the 
exposure amount of the hedged exposure, multiplied by the percentage 
coverage of the credit risk mitigant. For example, the effective 
notional amount of a guarantee that covers, on a pro rata basis, 40 
percent of any losses on a $100 bond would be $40.
(c) Maturity Mismatch Haircut
    A banking organization that seeks to reduce the risk-weighted asset 
amount of an exposure by recognizing an eligible guarantee or eligible 
credit derivative would have to adjust the effective notional amount of 
the credit risk mitigant downward to reflect any maturity mismatch 
between the hedged exposure and the credit risk mitigant. A maturity 
mismatch occurs when the residual maturity of a credit risk mitigant is 
less than that of the hedged exposure(s). When a banking organization 
has a group of hedged exposures with different residual maturities that 
are covered by a single eligible guarantee or eligible credit 
derivative, a banking organization would treat each hedged exposure as 
if it were fully covered by a separate eligible guarantee or eligible 
credit derivative. To determine whether any of the hedged exposures has 
a maturity mismatch with the eligible guarantee or credit derivative, 
the banking organization would assess whether the residual maturity of 
the eligible guarantee or eligible credit derivative is less than that 
of the hedged exposure.
    The residual maturity of a hedged exposure would be the longest 
possible remaining time before the obligor is scheduled to fulfill its 
obligation on the exposure. Embedded options that may reduce the term 
of the credit risk mitigant would be taken into account so that the 
shortest possible residual maturity for the credit risk mitigant would 
be used to determine the

[[Page 44002]]

potential maturity mismatch. Where a call is at the discretion of the 
protection provider, the residual maturity of the eligible guarantee or 
eligible credit derivative would be at the first call date. If the call 
is at the discretion of the banking organization purchasing the 
protection, but the terms of the arrangement at the origination of the 
eligible guarantee or eligible credit derivative contain a positive 
incentive for the banking organization to call the transaction before 
contractual maturity, the remaining time to the first call date would 
be the residual maturity of the credit risk mitigant. For example, 
where there is a step-up in the cost of credit protection in 
conjunction with a call feature or where the effective cost of 
protection increases over time even if credit quality remains the same 
or improves, the residual maturity of the credit risk mitigant would be 
the remaining time to the first call.
    Under the proposed rule, a banking organization would only 
recognize an eligible guarantee or an eligible credit derivative with a 
maturity mismatch if the original maturity is equal to or greater than 
one year and the residual maturity is greater than three months.
    When a maturity mismatch exists, a banking organization would have 
to apply the following maturity mismatch adjustment to the effective 
notional amount of the guarantee or credit derivative adjusted for 
maturity mismatch:

Pm = E x (t-0.25) / (T-0.25),

Where:

(i) Pm = effective notional amount of the guarantee or credit 
derivative adjusted for maturity mismatch;
(ii) E = effective notional amount of the guarantee or credit 
derivative;
(iii) t = lesser of T or residual maturity of the guarantee or 
credit derivative, expressed in years; and
(iv) T = lesser of 5 or residual maturity of the hedged exposure, 
expressed in years.
(d) Restructuring Haircut
    A banking organization that seeks to recognize an eligible credit 
derivative that does not include a restructuring as a credit event that 
triggers payment under the derivative would have to reduce the 
recognition of the credit derivative by 40 percent. For these purposes, 
a restructuring involves forgiveness or postponement of principal, 
interest, or fees that result in a credit loss event (that is, a charge 
off, specific provision, or other similar debit to the profit and loss 
account).
    In other words, the effective notional amount of the credit 
derivative adjusted for lack of restructuring credit event (and 
maturity mismatch, if applicable) would be:

Pr = Pm x 0.60,

Where:

(i) Pr = effective notional amount of the credit derivative, 
adjusted for lack of restructuring credit event (and maturity 
mismatch, if applicable); and
(ii) Pm = effective notional amount of the credit derivative 
(adjusted for maturity mismatch, if applicable).
(e) Currency Mismatch Haircut
    Where the eligible guarantee or eligible credit derivative is 
denominated in a currency different from that in which any hedged 
exposure is denominated, the effective notional amount of the guarantee 
or credit derivative adjusted for currency mismatch (and maturity 
mismatch and lack of restructuring credit event, if applicable) would 
be calculated as:

Pc = Pr x (1-Hfx),

Where:

(i) Pc = effective notional amount of the guarantee or credit 
derivative, adjusted for currency mismatch (and maturity mismatch 
and lack of restructuring credit event, if applicable);
(ii) Pr = effective notional amount of the guarantee or credit 
derivative (adjusted for maturity mismatch and lack of restructuring 
credit event, if applicable); and
(iii) Hfx = haircut appropriate for the currency mismatch between 
the guarantee or credit derivative and the hedged exposure.

    Except as provided below, a banking organization would be required 
to use a standard supervisory haircut of 8.0 percent for Hfx (based on 
a ten-business day holding period and daily marking-to-market and 
remargining). Alternatively, a banking organization could use 
internally estimated haircuts for Hfx based on a ten-business day 
holding period and daily marking-to-market and remargining if the 
banking organization qualifies to use the own-estimates haircuts, or 
the simple VaR method as provided in section 37(d) of this NPR. The 
banking organization would scale these haircuts up using the square 
root of time formula if the banking organization revalues the guarantee 
or credit derivative less frequently than once every ten business days. 
The applicable haircut (HM) is calculated using the following square 
root of time formula:
[GRAPHIC] [TIFF OMITTED] TP29JY08.000

Where:

(i) TM = greater of ten and the number of days between revaluations 
of the credit derivative or guarantee;
(ii) TN = holding period used by the banking organization to derive 
HN; and
(iii) HN = haircut based on the holding period TN.
(f) Multiple Credit Risk Mitigants
    If multiple credit risk mitigants (for example, two eligible 
guarantees) cover a single exposure, the CRM section in the New Accord 
provides that a banking organization must disaggregate the exposure 
into portions covered by each credit risk mitigant (for example, the 
portion covered by each guarantee) and must calculate separately the 
risk-based capital requirement of each portion.\33\ The New Accord also 
indicates that when credit risk mitigants provided by a single 
protection provider have differing maturities, the mitigants should be 
subdivided into separate layers of protection.\34\ The agencies propose 
to permit a banking organization to take this approach.
---------------------------------------------------------------------------

    \33\ New Accord, ] 206.
    \34\ Id.
---------------------------------------------------------------------------

(2) Collateralized Transactions
    The general risk-based capital rules recognize limited types of 
collateral: Cash on deposit; securities issued or guaranteed by central 
governments of the OECD countries; securities issued or guaranteed by 
the U.S. government or its agencies; and securities issued by certain 
multilateral development banks.\35\
---------------------------------------------------------------------------

    \35\ The agencies' rules for collateral transactions, however, 
differ somewhat as described in the agencies' joint report to 
Congress. ``Joint Report: Differences in Accounting and Capital 
Standards among the Federal Banking Agencies,'' 71 FR 16776 (April 
4, 2006).
---------------------------------------------------------------------------

(a) Collateral Proposal
    In the past, the banking industry has urged the agencies to 
recognize a wider array of collateral types for purposes of reducing 
risk-based capital requirements. The agencies agree that their general 
risk-based capital rules for collateral are restrictive and, in some 
cases, ignore market practice. Accordingly, the agencies propose to 
recognize the credit mitigating impact of financial collateral. For 
purposes of this NPR, financial collateral means collateral in the form 
of any of the following instruments: (i) Cash on deposit with the 
banking organization (including cash held for the banking organization 
by a third-party custodian or trustee); (ii) gold bullion; (iii) long-
term debt securities that have an applicable external rating of one 
category below investment grade or higher (for example, at least BB-); 
(iv)

[[Page 44003]]

short-term debt instruments that have an applicable external rating of 
at least investment grade (for example, at least A-3); (v) equity 
securities that are publicly traded; (vi) convertible bonds that are 
publicly traded; (vii) money market mutual fund shares and other mutual 
fund shares if a price for the shares is publicly quoted daily; or 
(viii) conforming residential mortgage exposures. With the exception of 
cash on deposit, the banking organization would have to have a 
perfected, first-priority security interest in the collateral or, 
outside of the United States, the legal equivalent thereof, 
notwithstanding the prior security interest of any custodial agent. A 
banking organization could recognize partial collateralization of the 
exposure.
    The agencies propose to permit a banking organization to recognize 
the risk-mitigating effects of financial collateral using the simple 
approach, the collateral haircut approach, and the simple VaR approach. 
The collateral haircut and simple VaR approaches are the same as the 
collateral haircut and simple VaR approaches in the advanced approaches 
final rule. The agencies do not propose, however, to include the 
internal models method (for example, the expected positive exposure 
(EPE) method) in this NPR.
    The agencies propose to permit a banking organization to use any 
applicable approach to recognize collateral provided the banking 
organization uses the same approach for similar exposures. Under this 
NPR as under the advanced approaches final rule, a banking organization 
could use the collateral haircut approach only for repo-style 
transactions, eligible margin loans, collateralized OTC derivative 
transactions, and single-product netting sets thereof, and the simple 
VaR approach only for single-product netting sets of repo-style 
transactions and eligible margin loans.
    Table 10 illustrates the CRM methods that would be available for 
various types of transactions under the proposed rule.

                                     Table 10.--Applicability of CRM Methods
----------------------------------------------------------------------------------------------------------------
                                                                                   Collateral
                   Collateralized exposure                          Simple          haircut         Simple VaR
                                                                   approach         approach          method
----------------------------------------------------------------------------------------------------------------
Any exposure.................................................               X   ...............  ...............
OTC Derivative Contract......................................               X                X   ...............
Repo-Style Transaction.......................................               X                X                X
Eligible Margin Loan.........................................               X                X                X
----------------------------------------------------------------------------------------------------------------

    The proposed rule defines repo-style transaction as a repurchase or 
reverse repurchase transaction, or a securities borrowing or securities 
lending transaction (including a transaction in which the banking 
organization acts as agent for a customer and indemnifies the customer 
against loss), provided that:
    (i) The transaction is based solely on liquid and readily 
marketable securities, cash, gold, or conforming residential mortgage 
exposures;
    (ii) The transaction is marked-to-market daily and subject to daily 
margin maintenance requirements;
    (iii)(a) The transaction is a ``securities contract'' or 
``repurchase agreement'' under section 555 or 559, respectively, of the 
Bankruptcy Code (11 U.S.C. 555 or 559), a qualified financial contract 
under section 11(e)(8) of the Federal Deposit Insurance Act (12 U.S.C. 
1821(e)(8)), or a netting contract between or among financial 
institutions under sections 401-407 of the Federal Deposit Insurance 
Corporation Improvement Act of 1991 (12 U.S.C. 4401-4407) or the 
Federal Reserve Board's Regulation EE (12 CFR part 231); or (b) if the 
transaction does not meet the criteria in paragraph (iii)(a) of this 
definition, then: Either the transaction is executed under an agreement 
that provides the banking organization the right to accelerate, 
terminate, and close out the transaction on a net basis and to 
liquidate or set off collateral promptly upon an event of default 
(including upon an event of bankruptcy, insolvency, or similar 
proceeding) of the counterparty, provided that, in any such case, any 
exercise of rights under the agreement will not be stayed or avoided 
under applicable law in the relevant jurisdictions; or the transaction 
is either overnight or unconditionally cancelable at any time by the 
banking organization and is executed under an agreement that provides 
the banking organization the right to accelerate, terminate, and close 
out the transaction on a net basis and to liquidate or set off 
collateral promptly upon an event of counterparty default; and
    (iv) The banking organization has conducted sufficient legal review 
to conclude with a well-founded basis (and maintains sufficient 
documentation of that legal review) that the agreement meets the 
requirements of paragraph (iii) of this definition and is legal, valid, 
binding, and enforceable under applicable law in the relevant 
jurisdictions.
    This NPR defines an eligible margin loan as an extension of credit 
where: (i) the extension of credit is collateralized exclusively by 
liquid and readily marketable debt or equity securities, gold, or 
conforming residential mortgage exposures; (ii) the collateral is 
marked-to-market daily, and the transaction is subject to daily margin 
maintenance requirements; (iii) the extension of credit is conducted 
under an agreement that provides the banking organization the right to 
accelerate and terminate the extension of credit and to liquidate or 
set off collateral promptly upon an event of default (including upon an 
event of bankruptcy, insolvency, or similar proceeding) of the 
counterparty, provided that, in any such case, any exercise of rights 
under the agreement will not be stayed or avoided under applicable law 
in the relevant jurisdictions; \36\ and (iv) the banking organization 
has conducted sufficient legal review to conclude with a well-founded 
basis (and maintains sufficient written documentation of that legal 
review) that the agreement meets the requirements of paragraph (iii) of 
this definition and is legal, valid, binding, and enforceable under 
applicable law in the relevant jurisdictions.
---------------------------------------------------------------------------

    \36\ This requirement is met where all transactions under the 
agreement are (i) executed under U.S. law and (ii) constitute 
``securities contracts'' under section 555 of the Bankruptcy code 
(11 U.S.C. 555), qualified financial contracts under section 
11(e)(8) of the Federal Deposit Insurance Act (12 U.S.C. 1821(e)(8), 
or netting contracts between or among financial institutions under 
sections 401-407 of the Federal Deposit Insurance Corporation 
Improvement Act of 1991 (12 U.S.C. 4401-4407) or the Federal Reserve 
Board's Regulation EE (12 CFR part 231).
---------------------------------------------------------------------------

(b) Risk Management Guidance for Recognizing Collateral
    Before relying on the CRM benefits of collateral to risk weight its 
exposures, a banking organization should: (i) Conduct sufficient legal 
review to ensure, at inception and on an ongoing basis, that all 
documentation used in the

[[Page 44004]]

collateralized transaction is binding on all parties and legally 
enforceable in all relevant jurisdictions; (ii) consider the 
correlation between obligor risk of the underlying direct exposure and 
collateral risk in the transaction; and (iii) fully take into account 
the time and cost needed to realize the liquidation proceeds and the 
potential for a decline in collateral value over this time period.
    A banking organization also should ensure that: (i) the legal 
mechanism under which the collateral is pledged or transferred ensures 
that the banking organization has the right to liquidate or take legal 
possession of the collateral in a timely manner in the event of the 
default, insolvency, or bankruptcy (or other defined credit event) of 
the obligor and, where applicable, the custodian holding the 
collateral; (ii) the banking organization has taken all steps necessary 
to fulfill legal requirements to secure its interest in the collateral 
so that it has and maintains an enforceable security interest; (iii) 
the banking organization has clear and robust procedures to ensure 
observation of any legal conditions required for declaring the default 
of the borrower and prompt liquidation of the collateral in the event 
of default; (iv) the banking organization has established procedures 
and practices for conservatively estimating, on a regular ongoing 
basis, the market value of the collateral, taking into account factors 
that could affect that value (for example, the liquidity of the market 
for the collateral and obsolescence or deterioration of the 
collateral); and (v) the banking organization has in place systems for 
promptly requesting and receiving additional collateral for 
transactions whose terms require maintenance of collateral values at 
specified thresholds.
(c) Simple Approach
    The agencies propose to allow a banking organization to apply the 
simple approach, which is similar to the approach in the agencies' 
general risk-based capital rules, in a manner generally consistent with 
the New Accord. Generally, under the simple approach, the 
collateralized portion of the exposure would receive the risk weight 
applicable to the collateral. Subject to certain exceptions, the risk 
weight assigned to the collateralized portion of the exposure may not 
be less than 20 percent. In most cases, the collateral would have to be 
financial collateral. For repurchase agreements, reverse repurchase 
agreements, and securities lending and borrowing transactions, the 
collateral is the instruments, gold, and cash the banking organization 
has borrowed, purchased subject to resale, or taken as collateral from 
the counterparty under the transaction. A banking organization, 
however, could recognize any collateral for a repo-style transaction 
that is included in the banking organization's VaR-based measure under 
the MRR. In all cases, the collateral agreement would have to be for at 
least the life of the exposure, a banking organization would have to 
revalue the collateral at least every six months, and the exposure and 
the collateral (other than gold) would have to be denominated in the 
same currency.
    In certain cases, collateral may be used to reduce the risk weight 
to less than 20 percent for an exposure. The exceptions to the risk-
weight floor of 20 percent are: (i) OTC derivative transactions that 
are marked-to-market on a daily basis and subject to a daily margin 
maintenance agreement, which could receive (1) a zero percent risk 
weight to the extent that they are collateralized by cash on deposit, 
and (2) a 10 percent risk weight to the extent that they are 
collateralized by a sovereign security or PSE security that qualifies 
for a zero percent risk weight under section 33 of this NPR; (ii) the 
portion of exposures collateralized by cash on deposit could receive a 
zero percent risk weight; and (iii) the portion of exposures 
collateralized by a sovereign security or a PSE security denominated in 
the same currency could receive a zero percent risk weight provided 
that the banking organization discounts the market value of the 
collateral by 20 percent.
    In the case where a banking organization chooses to recognize 
collateral in the form of conforming residential mortgages, the banking 
organization must risk weight the portion of the exposure that is 
secured by the conforming residential mortgage at 50 percent.
(d) Collateral Haircut and Simple VaR Approaches
    The agencies propose to permit a banking organization to use the 
collateral haircut approach to recognize the risk mitigating effect of 
financial collateral that secures a repo-style transaction, eligible 
margin loan, collateralized OTC derivative contract, or single-product 
netting set of such transactions through an adjustment to the exposure 
amount. The collateral haircut approach contains two methods for 
calculating the haircuts: Supervisory haircuts or own-estimates 
haircuts. Additionally, the banking organization could use the simple 
VaR approach for single-product netting sets of repo-style transactions 
or eligible margin loans. In this proposed rule, a netting set means a 
group of transactions with a single counterparty that are subject to a 
qualifying master netting agreement.
    Although a banking organization could use any combination of 
supervisory haircuts, own-estimate haircuts, and simple VaR (only for 
single-product netting sets of repo-style transactions or eligible 
margin loans) to recognize collateral, it would have to use the same 
approach for similar exposures. A banking organization could, however, 
apply a different method to subsets of repo-style transactions, 
eligible margin loans, or OTC derivatives by product type or geographic 
location if its application of different methods were designed to 
separate transactions that do no have similar risk profiles and was not 
designed for arbitrage purposes. For example, a banking organization 
could choose to use one method for agency securities lending 
transactions, that is, repo-style transactions in which the banking 
organization, acting as agent for a customer, lends the customer's 
securities and indemnifies the customer against loss, and another 
method for all other repo-style transactions. The agencies propose to 
require use of the supervisory haircut approach to recognize the risk-
mitigating effect of conforming residential mortgages in exposure 
amount. Use of the standard supervisory haircut approach for repo-style 
transactions, eligible margin loans, and OTC derivatives collateralized 
by conforming mortgages, however, would not preclude a banking 
organization's use of own estimates haircuts or the simple VaR approach 
for exposures collateralized by other types of financial collateral.
    Consistent with the New Accord and the advanced approaches final 
rule, a banking organization could also use the collateral haircut 
approaches to recognize the benefits of any collateral (not only 
financial collateral) mitigating the counterparty credit risk of repo-
style transactions included in a banking organization's VaR-based 
measure under the MRR. In this instance, a banking organization would 
not need to apply the supervisory haircut approach to conforming 
mortgage collateral, but could use one of the other approaches to 
recognize that collateral.
(e) Exposure Amount for Repo-Style Transactions, Eligible Margin Loans, 
and Collateralized OTC Derivatives
    Under the collateral haircut approach, a banking organization would 
set the exposure amount equal to the greater of zero and the sum of 
three quantities:

[[Page 44005]]

    (i) The value of the exposure less the value of the collateral (for 
eligible margin loans and repo-style transactions, the value of the 
exposure is the sum of the current market values of all instruments, 
gold, and cash the banking organization has lent, sold subject to 
repurchase, or posted as collateral to the counterparty under the 
transaction (or netting set); for collateralized OTC derivative 
contracts, the value of the exposure is the exposure amount that is 
calculated under section 35(c) or (d) of this proposed rule; the value 
of the collateral is the sum of the current market values of all 
instruments, gold and cash the banking organization has borrowed, 
purchased subject to resale, or taken as collateral from the 
counterparty under the transaction (or netting set));
    (ii) The absolute value of the net position in a given instrument 
or in gold (where the net position in a given instrument or in gold 
equals the sum of the current market values of the instrument or gold 
the banking organization has lent, sold subject to repurchase, or 
posted as collateral to the counterparty minus the sum of the current 
market values of that same instrument or gold the banking organization 
has borrowed, purchased subject to resale, or taken as collateral from 
the counterparty) multiplied by the market price volatility haircut 
appropriate to the instrument or gold; and
    (iii) The sum of the absolute values of the net position of any 
cash or instruments in each currency that is different from the 
settlement currency multiplied by the haircut appropriate to each 
currency mismatch.
    To determine the appropriate haircuts, a banking organization may 
choose to use standard supervisory haircuts or, with prior written 
approval from its primary Federal supervisor, its own estimates of 
haircuts. After determining the exposure amount, the banking 
organization would risk weight the exposure amount according to the 
obligor or guarantor if applicable.
    For purposes of the collateral haircut approach, a given instrument 
would include, for example, all securities with a single Committee on 
Uniform Securities Identification Procedures (CUSIP) number and would 
not include securities with different CUSIP numbers, even if issued by 
the same issuer with the same maturity date.
    For purposes of this calculation, the net position in a given 
currency equals the sum of the current market values of any instruments 
or cash in the currency the banking organization has lent, sold subject 
to repurchase, or posted as collateral to the counterparty minus the 
sum of the current market values of any instruments or cash in the 
currency the banking organization has borrowed, purchased subject to 
resale, or taken as collateral from the counterparty.
(f) Standard Supervisory Haircuts
    Under this NPR, if a banking organization chooses to use standard 
supervisory haircuts, it would use an 8.0 percent haircut for each 
currency mismatch and use the market price volatility haircut 
appropriate to each security in Table 11 below. These haircuts are 
based on the ten-business-day holding period for eligible margin loans 
and collateralized OTC derivative contracts and may be multiplied by 
the square root of \1/2\ to convert the standard supervisory haircuts 
to the five-business-day minimum holding period for repo-style 
transactions (unless the collateral is conforming residential 
mortgages, in which case the banking organization must use a minimum 
ten-business-day holding period). A banking organization would adjust 
the standard supervisory haircuts upward on the basis of a holding 
period longer than ten business days for eligible margin loans and 
collateralized OTC derivative contracts or five business days for repo-
style transactions where and as appropriate to take into account the 
illiquidity of an instrument.

                  Table 11.--Standard Supervisory Haircuts Based on Market Price Volatility \1\
----------------------------------------------------------------------------------------------------------------
 Applicable external rating grade category     Residual maturity for debt     Sovereign entity
            for debt securities                        securities               issuers \2\       Other issuers
----------------------------------------------------------------------------------------------------------------
Two highest investment grade rating          <= 1 year.....................               .005               .01
 categories for long-term ratings/highest    >1 year, <= 5 years...........               .02                .04
 investment grade rating category for short- >5 years......................               .04                .08
 term ratings.
----------------------------------------------------------------------------------------------------------------
Two lowest investment grade rating           <= 1 year.....................               .01                .02
 categories for both short- and long-term    >1 year, <= 5 years...........               .03                .06
 ratings.                                    > 5 years.....................               .06                .12
----------------------------------------------------------------------------------------------------------------
One rating category below investment grade.  All...........................               .15                .25
----------------------------------------------------------------------------------------------------------------
Main index equities \37\ (including convertible bonds) and gold............               .15                .15
----------------------------------------------------------------------------------------------------------------
Other publicly traded equities (including convertible bonds), conforming                  .25                .25
 residential mortgages, and non-financial collateral.
----------------------------------------------------------------------------------------------------------------
Mutual funds.................................(1) Highest haircut applicable to any security in
                                              which the fund can invest.
----------------------------------------------------------------------------------------------------------------
Cash on deposit with the bank (including a certificate of deposit issued by              0                     0
 the banking organization).
----------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircuts in Table 11 are based on a ten-business-day holding period.
\2\ This column includes the haircuts for MDBs and foreign PSEs that would receive a zero percent risk weight.

    As an example, if a banking organization that uses standard 
supervisory haircuts has extended an eligible margin loan of $100 that 
is collateralized by five-year U.S. Treasury notes with a market value 
of $100, the value of the exposure less the value of the collateral 
would be zero, and the net position in the security ($100) times the 
supervisory haircut (.02) would be $2. There is no currency mismatch.

[[Page 44006]]

Therefore, the exposure amount would be $0 + $2 = $2.
---------------------------------------------------------------------------

    \37\ The proposed rule defines a ``main index'' as the S&P 500 
Index, the FTSE All-World Index, and any other index for which the 
bank demonstrates to the satisfaction of its primary Federal 
supervisor that the equities represented in the index have 
comparable liquidity, depth of market, and size of bid-ask spreads 
as equities in the S&P 500 Index and the FTSE All-World Index.
---------------------------------------------------------------------------

(g) Own Estimates of Haircuts
    With the prior written approval of the banking organization's 
primary Federal supervisor, a banking organization could calculate 
market price volatility and currency mismatch haircuts using its own 
internal estimates of market price volatility and foreign exchange 
volatility. The banking organization's primary Federal supervisor would 
base approval to use internally estimated haircuts on the satisfaction 
of certain minimum qualitative and quantitative standards. These 
standards include: (i) The banking organization would use a 99th 
percentile one-tailed confidence interval and a minimum five-business-
day holding period for repo-style transactions and a minimum ten-
business-day holding period for all other transactions; (ii) the 
banking organization would adjust holding periods upward where and as 
appropriate to take into account the illiquidity of an instrument; 
(iii) the banking organization would select a historical observation 
period for calculating haircuts of at least one year; and (iv) the 
banking organization would update its data sets and compute haircuts no 
less frequently than quarterly and would update its data sets and 
compute haircuts whenever market prices change materially. A banking 
organization would estimate individually the volatilities of the 
exposure, the collateral, and foreign exchange rates and may not take 
into account the correlations between them.
    A banking organization that uses internally estimated haircuts 
would have to adhere to the following rules. The banking organization 
could calculate internally estimated haircuts for categories of debt 
securities that have an applicable external or applicable inferred 
rating of at least investment grade. The haircut for a category of 
securities would have to be representative of the internal volatility 
estimates for securities in that category that the banking organization 
has actually lent, sold subject to repurchase, posted as collateral, 
borrowed, purchased subject to resale, or taken as collateral. In 
determining relevant categories, the banking organization would at a 
minimum have to take into account (i) the type of issuer of the 
security; (ii) the applicable external rating of the security; (iii) 
the maturity of the security; and (iv) the interest rate sensitivity of 
the security. A banking organization would calculate a separate 
internally estimated haircut for each individual debt security that has 
an applicable external rating below investment grade and for each 
individual equity security. In addition, a banking organization would 
estimate a separate currency mismatch haircut for its net position in 
each mismatched currency based on estimated volatilities for foreign 
exchange rates between the mismatched currency and the settlement 
currency where an exposure or collateral (whether in the form of cash 
or securities) is denominated in a currency that differs from the 
settlement currency.
    When a banking organization calculates an internally estimated 
haircut on a TN-day holding period, which is different from 
the minimum holding period for the transaction type, the banking 
organization would have to calculate the applicable haircut 
(HM) using the following square root of time formula:
[GRAPHIC] [TIFF OMITTED] TP29JY08.001

Where:

(i) TM = five for repo-style transactions and ten for eligible 
margin loans and OTC derivatives;
(ii) TN = holding period used by the banking organization to derive 
HN; and
(iii) HN = haircut based on the holding period TN.
(h) Simple VaR Method
    With the prior written approval of its primary Federal supervisor, 
a banking organization could estimate the exposure amount for repo-
style transactions and eligible margin loans subject to a single-
product qualifying master netting agreement using a VaR model. Under 
the simple VaR method, a banking organization's exposure amount for 
transactions subject to such a netting agreement would be equal to the 
value of the exposures minus the value of the collateral plus a VaR-
based estimate of the PFE. The value of the exposures would be the sum 
of the current market values of all instruments, gold, and cash the 
banking organization has lent, sold subject to repurchase, or posted as 
collateral to a counterparty under the netting set. The value of the 
collateral would be the sum of the current market values of all 
instruments, gold, and cash the banking organization has borrowed, 
purchased subject to resale, or taken as collateral from a counterparty 
under the netting set. The VaR-based estimate of the PFE would be an 
estimate of the banking organization's maximum exposure on the netting 
set over a fixed time horizon with a high level of confidence.
    To qualify for the simple VaR approach, a banking organization's 
VaR model would have to estimate the banking organization's 99th 
percentile, one-tailed confidence interval for an increase in the value 
of the exposures minus the value of the collateral ([Sigma]E - 
[Sigma]C) over a five-business-day holding period for repo-style 
transactions or over a ten-business-day holding period for eligible 
margin loans using a minimum one-year historical observation period of 
price data representing the instruments that the banking organization 
has lent, sold subject to repurchase, posted as collateral, borrowed, 
purchased subject to resale, or taken as collateral. The main ongoing 
qualification requirement for using a VaR model is that the banking 
organization would have to validate its VaR model by establishing and 
maintaining a rigorous and regular backtesting regime. In this NPR, 
backtesting means the comparison of a banking organization's internal 
estimates with actual outcomes during a sample period not used in model 
development.
(i) Zero H Approach
    The New Accord includes an additional approach, the Zero H 
approach, to recognize the risk mitigating benefits of certain 
collateral types in repo-style transactions conducted with a limited 
group of counterparties. The Zero H approach permits a banking 
organization that uses the collateral haircut approach to apply a 
haircut of zero percent to financial collateral in repo-style 
transactions that meet the criteria described below and are conducted 
with core market participants. Under the New Accord, the definition of 
core market participants includes sovereign entities, central banks, 
PSEs, banks and securities firms, other financial companies eligible 
for a 20 percent risk weight, regulated mutual funds, regulated pension 
funds, and recognized clearing organizations. A repo-style transaction 
conducted with a core market participant qualifies for the Zero H 
approach if: (i) Both the exposure and the collateral are cash or a 
sovereign or PSE security that qualifies for a zero percent risk weight 
and are denominated in the same currency; (ii) following a 
counterparty's failure to remargin, the time required between the last 
mark-to-market before the failure to remargin and the liquidation \38\ 
of the collateral is no more than four business days; (iii) the

[[Page 44007]]

transaction is settled across a settlement system proven for that type 
of transaction; (iv) the documentation covering the agreement is 
standard market documentation for repo-style transactions in the 
securities concerned; (v) the transaction is governed by documentation 
specifying that if the counterparty fails to satisfy an obligation to 
deliver cash or securities or to deliver margin or otherwise defaults, 
then the transaction is immediately terminable; and (vi) upon any 
default event, regardless of whether the counterparty is insolvent or 
bankrupt, the banking organization has the unfettered, legally 
enforceable right to immediately seize and liquidate the collateral for 
its benefit.
---------------------------------------------------------------------------

    \38\ The banking organization does not have to liquidate the 
collateral, but it would have to be able to do so within the time 
frame.
---------------------------------------------------------------------------

    The New Accord also includes a variation of the Zero H approach for 
banking organizations that use the simple approach to recognize 
financial collateral. For repo-style transactions that meet the Zero H 
criteria and are conducted with core market participants, the banking 
organization would assign a risk weight of zero percent. A banking 
organization would assign a risk weight of 10 percent to repo-style 
transaction exposures that meet the criteria and are conducted with 
non-core market participants.
    The agencies have decided not to include the Zero H approach and 
the variation for the simple approach in this proposal because the 
agencies believe that doing so would add unnecessary complexity. In the 
New Accord, a banking organization must choose to use either the simple 
approach or the comprehensive approach \39\ for all its collateralized 
transactions. The agencies have proposed a more flexible treatment that 
would permit a banking organization to select its approach to 
collateral based on transaction type. This flexibility allows for more 
risk sensitivity in the capital calculation for repo-style 
transactions. For example, a banking organization could choose the 
collateral haircut or simple VaR approach for repo-style transactions 
and the simple approach for other transaction types. Additionally, the 
agencies question whether the capital requirements prescribed by the 
Zero H approach adequately address the credit risk of repo-style 
transactions. In both this proposal and the New Accord, banking 
organizations would be subject to the operational risk capital 
requirement for these transactions.
---------------------------------------------------------------------------

    \39\ The comprehensive approach in the New Accord includes the 
collateral haircut approaches, the simple VaR approach, and the 
internal models approach.
---------------------------------------------------------------------------

    Question 16: The agencies seek comment on whether these Zero H 
approaches should be included in the standardized framework. 
Additionally, the agencies seek comment on whether the Zero H 
approaches would adequately address the credit risk of repo-style 
transactions that would qualify for those approaches.
(j) Internal Models Methodology
    The advanced approaches final rule includes an internal models 
methodology for the calculation of the exposure amount for the 
counterparty credit exposure for OTC derivatives, eligible margin 
loans, and repo-style transactions. This methodology requires a risk 
model that captures counterparty credit risk and estimates the exposure 
amount at the level of a netting set. A banking organization may use 
the internal models methodology for OTC derivatives, eligible margin 
loans, and repo-style transactions.
    The internal models methodology is fully discussed in the advanced 
approaches final rule.\40\ The specific references in the advanced 
approaches final rule's preamble and common rule text are: (i) 
Preamble; \41\ (ii) section 22(c) and certain other paragraphs in 
section 22 of the common rule text,\42\ such as paragraphs (a)(2) and 
(3), (i), (j), and (k), which discuss the qualification requirements 
for the advanced systems in general and therefore would apply to the 
expected positive exposure modeling approach (EPE) as part of the 
internal models methodology; (iii) section 32(c) and (d) of the common 
rule text; \43\ (iv) applicable definitions in Section 2 of the common 
rule text; \44\ and (v) applicable disclosure requirements in Tables 
11.6 and 11.7 of the common rule text.\45\
---------------------------------------------------------------------------

    \40\ See 72 FR 69288 (December 7, 2007).
    \41\ Id. at 69346-49 and 69302-21.
    \42\ Id. at 69407-08.
    \43\ Id. at 69413-16.
    \44\ Id. at 69397-405.
    \45\ Id. at 69443.
---------------------------------------------------------------------------

    Although the internal models methodology is not part of this 
proposed rule, the standardized approach in the New Accord does 
incorporate an internal models methodology for credit risk mitigants. 
Therefore, the agencies are considering whether to implement the 
internal models methodology in a final rule consistent with the 
requirements in the advanced approaches final rule.
    Question 17: The agencies request comment on the appropriateness of 
including the internal models methodology for calculating exposure 
amounts for OTC derivatives, eligible margin loans, and repo-style 
transactions in any final rule implementing the standardized framework. 
The agencies also requested comment on the extent to which banking 
organizations contemplating implementing the standardized framework 
believe they can meet the associated advanced modeling and systems 
requirements. (For purposes of reviewing the internal models 
methodology in the advanced approaches final rule, commenters should 
substitute the term ``exposure amount'' for the term ``exposure at 
default'' and ``EAD'' each time these terms appear in the advanced 
approaches final rule.)

L. Unsettled Transactions

    Consistent with the New Accord and the advanced approaches final 
rule, the agencies propose to institute a more risk-sensitive risk-
based capital requirement for unsettled and failed securities, foreign 
exchange, and commodities transactions.
    The proposed capital requirement, however, would not apply to 
certain transaction types, including:
    (i) Transactions accepted by a qualifying central counterparty \46\ 
that are subject to daily marking-to-market and daily receipt and 
payment of variation margin (which do not have a risk-based capital 
requirement);
---------------------------------------------------------------------------

    \46\ Qualifying central counterparty would be defined as a 
counterparty that: (i) Facilitates trades between counterparties in 
one or more financial markets by either guaranteeing trades or 
novating contracts; (ii) requires all participants in its 
arrangements to be fully collateralized on a daily basis; and (iii) 
the banking organization demonstrates to the satisfaction of the 
agency is in sound financial condition and is subject to effective 
oversight by a national supervisory authority. The agencies consider 
a qualifying central counterparty to be the functional equivalent of 
an exchange and have long exempted exchange-traded contracts from 
risk-based capital requirements.
---------------------------------------------------------------------------

    (ii) Repo-style transactions;
    (iii) One-way cash payments on OTC derivative contracts; and
    (iv) Transactions with a contractual settlement period that is 
longer than the normal settlement period as defined below. (Such 
transactions would be treated as OTC derivative contracts and assessed 
a risk-based capital requirement under section 31 of the proposed 
rule.) This proposed rule also provides that, in the case of a system-
wide failure of a settlement or clearing system, the banking 
organization's primary Federal supervisor could waive risk-based 
capital requirements for unsettled and failed transactions until the 
situation is rectified.
    This NPR contains separate treatments for delivery-versus-payment

[[Page 44008]]

(DvP) and payment-versus-payment (PvP) transactions with a normal 
settlement period, and non-DvP/non-PvP transactions with a normal 
settlement period. This NPR provides the following definitions of a DvP 
transaction, a PvP transaction, and a normal settlement period:
     A DvP transaction is a securities or commodities 
transaction in which the buyer is obligated to make payment only if the 
seller has made delivery of the securities or commodities and the 
seller is obligated to deliver the securities or commodities only if 
the buyer has made payment.
     A PvP transaction is a foreign exchange transaction in 
which each counterparty is obligated to make a final transfer of one or 
more currencies only if the other counterparty has made a final 
transfer of one or more currencies.
     A transaction has a normal settlement period if the 
contractual settlement period for the transaction is equal to or less 
than the market standard for the instrument underlying the transaction 
and equal to or less than five business days.
    A banking organization would have to hold risk-based capital 
against a DvP or PvP transaction with a normal settlement period if the 
banking organization's counterparty has not made delivery or payment 
within five business days after the settlement date. The banking 
organization would determine its risk-weighted asset amount for such a 
transaction by multiplying the positive current exposure of the 
transaction for the banking organization by the appropriate risk weight 
in Table 12. The positive current exposure of a transaction of a 
banking organization would be the difference between the transaction 
value at the agreed settlement price and the current market price of 
the transaction, if the difference results in a credit exposure of the 
banking organization to the counterparty.

      Table 12.--Risk Weights for Unsettled DvP and PvP Transactions
------------------------------------------------------------------------
                                                          Risk weight to
                                                          be applied to
  Number of business days after contractual settlement       positive
                          date                               current
                                                          exposure  (in
                                                             percent)
------------------------------------------------------------------------
From 5 to 15...........................................            100.0
From 16 to 30..........................................            625.0
From 31 to 45..........................................            937.5
46 or more.............................................          1,250.0
------------------------------------------------------------------------

    A banking organization would hold risk-based capital against any 
non-DvP/non-PvP transaction with a normal settlement period if the 
banking organization delivered cash, securities, commodities, or 
currencies to its counterparty but has not received its corresponding 
deliverables by the end of the same business day. The banking 
organization would continue to hold risk-based capital against the 
transaction until the banking organization received its corresponding 
deliverables. From the business day after the banking organization made 
its delivery until five business days after the counterparty delivery 
is due, the banking organization would calculate its risk-based capital 
requirement for the transaction by risk weighting the current market 
value of the deliverables owed to the banking organization using the 
risk weight appropriate for an exposure to the counterparty.
    If, in a non-DvP/non-PvP transaction with a normal settlement 
period, the banking organization has not received its deliverables by 
the fifth business day after the counterparty delivery due date, the 
banking organization would deduct the current market value of the 
deliverables owed to the banking organization 50 percent from tier 1 
capital and 50 percent from tier 2 capital.

M. Risk-Weighted Assets for Securitization Exposures

    Under the agencies' general risk-based capital rules, a banking 
organization may use external ratings issued by NRSROs to assign risk 
weights to certain recourse obligations, residual interests, direct 
credit substitutes, and asset- and mortgage-backed securities. 
Exposures to securitization transactions may also be subject to capital 
requirements that can result in effective risk weights of 1,250 
percent, or a dollar-for-dollar capital requirement. A banking 
organization must deduct certain CEIOs from tier 1 capital.\47\
---------------------------------------------------------------------------

    \47\ 12 CFR part 3, Appendix A, section 4 (OCC); 12 CFR parts 
208 and 225, Appendix A, section III.B.3 (Board); 12 CFR part 325, 
Appendix A section II.B.1 (FDIC); and 12 CFR 567.6(b) (OTS).
---------------------------------------------------------------------------

(1) Securitization Overview and Definitions
    The securitization framework in this NPR is designed to address the 
credit risk of exposures that involve the tranching of the credit risk 
of one or more underlying financial exposures. The agencies believe 
that requiring all or substantially all of the underlying exposures for 
a securitization to be financial exposures creates an important 
boundary between the general credit risk framework and the 
securitization framework. Examples of financial exposures are loans, 
commitments, receivables, asset-backed securities, mortgage-backed 
securities, other debt securities, equity securities, or credit 
derivatives. Based on their cash flow characteristics, for purposes of 
this proposal, the agencies would also consider asset classes such as 
lease residuals and entertainment royalties to be financial assets. The 
securitization framework is designed to address the tranching of the 
credit risk of financial exposures and is not designed, for example, to 
apply to tranched credit exposures to commercial or industrial 
companies or nonfinancial assets. Accordingly, under this NPR, a 
specialized loan to finance the construction or acquisition of large-
scale projects (for example, airports or power plants), objects (for 
example, ships, aircraft, or satellites), or commodities (for example, 
reserves, inventories, precious metals, oil, or natural gas) generally 
would not be a securitization exposure because the assets backing the 
loan typically are nonfinancial assets (the facility, object, or 
commodity being financed).
    Consistent with the advanced approaches final rule, this NPR would 
define a securitization exposure as an on-balance sheet or off-balance 
sheet credit exposure that arises from a traditional or synthetic 
securitization (including credit-enhancing representations and 
warranties). A traditional securitization means a transaction in which: 
(i) All or a portion of the credit risk of one or more underlying 
exposures is transferred to one or more third parties other than 
through the use of credit derivatives or guarantees; (ii) the credit 
risk associated with the underlying exposures has been separated into 
at least two tranches reflecting different levels of seniority; (iii) 
the performance of the securitization exposures depends upon the 
performance of the underlying exposures; (iv) all or substantially all 
of the underlying exposures are financial exposures (such as loans, 
commitments, credit derivatives, guarantees, receivables, asset-backed 
securities, mortgage-backed securities, other debt securities, or 
equity securities); (v) the underlying exposures are not owned by an 
operating company; (vi) the underlying exposures are not owned by a 
small business investment company described in section 302 of the Small 
Business Investment Act of 1958 (15 U.S.C. 682); and (vii) (a) for 
banks and bank holding companies, the underlying exposures are not 
owned by a firm an investment in which qualifies as a community 
development investment under 12 U.S.C. 24 (Eleventh); or (b) for

[[Page 44009]]

savings associations, the underlying exposures are not owned by a firm 
an investment in which is designed primarily to promote community 
welfare, including the welfare of low- and moderate-income communities 
or families, such as by providing services or employment.
    In this proposed rule, operating companies would not fall under the 
definition of a traditional securitization (even if substantially all 
of their assets are financial exposures). For purposes of this proposed 
rule's definition of a traditional securitization, operating companies 
generally are companies that produce goods or provide services beyond 
the business of investing, reinvesting, holding, or trading in 
financial assets. Examples of operating companies are depository 
institutions, bank holding companies, securities brokers and dealers, 
insurance companies, and non-bank mortgage lenders. Accordingly, an 
equity investment in an operating company, such as a bank, generally 
would be an equity exposure under the proposed rule. Investment firms, 
which generally do not produce goods or provide services beyond the 
business of investing, reinvesting, holding, or trading in financial 
assets, would not be operating companies for purposes of this proposed 
rule and would not qualify for this general exclusion from the 
definition of traditional securitization. Examples of investment firms 
would include companies that are exempted from the definition of an 
investment company under section 3(a) of the Investment Company Act of 
1940 (15 U.S.C. 80a-3(a)) by either section 3(c)(1) (15 U.S.C. 80a-
3(c)(1)) or section 3(c)(7) (15 U.S.C. 80a-3(c)(7)) of the Act.
    Under this proposed rule, a primary Federal supervisor of a banking 
organization would have the discretion to exclude from the definition 
of traditional securitization transactions in which the underlying 
exposures are owned by investment firms that exercise substantially 
unfettered control over the size and composition of their assets, 
liabilities, and off-balance sheet transactions. The agencies would 
consider a number of factors in the exercise of this discretion, 
including the assessment of the investment firm's leverage, risk 
profile, and economic substance. This supervisory exclusion would give 
the primary Federal supervisor the discretion to distinguish structured 
finance transactions, to which the securitization framework was 
designed to apply, from those of flexible investment firms such as many 
hedge funds and private equity funds. Only investment firms that can 
easily change the size and composition of their capital structure, as 
well as the size and composition of their assets and off-balance sheet 
exposures, would be eligible for the exclusion from the definition of 
traditional securitization under this provision. The agencies do not 
consider managed collateralized debt obligation vehicles, structured 
investment vehicles, and similar structures, which allow considerable 
management discretion regarding asset composition but are subject to 
substantial restrictions regarding capital structure, to have 
substantially unfettered control. Thus, such transactions would meet 
the definition of traditional securitization.
    The agencies are concerned that the line between securitization 
exposures and non-securitization exposures may be difficult to draw in 
some circumstances. In addition to the supervisory exclusion from the 
definition of traditional securitization described above, a primary 
Federal supervisor may scope certain transactions into the 
securitization framework if justified by the economics of the 
transaction. Similar to the analysis for excluding an investment firm 
from treatment as a traditional securitization, the agencies would 
consider the economic substance, leverage, and risk profile of 
transactions to ensure that the appropriate risk-based capital 
classification is made. The agencies would consider a number of factors 
when assessing the economic substance of a transaction including, for 
example, the amount of equity in the structure, overall leverage 
(whether on-or off-balance sheet), whether redemption rights attach to 
the equity investor, and the ability of the junior tranches to absorb 
losses without interrupting contractual payments to more senior 
tranches.
    A synthetic securitization means a transaction in which: (i) All or 
a portion of the credit risk of one or more underlying exposures is 
transferred to one or more third parties through the use of one or more 
credit derivatives or guarantees (other than a guarantee that transfers 
only the credit risk of an individual retail exposure); (ii) the credit 
risk associated with the underlying exposures has been separated into 
at least two tranches reflecting different levels of seniority; (iii) 
performance of the securitization exposures depends upon the 
performance of the underlying exposures; and (iv) all or substantially 
all of the underlying exposures are financial exposures (such as loans, 
commitments, credit derivatives, guarantees, receivables, asset-backed 
securities, mortgage-backed securities, other debt securities, or 
equity securities).
    Both the designation of exposures as securitization exposures and 
the calculation of risk-based capital requirements for securitization 
exposures would be guided by the economic substance of a transaction 
rather than its legal form. Provided there is a tranching of credit 
risk, securitization exposures could include, among other things, 
asset-backed and mortgage-backed securities, loans, lines of credit, 
liquidity facilities, financial standby letters of credit, credit 
derivatives and guarantees, loan servicing assets, servicer cash 
advance facilities, reserve accounts, credit-enhancing representations 
and warranties, and CEIOs. Securitization exposures also could include 
assets sold with retained tranches. Mortgage-backed pass-through 
securities, for example, those guaranteed by Fannie Mae or Freddie Mac, 
do not meet the proposed definition of securitization exposure because 
they do not involve a tranching of credit risk. Rather, only those 
mortgage-backed securities that involve tranching of credit risk would 
be securitization exposures. Banking organizations are encouraged to 
consult with their primary Federal supervisor about transactions that 
require additional guidance.
(2) Operational Requirements
(a) Operational Requirements for Traditional Securitizations
    In a traditional securitization, an originating banking 
organization typically transfers a portion of the credit risk of 
exposures to third parties by selling them to a securitization special 
purpose entity (SPE). Under this NPR, a banking organization would be 
an originating banking organization if it: (i) Directly or indirectly 
originated or securitized the underlying exposures included in the 
securitization; or (ii) serves as an asset-backed commercial paper 
(ABCP) program sponsor to the securitization. Under the proposed rule, 
a banking organization that engages in a traditional securitization 
would exclude the underlying exposures from the calculation of risk-
weighted assets only if each of the following conditions are met: (i) 
the transfer is a sale under GAAP; (ii) the originating banking 
organization transfers to one or more third parties credit risk 
associated with the underlying exposures; and (iii) any clean-up calls 
relating to the securitization are eligible clean-up calls (as 
discussed below). An originating banking organization that meets these

[[Page 44010]]

conditions would hold regulatory capital against any securitization 
exposures it retains in connection with the securitization. An 
originating banking organization that fails to meet these conditions 
would instead hold regulatory capital against the transferred exposures 
as if they had not been securitized and would deduct from tier 1 
capital any after-tax gain-on-sale resulting from the transaction.
    Consistent with the general risk-based capital rules, the above 
operational requirements refer specifically to GAAP for the purpose of 
determining whether a securitization transaction should be treated as 
an asset sale or a financing. In contrast, the New Accord stipulates 
guiding principles for determining whether sale treatment is warranted. 
The agencies believe that the conditions currently outlined under GAAP 
to qualify for sale treatment are broadly consistent with the guiding 
principles enumerated in the New Accord. However, if GAAP in this area 
were to materially change, the agencies would reassess, and possibly 
revise, the operational standards.
(b) Clean-Up Calls
    To satisfy the operational requirements for securitizations and 
enable an originating banking organization to exclude the underlying 
exposures from the calculation of its risk-based capital requirements, 
any clean-up call associated with a securitization must be an eligible 
clean-up call. The proposed rule defines a clean-up call as a 
contractual provision that permits an originating banking organization 
or servicer to call securitization exposures (for example, asset-backed 
securities) before the stated maturity or call date. In the case of a 
traditional securitization, a clean-up call is generally accomplished 
by repurchasing the remaining securitization exposures once the amount 
of underlying exposures or outstanding securitization exposures falls 
below a specified level. In the case of a synthetic securitization, the 
clean-up call may take the form of a clause that extinguishes the 
credit protection once the amount of underlying exposures has fallen 
below a specified level.
    Under the proposed rule, an eligible clean-up call is a clean-up 
call that:
    (i) Is exercisable solely at the discretion of the originating 
banking organization or servicer;
    (ii) Is not structured to avoid allocating losses to securitization 
exposures held by investors or otherwise structured to provide credit 
enhancement to the securitization (for example, to purchase non-
performing underlying exposures); and
    (iii)(a) For a traditional securitization, is only exercisable when 
10 percent or less of the principal amount of the underlying exposures 
or securitization exposures (determined as of the inception of the 
securitization) is outstanding; or
    (b) For a synthetic securitization, is only exercisable when 10 
percent or less of the principal amount of the reference portfolio of 
underlying exposures (determined as of the inception of the 
securitization) is outstanding.
    Where a securitization SPE is structured as a master trust, a 
clean-up call with respect to a particular series or tranche issued by 
the master trust would meet criteria (iii)(a) and (iii)(b) as long as 
the outstanding principal amount in that series was 10 percent or less 
of its original amount at the inception of the series.
(c) Operational Requirements for Synthetic Securitizations
    In general, the proposed rule's treatment of synthetic 
securitizations is similar to that of traditional securitizations. The 
operational requirements for synthetic securitizations, however, are 
more rigorous to ensure that the originating banking organization has 
truly transferred credit risk of the underlying exposures to one or 
more third-party protection providers.
    For synthetic securitizations, an originating banking organization 
would recognize the use of credit risk mitigation to hedge, or transfer 
credit risk associated with, underlying exposures for risk-based 
capital purposes only if each of the following conditions were 
satisfied:
    (i) The credit risk mitigant is financial collateral, an eligible 
credit derivative, or an eligible guarantee.
    (ii) The banking organization transfers credit risk associated with 
the underlying exposures to one or more third parties, and the terms 
and conditions in the credit risk mitigants do not include provisions 
that:
    (a) Allow for the termination of the credit protection due to 
deterioration in the credit quality of the underlying exposures;
    (b) Require the banking organization to alter or replace the 
underlying exposures to improve the credit quality of the underlying 
exposures;
    (c) Increase the banking organization's cost of credit protection 
in response to deterioration in the credit quality of the underlying 
exposures;
    (d) Increase the yield payable to parties other than the banking 
organization in response to a deterioration in the credit quality of 
the underlying exposures; or
    (e) Provide for increases in a retained first loss position or 
credit enhancement provided by the banking organization after the 
inception of the securitization.
    (iii) The banking organization obtains a well-reasoned opinion from 
legal counsel that confirms the enforceability of the credit risk 
mitigant in all relevant jurisdictions.
    (iv) Any clean-up calls relating to the securitization are eligible 
clean-up calls (as discussed above).
    Failure to meet the above operational requirements for a synthetic 
securitization would prevent the originating banking organization from 
using this securitization framework and would require the originating 
banking organization to hold risk-based capital against the underlying 
exposures as if they had not been synthetically securitized. A banking 
organization that provides credit protection to a synthetic 
securitization would use the securitization framework to compute risk-
based capital requirements for its exposures to the synthetic 
securitization even if the originating banking organization failed to 
meet one or more of the operational requirements for a synthetic 
securitization.
(3) Hierarchy of Approaches
    Under the proposed rule a banking organization generally would 
determine the amount of a traditional or synthetic securitization 
exposure and then determine the risk-based capital requirement for the 
securitization exposure according to two general approaches: A ratings-
based approach (RBA) and an approach for exposures that do not qualify 
for the RBA. Although synthetic securitizations typically employ credit 
derivatives, a banking organization must first apply the securitization 
framework when calculating risk-based capital requirements for a 
synthetic securitization exposure. Under this proposed rule, a banking 
organization could ultimately be redirected to the securitization CRM 
rules to adjust the securitization framework capital requirement for an 
exposure to reflect the CRM technique used in the transaction.
(a) Exposure Amount of a Securitization Exposure
    Under this proposed rule, the amount of an on-balance sheet 
securitization exposure that is not a repo-style transaction, eligible 
margin loan, or OTC derivative contract (other than a credit 
derivative) would be the banking

[[Page 44011]]

organization's carrying value minus any unrealized gains and plus any 
unrealized losses on the exposure if the exposure were a security 
classified as available-for-sale, or the banking organization's 
carrying value if the exposure were not a security classified as 
available-for-sale.
    The amount of an off-balance sheet securitization exposure that is 
not an eligible ABCP liquidity facility, a repo-style transaction, or 
an OTC derivative contract (other than a credit derivative) would be 
the notional amount of the exposure.
    This NPR defines an eligible ABCP liquidity facility as a liquidity 
facility supporting ABCP, in form or in substance, that is subject to 
an asset quality test at the time of draw that precludes funding 
against assets that are 90 days or more past due or in default. In 
addition, if the assets or exposures that an eligible ABCP liquidity 
facility is required to fund against are externally rated assets or 
exposures at the inception of the facility, the facility can be used to 
fund only those assets or exposures with an applicable external rating 
of at least investment grade at the time of funding. Notwithstanding 
these eligibility requirements, a liquidity facility will be considered 
an eligible ABCP liquidity facility if the assets or exposures funded 
under the liquidity facility and that do not meet the eligibility 
requirements are guaranteed, either conditionally or unconditionally, 
by a sovereign entity with an issuer rating in one of the three highest 
investment grade rating categories.
    Consistent with the New Accord, the exposure amount of an eligible 
ABCP liquidity facility would be the notional amount of the exposure 
multiplied by (i) a 20 percent CCF, for a facility with an original 
maturity of one year or less that does not qualify for the RBA; (ii) a 
50 percent CCF, for a facility with an original maturity of over one 
year that does not qualify for the RBA; or (iii) 100 percent, for a 
facility that qualifies for the RBA. The proposed CCF for eligible ABCP 
liquidity facilities with an original maturity of less than one year is 
greater than the 10 percent CCF prescribed under the general risk-based 
capital rules. The agencies believe the credit risk of eligible ABCP 
liquidity facilities is similar to that of other short-term commitments 
to lend or purchase assets, and believe that a 20 percent CCF is 
appropriate for both eligible ABCP liquidity facilities and non-
securitization commitments with an original maturity of one year or 
less.
    Under this proposed rule, when a securitization exposure to an ABCP 
program is a commitment, such as a liquidity facility, the notional 
amount could be reduced to the maximum potential amount that the 
banking organization could be required to fund given the ABCP program's 
current underlying assets (calculated without regard to the current 
credit quality of those assets). Thus, if $100 is the maximum amount 
that could be drawn given the current volume and current credit quality 
of the program's assets, but the maximum potential draw against these 
same assets could increase to as much as $200 under some scenarios if 
their credit quality were to deteriorate, then the exposure amount is 
$200.
    The amount of securitization exposure that is a repo-style 
transaction, eligible margin loan, or an OTC derivative (other than a 
credit derivative) would be the exposure amount as calculated in 
section 35 or 37 of this proposed rule.
(b) Gains-on-Sale and CEIOs
    Under the proposed rule, a banking organization would first deduct 
from tier 1 capital any after-tax gain-on-sale resulting from a 
securitization and would deduct from total capital any portion of a 
CEIO that does not constitute an after-tax gain-on-sale, as described 
in section 21 of the proposed rule. Thus, if the after-tax gain-on-sale 
associated with a securitization equaled $100 while the amount of CEIOs 
associated with that same securitization equaled $120, the banking 
organization would deduct $100 from tier 1 capital and $20 from total 
capital ($10 from tier 1 capital and $10 from tier 2 capital). The 
agencies believe these deductions are appropriate given historical 
supervisory concerns with the subjectivity involved in valuations of 
gains-on-sale and CEIOs. Furthermore, although the treatments of gains-
on-sale and CEIOs can increase an originating banking organization's 
risk-based capital requirement following a securitization, the agencies 
believe that such anomalies will be rare where a securitization 
transfers significant credit risk from the originating banking 
organization to third parties.
(c) Ratings-Based Approach
    If a securitization exposure is not a gain-on-sale or CEIO, a 
banking organization would apply the RBA to a securitization exposure 
if the exposure qualifies for the RBA.\48\ Generally, an exposure would 
qualify for the RBA if the exposure has an external rating from an 
NRSRO or has an inferred rating (that is, the exposure is senior to 
another securitization exposure in the transaction that has an external 
rating from an NRSRO).
---------------------------------------------------------------------------

    \48\A securitization exposure held by an originating bank must 
have two or more external ratings or inferred ratings to qualify for 
the RBA.
---------------------------------------------------------------------------

(d) Securitization Exposures That Do Not Qualify for the RBA
    If a securitization exposure is not a gain-on-sale or CEIO and does 
not qualify for the RBA, a banking organization generally would be 
required to deduct the exposure from total capital. However, there are 
several situations in the approach for unrated exposures described 
below and in section 44 of the proposed rule in which an alternative 
risk-based capital treatment is permitted.
(e) Exceptions to the General Hierarchy of Approaches
    There are four exceptions to the general approach described above 
that parallel the agencies' general risk-based capital rules. First, an 
interest-only mortgage-backed security would be assigned a risk weight 
that is no less than 100 percent. The agencies believe that a minimum 
risk weight of 100 percent is prudent in light of the uncertainty 
implied by the substantial price volatility of these securities. 
Second, a sponsoring banking organization that qualifies as a primary 
beneficiary and must consolidate an ABCP program as a variable interest 
entity under GAAP could exclude the consolidated ABCP program assets 
from risk-weighted assets.\49\ In such cases, the banking organization 
would hold risk-based capital against any of its securitization 
exposures to the ABCP program. Third, as required by Federal statute, a 
special set of rules would continue to apply to transfers of small-
business loans and leases with recourse by well-capitalized depository 
institutions.\50\ Finally, under this NPR, if a securitization exposure 
is an OTC derivative contract (other than a credit derivative) that has 
a first priority claim on the cash flows from the underlying exposures 
(notwithstanding amounts due under interest rate or currency derivative 
contracts, fees due, or other similar payments), a banking organization 
may choose to apply an

[[Page 44012]]

effective 100 percent risk weight to the exposure rather than the 
general securitization hierarchy of approaches. This treatment would be 
subject to supervisory approval.
---------------------------------------------------------------------------

    \49\ See Financial Accounting Standards Board, ``Interpretation 
No. 46(R): Consolidation of Certain Variable Interest Entities'' 
(December 2003).
    \50\ See 12 U.S.C. 1835, which places a cap on the risk-based 
capital requirement applicable to a well-capitalized depository 
institution that transfers small-business loans with recourse. The 
final rule does not expressly state that the agencies may permit 
adequately capitalized banks to use the small business recourse rule 
on a case-by-case basis because the agencies may do this under the 
general reservation of authority contained in section 1 of the rule.
---------------------------------------------------------------------------

(f) Overlapping Exposures
    This proposal also includes provisions to limit the double counting 
of risks in situations involving overlapping securitization exposures. 
If a banking organization has multiple securitization exposures that 
provide duplicative coverage to the underlying exposures of a 
securitization (such as when a banking organization provides a program-
wide credit enhancement and multiple pool-specific liquidity facilities 
to an ABCP program), the banking organization is not required to hold 
duplicative risk-based capital against the overlapping position. 
Instead, the banking organization would apply to the overlapping 
position the applicable risk-based capital treatment under the 
securitization framework that results in the highest capital 
requirement. If different banking organizations have overlapping 
exposures to a securitization, however, each banking organization would 
hold capital against the entire maximum amount of its exposure. 
Although duplication of capital requirements will not occur for an 
individual banking organization, some systemic duplication would occur 
where multiple banking organizations have overlapping exposures to the 
same securitization.
(g) Servicer Cash Advances
    A traditional securitization typically employs a servicing banking 
organization that, on a day-to-day basis, collects principal, interest, 
and other payments from the underlying exposures of the securitization 
and forwards such payments to the securitization SPE or to investors in 
the securitization. Such servicing banking organizations often provide 
a credit facility to the securitization under which the servicing 
banking organization could advance cash to ensure an uninterrupted flow 
of payments to investors in the securitization (including advances made 
to cover foreclosure costs or other expenses to facilitate the timely 
collection of the underlying exposures). These servicer cash advance 
facilities are securitization exposures.
    Under the proposed rule, a servicing banking organization would 
determine its risk-based capital requirement for any advances under 
such a facility using either the RBA or the approach for securitization 
exposures that do not qualify for the RBA as described below. The 
treatment of the undrawn portion of the facility would depend on 
whether the facility is an ``eligible'' servicer cash advance facility. 
An eligible servicer cash advance facility would be defined as a 
servicer cash advance facility in which: (i) The servicer is entitled 
to full reimbursement of advances (except that a servicer could be 
obligated to make non-reimbursable advances for a particular underlying 
exposure if any such advance is contractually limited to an 
insignificant amount of the outstanding principal balance of that 
exposure); (ii) the servicer's right to reimbursement is senior in 
right of payment to all other claims on the cash flows from the 
underlying exposures of the securitization; and (iii) the servicer has 
no legal obligation to, and does not, make advances to the 
securitization if the servicer concludes the advances are unlikely to 
be repaid. Consistent with the general risk-based capital rules with 
respect to residential mortgage servicer cash advances, a servicing 
banking organization would not be required to hold risk-based capital 
against the undrawn portion of an eligible servicer cash advance 
facility. A banking organization that provides a non-eligible servicer 
cash advance facility would determine its risk-based capital 
requirement for the undrawn portion of the facility in the same manner 
as the banking organization would determine its risk-based capital 
requirement for any other off-balance sheet securitization exposure.
(h) Implicit Support
    The proposed rule also specifies the regulatory capital consequence 
if a banking organization provides support to a securitization in 
excess of the banking organization's predetermined contractual 
obligation. First, consistent with the general risk-based capital 
rules, a banking organization that provides such implicit support would 
have to hold regulatory capital against all of the underlying exposures 
associated with the securitization as if the exposures had not been 
securitized, and would deduct from tier 1 capital any after-tax gain-
on-sale resulting from the securitization.\51\ Second, the banking 
organization would have to disclose publicly (i) that it has provided 
implicit support to the securitization, and (ii) the regulatory capital 
impact to the banking organization of providing the implicit support. 
The banking organization's primary Federal supervisor also could 
require the banking organization to hold regulatory capital against all 
the underlying exposures associated with some or all of the banking 
organization's other securitizations as if the exposures had not been 
securitized, and to deduct from tier 1 capital any after-tax gain-on-
sale resulting from such securitizations.
---------------------------------------------------------------------------

    \51\ ``Interagency Guidance on Implicit Recourse in Asset 
Securitizations,'' May 23, 2002. OCC Bulletin 2002-20 (OCC); SR02-15 
(Board); FIL-52-2002 (FDIC); and CEO Memo No. 162 (OTS).
---------------------------------------------------------------------------

    Over the last several years, the agencies have published a 
significant amount of supervisory guidance to assist banking 
organizations with the capital treatment of securitization exposures. 
In general, the agencies expect banking organizations to continue to 
use this guidance, most of which would remain applicable to the 
standardized securitization framework.
(4) Ratings-Based Approach
    Under this NPR, a banking organization would determine the risk-
weighted asset amount for a securitization exposure that is eligible 
for the RBA by multiplying the exposure amount by the appropriate risk 
weight provided in Table 13 or Table 14. Banking organizations would 
deduct from total capital exposures that have applicable long-term 
ratings of two categories or more below investment grade and applicable 
short-term ratings below the lowest investment grade rating.
    Under the proposal, whether a securitization exposure is eligible 
for the RBA would depend on whether the banking organization holding 
the securitization exposure is an originating banking organization or 
an investing banking organization. An originating banking organization 
would be required to use the RBA for a securitization exposure if (i) 
the exposure has two or more external ratings, or (ii) the exposure has 
two or more external or inferred ratings. In contrast, an investing 
banking organization would be required to use the RBA for a 
securitization exposure if the exposure has one or more external or 
inferred ratings.

[[Page 44013]]



      Table 13.--Long-Term Credit Rating Risk Weights Under the RBA
------------------------------------------------------------------------
 Applicable external rating or
applicable inferred rating of a        Example         Risk weight  (in
    securitization exposure                                percent)
------------------------------------------------------------------------
Highest investment grade rating  AAA...............  20.
Second-highest investment grade  AA................  20.
 rating.
Third-highest investment grade   A.................  50.
 rating.
Lowest investment grade rating.  BBB...............  100.
One category below investment    BB................  350.
 grade.
Two categories below investment  B.................  Deduction.
 grade.
Three categories or more below   CCC...............  Deduction.
 investment grade.
------------------------------------------------------------------------


     Table 14.--Short-Term Credit Rating Risk Weights Under the RBA
------------------------------------------------------------------------
     Applicable external or
applicable inferred rating of a        Example         Risk weight  (in
    securitization exposure                                percent)
------------------------------------------------------------------------
Highest investment grade rating  A-1/P-1...........  20.
Second-highest investment grade  A-2/P-2...........  50.
 rating.
Lowest investment grade rating.  A-3/P-3...........  100.
All other ratings..............  N/A...............  Deduction.
------------------------------------------------------------------------

    Under the proposed rule, securitization exposures with an inferred 
rating are treated the same as securitization exposures with an 
identical external rating. However, the proposed rule includes a 
different provision for determining inferred ratings for securitization 
exposures than for other types of exposures. A securitization exposure 
that does not have an external rating (an unrated securitization 
exposure) would have an inferred rating equal to the external rating of 
a securitization exposure that is issued by the same issuer and secured 
by the same underlying exposures and (i) has an external rating; (ii) 
is subordinate in all respects to the unrated securitization exposure; 
(iii) does not benefit from any credit enhancement that is not 
available to the unrated securitization exposure; (iv) has an effective 
remaining maturity that is equal to or longer than the unrated 
securitization exposure; and (v) is the most immediately subordinated 
exposure to the unrated securitization exposure that meets the criteria 
in (i) through (iv) above. For example, a securitization might issue 
three tranches of securities designated as senior, mezzanine, and 
subordinated. If the senior tranche is unrated, the mezzanine tranche 
is rated A and meets the criteria in (i) through (iv) above, and the 
subordinated tranche is rated BB, the senior tranche could receive an 
inferred rating of A based on the rating of the mezzanine tranche, 
regardless of the rating of the subordinated tranche. If the mezzanine 
tranche has two ratings, the senior tranche could receive an applicable 
inferred rating based only on the lowest of the ratings on the 
mezzanine tranche. If a securitization exposure has multiple inferred 
ratings, the applicable inferred rating is the lowest inferred rating.
    Banking organizations would not be permitted to assign an inferred 
rating based on the ratings of the underlying exposures in a 
securitization, even when the unrated securitization exposure is 
secured by a single, externally rated security. Such an approach would 
fail to meet the requirements that the rated reference exposure be 
issued by the same issuer, secured by the same underlying assets, and 
subordinated in all respects to the unrated securitization exposure.
(5) Exposures That Do Not Qualify for the RBA
    A banking organization would generally be required to deduct from 
total capital securitization exposures that do not qualify for the RBA, 
with the following exceptions that apply provided that the banking 
organization knows the composition of the underlying exposures at all 
times: (i) Eligible ABCP liquidity facilities, (ii) first priority 
securitization exposures, and (iii) exposures in a second loss position 
or better to an ABCP program.
(a) Eligible ABCP Liquidity Facilities
    In this NPR, consistent with the New Accord, the exposure amount of 
an eligible ABCP liquidity facility would be assigned to the highest 
risk weight applicable to any of the underlying individual exposures 
covered by the liquidity facility.
(b) First-Priority Securitization Exposures
    If a first-priority securitization exposure does not qualify for 
the RBA, a banking organization could determine the risk weight of the 
exposure by ``looking through'' the exposure to its underlying assets. 
The risk-weighted asset amount would be the weighted-average risk 
weight of the underlying exposures multiplied by the exposure amount of 
the first-priority securitization exposure. If a banking organization 
is unable to determine the risk weights of the underlying credit risk 
exposures, the first-priority securitization exposure would be deducted 
from total capital.
    First-priority securitization exposure would be defined as a 
securitization exposure that has a first-priority claim on the cash 
flows from the underlying exposures and that is not an eligible ABCP 
liquidity facility. When determining whether a securitization exposure 
has a first-priority claim on the cash flows from the underlying 
exposures, a banking organization would not be required to consider 
amounts due under interest rate or currency derivative contracts, fees 
due, or other similar payments. Generally, only the most senior tranche 
of a securitization would be a first-priority securitization exposure.
(c) Securitization Exposures in a Second Loss Position or Better to an 
ABCP Program
    This NPR would define an ABCP program as a program that primarily 
issues commercial paper that has an external rating and is backed by 
underlying exposures held in a bankruptcy-remote securitization SPE. In 
this NPR, a banking organization would not be required to deduct from 
total capital a securitization exposure to an ABCP program that does 
not qualify for the RBA and is not an eligible ABCP

[[Page 44014]]

liquidity facility or a first-priority securitization exposure, 
provided that it satisfies the following requirements: (i) The exposure 
must be economically in a second loss position or better and the first 
loss position must provide significant credit protection to the second 
loss position, (ii) the credit risk associated with the exposure must 
be the equivalent of investment grade or better,\52\ and (iii) the 
banking organization holding the exposure must not retain or provide 
the first loss position.
---------------------------------------------------------------------------

    \52\ Interagency guidance on assessing whether a banking 
organization's internal risk rating system used in measuring risk 
exposures in ABCP programs is adequate and reasonably corresponds to 
the NRSRO's rating categories is set forth in ``Interagency Guidance 
on assisting in the determination of the appropriate risk-based 
capital treatment to be applied to direct credit substitutes issued 
in connection with asset-backed commercial paper programs.'' March 
31, 2005. OCC Bulletin 2005-12 (OCC); SR 05-6 (Board); FIL-26-2005 
(FDIC); and CEO Letter 217, dated April 1, 2005 (OTS).
---------------------------------------------------------------------------

    If the exposure meets the above requirements, the risk weight would 
be the higher of 100 percent or the highest risk weight assigned to any 
of the individual exposures covered by the ABCP program. The agencies 
believe that this approach, which is consistent with the New Accord, 
appropriately and conservatively assesses the credit risk of non-first 
loss exposures to ABCP programs.
    Under the agencies' general risk-based capital rules, certain 
securitization exposures that are not rated by an NRSRO may be risk 
weighted based on alternative methods. These methods include internal 
risk ratings for ABCP programs, program ratings, and computer program 
ratings and are not included in this NPR.
    Question 18: The agencies solicit comment on the decision not to 
include internal risk ratings for ABCP programs, program ratings, and 
computer program ratings in this proposal.
(6) CRM for Securitization Exposures
    The proposed treatment of CRM for securitization exposures differs 
slightly from the CRM treatment of other exposures. An originating 
banking organization that has obtained a credit risk mitigant to hedge 
its securitization exposure to a synthetic or traditional 
securitization that satisfies the operational criteria in section 41 of 
the proposed rule could recognize the credit risk mitigant, but only as 
provided in section 45. An investing banking organization that has 
obtained a credit risk mitigant to hedge a securitization exposure also 
could recognize the credit risk mitigant, but only as provided in 
section 45.
    In general, to recognize the risk mitigating effects of financial 
collateral or an eligible guarantee or an eligible credit derivative 
for a securitization exposure, a banking organization could use the 
approaches for collateralized transactions or the substitution 
treatment for guarantees and credit derivatives described in section 
36. However, section 45 of the proposed rule contains specific 
provisions a banking organization would have to follow when applying 
those approaches to securitization exposures.
    In this NPR, a banking organization that determines its risk-based 
capital requirement for a securitization exposure based on external or 
inferred rating(s) that reflect the benefits of a particular credit 
risk mitigant provided to the associated securitization or that 
supports some or all of the underlying exposures, could not use the 
credit risk mitigation rules to further reduce its risk-based capital 
requirement for the exposure based on the credit risk mitigant. For 
example, a banking organization that owns an AAA-rated asset-backed 
security that benefits, along with all the other securities issued by 
the securitization SPE, from an insurance wrap that is part of the 
securitization transaction would calculate its risk-based capital 
requirement for the security strictly using the RBA. No additional 
credit would be given for the presence of the insurance wrap. In 
contrast, if a banking organization owns a BBB-rated asset-backed 
security and obtains a credit default swap from a AAA-rated 
counterparty to protect the banking organization from losses on the 
security, the banking organization would be able to apply the 
securitization CRM rules to recognize the risk mitigating effects of 
the credit default swap and determine the risk-based capital 
requirement for the position.
    For purposes of this section, a banking organization may only 
recognize an eligible guarantee or eligible credit derivative from an 
eligible guarantor if the guarantor: (i) Is a sovereign entity, the 
Bank for International Settlements, the International Monetary Fund, 
the European Central Bank, the European Commission, a Federal Home Loan 
Bank, Farmer Mac, an MDB, a depository institution, a foreign bank, a 
credit union, a bank holding company, or a savings and loan holding 
company; or (ii) has issued and has outstanding an unsecured long-term 
debt security without credit enhancement that has a long-term 
applicable external rating in one of the three highest investment grade 
rating categories.
    With respect to eligible guarantees and credit derivatives, in the 
context of a synthetic securitization, when an eligible guarantee or 
eligible credit derivative covers multiple hedged exposures that have 
different residual maturities, the banking organization must use the 
longest residual maturity of any of the hedged exposures as the 
residual maturity of all the hedged exposures.
(a) Nth-to-Default Credit Derivatives
    Credit derivatives that provide credit protection only for the nth 
defaulting reference exposure in a group of reference exposures (nth-
to-default credit derivatives) are similar to synthetic securitizations 
that provide credit protection only after the first-loss tranche has 
defaulted or become a loss. A simplified treatment would be available 
to banking organizations that purchase and provide such credit 
protection. A banking organization that obtains credit protection on a 
group of underlying exposures through a first-to-default credit 
derivative would determine its risk-based capital requirement for the 
underlying exposures as if the banking organization had synthetically 
securitized only the underlying exposure with the lowest capital 
requirement and had obtained no credit risk mitigant on the other 
(higher capital requirement) underlying exposures. If the banking 
organization purchased credit protection on a group of underlying 
exposures through an nth-to-default credit derivative (other than a 
first-to-default credit derivative), it would only recognize the credit 
protection for risk-based capital purposes either if it had obtained 
credit protection on the same underlying exposures in the form of 
first-through-(n-1)-to-default credit derivatives, or if n-1 of the 
underlying exposures have already defaulted. In such a case, the 
banking organization would determine its risk-based capital requirement 
for the underlying exposures as if the banking organization had only 
synthetically securitized the n-1 underlying exposures with the lowest 
capital requirement and had obtained no credit risk mitigant on the 
other underlying exposures.
    A banking organization that provides credit protection on a group 
of underlying exposures through a first-to-default credit derivative 
would determine its risk-weighted asset amount for the derivative by 
applying the risk weights in Table 13 or 14 (if the derivative 
qualifies for the RBA) or, by setting its risk-weighted asset amount

[[Page 44015]]

for the derivative equal to the product of (i) the protection amount of 
the derivative; and (ii) the sum of the risk weights of the individual 
underlying exposures, up to a maximum of 1,250 percent.
    If a banking organization provides credit protection on a group of 
underlying exposures through an nth-to-default credit derivative (other 
than a first-to-default credit derivative), the banking organization 
would determine its risk-weighted asset amount for the derivative by 
applying the risk weights in Table 13 or 14 (if the derivative 
qualifies for the RBA) or, by setting the risk-weighted asset amount 
for the derivative equal to the product of (i) the protection amount of 
the derivative and (ii) the sum of the risk weights of the individual 
underlying exposures (excluding the n-1 underlying exposures with the 
lowest risk-based capital requirements), up to a maximum of 1,250 
percent.
    For example, a banking organization provides credit protection in 
the form of a second-to-default credit derivative on a basket of five 
reference exposures. The derivative is unrated and the protection 
amount of the derivative is $100. The risk weights for the underlying 
exposures are 20 percent, 50 percent, 100 percent, 100 percent, and 150 
percent. The risk-weighted asset amount of the derivative would be $100 
x (50% + 100% + 100% + 150%) or $400. If the derivative were externally 
rated one category below investment grade, the risk-weighted asset 
amount would be $100 x 350% or $350.
(7) Risk-Weighted Assets for Early Amortization Provisions
    Many securitizations of revolving credit facilities (for example, 
credit card receivables) contain provisions that require the 
securitization to wind down and repay investors if the excess spread 
falls below a certain threshold.\53\ This decrease in excess spread 
may, in some cases, be caused by deterioration in the credit quality of 
the underlying exposures. An early amortization event can increase a 
banking organization's capital needs if the banking organization would 
have to finance new draws on the revolving credit facilities with on-
balance sheet sources of funding. The payment allocations a banking 
organization uses to distribute principal and finance charge 
collections during the amortization phase of these transactions also 
can expose it to greater risk of loss than in other securitization 
transactions. Consistent with the New Accord, this NPR includes a risk-
based capital requirement that, in general, is linked to the likelihood 
of an early amortization event to address the risks that early 
amortization of a securitization poses to originating banking 
organizations.
---------------------------------------------------------------------------

    \53\ The NPR defines excess spread for a period as gross finance 
charge collections (including market interchange fees) and other 
income received by the SPE over the period minus interest paid to 
holders of securitization exposures, servicing fees, charge-offs, 
and other senior trust similar expenses of the SPE over the period, 
all divided by the principal balance of the underlying exposures at 
the end of the period.
---------------------------------------------------------------------------

    The proposed rule defines an early amortization as a provision in a 
securitization's governing documentation that, when triggered, causes 
investors in the securitization exposures to be repaid before the 
original stated maturity of the securitization exposure, unless the 
provision is triggered solely by events not related to the performance 
of the underlying exposures or the originating banking organization 
(for example, material changes in tax laws or regulations) or leaves 
investors exposed to future draws by obligors on the underlying 
exposures even after the provision is triggered.
    Under the NPR, an originating banking organization would hold 
regulatory capital against its own interest and the investors' interest 
in a securitization that (i) includes one or more underlying exposures 
in which the borrower is permitted to vary the drawn amount within an 
agreed line of credit, and (ii) contains an early amortization 
provision. Investors' interest means, with respect to a securitization, 
the exposure amount of the underlying exposures multiplied by the ratio 
of (i) the total amount of securitization exposures issued by the 
securitization special purpose entity (SPE); divided by (ii) the 
outstanding principal amount of the underlying exposures. A banking 
organization would compute the risk-weighted asset amount for its 
interest using the hierarchy of approaches for securitization exposures 
described above. An originating banking organization would calculate 
the risk-weighted asset amount for the investors' interest in the 
securitization as the product of (i) the investors' interest, (ii) the 
appropriate conversion factor (CF), (iii) the weighted-average risk 
weight that would apply under this NPR to the underlying exposure type 
if the underlying exposures had not been securitized, and (iv) the 
proportion of the underlying exposures in which the borrower is 
permitted to vary the drawn amount within an agreed limit under a line 
of credit.
    The CF would differ according to whether the securitized exposures 
are revolving retail credit facilities (for example, credit card 
receivables) or other revolving credit facilities (for example, 
revolving corporate credit facilities) and whether the early 
amortization provision is controlled or non-controlled; and whether the 
line is committed or uncommitted. A line would qualify as uncommitted 
if it were unconditionally cancelable to the extent permitted under 
applicable law.
(a) Controlled Early Amortization
    Under the proposed rule, a controlled early amortization provision 
would have to meet each of the following conditions: (i) The 
originating banking organization has appropriate policies and 
procedures to ensure that it has sufficient capital and liquidity 
available in the event of an early amortization; (ii) throughout the 
duration of the securitization (including the early amortization 
period) there is the same pro rata sharing of interest, principal, 
expenses, losses, fees, recoveries, and other cash flows from the 
underlying exposures, based on the originating banking organizations' 
and the investors' relative shares of the underlying exposures 
outstanding measured on a consistent monthly basis; (iii) the 
amortization period is sufficient for at least 90 percent of the total 
underlying exposures outstanding at the beginning of the early 
amortization period to have been repaid or recognized as in default; 
and (iv) the schedule for repayment of investor principal is not more 
rapid than would be allowed by straight-line amortization over an 18-
month period. An early amortization provision that does not meet any of 
the above criteria would be a ``non-controlled'' early amortization 
provision.
    To calculate the appropriate CF for a securitization of uncommitted 
revolving retail exposures that contains a controlled early 
amortization provision, a banking organization would compare the three-
month average annualized excess spread for the securitization to the 
point at which the banking organization has to trap excess spread under 
the securitization transaction. In securitizations that do not require 
trapping of excess spread, or that specify a trapping point based 
primarily on performance measures other than the three-month average 
annualized excess spread, the excess spread trapping point would be 4.5 
percent. The banking organization would divide the three-month average 
excess spread level by the excess spread trapping point and apply the 
appropriate CF from Table 15.
    A banking organization would apply a 90 percent CF for all other 
revolving

[[Page 44016]]

underlying exposures (that is, committed exposures and non-retail 
exposures) in securitizations with a controlled early amortization 
provision. The proposed CFs for uncommitted revolving retail credit 
lines are much lower than for committed retail credit lines or for non-
retail credit lines because banking organizations have demonstrated the 
ability to monitor and, when appropriate, to curtail uncommitted retail 
credit lines promptly when a customer's credit quality deteriorates. 
Such account management tools are unavailable for committed lines, and 
banking organizations may be less proactive about using such tools in 
the case of uncommitted non-retail credit lines owing to lender 
liability concerns and the prominence of broad-based, longer-term 
customer relationships.

     Table 15.--Conversion Factors for Controlled Early Amortization
------------------------------------------------------------------------
                                          Uncommitted CF   Committed CF
      3-month average excess spread        (in percent)    (in percent)
------------------------------------------------------------------------
Retail Credit Lines:
    Greater than or equal to 133.33% of                0              90
     trapping point.....................
    Less than 133.33% to 100% of                       1  ..............
     trapping point.....................
    Less than 100% to 75% of trapping                  2  ..............
     point..............................
    Less than 75% to 50% of trapping                  10  ..............
     point..............................
    Less than 50% to 25% of trapping                  20  ..............
     point..............................
    Less than 25% of trapping point.....              40  ..............
Non-retail credit lines.................              90              90
------------------------------------------------------------------------

(b) Non-Controlled Early Amortization
    To calculate the appropriate CF for securitizations of uncommitted 
revolving retail exposures that contain a non-controlled early 
amortization provision, a banking organization would have to perform 
the excess spread calculations described in the controlled early 
amortization section above and then apply the CFs in Table 16.
    A banking organization would use a 100 percent CF for all other 
revolving underlying exposures (that is, committed exposures and non-
retail exposures) in securitizations with a non-controlled early 
amortization provision. In other words, no risk transference would be 
recognized for these transactions.
    Where a securitization contains a mix of retail and non-retail 
exposures or a mix of committed and uncommitted exposures, a banking 
organization could take a pro-rata approach to determining the risk-
based capital requirement for the securitization's early amortization 
provision. If a pro-rata approach were not feasible, a banking 
organization would treat a securitization with an underlying exposure 
that is non-retail as a securitization of non-retail exposures and 
would treat the securitization as a securitization of committed 
exposures if a single underlying exposure is a committed exposure.

   Table 16.--Conversion Factors for Non-Controlled Early Amortization
------------------------------------------------------------------------
                                          Uncommitted CF   Committed CF
      3-month average excess spread        (in percent)    (in percent)
------------------------------------------------------------------------
Retail Credit Lines:
    Greater than or equal to 133.33% of                0             100
     trapping point.....................
    Less than 133.33% to 100% of                       5  ..............
     trapping point.....................
    Less than 100% to 75% of trapping                 15  ..............
     point..............................
    Less than 75% to 50% of trapping                  50  ..............
     point..............................
    Less than 50% of trapping point.....             100  ..............
Non-retail credit lines.................             100             100
------------------------------------------------------------------------

(c) Revolving Residential Mortgage Exposures
    Unlike credit card securitizations, HELOC securitizations in the 
United States typically do not generate material excess spread and 
typically are structured with credit enhancements and early 
amortization triggers based on other factors, such as portfolio loss 
rates. Under the New Accord, a banking organization would have to hold 
capital against the potential early amortization of most U.S. HELOC 
securitizations at their inception, rather than only if the credit 
quality of the underlying exposures deteriorated. Although the 
securitization framework in the New Accord does not provide an 
alternative methodology in such cases, the agencies have concluded that 
the features of the U.S. HELOC securitization market would warrant an 
alternative approach. Accordingly, the proposed rule allows a banking 
organization the option of applying either (i) the CFs in Tables 15 and 
16, as appropriate, or (ii) a fixed CF of 10 percent to its 
securitizations for which all or substantially all of the underlying 
exposures are revolving residential mortgage exposures. If a banking 
organization chooses the fixed CF of 10 percent, it would have to use 
that CF for all securitizations for which all or substantially all of 
the underlying exposures are revolving residential mortgage exposures.
(8) Maximum Capital Requirement
    The total capital requirement for a banking organization's 
exposures to a single securitization with an early amortization 
provision is subject to a maximum capital requirement equal to the 
greater of (i) the capital requirement for the retained securitization 
exposures or (ii) the capital requirement for the underlying exposures 
that would apply if the banking organization directly held the 
underlying exposures on its balance sheet.

[[Page 44017]]

N. Equity Exposures

(1) Introduction and Exposure Measurement
    Under the FDIC, OCC, and Board's general risk-based capital rules, 
a banking organization must deduct a portion of non-financial equity 
investments from tier 1 capital. This deduction depends upon the 
aggregate adjusted carrying value of all non-financial equity 
investments held directly or indirectly by the banking organization as 
a percentage of its tier 1 capital. By contrast, OTS rules require the 
deduction of most equity securities from total capital.\54\
---------------------------------------------------------------------------

    \54\ See preamble discussion at section II.E.
---------------------------------------------------------------------------

    Under this proposed rule, a banking organization would use the 
simple risk-weight approach (SRWA) for equity exposures that are not 
exposures to an investment fund. This approach is consistent with the 
SRWA for equity exposures and investment fund approach provided in the 
advanced approaches final rule. A banking organization could use the 
various look-through approaches for equity exposures to an investment 
fund.
    This NPR defines an equity exposure as:
    (i) A security or instrument (whether voting or non-voting) that 
represents a direct or indirect ownership interest in, and is a 
residual claim on, the assets and income of a company, unless:
    (a) The issuing company is consolidated with the banking 
organization under GAAP;
    (b) The banking organization is required to deduct the ownership 
interest from tier 1 or tier 2 capital under this appendix;
    (c) The ownership interest incorporates a payment or other similar 
obligation on the part of the issuing company (such as an obligation to 
make periodic payments); or
    (d) The ownership interest is a securitization exposure;
    (ii) A security or instrument that is mandatorily convertible into 
a security or instrument described in paragraph (i) of this definition;
    (iii) An option or warrant that is exercisable for a security or 
instrument described in paragraph (i) of this definition; or
    (iv) Any other security or instrument (other than a securitization 
exposure) to the extent the return on the security or instrument is 
based on the performance of a security or instrument described in 
paragraph (i) of this definition.
    Under the proposed SRWA, a banking organization generally would 
assign a 300 percent risk weight to publicly traded equity exposures, a 
400 percent risk weight to non-publicly traded equity exposures, and a 
600 percent risk weight to certain equity exposures to investment firms 
as described below. Certain equity exposures to sovereign entities, 
supranational entities, MDBs, PSEs, and others would have a risk weight 
of zero percent, 20 percent, or 100 percent; and certain community 
development equity exposures, the effective portion of hedged pairs, 
and, up to certain limits, non-significant equity exposures would 
receive a 100 percent risk weight.
    The proposed rule defines publicly traded to mean traded on: (i) 
Any exchange registered with the SEC as a national securities exchange 
under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f); 
or (ii) any non-U.S.-based securities exchange that is registered with, 
or approved by, a national securities regulatory authority and that 
provides a liquid, two-way market for the exposure (that is, there are 
enough independent bona fide offers to buy and sell so that a sales 
price is reasonably related to the last sales price or current bona 
fide competitive bid and offer quotations can be determined promptly 
and a trade can be settled at such a price within five business days).
    A banking organization using the SRWA would determine the adjusted 
carrying value for each equity exposure. The proposed rule defines the 
adjusted carrying value of an equity exposure as: (i) For the on-
balance sheet component of an equity exposure, the banking 
organization's carrying value of the exposure reduced by any unrealized 
gains on the exposure that are reflected in such carrying value but 
excluded from the banking organization's tier 1 and tier 2 capital; 
\55\ and (ii) for the off-balance sheet component of an equity exposure 
that is not an equity commitment, the effective notional principal 
amount of the exposure, the size of which is equivalent to a 
hypothetical on-balance sheet position in the underlying equity 
instrument that would evidence the same change in fair value (measured 
in dollars) for a given small change in the price of the underlying 
equity instrument, minus the adjusted carrying value of the on-balance 
sheet component of the exposure as calculated above in (i).
---------------------------------------------------------------------------

    \55\ The potential downward adjustment to the carrying value of 
an equity exposure reflects the fact that 100 percent of the 
unrealized gains on available-for-sale equity exposures are included 
in carrying value but only up to 45 percent of any such unrealized 
gains are included in regulatory capital.
---------------------------------------------------------------------------

    For an unfunded equity commitment that is unconditional, the 
adjusted carrying value is the effective notional principal multiplied 
by a 100 percent conversion factor. If the unfunded equity commitment 
is conditional, the adjusted carrying value is the effective notional 
principal amount of the commitment multiplied by a 20 percent 
conversion factor for a commitment with a maturity of one year or less 
or multiplied by a 50 percent conversion factor to the effective 
notional principal amount for a commitment with a maturity of over one 
year.
    The agencies created the concept of the effective notional 
principal amount of the off-balance sheet portion of an equity exposure 
to provide a uniform method for banking organizations to measure the 
on-balance sheet equivalent of an off-balance sheet exposure. For 
example, if the value of a derivative contract referencing the common 
stock of company X changes the same amount as the value of 150 shares 
of common stock of company X, for a small (for example, 1.0 percent) 
change in the value of the common stock of company X, the effective 
notional principal amount of the derivative contract is the current 
value of 150 shares of common stock of company X regardless of the 
number of shares the derivative contract references. The adjusted 
carrying value of the off-balance sheet component of the derivative is 
the current value of 150 shares of common stock of company X minus the 
adjusted carrying value of any on-balance sheet amount associated with 
the derivative.
(2) Hedge Transactions
    The agencies are proposing specific rules for recognizing hedged 
equity exposures. For purposes of determining risk-weighted assets 
under the SRWA, a banking organization may identify hedge pairs, which 
would be defined as two equity exposures that form an effective hedge 
provided each equity exposure is publicly traded or has a return that 
is primarily based on a publicly traded equity exposure. A banking 
organization may risk weight only the effective and ineffective 
portions of a hedge pair rather than the entire adjusted carrying value 
of each exposure that makes up the pair. Two equity exposures form an 
effective hedge if the exposures either have the same remaining 
maturity or each has a remaining maturity of at least three months; the 
hedge relationship is documented formally before the banking 
organization acquires at least one of the equity exposures; the 
documentation specifies the measure of effectiveness (E) (defined 
below) the banking organization would use for the hedge relationship 
throughout the life of the transaction; and the hedge relationship

[[Page 44018]]

has an E greater than or equal to 0.8. A banking organization would 
measure E at least quarterly and would use one of three alternative 
measures of E: The dollar-offset method, the variability-reduction 
method, or the regression method.
    It is possible that only part of a banking organization's exposure 
to a particular equity instrument is part of a hedge pair. For example, 
assume a banking organization has an equity exposure A with a $300 
adjusted carrying value and chooses to hedge a portion of that exposure 
with an equity exposure B with an adjusted carrying value of $100. Also 
assume that the combination of equity exposure B and $100 of the 
adjusted carrying value of equity exposure A form an effective hedge 
with an E of 0.8. In this situation the banking organization would 
treat $100 of equity exposure A and $100 of equity exposure B as a 
hedge pair, and the remaining $200 of its equity exposure A as a 
separate, stand-alone equity position.
    The effective portion of a hedge pair would be E multiplied by the 
greater of the adjusted carrying values of the equity exposures forming 
the hedge pair, and the ineffective portion would be (1-E) multiplied 
by the greater of the adjusted carrying values of the equity exposures 
forming the hedge pair. In the above example, the effective portion of 
the hedge pair would be 0.8 x $100 = $80 and the ineffective portion of 
the hedge pair would be (1 - 0.8) x $100 = $20.
(3) Measures of Hedge Effectiveness
    Under the dollar-offset method of measuring effectiveness, the 
banking organization would determine the ratio of the cumulative sum of 
the periodic changes in the value of one equity exposure to the 
cumulative sum of the periodic changes in the value of the other equity 
exposure, termed the ratio of value change (RVC). If the changes in the 
values of the two exposures perfectly offset each other, the RVC would 
be -1.0. If RVC is positive, implying that the values of the two equity 
exposures move in the same direction, the hedge is not effective and E 
= 0. If RVC is negative and greater than or equal to -1.0 (that is, 
between zero and -1.0), then E would equal the absolute value of RVC. 
If RVC is negative and less than -1.0, then E would equal 2.0 plus RVC.
    The variability-reduction method of measuring effectiveness 
compares changes in the value of the combined position of the two 
equity exposures in the hedge pair (labeled X) to changes in the value 
of one exposure as though that one exposure were not hedged (labeled 
A). This measure of E expresses the time-series variability in X as a 
proportion of the variability of A. As the variability described by the 
numerator becomes small relative to the variability described by the 
denominator, the measure of effectiveness improves, but is bounded from 
above by a value of one. E would be computed as:
[GRAPHIC] [TIFF OMITTED] TP29JY08.002

Where:

Xt = At - Bt
At = the value at time t of the one exposure in a hedge pair, and
Bt = the value at time t of the other exposure in the hedge pair.

    The value of t would range from zero to T, where T is the length of 
the observation period for the values of A and B, and is comprised of 
shorter values each labeled t.
    The regression method of measuring effectiveness is based on a 
regression in which the change in value of one exposure in a hedge pair 
is the dependent variable and the change in value of the other exposure 
in the hedge pair is the independent variable. E would equal the 
coefficient of determination of this regression, which is the 
proportion of the variation in the dependent variable explained by 
variation in the independent variable. However, if the estimated 
regression coefficient is positive, then the value of E is zero. The 
closer the relationship between the values of the two exposures, the 
higher E will be.
(4) Simple Risk-Weight Approach (SRWA)
    Under the SRWA, a banking organization would determine the risk-
weighted asset amount for each equity exposure, other than an equity 
exposure to an investment fund, by multiplying the adjusted carrying 
value of the equity exposure, or the effective portion and ineffective 
portion of a hedge pair as described above, by the lowest applicable 
risk weight in Table 17. A banking organization would determine the 
risk-weighted asset amount for an equity exposure to an investment fund 
under section 52 of the proposed rule.
    The banking organization's aggregate risk-weighted asset amount for 
its equity exposures (other than equity exposures to investment funds) 
would be equal to the sum of the risk-weighted asset amounts for each 
of the banking organization's individual equity exposures.
(5) Non-Significant Equity Exposures
    Under the SRWA, a banking organization may apply a 100 percent risk 
weight to non-significant equity exposures. The proposed rule defines 
non-significant equity exposures as equity exposures \56\ to the extent 
that the aggregate adjusted carrying value of the exposures does not 
exceed 10 percent of the banking organization's tier 1 capital plus 
tier 2 capital.
---------------------------------------------------------------------------

    \56\ Excluding exposures to an investment firm that would meet 
the definition of traditional securitization were it not for the 
primary Federal supervisor's application of paragraph (8) of that 
definition and has greater than immaterial leverage.
---------------------------------------------------------------------------

    When computing the aggregate adjusted carrying value of a banking 
organization's equity exposures for determining non-significance, the 
banking organization may exclude (i) equity exposures that receive less 
than a 300 percent risk weight under the SRWA (other than equity 
exposures determined to be non-significant); (ii) the equity exposure 
in a hedge pair with the smaller adjusted carrying value; and (iii) a 
proportion of each equity exposure to an investment fund equal to the 
proportion of the assets of the investment fund that are not equity 
exposures or that qualify as community development equity exposures. If 
a banking organization does not know the actual holdings of the 
investment fund, the banking organization may calculate the proportion 
of the assets of the fund that are not equity exposures based on the 
terms of the prospectus, partnership agreement, or similar contract 
that defines the fund's permissible investments. If the sum of the 
investment limits for all exposure classes within the fund exceeds 100 
percent, the banking organization would assume that the investment fund 
invests to the maximum extent possible in equity exposures.
    When determining which of a banking organization's equity exposures 
qualify for a 100 percent risk weight based on non-significance, a 
banking organization first would include equity exposures to 
unconsolidated small business investment companies, or those held 
through consolidated small business investment companies described in 
section 302 of the Small Business Investment Act of 1958 (15 U.S.C. 
682), then would include publicly traded equity exposures (including 
those held indirectly through investment funds), and then would include 
non-publicly traded equity exposures (including those held indirectly 
through investment funds).

[[Page 44019]]

    As discussed above in the Securitization section of this NPR, the 
agencies would have discretion under the proposed rule to exclude from 
the definition of a traditional securitization those investment firms 
that exercise substantially unfettered control over the size and 
composition of their assets, liabilities, and off-balance sheet 
exposures. Equity exposures to investment firms that would otherwise be 
a traditional securitization were it not for the specific agency 
exclusion are leveraged exposures to the underlying financial assets of 
the investment firm. The agencies believe that equity exposure to such 
firms with greater than immaterial leverage warrant a 600 percent risk 
weight under the SRWA, due to their particularly high risk. Moreover, 
the agencies believe that the 100 percent risk weight assigned to non-
significant equity exposures is inappropriate for equity exposures to 
investment firms with greater than immaterial leverage.
    The SRWA is summarized in Table 17:

                 Table 17.--Simple Risk-Weight Approach
------------------------------------------------------------------------
   Risk weight (in percent)                 Equity exposure
------------------------------------------------------------------------
0............................  An equity exposure to a sovereign entity,
                                the Bank for International Settlements,
                                the European Central Bank, the European
                                Commission, the International Monetary
                                Fund, a MDB, a PSE, and any other entity
                                whose credit exposures receive a zero
                                percent risk weight under section 33 of
                                this proposed rule that may be assigned
                                a zero percent risk weight.
20...........................  An equity exposure to a Federal Home Loan
                                Bank or Farmer Mac.
100..........................   Community development equity
                                exposures.\57\
                                The effective portion of a hedge
                                pair.
                                Non-significant equity exposures
                                to the extent less than 10 percent of
                                tier 1 plus tier 2 capital.
300..........................  A publicly traded equity exposure (other
                                than an equity exposure that receives a
                                600 percent risk weight and including
                                the ineffective portion of a hedge
                                pair).
400..........................  An equity exposure that is not publicly
                                traded (other than an equity exposure
                                that receives a 600 percent risk
                                weight).
600..........................  An equity exposure to an investment firm
                                that (1) would meet the definition of a
                                traditional securitization were it not
                                for the primary Federal supervisor's
                                application of paragraph (8) of that
                                definition and (2) has greater than
                                immaterial leverage.
------------------------------------------------------------------------

(6) Equity Exposures to Investment Funds
    Under the agencies' general risk-based capital rules, exposures to 
investments funds are captured through one of two methods. These 
methods are similar to the alternative modified look-through approach 
and the simple modified look-through approach described below. The 
agencies propose two additional options in this NPR, the full look-
through approach and money market fund approach.
---------------------------------------------------------------------------

    \57\ The proposed rule generally defines these exposures as 
exposures that would qualify as community development investments 
under 12 U.S.C. 24 (Eleventh), excluding equity exposures to an 
unconsolidated small business investment company and equity 
exposures held through a consolidated small business investment 
company described in section 302 of the Small Business Investment 
Act of 1958 (15 U.S.C. 682). For savings associations, community 
development investments would be defined to mean equity investments 
that are designed primarily to promote community welfare, including 
the welfare of low- and moderate-income communities or families, 
such as by providing services or jobs, and excluding equity 
exposures to an unconsolidated small business investment company and 
equity exposures held through a consolidated small business 
investment company described in section 302 of the Small Business 
Investment Act of 1958 (15 U.S.C. 682).
---------------------------------------------------------------------------

    The agencies are proposing a separate treatment for equity 
exposures to an investment fund to prevent banks from arbitraging the 
proposed rule's risk-based capital requirements for certain high-risk 
exposures and to ensure that banking organizations do not receive a 
punitive risk-based capital requirement for equity exposures to 
investment funds that hold only low-risk assets. Under this proposal, 
the agencies would define an investment fund as a company (i) all or 
substantially all of the assets of which are financial assets and (ii) 
that has no material liabilities. As proposed, a banking organization 
would determine the risk-weighted asset amount for equity exposures to 
investment funds using one of four approaches: The full look-through 
approach, the simple modified look-through approach, the alternative 
modified look-through approach, or for qualifying investment funds, the 
money market fund approach, unless the equity exposure to an investment 
fund is a community development equity exposure. Such community 
development equity exposures would be subject to a 100 percent risk 
weight. If an equity exposure to an investment fund is part of a hedge 
pair, a banking organization could use the ineffective portion of the 
hedge pair as the adjusted carrying value for the equity exposure to 
the investment fund. The risk-weighted asset amount of the effective 
portion of the hedge pair would be equal to its adjusted carrying 
value. A banking organization could choose to apply a different 
approach among the four alternatives to different equity exposures to 
investment funds.
(7) Full Look-Through Approach
    A banking organization may use the full look-through approach only 
if the banking organization is able to compute a risk-weighted asset 
amount for each of the exposures held by the investment fund. Under the 
proposed rule, a banking organization would be required to calculate 
the risk-weighted asset amount for each of the exposures held by the 
investment fund as if the exposures were held directly by the banking 
organization. Depending on the exposure type, a banking organization 
would apply the appropriate proposed rule treatment to an equity 
exposure to an investment fund. The banking organization's risk-
weighted asset amount for the fund would be equal to the total risk-
weighted amount for the exposures held by the fund multiplied by the 
banking organization's proportional interest in the fund.
(8) Simple Modified Look-Through Approach
    Under the proposed simple modified look-through approach, a banking 
organization would set the risk-weighted asset amount for its equity 
exposure to an investment fund equal to the adjusted carrying value of 
the equity exposure multiplied by the highest risk weight that applies 
to any exposure the fund is permitted to hold under its prospectus, 
partnership agreement, or similar contract that defines the fund's

[[Page 44020]]

permissible investments. The banking organization could exclude 
derivative contracts held by the fund that are used for hedging, not 
speculative purposes, and do not constitute a material portion of the 
fund's exposures.
(9) Alternative Modified Look-Through Approach
    Under this approach, a banking organization may assign the adjusted 
carrying value of an equity exposure to an investment fund on a pro 
rata basis to risk-weight categories based on the investment limits in 
the fund's prospectus, partnership agreement, or similar contract that 
defines the fund's permissible investments. The risk-weighted amount 
for the banking organization's equity exposure to the investment fund 
would be equal to the sum of each portion of the adjusted carrying 
value assigned to an exposure class multiplied by the applicable risk 
weight. If the sum of the investment limits for all exposure classes 
within the fund exceeds 100 percent, the banking organization must 
assume that the fund invests to the maximum extent permitted under its 
investment limits in the exposure class with the highest risk weight in 
this proposed rule, and continues to make investments in the order of 
the exposure class with the next highest risk weight until the maximum 
total investment level is reached. If more than one exposure class 
applies to an exposure, the banking organization would use the highest 
applicable risk weight. A banking organization could exclude derivative 
contracts held by the fund that are used for hedging, not speculative, 
purposes and do not constitute a material portion of the fund's 
exposures.
(10) Money Market Fund Approach
    Under this proposed rule, a banking organization may apply a seven 
percent risk weight to an equity exposure to a money market fund that 
is subject to SEC rule 2a-7 and that has an applicable external rating 
in the highest investment-grade category.

O. Operational Risk

(1) Basic Indicator Approach (BIA)
    The general risk-based capital rules do not include an explicit 
capital charge for operational risk. Rather, the general risk-based 
capital rules were designed to focus on credit risk. However, due to 
their broad-brush nature, the rules implicitly cover other types of 
risks such as operational risk. The more risk-sensitive treatment under 
the standardized approach for credit risk sharpens the capital measure 
for that element of the risk-based capital charge and lessens the 
implicit capital buffer for other risks.
    The agencies recognize that operational risk is an important risk 
and that a number of factors are driving increases in operational risk. 
These factors include greater use of automated technology; 
proliferation of new and highly complex products; growth of e-banking 
transactions and related business applications; large-scale 
acquisitions, mergers and consolidations; and greater use of 
outsourcing arrangements. These factors, and in light of the agencies' 
goal to promote improved risk measurement processes support the 
inclusion of an explicit capital requirement for operational risk for 
those institutions that adopt the proposed rule.
    Consistent with the New Accord, the agencies propose to implement 
the BIA for determining a banking organization's risk-based capital 
requirement for operational risk. The operational risk capital 
requirement would cover the risk of loss resulting from inadequate or 
failed internal processes, people, and systems or from external events. 
Operational risk includes legal risk, which is the risk of loss 
(including litigation costs, settlements, and regulatory fines) 
resulting from the failure of the banking organization to comply with 
laws, regulations, prudent ethical standards, and contractual 
obligations in any aspect of the banking organization's business, but 
excludes strategic and reputational risks.
    Under the BIA, a banking organization's risk-weighted assets for 
operational risk would equal 15 percent of its average positive annual 
gross income over the previous three years multiplied by 12.5. The 
calculation of average positive annual gross income is based on annual 
gross income as reported by the banking organization in its regulatory 
financial reports over the three most recent calendar years as 
discussed below. Gross income is a proxy for the scale of a banking 
organization's operational risk exposure and can, in some instances 
(for example, for a banking organization with low margins or 
profitability) underestimate the banking organization's capital needs 
for operational risk. Therefore, a banking organization using the BIA 
should manage its operational risk consistent with the Basel 
Committee's ``Sound Practices for the Management and Supervision of 
Operational Risk'' guidance, which includes a set of principles for the 
effective management of operational risk.\58\
---------------------------------------------------------------------------

    \58\ See the February 2003 BCBS publication entitled ``Sound 
Practices for the Management and Supervision of Operational Risk.''
---------------------------------------------------------------------------

    The proposed rule defines average positive annual gross income as 
the sum of the banking organization's positive annual gross income, as 
described below, over the three most recent calendar years. This 
calculation would not include any amounts from any year in which annual 
gross income is negative or zero; that is, it is the sum of its 
positive annual gross income divided by the number of years in which 
its annual gross income was positive. Annual gross income would equal:
    (i) For a bank, its net interest income plus its total noninterest 
income minus its underwriting income from insurance and reinsurance 
activities as reported on the bank's year-end Consolidated Reports of 
Condition and Income (Call Report).
    (ii) For a bank holding company, its net interest income plus its 
total noninterest income minus its underwriting income from insurance 
and reinsurance activities as reported on the bank holding company's 
Consolidated Financial Statements for Bank Holding Companies (Y9-C 
Report).
    (iii) For a savings association, its net interest income (expense) 
before provision for losses on interest-bearing assets, plus total 
noninterest income, minus the portion of its other fees and charges 
that represents income derived from insurance and reinsurance 
underwriting activities, minus (plus) its income (loss) from the sale 
of assets held-for-sale and available-for-sale securities to include 
only the profit or loss from the disposition of available-for-sale 
securities pursuant to FASB Statement No. 115, minus (plus) its income 
(loss) from the sale of securities held-to-maturity, all as reported on 
the savings association's year-end Thrift Financial Report (TFR).

[[Page 44021]]

    Table 18 illustrates the relevant components of average positive 
annual gross income from regulatory reports.

                                 Table 18.--Calculation of Gross Income for BIA
----------------------------------------------------------------------------------------------------------------
       For Bank FFIEC 031/041, BHC Y-9C, and TFR reporting          Call report        Y-9C             TFR
----------------------------------------------------------------------------------------------------------------
                    Item No. from
    Item No.       Schedules RI and        Description                 RIAD            BHC K            SO
                          HI
----------------------------------------------------------------------------------------------------------------
1...............  3................  Net interest income...  ...            4074            4074           SO312
2...............  5.m..............  Total noninterest        +             4079            4079            SO42
                                      income.
3...............  5.d.(4)..........  Underwriting income      -             C386            C386             n/a
                                      from insurance and
                                      reinsurance
                                      activities.
4...............  n/a..............  Other fees and charges   -              n/a             n/a       \1\ SO420
5...............  n/a..............  Sale of assets held-     -              n/a             n/a       \2\ SO430
                                      for-sale and of
                                      available-for-sale
                                      securities.
6...............  n/a..............  Sale of securities       -              n/a             n/a           SO467
                                      held-to-maturity.
7...............  n/a..............  Gross income for BIA..  ...  ..............  ..............  ..............
----------------------------------------------------------------------------------------------------------------
\1\ Include only the portion of SO420 that represents income derived from insurance and reinsurance underwriting
  activities.
\2\ Include only ``profit or loss from the disposition of available-for-sale securities pursuant to FASB
  Statement No. 115'' from SO430.

    Question 19: The agencies solicit comment on this proposed 
treatment of operational risk, and, in particular, on the 
appropriateness of the proposed average positive gross income 
calculation.
(2) Advanced Measurement Approaches (AMA)
    Under the AMA framework of the New Accord, a banking organization 
that meets the qualifying criteria for AMA would use its internal 
operational risk quantifications system to calculate its risk-based 
capital requirement for operational risk. The AMA framework is fully 
discussed in the advanced approaches final rule. The specific 
references in the advanced approaches final rule's preamble and common 
rule text are: (i) Preamble; \59\ (ii) section 22(c) and certain other 
paragraphs in section 22 of the common rule text,\60\ such as (a)(2) 
and (3), (i), (j), and (k), which discuss advanced systems in general 
and therefore would apply to AMA; (iii) sections 22(h), 61, and 62 of 
the common rule text; \61\ (iv) applicable definitions in section 2 of 
the common rule text; \62\ and (v) applicable disclosure requirements 
in Table 11.9 of the common rule text. \63\
---------------------------------------------------------------------------

    \59\ See 72 FR 69302-21, 69382-84, and 69293-94 (December 7, 
2007).
    \60\ Id. at 69407-08.
    \61\ Id. at 69407-08 and 69428-29.
    \62\ Id. at 69397-405.
    \63\ Id. at 69436.
---------------------------------------------------------------------------

    Under the New Accord, the AMA option may be made available for 
banking organizations that apply any of the New Accord's approaches to 
credit risk. The agencies are considering whether to implement the AMA 
option in a standardized framework final rule consistent with the 
requirements in the advanced approaches final rule. Accordingly, the 
agencies would like to know whether any banking organizations that 
would be eligible to opt in to a standardized framework believe that 
they can meet the advance systems requirements that would qualify them 
to use the more complex AMA approach for calculating their risk-based 
capital requirement for operational risk.
    Question 20: The agencies therefore solicit comment on the 
appropriateness of including the AMA for calculating the risk-based 
capital requirement for operational risk in any final rule implementing 
the standardized framework and the extent to which banking 
organizations implementing the standardized approach believe they can 
meet the associated advanced modeling and systems requirements.

P. Supervisory Oversight and Internal Capital Adequacy Assessment

    One of the objectives of the New Accord is to provide incentives 
for banking organizations to develop and apply better techniques for 
measuring and managing risks and ensuring that capital is adequate to 
support those risks, not just to meet minimum regulatory capital 
requirements. Consistent with the agencies' general risk-based capital 
rules and Pillar 2 of the New Accord, the proposed rule would require a 
banking organization to hold capital that is commensurate with the 
level and nature of all risks to which the banking organization is 
exposed, and to have both a rigorous process for assessing its overall 
capital adequacy in relation to its risk profile and a comprehensive 
strategy for maintaining appropriate capital levels.
    Consistent with existing supervisory practice, a banking 
organization's primary Federal supervisor would evaluate a banking 
organization's compliance with the minimum capital requirements and 
also evaluate how well the banking organization is assessing its 
capital needs relative to its risks and capital goals. Also, consistent 
with existing supervisory practice, a primary Federal supervisor may 
require a banking organization under its jurisdiction to increase its 
capital levels or reduce its risk exposures if capital is deemed 
inadequate relative to a banking organization's risk profile.

Q. Market Discipline

(1) Overview
    The general risk-based capital rules do not require disclosures 
beyond the filing of the risk-based capital section of the agencies' 
regulatory reports (that is, FR Y9-C, Call Reports, TFR, etc). The 
agencies, however, have long supported meaningful public disclosure by 
banking organizations to improve market discipline. The agencies 
recognize the importance of market discipline in encouraging sound risk 
management practices and fostering financial stability.
    Pillar 3 of the New Accord, market discipline, complements the 
minimum capital requirements and the supervisory review process by 
encouraging market discipline through enhanced and meaningful public 
disclosure. These proposed public disclosure requirements are intended 
to allow market participants to assess key information about a banking 
organization's risk profile and its associated level of capital.

[[Page 44022]]

    With enhanced transparency, investors can better evaluate a banking 
organization's capital structure, risk exposures, and capital adequacy. 
With sufficient and relevant information, market participants can 
better evaluate a banking organization's risk management performance, 
earnings potential, and financial strength.
    Improvements in public disclosures come not only from regulatory 
standards, but also through efforts by a banking organization's 
management to improve communications to public shareholders and other 
market participants. In this regard, improvements to risk management 
processes and internal reporting systems provide opportunities to 
improve significantly public disclosures over time. Accordingly, the 
agencies strongly encourage the management of each banking organization 
to review regularly its public disclosures and enhance these 
disclosures, where appropriate, to identify clearly all significant 
risk exposures, whether on- or off-balance sheet, and their effects on 
the banking organization's financial condition and performance, cash 
flow, and earnings potential.
(2) General Requirements
    The proposed public disclosure requirements apply to the top-tier 
legal entity that is a banking organization within a consolidated 
banking group (that is, the top-tier banking organization). In general, 
a banking organization that is a subsidiary of a bank holding company 
(BHC) or another banking organization would not be subject to the 
disclosure requirements, except that every banking organization would 
have to disclose total and tier 1 capital ratios and their components, 
similar to current requirements. If a banking organization is not a 
subsidiary of a BHC or another banking organization that must make the 
full set of disclosures, the banking organization would have to make 
these disclosures.
    A banking organization's exposure to risk and the techniques that 
it uses to identify, measure, monitor, and control those risks are 
important factors that market participants consider in their assessment 
of the institution. Accordingly, each banking organization that is 
subject to the disclosure requirements would have a formal disclosure 
policy approved by its board of directors that addresses the banking 
organization's approach for determining the disclosures it should make. 
The policy should address the associated internal controls and 
disclosure controls and procedures. The board of directors and senior 
management would have to ensure that appropriate review of the 
disclosures takes place and that effective internal controls and 
disclosure controls and procedures are maintained.
    A banking organization should decide which disclosures are relevant 
for it based on a materiality concept. Information would be regarded as 
material if its omission or misstatement could change or influence the 
assessment or decision of a user relying on that information for the 
purpose of making investment decisions.
    A banking organization may be able to fulfill some of the proposed 
disclosure requirements by relying on similar disclosures made in 
accordance with accounting standards or SEC mandates. In these 
situations, a banking organization must explain material differences 
between the accounting or other disclosures and the disclosures 
required under this proposed rule.
(3) Frequency/Timeliness
    Consistent with longstanding requirements in the United States for 
robust quarterly disclosures in financial and regulatory reports, and 
considering the potential for rapid changes in risk profiles, this NPR 
would require that quantitative disclosures be made quarterly. However, 
qualitative disclosures that provide a general summary of a banking 
organization's risk management objectives and policies, reporting 
system, and definitions may be disclosed annually, provided any 
significant changes to these are disclosed in the interim. The 
disclosures must be timely, that is, made by the reporting deadline for 
financial reports (for example SEC forms 10-Q and 10-K) or 45 days 
after the calendar quarter-end. When these deadlines differ, the later 
deadline should be used.
    In some cases, management may determine that a significant change 
has occurred, such that the most recent reported amounts do not reflect 
the banking organization's capital adequacy and risk profile. In those 
cases, a banking organization would have to disclose the general nature 
of these changes and briefly describe how they are likely to affect 
public disclosures going forward. A banking organization would make 
these interim disclosures as soon as practicable after the 
determination that a significant change has occurred.
(4) Location of Disclosures and Audit/Certification Requirements
    The disclosures would have to be publicly available (for example, 
included on a public Web site) for each of the last three years or such 
shorter time period since the banking organization opted into the 
standardized framework. Except as discussed below, management would 
have some discretion to determine the appropriate medium and location 
of the disclosure. Furthermore, a banking organization would have 
flexibility in formatting its public disclosures.
    The agencies encourage management to provide all of the required 
disclosures in one place on the entity's public Web site. The public 
Web site address would be reported in a regulatory report. 
Alternatively, banking organizations would be permitted to provide the 
disclosures in more than one place, as some of them may be included in 
public financial reports (for example, in Management's Discussion and 
Analysis included in SEC filings) or other regulatory reports. The 
agencies would encourage such banking organizations to provide a 
summary table on their public Web site that specifically indicates 
where all the disclosures may be found (for example, regulatory report 
schedules, pages numbers in annual reports).
    Disclosures of tier 1 and total capital ratios would be tested by 
external auditors as part of the financial statement audit, if the 
banking organization is required to obtain financial statement audits. 
Disclosures that are not included in the footnotes to the audited 
financial statements are not subject to external audit reports for 
financial statements or internal control reports from management and 
the external auditor. Due to the importance of reliable disclosures, 
the agencies would require one or more senior officers to attest that 
the disclosures would meet the proposed disclosure requirements. The 
senior officer may be the chief financial officer, the chief risk 
officer, an equivalent senior officer, or a combination thereof.
(5) Proprietary and Confidential Information
    The agencies believe that the proposed requirements strike an 
appropriate balance between the need for meaningful disclosure and the 
protection of proprietary and confidential information.\64\ 
Accordingly, the agencies believe that banking organizations would be 
able to provide

[[Page 44023]]

all of these disclosures without revealing proprietary and confidential 
information. Only in rare circumstances might disclosure of certain 
items of information required by the proposed rule compel a banking 
organization to reveal confidential and proprietary information. In 
these unusual situations, the agencies propose that if a banking 
organization believes that disclosure of specific commercial or 
financial information would prejudice seriously the position of the 
banking organization by making public information that is either 
proprietary or confidential in nature, the banking organization need 
not disclose those specific items. Instead, the banking organization 
must disclose more general information about the subject matter of the 
requirement, together with the fact that, and the reason why, the 
specific items of information have not been disclosed. This provision 
would apply only to those disclosures included in this NPR and does not 
apply to disclosure requirements imposed by accounting standards or 
other regulatory agencies.
---------------------------------------------------------------------------

    \64\ Proprietary information encompasses information that, if 
shared with competitors, would render a banking organization's 
investment in these products/systems less valuable, and, hence, 
could undermine its competitive position. Information about 
customers is often confidential, in that it is provided under the 
terms of a legal agreement or counterparty relationship.
---------------------------------------------------------------------------

    Question 21: The agencies seek commenters' views on all of the 
elements of the proposed public disclosure requirements. In particular, 
the agencies seek comment on the extent to which the proposed 
disclosures balance providing market participants with sufficient 
information to appropriately assess the risk profile and capital 
strength of individual institutions, fostering comparability across 
banking organizations, and minimizing burden on the banking 
organizations that are reporting the information. The agencies further 
request comment on whether certain banking organizations (for example, 
those not publicly listed or not required to have audited financial 
statements) should be exempt or have more limited disclosure 
requirements and, if so, how to preserve competitive equity with 
banking organizations required to make a full set of disclosures.
(6) Summary of Specific Public Disclosure Requirements
    The public disclosure requirements described in the tables in the 
proposed rule provide important information to market participants on 
the scope of application, capital, risk exposures, risk assessment 
processes, and, hence, the capital adequacy of the banking 
organization. The table numbers below refer to the table numbers in the 
proposed rule. For each separate risk area described in Table 15.4 
through 15.10, the banking organization would be required to describe 
its risk management objectives and policies. The agencies expect that 
these objectives and policies would include: (i) Strategies and 
processes; (ii) the structure and organization of the relevant risk 
management function; (iii) the scope and nature of risk reporting and/
or measurement systems; and (iv) policies for hedging and/or mitigating 
risk and strategies and processes for monitoring the continuing 
effectiveness of hedges/mitigants.
    A banking organization should focus on the substantive content of 
the tables, not the tables themselves. The proposed disclosures are:
     Table 15.1, Scope of Application, would include a 
description of the level in the banking organization to which the 
disclosures apply and an outline of any differences in consolidation 
for accounting and regulatory capital purposes, as well as a 
description of any restrictions on the transfer of funds and capital 
within the banking organization. These disclosures provide the basic 
context underlying regulatory capital calculations.
     Table 15.2, Capital Structure, would provide information 
on various components of regulatory capital available to absorb losses 
and allow for an evaluation of the quality of the capital available to 
absorb losses within the banking organization.
     Table 15.3, Capital Adequacy, would provide information 
about how a banking organization assesses the adequacy of its capital 
and set requirements that the banking organization disclose its risk-
weighted asset amounts for various asset categories. The table also 
requires disclosure of the regulatory capital ratios of the 
consolidated group and each DI subsidiary. Such disclosures provide 
insight into the overall adequacy of capital based on the risk profile 
of the banking organization.
     Tables 15.4 and 15.6, Credit Risk, would provide 
information for different types and concentrations of a banking 
organization's exposure to credit risk and the techniques the banking 
organization uses to measure, monitor, and mitigate that risk.
     Table 15.5, General Disclosures for Counterparty Credit 
Risk-Related Exposures, would provide information related to 
counterparty credit risk-related exposures.
     Table 15.7, Securitization, would provide information to 
market participants on the amount of credit risk transferred and 
retained by the banking organization through securitization 
transactions and the types of products securitized by the organization. 
These disclosures provide users a better understanding of how 
securitization transactions impact the credit risk of the banking 
organization.
     Table 15.8, Operational Risk, would provide insight into 
the banking organization's operational risk exposure.
     Table 15.9, Equities Not Subject to the Market Risk Rule, 
would provide market participants with an understanding of the types of 
equity securities held by the banking organization and how they are 
valued. This disclosure also would provide information on the capital 
allocated to different equity products and the amount of unrealized 
gains and losses.
     Table 15.10, Interest Rate Risk in Non-Trading Activities, 
would provide information about the potential risk of loss that may 
result from changes in interest rates and how the banking organization 
measures such risk.

III. Regulatory Analysis

A. Regulatory Flexibility Act Analysis

    Pursuant to section 605(b) of the Regulatory Flexibility Act, 5 
U.S.C. 605(b) (RFA), the regulatory flexibility analysis otherwise 
required under section 604 of the RFA is not required if an agency 
certifies that the rule will not have a significant economic impact on 
a substantial number of small entities (defined for purposes of the RFA 
to include banking organizations with assets less than or equal to $165 
million) and publishes its certification and a short, explanatory 
statement in the Federal Register along with its rule. Pursuant to 
section 605(b) of the RFA, the agencies certify that this proposed rule 
will not have a significant economic impact on a substantial number of 
small entities. Accordingly, a regulatory flexibility analysis is not 
needed. The amendments to the agencies' regulations described above are 
elective. They will apply only to banking organizations that opt to 
take advantage of the proposed revisions to the existing domestic risk-
based capital framework and that will not be required to use the 
advanced approaches contained in the advanced approaches final rule. 
The agencies believe that banking organizations that elect to adopt 
these proposals will generally be able to do so with data they 
currently use as part of their credit approval and portfolio management 
processes. Banking organizations not exercising this option would 
remain subject to the current capital framework. The proposal does not 
impose any new mandatory requirements or burdens. Moreover, industry 
groups representing small banking organizations that commented on the 
Basel IA NPR noted that small banking organizations typically hold

[[Page 44024]]

more capital than is required by the capital rules and would prefer to 
remain under the general risk-based capital rules. For these reasons, 
the proposal will not result in a significant economic impact on a 
substantial number of small entities.

B. OCC Executive Order 12866 Determination

    Executive Order 12866 requires federal agencies to prepare a 
regulatory impact analysis for agency actions that are found to be 
``significant regulatory actions''. Significant regulatory actions 
include, among other things, rulemakings that ``have an annual effect 
on the economy of $100 million or more or adversely affect in a 
material way the economy, a sector of the economy, productivity, 
competition, jobs, the environment, public health or safety, or state, 
local, or tribal governments or communities.'' \65\ Regulatory actions 
that satisfy one or more of these criteria are referred to as 
``economically significant regulatory actions.''
---------------------------------------------------------------------------

    \65\ Executive Order 12866 (September 30, 1993), 58 FR 51735 
(October 4, 1993), as amended by Executive Order 13258, 67 FR 9385 
(February 28, 2002) and by Executive Order 13422, 72 FR 2763 
(January 23, 2007). For the complete text of the definition of 
``significant regulatory action,'' see E.O. 12866 at Sec.  3(f). A 
``regulatory action'' is ``any substantive action by an agency 
(normally published in the Federal Register) that promulgates or is 
expected to lead to the promulgation of a final rule or regulation, 
including notices of inquiry, advance notices of proposed 
rulemaking, and notices of proposed rulemaking.'' E.O. 12866 at 
Sec.  3(e).
---------------------------------------------------------------------------

    Based on the OCC's estimate of the number of national banks likely 
to adopt this proposal and the proposal's total cost of approximately 
$74 million, the proposed rule would not have an annual effect on the 
economy of $100 million or more. In light of certain unique features of 
the proposal, the OCC has nevertheless prepared this regulatory impact 
analysis. Specifically, this proposal affords most national banks the 
option to apply this approach, which results in additional uncertainty 
in estimating the total costs.
    In conducting the regulatory analysis for an economically 
significant regulatory action, Executive Order 12866 requires each 
federal agency to provide to the Administrator of the Office of 
Management and Budget's Office of Information and Regulatory Affairs 
(OIRA):
     The text of the draft regulatory action, together with a 
reasonably detailed description of the need for the regulatory action 
and an explanation of how the regulatory action will meet that need;
     An assessment of the potential costs and benefits of the 
regulatory action, including an explanation of the manner in which the 
regulatory action is consistent with a statutory mandate and, to the 
extent permitted by law, promotes the President's priorities and avoids 
undue interference with state, local, and tribal governments in the 
exercise of their governmental functions;
     An assessment, including the underlying analysis, of 
benefits anticipated from the regulatory action (such as, but not 
limited to, the promotion of the efficient functioning of the economy 
and private markets, the enhancement of health and safety, the 
protection of the natural environment, and the elimination or reduction 
of discrimination or bias) together with, to the extent feasible, a 
quantification of those benefits;
     An assessment, including the underlying analysis, of costs 
anticipated from the regulatory action (such as, but not limited to, 
the direct cost both to the government in administering the regulation 
and to businesses and others in complying with the regulation, and any 
adverse effects on the efficient functioning of the economy, private 
markets (including productivity, employment, and competitiveness), 
health, safety, and the natural environment), together with, to the 
extent feasible, a quantification of those costs; and
     An assessment, including the underlying analysis, of costs 
and benefits of potentially effective and reasonably feasible 
alternatives to the planned regulation, identified by the agencies or 
the public (including improving the current regulation and reasonably 
viable nonregulatory actions), and an explanation why the planned 
regulatory action is preferable to the identified potential 
alternatives.
    Set forth below is a summary of the OCC's regulatory impact 
analysis, which can be found in its entirety at http://
www.occ.treas.gov/law/basel.htm under the link of ``Regulatory Impact 
Analysis for Risk-Based Capital Guidelines; Capital Adequacy 
Guidelines; Capital Maintenance: Standardized Risk-Based Capital Rules 
(Basel II: Standardized Option), Office of the Comptroller of the 
Currency, International and Economic Affairs (2008)''.

I. The Need for the Regulatory Action

    Federal banking law directs federal banking agencies, including the 
Office of the Comptroller of the Currency (OCC), to require banking 
organizations to hold adequate capital. The law authorizes federal 
banking agencies to set minimum capital levels to ensure that banking 
organizations maintain adequate capital. The law also gives federal 
banking agencies broad discretion with respect to capital regulation by 
authorizing them to also use any other methods that they deem 
appropriate to ensure capital adequacy.
    Capital regulation seeks to address market failures that stem from 
several sources. Asymmetric information about the risk in a banking 
organization's portfolio creates a market failure by hindering the 
ability of creditors and outside monitors to discern a banking 
organization's actual risk and capital adequacy. Moral hazard creates 
market failure in which the banking organization's creditors fail to 
restrain the banking organization from taking excessive risks because 
deposit insurance either fully or partially protects them from losses. 
Public policy addresses these market failures because individual banks 
fail to adequately consider the positive externality or public benefit 
that adequate capital brings to financial markets and the economy as a 
whole.
    Capital regulations cannot be static. Innovation in and 
transformation of financial markets require periodic reassessments of 
what may count as capital and what amount of capital is adequate. 
Continuing changes in financial markets create both a need and an 
opportunity to refine capital standards in banking. The proposed 
revisions to U.S. risk-based capital rules, ``Risk-Based Capital 
Guidelines; Capital Adequacy Guidelines; Capital Maintenance: 
Standardized Risk-Based Capital Rules'' (standardized option), which we 
address in this impact analysis, provide a new option for determining 
risk-based capital for banking organizations not required to operate 
under ``Risk-Based Capital Standards: Advanced Capital Adequacy 
Framework'' (advanced approaches). The standardized option and the 
advanced approaches reflect the implementation in the United States of 
the Basel Committee on Banking Supervision's ``International 
Convergence of Capital Measurement and Capital Standards: A Revised 
Framework'' (New Accord).

II. Regulatory Background

    The proposed capital regulation examined in this analysis would 
apply to commercial banks and savings associations (collectively, 
banks). Three banking agencies, the OCC, the Board of Governors of the 
Federal Reserve System (Board), and the Federal Deposit Insurance 
Corporation (FDIC) regulate commercial banks, while the Office of 
Thrift Supervision (OTS) regulates all federally chartered and many 
state-chartered savings associations.

[[Page 44025]]

Throughout this document, the four are jointly referred to as the 
federal banking agencies.
    The New Accord comprises three mutually reinforcing ``pillars'' as 
summarized below.
1. Minimum Capital Requirements (Pillar 1)
    The first pillar establishes a method for calculating minimum 
regulatory capital. It sets new requirements for assessing credit risk 
and operational risk while generally retaining the approach to market 
risk as developed in the 1996 amendments to the 1988 Accord.
    The New Accord offers banks a choice of three methodologies for 
calculating the capital charge for credit risk. The first approach, 
called the standardized approach, essentially refines the risk-
weighting framework of the 1988 Accord. The other two approaches are 
variations on an internal ratings-based (IRB) approach that leverages 
banks' internal credit-rating systems: A ``foundation'' methodology, 
whereby banks estimate the probability of borrower or obligor default, 
and an ``advanced'' approach, whereby organizations also supply other 
inputs needed for the capital calculation. In addition, the new 
framework uses more risk-sensitive methods for dealing with collateral, 
guarantees, credit derivatives, securitizations, and receivables.
    The New Accord also introduces an explicit capital requirement for 
operational risk.\66\ The New Accord offers banking organizations a 
choice of three methodologies for calculating their capital charge for 
operational risk. The first method, called the basic indicator 
approach, requires banks to hold capital for operational risk equal to 
15 percent of annual gross income (averaged over the most recent three 
years). The second option, called the standardized approach, uses a 
formula that divides a banking organization's activities into eight 
business lines, calculates the capital charge for each business line as 
a fixed percentage of gross income (12 percent, 15 percent, or 18 
percent depending on the nature of the business, again averaged over 
the most recent three years), and then sums across business lines. The 
third option, called the advanced measurement approaches (AMA), uses an 
institution's internal operational risk measurement system to determine 
the capital requirement.
---------------------------------------------------------------------------

    \66\ Operational risk is the risk of loss resulting from 
inadequate or failed processes, people, and systems or from external 
events. It includes legal risk but excludes strategic risk and 
reputation risk.
---------------------------------------------------------------------------

2. Supervisory Review Process (Pillar 2)
    The second pillar calls upon banking organizations to have an 
internal capital assessment process and banking supervisors to evaluate 
each banking organization's overall risk profile as well as its risk 
management and internal control processes. This pillar establishes an 
expectation that banking organizations hold capital beyond the minimums 
computed under Pillar 1, including additional capital for any risks 
that are not adequately captured under Pillar 1. It encourages banking 
organizations to develop better risk management techniques for 
monitoring and managing their risks. Pillar 2 also charges supervisors 
with the responsibility to ensure that banking organizations using 
advanced Pillar 1 techniques, such as the advanced IRB approach to 
credit risk and the AMA for operational risk, comply with the minimum 
standards and disclosure requirements of those methods, and take action 
promptly if capital is not adequate.
3. Market Discipline (Pillar 3)
    The third pillar of the New Accord sets minimum disclosure 
requirements for banking organizations. The disclosures, covering the 
composition and structure of the banking organization's capital, the 
nature of its risk exposures, its risk management and internal control 
processes, and its capital adequacy, are intended to improve 
transparency and strengthen market discipline. By establishing a common 
set of disclosure requirements, Pillar 3 seeks to provide a consistent 
and understandable disclosure framework that market participants can 
use to assess key pieces of information on the risks and capital 
adequacy of a banking organization.
4. U.S. Implementation
    The proposed standardized option rule seeks to improve the risk 
sensitivity of existing risk-based capital rules. The standardized 
option would be voluntary and available to banking organizations not 
subject to the advanced approaches rule. Any institution that is not an 
advanced approaches bank would be able to remain under the existing 
risk-based capital rules or elect to adopt the standardized option. The 
standardized option would:
    1. Include a capital requirement for operational risk.
    2. Use external credit ratings to risk weight sovereign, public 
sector entity, corporate, and securitization exposures.
    3. Use the risk weight of the appropriate sovereign to assign risk 
weights for exposures to banks.
    4. Use loan-to-value ratios to risk-weight residential mortgages.
    5. Lower the risk weights for some retail exposures and small loans 
to businesses.
    6. Expand the range of credit risk mitigation techniques that are 
recognized for risk-based capital purposes, including expanding the 
range of recognized collateral and eligible guarantors.
    7. Increase the credit conversion factor for certain commitments 
with an original maturity of one year or less that are not 
unconditionally cancelable.
    8. Revise the risk weights for securitization exposures and assess 
a capital charge for early amortizations in securitizations of 
revolving exposures.
    9. Remove the 50 percent limit on the risk weight for certain 
derivative transactions.
    10. Revise the risk-based capital treatment for unsettled and 
failed trades for securities, foreign exchange, and commodities.
    11. Expand the range of methodologies available to banking 
organizations for measuring counterparty credit risk.
    The Agencies would continue to reserve the authority to require 
banking organizations to hold additional capital where appropriate.

III. Cost-Benefit Analysis of the Proposed Rule

    A cost-benefit analysis considers the costs and benefits of a 
proposal as they relate to society as a whole. The social benefits of a 
proposal are benefits that accrue directly to those subject to a 
proposal plus benefits that might accrue indirectly to the rest of 
society. Similarly, the overall social costs of a proposal are costs 
incurred directly by those subject to the rule and costs incurred 
indirectly by others. In the case of the Standardized Option, direct 
costs and benefits are those that apply to the banking organizations 
that are subject to the proposal. Indirect costs and benefits then stem 
from banks and other financial institutions that are not subject to the 
proposal, bank customers, and, through the safety and soundness 
externality, society as a whole.
    The broad social and economic benefit that derives from a safe and 
sound banking system supported by vigorous and comprehensive 
supervision, including ensuring adequate capital, clearly dwarfs any 
direct benefits that might accrue to institutions adopting the 
Standardized Option. Similarly, the social and economic cost of any 
reduction in the safety and soundness of the banking system would 
dramatically overshadow

[[Page 44026]]

any cost borne by banking organizations subject to the rule. The 
banking agencies are confident that the enhanced risk sensitivity of 
the proposed rule could allow banking organizations to more effectively 
achieve objectives that are consistent with a safe and sound banking 
system.
    Beyond this societal benefit from maintaining a safe and sound 
banking system, we do not anticipate additional benefits outside of 
those accruing directly to the banking organizations that elect to 
adopt the Standardized Option. Because many factors besides regulatory 
capital requirements affect pricing and lending decisions, we do not 
expect the adoption or non-adoption of the Standardized Option to 
affect pricing or lending. Hence, we do not anticipate any costs or 
benefits affecting the customers or competitors of institutions 
adopting the Standardized Option. For these reasons, the cost and 
benefit analysis of the Standardized Option is primarily an analysis of 
the costs and benefits directly attributable to institutions that might 
elect to adopt its capital rules.

A. Organizations Affected by the Proposed Rule \67\
---------------------------------------------------------------------------

    \67\ Unless otherwise noted, the population of banks and thrifts 
used in this analysis consists of all FDIC-insured institutions. 
Banking organizations are aggregated to the top holding company 
level.
---------------------------------------------------------------------------

    As of December 31, 2007, twelve banking organizations meet the 
criteria that would require them to adopt the U.S. implementation of 
the New Accord's advanced approaches. Removing those twelve mandatory 
advanced approaches institutions from the 7,415 FDIC-insured banking 
organizations active in December 2007 leaves 7,403 organizations that 
would be eligible to adopt the Standardized Option. Seven of the twelve 
mandatory advanced approaches institutions are national banks. Out of 
1,421 banking organizations with national banks, 1,414 national banking 
organizations would thus be eligible to adopt the Standardized Option.

B. Benefits of the Proposed Rule

    The proposed rule aims to enhance safety and soundness by improving 
the risk sensitivity of regulatory capital requirements. The proposed 
rule:
    1. Enhances the risk sensitivity of capital charges.
    2. Facilitates more efficient use of required bank capital.
    3. Recognizes new developments in financial markets.
    4. Mitigates potential distortions in minimum regulatory capital 
requirements between Advanced Approaches banking organizations and 
other banking organizations.
    5. Better aligns capital and operational risk and encourages 
banking organizations to mitigate operational risk.
    6. Enhances supervisory feedback.
    7. Promotes market discipline through enhanced disclosure.
    8. Preserves the benefits of international consistency and 
coordination achieved with the 1988 Basel Accord.
    9. Offers long-term flexibility to banking organizations by 
providing the ability to opt in to the standardized approach.

C. Costs of the Proposed Rule

    As with any rule, the costs of the proposal include necessary 
expenditures by banks and thrifts necessary to comply with the new 
regulation and costs to the federal banking agencies of implementing 
the new rules. Because of a lack of cost estimates from banking 
organizations, the OCC found it necessary to use a scope-of-work 
comparison with the Advanced Approaches in order to arrive at a cost 
estimate for the Standardized Option. Based on this rough assessment, 
we estimate that implementation costs for the Standardized Option could 
range from $200,000 at smaller institutions to $5 million at larger 
institutions.
1. Costs to Banking Organizations
    Explicit costs of implementing the proposed rule at banking 
organizations fall into two categories: Setup costs and ongoing costs. 
Setup costs are typically one-time expenses associated with introducing 
the new programs and procedures necessary to achieve initial compliance 
with the proposed rule. Setup costs may also involve expenses related 
to tracking and retrieving data needed to implement the proposed rule. 
Ongoing costs are also likely to reflect data costs associated with 
retrieving and preserving data.
    The total cost of the standardized option depends entirely on the 
number and size of institutions that elect to adopt the voluntary rule. 
Obviously, if the number of institutions adopting the standardized 
option is zero, then the cost to banks will be zero. Based on comment 
letters and discussions with bank supervision staff, we sought to 
identify national banks that would be most likely to adopt the 
standardized option. Because one of the principal changes in the 
standardized option affects the risk weighting for residential 
mortgages, we selected national banks with significant mortgage 
holdings as the more likely adopters of the new rule. In particular, 
our list of more likely adopters includes national banks where one-to-
four family first-lien mortgages comprise over 30 percent of all assets 
if the institution has less than $1 billion in assets and where the 
mortgage to asset ratio is over 20 percent at larger institutions. We 
also include the few national banks that do not meet the well-
capitalized threshold for their risk based capital-to-assets ratio as 
of December 31, 2007. Using those criteria, we identified 113 national 
banks, which if they adopted the standardized option would result in a 
total cost to national banks of approximately $74 million. Over time, 
the standardized option may become more appealing to a larger number of 
banks. The total cost of the proposed rule would consequently increase 
to the extent that more institutions opt into the standardized option 
over time. At present, it is unclear how many national banks will 
ultimately elect to adopt the standardized option. The standardized 
option's provision for an explicit charge for operational risk is 
another important factor that national banks will undoubtedly consider 
in assessing whether to adopt the standardized option. Although we are 
unable to estimate how many of our estimated adopters might be 
dissuaded from the standardized option because of an operational risk 
capital charge, we do believe that the explicit charge for operational 
risk could significantly reduce the number of likely adopters.\68\
---------------------------------------------------------------------------

    \68\ If the advanced measurement approach (AMA) option for 
operational risk were to be made available as part of the 
standardized option, we believe that its considerable startup 
requirements and accompanying costs would dissuade almost all 
institutions with less than $10 billion in assets from pursuing the 
AMA operational risk option.
---------------------------------------------------------------------------

2. Government Administrative Costs
    Like the banking organizations subject to new requirements, the 
costs to government agencies of implementing the proposed rule also 
involve both startup and ongoing costs. Startup costs include expenses 
related to the development of the regulatory proposals, costs of 
establishing new programs and procedures, and costs of initial training 
of bank examiners in the new programs and procedures. Ongoing costs 
include maintenance expenses for any additional examiners and analysts 
needed to regularly apply the new supervisory processes. In the case of 
the standardized option, because modest changes to Call Reports will 
capture most of the rule changes, these ongoing costs are likely to be 
minor.
    OCC expenditures fall into three broad categories: Training, 
guidance,

[[Page 44027]]

and supervision. Training includes expenses for workshops and other 
training courses and seminars for examiners. Guidance expenses reflect 
expenditures on the development of standardized option guidance. 
Supervision expenses reflect organization-specific supervisory 
activities. We estimate that OCC expenses for the standardized option 
will be approximately $4.3 million through 2008. We also expect 
expenditures of $1 million per year between 2009 and 2011. Applying a 
five percent discount rate to future expenditures, past expenses ($4.3 
million) plus the present value of future expenditures ($2.7 million) 
equals total OCC expenditures of $7 million on the standardized option.
3. Total Cost Estimate of Proposed Rule
    The OCC's estimate of the total cost of the proposed rule includes 
expenditures by banking organizations and the OCC from the present 
through 2011. Based on our estimate that approximately 113 national 
banks will adopt the standardized option at a cost to each institution 
of between $200,000 and $5 million depending on the size of the 
institution, we estimate that national banks will spend approximately 
$74 million on the standardized option. Combining expenditures provides 
an estimate of $81 million for the total cost of the proposed rule for 
the OCC and national banks.

IV. Analysis of Baseline and Alternatives

    In order to place the costs and benefits of the proposed rule in 
context, Executive Order 12866 requires a comparison between the 
proposed rule, a baseline of what the world would look like without the 
proposed rule, and a reasonable alternative to the proposed rule. In 
this regulatory impact analysis, we analyze one baseline and one 
alternative to the proposed rule. The baseline considers the 
possibility that the proposed standardized option rule is not adopted 
and current capital standards continue to apply.
    The baseline scenario appears in this analysis in order to estimate 
the effects of adopting the proposed rule relative to a hypothetical 
regulatory regime that might exist without the Standardized Option. 
Because the baseline scenario considers costs and benefits as if the 
proposed rule never existed, we set the costs and benefits of the 
baseline scenario to zero. Obviously, banking organizations face 
compliance costs and reap the benefits of a well-capitalized banking 
system even under the baseline. However, because we cannot quantify 
these costs and benefits, we normalize the baseline costs and benefits 
to zero and estimate the costs and benefits of the proposed rule and 
alternative as deviations from this zero baseline.
    1. Baseline Scenario: Current capital standards based on the 1988 
Basel Accord continue to apply.

Description of Baseline Scenario

    Under the Baseline Scenario, current capital rules would continue 
to apply to all banking organizations in the United States that are not 
subject to the U.S. implementation of the advanced approaches. Under 
this scenario, the United States would not adopt the proposed 
standardized option, but the implementation of the advanced approaches 
final rule would continue.

Change in Benefits: Baseline Scenario

    Staying with current capital rules instead of adopting the 
standardized option proposal would eliminate the nine benefits of the 
proposed rule listed above. Under the baseline, banking organizations 
not subject to the advanced approaches would not be given the option of 
voluntarily selecting the standardized option. Institutions that would 
have adopted the standardized option would not be able to take 
advantage of the enhanced risk sensitivity of its capital charges and 
the more efficient use of bank capital that implies.
    Without the standardized option, an institution would have to 
choose between the advanced approaches and the status quo. The baseline 
without the standardized option would leave a level playing field for 
all the non-core banks. However, the absence of an opportunity to 
mitigate potential distortions in minimum required capital would likely 
diminish this benefit in the eyes of an institution concerned about 
potential distortions created by the implementation of the advanced 
approaches.

Changes in Costs: Baseline Scenario

    Continuing to use current capital rules eliminates the benefits and 
the costs of adopting the proposed rule. As discussed above, under the 
proposed rule we estimate that organizations would spend up to $74 
million on implementation-related expenditures. Retaining current 
capital rules would eliminate any costs associated with the proposed 
rule, even though banking organizations would only incur those costs if 
they elected to do so.
    2. Alternative: Require all U.S. banking organizations not subject 
to the Advanced Approaches rule to adopt the Standardized Option.

Description of Alternative

    The only change between the proposed rule and the alternative is 
that adoption of the proposed rule would be mandatory under the 
alternative rather than voluntary. Under this alternative, the 
provisions of the proposed rule would remain intact and apply to all 
national banks that are not subject to the advanced approaches rule, 
i.e., mandatory advanced approaches institutions and those institutions 
that elect to adopt the advanced approaches framework.

Change in Benefits: Alternative

    Because there are no changes to the elements of the proposed rule 
under the alternative, the list of benefits remains the same. Among 
these benefits, only one benefit is lost by making the proposed rule 
mandatory: The benefit derived from the fact that the proposed rule is 
voluntary. As for the benefits relating to the enhanced risk 
sensitivity of capital charges, because adoption of the standardized 
option is mandatory under the alternative, more banks will be subject 
to the standardized option provisions and the aggregate level of 
benefits will be higher. Because we estimate that 113 national banks 
would adopt the standardized option voluntarily, the difference in the 
aggregate benefit level could be considerable.

Changes in Costs: Alternative

    Clearly the most significant drawback to the alternative is the 
dramatically increased cost of applying a new set of capital rules to 
almost all U.S. banking organizations. Under the alternative, direct 
costs would increase for every U.S. banking organization that would 
have elected to continue to use current capital rules under the 
proposed rule. The cost estimate for the alternative is the total cost 
estimate for a 100 percent adoption rate of the standardized option. 
With 1,414 national banking organizations eligible for the standardized 
option, we estimate that the cost to national banking organizations of 
the alternative is approximately $740 million. The actual cost may be 
somewhat less depending on the number of national banks that elect to 
adopt the advanced approaches rule, but it is much greater than our 
cost estimate of $74 million for the proposed rule.
    3. Overall Comparison of Proposed Rule with Baseline and 
Alternative.
    The New Accord and its U.S. implementation seek to incorporate risk 
measurement and risk management advances into capital requirements.

[[Page 44028]]

Risk-sensitive capital requirements are integral to ensuring an 
adequate capital cushion to absorb financial losses at financial 
institutions. In implementing the standardized option in the United 
States, the agencies' intent is to enhance risk sensitivity while 
maintaining a regulatory capital regime that is as rigorous as the 
current system. Total capital requirements under the standardized 
option, including capital for operational risk, will better allocate 
capital in the system. A better allocation will occur regardless of 
whether the minimum required capital at a particular institution is 
greater or less than it would be under current capital rules.
    The objective of the proposed rule is to enhance the risk 
sensitivity of capital charges for institutions not subject to the 
advanced approaches rule. The proposal also seeks to mitigate any 
potential distortions in minimum regulatory capital requirements that 
the implementation of the advanced approaches rule might create between 
large and small banking organizations. Like the Advanced Approaches 
rule, the anticipated benefits of the standardized option proposal are 
difficult to quantify in dollar terms. Nevertheless, the OCC believes 
that the proposed rule provides benefits associated with enhanced risk 
sensitivity and preserves the safety and soundness of the banking 
industry and the security of the Federal Deposit Insurance system. To 
offset the costs of the proposed rule, its voluntary nature offers 
regulatory flexibility that will allow institutions to adopt the 
standardized option on a bank-by-bank basis when an institution's 
anticipated benefits exceed the anticipated costs of adopting this 
regulation.
    The banking agencies are confident that the proposed rule could 
serve to strengthen institutions electing to adopt the standardized 
option while the safety and soundness of institutions electing to forgo 
the standardized option and the advanced approaches rule will not 
diminish. On the basis of our analysis, we believe that the benefits of 
the proposed rule are sufficient to offset the costs of implementing 
the proposed rule. However, with safety and soundness secure under 
either capital rule, we believe it is best to make the proposed rule 
voluntary in order to let each national bank decide whether it is in 
that institution's best interest to adopt the standardized option. This 
will help to ensure that the costs associated with implementation of 
the standardized option do not rise precipitously and outweigh the 
benefits. Because adoption is voluntary, the proposed rule offers an 
improvement over the baseline scenario and the alternative. The 
proposed rule offers an important degree of flexibility unavailable 
with either the baseline or the alternative. The baseline does not give 
banking organizations a way into the standardized option and the 
alternative does not offer them a way out. The alternative for 
mandatory adoption would compel most banking organizations to follow a 
new set of capital rules and require them to undertake the time and 
expense of adjusting to these new rules. The proposed rule offers a 
better balance between costs and benefits than either the baseline or 
the alternative. Overall, the OCC believes that the benefits of the 
proposed rule justify its potential costs.

C. OTS Executive Order 12866 Determination

    OTS concurs with OCC's RIA. Rather than replicate that analysis, 
OTS drafted an RIA incorporating OCC's analysis by reference and adding 
appropriate material reflecting unique aspects of the thrift industry. 
The full text of OTS's RIA is available at the locations designated for 
viewing the OTS docket, which are indicated in the ADDRESSES section 
above. OTS believes that its analysis meets the requirements of 
Executive Order 12866. The following discussion supplements OCC's 
summary of its RIA.
    OTS is the primary federal regulator for 826 federal- and state-
chartered savings associations with assets of $1.51 trillion as of 
December 31, 2007. OTS-regulated savings association assets are highly 
concentrated in residential mortgage-related assets, with approximately 
67 percent of total assets in residential mortgage-related assets. By 
contrast, OCC-regulated institutions tend to concentrate their assets 
in commercial loans, non-interest earning deposits, and other kinds of 
non-mortgage loans, with only 35 percent of total assets in residential 
mortgage-related assets. Accordingly, OTS's analysis focuses on the 
impact on proposed changes to the capital treatment of residential 
mortgages.
Benefit-Cost Analysis
    Overall, OTS believes that the benefits of the proposed rule 
justify its costs. OTS notes, however, that measuring costs and 
benefits of changes in minimum capital requirements pose considerable 
challenges. Costs can be difficult to attribute to particular 
expenditures because institutions are likely to incur some of the costs 
as part of their ongoing efforts to improve risk measurement and 
management systems. The measurement of benefits is more problematic 
because the benefits of the NPR are more qualitative than quantitative. 
Further, measurement problems exist even for those factors that 
ostensibly may have measurable effects, such as a lower capital 
requirement. Savings associations, particularly smaller institutions, 
generally hold capital well above regulatory minimums for a variety of 
reasons. Thus, the effect of reducing the regulatory capital 
requirement is uncertain and likely to vary across regulated savings 
associations. Nonetheless, OTS anticipates that a more risk sensitive 
allocation of regulatory capital may have a slight marginal effect on 
pricing and lending of adopting savings associations, but may not have 
a measurable effect on pricing and lending in the market at a whole.
    Under OTS's analysis, direct costs and benefits include costs and 
benefits to the approximately 180 savings associations that opt in to 
the proposed rule.\69\ Direct costs and benefits also include OTS's 
costs of implementing the proposed rule.
---------------------------------------------------------------------------

    \69\ OTS identified potential opt-in savings associations based 
on asset size, asset composition, and complexity. Specifically, OTS 
identified savings associations with total assets in excess of $500 
million as an appropriate threshold for opting in to the new 
framework. It further estimated that savings associations would opt 
in to the new framework if the institution has a concentration of 
first-lien mortgages equal to 30 percent (for savings associations 
with total assets between $500 million and $1 billion) and 20 
percent (for savings associations with assets in excess of $1 
billion).
---------------------------------------------------------------------------

1. Benefits
    OTS concurs with the OCC analysis identifying the benefits 
associated with the proposed rule. Among the benefits cited by OCC was 
the enhanced risk sensitivity of minimum regulatory capital 
requirements. Because savings associations have a greater concentration 
of their assets in first-lien mortgages, the most significant change 
for savings associations will involve the risk weighting of residential 
mortgages. Under the general risk-based capital rules, most prudently 
underwritten residential mortgages with LTV ratios at origination of 
less than 90 percent are risk weighed at 50 percent. Most other 
residential mortgages receive a risk weight of 100 percent. Under the 
proposed rule, risk-weights for residential mortgages would increase as 
the LTV ratios increase. Thus, the benefits of opting in to the new 
rules will be greater for savings associations to the extent that their 
lending and portfolio practices include lower LTV mortgages. OTS 
believes that this aspect of the proposed rule is likely to be the

[[Page 44029]]

major factor in a savings association's decision to adopt the proposed 
rule.
2. Costs
    OTS anticipates that the total direct costs of implementing the 
proposed rule will be $143.8 million. This estimate includes direct 
costs of $137.6 million for approximately 180 savings associations that 
would opt in to the proposed rule.\70\ OTS further estimated that the 
direct costs for OTS implementation expenses would be $6.2 million.
---------------------------------------------------------------------------

    \70\ The estimated cost per institution increased with the size 
of the total assets. OTS estimated that savings associations would 
have implementation costs of $500,000 (for savings associations with 
total assets between $500 million and $1 billion); $1 million (for 
savings associations with total assets between $1 billion and $10 
billion); and $5 million (for savings associations with total assets 
in excess of $10 billion.
---------------------------------------------------------------------------

3. Uncertainty of Costs and Benefits
    OTS concurs with the OCC discussion regarding the uncertainty of 
costs and benefits. To the extent that undesirable competitive 
inequities may emerge, the banking agencies have the power to respond 
to them through many channels, including, but not limited to suitable 
changes to capital adequacy regulation.
Analysis of Baseline and Alternatives.
    The OCC analysis includes a comparison between the NPR, a baseline 
scenario of what the world would look like without the NPR, and an 
alternative to the NPR. The selected alternative would require all 
banking organizations that are not subject to the advanced approaches 
rule to apply the NPR. OTS concurs in the OCC analysis and finds 
analogous results for savings associations. Specifically, OTS agrees 
with the OCC conclusion that the NPR could strengthen savings 
associations electing to opt in to the NPR and would not diminish the 
safety and soundness of savings associations that elect to forego the 
NPR or the advanced approaches.
1. Baseline Scenario
    In its analysis of the baseline scenario, which would leave the 
current risk-based capital rules unchanged, OCC determines that 
national banks could avoid $74 million of implementation-related 
expenditures that would otherwise be required by the NPR. As noted 
above, OTS estimates that 180 savings associations would spend up to 
$137.6 million to implement the NPR. Retaining the current capital 
rules without adopting the NPR would permit these savings associations 
to avoid these new expenditures.
2. Alternative Scenario
    In its analysis of the alternative scenario, OCC concludes that the 
aggregate benefits would considerably increase because 1,414 national 
banks, rather than 113, would implement the alternative. Under the 
alternative scenario, OTS estimates that the aggregate costs to savings 
associations would also increase considerably. Specifically, OTS 
estimates that these costs would increase from $137.6 million (for 180 
savings associations) to $339.8 million (for 820 savings 
associations).\71\
---------------------------------------------------------------------------

    \71\ Six of the 826 savings associations could not apply the NPR 
because they are subject to the advanced approaches rule.
---------------------------------------------------------------------------

D. OCC Executive Order 13132 Determination

    The OCC has determined that this proposed rule does not have any 
Federalism implications, as required by Executive Order 13132.

E. Paperwork Reduction Act

(1) Request for Comment on Proposed Information Collection
    In accordance with the requirements of the Paperwork Reduction Act 
of 1995, the agencies may not conduct or sponsor, and the respondent is 
not required to respond to, an information collection unless it 
displays a currently valid Office of Management and Budget (OMB) 
control number. The agencies are requesting comment on a proposed 
information collection. The agencies are also giving notice that the 
proposed collection of information has been submitted to OMB for review 
and approval.
    Comments are invited on:
    (a) Whether the collection of information is necessary for the 
proper performance of the agencies' functions, including whether the 
information has practical utility;
    (b) The accuracy of the estimates of the burden of the information 
collection, including the validity of the methodology and assumptions 
used;
    (c) Ways to enhance the quality, utility, and clarity of the 
information to be collected;
    (d) Ways to minimize the burden of the information collection on 
respondents, including through the use of automated collection 
techniques or other forms of information technology; and
    (e) Estimates of capital or startup costs and costs of operation, 
maintenance, and purchase of services to provide information.
    Commenters may submit comments on aspects of this notice that may 
affect reporting and disclosure requirements to the addresses listed in 
the ADDRESSES section of this NPR. Paperwork burden comments directed 
to the OCC should reference ``OMB Control No. 1557-NEW'' instead of the 
Docket ID.
(2) Proposed Information Collection
    Title of Information Collection: Risk-Based Capital Guidelines; 
Standardized Risk-Based Capital Rules
    Frequency of Response: event-generated and quarterly.
    Affected Public:
    OCC: National banks.
    Board: State member banks and bank holding companies.
    FDIC: Insured nonmember banks, insured state branches of foreign 
banks, and certain subsidiaries of these entities.
    OTS: Savings associations and certain of their subsidiaries.
    Abstract: The proposed rule sets forth revisions to the agencies' 
existing risk-based capital rules based on the provisions in the 
Standardized Approach for credit risk and the Basic Indicator Approach 
for operational risk contained in the capital adequacy framework titled 
``International Convergence of Capital Measurement and Capital 
Standards: A Revised Framework'' published by the Basel Committee on 
Banking Supervision in June 2004.
    The new information collection requirements in the proposed rule 
are found in Sections 1, 37, 42, and 71. The collections of information 
are necessary in order to implement the proposed standardized capital 
adequacy framework.
    Section 1 requires banking organizations to provide written 
notification prior to using the appendix to calculate their risk-based 
capital requirements (opt-in letter) or ceasing its use (opt-out 
letter). It also requires written notification prior to applying the 
principle of conservatism for a particular exposure. Section 37 
requires a banking organization's prior written notification before it 
can calculate its own collateral haircuts using its own internal 
estimates. It also requires a banking organization's prior written 
notification before it can estimate an exposure amount for a single-
product netting set of repo-style transactions and eligible margin 
loans when recognizing the risk-mitigating effects of financial 
collateral using the simple VaR methodology. The agencies believe that 
the notifications in Section 37 would in most cases be included in the 
opt-in letter discussed in Section 1. Section 42 requires certain 
public disclosures if a banking organization provides support

[[Page 44030]]

to a securitization in excess of its contractual obligation. Section 71 
requires a number of qualitative and quantitative disclosures regarding 
a banking organization's risk-based capital ratios and their 
components.
    Estimated Burden: The burden estimates below exclude any regulatory 
reporting burden associated with changes to the Consolidated Reports of 
Income and Condition for banks (FFIEC 031 and FFIEC 031; OMB Nos. 7100-
0036, 3064-0052, 1557-0081), the Thrift Financial Report for thrifts 
(TFR; OMB No. 1550-0023), and the Financial Statements for Bank Holding 
Companies (FR Y-9; OMB No. 7100-0128). The agencies are still 
considering whether to revise these information collections or to 
implement a new information collection for the regulatory reporting 
requirements. In either case, a separate notice would be published for 
comment on the regulatory reporting requirements.
    The burden associated with this collection of information may be 
summarized as follows:
OCC
    Number of Respondents: 113.
    Estimated Burden Per Respondent: Opt-in letter and prior approvals, 
3 hours; opt-out letter, 1 hour; and disclosures, 144 hours.
    Total Estimated Annual Burden: 16,272 hours.
Board
    Number of Respondents: 60.
    Estimated Burden Per Respondent: Opt-in letter and prior approvals, 
3 hours; opt-out letter, 1 hour; and disclosures, 144 hours.
    Total Estimated Annual Burden: 8,880 hours.
FDIC
    Number of Respondents: 61.
    Estimated Burden Per Respondent: Opt-in letter and prior approvals, 
3 hours; opt-out letter, 1 hour; and disclosures, 144 hours.
    Total Estimated Annual Burden: 9,032 hours.
OTS
    Number of Respondents: 180.
    Estimated Burden Per Respondent: Opt-in letter, 0.5 hours; prior 
approvals, 2.5 hours; opt-out letter, 1 hour; and disclosures, 144 
hours.
    Total Estimated Annual Burden: 26,120 hours.
    The agencies' estimates represent an average across all respondents 
and reflect variations between institutions based on their size, 
complexity, and practices. Each agency is responsible for estimating 
and reporting to OMB the total paperwork burden for the institutions 
for which they have administrative enforcement authority. They may, but 
are not required to, use the same methodology to determine their burden 
estimates.

F. OCC Unfunded Mandates Reform Act of 1995 Determination

    The Unfunded Mandates Reform Act of 1995 (Pub. L. 104-4) (UMRA) 
requires cost-benefit and other analyses for a rule that would include 
any Federal mandate that may result in the expenditure by state, local, 
and tribal governments, in the aggregate, or by the private sector of 
$100 million or more (adjusted annually for inflation) in any one year. 
The current inflation-adjusted expenditure threshold is $119.6 million. 
The requirements of the UMRA include assessing a rule's effects on 
future compliance costs; particular regions or state, local, or tribal 
governments; communities; segments of the private sector; productivity; 
economic growth; full employment; creation of productive jobs; and the 
international competitiveness of U.S. goods and services. The proposed 
rule qualifies as a significant regulatory action under the UMRA 
because its Federal mandates may result in the expenditure by the 
private sector of $119.6 or more in any one year. As permitted by 
section 202(c) of the UMRA, the required analyses have been prepared in 
conjunction with the Executive Order 12866 analysis document titled 
Regulatory Impact Analysis for Risk-Based Capital Guidelines; Capital 
Adequacy Guidelines; Capital Maintenance: Standardized Risk-Based 
Capital Rules (Basel II: Standardized Option). The analysis is 
available on the Internet at http://www.occ.treas.gov/law/basel.htm 
under the link of ``Regulatory Impact Analysis for Risk-Based Capital 
Guidelines; Capital Adequacy Guidelines; Capital Maintenance: 
Standardized Risk-Based Capital Rules (Basel II: Standardized Option), 
Office of the Comptroller of the Currency, International and Economic 
Affairs (2008).''

G. OTS Unfunded Mandates Reform Act of 1995 Determination

    The Unfunded Mandates Reform Act of 1995 (Pub. L. 104-4) (UMRA) 
requires cost-benefit and other analyses for a rule that would include 
any Federal mandate that may result in the expenditure by state, local, 
and tribal governments, in the aggregate, or by the private sector of 
$100 million or more (adjusted annually for inflation) in any one year. 
The current inflation-adjusted expenditure threshold is $119.6 million. 
The requirements of the UMRA include assessing a rule's effects on 
future compliance costs; particular regions or State, local, or tribal 
governments; communities; segments of the private sector; productivity; 
economic growth; full employment; creation of productive jobs; and the 
international competitiveness of U.S. goods and services. The proposed 
rule qualifies as a significant regulatory action under the UMRA 
because its Federal mandates may result in the expenditure by the 
private sector of $119.6 or more in any one year. As permitted by 
section 202(c) of the UMRA, the required analyses have been prepared in 
conjunction with the Executive Order 12866 analysis document titled 
Regulatory Impact Analysis for Risk-Based Capital Standards: Capital 
Adequacy Guidelines; Capital Maintenance; Domestic Capital 
Modifications (Basel II: Standardized Option). The analysis is 
available at the locations designated for viewing the OTS docket 
indicated in the ADDRESSES section above.

H. Solicitation of Comments on Use of Plain Language

    Section 722 of the GLBA required the Federal banking agencies to 
use plain language in all proposed and final rules published after 
January 1, 2000. The Federal banking agencies invite comment on how to 
make this proposed rule easier to understand. For example:
     Have we organized the material to suit your needs? If not, 
how could the rule be more clearly stated?
     Are the requirements in the rule clearly stated? If not, 
how could the rule be more clearly stated?
     Do the regulations contain technical language or jargon 
that is not clear? If so, which language requires clarification?
     Would a different format (grouping and order of sections, 
use of headings, paragraphing) make the regulation easier to 
understand? If so, what changes would make the regulation easier to 
understand?
     Would more, but shorter, sections be better? If so, which 
sections should be changed?
     What else could we do to make the regulation easier to 
understand?

Text of Common Appendix (All Agencies)

    The text of the agencies' common appendix appears below:

[[Page 44031]]

Appendix [--] to Part [--]--Capital Adequacy Guidelines for [Banks]: 
\72\ Standardized Framework
---------------------------------------------------------------------------

    \72\ For simplicity, and unless otherwise noted, this NPR uses 
the term [BANK] to include banks, savings associations, and bank 
holding companies. The term [agency] refers to the primary Federal 
supervisor of the bank applying the rule. The term [the general 
risk-based capital rules] refers to each agency's existing non-
internal ratings based capital rules. The term [the advanced 
approaches risk-based capital rules] refers to each agency's 
existing internal ratings based capital rules. The term [the market 
risk rule] refers to the agencies' existing market risk capital 
rules.
---------------------------------------------------------------------------

Part I General Provisions
    Section 1 Purpose, Applicability, Election Procedures, and 
Reservation of Authority
    Section 2 Definitions
    Section 3 Minimum Risk-Based Capital Requirements and Overall 
Capital Adequacy
    Section 4 Merger and Acquisition Transitional Arrangements
Part II Qualifying Capital
    Section 21 Modifications to Tier 1 and Tier 2 Capital
Part III Risk-Weighted Assets for General Credit Risk
    Section 31 Mechanics for Calculating Risk-Weighted Assets for 
General Credit Risk
    Section 32 Inferred Ratings for General Credit Risk
    Section 33 General Risk Weights
    Section 34 Off-Balance Sheet Exposures
    Section 35 OTC Derivative Contracts
    Section 36 Guarantees and Credit Derivatives: Substitution 
Treatment
    Section 37 Collateralized Transactions
    Section 38 Unsettled Transactions
Part IV Risk-Weighted Assets for Securitization Exposures
    Section 41 Operational Requirements for Securitization Exposures
    Section 42 Risk-Weighted Assets for Securitization Exposures
    Section 43 Ratings-Based Approach (RBA)
    Section 44 Securitization Exposures That Do Not Qualify for the 
RBA
    Section 45 Recognition of Credit Risk Mitigants for 
Securitization Exposures
    Section 46 Risk-Weighted Assets for Securitizations With Early 
Amortization Provisions
Part V Risk-Weighted Assets for Equity Exposures
    Section 51 Introduction and Exposure Measurement
    Section 52 Simple Risk-Weight Approach (SRWA)
    Section 53 Equity Exposures to Investment Funds
Part VI Risk-Weighted Assets for Operational Risk
    Section 61 Basic Indicator Approach
Part VII Disclosure
    Section 71 Disclosure Requirements

Part I. General Provisions

Section 1. Purpose, Applicability, Election Procedures, and 
Reservation of Authority

    (a) Purpose. This appendix establishes:
    (1) Methodologies for the calculation of risk-based capital 
requirements for [BANK]s that elect to use this appendix; and
    (2) Operational and public disclosure requirements for such 
[BANK]s.
    (b) Applicability. This appendix applies to a [BANK] that:
    (1) Elects to use this appendix to calculate its risk-based 
capital requirements;
    (2) Must use this appendix based on a determination by the 
[agency] under paragraph (c)(3) of this section;
    (3) Is a subsidiary of or controls a depository institution that 
uses 12 CFR part 3, appendix D; 12 CFR part 208, appendix G; 12 CFR 
part 325, appendix E; or 12 CFR part 567, appendix B to calculate it 
risk-based capital requirements; or
    (4) Is a subsidiary of a bank holding company that uses 12 CFR 
part 225, appendix H, to calculate its risk-based capital 
requirements.
    (c) Election procedures. (1) Opt-in procedures. (i) Except for a 
[BANK] that is required under section 1(b)(1) of [the advanced 
approaches risk-based capital rules] to use that capital framework 
(other than a [BANK] that is exempt under section 1(b)(3) of [the 
advanced approaches risk-based capital rules]), any [BANK] may elect 
to use this appendix to calculate its risk-based capital 
requirements.
    (ii) Unless otherwise waived by the [agency], a [BANK] must 
notify the [agency] of its intent to use this appendix in writing at 
least 60 days before the beginning of the calendar quarter in which 
it first uses this appendix. This notice must contain a list of any 
affiliated depository institutions or bank holding companies, if 
applicable, that seek not to apply this appendix under section 
1(c)(2)(iii) of 12 CFR part 3, appendix D; 12 CFR part 208, appendix 
G; 12 CFR part 225, appendix H; 12 CFR part 325, appendix E; or 12 
CFR part 567, appendix B.
    (2) Opt-out procedures. (i) A [BANK] that uses this appendix to 
calculate its risk-based capital requirements may instead elect to 
use the [the general risk-based capital rules] or [the advanced 
approaches risk-based capital rules].
    (ii) Unless otherwise waived by the [agency], a [BANK] must 
notify the [agency] of its intent to cease the use of this appendix 
in writing at least 60 days before the beginning of the calendar 
quarter in which it plans to cease the use of this appendix. Such 
notice must include an explanation of the [BANK]'s rationale for 
ceasing the use of this appendix and a statement regarding the 
appendix or rules the [BANK] plans to use to calculate its risk-
based capital requirements.
    (iii) A [BANK] that otherwise would be required to apply this 
appendix under paragraph (b)(3) or (b)(4) of this section may 
continue to use [the general risk-based capital rules] if the 
[agency] determines in writing that application of this appendix is 
not appropriate in light of the [BANK]'s asset size, level of 
complexity, risk profile, or scope of operations.
    (3) Supervisory application of this appendix and exclusion. (i) 
The [agency] may apply this appendix to any [BANK] if the [agency] 
determines that application of this appendix is appropriate in light 
of the [BANK]'s asset size, level of complexity, risk profile, or 
scope of operations.
    (ii) The [agency] may exclude a [BANK] that has opted-in under 
paragraph (c)(1) of this section from using this appendix if the 
[agency] determines that application of this appendix is not 
appropriate in light of the [BANK]'s asset size, level of 
complexity, risk profile, or scope of operations.
    (d) Reservation of authority. (1) Additional capital in the 
aggregate. The [agency] may require a [BANK] to hold an amount of 
capital greater than otherwise required under this appendix if the 
[agency] determines that the [BANK]'s risk-based capital requirement 
under this appendix is not commensurate with the [BANK]'s credit, 
market, operational, or other risks.
    (2) Risk-weighted asset amounts. (i) If the [agency] determines 
that the risk-weighted asset amount calculated under this appendix 
by the [BANK] for one or more exposures is not commensurate with the 
risks associated with those exposures, the [agency] may require the 
[BANK] to assign a different risk-weighted asset amount to the 
exposure(s) or to deduct the amount of the exposure from capital.
    (ii) If the [agency] determines that the risk-weighted asset 
amount for operational risk produced by the [BANK] under this 
appendix is not commensurate with the operational risks of the 
[BANK], the [agency] may require the [BANK] to assign a different 
risk-weighted asset amount for operational risk.
    (3) Other supervisory authority. Nothing in this appendix limits 
the authority of the [agency] under any other provision of law or 
regulation to take supervisory or enforcement action, including 
action to address unsafe or unsound practices or conditions, 
deficient capital levels, or violations of law.
    (e) Notice and response procedures. In making a determination 
under paragraph (c)(2)(iii), (c)(3), or (d) of this section, the 
[agency] will apply notice and response procedures in the same 
manner as the notice and response procedures in 12 CFR 3.12 (for 
national banks), 12 CFR 263.202 (for bank holding companies and 
state member banks), 12 CFR 325.6(c) (for state nonmember banks), 
and 12 CFR 567.3(d) (for savings associations).
    (f) Principle of conservatism. Notwithstanding the requirements 
of this appendix, a [BANK] may choose not to apply a provision of 
this appendix to one or more exposures, provided that:
    (1) The [BANK] can demonstrate on an ongoing basis to the 
satisfaction of the [agency] that not applying the provision would, 
in all circumstances, unambiguously generate a risk-based capital 
requirement for each such exposure greater than that which would 
otherwise be required under this appendix;
    (2) The [BANK] appropriately manages the risk of each such 
exposure;
    (3) The [BANK] notifies the [agency] in writing prior to 
applying this principle to each such exposure; and
    (4) The exposures to which the [BANK] applies this principle are 
not, in the aggregate, material to the [BANK].

[[Page 44032]]

Section 2. Definitions

    For the purposes of this appendix, the following definitions 
apply:
    Affiliate with respect to a company means any company that 
controls, is controlled by, or is under common control with, the 
company.
    Applicable external rating. (1) With respect to an exposure, 
applicable external rating means:
    (i) If the exposure has a single external rating, the external 
rating; and
    (ii) If the exposure has multiple external ratings, the lowest 
external rating.
    (2) See also external rating.
    Applicable inferred rating. (1) With respect to an exposure, 
applicable inferred rating means:
    (i) If the exposure has a single inferred rating, the inferred 
rating; and
    (ii) If the exposure has multiple inferred ratings, the lowest 
inferred rating.
    (2) See also external rating, inferred rating.
    Asset-backed commercial paper (ABCP) program means a program 
that primarily issues commercial paper that:
    (1) Has an external rating; and
    (2) Is backed by underlying exposures held in a bankruptcy-
remote securitization special purpose entity (SPE).
    Asset-backed commercial paper (ABCP) program sponsor means a 
[BANK] that:
    (1) Establishes an ABCP program;
    (2) Approves the sellers permitted to participate in an ABCP 
program;
    (3) Approves the exposures to be purchased by an ABCP program; 
or
    (4) Administers the ABCP program by monitoring the underlying 
exposures, underwriting or otherwise arranging for the placement of 
debt or other obligations issued by the program, compiling monthly 
reports, or ensuring compliance with the program documents and with 
the program's credit and investment policy.
    Carrying value means, with respect to an asset, the value of the 
asset on the balance sheet of the [BANK] determined in accordance 
with generally accepted accounting principles (GAAP).
    Clean-up call means a contractual provision that permits an 
originating [BANK] or servicer to call securitization exposures 
before their stated maturity or call date. (See also eligible clean-
up call.)
    Commitment means any legally binding arrangement that obligates 
a [BANK] to extend credit or to purchase assets.
    Commodity derivative contract means a commodity-linked swap, 
purchased commodity-linked option, forward commodity-linked 
contract, or any other instrument linked to commodities that gives 
rise to similar counterparty credit risks.
    Company means a corporation, partnership, limited liability 
company, business trust, special purpose entity, depository 
institution, association, or similar organization.
    Control. A person or company controls a company if it:
    (1) Owns, controls, or holds with power to vote 25 percent or 
more of a class of voting securities of the company; or
    (2) Consolidates the company for financial reporting purposes.
    Controlled early amortization provision means an early 
amortization provision that meets all the following conditions:
    (1) The originating [BANK] has appropriate policies and 
procedures to ensure that it has sufficient capital and liquidity 
available in the event of an early amortization;
    (2) Throughout the duration of the securitization (including the 
early amortization period), there is the same pro rata sharing of 
interest, principal, expenses, losses, fees, recoveries, and other 
cash flows from the underlying exposures based on the originating 
[BANK]'s and the investors' relative shares of the underlying 
exposures outstanding measured on a consistent monthly basis;
    (3) The amortization period is sufficient for at least 90 
percent of the total underlying exposures outstanding at the 
beginning of the early amortization period to be repaid or 
recognized as in default; and
    (4) The schedule for repayment of investor principal is not more 
rapid than would be allowed by straight-line amortization over an 
18-month period.
    Corporate exposure means a credit exposure to a natural person 
or a company (including an industrial development bond, an exposure 
to a government-sponsored entity (GSE), or an exposure to a 
securities broker or dealer) that is not:
    (1) An exposure to a sovereign entity, the Bank for 
International Settlements, the European Central Bank, the European 
Commission, the International Monetary Fund, a multilateral 
development bank (MDB), a depository institution, a foreign bank, a 
credit union, or a public sector entity (PSE);
    (2) A regulatory retail exposure;
    (3) A residential mortgage exposure;
    (4) A pre-sold construction loan;
    (5) A statutory multifamily mortgage;
    (6) A securitization exposure; or
    (7) An equity exposure.
    Credit derivative means a financial contract executed under 
standard industry credit derivative documentation that allows one 
party (the protection purchaser) to transfer the credit risk of one 
or more exposures (reference exposure) to another party (the 
protection provider). (See also eligible credit derivative.)
    Credit-enhancing interest-only strip (CEIO) means an on-balance 
sheet asset that, in form or in substance:
    (1) Represents a contractual right to receive some or all of the 
interest and no more than a minimal amount of principal due on the 
underlying exposures of a securitization; and
    (2) Exposes the holder to credit risk directly or indirectly 
associated with the underlying exposures that exceeds a pro rata 
share of the holder's claim on the underlying exposures, whether 
through subordination provisions or other credit-enhancement 
techniques.
    Credit-enhancing representations and warranties means 
representations and warranties that are made or assumed in 
connection with a transfer of underlying exposures (including loan 
servicing assets) and that obligate a [BANK] to protect another 
party from losses arising from the credit risk of the underlying 
exposures. Credit-enhancing representations and warranties include 
provisions to protect a party from losses resulting from the default 
or nonperformance of the obligors of the underlying exposures or 
from an insufficiency in the value of the collateral backing the 
underlying exposures. Credit-enhancing representations and 
warranties do not include:
    (1) Early default clauses and similar warranties that permit the 
return of, or premium refund clauses that cover, loans secured by a 
first lien on one-to-four family residential property for a period 
not to exceed 120 days from the date of transfer, provided that the 
date of transfer is within one year of origination of the 
residential mortgage exposure;
    (2) Premium refund clauses that cover underlying exposures 
guaranteed, in whole or in part, by the U.S. Government, a U.S. 
Government Agency, or a GSE, provided that the clauses are for a 
period not to exceed 120 days from the date of transfer; or
    (3) Warranties that permit the return of underlying exposures in 
instances of misrepresentation, fraud, or incomplete documentation.
    Credit risk mitigant means collateral, a credit derivative, or a 
guarantee.
    Depository institution means a depository institution as defined 
in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813).
    Derivative contract means a financial contract whose value is 
derived from the values of one or more underlying assets, reference 
rates, or indices of asset values or reference rates. Derivative 
contracts include interest rate derivative contracts, exchange rate 
derivative contracts, equity derivative contracts, commodity 
derivative contracts, credit derivative contracts, and any other 
instrument that poses similar counterparty credit risks. Derivative 
contracts also include unsettled securities, commodities, and 
foreign exchange transactions with a contractual settlement or 
delivery lag that is longer than the lesser of the market standard 
for the particular instrument or five business days.
    Early amortization provision means a provision in the 
documentation governing a securitization that, when triggered, 
causes investors in the securitization exposures to be repaid before 
the original stated maturity of the securitization exposures, unless 
the provision:
    (1) Is triggered solely by events not directly related to the 
performance of the underlying exposures or the originating [BANK] 
(such as material changes in tax laws or regulations); or
    (2) Leaves investors fully exposed to future draws by obligors 
on the underlying exposures even after the provision is triggered. 
(See also controlled early amortization provision.)
    Effective notional amount means, for an eligible guarantee or 
eligible credit derivative, the lesser of the contractual notional 
amount of the credit risk mitigant or the exposure amount of the 
hedged exposure, multiplied by the percentage coverage of the credit 
risk mitigant. For example, the effective notional amount of an 
eligible

[[Page 44033]]

guarantee that covers, on a pro rata basis, 40 percent of any losses 
on a $100 bond would be $40.
    Eligible asset-backed commercial paper (ABCP) liquidity facility 
means a liquidity facility supporting ABCP, in form or in substance, 
that is subject to an asset quality test at the time of draw that 
precludes funding against assets that are 90 days or more past due 
or in default. If the assets or exposures that an eligible ABCP 
liquidity facility is required to fund against are externally rated 
at the inception of the facility, the facility can be used to fund 
only those assets or exposures with an applicable external rating of 
at least investment grade at the time of funding. Notwithstanding 
the two preceding sentences, a liquidity facility is an eligible 
ABCP liquidity facility if the assets or exposures funded under the 
liquidity facility that do not meet the eligibility requirements are 
guaranteed by a sovereign entity with an issuer rating in one of the 
three highest investment grade rating categories.
    Eligible clean-up call means a clean-up call that:
    (1) Is exercisable solely at the discretion of the originating 
[BANK] or servicer;
    (2) Is not structured to avoid allocating losses to 
securitization exposures held by investors or otherwise structured 
to provide credit enhancement to the securitization; and
    (3)(i) For a traditional securitization, is only exercisable 
when 10 percent or less of the principal amount of the underlying 
exposures or securitization exposures (determined as of the 
inception of the securitization) is outstanding; or
    (ii) For a synthetic securitization, is only exercisable when 10 
percent or less of the principal amount of the reference portfolio 
of underlying exposures (determined as of the inception of the 
securitization) is outstanding.
    Eligible credit derivative means a credit derivative in the form 
of a credit default swap, nth-to-default swap, total return swap, or 
any other form of credit derivative approved by the [agency], 
provided that:
    (1) The contract meets the requirements of an eligible guarantee 
and has been confirmed by the protection purchaser and the 
protection provider;
    (2) Any assignment of the contract has been confirmed by all 
relevant parties;
    (3) If the credit derivative is a credit default swap or nth-to-
default swap, the contract includes the following credit events:
    (i) Failure to pay any amount due under the terms of the 
reference exposure, subject to any applicable minimal payment 
threshold that is consistent with standard market practice and with 
a grace period that is closely in line with the grace period of the 
reference exposure; and
    (ii) Bankruptcy, insolvency, or inability of the obligor on the 
reference exposure to pay its debts, or its failure or admission in 
writing of its inability generally to pay its debts as they become 
due, and similar events;
    (4) The terms and conditions dictating the manner in which the 
contract is to be settled are incorporated into the contract;
    (5) If the contract allows for cash settlement, the contract 
incorporates a robust valuation process to estimate loss reliably 
and specifies a reasonable period for obtaining post-credit event 
valuations of the reference exposure;
    (6) If the contract requires the protection purchaser to 
transfer an exposure to the protection provider at settlement, the 
terms of at least one of the exposures that is permitted to be 
transferred under the contract provide that any required consent to 
transfer may not be unreasonably withheld;
    (7) If the credit derivative is a credit default swap or nth-to-
default swap, the contract clearly identifies the parties 
responsible for determining whether a credit event has occurred, 
specifies that this determination is not the sole responsibility of 
the protection provider, and gives the protection purchaser the 
right to notify the protection provider of the occurrence of a 
credit event; and
    (8) If the credit derivative is a total return swap and the 
[BANK] records net payments received on the swap as net income, the 
[BANK] records offsetting deterioration in the value of the hedged 
exposure (through reductions in fair value).
    Eligible guarantee means a guarantee from an eligible guarantor 
that:
    (1) Is written;
    (2) Is either unconditional, or a contingent obligation of the 
United States Government or its agencies, the validity of which to 
the beneficiary is dependent upon some affirmative action on the 
part of the beneficiary of the guarantee or a third party (for 
example, servicing requirements);
    (3) Covers all or a pro rata portion of all contractual payments 
of the obligor on the reference exposure;
    (4) Gives the beneficiary a direct claim against the protection 
provider;
    (5) Is not unilaterally cancelable by the protection provider 
for reasons other than the breach of the contract by the 
beneficiary;
    (6) Is legally enforceable against the protection provider in a 
jurisdiction where the protection provider has sufficient assets 
against which a judgment may be attached and enforced;
    (7) Requires the protection provider to make payment to the 
beneficiary on the occurrence of a default (as defined in the 
guarantee) of the obligor on the reference exposure in a timely 
manner without the beneficiary first having to take legal actions to 
pursue the obligor for payment;
    (8) Does not increase the beneficiary's cost of credit 
protection on the guarantee in response to deterioration in the 
credit quality of the reference exposure; and
    (9) Is not provided by an affiliate of the [BANK], unless the 
affiliate is an insured depository institution, foreign bank, 
securities broker or dealer, or insurance company that:
    (i) Does not control the [BANK]; and
    (ii) Is subject to consolidated supervision and regulation 
comparable to that imposed on U.S. depository institutions, 
securities brokers or dealers, or insurance companies (as the case 
may be).
    Eligible guarantor means:
    (1) A sovereign entity, the Bank for International Settlements, 
the International Monetary Fund, the European Central Bank, the 
European Commission, a Federal Home Loan Bank, the Federal 
Agricultural Mortgage Corporation (Farmer Mac), an MDB, a depository 
institution, a foreign bank, a credit union, a bank holding company 
(as defined in section 2 of the Bank Holding Company Act (12 U.S.C. 
1841)), or a savings and loan holding company (as defined in 12 
U.S.C. 1467a) provided all or substantially all of the holding 
company's activities are permissible for a financial holding company 
under 12 U.S.C. 1843(k); or
    (2) Any other entity (other than a SPE) if at the time the 
entity issued the guarantee or credit derivative or any time 
thereafter, the entity has issued and outstanding an unsecured debt 
security without credit enhancement that has an applicable external 
rating based on a long-term rating.
    Eligible margin loan means an extension of credit where:
    (1) The extension of credit is collateralized exclusively by 
liquid and readily marketable debt or equity securities, gold, or 
conforming residential mortgage exposures;
    (2) The collateral is marked-to-market daily, and the 
transaction is subject to daily margin maintenance requirements;
    (3) The extension of credit is conducted under an agreement that 
provides the [BANK] the right to accelerate and terminate the 
extension of credit and to liquidate or set off collateral promptly 
upon an event of default (including upon an event of bankruptcy, 
insolvency, or similar proceeding) of the counterparty, provided 
that, in any such case, any exercise of rights under the agreement 
will not be stayed or avoided under applicable law in the relevant 
jurisdictions; \73\ and
---------------------------------------------------------------------------

    \73\ This requirement is met where all transactions under the 
agreement are (i) executed under U.S. law and (ii) constitute 
``securities contracts'' under section 555 of the Bankruptcy Code 
(11 U.S.C. 555), qualified financial contracts under section 
11(e)(8) of the Federal Deposit Insurance Act (12 U.S.C. 
1821(e)(8)), or netting contracts between or among financial 
institutions under sections 401-407 of the Federal Deposit Insurance 
Corporation Improvement Act of 1991 (12 U.S.C. 4401-4407) or the 
Federal Reserve Board's Regulation EE (12 CFR part 231).
---------------------------------------------------------------------------

    (4) The [BANK] has conducted sufficient legal review to conclude 
with a well-founded basis (and maintains sufficient written 
documentation of that legal review) that the agreement meets the 
requirements of paragraph (3) of this definition and is legal, 
valid, binding, and enforceable under applicable law in the relevant 
jurisdictions.
    Eligible servicer cash advance facility means a servicer cash 
advance facility in which:
    (1) The servicer is entitled to full reimbursement of advances, 
except that a servicer may be obligated to make non-reimbursable 
advances for a particular underlying exposure if any such advance is 
contractually limited to an insignificant amount of the outstanding 
principal balance of that exposure;
    (2) The servicer's right to reimbursement is senior in right of 
payment to all other claims on the cash flows from the underlying 
exposures of the securitization; and
    (3) The servicer has no legal obligation to, and does not, make 
advances to the

[[Page 44034]]

securitization if the servicer concludes the advances are unlikely 
to be repaid.
    Equity derivative contract means an equity-linked swap, 
purchased equity-linked option, forward equity-linked contract, or 
any other instrument linked to equities that gives rise to similar 
counterparty credit risks.
    Equity exposure means:
    (1) A security or instrument (whether voting or non-voting) that 
represents a direct or indirect ownership interest in, and is a 
residual claim on, the assets and income of a company, unless:
    (i) The issuing company is consolidated with the [BANK] under 
GAAP;
    (ii) The [BANK] is required to deduct the ownership interest 
from tier 1 or tier 2 capital under this appendix;
    (iii) The ownership interest incorporates a payment or other 
similar obligation on the part of the issuing company (such as an 
obligation to make periodic payments); or
    (iv) The ownership interest is a securitization exposure;
    (2) A security or instrument that is mandatorily convertible 
into a security or instrument described in paragraph (1) of this 
definition;
    (3) An option or warrant that is exercisable for a security or 
instrument described in paragraph (1) of this definition; or
    (4) Any other security or instrument (other than a 
securitization exposure) to the extent the return on the security or 
instrument is based on the performance of a security or instrument 
described in paragraph (1) of this definition.
    Exchange rate derivative contract means a cross-currency 
interest rate swap, forward foreign-exchange contract, currency 
option purchased, or any other instrument linked to exchange rates 
that gives rise to similar counterparty credit risks.
    Exposure amount means:
    (1) For the on-balance sheet component of an exposure (other 
than an OTC derivative contract; a repo-style transaction or an 
eligible margin loan for which the [BANK] determines the exposure 
amount under paragraph (c) or (d) of section 37 of this appendix; or 
a securitization exposure), exposure amount means:
    (i) If the exposure is a security classified as available-for-
sale, the [BANK]'s carrying value of the exposure, less any 
unrealized gains on the exposure, plus any unrealized losses on the 
exposure.
    (ii) If the exposure is not a security classified as available-
for-sale, the [BANK]'s carrying value of the exposure.
    (2) For the off-balance sheet component of an exposure (other 
than an OTC derivative contract; a repo-style transaction or an 
eligible margin loan for which the [BANK] calculates the exposure 
amount under paragraph (c) or (d) of section 37 of this appendix; or 
a securitization exposure), exposure amount means the notional 
amount of the off-balance sheet component multiplied by the 
appropriate credit conversion factor (CCF) in section 34 of this 
appendix.
    (3) If the exposure is an OTC derivative contract, the exposure 
amount determined under section 35 or 37 of this appendix.
    (4) If the exposure is an eligible margin loan or repo-style 
transaction for which the [BANK] calculates the exposure amount as 
provided in paragraph (c) or (d) of section 37 of this appendix, the 
exposure amount determined under section 37.
    (5) If the exposure is a securitization exposure, the exposure 
amount determined under section 42 of this appendix.
    External rating means a credit rating that is assigned by a 
nationally recognized statistical rating organization (NRSRO) to an 
exposure, provided:
    (1) The credit rating fully reflects the entire amount of credit 
risk with regard to all payments owed to the holder of the exposure. 
If a holder is owed principal and interest on an exposure, the 
credit rating must fully reflect the credit risk associated with 
timely repayment of principal and interest. If a holder is owed only 
principal on an exposure, the credit rating must fully reflect only 
the credit risk associated with timely repayment of principal; and
    (2) The credit rating is published in an accessible form and is 
or will be included in the transition matrices made publicly 
available by the NRSRO that summarize the historical performance of 
positions rated by the NRSRO. (See also applicable external rating, 
applicable inferred rating, inferred rating, issuer rating.)
    Financial collateral means collateral:
    (1) In the form of:
    (i) Cash on deposit with the [BANK] (including cash held for the 
[BANK] by a third-party custodian or trustee);
    (ii) Gold bullion;
    (iii) Long-term debt securities that have an applicable external 
rating of one category below investment grade or higher;
    (iv) Short-term debt instruments that have an applicable 
external rating of at least investment grade;
    (v) Equity securities that are publicly traded;
    (vi) Convertible bonds that are publicly traded;
    (vii) Money market mutual fund shares and other mutual fund 
shares if a price for the shares is publicly quoted daily; or
    (viii) Conforming residential mortgage exposures; and
    (2) In which the [BANK] has a perfected, first priority security 
interest or, outside of the United States, the legal equivalent 
thereof (with the exception of cash on deposit and notwithstanding 
the prior security interest of any custodial agent).
    Financial standby letter of credit means a letter of credit or 
similar arrangement that represents an irrevocable obligation of a 
[BANK] to a third-party beneficiary:
    (1) To repay money borrowed by, or advanced to, or for the 
account of, a second party (the account party); or
    (2) To make payment on behalf of the account party, in the event 
that the account party fails to fulfill its financial obligation to 
the beneficiary.
    First-lien residential mortgage exposure means a residential 
mortgage exposure secured by a first lien or a residential mortgage 
exposure secured by first and junior lien(s) where no other party 
holds an intervening lien. (See also residential mortgage exposure.)
    Foreign bank means a foreign bank as defined in Sec.  211.2 of 
the Federal Reserve Board's Regulation K (12 CFR 211.2) other than a 
depository institution. (See also depository institution.)
    GAAP means generally accepted accounting principles as used in 
the United States.
    Gain-on-sale means an increase in the equity capital (as 
reported on Schedule RC of the Consolidated Statement of Condition 
and Income (Call Report), Schedule HC of the FR Y-9C Report, or 
Schedule SC of the Thrift Financial Report) of a [BANK] that results 
from a securitization (other than an increase in equity capital that 
results from the [BANK]'s receipt of cash in connection with the 
securitization). (See also securitization.)
    Guarantee means a financial guarantee, letter of credit, 
insurance, or other similar financial instrument (other than a 
credit derivative) that allows one party (beneficiary) to transfer 
the credit risk of one or more specific exposures (reference 
exposure) to another party (protection provider). (See also eligible 
guarantee.)
    Inferred rating. (1) Securitization exposures. A securitization 
exposure has an inferred rating equal to the external rating of the 
securitization exposure referenced in paragraph (1)(ii) of this 
definition if:
    (i) The securitization exposure does not have an external 
rating; and
    (ii) Another securitization exposure issued by the same obligor 
and secured by the same underlying exposures:
    (A) Has an external rating;
    (B) Is subordinated in all respects to the exposure with no 
external rating;
    (C) Does not benefit from any credit enhancement that is not 
available to the exposure with no external rating;
    (D) Has an effective remaining maturity that is equal to or 
longer than that of the exposure with no external rating; and
    (E) Is the most immediately subordinated exposure to the 
exposure with no external rating that meets the requirements of 
paragraph (1)(ii)(A) through (1)(ii)(D) of this definition.
    (2) Other exposures. With respect to an exposure to a sovereign 
entity, an exposure to a PSE, or a corporate exposure, inferred 
rating means an inferred rating based on an issuer rating and an 
inferred rating based on a specific issue as determined under 
section 32 of this appendix. (See also applicable external rating, 
applicable inferred rating, external rating, issuer rating.)
    Interest rate derivative contract means a single-currency 
interest rate swap, basis swap, forward rate agreement, purchased 
interest rate option, when-issued securities, or any other 
instrument linked to interest rates that gives rise to similar 
counterparty credit risks.
    Investing [BANK] means, with respect to a securitization, a 
[BANK] that assumes the credit risk of a securitization exposure 
(other than an originating [BANK] of the securitization). In a 
typical synthetic securitization, the investing [BANK] sells credit 
protection on a pool of underlying exposures to the originating 
[BANK].
    Investment fund means a company:
    (1) All or substantially all of the assets of which are 
financial assets; and
    (2) That has no material liabilities.

[[Page 44035]]

    Issuer rating means a credit rating that is assigned by an NRSRO 
to an entity, provided:
    (1) The credit rating reflects the entity's capacity and 
willingness to satisfy all of its financial obligations; and
    (2) The credit rating is published in an accessible form and is 
or will be included in the transition matrices made publicly 
available by the NRSRO that summarize the historical performance of 
the NRSRO's ratings. (See also applicable external rating, 
applicable inferred rating.)
    Junior-lien residential mortgage exposure means a residential 
mortgage exposure that is not a first-lien residential mortgage 
exposure. (See also first-lien residential mortgage exposure, 
residential mortgage exposure.)
    Main index means the Standard & Poor's 500 Index, the FTSE All-
World Index, and any other index for which the [BANK] can 
demonstrate to the satisfaction of the [agency] that the equities 
represented in the index have comparable liquidity, depth of market, 
and size of bid-ask spreads as equities in the Standard & Poor's 500 
Index and FTSE All-World Index.
    Multi-lateral development bank (MDB) means the International 
Bank for Reconstruction and Development, the International Finance 
Corporation, the Inter-American Development Bank, the Asian 
Development Bank, the African Development Bank, the European Bank 
for Reconstruction and Development, the European Investment Bank, 
the European Investment Fund, the Nordic Investment Bank, the 
Caribbean Development Bank, the Islamic Development Bank, the 
Council of Europe Development Bank, and any other multilateral 
lending institution or regional development bank in which the U.S. 
government is a shareholder or contributing member or which the 
[agency] determines poses comparable credit risk.
    Nationally recognized statistical rating organization (NRSRO) 
means an entity registered with the Securities and Exchange 
Commission (SEC) as a nationally recognized statistical rating 
organization under section 15E of the Securities Exchange Act of 
1934 (15 U.S.C. 78o-7).
    Netting set means a group of transactions with a single 
counterparty that is subject to a qualifying master netting 
agreement.
    Nth-to-default credit derivative means a credit derivative that 
provides credit protection only for the nth-defaulting reference 
exposure in a group of reference exposures.
    Operational risk means the risk of loss resulting from 
inadequate or failed internal processes, people, and systems or from 
external events (including legal risk but excluding strategic and 
reputational risk).
    Original maturity with respect to an off-balance sheet 
commitment means the length of time between the date a commitment is 
issued and:
    (1) For a commitment that is not subject to extension or 
renewal, the stated expiration date of the commitment; or
    (2) For a commitment that is subject to extension or renewal, 
the earliest date on which the [BANK] can, at its option, 
unconditionally cancel the commitment.
    Originating [BANK], with respect to a securitization, means a 
[BANK] that:
    (1) Directly or indirectly originated or securitized the 
underlying exposures included in the securitization; or
    (2) Serves as an ABCP program sponsor to the securitization.
    Over-the-counter (OTC) derivative contract means a derivative 
contract that is not traded on an exchange that requires the daily 
receipt and payment of cash-variation margin.
    Performance standby letter of credit (or performance bond) means 
an irrevocable obligation of a [BANK] to pay a third-party 
beneficiary when a customer (account party) fails to perform on any 
contractual nonfinancial or commercial obligation. To the extent 
permitted by law or regulation, performance standby letters of 
credit include arrangements backing, among other things, 
subcontractors' and suppliers' performance, labor and materials 
contracts, and construction bids.
    Pre-sold construction loan means any one-to-four family 
residential pre-sold construction loan for a residence meeting the 
requirements under section 618(a)(1) or (2) of the Resolution Trust 
Corporation Refinancing, Restructuring, and Improvement Act of 1991 
(RTCRRI Act) and under 12 CFR part 3, appendix A, section 
3(a)(3)(iv) (for national banks); 12 CFR part 208, appendix A, 
section III.C.3. (for state member banks); 12 CFR part 225, appendix 
A, section III.C.3. (for bank holding companies); 12 CFR part 325, 
appendix A, section II.C. (for state nonmember banks), and that is 
not 90 days or more past due or on nonaccrual; or 12 CFR 567.1 
(definition of ``qualifying residential construction loan'') (for 
savings associations), and that is not on nonaccrual.
    Protection amount (P) means, with respect to an exposure hedged 
by an eligible guarantee or eligible credit derivative, the 
effective notional amount of the guarantee or credit derivative as 
reduced to reflect any currency mismatch, maturity mismatch, or lack 
of restructuring coverage (as provided in section 36 of this 
appendix).
    Publicly traded means traded on:
    (1) Any exchange registered with the SEC as a national 
securities exchange under section 6 of the Securities Exchange Act 
of 1934 (15 U.S.C. 78f); or
    (2) Any non-U.S.-based securities exchange that:
    (i) Is registered with, or approved by, a national securities 
regulatory authority; and
    (ii) Provides a liquid, two-way market for the instrument in 
question, meaning that there are enough independent bona fide offers 
to buy and sell so that a sales price reasonably related to the last 
sales price or current bona fide competitive bid and offer 
quotations can be determined promptly and a trade can be settled at 
such a price within five business days.
    Public sector entity (PSE) means a state, local authority, or 
other governmental subdivision below the sovereign entity level.
    Qualifying master netting agreement means any written, legally 
enforceable bilateral netting agreement, provided that:
    (1) The agreement creates a single legal obligation for all 
individual transactions covered by the agreement upon an event of 
default, including bankruptcy, insolvency, or similar proceeding, of 
the counterparty;
    (2) The agreement provides the [BANK] the right to accelerate, 
terminate, and close out on a net basis all transactions under the 
agreement and to liquidate or set off collateral promptly upon an 
event of default, including upon an event of bankruptcy, insolvency, 
or similar proceeding, of the counterparty, provided that, in any 
such case, any exercise of rights under the agreement will not be 
stayed or avoided under applicable law in the relevant 
jurisdictions;
    (3) The [BANK] has conducted sufficient legal review to conclude 
with a well-founded basis (and has maintained sufficient written 
documentation of that legal review) that:
    (i) The agreement meets the requirements of paragraph (2) of 
this definition; and
    (ii) In the event of a legal challenge (including one resulting 
from default or from bankruptcy, insolvency, or similar proceeding) 
the relevant court and administrative authorities would find the 
agreement to be legal, valid, binding, and enforceable under the law 
of the relevant jurisdictions;
    (4) The [BANK] establishes and maintains procedures to monitor 
possible changes in relevant law and to ensure that the agreement 
continues to satisfy the requirements of this definition; and
    (5) The agreement does not contain a walkaway clause (that is, a 
provision that permits a non-defaulting counterparty to make a lower 
payment than it would make otherwise under the agreement, or no 
payment at all, to a defaulter or the estate of a defaulter, even if 
the defaulter or the estate of the defaulter is a net creditor under 
the agreement).
    Regulatory retail exposure means an exposure that meets the 
following requirements:
    (1) The [BANK]'s aggregate exposure to a single obligor does not 
exceed $1 million;
    (2) The exposure is part of a well diversified portfolio; and
    (3) The exposure is not:
    (i) An exposure to a sovereign entity, the Bank for 
International Settlements, the European Central Bank, the European 
Commission, the International Monetary Fund, an MDB, a depository 
institution, a foreign bank, a credit union, or a PSE;
    (ii) An acquisition, development, and construction loan;
    (iii) A residential mortgage exposure;
    (iv) A pre-sold construction loan;
    (v) A statutory multifamily mortgage;
    (vi) A securitization exposure;
    (vii) An equity exposure; or
    (viii) A debt security.
    Repo-style transaction means a repurchase or reverse repurchase 
transaction, or a securities borrowing or securities lending 
transaction, including a transaction in which the [BANK] acts as 
agent for a customer and indemnifies the customer against loss, 
provided that:
    (1) The transaction is based solely on liquid and readily 
marketable securities, cash, gold, or conforming residential 
mortgage exposures;
    (2) The transaction is marked-to-market daily and subject to 
daily margin maintenance requirements;

[[Page 44036]]

    (3)(i) The transaction is a ``securities contract'' or 
``repurchase agreement'' under section 555 or 559, respectively, of 
the Bankruptcy Code (11 U.S.C. 555 or 559), a qualified financial 
contract under section 11(e)(8) of the Federal Deposit Insurance Act 
(12 U.S.C. 1821(e)(8)), or a netting contract between or among 
financial institutions under sections 401-407 of the Federal Deposit 
Insurance Corporation Improvement Act of 1991 (12 U.S.C. 4401-4407) 
or the Federal Reserve Board's Regulation EE (12 CFR part 231); or
    (ii) If the transaction does not meet the criteria in paragraph 
(3)(i) of this definition, then either:
    (A) The transaction is executed under an agreement that provides 
the [BANK] the right to accelerate, terminate, and close out the 
transaction on a net basis and to liquidate or set off collateral 
promptly upon an event of default (including upon an event of 
bankruptcy, insolvency, or similar proceeding) of the counterparty, 
provided that, in any such case, any exercise of rights under the 
agreement will not be stayed or avoided under applicable law in the 
relevant jurisdictions; or
    (B) The transaction is:
    (I) Either overnight or unconditionally cancelable at any time 
by the [BANK]; and
    (II) Executed under an agreement that provides the [BANK] the 
right to accelerate, terminate, and close out the transaction on a 
net basis and to liquidate or set off collateral promptly upon an 
event of counterparty default; and
    (4) The [BANK] has conducted sufficient legal review to conclude 
with a well-founded basis (and maintains sufficient written 
documentation of that legal review) that the agreement meets the 
requirements of paragraph (3) of this definition and is legal, 
valid, binding, and enforceable under applicable law in the relevant 
jurisdictions.
    Residential mortgage exposure means an exposure (other than a 
pre-sold construction loan) that is primarily secured by one-to-four 
family residential property. (See also first-lien residential 
mortgage exposure, junior-lien residential mortgage exposure.)
    Securities and Exchange Commission (SEC) means the U.S. 
Securities and Exchange Commission.
    Securitization means a traditional securitization or a synthetic 
securitization.
    Securitization exposure means an on-balance sheet or off-balance 
sheet credit exposure that arises from a traditional or synthetic 
securitization (including credit-enhancing representations and 
warranties). (See also synthetic securitization, traditional 
securitization.)
    Securitization special purpose entity (securitization SPE) means 
a corporation, trust, or other entity organized for the specific 
purpose of holding underlying exposures of a securitization, the 
activities of which are limited to those appropriate to accomplish 
this purpose, and the structure of which is intended to isolate the 
underlying exposures held by the entity from the credit risk of the 
seller of the underlying exposures to the entity.
    Servicer cash advance facility means a facility under which the 
servicer of the underlying exposures of a securitization may advance 
cash to ensure an uninterrupted flow of payments to investors in the 
securitization, including advances made to cover foreclosure costs 
or other expenses to facilitate the timely collection of the 
underlying exposures. (See also eligible servicer cash advance 
facility.)
    Sovereign entity means a central government (including the U.S. 
Government) or an agency, department, ministry, or central bank of a 
central government.
    Sovereign of incorporation means the country where an entity is 
incorporated, chartered, or similarly established.
    Statutory multifamily mortgage means any multifamily residential 
mortgage that:
    (1) Meets the requirements under section 618(b)(1) of the RTCRRI 
Act, and under 12 CFR part 3, appendix A, section 3(a)(3)(v) (for 
national banks); 12 CFR part 208, appendix A, section III.C.3. (for 
state member banks); 12 CFR part 225, appendix A, section III.C.3. 
(for bank holding companies); 12 CFR part 325, appendix A, section 
II.C. (for state nonmember banks); or 12 CFR 567.1 (definition of 
``qualifying multifamily mortgage loan'') and 12 CFR 
567.6(a)(1)(iii) (for savings associations); and
    (2) Is not on nonaccrual.
    Subsidiary means, with respect to a company, a company 
controlled by that company.
    Synthetic securitization means a transaction in which:
    (1) All or a portion of the credit risk of one or more 
underlying exposures is transferred to one or more third parties 
through the use of one or more credit derivatives or guarantees 
(other than a guarantee that transfers only the credit risk of an 
individual retail exposure);
    (2) The credit risk associated with the underlying exposures has 
been separated into at least two tranches reflecting different 
levels of seniority;
    (3) Performance of the securitization exposures depends upon the 
performance of the underlying exposures; and
    (4) All or substantially all of the underlying exposures are 
financial exposures (such as loans, commitments, credit derivatives, 
guarantees, receivables, asset-backed securities, mortgage-backed 
securities, other debt securities, or equity securities).
    Tier 1 capital has the same meaning as in [the general risk-
based capital rules], except as modified in part II of this 
appendix.
    Tier 2 capital has the same meaning as in [the general risk-
based capital rules], except as modified in part II of this 
appendix.
    Total qualifying capital means the sum of tier 1 capital and 
tier 2 capital, after all deductions required in this appendix.
    Total risk-weighted assets means the sum of a [BANK]'s:
    (1) Total risk-weighted assets for general credit risk as 
calculated under section 31 of this appendix;
    (2) Total risk-weighted assets for unsettled transactions as 
calculated under paragraph (f) of section 38 of this appendix;
    (3) Total risk-weighted assets for securitization exposures as 
calculated under paragraph (b) of section 42 of this appendix;
    (4) Total risk-weighted assets for equity exposures as 
calculated under paragraph (a) of section 52 of this appendix; and
    (5) Risk-weighted assets for operational risk as calculated 
under section 61 of this appendix.
    Traditional securitization means a transaction in which:
    (1) All or a portion of the credit risk of one or more 
underlying exposures is transferred to one or more third parties 
other than through the use of credit derivatives or guarantees.
    (2) The credit risk associated with the underlying exposures has 
been separated into at least two tranches reflecting different 
levels of seniority.
    (3) Performance of the securitization exposures depends upon the 
performance of the underlying exposures.
    (4) All or substantially all of the underlying exposures are 
financial exposures (such as loans, commitments, credit derivatives, 
guarantees, receivables, asset-backed securities, mortgage-backed 
securities, other debt securities, or equity securities).
    (5) The underlying exposures are not owned by an operating 
company.
    (6) The underlying exposures are not owned by a small business 
investment company described in section 302 of the Small Business 
Investment Act of 1958 (15 U.S.C. 682).
    (7)(i) For banks and bank holding companies, the underlying 
exposures are not owned by a firm an investment in which qualifies 
as a community development investment under 12 U.S.C. 24 (Eleventh); 
or
    (ii) For savings associations, the underlying exposures are not 
owned by a firm an investment in which is designed primarily to 
promote community welfare, including the welfare of low- and 
moderate-income communities or families, such as by providing 
services or employment.
    (8) The [agency] may determine that a transaction in which the 
underlying exposures are owned by an investment firm that exercises 
substantially unfettered control over the size and composition of 
its assets, liabilities, and off-balance sheet exposures is not a 
traditional securitization based on the transaction's leverage, risk 
profile, or economic substance.
    (9) The [agency] may deem a transaction that meets the 
definition of a traditional securitization, notwithstanding 
paragraph (5), (6), or (7) of this definition, to be a traditional 
securitization based on the transaction's leverage, risk profile, or 
economic substance.
    Unconditionally cancelable means with respect to a commitment 
that a [BANK] may, at any time, with or without cause, refuse to 
extend credit under the facility (to the extent permitted under 
applicable law).
    Underlying exposures means one or more exposures that have been 
securitized in a securitization transaction.
    Value-at-Risk (VaR) means the estimate of the maximum amount 
that the value of one or more exposures could decline due to market 
price or rate movements during a fixed holding period within a 
stated confidence interval.

[[Page 44037]]

Section 3. Minimum Risk-Based Capital Requirements and Overall 
Capital Adequacy

    (a) Except as modified by paragraph (c) of this section, each 
[BANK] must meet a minimum ratio of:
    (1) Total qualifying capital to total risk-weighted assets of 
8.0 percent; and
    (2) Tier 1 capital to total risk-weighted assets of 4.0 percent.
    (b) Each [BANK] must hold capital commensurate with the level 
and nature of all risks to which the [BANK] is exposed.
    (c) When a [BANK] subject to [the market risk rule] calculates 
its risk-based capital requirements under this appendix, the [BANK] 
must also refer to [the market risk rule] for supplemental rules to 
calculate risk-based capital requirements adjusted for market risk.
    (d) A [BANK] must have a rigorous process for assessing its 
overall capital adequacy in relation to its risk profile and a 
comprehensive strategy for maintaining an appropriate level of 
capital.

Section 4. Merger and Acquisition Transitional Arrangements

    (a) Mergers and acquisitions of companies that use the general 
risk-based capital rules. If a [BANK] that uses this appendix merges 
with or acquires a company that uses the general risk-based capital 
rules (12 CFR part 3, appendix A; 12 CFR part 208, appendix A; 12 
CFR part 225, appendix A; 12 CFR part 325, appendix A; or 12 CFR 
part 567, subpart B), the [BANK] may use the general risk-based 
capital rules to calculate the risk-weighted asset amounts for, and 
the deductions from capital associated with, the merged or acquired 
company's exposures for up to 12 months after the last day of the 
calendar quarter during which the merger or acquisition consummates. 
The risk-weighted assets of the merged or acquired company 
calculated under the general risk-based capital rules are included 
in the [BANK]'s total risk-weighted assets. Deductions associated 
with the exposures of the merged or acquired company are deducted 
from the [BANK]'s tier 1 capital and tier 2 capital. If a [BANK] 
relies on this paragraph, the [BANK] separately must disclose 
publicly the amounts of risk-weighted assets and total qualifying 
capital calculated under this appendix for the acquiring [BANK] and 
under the general risk-based capital rules for the acquired company.
    (b) Mergers and acquisitions of companies that use the 
standardized risk-based capital rules. If a [BANK] that uses this 
appendix merges with or acquires a company that uses different 
aspects of the standardized risk-based capital rules (12 CFR part 3, 
appendix D; 12 CFR part 208, appendix G; 12 CFR part 225, appendix 
H; 12 CFR part 325, appendix E; or 12 CFR part 567, appendix B), the 
[BANK] may continue to use the merged or acquired company's systems 
to determine the risk-weighted asset amounts for, and deductions 
from capital associated with, the merged or acquired company's 
exposures for up to 12 months after the last day of the calendar 
quarter during which the merger or acquisition consummates. The 
risk-weighted assets of the merged or acquired company are included 
in the [BANK]'s total risk-weighted assets. Deductions associated 
with the exposures of the merged or acquired company are deducted 
from the [BANK]'s tier 1 capital and tier 2 capital. If a [BANK] 
relies on this paragraph, the [BANK] separately must disclose 
publicly the amounts of risk-weighted assets and total qualifying 
capital for the acquiring [BANK] and for the merged or acquired 
company under the standardized risk-based capital rules.
    (c) Mergers and acquisitions of companies that use the advanced 
approaches risk-based capital rules. If a [BANK] that uses this 
appendix merges with or acquires a company that uses the advanced 
approaches risk-based capital rules (12 CFR part 3, appendix C; 12 
CFR part 208, appendix F; 12 CFR part 225, appendix G; 12 CFR part 
325, appendix D; or 12 CFR part 567, appendix C), the [BANK] may use 
the advanced approaches risk-based capital rules to determine the 
risk-weighted asset amounts for, and deductions from capital 
associated with, the merged or acquired company's exposures for up 
to 12 months after the last day of the calendar quarter during which 
the merger or acquisition consummates. During the period when the 
advanced approaches risk-based capital rules apply to the merged or 
acquired company, any ALLL associated with the merged or acquired 
company's exposures must be excluded from the [BANK]'s tier 2 
capital. Any excess eligible credit reserves associated with the 
merged or acquired company's exposures may be included in the 
acquiring [BANK]'s tier 2 capital up to 0.6 percent of the acquired 
company's risk-weighted assets. (Excess eligible credit reserves 
must be determined according to paragraph (a)(2) of section 13 of 
the advanced approaches risk-based capital rules.) If a [BANK] 
relies on this paragraph, the [BANK] separately must disclose 
publicly the amounts of risk-weighted assets and qualifying capital 
calculated under this appendix for the acquiring [BANK] and under 
the advanced approaches risk-based capital rules for the acquired 
company.

Part II. Qualifying Capital

Section 21. Modifications to Tier 1 and Tier 2 Capital

    (a) Modifications to tier 1 and tier 2 capital. A [BANK] that 
uses this appendix must make the same deductions from its tier 1 
capital and tier 2 capital required in [the general risk-based 
capital rules], except that:
    (1) A [BANK] is not required to make the deductions from capital 
for CEIOs in 12 CFR part 3, appendix A, section 2(c)(1)(iv) (for 
national banks); 12 CFR part 208, appendix A, section II.B.1.e. (for 
state member banks); 12 CFR part 225, appendix A, section II.B.1.e. 
(for bank holding companies); 12 CFR part 325, appendix A, section 
II.B.5. (for state nonmember banks); and 12 CFR 567.5(a)(2)(iii) and 
567.12(e) (for savings associations);
    (2)(i) A bank or bank holding company is not required to make 
the deductions from capital for nonfinancial equity investments in 
12 CFR part 3, appendix A, section 2(c)(1)(v) (for national banks); 
12 CFR part 208, appendix A, section II.B.5. (for state member 
banks); 12 CFR part 225, appendix A, section II.B.5. (for bank 
holding companies); and 12 CFR part 325, appendix A, section II.B. 
(for state nonmember banks);
    (ii) A savings association is not required to deduct investments 
in equity securities from capital under 12 CFR 567.5(c)(2)(ii). 
However, it must continue to deduct equity investments in real 
estate under that section. See 12 CFR 567.1, which defines equity 
investments, including equity securities and equity investments in 
real estate; and
    (3) A [BANK] must make the additional deductions from capital 
required by paragraphs (b) and (c) of this section.
    (b) Deductions from tier 1 capital. In accordance with paragraph 
(a) of section 41 and paragraph (a)(1) of section 42, a [BANK] must 
deduct any after-tax gain-on-sale resulting from a securitization 
from tier 1 capital.
    (c) Deductions from tier 1 and tier 2 capital. A [BANK] must 
deduct the exposures specified in paragraphs (c)(1) through (c)(3) 
in this section 50 percent from tier 1 capital and 50 percent from 
tier 2 capital. If the amount deductible from tier 2 capital exceeds 
the [BANK]'s actual tier 2 capital, however, the [BANK] must deduct 
the excess amount from tier 1 capital.
    (1) Credit-enhancing interest-only strips (CEIOs). In accordance 
with paragraphs (a)(1) and (c) of section 42, any CEIO that does not 
constitute after-tax gain-on-sale.
    (2) Certain securitization exposures. In accordance with 
paragraphs (a)(3) and (c) of section 42 and sections 43 and 44, 
certain securitization exposures that are required to be deducted 
from capital.
    (3) Certain unsettled transactions. In accordance with paragraph 
(e)(3) of section 38, the [BANK]'s exposure on certain unsettled 
transactions.

Part III. Risk-Weighted Assets for General Credit Risk

Section 31. Mechanics for Calculating Risk-Weighted Assets for 
General Credit Risk

    A [BANK] must risk weight its assets and exposures as follows:
    (a) A [BANK] must determine the exposure amount of each on-
balance sheet asset, each OTC derivative contract, and each off-
balance sheet commitment, trade and transaction-related contingency, 
guarantee, repurchase agreement, securities lending and borrowing 
transaction, financial standby letter of credit, forward agreement, 
or other similar transaction that is not:
    (1) An unsettled transaction subject to section 38;
    (2) A securitization exposure; or
    (3) An equity exposure (other than an equity derivative 
contract).
    (b) A [BANK] must multiply each exposure amount identified under 
paragraph (a) of this section by the risk weight appropriate to the 
exposure based on the obligor or exposure type, eligible guarantor, 
or financial collateral to determine the risk-weighted asset amount 
for each exposure.
    (c) Total risk-weighted assets for general credit risk equals 
the sum of the risk-weighted asset amounts calculated under 
paragraph (b) of this section.

[[Page 44038]]

Section 32. Inferred Ratings for General Credit Risk

    (a) General. This section describes two kinds of inferred 
ratings, an inferred rating based on an issuer rating and an 
inferred rating based on a specific issue. This section applies to 
an exposure to a sovereign entity, an exposure to a PSE, and a 
corporate exposure, except as otherwise provided in this appendix.
    (b) Inferred rating based on an issuer rating. If a senior 
exposure to an obligor (that is, an exposure that ranks pari passu 
with an obligor's general creditors in the event of bankruptcy, 
insolvency, or other similar proceeding) has no external rating and 
the obligor has one or more issuer ratings, the senior exposure has 
inferred rating(s) equal to the issuer rating(s) of the obligor that 
reflects the currency in which the exposure is denominated.
    (c) Inferred rating based on a specific issue. (1) An exposure 
with no external rating (the unrated exposure) has inferred 
rating(s) based on a specific issue equal to the external rating in 
paragraph (c)(1)(ii), if another exposure issued by the same obligor 
and secured by the same collateral (if any):
    (i) Ranks pari passu with the unrated exposure (or at the 
[BANK]'s option, is subordinated in all respects to the unrated 
exposure);
    (ii) Has an external rating based on a long-term rating;
    (iii) Does not benefit from any credit enhancement that is not 
available to the unrated exposure;
    (iv) Has an effective remaining maturity that is equal to or 
longer than that of the unrated exposure; and
    (v) Is denominated in the same currency as the unrated exposure. 
This requirement does not apply where the unrated exposure is 
denominated in a foreign currency that arises from a [BANK]'s 
participation in a loan extended or guaranteed by an MDB against 
convertibility and transfer risk. If the [BANK]'s participation is 
only partially guaranteed against convertibility and transfer risk 
by an MDB, the [BANK] may only use the external rating denominated 
in the foreign currency for the portion of the participation that 
benefits from the MDB's guarantee.
    (2) An unrated exposure has inferred rating(s) equal to the 
external rating(s) based on any long-term rating of low-quality 
exposure(s) that are issued by the same obligor and that are senior 
in all respects to the unrated exposure. For the purposes of this 
paragraph, a low-quality exposure is an exposure that would receive 
a risk weight of 150 percent (for an exposure to a sovereign entity 
or a corporate exposure) or 100 percent or greater (for an exposure 
to a PSE) under section 33.

Section 33. General Risk Weights

    (a) Exposures to sovereign entities. (1) A [BANK] must assign a 
risk weight to an exposure to a sovereign entity using the risk 
weight that corresponds to its applicable external or applicable 
inferred rating in Table 1.
    (2) Notwithstanding paragraph (a)(1) of this section, a [BANK] 
may assign a risk weight that is lower than the applicable risk 
weight in Table 1 to an exposure to a sovereign entity if:
    (i) The exposure is denominated in the sovereign entity's 
currency;
    (ii) The [BANK] has at least an equivalent amount of liabilities 
in that currency; and
    (iii) The sovereign entity allows banks under its jurisdiction 
to assign the lower risk weight to the same exposures to the 
sovereign entity.

                Table 1.--Exposures to Sovereign Entities
------------------------------------------------------------------------
 Applicable external or applicable
inferred rating of an exposure to a        Example          Risk weight
          sovereign entity                                 (in percent)
------------------------------------------------------------------------
Highest investment grade rating....  AAA................               0
Second-highest investment grade      AA.................               0
 rating.
Third-highest investment grade       A..................              20
 rating.
Lowest investment grade rating.....  BBB................              50
One category below investment grade  BB.................             100
Two categories below investment      B..................             100
 grade.
Three categories or more below       CCC................             150
 investment grade.
No applicable rating...............  N/A................             100
------------------------------------------------------------------------

    (b) Certain supranational entities and multilateral development 
banks. A [BANK] may assign a zero percent risk weight to an exposure 
to the Bank for International Settlements, the European Central 
Bank, the European Commission, the International Monetary Fund, or 
an MDB.
    (c) Exposures to depository institutions, foreign banks, and 
credit unions. (1) Except as provided in paragraph (c)(2) of this 
section, a [BANK] must assign a risk weight to an exposure to a 
depository institution, a foreign bank, or a credit union using the 
risk weight that corresponds to the lowest issuer rating of the 
entity's sovereign of incorporation in Table 2.
    (2) A [BANK] must assign a risk weight of at least 100 percent 
to an exposure to a depository institution or a foreign bank that is 
includable in the depository institution's or foreign bank's 
regulatory capital and that is not subject to deduction as a 
reciprocal holding pursuant to 12 CFR part 3, appendix A, section 
2(c)(6)(ii) (national banks); 12 CFR part 208, appendix A, section 
II.B.3 (state member banks); 12 CFR part 225, appendix A, section 
II.B.3 (bank holding companies); 12 CFR part 325, appendix A, 
section I.B.(4) (state nonmember banks); and 12 CFR part 
567.5(c)(2)(i) (savings associations).

   Table 2.--Exposures to Depository Institutions, Foreign Banks, and
                              Credit Unions
------------------------------------------------------------------------
    Lowest issuer rating of the                             Risk weight
     sovereign of incorporation            Example         (in percent)
------------------------------------------------------------------------
Highest investment grade rating....  AAA................              20
Second-highest investment grade      AA.................              20
 rating.
Third-highest investment grade       A..................              50
 rating.
Lowest investment grade rating.....  BBB................             100
One category below investment grade  BB.................             100
Two categories below investment      B..................             100
 grade.
Three categories or more below       CCC................             150
 investment grade.
No issuer rating...................  N/A................             100
------------------------------------------------------------------------

    (d) Exposures to public sector entities. (1) Subject to the 
limitation in paragraph (d)(2) of this section, a [BANK]:
    (i) Must risk weight an exposure to a PSE with an applicable 
external or applicable inferred rating based on a long-term rating 
using the risk weight that corresponds to the applicable external or 
applicable inferred

[[Page 44039]]

rating based on a long-term rating in Table 3.
    (ii) Must assign a 50 percent risk weight to an exposure to a 
PSE with no applicable external rating based on a long-term rating 
and no applicable inferred rating based on a long-term rating.
    (iii) May assign a lower risk weight than would otherwise apply 
under Table 3 to an exposure to a foreign PSE if:
    (A) The PSE's sovereign of incorporation allows banks under its 
jurisdiction to assign the lower risk weight; and
    (B) The risk weight is not lower than the risk weight that 
corresponds to the lowest issuer rating of the PSE's sovereign of 
incorporation in Table 1.
    (2) A [BANK] may not assign an exposure to a PSE with no 
external rating a risk weight that is lower than the risk weight 
that corresponds to the lowest issuer rating of the PSE's sovereign 
of incorporation in Table 1.

 Table 3.--Exposures to Public Sector Entities: Long-Term Credit Rating
------------------------------------------------------------------------
 Applicable external or applicable
inferred rating of an exposure to a        Example          Risk weight
                PSE                                        (in percent)
------------------------------------------------------------------------
Highest investment grade rating....  AAA................              20
Second-highest investment grade      AA.................              20
 rating.
Third-highest investment grade       A..................              50
 rating.
Lowest investment grade rating.....  BBB................              50
One category below investment grade  BB.................             100
Two categories below investment      B..................             100
 grade.
Three categories or more below       CCC................             150
 investment grade.
No applicable rating...............  N/A................              50
------------------------------------------------------------------------

    (e) Corporate exposures. A [BANK] must use one of the following 
approaches to assign risk weights to corporate exposures:
    (1) 100 percent risk weight approach. A [BANK] that chooses this 
approach must assign a 100 percent risk weight to all corporate 
exposures.
    (2) Ratings approach. (i) Subject to the limitations in 
paragraph (e)(2)(ii) of this section, a [BANK] that chooses this 
approach:
    (A) Must assign a risk weight to a corporate exposure with an 
applicable external or applicable inferred rating based on a long-
term rating using the risk weight that corresponds to the applicable 
external or applicable inferred rating based on a long-term rating 
in Table 4.
    (B) Must assign a risk weight to a corporate exposure with an 
applicable external rating based on a short-term rating using the 
risk weight that corresponds to the applicable external rating based 
on a short-term rating in Table 5.
    (C) Must assign a 100 percent risk weight to all corporate 
exposures with no external rating and no inferred rating.
    (ii) Limitations. (A) A [BANK] may not assign a corporate 
exposure with no external rating a risk weight that is lower than 
the risk weight that corresponds to the lowest issuer rating of the 
obligor's sovereign of incorporation in Table 1.
    (B) If an obligor has any exposure with an external rating based 
on a short-term rating that corresponds to a risk weight of 150 
percent under Table 5, a [BANK] must assign a 150 percent risk 
weight to a corporate exposure to that obligor with no external 
rating and that ranks pari passu with or is subordinated to the 
externally rated exposure.

         Table 4.--Corporate Exposures: Long-Term Credit Rating
------------------------------------------------------------------------
 Applicable external or applicable
  inferred rating of the corporate         Example          Risk weight
              exposure                                     (in percent)
------------------------------------------------------------------------
Highest investment grade rating....  AAA................              20
Second-highest investment grade      AA.................              20
 rating.
Third-highest investment grade       A..................              50
 rating.
Lowest investment grade rating.....  BBB................             100
One category below investment grade  BB.................             100
Two categories below investment      B..................             150
 grade.
Three categories or more below       CCC................             150
 investment grade.
No applicable rating...............  N/A................             100
------------------------------------------------------------------------


         Table 5.--Corporate Exposures: Short-Term Credit Rating
------------------------------------------------------------------------
 Applicable external rating of the                          Risk weight
         corporate exposure                Example         (in percent)
------------------------------------------------------------------------
Highest investment grade rating....  A-1/P-1............              20
Second-highest investment grade      A-2/P-2............              50
 rating.
Third-highest investment grade       A-3/P-3............             100
 rating.
Below investment grade.............  B, C and non-prime.             150
No applicable external rating......  N/A................             100
------------------------------------------------------------------------

    (f) Regulatory retail exposures. A [BANK] must assign a 75 
percent risk weight to a regulatory retail exposure.
    (g) Residential mortgage exposures. (1) First-lien residential 
mortgage exposures. (i) A [BANK] must assign the applicable risk 
weight in Table 6, using the loan-to-value ratio (LTV ratio) as 
described in paragraph (g)(3) of this section, to a first-lien 
residential mortgage exposure that is secured by property that is 
owner-occupied or rented, is prudently underwritten, is not 90 days 
or more past due, and is not on nonaccrual. A first-lien residential 
mortgage exposure that has been restructured may receive a risk 
weight lower than 100 percent only if the [BANK] updates the LTV 
ratio at the time of restructuring as provided under paragraph 
(g)(3) of this section.
    (ii) If a first-lien residential mortgage exposure does not 
satisfy these requirements, the [BANK] must assign a 100 percent 
risk weight to the exposure if the LTV ratio is 90 percent or less, 
and must assign a 150 percent risk weight if the LTV ratio is 
greater than 90 percent.

[[Page 44040]]



  Table 6.--Risk Weights for First-Lien Residential Mortgage Exposures
------------------------------------------------------------------------
                                                            Risk weight
            Loan-to-value ratio  (in percent)              (in percent)
------------------------------------------------------------------------
Less than or equal to 60................................              20
Greater than 60 and less than or equal to 80............              35
Greater than 80 and less than or equal to 85............              50
Greater than 85 and less than or equal to 90............              75
Greater than 90 and less than or equal to 95............             100
Greater than 95.........................................             150
------------------------------------------------------------------------

    (2) Junior-lien residential mortgage exposures. (i) A [BANK] 
must assign the applicable risk weight in Table 7, using the LTV 
ratio described in paragraph (g)(3) of this section, to a junior-
lien residential mortgage exposure that is not 90 days or more past 
due or on nonaccrual.
    (ii) If a junior-lien residential mortgage exposure is 90 days 
or more past due or on nonaccrual, a [BANK] must assign a 150 
percent risk weight to the exposure.

  Table 7.--Risk Weights for Junior-Lien Residential Mortgage Exposures
------------------------------------------------------------------------
                                                            Risk weight
            Loan-to-value ratio  (in percent)              (in percent)
------------------------------------------------------------------------
Less than or equal to 60................................              75
Greater than 60 and less than or equal to 90............             100
Greater than 90.........................................             150
------------------------------------------------------------------------

    (3) LTV ratio calculation. To determine the appropriate risk 
weight for a residential mortgage exposure under this paragraph (g), 
a [BANK] must calculate the LTV ratio (that is, the loan amount of 
the exposure divided by the value of the property) as described in 
this paragraph. A [BANK] must calculate a separate LTV ratio for the 
funded and unfunded portions of a residential mortgage exposure and 
must assign a risk weight to the exposure amount of each portion 
according to its respective LTV ratio.
    (i) Loan amount for calculating the LTV ratio of the funded 
portion of a residential mortgage exposure.
    (A) First-lien residential mortgage exposure. The loan amount of 
the funded portion of a first-lien residential mortgage exposure is 
the principal amount of the exposure.
    (B) Junior-lien residential mortgage exposure. The loan amount 
of the funded portion of a junior-lien residential mortgage exposure 
is the principal amount of the exposure plus the principal amounts 
of all senior exposures secured by the same residential property on 
the date of origination of the junior-lien residential mortgage 
exposure plus the unfunded portion of the maximum contractual amount 
of any senior exposure(s) secured by the same residential property.
    (ii) Loan amount for calculating the LTV ratio of the unfunded 
portion of a residential mortgage exposure. The loan amount of the 
unfunded portion of a residential mortgage exposure is:
    (A) The amount calculated under paragraph (g)(3)(i) of this 
section; plus
    (B) The unfunded portion of the maximum contractual amount of 
the exposure.
    (iii) PMI. A [BANK] may reduce the loan amount in the LTV ratio 
up to the amount covered by loan-level private mortgage insurance 
(PMI). The loan-level PMI must protect the [BANK] in the event of 
borrower default up to a predetermined amount of the residential 
mortgage exposure, and may not have a pool-level cap that would 
effectively reduce coverage below the predetermined amount of the 
exposure. Loan-level PMI must be provided by a regulated mortgage 
insurance company that is not an affiliate of the [BANK], and that:
    (A) Has issued long-term senior debt (without credit 
enhancement) that has an external rating that is in at least the 
third-highest investment grade rating category; or
    (B) Has a claims-paying rating that is in at least the third-
highest investment grade rating category.
    (iv) Value. (A) The value of the property is the lesser of the 
actual acquisition cost (for a purchase transaction) or the estimate 
of the property's value at the origination of the loan or, at the 
[BANK]'s option, at the time of restructuring.
    (B) A [BANK] must base all estimates of a property's value on an 
appraisal or evaluation of the property that satisfies subpart C of 
12 CFR part 34 (national banks); subpart E of 12 CFR part 208 (state 
member banks); 12 CFR part 323 (state nonmember banks); and 12 CFR 
part 564 (savings associations).
    (h) Pre-sold residential construction loans. A [BANK] must 
assign a 50 percent risk weight to a pre-sold construction loan 
unless the purchase contract is cancelled. A [BANK] must assign a 
100 percent risk weight to such loan if the purchase contract is 
cancelled.
    (i) Statutory multifamily mortgages. A [BANK] must assign a 50 
percent risk weight to a statutory multifamily mortgage.
    (j) Past due exposures. Except for a residential mortgage 
exposure, if an exposure is 90 days or more past due or on 
nonaccrual:
    (1) A [BANK] must assign a 150 percent risk weight to the 
portion of the exposure that does not have a guarantee or that is 
unsecured.
    (2) A [BANK] may assign a risk weight to the collateralized 
portion of the exposure based on the risk weight of the collateral 
under this section if the collateral meets the requirements of 
paragraph (b)(1) of section 37 of this appendix.
    (3) A [BANK] may assign a risk weight to the guaranteed portion 
of the exposure based on the risk weight that would apply under 
section 36 of this appendix if the guarantee or credit derivative 
meets the requirements of that section.
    (k) Other assets. (1) A [BANK] may assign a zero percent risk 
weight to cash owned and held in all offices of the [BANK] or in 
transit; to gold bullion held in the [BANK]'s own vaults or held in 
another depository institution's vaults on an allocated basis, to 
the extent the gold bullion assets are offset by gold bullion 
liabilities; and to derivative contracts that are publicly traded on 
an exchange that requires the daily receipt and payment of cash-
variation margin.
    (2) A [BANK] may assign a 20 percent risk weight to cash items 
in the process of collection.
    (3) A [BANK] must apply a 100 percent risk weight to all assets 
not specifically assigned a different risk weight under this 
appendix (other than exposures that are deducted from tier 1 or tier 
2 capital).

Section 34. Off-Balance Sheet Exposures

    (a) General. (1) A [BANK] must calculate the exposure amount of 
an off-balance sheet exposure using the credit conversion factors 
(CCFs) in paragraph (b) of this section.
    (2) Where a [BANK] commits to provide a commitment, the [BANK] 
may apply the lower of the two applicable CCFs.
    (3) Where a [BANK] provides a commitment structured as a 
syndication or participation, the [BANK] is only required to 
calculate the exposure amount for its pro rata share of the 
commitment.
    (b) Credit conversion factors. (1) Zero percent CCF. A [BANK] 
must apply a zero percent CCF to the unused portion of commitments 
that are unconditionally cancelable.
    (2) 20 percent CCF. A [BANK] must apply a 20 percent CCF to the 
following off-balance-sheet exposures:
    (i) Commitments with an original maturity of one year or less 
that are not unconditionally cancelable.
    (ii) Self-liquidating, trade-related contingent items that arise 
from the movement of goods, with an original maturity of one year or 
less.
    (3) 50 percent CCF. A [BANK] must apply a 50 percent CCF to the 
following off-balance-sheet exposures:
    (i) Commitments with an original maturity of more than one year 
that are not unconditionally cancelable by the [BANK].
    (ii) Transaction-related contingent items, including performance 
bonds, bid bonds, warranties, and performance standby letters of 
credit.
    (4) 100 percent CCF. A [BANK] must apply a 100 percent CCF to 
the following off-balance-sheet items and other similar 
transactions:
    (i) Guarantees;
    (ii) Repurchase agreements (the off-balance sheet component of 
which equals the sum of the current market values of all positions 
the [BANK] has sold subject to repurchase);
    (iii) Off-balance sheet securities lending transactions (the 
off-balance sheet component of which equals the sum of the current 
market values of all positions the [BANK] has lent under the 
transaction);
    (iv) Off-balance sheet securities borrowing transactions (the 
off-balance sheet component of which equals the sum of the current 
market values of all non-cash positions the [BANK] has posted as 
collateral under the transaction);
    (v) Financial standby letters of credit; and
    (vi) Forward agreements. Forward agreements are legally binding 
contractual

[[Page 44041]]

obligations to purchase assets with certain drawdown at a specified 
future date. Such obligations do not include commitments to make 
residential mortgage loans or forward foreign exchange contracts.

Section 35. OTC Derivative Contracts

    A [BANK] must calculate the exposure amount of an OTC derivative 
contract under this section.
    (a) A [BANK] must determine the exposure amount for an OTC 
derivative contract that is not subject to a qualifying master 
netting agreement using the single OTC derivative contract 
calculation in paragraph (c) of this section.
    (b) A [BANK] must determine the exposure amount for multiple OTC 
derivative contracts that are subject to a qualifying master netting 
agreement using the multiple OTC derivative contracts calculation in 
paragraph (d) of this section.
    (c) Single OTC derivative contract. Except as modified by 
paragraph (e) of this section, the exposure amount for a single OTC 
derivative contract that is not subject to a qualifying master 
netting agreement is equal to the sum of the [BANK]'s current credit 
exposure and potential future credit exposure (PFE) on the 
derivative contract.
    (1) Current credit exposure. The current credit exposure for a 
single OTC derivative contract is the greater of the mark-to-market 
value of the derivative contract or zero.
    (2) PFE. The PFE for a single OTC derivative contract, including 
an OTC derivative contract with a negative mark-to-market value, is 
calculated by multiplying the notional principal amount of the 
derivative contract by the appropriate conversion factor in Table 8. 
For purposes of calculating either the PFE under this paragraph or 
the gross PFE under paragraph (d) of this section for exchange rate 
contracts and other similar contracts in which the notional 
principal amount is equivalent to the cash flows, notional principal 
amount is the net receipts to each party falling due on each value 
date in each currency. For any OTC derivative contract that does not 
fall within one of the specified categories in Table 8, the PFE must 
be calculated using the appropriate ``other'' conversion factor. A 
[BANK] must use an OTC derivative contract's effective notional 
principal amount (that is, its apparent or stated notional principal 
amount multiplied by any multiplier in the OTC derivative contract) 
rather than its apparent or stated notional principal amount in 
calculating PFE. PFE of the protection provider of a credit 
derivative is capped at the net present value of the amount of 
unpaid premiums.

                                           Table 8.--Conversion Factor Matrix for OTC Derivative Contracts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              Credit       Credit (non-
                                                              Foreign      (investment-     investment-                      Precious
         Remaining maturity \2\            Interest rate   exchange rate       grade           grade          Equity      metals (except       Other
                                                             and gold        reference       reference                         gold)
                                                                           obligor) \3\      obligor)
--------------------------------------------------------------------------------------------------------------------------------------------------------
One year or less........................           0.00            0.01             0.05            0.10            0.06            0.07            0.10
Greater than one year and less than or             0.005           0.05             0.05            0.10            0.08            0.07            0.12
 equal to five years....................
Greater than five years.................           0.015           0.075            0.05            0.10            0.10            0.08            0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ For an OTC derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the
  derivative contract.
\2\ For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that
  the market value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract
  with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005.
\3\ A [BANK] must use the column labeled ``Credit (investment-grade reference obligor)'' for a credit derivative whose reference obligor has an
  outstanding unsecured debt security that has an applicable external rating based on a long-term rating of at least investment grade without credit
  enhancement. A [BANK] must use the column labeled ``Credit (non-investment grade reference obligor)'' for all other credit derivatives.

    (d) Multiple OTC derivative contracts subject to a qualifying 
master netting agreement. Except as modified by paragraph (e) of 
this section, the exposure amount for multiple OTC derivative 
contracts subject to a qualifying master netting agreement is equal 
to the sum of the net current credit exposure and the adjusted sum 
of the PFE for all OTC derivative contracts subject to the 
qualifying master netting agreement.
    (1) Net current credit exposure. The net current credit exposure 
is the greater of the net sum of all positive and negative mark-to-
market values of the individual OTC derivative contracts subject to 
the qualifying master netting agreement or zero.
    (2) Adjusted sum of the PFE. The adjusted sum of the PFE, Anet, 
is calculated as

Anet = (0.4 x Agross) + (0.6 x NGR x Agross),

Where:

(i) Agross = the gross PFE (that is, the sum of the PFE amounts (as 
determined under paragraph (c)(2) of this section) for each 
individual OTC derivative contract subject to the qualifying master 
netting agreement); and
(ii) NGR = the net to gross ratio (that is, the ratio of the net 
current credit exposure to the gross current credit exposure). In 
calculating the NGR, the gross current credit exposure equals the 
sum of the positive current credit exposures (as determined under 
paragraph (c)(1) of this section) of all individual OTC derivative 
contracts subject to the qualifying master netting agreement.

    (e) Collateralized OTC derivative contracts. A [BANK] may 
recognize the credit risk mitigation benefits of financial 
collateral that secures an OTC derivative contract or multiple OTC 
derivatives subject to a qualifying master netting agreement 
(netting set) by using the simple approach in paragraph (b) of 
section 37 of this appendix. Alternatively, a [BANK] may recognize 
the credit risk mitigation benefits of financial collateral that 
secures such a contract or netting set if the financial collateral 
is marked-to-market on a daily basis and subject to a daily margin 
maintenance requirement by applying a risk weight to the exposure as 
if it is uncollateralized and adjusting the exposure amount 
calculated under paragraph (c) or (d) of this section using the 
collateral haircut approach in paragraph (c) of section 37 of this 
appendix. The [BANK] must substitute the exposure amount calculated 
under paragraph (c) or (d) of this section for [Sigma]E in the 
equation in paragraph (c)(3) of section 37 and must use a 10-
business-day minimum holding period (TM = 10).
    (f) Counterparty credit risk for credit derivatives. (1) A 
[BANK] that purchases a credit derivative that is recognized under 
section 36 of this appendix as a credit risk mitigant for an 
exposure that is not a covered position under [the market risk rule] 
is not required to compute a separate counterparty credit risk 
capital requirement under section 31 of this appendix provided that 
the [BANK] does so consistently for all such credit derivatives and 
either includes all or excludes all such credit derivatives that are 
subject to a qualifying master netting agreement from any measure 
used to determine counterparty credit risk exposure to all relevant 
counterparties for risk-based capital purposes.
    (2) A [BANK] that is the protection provider in a credit 
derivative must treat the credit derivative as an exposure to the 
reference obligor and is not required to compute a counterparty 
credit risk capital requirement for the credit derivative under 
section 31 of this appendix provided that it does so consistently 
for all such credit derivatives and either includes all or excludes 
all such credit derivatives that are

[[Page 44042]]

subject to a qualifying master netting agreement from any measure 
used to determine counterparty credit risk exposure to all relevant 
counterparties for risk-based capital purposes (unless the [BANK] is 
treating the credit derivative as a covered position under [the 
market risk rule], in which case the [BANK] must compute a 
supplemental counterparty credit risk capital requirement under this 
section).
    (g) Counterparty credit risk for equity derivatives. (1) A 
[BANK] must treat an equity derivative contract as an equity 
exposure and compute a risk-weighted asset amount for the equity 
derivative contract under part V of this appendix (unless the [BANK] 
is treating the contract as a covered position under [the market 
risk rule]).
    (2) In addition, the [BANK] must also calculate a risk-based 
capital requirement for the counterparty credit risk of an equity 
derivative contract under this part if the [BANK] is treating the 
contract as a covered position under [the market risk rule].
    (3) If the [BANK] risk weights the contract under the Simple 
Risk-Weight Approach (SRWA) in section 52 of this appendix, a [BANK] 
may choose not to hold risk-based capital against the counterparty 
credit risk of the equity derivative contract, as long as it does so 
for all such contracts. Where the equity derivative contracts are 
subject to a qualified master netting agreement, a [BANK] using the 
SRWA must either include all or exclude all of the contracts from 
any measure used to determine counterparty credit risk exposure.

Section 36. Guarantees and Credit Derivatives: Substitution 
Treatment

    (a) Scope. (1) General. A [BANK] may recognize the credit risk 
mitigation benefits of an eligible guarantee or eligible credit 
derivative by substituting the risk weight associated with a 
protection provider for the risk weight assigned to an exposure, as 
provided under this section.
    (2) This section applies to exposures for which:
    (i) Credit risk is fully covered by an eligible guarantee or 
eligible credit derivative; or
    (ii) Credit risk is covered on a pro rata basis (that is, on a 
basis in which the [BANK] and the protection provider share losses 
proportionately) by an eligible guarantee or eligible credit 
derivative.
    (3) Exposures on which there is a tranching of credit risk 
(reflecting at least two different levels of seniority) generally 
are securitization exposures subject to the securitization framework 
in part IV of this appendix.
    (4) If multiple eligible guarantees or eligible credit 
derivatives cover a single exposure described in paragraph (a)(2) of 
this section, a [BANK] may treat the hedged exposure as multiple 
separate exposures each covered by a single eligible guarantee or 
eligible credit derivative and may calculate a separate risk-
weighted asset amount for each separate exposure as described in 
paragraph (c) of this section.
    (5) If a single eligible guarantee or eligible credit derivative 
covers multiple hedged exposures described in paragraph (a)(2) of 
this section, a [BANK] must treat each hedged exposure as covered by 
a separate eligible guarantee or eligible credit derivative and must 
calculate a separate risk-weighted asset amount for each exposure as 
described in paragraph (c) of this section.
    (6) If a [BANK] calculates the risk-weighted asset amount under 
section 31 for an exposure whose applicable external or applicable 
inferred rating reflects the benefits of a credit risk mitigant 
provided to the exposure, the [BANK] may not use the credit risk 
mitigation rules in this section to further reduce the risk-weighted 
asset amount for the exposure to reflect that credit risk mitigant.
    (b) Rules of recognition. (1) A [BANK] may only recognize the 
credit risk mitigation benefits of eligible guarantees and eligible 
credit derivatives.
    (2) A [BANK] may only recognize the credit risk mitigation 
benefits of an eligible credit derivative to hedge an exposure that 
is different from the credit derivative's reference exposure used 
for determining the derivative's cash settlement value, deliverable 
obligation, or occurrence of a credit event if:
    (i) The reference exposure ranks pari passu with or is 
subordinated to the hedged exposure; and
    (ii) The reference exposure and the hedged exposure are to the 
same legal entity, and legally enforceable cross-default or cross-
acceleration clauses are in place to assure payments under the 
credit derivative are triggered when the obligor fails to pay under 
the terms of the hedged exposure.
    (c) Substitution approach. (1) Full coverage. If an eligible 
guarantee or eligible credit derivative meets the conditions in 
paragraphs (a) and (b) of this section and the protection amount (P) 
of the guarantee or credit derivative is greater than or equal to 
the exposure amount of the hedged exposure, a [BANK] may recognize 
the guarantee or credit derivative in determining the risk-weighted 
asset amount for the hedged exposure by substituting the risk weight 
applicable to the guarantee or credit derivative under section 33 
for the risk weight assigned to the exposure. If the [BANK] 
determines that full substitution under this paragraph leads to an 
inappropriate degree of risk mitigation, the [BANK] may substitute a 
higher risk weight than that applicable to the guarantee or credit 
derivative.
    (2) Partial coverage. If an eligible guarantee or eligible 
credit derivative meets the conditions in paragraphs (a) and (b) of 
this section and the protection amount (P) of the guarantee or 
credit derivative is less than the exposure amount of the hedged 
exposure, the [BANK] must treat the hedged exposure as two separate 
exposures (protected and unprotected) in order to recognize the 
credit risk mitigation benefit of the guarantee or credit 
derivative.
    (i) The [BANK] may calculate the risk-weighted asset amount for 
the protected exposure under section 31 of this appendix, where the 
applicable risk weight is the risk weight applicable to the 
guarantee or credit derivative. If the [BANK] determines that full 
substitution under this paragraph leads to an inappropriate degree 
of risk mitigation, the [BANK] may use a higher risk weight than 
that applicable to the guarantee or credit derivative.
    (ii) The [BANK] must calculate the risk-weighted asset amount 
for the unprotected exposure under section 31 of this appendix, 
where the applicable risk weight is that of the hedged exposure.
    (iii) The treatment in this paragraph (c)(2) is applicable when 
the credit risk of an exposure is covered on a partial pro rata 
basis and may be applicable when an adjustment is made to the 
effective notional amount of the guarantee or credit derivative 
under paragraph (d), (e), or (f) of this section.
    (d) Maturity mismatch adjustment. (1) A [BANK] that recognizes 
an eligible guarantee or eligible credit derivative in determining 
the risk-weighted asset amount for a hedged exposure must adjust the 
effective notional amount of the credit risk mitigant to reflect any 
maturity mismatch between the hedged exposure and the credit risk 
mitigant.
    (2) A maturity mismatch occurs when the residual maturity of a 
credit risk mitigant is less than that of the hedged exposure(s).
    (3) The residual maturity of a hedged exposure is the longest 
possible remaining time before the obligor is scheduled to fulfil 
its obligation on the exposure. If a credit risk mitigant has 
embedded options that may reduce its term, the [BANK] (protection 
purchaser) must use the shortest possible residual maturity for the 
credit risk mitigant. If a call is at the discretion of the 
protection provider, the residual maturity of the credit risk 
mitigant is at the first call date. If the call is at the discretion 
of the [BANK] (protection purchaser), but the terms of the 
arrangement at origination of the credit risk mitigant contain a 
positive incentive for the [BANK] to call the transaction before 
contractual maturity, the remaining time to the first call date is 
the residual maturity of the credit risk mitigant. For example, 
where there is a step-up in cost in conjunction with a call feature 
or where the effective cost of protection increases over time even 
if credit quality remains the same or improves, the residual 
maturity of the credit risk mitigant will be the remaining time to 
the first call.
    (4) A credit risk mitigant with a maturity mismatch may be 
recognized only if its original maturity is greater than or equal to 
one year and its residual maturity is greater than three months.
    (5) When a maturity mismatch exists, the [BANK] must apply the 
following adjustment to reduce the effective notional amount of the 
credit risk mitigant:

Pm = E x (t-0.25)/(T-0.25),

where:

(i) Pm = effective notional amount of the credit risk 
mitigant, adjusted for maturity mismatch;
(ii) E = effective notional amount of the credit risk mitigant;
(iii) t = the lesser of T or the residual maturity of the credit 
risk mitigant, expressed in years; and
(iv) T = the lesser of five or the residual maturity of the hedged 
exposure, expressed in years.

    (e) Adjustment for credit derivatives without restructuring as a 
credit event. If a [BANK] recognizes an eligible credit

[[Page 44043]]

derivative that does not include as a credit event a restructuring 
of the hedged exposure involving forgiveness or postponement of 
principal, interest, or fees that results in a credit loss event 
(that is, a charge-off, specific provision, or other similar debit 
to the profit and loss account), the [BANK] must apply the following 
adjustment to reduce the effective notional amount of the credit 
derivative:

Pr = Pm x 0.60,

where:

(1) Pr = effective notional amount of the credit risk 
mitigant, adjusted for lack of restructuring event (and maturity 
mismatch, if applicable); and
(2) Pm = effective notional amount of the credit risk 
mitigant (adjusted for maturity mismatch, if applicable).
    (f) Currency mismatch adjustment. (1) If a [BANK] recognizes an 
eligible guarantee or eligible credit derivative that is denominated 
in a currency different from that in which the hedged exposure is 
denominated, the [BANK] must apply the following formula to the 
effective notional amount of the guarantee or credit derivative:

Pc = Pr x (1-HFX),

where:
(i) Pc = effective notional amount of the credit risk 
mitigant, adjusted for currency mismatch (and maturity mismatch and 
lack of restructuring event, if applicable);
(ii) Pr = effective notional amount of the credit risk 
mitigant (adjusted for maturity mismatch and lack of restructuring 
event, if applicable); and
(iii) HFX = haircut appropriate for the currency mismatch 
between the credit risk mitigant and the hedged exposure.

    (2) A [BANK] must set HFX equal to eight percent 
unless it qualifies for the use of and uses its own internal 
estimates of foreign exchange volatility based on a 10-business-day 
holding period and daily marking-to-market and remargining. A [BANK] 
qualifies for the use of its own internal estimates of foreign 
exchange volatility if it qualifies for:
    (i) The own-estimates haircuts in paragraph (c)(5) of section 
37; or
    (ii) The simple VaR methodology in paragraph (d) of section 37.
    (3) A [BANK] must adjust HFX calculated in paragraph 
(f)(2) of this section upward if the [BANK] revalues the guarantee 
or credit derivative less frequently than once every 10 business 
days using the following square root of time formula:
[GRAPHIC] [TIFF OMITTED] TP29JY08.003

where:

(i) TM equals the greater of 10 or the number of days 
between revaluation;
(ii) TN equals the holding period used by the [BANK] to 
derive HN; and
(iii) HN equals the haircut based on the holding period 
TN.

Section 37. Collateralized Transactions

    (a) General. (1) This section provides three approaches that a 
[BANK] may use to recognize the risk-mitigating effects of financial 
collateral:
    (i) The simple approach. A [BANK] may use the simple approach 
for any exposure.
    (ii) The collateral haircut approach. A [BANK] may use the 
collateral haircut approach for repo-style transactions, eligible 
margin loans, collateralized OTC derivative contracts, and single-
product netting sets of such transactions.
    (iii) The simple VaR methodology. A [BANK] may use the simple 
VaR methodology for single-product netting sets of repo-style 
transactions and eligible margin loans.
    (2) A [BANK] may use any approach described in this section that 
is valid for a particular type of exposure or transaction; however, 
it must use the same approach for similar exposures or transactions.
    (3) If a [BANK] calculates its risk-weighted asset amount under 
section 31 for an exposure whose applicable external or applicable 
inferred rating reflects the benefits of financial collateral to the 
exposure, the [BANK] may not use the credit risk mitigation rules in 
this section to further reduce the risk-weighted asset amount for 
the exposure to reflect that financial collateral.
    (b) The simple approach. (1) General requirements. (i) A [BANK] 
may recognize the credit risk mitigation benefits of financial 
collateral that secures any exposure or any collateral that secures 
a repo-style transaction that is included in the [BANK]'s VaR-based 
measure under [the market risk rule].
    (ii) To qualify for the simple approach the collateral must meet 
the following requirements:
    (A) The collateral must be subject to a collateral agreement for 
at least the life of the exposure;
    (B) The collateral must be revalued at least every six months; 
and
    (C) The collateral (other than gold) and the exposure must be 
denominated in the same currency.
    (2) Risk weight substitution. (i) A [BANK] may risk weight the 
portion of an exposure that is secured by the market value of 
collateral (that meets the requirements of paragraph (b)(1) of this 
section) based on the risk weight assigned to the collateral under 
this appendix. For repurchase agreements, reverse repurchase 
agreements, and securities lending and borrowing transactions, the 
collateral is the instruments, gold, and cash the [BANK] has 
borrowed, purchased subject to resale, or taken as collateral from 
the counterparty under the transaction. Except as provided in 
paragraph (b)(3) of this section, the risk weight assigned to the 
collateralized portion of the exposure may not be less than 20 
percent.
    (ii) A [BANK] must risk weight the unsecured portion of the 
exposure based on the risk weight assigned to the exposure under 
this appendix.
    (3) Exceptions to the 20 percent risk-weight floor and other 
requirements. Notwithstanding paragraph (b)(2)(i) of this section:
    (i) A [BANK] may assign a zero percent risk weight to an 
exposure to an OTC derivative contract that is marked-to-market on a 
daily basis and subject to a daily margin maintenance requirement, 
to the extent the contract is collateralized by cash on deposit.
    (ii) A [BANK] may assign a 10 percent risk weight to an exposure 
to an OTC derivative contract that is marked-to-market on a daily 
basis and subject to a daily margin maintenance requirement, to the 
extent that the contract is collateralized by a sovereign security 
or a PSE security that qualifies for a zero percent risk weight 
under section 33 of this appendix.
    (iii) A [BANK] may assign a zero percent risk weight to the 
collateralized portion of an exposure where:
    (A) The financial collateral is cash on deposit; or
    (B) The financial collateral is a sovereign security or a PSE 
security, the security qualifies for a zero percent risk weight 
under section 33, and the [BANK] has discounted the market value of 
the collateral by 20 percent.
    (iv) If a [BANK] recognizes collateral in the form of a 
conforming residential mortgage, the [BANK] must risk weight the 
portion of the exposure that is secured by the conforming 
residential mortgage at 50 percent.
    (c) Collateral haircut approach. (1) General. A [BANK] may 
recognize the credit risk mitigation benefits of financial 
collateral that secures an eligible margin loan, repo-style 
transaction, collateralized OTC derivative contract, or single-
product netting set of such transactions, and of any collateral that 
secures a repo-style transaction that is included in the [BANK]'s 
VaR-based measure under [the market risk rule] by using the 
collateral haircut approach in this paragraph (c).
    (2) Approaches for the calculation of collateral haircuts. There 
are two ways to calculate collateral haircuts: the standard 
supervisory haircuts approach and the own internal estimates for 
haircuts approach. For exposures other than repo-style transactions 
included in the [BANK]'s VaR-based measure under the [the market 
risk rule], a [BANK] must use the standard supervisory haircut 
approach with a minimum 10-business-day holding period if it chooses 
to recognize in the exposure amount the benefits of collateral in 
the form of a conforming residential mortgage.
    (3) Exposure amount equation. Under either collateral haircut 
approach, a [BANK] must determine the exposure amount for an 
eligible margin loan, repo-style transaction, collateralized OTC 
derivative contract, or a single-product netting set of such 
transactions by setting the exposure amount equal to max 0, 
[([Sigma]E-[Sigma]C) + [Sigma](Es x Hs) + [Sigma](Efx x Hfx)] , 
where:
    (i)(A) For eligible margin loans and repo-style transactions, 
[Sigma]E equals the value of the exposure (the sum of the current 
market values of all instruments, gold, and cash the [BANK] has 
lent, sold subject to repurchase, or posted as collateral to the 
counterparty under the transaction (or netting set)); and
    (B) For collateralized OTC derivative contracts and netting sets 
thereof, [Sigma]E equals the exposure amount of the OTC derivative 
contract (or netting set) calculated under paragraph (c) or (d) of 
section 35 of this appendix;

[[Page 44044]]

    (ii) [Sigma]C equals the value of the collateral (the sum of the 
current market values of all instruments, gold and cash the [BANK] 
has borrowed, purchased subject to resale, or taken as collateral 
from the counterparty under the transaction (or netting set));
    (iii) Es equals the absolute value of the net position in a 
given instrument or in gold (where the net position in a given 
instrument or in gold equals the sum of the current market values of 
the instrument or gold the [BANK] has lent, sold subject to 
repurchase, or posted as collateral to the counterparty minus the 
sum of the current market values of that same instrument or gold the 
[BANK] has borrowed, purchased subject to resale, or taken as 
collateral from the counterparty);
    (iv) Hs equals the market price volatility haircut appropriate 
to the instrument or gold referenced in Es;
    (v) Efx equals the absolute value of the net position of 
instruments and cash in a currency that is different from the 
settlement currency (where the net position in a given currency 
equals the sum of the current market values of any instruments or 
cash in the currency the [BANK] has lent, sold subject to 
repurchase, or posted as collateral to the counterparty minus the 
sum of the current market values of any instruments or cash in the 
currency the [BANK] has borrowed, purchased subject to resale, or 
taken as collateral from the counterparty); and
    (vi) Hfx equals the haircut appropriate to the mismatch between 
the currency referenced in Efx and the settlement currency.
    (4) Standard supervisory haircuts. Under the standard 
supervisory haircuts approach:
    (i) A [BANK] must use the haircuts for market price volatility 
(Hs) in Table 9, as adjusted in certain circumstances as provided 
under in paragraph (c)(4)(iii) and (iv) of this section:

                       Table 9.--Standard Supervisory Market Price Volatility Haircuts \1\
----------------------------------------------------------------------------------------------------------------
 Applicable external rating grade category for     Residual maturity for debt       Sovereign
                debt securities                            securities             entities \2\    Other issuers
----------------------------------------------------------------------------------------------------------------
Two highest investment-grade rating categories  <= 1 year.......................         0.005              0.01
 for long-term ratings/highest investment-      > 1 year, <= 5 years............          0.02              0.04
 grade rating category for short-term ratings.  > 5 years.......................          0.04              0.08
----------------------------------------------------------------------------------------------------------------
Two lowest investment-grade rating categories   <= 1 year.......................          0.01              0.02
 for both short- and long-term ratings.         > 1 year, <= 5 years............          0.03              0.06
                                                > 5 years.......................          0.06              0.12
----------------------------------------------------------------------------------------------------------------
One rating category below investment grade....  All.............................          0.15              0.25
----------------------------------------------------------------------------------------------------------------
Main index equities (including convertible bonds) and gold...........0.15.......
----------------------------------------------------------------------------------------------------------------
Other publicly traded equities (including convertible bonds), conform0.25
 residential mortgages, and nonfinancial collateral.
----------------------------------------------------------------------------------------------------------------
Mutual funds....................................Highest haircut applicable to any security in
                                                 which the fund can invest.
----------------------------------------------------------------------------------------------------------------
Cash on deposit with the [BANK] (including a certificate of deposit iss0ed by
 the [BANK]).
----------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircuts in Table 9 are based on a 10-business-day holding period.
\2\ This column includes the haircuts for MDBs and foreign PSEs that receive a zero percent risk weight under
  section 33 of this appendix.

    (ii) For currency mismatches, a [BANK] must use a haircut for 
foreign exchange rate volatility (Hfx) of 8.0 percent, as adjusted 
in certain circumstances as provided under paragraph (c)(4)(iii) and 
(iv) of this section.
    (iii) For repo-style transactions, a [BANK] may multiply the 
standard supervisory haircuts provided in paragraphs (c)(4)(i) and 
(ii) of this section by the square root of \1/2\ (which equals 
0.707107).
    (iv) A [BANK] must adjust the standard supervisory haircuts 
provided in paragraphs (c)(4)(i) and (ii) of this section upward on 
the basis of a holding period longer than 10 business days (for 
eligible margin loans and OTC derivative contracts) or five business 
days (for repo-style transactions) where and as appropriate to take 
into account the illiquidity of an instrument.
    (5) Own internal estimates for haircuts. With the prior written 
approval of the [agency], a [BANK] may calculate haircuts (Hs and 
Hfx) using its own internal estimates of the volatilities of market 
prices and foreign exchange rates.
    (i) To receive [agency] approval to use its own internal 
estimates, a [BANK] must satisfy the following minimum quantitative 
standards:
    (A) A [BANK] must use a 99th percentile one-tailed confidence 
interval.
    (B) The minimum holding period for a repo-style transaction is 
five business days and for an eligible margin loan or OTC derivative 
contract is 10 business days. When a [BANK] calculates an own-
estimates haircut on a TN-day holding period, which is 
different from the minimum holding period for the transaction type, 
the applicable haircut (HM) is calculated using the 
following square root of time formula:
[GRAPHIC] [TIFF OMITTED] TP29JY08.004

where:
(1) TM equals 5 for repo-style transactions and 10 for 
eligible margin loans and OTC derivative contracts;
(2) TN equals the holding period used by the [BANK] to 
derive HN; and
(3) HN equals the haircut based on the holding period 
TN.

    (C) A [BANK] must adjust holding periods upward where and as 
appropriate to take into account the illiquidity of an instrument.
    (D) The historical observation period must be at least one year.
    (E) A [BANK] must update its data sets and recompute haircuts no 
less frequently than quarterly and must also reassess data sets and 
haircuts whenever market prices change materially.
    (ii) With respect to debt securities that have an applicable 
external rating of investment grade, a [BANK] may calculate haircuts 
for categories of securities. For a category of securities, the 
[BANK] must calculate the haircut on the basis of internal 
volatility estimates for securities in that category that are 
representative of the securities in that category that the [BANK] 
has lent, sold subject to repurchase, posted as collateral, 
borrowed, purchased subject to resale, or taken as collateral. In 
determining relevant categories, the [BANK] must at a minimum take 
into account:
    (A) The type of issuer of the security;
    (B) The applicable external rating of the security;
    (C) The maturity of the security; and
    (D) The interest rate sensitivity of the security.
    (iii) With respect to debt securities that have an applicable 
external rating of below investment grade and equity securities, a 
[BANK] must calculate a separate haircut for each individual 
security.
    (iv) Where an exposure or collateral (whether in the form of 
cash or securities) is denominated in a currency that differs from 
the settlement currency, the [BANK] must

[[Page 44045]]

calculate a separate currency mismatch haircut for its net position 
in each mismatched currency based on estimated volatilities of 
foreign exchange rates between the mismatched currency and the 
settlement currency.
    (v) A [BANK]'s own estimates of market price and foreign 
exchange rate volatilities may not take into account the 
correlations among securities and foreign exchange rates on either 
the exposure or collateral side of a transaction (or netting set) or 
the correlations among securities and foreign exchange rates between 
the exposure and collateral sides of the transaction (or netting 
set).
    (d) Simple VaR methodology. (1) With the prior written approval 
of the [agency], a [BANK] may estimate the exposure amount for a 
single-product netting set of repo-style-transactions or eligible 
margin loans using a VaR model that meets the requirements in 
paragraph (d)(3) of this section. However, a [BANK] may not use the 
VaR model described below to recognize in the exposure amount the 
benefits of collateral in the form of a conforming residential 
mortgage (other than for repo-style transactions included in the 
[BANK]'s VaR-based measure under [the market risk rule]).
    (2) The [BANK] must set the exposure amount equal to max

0, [([Sigma]E - [Sigma]C) + PFE] ,

where:

(i) [Sigma]E equals the value of the exposure (the sum of the 
current market values of all instruments, gold, and cash the [BANK] 
has lent, sold subject to repurchase, or posted as collateral to the 
counterparty under the netting set);
(ii) [Sigma]C equals the value of the collateral (the sum of the 
current market values of all instruments, gold, and cash the [BANK] 
has borrowed, purchased subject to resale, or taken as collateral 
from the counterparty under the netting set); and
(iii) PFE equals the [BANK]'s empirically based best estimate of the 
99th percentile, one-tailed confidence interval for an increase in 
the value of ([Sigma]E - [Sigma]C) over a five-business-day holding 
period for repo-style transactions or over a 10-business-day holding 
period for eligible margin loans using a minimum one-year historical 
observation period of price data representing the instruments that 
the [BANK] has lent, sold subject to repurchase, posted as 
collateral, borrowed, purchased subject to resale, or taken as 
collateral.

    (3) The [BANK] must validate its VaR model, including by 
establishing and maintaining a rigorous and regular backtesting 
regime. For the purposes of this section, backtesting means a 
comparison of a [BANK]'s internal estimates with actual outcomes 
during a sample period not used in model development.

Section 38. Unsettled Transactions

    (a) Definitions. For purposes of this section:
    (1) Delivery-versus-payment (DvP) transaction means a securities 
or commodities transaction in which the buyer is obligated to make 
payment only if the seller has made delivery of the securities or 
commodities and the seller is obligated to deliver the securities or 
commodities only if the buyer has made payment.
    (2) Payment-versus-payment (PvP) transaction means a foreign 
exchange transaction in which each counterparty is obligated to make 
a final transfer of one or more currencies only if the other 
counterparty has made a final transfer of one or more currencies.
    (3) Qualifying central counterparty means a counterparty (for 
example, a clearing house) that:
    (i) Facilitates trades between counterparties in one or more 
financial markets by either guaranteeing trades or novating 
contracts;
    (ii) Requires all participants in its arrangements to be fully 
collateralized on a daily basis; and
    (iii) The [BANK] demonstrates to the satisfaction of the 
[agency] is in sound financial condition and is subject to effective 
oversight by a national supervisory authority.
    (4) Normal settlement period. A transaction has a normal 
settlement period if the contractual settlement period for the 
transaction is equal to or less than the market standard for the 
instrument underlying the transaction and equal to or less than five 
business days.
    (5) Positive current exposure. The positive current exposure of 
a [BANK] for a transaction is the difference between the transaction 
value at the agreed settlement price and the current market price of 
the transaction, if the difference results in a credit exposure of 
the [BANK] to the counterparty.
    (b) Scope. This section applies to all transactions involving 
securities, foreign exchange instruments, and commodities that have 
a risk of delayed settlement or delivery. This section does not 
apply to:
    (1) Transactions accepted by a qualifying central counterparty 
that are subject to daily marking-to-market and daily receipt and 
payment of variation margin;
    (2) Repo-style transactions, including unsettled repo-style 
transactions;
    (3) One-way cash payments on OTC derivative contracts; or
    (4) Transactions with a contractual settlement period that is 
longer than the normal settlement period (which are treated as OTC 
derivative contracts as provided in section 35).
    (c) System-wide failures. In the case of a system-wide failure 
of a settlement or clearing system, the [agency] may waive risk-
based capital requirements for unsettled and failed transactions 
until the situation is rectified.
    (d) Delivery-versus-payment (DvP) and payment-versus-payment 
(PvP) transactions. A [BANK] must hold risk-based capital against 
any DvP or PvP transaction with a normal settlement period if the 
[BANK]'s counterparty has not made delivery or payment within five 
business days after the settlement date. The [BANK] must determine 
its risk-weighted asset amount for such a transaction by multiplying 
the positive current exposure of the transaction for the [BANK] by 
the appropriate risk weight in Table 10.

     Table 10.--Risk Weights for Unsettled DvP and PvP Transactions
------------------------------------------------------------------------
                                                          Risk weight to
                                                           be applied to
  Number of business days after contractual settlement       positive
                          date                                current
                                                           exposure (in
                                                             percent)
------------------------------------------------------------------------
From 5 to 15............................................           100.0
From 16 to 30...........................................           625.0
From 31 to 45...........................................           937.5
46 or more..............................................         1,250.0
------------------------------------------------------------------------

    (e) Non-DvP/non-PvP (non-delivery-versus-payment/non-payment-
versus-payment) transactions. (1) A [BANK] must hold risk-based 
capital against any non-DvP/non-PvP transaction with a normal 
settlement period if the [BANK] has delivered cash, securities, 
commodities, or currencies to its counterparty but has not received 
its corresponding deliverables by the end of the same business day. 
The [BANK] must continue to hold risk-based capital against the 
transaction until the [BANK] has received its corresponding 
deliverables.
    (2) From the business day after the [BANK] has made its delivery 
until five business days after the counterparty delivery is due, the 
[BANK] must calculate the risk-weighted asset amount for the 
transaction by treating the current market value of the deliverables 
owed to the [BANK] as an exposure to the counterparty and using the 
applicable counterparty risk weight in section 33 of this appendix.
    (3) If the [BANK] has not received its deliverables by the fifth 
business day after counterparty delivery was due, the [BANK] must 
deduct the current market value of the deliverables owed to the 
[BANK] 50 percent from tier 1 capital and 50 percent from tier 2 
capital.
    (f) Total risk-weighted assets for unsettled transactions. Total 
risk-weighted assets for unsettled transactions is the sum of the 
risk-weighted asset amounts of all DvP, PvP, and non-DvP/non-PvP 
transactions.

Part IV. Risk-Weighted Assets for Securitization Exposures

Section 41. Operational Requirements for Securitization Exposures

    (a) Operational criteria for traditional securitizations. A 
[BANK] that transfers exposures it has originated or purchased to a 
securitization SPE or other third party in connection with a 
traditional securitization may exclude the exposures from the 
calculation of its risk-weighted assets only if each condition in 
this paragraph (a) is satisfied. A [BANK] that meets these 
conditions must hold risk-based capital against any securitization 
exposures it retains in connection with the securitization. A [BANK] 
that fails to meet these conditions must instead hold risk-based 
capital against the transferred exposures as if they had not been 
securitized and must deduct from tier 1 capital any after-tax gain-
on-sale resulting from the transaction. The conditions are:
    (1) The transfer is considered a sale under GAAP;

[[Page 44046]]

    (2) The [BANK] has transferred to one or more third parties 
credit risk associated with the underlying exposures; and
    (3) Any clean-up calls relating to the securitization are 
eligible clean-up calls.
    (b) Operational criteria for synthetic securitizations. For 
synthetic securitizations, a [BANK] may recognize for risk-based 
capital purposes the use of a credit risk mitigant to hedge 
underlying exposures only if each condition in this paragraph (b) is 
satisfied. A [BANK] that fails to meet these conditions must instead 
hold risk-based capital against the underlying exposures as if they 
had not been synthetically securitized. The conditions are:
    (1) The credit risk mitigant is financial collateral, an 
eligible credit derivative, or an eligible guarantee;
    (2) The [BANK] transfers credit risk associated with the 
underlying exposures to one or more third parties, and the terms and 
conditions in the credit risk mitigants employed do not include 
provisions that:
    (i) Allow for the termination of the credit protection due to 
deterioration in the credit quality of the underlying exposures;
    (ii) Require the [BANK] to alter or replace the underlying 
exposures to improve the credit quality of the pool of underlying 
exposures;
    (iii) Increase the [BANK]'s cost of credit protection in 
response to deterioration in the credit quality of the underlying 
exposures;
    (iv) Increase the yield payable to parties other than the [BANK] 
in response to a deterioration in the credit quality of the 
underlying exposures; or
    (v) Provide for increases in a retained first loss position or 
credit enhancement provided by the [BANK] after the inception of the 
securitization;
    (3) The [BANK] obtains a well-reasoned opinion from legal 
counsel that confirms the enforceability of the credit risk mitigant 
in all relevant jurisdictions; and
    (4) Any clean-up calls relating to the securitization are 
eligible clean-up calls.

Section 42. Risk-Weighted Assets for Securitization Exposures

    (a) Hierarchy of approaches. Except as provided elsewhere in 
this section or in section 41:
    (1) A [BANK] must deduct from tier 1 capital any after-tax gain-
on-sale resulting from a securitization and must deduct from total 
capital in accordance with paragraph (c) of this section the portion 
of any CEIO that does not constitute after-tax gain-on-sale.
    (2) If a securitization exposure does not require deduction 
under paragraph (a)(1) of this section and qualifies for the 
Ratings-Based Approach (RBA) in section 43 of this appendix, a 
[BANK] must apply the RBA to the exposure.
    (3) If a securitization exposure does not require deduction 
under paragraph (a)(1) of this section and does not qualify for the 
RBA, a [BANK] must apply the treatments in section 44.
    (4) If a securitization exposure is an OTC derivative contract 
(other than a credit derivative) that has a first priority claim on 
the cash flows from the underlying exposures (notwithstanding 
amounts due under interest rate or currency derivative contracts, 
fees due, or other similar payments), with approval of the [agency], 
a [BANK] may choose to set the risk-weighted asset amount of the 
exposure equal to the amount of the exposure as determined in 
paragraph (d) of this section rather than apply the hierarchy of 
approaches described in paragraphs (a)(1) through (3) of this 
section.
    (b) Total risk-weighted assets for securitization exposures. A 
[BANK]'s total risk-weighted assets for securitization exposures 
equals the sum of the risk-weighted asset amount for securitization 
exposures that the [BANK] risk weights under section 43, 44, or 45 
of this appendix plus any risk-weighted asset amount calculated 
under section 46 of this appendix, as modified by paragraphs (e) 
through (k) of this section.
    (c) Deductions. (1) If a [BANK] must deduct a securitization 
exposure from total capital, the [BANK] must take the deduction 50 
percent from tier 1 capital and 50 percent from tier 2 capital. If 
the amount deductible from tier 2 capital exceeds the [BANK]'s tier 
2 capital, the [BANK] must deduct the excess from tier 1 capital.
    (2) A [BANK] may calculate any deduction from tier 1 capital and 
tier 2 capital for a securitization exposure net of any deferred tax 
liabilities associated with the securitization exposure.
    (d) Exposure amount of a securitization exposure. (1) On-balance 
sheet securitization exposures. The exposure amount of an on-balance 
sheet securitization exposure that is not a repo-style transaction, 
eligible margin loan, or OTC derivative contract (other than a 
credit derivative) is:
    (i) The [BANK]'s carrying value minus any unrealized gains and 
plus any unrealized losses on the exposure, if the exposure is a 
security classified as available-for-sale; or
    (ii) The [BANK]'s carrying value, if the exposure is not a 
security classified as available-for-sale.
    (2) Off-balance sheet securitization exposures. (i) The exposure 
amount of an off-balance sheet securitization exposure that is not a 
repo-style transaction or an OTC derivative contract (other than a 
credit derivative) is the notional amount of the exposure. For an 
off-balance sheet securitization exposure to an ABCP program, such 
as a liquidity facility, the notional amount may be reduced to the 
maximum potential amount that the [BANK] could be required to fund 
given the ABCP program's current underlying assets (calculated 
without regard to the current credit quality of those assets).
    (ii) A [BANK] must determine the exposure amount of an eligible 
ABCP liquidity facility by multiplying the notional amount of the 
exposure by the appropriate CCF:
    (A) 20 percent, for an eligible ABCP liquidity facility with an 
original maturity of one year or less that does not qualify for the 
RBA.
    (B) 50 percent, for an eligible ABCP liquidity facility with an 
original maturity of over one year that does not qualify for the 
RBA.
    (C) 100 percent, for an eligible ABCP liquidity facility that 
qualifies for the RBA.
    (3) Repo-style transactions, eligible margin loans, and OTC 
derivative contracts. The exposure amount of a securitization 
exposure that is a repo-style transaction, eligible margin loan, or 
OTC derivative contract (other than a credit derivative) is the 
exposure amount of the transaction as calculated under section 35 or 
37 of this appendix.
    (e) Overlapping exposures. If a [BANK] has multiple 
securitization exposures that provide duplicative coverage to the 
underlying exposures of a securitization (such as when a [BANK] 
provides a program-wide credit enhancement and multiple pool-
specific liquidity facilities to an ABCP program), the [BANK] is not 
required to hold duplicative risk-based capital against the 
overlapping position. Instead, the [BANK] may apply to the 
overlapping position the applicable risk-based capital treatment 
that results in the highest risk-based capital requirement.
    (f) Implicit support. If a [BANK] provides support to a 
securitization in excess of the [BANK]'s contractual obligation to 
provide credit support to the securitization (implicit support):
    (1) The [BANK] must hold regulatory capital against all of the 
underlying exposures associated with the securitization as if the 
exposures had not been securitized and must deduct from tier 1 
capital any after-tax gain-on-sale resulting from the 
securitization; and
    (2) The [BANK] must disclose publicly:
    (i) That it has provided implicit support to the securitization; 
and
    (ii) The regulatory capital impact to the [BANK] of providing 
such implicit support.
    (g) Undrawn portion of an eligible servicer cash advance 
facility. Regardless of any other provision of this part, a [BANK] 
is not required to hold risk-based capital against the undrawn 
portion of an eligible servicer cash advance facility.
    (h) Interest-only mortgage-backed securities. Regardless of any 
other provisions of this part, the risk weight for a non-credit-
enhancing interest-only mortgage-backed security may not be less 
than 100 percent.
    (i) Small-business loans and leases on personal property 
transferred with recourse. (1) Regardless of any other provisions of 
this appendix, a [BANK] that has transferred small-business loans 
and leases on personal property (small-business obligations) with 
recourse must include in risk-weighted assets only the contractual 
amount of retained recourse if all the following conditions are met:
    (i) The transaction is a sale under GAAP.
    (ii) The [BANK] establishes and maintains, pursuant to GAAP, a 
non-capital reserve sufficient to meet the [BANK]'s reasonably 
estimated liability under the recourse arrangement.
    (iii) The loans and leases are to businesses that meet the 
criteria for a small-business concern established by the Small 
Business Administration under section 3(a) of the Small Business Act 
(15 U.S.C. 632).
    (iv) The [BANK] is well capitalized, as defined in the 
[agency]'s prompt corrective action regulation--12 CFR part 6 (for 
national banks); 12 CFR part 208, subpart D (for state

[[Page 44047]]

member banks or bank holding companies); 12 CFR part 325, subpart B 
(for state nonmember banks); and 12 CFR part 565 (for savings 
associations). For purposes of determining whether a [BANK] is well 
capitalized for purposes of this paragraph, the [BANK]'s capital 
ratios must be calculated without regard to the capital treatment 
for transfers of small-business obligations with recourse specified 
in this paragraph (i)(1).
    (2) The total outstanding amount of recourse retained by a 
[BANK] on transfers of small-business obligations receiving the 
capital treatment specified in paragraph (i)(1) of this section 
cannot exceed 15 percent of the [BANK]'s total qualifying capital.
    (3) If a [BANK] ceases to be well capitalized or exceeds the 15 
percent capital limitation, the capital treatment specified in 
paragraph (i)(1) of this section will continue to apply to any 
transfers of small-business obligations with recourse that occurred 
during the time that the [BANK] was well capitalized and did not 
exceed the capital limit.
    (4) The risk-based capital ratios of the [BANK] must be 
calculated without regard to the capital treatment for transfers of 
small-business obligations with recourse specified in paragraph 
(i)(1) of this section as provided in 12 CFR part 3, appendix A (for 
national banks); 12 CFR part 208, appendix A (for state member 
banks); 12 CFR part 225, appendix A (for bank holding companies); 12 
CFR part 325, appendix A (for state nonmember banks); and 12 CFR 
567.6(b)(5)(v) (for savings associations).
    (j) Consolidated ABCP programs. (1) A [BANK] that qualifies as a 
primary beneficiary and must consolidate an ABCP program as a 
variable interest entity under GAAP may exclude the consolidated 
ABCP program assets from risk-weighted assets if the [BANK] is the 
sponsor of the ABCP program. If a [BANK] excludes such consolidated 
ABCP program assets from risk-weighted assets, the [BANK] must hold 
risk-based capital against any securitization exposures of the 
[BANK] to the ABCP program in accordance with this part.
    (2) If a [BANK] either is not permitted, or elects not, to 
exclude consolidated ABCP program assets from its risk-weighted 
assets, the [BANK] must hold risk-based capital against the 
consolidated ABCP program assets in accordance with this appendix 
but is not required to hold risk-based capital against any 
securitization exposures of the [BANK] to the ABCP program.
    (k) Nth-to-default credit derivatives. (1) First-to-default 
credit derivatives. (i) Protection purchaser. A [BANK] that obtains 
credit protection on a group of underlying exposures through a 
first-to-default credit derivative must determine its risk-based 
capital requirement for the underlying exposures as if the [BANK] 
synthetically securitized the underlying exposure with the lowest 
risk-based capital requirement and had obtained no credit risk 
mitigant on the other underlying exposures.
    (ii) Protection provider. A [BANK] that provides credit 
protection on a group of underlying exposures through a first-to-
default credit derivative must determine its risk-weighted asset 
amount for the derivative by applying the RBA or, if the derivative 
does not qualify for the RBA, by setting its risk-weighted asset 
amount for the derivative equal to the product of:
    (A) The protection amount of the derivative; and
    (B) The sum of the risk weights of the individual underlying 
exposures, up to a maximum of 1,250 percent.
    (2) Second-or-subsequent-to-default credit derivatives. (i) 
Protection purchaser. (A) A [BANK] that obtains credit protection on 
a group of underlying exposures through an nth-to-default credit 
derivative (other than a first-to-default credit derivative) may 
recognize the credit risk mitigation benefits of the derivative only 
if:
    (1) The [BANK] also has obtained credit protection on the same 
underlying exposures in the form of first-through-(n-1)-to-default 
credit derivatives; or
    (2) If n-1 of the underlying exposures have already defaulted.
    (B) If a [BANK] satisfies the requirements of paragraph 
(k)(2)(i)(A) of this section, the [BANK] must determine its risk-
based capital requirement for the underlying exposures as if the 
[BANK] had only synthetically securitized the underlying exposure 
with the nth lowest risk-based capital requirement and had obtained 
no credit risk mitigant on the other underlying exposures.
    (ii) Protection provider. A [BANK] that provides credit 
protection on a group of underlying exposures through an nth-to-
default credit derivative (other than a first-to-default credit 
derivative) must determine its risk-weighted asset amount for the 
derivative by applying the RBA in section 43 of this appendix (if 
the derivative qualifies for the RBA) or, if the derivative does not 
qualify for the RBA, by setting its risk-weighted asset amount for 
the derivative equal to the product of:
    (A) The protection amount of the derivative; and
    (B) The sum of the risk weights of the individual underlying 
exposures (excluding the n-1 underlying exposures with the lowest 
risk-based capital requirement), up to a maximum of 1,250 percent.

Section 43. Ratings-Based Approach (RBA)

    (a) Eligibility requirements for use of the RBA. (1) Originating 
[BANK]. An originating [BANK] must use the RBA to calculate its 
risk-based capital requirement for a securitization exposure if the 
exposure has two or more external or inferred ratings (and may not 
use the RBA if the exposure has fewer than two external or inferred 
ratings).
    (2) Investing [BANK]. An investing [BANK] must use the RBA to 
calculate the risk-based capital requirement for a securitization 
exposure if the exposure has one or more external or inferred 
ratings (and may not use the RBA if the exposure has no external 
rating or inferred rating).
    (b) Ratings-based approach. (1) A [BANK] must determine its 
risk-based capital requirement for a securitization exposure not 
required to be deducted under Table 11 or 12 by multiplying the 
exposure amount (as determined in paragraph (d) of section 42) by 
the risk weight that corresponds to the applicable external or 
applicable inferred rating provided in Table 11 or 12. If the 
applicable table requires deduction, the exposure amount must be 
deducted from total capital in accordance with paragraph (c) of 
section 42 of this appendix.
    (2) A [BANK] must apply the risk weights in Table 11 when the 
securitization exposure's applicable external or applicable inferred 
rating represents a long-term credit rating, and must apply the risk 
weights in Table 12 when the securitization exposure's applicable 
external or applicable inferred rating represents a short-term 
credit rating.

      Table 11.--Long-term Credit Rating Risk Weights Under the RBA
------------------------------------------------------------------------
Applicable external or applicable
       inferred rating of a             Example         Risk weight (in
     securitization exposure                               percent)
------------------------------------------------------------------------
Highest investment grade rating..  AAA..............  20.
Second-highest investment grade    AA...............  20.
 rating.
Third-highest investment grade     A................  50.
 rating.
Lowest investment grade rating...  BBB..............  100.
One category below investment      BB...............  350.
 grade.
Two categories below investment    B................  Deduction.
 grade.
Three categories or more below     CCC..............  Deduction.
 investment grade.
------------------------------------------------------------------------


[[Page 44048]]


     Table 12.--Short-term Credit Rating Risk Weights Under the RBA
------------------------------------------------------------------------
Applicable external or applicable
       inferred rating of a             Example         Risk Weight (in
     securitization exposure                               percent)
------------------------------------------------------------------------
Highest investment grade rating..  A-1/P-1..........  20.
Second-highest investment grade    A-2/P-2..........  50.
 rating.
Third-highest investment grade     A-3/P-3..........  100.
 rating.
All other ratings................  N/A..............  Deduction.
------------------------------------------------------------------------

Section 44. Securitization Exposures That Do Not Qualify for the 
RBA

    A [BANK] must deduct from total capital all securitization 
exposures that do not qualify for the RBA in section 43 of this 
appendix with the following exceptions, provided that the [BANK] 
knows the composition of the underlying exposures at all times:
    (a) An eligible ABCP liquidity facility. A [BANK] may determine 
the risk-weighted asset amount of an eligible ABCP liquidity 
facility by multiplying the exposure amount by the highest risk 
weight applicable to any of the individual underlying exposures 
covered by the facility.
    (b) A first priority securitization exposure. A [BANK] may 
determine the risk-weighted asset amount of a first priority 
securitization exposure by multiplying the exposure amount by the 
weighted-average risk weight of the underlying exposures. For 
purposes of this section, a first priority securitization exposure 
is a securitization exposure that has a first priority claim on the 
cash flows from the underlying exposures and that is not an eligible 
ABCP liquidity facility. When determining whether a securitization 
exposure has a first priority claim on the cash flows from the 
underlying exposures, a [BANK] is not required to consider amounts 
due under interest rate or currency derivative contracts, fees due, 
or other similar payments.
    (c) A securitization exposure in a second loss position or 
better in an ABCP program. (1) A [BANK] may determine the risk-
weighted asset amount of a securitization exposure that is in a 
second loss position or better in an ABCP program that meets the 
requirements of paragraph (c)(2) of this section by multiplying the 
exposure amount by the higher of the following risk weights:
    (i) 100 percent; or
    (ii) The highest risk weight applicable to any of the individual 
underlying exposures of the ABCP program.
    (2) Requirements. (i) The exposure is not a first priority 
securitization exposure or an eligible ABCP liquidity facility;
    (ii) The exposure must be economically in a second loss position 
or better, and the first loss position must provide significant 
credit protection to the second loss position;
    (iii) The credit risk of the exposure must be the equivalent of 
investment grade or better; and
    (iv) The [BANK] holding the exposure must not retain or provide 
the first loss position.

Section 45. Recognition of Credit Risk Mitigants for Securitization 
Exposures

    (a) General. (1) An originating [BANK] that has obtained a 
credit risk mitigant to hedge its securitization exposure to a 
synthetic or traditional securitization that satisfies the 
operational criteria in section 41 of this appendix may recognize 
the credit risk mitigant under section 36 or 37 of this appendix, 
but only as provided in this section.
    (2) An investing [BANK] that has obtained a credit risk mitigant 
to hedge a securitization exposure may recognize the credit risk 
mitigant under section 36 or 37 of this appendix, but only as 
provided in this section.
    (3) A [BANK] that has used section 43 or section 44 to calculate 
its risk-based capital requirement for a securitization exposure 
based on external or inferred ratings that reflect the benefits of a 
credit risk mitigant provided to the associated securitization or 
that supports some or all of the underlying exposures may not use 
the credit risk mitigation rules in this section to further reduce 
its risk-based capital requirement for the exposure to reflect that 
credit risk mitigant.
    (b) Eligible guarantors for securitization exposures. A [BANK] 
may only recognize an eligible guarantee or eligible credit 
derivative from an eligible guarantor that:
    (1) Is described in paragraph (1) of the definition of eligible 
guarantor; or
    (2) Has issued and outstanding an unsecured debt security 
without credit enhancement that has an applicable external rating 
based on a long-term rating in one of the three highest investment 
grade rating categories.
    (c) Mismatches. A [BANK] must make applicable adjustments to the 
protection amount of an eligible guarantee or credit derivative as 
required in paragraphs (d), (e), and (f) of section 36 of this 
appendix for any hedged securitization exposure. In the context of a 
synthetic securitization, when an eligible guarantee or eligible 
credit derivative covers multiple hedged exposures that have 
different residual maturities, the [BANK] must use the longest 
residual maturity of any of the hedged exposures as the residual 
maturity of all the hedged exposures.

Section 46. Risk-Weighted Assets for Securitizations with Early 
Amortization Provisions

    (a) General. (1) An originating [BANK] must hold risk-based 
capital against the sum of the originating [BANK]'s interest and the 
investors' interest in a securitization that:
    (i) Includes one or more underlying exposures in which the 
borrower is permitted to vary the drawn amount within an agreed 
limit under a line of credit; and
    (ii) Contains an early amortization provision.
    (2) The total capital requirement for a [BANK]'s exposures to a 
single securitization with an early amortization provision is 
subject to a maximum capital requirement equal to the greater of:
    (i) The capital requirement for retained securitization 
exposures, or
    (ii) The capital requirement for the underlying exposures that 
would apply if the [BANK] directly held the underlying exposures.
    (3) For securitizations described in paragraph (a)(1) of this 
section, an originating [BANK] must calculate the risk-based capital 
requirement for the originating [BANK]'s interest under sections 42 
through 45 of this appendix, and the risk-weighted asset amount for 
the investors' interest under paragraph (c) of this section.
    (b) Definitions. For purposes of this section:
    (1) Investors' interest means, with respect to a securitization, 
the exposure amount of the underlying exposures multiplied by the 
ratio of:
    (i) The total amount of securitization exposures issued by the 
securitization SPE; divided by
    (ii) The outstanding principal amount of the underlying 
exposures.
    (2) Excess spread for a period means:
    (i) Gross finance charge collections and other income received 
by a securitization SPE (including market interchange fees) over a 
period minus interest paid to the holders of the securitization 
exposures, servicing fees, charge-offs, and other senior trust or 
similar expenses of the SPE over the period; divided by
    (ii) The principal balance of the underlying exposures at the 
end of the period.
    (c) Risk-weighted asset amount for investors' interest. The 
originating [BANK]'s risk-weighted asset amount for the investors' 
interest in the securitization is equal to the product of the 
following four quantities:
    (1) The investors' interest;
    (2) The appropriate conversion factor in paragraph (d) of this 
section;
    (3) The weighted-average risk weight that would apply under this 
appendix to the underlying exposures if the underlying exposures had 
not been securitized; and
    (4) The proportion of the underlying exposures in which the 
borrower is permitted to vary the drawn amount within an agreed 
limit under a line of credit.
    (d) Conversion factors. (1)(i) Except as provided in paragraph 
(d)(2) of this section, to calculate the appropriate conversion 
factor, a [BANK] must use Table 13 for a securitization that 
contains a controlled early amortization provision and must use 
Table 14 for a securitization that contains a non-controlled early 
amortization provision. In

[[Page 44049]]

circumstances where a securitization contains a mix of retail and 
nonretail exposures or a mix of committed and uncommitted exposures, 
a [BANK] may take a pro rata approach to determining the conversion 
factor for the securitization's early amortization provision. If a 
pro rata approach is not feasible, a [BANK] must treat the mixed 
securitization as a securitization of nonretail exposures if a 
single underlying exposure is a nonretail exposure and must treat 
the mixed securitization as a securitization of committed exposures 
if a single underlying exposure is a committed exposure.
    (ii) To find the appropriate conversion factor in the tables, a 
[BANK] must divide the three-month average annualized excess spread 
of the securitization by the excess spread trapping point in the 
securitization structure. In securitizations that do not require 
excess spread to be trapped, or that specify trapping points based 
primarily on performance measures other than the three-month average 
annualized excess spread, the excess spread trapping point is 4.5 
percent.

           Table 13.--Controlled Early Amortization Provisions
------------------------------------------------------------------------
                                          Uncommitted CF   Committed  CF
3-month average annualized excess spread   (in percent)    (in percent)
------------------------------------------------------------------------
Retail Credit Lines:
    Greater than or equal to 133.33% of                0              90
     trapping point.....................
    Less than 133.33% to 100% of                       1  ..............
     trapping point.....................
    Less than 100% to 75% of trapping                  2  ..............
     point..............................
    Less than 75% to 50% of trapping                  10  ..............
     point..............................
    Less than 50% to 25% of trapping                  20  ..............
     point..............................
    Less than 25% of trapping point.....              40  ..............
Non-retail credit lines.................              90              90
------------------------------------------------------------------------


         Table 14.--Non-controlled Early Amortization Provisions
------------------------------------------------------------------------
                                          Uncommitted CF   Committed  CF
3-month average annualized excess spread   (in percent)    (in percent)
------------------------------------------------------------------------
Retail Credit Lines:
    Greater than or equal to 133.33% of                0             100
     trapping point.....................
    Less than 133.33% to 100% of                       5  ..............
     trapping point.....................
    Less than 100% to 75% of trapping                 15  ..............
     point..............................
    Less than 75% to 50% of trapping                  50  ..............
     point..............................
    Less than 50% of trapping point.....             100  ..............
Non-retail credit lines.................             100             100
------------------------------------------------------------------------

    (2) For a securitization for which all or substantially all of 
the underlying exposures are secured by liens on one-to-four family 
residential property, a [BANK] may calculate the appropriate 
conversion factor discussed in paragraph (c)(2) of this section 
using paragraph (d)(1) of this section or may use a conversion 
factor of 10 percent. If the [BANK] chooses to use a conversion 
factor of 10 percent, it must use that conversion factor for all 
securitizations for which all or substantially all of the underlying 
exposures are secured by liens on one-to-four family residential 
property.

Part V. Risk-Weighted Assets for Equity Exposures

Section 51. Introduction and Exposure Measurement

    (a) General. To calculate its risk-weighted asset amounts for 
equity exposures that are not equity exposures to investment funds, 
a [BANK] must use the Simple Risk-Weight Approach (SRWA) in section 
52. A [BANK] must use the look-through approaches in section 53 to 
calculate its risk-weighted asset amounts for equity exposures to 
investment funds.
    (b) Adjusted carrying value. For purposes of this part, the 
adjusted carrying value of an equity exposure is:
    (1) For the on-balance sheet component of an equity exposure, 
the [BANK]'s carrying value of the exposure reduced by any 
unrealized gains on the exposure that are reflected in such carrying 
value but excluded from the [BANK]'s tier 1 and tier 2 capital; and
    (2) For the off-balance sheet component of an equity exposure 
that is not an equity commitment, the effective notional principal 
amount of the exposure, the size of which is equivalent to a 
hypothetical on-balance sheet position in the underlying equity 
instrument that would evidence the same change in fair value 
(measured in dollars) for a given small change in the price of the 
underlying equity instrument, minus the adjusted carrying value of 
the on-balance sheet component of the exposure as calculated in 
paragraph (b)(1) of this section.
    (3) For a commitment to acquire an equity exposure (an equity 
commitment), the effective notional principal amount of the exposure 
multiplied by the following conversion factors (CFs):
    (i) Conditional equity commitments with an original maturity of 
one year or less receive a CF of 20 percent.
    (ii) Conditional equity commitments with an original maturity of 
over one year receive a CF of 50 percent.
    (iii) Unconditional equity commitments receive a CF of 100 
percent.

Section 52. Simple Risk-Weight Approach (SRWA)

    (a) General. Under the SRWA, a [BANK]'s total risk-weighted 
assets for equity exposures equals the sum of the risk-weighted 
asset amounts for each of the [BANK]'s individual equity exposures 
(other than equity exposures to an investment fund) as determined in 
this section and the risk-weighted asset amounts for each of the 
[BANK]'s individual equity exposures to an investment fund as 
determined in section 53.
    (b) SRWA computation for individual equity exposures. A [BANK] 
must determine the risk-weighted asset amount for an individual 
equity exposure (other than an equity exposure to an investment 
fund) by multiplying the adjusted carrying value of the equity 
exposure or the effective portion and ineffective portion of a hedge 
pair (as defined in paragraph (c) of this section) by the lowest 
applicable risk weight in this paragraph (b).
    (1) Zero percent risk weight equity exposures. An equity 
exposure to a sovereign entity, the Bank for International 
Settlements, the European Central Bank, the European Commission, the 
International Monetary Fund, an MDB, a PSE, and any other entity 
whose credit exposures receive a zero percent risk weight under 
section 33 may be assigned a zero percent risk weight.
    (2) 20 percent risk weight equity exposures. An equity exposure 
to a Federal Home Loan Bank or Federal Agricultural Mortgage 
Corporation (Farmer Mac) is assigned a 20 percent risk weight.
    (3) 100 percent risk weight equity exposures. The following 
equity exposures are assigned a 100 percent risk weight:

[[Page 44050]]

    (i) Community development equity exposures. (A) For banks and 
bank holding companies, an equity exposure that qualifies as a 
community development investment under 12 U.S.C. 24 (Eleventh), 
excluding equity exposures to an unconsolidated small business 
investment company and equity exposures held through a consolidated 
small business investment company described in section 302 of the 
Small Business Investment Act of 1958 (15 U.S.C. 682).
    (B) For savings associations, an equity exposure that is 
designed primarily to promote community welfare, including the 
welfare of low- and moderate-income communities or families, such as 
by providing services or employment, and excluding equity exposures 
to an unconsolidated small business investment company and equity 
exposures held through a small business investment company described 
in section 302 of the Small Business Investment Act of 1958 (15 
U.S.C. 682).
    (ii) Effective portion of hedge pairs. The effective portion of 
a hedge pair.
    (iii) Non-significant equity exposures. Equity exposures, 
excluding exposures to an investment firm that would meet the 
definition of a traditional securitization were it not for the 
[agency]'s application of paragraph (8) of that definition and has 
greater than immaterial leverage, to the extent that the aggregate 
adjusted carrying value of the exposures does not exceed 10 percent 
of the [BANK]'s tier 1 capital plus tier 2 capital.
    (A) To compute the aggregate adjusted carrying value of a 
[BANK]'s equity exposures for purposes of this paragraph 
(b)(3)(iii), the [BANK] may exclude equity exposures described in 
paragraphs (b)(1), (b)(2), (b)(3)(i), and (b)(3)(ii) of this 
section, the equity exposure in a hedge pair with the smaller 
adjusted carrying value, and a proportion of each equity exposure to 
an investment fund equal to the proportion of the assets of the 
investment fund that are not equity exposures or that meet the 
criterion of paragraph (b)(3)(i) of this section. If a [BANK] does 
not know the actual holdings of the investment fund, the [BANK] may 
calculate the proportion of the assets of the fund that are not 
equity exposures based on the terms of the prospectus, partnership 
agreement, or similar contract that defines the fund's permissible 
investments. If the sum of the investment limits for all exposure 
classes within the fund exceeds 100 percent, the [BANK] must assume 
for purposes of this paragraph (b)(3)(iii) that the investment fund 
invests to the maximum extent possible in equity exposures.
    (B) When determining which of a [BANK]'s equity exposures 
qualify for a 100 percent risk weight under this paragraph, a [BANK] 
first must include equity exposures to unconsolidated small business 
investment companies or held through consolidated small business 
investment companies described in section 302 of the Small Business 
Investment Act of 1958 (15 U.S.C. 682), then must include publicly 
traded equity exposures (including those held indirectly through 
investment funds), and then must include non-publicly traded equity 
exposures (including those held indirectly through investment 
funds).
    (4) 300 percent risk weight equity exposures. A publicly traded 
equity exposure (other than an equity exposure described in 
paragraph (b)(6) of this section and including the ineffective 
portion of a hedge pair) is assigned a 300 percent risk weight.
    (5) 400 percent risk weight equity exposures. An equity exposure 
(other than an equity exposure described in paragraph (b)(6) of this 
section) that is not publicly traded is assigned a 400 percent risk 
weight.
    (6) 600 percent risk weight equity exposures. An equity exposure 
to an investment firm that:
    (i) Would meet the definition of a traditional securitization 
were it not for the [agency]'s application of paragraph (8) of that 
definition, and
    (ii) Has greater than immaterial leverage is assigned a 600 
percent risk weight.
    (c) Hedge transactions. (1) Hedge pair. A hedge pair is two 
equity exposures that form an effective hedge so long as each equity 
exposure is publicly traded or has a return that is primarily based 
on a publicly traded equity exposure.
    (2) Effective hedge. Two equity exposures form an effective 
hedge if the exposures either have the same remaining maturity or 
each has a remaining maturity of at least three months; the hedge 
relationship is formally documented in a prospective manner (that 
is, before the [BANK] acquires at least one of the equity 
exposures); the documentation specifies the measure of effectiveness 
(E) the [BANK] will use for the hedge relationship throughout the 
life of the transaction; and the hedge relationship has an E greater 
than or equal to 0.8. A [BANK] must measure E at least quarterly and 
must use one of three alternative measures of E:
    (i) Under the dollar-offset method of measuring effectiveness, 
the [BANK] must determine the ratio of value change (RVC). The RVC 
is the ratio of the cumulative sum of the periodic changes in value 
of one equity exposure to the cumulative sum of the periodic changes 
in the value of the other equity exposure. If RVC is positive, the 
hedge is not effective and E equals 0. If RVC is negative and 
greater than or equal to -1 (that is, between zero and -1), then E 
equals the absolute value of RVC. If RVC is negative and less than -
1, then E equals 2 plus RVC.
    (ii) Under the variability-reduction method of measuring 
effectiveness:

[GRAPHIC] [TIFF OMITTED] TP29JY08.005

where:
(A) Xt = At - Bt;
(B) At = the value at time t of one exposure in a hedge pair; and
(C) Bt = the value at time t of the other exposure in a hedge pair.

    (iii) Under the regression method of measuring effectiveness, E 
equals the coefficient of determination of a regression in which the 
change in value of one exposure in a hedge pair is the dependent 
variable and the change in value of the other exposure in a hedge 
pair is the independent variable. However, if the estimated 
regression coefficient is positive, then the value of E is zero.
    (3) The effective portion of a hedge pair is E multiplied by the 
greater of the adjusted carrying values of the equity exposures 
forming a hedge pair.
    (4) The ineffective portion of a hedge pair is (1-E) multiplied 
by the greater of the adjusted carrying values of the equity 
exposures forming a hedge pair.

Section 53. Equity Exposures to Investment Funds

    (a) Available approaches. (1) Unless the exposure meets the 
requirements for a community development equity exposure in 
paragraph (b)(3)(i) of section 52, a [BANK] must determine the risk-
weighted asset amount of an equity exposure to an investment fund 
under the Full Look-Through Approach in paragraph (b) of this 
section, the Simple Modified Look-Through Approach in paragraph (c) 
of this section, the Alternative Modified Look-Through Approach in 
paragraph (d) of this section, or, if the investment fund qualifies 
for the Money Market Fund Approach, the Money Market Fund Approach 
in paragraph (e) of this section.
    (2) The risk-weighted asset amount of an equity exposure to an 
investment fund that meets the requirements for a community 
development equity exposure in paragraph (b)(3)(i) of section 52 is 
its adjusted carrying value.
    (3) If an equity exposure to an investment fund is part of a 
hedge pair and the [BANK] does not use the Full Look-Through 
Approach, the [BANK] may use the ineffective portion of the hedge 
pair as determined under paragraph (c) of section 52 as the adjusted 
carrying value for the equity exposure to the investment fund. The 
risk-weighted asset amount of the effective portion of the hedge 
pair is equal to its adjusted carrying value.
    (b) Full Look-Through Approach. A [BANK] that is able to 
calculate a risk-weighted asset amount for its proportional 
ownership share of each exposure held by the investment fund (as 
calculated under this appendix as if the proportional ownership 
share of each exposure were held directly by the [BANK]) may set the 
risk-weighted asset amount of the [BANK]'s exposure to the fund 
equal to the product of:
    (1) The aggregate risk-weighted asset amounts of the exposures 
held by the fund as if they were held directly by the [BANK]; and
    (2) The [BANK]'s proportional ownership share of the fund.
    (c) Simple Modified Look-Through Approach. Under this approach, 
the risk-weighted asset amount for a [BANK]'s equity exposure to an 
investment fund equals the adjusted carrying value of the equity 
exposure multiplied by the highest risk weight that applies to any 
exposure the fund is permitted to hold under its prospectus, 
partnership agreement, or similar contract that defines the fund's 
permissible

[[Page 44051]]

investments (excluding derivative contracts that are used for 
hedging rather than speculative purposes and that do not constitute 
a material portion of the fund's exposures).
    (d) Alternative Modified Look-Through Approach. Under this 
approach, a [BANK] may assign the adjusted carrying value of an 
equity exposure to an investment fund on a pro rata basis to 
different risk weight categories under this appendix based on the 
investment limits in the fund's prospectus, partnership agreement, 
or similar contract that defines the fund's permissible investments. 
The risk-weighted asset amount for the [BANK]'s equity exposure to 
the investment fund equals the sum of each portion of the adjusted 
carrying value assigned to an exposure class multiplied by the 
applicable risk weight under this appendix. If the sum of the 
investment limits for exposure classes within the fund exceeds 100 
percent, the [BANK] must assume that the fund invests to the maximum 
extent permitted under its investment limits in the exposure class 
with the highest applicable risk weight under this appendix and 
continues to make investments in order of the exposure class with 
the next highest applicable risk weight under this appendix until 
the maximum total investment level is reached. If more than one 
exposure class applies to an exposure, the [BANK] must use the 
highest applicable risk weight. A [BANK] may exclude derivative 
contracts held by the fund that are used for hedging rather than for 
speculative purposes and do not constitute a material portion of the 
fund's exposures.
    (e) Money Market Fund Approach. The risk-weighted asset amount 
for a [BANK]'s equity exposure to an investment fund that is a money 
market fund subject to 17 CFR 270.2a-7 and that has an applicable 
external rating in the highest investment-grade rating category 
equals the adjusted carrying value of the equity exposure multiplied 
by seven percent.

Part VI. Risk-Weighted Assets for Operational Risk

Section 61. Basic Indicator Approach

    (a) Risk-weighted assets for operational risk. Risk-weighted 
assets for operational risk equals 15 percent of a [BANK]'s average 
positive annual gross income multiplied by 12.5.
    (b) Average positive annual gross income. A [BANK]'s average 
positive annual gross income equals the sum of the [BANK]'s positive 
annual gross income, as described below, over the three most recent 
calendar years divided by the number of those years in which its 
annual gross income is positive. A [BANK] must exclude from this 
calculation amounts from any year in which the annual gross income 
is negative or zero.
    (c) Annual gross income equals:
    (1) For a [BANK], its net interest income plus its total 
noninterest income minus its underwriting income from insurance and 
reinsurance activities as reported on the [BANK]'s Call Report.
    (2) For a bank holding company, its net interest income plus its 
total noninterest income minus its underwriting income from 
insurance and reinsurance activities as reported on the bank holding 
company's Y9-C Report.
    (3) For a savings association, its net interest income (expense) 
before provision for losses on interest-bearing assets, plus total 
noninterest income, minus the portion of its other fees and charges 
that represents income derived from insurance and reinsurance 
underwriting activities, minus (plus) its income (loss) from the 
sale of assets held for sale and available-for-sale securities to 
include only the profit or loss from the disposition of available-
for-sale securities pursuant to FASB Statement No. 115, minus (plus) 
its income (loss) from the sale of securities held-to-maturity, all 
as reported on the savings association's year-end Thrift Financial 
Report.

Part VII. Disclosure

Section 71. Disclosure Requirements

    (a) Each [BANK] must publicly disclose each quarter its total 
and tier 1 risk-based capital ratios and their components (that is, 
tier 1 capital, tier 2 capital, total qualifying capital, and total 
risk-weighted assets).\74\
---------------------------------------------------------------------------

    \74\ Other public disclosure requirements continue to apply--for 
example, Federal securities law and regulatory reporting 
requirements.
---------------------------------------------------------------------------

    (b) A [BANK] must comply with paragraph (c) of this section 
unless it is a consolidated subsidiary of a bank holding company or 
depository institution that is subject to these disclosure 
requirements.
    (c) (1) Each [BANK] that is not a subsidiary of a non-U.S. 
banking organization that is subject to comparable public disclosure 
requirements in its home jurisdiction must provide timely public 
disclosures each calendar quarter of the information in tables 15.1-
15.10 below. If a significant change occurs, such that the most 
recent reported amounts are no longer reflective of the [BANK]'s 
capital adequacy and risk profile, then a brief discussion of this 
change and its likely impact must be provided as soon as practicable 
thereafter. Qualitative disclosures that typically do not change 
each quarter (for example, a general summary of the [BANK]'s risk 
management objectives and policies, reporting system, and 
definitions) may be disclosed annually, provided any significant 
changes to these are disclosed in the interim. Management is 
encouraged to provide all of the disclosures required by this 
appendix in one place on the [BANK]'s public Web site.\75\ The 
[BANK] must make these disclosures publicly available for each of 
the last three years (that is, twelve quarters) or such shorter 
period [beginning on the effective date of a [BANK]'s election to 
use this appendix].
---------------------------------------------------------------------------

    \75\ Alternatively, a [BANK] may provide the disclosures in more 
than one place, as some of them may be included in public financial 
reports (for example, in Management's Discussion and Analysis 
included in SEC filings) or other regulatory reports. The [BANK] 
must publicly provide a summary table that specifically indicates 
where all the disclosures may be found (for example, regulatory 
report schedules, page numbers in annual reports).
---------------------------------------------------------------------------

    (2) Each [BANK] is required to have a formal disclosure policy 
approved by the board of directors that addresses its approach for 
determining the disclosures it makes. The policy must address the 
associated internal controls and disclosure controls and procedures. 
The board of directors and senior management are responsible for 
establishing and maintaining an effective internal control structure 
over financial reporting, including the disclosures required by this 
appendix, and must ensure that appropriate review of the disclosures 
takes place. One or more senior officers of the [BANK] must attest 
that the disclosures meet the requirements of this appendix.
    (3) If a [BANK] believes that disclosure of specific commercial 
or financial information would prejudice seriously its position by 
making public information that is either proprietary or confidential 
in nature, the [BANK] need not disclose those specific items, but 
must disclose more general information about the subject matter of 
the requirement, together with the fact that, and the reason why, 
the specific items of information have not been disclosed.

                    Table 15.1.--Scope of Application
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures......  (a) The name of the top corporate entity
                                in the group to which the appendix
                                applies.
                               (b) An outline of differences in the
                                basis of consolidation for accounting
                                and regulatory purposes, with a brief
                                description of the entities \1\ within
                                the group:
                                  (1) that are fully consolidated;
                                  (2) that are deconsolidated and
                                   deducted;
                                  (3) for which the regulatory capital
                                   requirement is deducted; and
                                  (4) that are neither consolidated nor
                                   deducted (for example, where the
                                   investment is risk weighted).
                               (c) Any restrictions, or other major
                                impediments, on transfer of funds or
                                regulatory capital within the group.
Quantitative Disclosures.....  (d) The aggregate amount of surplus
                                capital of insurance subsidiaries
                                included in the regulatory capital of
                                the consolidated group.

[[Page 44052]]

 
                               (e) The aggregate amount by which actual
                                regulatory capital is less than the
                                minimum regulatory capital requirement
                                in all subsidiaries with regulatory
                                capital requirements and the name(s) of
                                the subsidiaries with such deficiencies.
------------------------------------------------------------------------
\1\ Entities include securities, insurance and other financial
  subsidiaries, commercial subsidiaries (where permitted), significant
  minority equity investments in insurance, financial and commercial
  entities.


                     Table 15.2.--Capital Structure
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures......  (a) Summary information on the terms and
                                conditions of the main features of all
                                capital instruments, especially in the
                                case of innovative, complex or hybrid
                                capital instruments.
Quantitative Disclosures.....  (b) The amount of tier 1 capital, with
                                separate disclosure of:
                                  (1) common stock/surplus;
                                  (2) retained earnings;
                                  (3) minority interests in the equity
                                   of subsidiaries;
                                  (4) restricted core capital elements
                                   as defined in [the general risk-based
                                   capital rules];
                                  (5) amounts deducted from tier 1
                                   capital, including goodwill and
                                   certain intangibles.
                               (c) The total amount of tier 2 capital,
                                with a separate disclosure of amounts
                                deducted from tier 2 capital.
                               (d) Other deductions from capital.
                               (e) Total eligible capital.
------------------------------------------------------------------------


                      Table 15.3.--Capital Adequacy
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures......  (a) A summary discussion of the [BANK]'s
                                approach to assessing the adequacy of
                                its capital to support current and
                                future activities.
Quantitative Disclosures.....  (b) Risk-weighted assets for:
                                  (1) Exposures to sovereign entities;
                                  (2) Exposures to certain supranational
                                   entities and MDBs;
                                  (3) Exposures to depository
                                   institutions, foreign banks, and
                                   credit unions;
                                  (4) Exposures to PSEs;
                                  (5) Corporate exposures;
                                  (6) Regulatory retail exposures;
                                  (7) Residential mortgage exposures;
                                  (8) Statutory multifamily mortgages
                                   and pre-sold construction loans;
                                  (9) Past due loans;
                                  (10) Other assets;
                                  (11) Securitization exposures; and
                                  (12) Equity exposures.
                               (c) Risk-weighted assets for market risk
                                as calculated under [the market risk
                                rule]: \1\
                                  (1) Standardized specific risk charge;
                                   and
                                  (2) Internal models approach for
                                   specific risk.
                               (d) Risk-weighted assets for operational
                                risk.
                               (e) Total and tier 1 risk-based capital
                                ratios:
                                  (1) For the top consolidated group;
                                   and
                                  (2) For each [BANK] subsidiary.
                               (f) Total risk-weighted assets.
------------------------------------------------------------------------
\1\ Risk-weighted assets determined under [the market risk rule] are to
  be disclosed only for the approaches used.

General qualitative disclosure requirement

    For each separate risk area described in tables 15.4 through 
15.10, the [BANK] must describe its risk management objectives and 
policies.

            Table 15.4.\1\--Credit Risk: General Disclosures
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures......  (a) The general qualitative disclosure
                                requirement with respect to credit risk
                                (excluding counterparty credit risk
                                disclosed in accordance with Table
                                16.5), including:
                                  (1) Definitions of past due and
                                   impaired (for accounting purposes);
                                  (2) Description of approaches followed
                                   for allowances, including statistical
                                   methods used where applicable;
                                  (3) Discussion of the [BANK]'s credit
                                   risk management policy.
Quantitative Disclosures.....  (b) Total gross credit risk exposures and
                                average credit risk exposures, after
                                accounting offsets in accordance with
                                GAAP,\2\ and without taking into account
                                the effects of credit risk mitigation
                                techniques (for example, collateral and
                                netting), over the period broken down by
                                major types of credit exposure. For
                                example, [BANK]s could apply a breakdown
                                similar to that used for accounting
                                purposes. Such a breakdown might, for
                                instance, be loans, off-balance sheet
                                commitments, and other non-derivative
                                off-balance sheet exposures; debt
                                securities; and OTC derivatives
                               (c) Geographic \3\ distribution of
                                exposures, broken down in significant
                                areas by major types of credit exposure.
                               (d) Industry or counterparty type
                                distribution of exposures, broken down
                                by major types of credit exposure.
                               (e) Remaining contractual maturity
                                breakdown (for example, one year or
                                less) of the whole portfolio, broken
                                down by major types of credit exposure.
                               (f)(1) By major industry or counterparty
                                type:

[[Page 44053]]

 
                                (2) Amount of impaired loans;
                                (3) Amount of past due loans; \4\
                                (4) Allowances; and
                                (5) Charge-offs during the period.
                               (g) Amount of impaired loans and, if
                                available, the amount of past due loans
                                broken down by significant geographic
                                areas including, if practical, the
                                amounts of allowances related to each
                                geographical area.\5\
                               (h) Reconciliation of changes in the
                                allowance for loan and lease losses.\6\
------------------------------------------------------------------------
\1\ Table 15.4 does not include equity exposures.
\2\ For example, FASB Interpretations 39 and 41.
\3\ Geographical areas may comprise individual countries, groups of
  countries, or regions within countries. A [BANK] might choose to
  define the geographical areas based on the way the [BANK]'s portfolio
  is geographically managed. The criteria used to allocate the loans to
  geographical areas must be specified.
\4\ A [BANK] is encouraged also to provide an analysis of the aging of
  past-due loans.
\5\ The portion of general allowance that is not allocated to a
  geographical area should be disclosed separately.
\6\ The reconciliation should include the following: a description of
  the allowance; the opening balance of the allowance; charge-offs taken
  against the allowance during the period; amounts provided (or
  reversed) for estimated probable loan losses during the period; any
  other adjustments (for example, exchange rate differences, business
  combinations, acquisitions and disposals of subsidiaries), including
  transfers between allowances; and the closing balance of the
  allowance. Charge-offs and recoveries that have been recorded directly
  to the income statement should be disclosed separately.


  Table 15.5.--General Disclosure for Counterparty Credit Risk-Related
                                Exposures
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures......  (a) The general qualitative disclosure
                                requirement with respect to OTC
                                derivatives, eligible margin loans, and
                                repo-style transactions, including:
                                  (1) Discussion of methodology used to
                                   assign economic capital and credit
                                   limits for counterparty credit
                                   exposures;
                                  (2) Discussion of policies for
                                   securing collateral, valuing and
                                   managing collateral, and establishing
                                   credit reserves;
                                  (3) Discussion of the primary types of
                                   collateral taken;
                                  (4) Discussion of policies with
                                   respect to wrong-way risk exposures;
                                   and
                                  (5) Discussion of the impact of the
                                   amount of collateral the [BANK] would
                                   have to provide given a credit rating
                                   downgrade.
Quantitative Disclosures.....  (b) Gross positive fair value of
                                contracts, netting benefits, netted
                                current credit exposure, collateral held
                                (including type, for example, cash,
                                government securities), and net
                                unsecured credit exposure.\1\ Also
                                report the notional value of credit
                                derivative hedges purchased for
                                counterparty credit risk protection and
                                the distribution of current credit
                                exposure by types of credit exposure.\2\
                               (c) Notional amount of purchased and sold
                                credit derivatives, segregated between
                                use for the [BANK]'s own credit
                                portfolio, as well as in its
                                intermediation activities, including the
                                distribution of the credit derivative
                                products used, broken down further by
                                protection bought and sold within each
                                product group.
------------------------------------------------------------------------
\1\ Net unsecured credit exposure is the credit exposure after
  considering both the benefits from legally enforceable netting
  agreements and collateral arrangements without taking into account
  haircuts for price volatility, liquidity, etc.
\2\ This may include interest rate derivative contracts, foreign
  exchange derivative contracts, equity derivative contracts, credit
  derivatives, commodity or other derivative contracts, repo-style
  transactions, and eligible margin loans.


            Table 15.6.--Credit Risk Mitigation \1\, \2\, \3\
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures......  (a) The general qualitative disclosure
                                requirement with respect to credit risk
                                mitigation including:
                                  (1) policies and processes for, and an
                                   indication of the extent to which the
                                   [BANK] uses, on- and off-balance
                                   sheet netting;
                                  (2) policies and processes for
                                   collateral valuation and management;
                                  (3) a description of the main types of
                                   collateral taken by the [BANK];
                                  (4) the main types of guarantors/
                                   credit derivative counterparties and
                                   their creditworthiness; and
                                  (5) information about (market or
                                   credit) risk concentrations within
                                   the mitigation taken.
Quantitative Disclosures.....  (b) For each separately disclosed
                                portfolio, the total exposure (after,
                                where applicable, on-or off-balance
                                sheet netting) that is covered by
                                guarantees/credit derivatives and the
                                risk-weighted asset amount associated
                                with that exposure.
------------------------------------------------------------------------
\1\ At a minimum, a [BANK] must give the disclosures in Table 15.6 in
  relation to credit risk mitigation that has been recognized for the
  purposes of reducing capital requirements under this appendix. Where
  relevant, [BANK]s are encouraged to give further information about
  mitigants that have not been recognized for that purpose.
\2\ Credit derivatives that are treated, for the purposes of this
  appendix, as synthetic securitization exposures should be excluded
  from the credit risk mitigation disclosures and included within those
  relating to securitization.
\3\ Counterparty credit risk-related exposures disclosed pursuant to
  Table 15.5 should be excluded from the credit risk mitigation
  disclosures in Table 15.6.


                       Table 15.7.--Securitization
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures......  (a) The general qualitative disclosure
                                requirement with respect to
                                securitization (including synthetic
                                securitizations), including a discussion
                                of:
                                  (1) the [BANK]'s objectives relating
                                   to securitization activity, including
                                   the extent to which these activities
                                   transfer credit risk of the
                                   underlying exposures away from the
                                   [BANK] to other entities;
                                  (2) the roles played by the [BANK] in
                                   the securitization process \1\ and an
                                   indication of the extent of the
                                   [BANK]'s involvement in each of them.
                               (b) Summary of the [BANK]'s accounting
                                policies for securitization activities,
                                including:

[[Page 44054]]

 
                                  (1) whether the transactions are
                                   treated as sales or financings;
                                  (2) recognition of gain-on-sale;
                                  (3) key assumptions for valuing
                                   retained interests, including any
                                   significant changes since the last
                                   reporting period and the impact of
                                   such changes; and
                                  (4) treatment of synthetic
                                   securitizations.
                               (c) Names of NRSROs used for
                                securitizations and the types of
                                securitization exposure for which each
                                organization is used.
Quantitative Disclosures.....  (d) The total outstanding exposures
                                securitized by the [BANK] in
                                securitizations that meet the operation
                                criteria in Section 41 (broken down into
                                traditional/synthetic), by underlying
                                exposure type.2 3 4
                               (e) For exposures securitized by the
                                [BANK] in securitizations that meet the
                                operational criteria in Section 41:
                                  (1) amount of securitized assets that
                                   are impaired/past due; and
                                  (2) losses recognized by the [BANK]
                                   during the current period \5\ broken
                                   down by exposure type.
                               (f) Aggregate amount of securitization
                                exposures broken down by underlying
                                exposure type.
                               (g) Aggregate amount of securitization
                                exposures and the associated capital
                                charges for these exposures by risk-
                                weight category. Exposures that have
                                been deducted from capital should be
                                disclosed separately by type of
                                underlying asset.
                               (h) For securitizations subject to the
                                early amortization treatment, the
                                following items by underlying asset type
                                for securitized facilities:
                                  (1) the aggregate drawn exposures
                                   attributed to the seller's and
                                   investors' interests; and
                                  (2) the aggregate capital charges
                                   incurred by the [BANK] against the
                                   investor's shares of drawn balances
                                   and undrawn lines.
                               (i) Summary of current year's
                                securitization activity, including the
                                amount of exposures securitized (by
                                exposure type), and recognized gain-or
                                loss-on-sale by asset type.
------------------------------------------------------------------------
\1\ For example: originator, investor, servicer, provider of credit
  enhancement, sponsor of asset-backed commercial paper facility,
  liquidity provider, swap provider.
\2\ Underlying exposure types may include, for example, mortgage loans
  secured by liens on one-to-four family residential property, home
  equity lines, credit card receivables, and auto loans.
\3\ Securitization transactions in which the originating [BANK] does not
  retain any securitization exposure should be shown separately but need
  only be reported for the year of inception.
\4\ Where relevant, a [BANK] is encouraged to differentiate between
  exposures resulting from activities in which they act only as
  sponsors, and exposures that result from all other [BANK]
  securitization activities.
\5\ For example, charge-offs/allowances (if the assets remain on the
  [BANK]'s balance sheet) or write-downs of I/O strips and other
  residual interests.


                      Table 15.8.--Operational Risk
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures......  (a) The general qualitative disclosure
                                requirement for operational risk.
                               (b) A description of the use of insurance
                                for the purpose of mitigating
                                operational risk.
------------------------------------------------------------------------


          Table 15.9.--Equities Not Subject to Market Risk Rule
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures......  (a) The general qualitative disclosure
                                requirement with respect to equity risk,
                                including:
                                  (1) differentiation between holdings
                                   on which capital gains are expected
                                   and those taken under other
                                   objectives including for relationship
                                   and strategic reasons; and
                                  (2) discussion of important policies
                                   covering the valuation of and
                                   accounting for equity holdings in the
                                   banking book. This includes the
                                   accounting techniques and valuation
                                   methodologies used, including key
                                   assumptions and practices affecting
                                   valuation as well as significant
                                   changes in these practices.
Quantitative Disclosures.....  (b) Value disclosed in the balance sheet
                                of investments, as well as the fair
                                value of those investments; for quoted
                                securities, a comparison to publicly-
                                quoted share values where the share
                                price is materially different from fair
                                value.
                               (c) The types and nature of investments,
                                including the amount that is:
                                  (1) Publicly traded; and
                                  (2) Non-publicly traded.
                               (d) The cumulative realized gains
                                (losses) arising from sales and
                                liquidations in the reporting period.
                               (e)(1) Total unrealized gains (losses)
                                \1\
                                  (2) Total latent revaluation gains
                                   (losses) \2\
                                  (3) Any amounts of the above included
                                   in tier 1 and/or tier 2 capital.
                               (f) Capital requirements broken down by
                                appropriate equity groupings, consistent
                                with the [BANK]'s methodology, as well
                                as the aggregate amounts and the type of
                                equity investments subject to any
                                supervisory transition regarding
                                regulatory capital requirements.
------------------------------------------------------------------------
\1\ Unrealized gains (losses) recognized in the balance sheet but not
  through earnings.
\2\ Unrealized gains (losses) not recognized either in the balance sheet
  or through earnings.


       Table 15.10.--Interest Rate Risk for Non-trading Activities
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures......  (a) The general qualitative disclosure
                                requirement, including the nature of
                                interest rate risk for non-trading
                                activities and key assumptions,
                                including assumptions regarding loan
                                prepayments and behavior of non-maturity
                                deposits, and frequency of measurement
                                of interest rate risk for non-trading
                                activities.
Quantitative disclosures.....  (b) The increase (decline) in earnings or
                                economic value (or relevant measure used
                                by management) for upward and downward
                                rate shocks according to management's
                                method for measuring interest rate risk
                                for non-trading activities, broken down
                                by currency (as appropriate).
------------------------------------------------------------------------


[[Page 44055]]

END OF COMMON RULE.
[END OF COMMON TEXT]

List of Subjects

12 CFR Part 3

    Administrative practices and procedure, Capital, National banks, 
Reporting and recordkeeping requirements, Risk.

12 CFR Part 208

    Confidential business information, Crime, Currency, Federal Reserve 
System, Mortgages, Reporting and recordkeeping requirements, 
Securities.

12 CFR Part 225

    Administrative practice and procedure, Banks, banking, Federal 
Reserve System, Holding companies, Reporting and recordkeeping 
requirements, Securities.

12 CFR Part 325

    Administrative practice and procedure, Banks, banking, Capital 
Adequacy, Reporting and recordkeeping requirements, Savings 
associations, State nonmember banks.

12 CFR Part 567

    Capital, Reporting and recordkeeping requirements, Savings 
associations.

Proposed Adoption of Common Appendix

    The proposed adoption of the common rules by the agencies, as 
modified by agency-specific text, is set forth below:

Department of the Treasury

Office of the Comptroller of the Currency

12 CFR Chapter I

Authority and Issuance

    For the reasons stated in the common preamble, the Office of the 
Comptroller of the Currency amends Part 3 of chapter I of Title 12, 
Code of Federal Regulations as follows:

PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES

    1. The authority citation for part 3 continues to read as follows:

    Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n 
note, 1835, 3907, and 3909.

    2. New Appendix D to part 3 is added as set forth at the end of the 
common preamble.
    3. Appendix D to part 3 is amended as set forth below:
    a. Remove ``[agency]'' and add ``OCC'' in its place wherever it 
appears.
    b. Remove ``[BANK]'' and add ``bank'' in its place wherever it 
appears, and remove ``[Banks]'' and add ``Banks'' in its place wherever 
it appears.
    c. Remove ``[Appendix--to Part--]'' and add ``Appendix D to Part 
3'' in its place wherever it appears.
    d. Remove ``[the general risk-based capital rules]'' and add ``12 
CFR part 3, appendix A'' in its place wherever it appears.
    e. Remove ``[the market risk rule]'' and add ``12 CFR part 3, 
appendix B'' in its place wherever it appears.
    f. Remove ``[the advanced approaches risk-based capital rules]'' 
and add ``12 CFR part 3, appendix C'' in its place wherever it appears.
    g. In section 1, revise paragraph (e) to read as follows:

Section 1. Purpose, Applicability, Election Procedures, and Reservation 
of Authority

* * * * *
    (e) Notice and response procedures. In making a determination 
under paragraphs (c)(3) or (d) of this section, the OCC will apply 
notice and response procedures in the same manner as the notice and 
response procedures in 12 CFR 3.12.
* * * * *

    h. In section 2, revise the definitions of gain-on-sale, pre-sold 
construction loan, statutory multifamily mortgage, and paragraph (7) of 
the definition of traditional securitization to read as follows:

Section 2. Definitions

* * * * *
    Gain-on-sale means an increase in the equity capital (as 
reported on Schedule RC of the Consolidated Statement of Condition 
and Income (Call Report)) of a bank that results from a 
securitization (other than an increase in equity capital that 
results from the bank's receipt of cash in connection with the 
securitization). (See also securitization.)
* * * * *
    Pre-sold construction loan means any one-to-four family 
residential pre-sold construction loan for a residence meeting the 
requirements under section 618(a)(1) or (2) of the Resolution Trust 
Corporation Refinancing, Restructuring, and Improvement Act of 1991 
(RTCRRI Act) and under 12 CFR part 3, appendix A, section 
3(a)(3)(iv).
* * * * *
    Statutory multifamily mortgage means any multifamily residential 
mortgage meeting the requirements under section 618(b)(1) of the 
RTCRRI Act, and under 12 CFR part 3, appendix A, section 3(a)(3)(v).
* * * * *
    Traditional securitization * * *
    (7) The underlying exposures are not owned by a firm an 
investment in which qualifies as a community development investment 
under 12 U.S.C. 24(Eleventh);
* * * * *

    i. In section 21, revise paragraph (a)(1) and (a)(2) to read as 
follows:

Section 21. Modifications to Tier 1 and Tier 2 Capital

    (a) * * *
    (1) A bank is not required to make the deductions from capital 
for CEIOs in 12 CFR part 3, appendix A, section 2(c)(1)(iv).
    (2) A bank is not required to make the deductions from capital 
for nonfinancial equity investments in 12 CFR part 3, appendix A, 
section 2(c)(1)(v).
* * * * *
    j. In section 33, revise paragraphs (c)(2) and (g)(3)(iv)(B) to 
read as follows:

Section 33. General Risk Weights

* * * * *
    (c)* * *
    (2) A bank must assign a risk weight of at least 100 percent to 
an exposure to a depository institution or a foreign bank that is 
includable in the depository institution's or foreign bank's 
regulatory capital and that is not subject to deduction as a 
reciprocal holding pursuant to 12 CFR part 3, appendix A, section 
2(c)(6)(ii).
* * * * *
    (g) * * *
    (3) * * *
    (iv) * * *
    (B) A bank must base all estimates of a property's value on an 
appraisal or evaluation of the property that satisfies subpart C of 
12 CFR part 34.
* * * * *
    k. Revise paragraph (i)(1)(iv) and paragraph (i)(4) of section 42 
to read as follows:

Section 42. Risk-Weighted Assets for Securitization Exposures

* * * * *
    (i) * * *
    (1) * * *
    (iv) The bank is well capitalized, as defined in the OCC's 
prompt corrective action regulation at 12 CFR part 6. For purposes 
of determining whether a bank is well capitalized for purposes of 
this paragraph, the bank's capital ratios must be calculated without 
regard to the capital treatment for transfers of small-business 
obligations with recourse specified in paragraph (i)(1) of this 
section.
* * * * *
    (4) The risk-based capital ratios of the bank must be calculated 
without regard to the capital treatment for transfers of small-
business obligations with recourse specified in paragraph (i)(1) of 
this section as provided in 12 CFR part 3, appendix A.
* * * * *
    l. In section 52, revise paragraph (b)(3)(i) to read as follows:

Section 52. Simple Risk-Weight Approach (SRWA)

* * * * *
    (b) * * *
    (3) * * *
    (i) Community development exposures. An equity exposure that 
qualifies as a community development investment under 12 U.S.C. 
24(Eleventh), excluding equity exposures to an unconsolidated small

[[Page 44056]]

business investment company and equity exposures held through a 
consolidated small business investment company described in section 
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *
    m. In section 61, revise paragraph (c) to read as follows:

Section 61. Basic Indicator Approach

* * * * *
    (c) Annual gross income. A bank's annual gross income equals its 
net interest income plus its total noninterest income minus its 
underwriting income from insurance and reinsurance activities as 
reported on the bank's Call Report.
* * * * *
    n. In section 71, revise paragraph (b) to read as follows:

Section 71. Disclosure Requirements

* * * * *
    (b) A bank must comply with paragraph (c) of section 71 of 
appendix H to the Federal Reserve Board's Regulation Y (12 CFR part 
225, appendix H), including Tables 15.1--15.10, unless it is a 
consolidated subsidiary of a bank holding company or depository 
institution that is subject to these requirements.
* * * * *
    o. In section 71, remove paragraph (c) and Tables 15.1-15.10.

Board of Governors of the Federal Reserve System

12 CFR Chapter II

Authority and Issuance

    For the reasons stated in the common preamble, the Board of 
Governors of the Federal Reserve System amends parts 208 and 225 of 
chapter II of title 12 of the Code of Federal Regulations as follows:

PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL 
RESERVE SYSTEM (REGULATION H)

    1. The authority citation for part 208 continues to read as 
follows:

    Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-338a, 
371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9), 1823(j), 
1828(o), 1831, 1831o, 1831p-1, 1831r-1, 1835a, 1882, 2901-2907, 
3105, 3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b, 78l(b), 78l(g), 
78l(i), 78o-4(c)(5), 78q, 78q-1, and 78w, 6801, and 6805; 31 U.S.C. 
5318; 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128.

    2. New Appendix G to part 208 is added as set forth at the end of 
the common preamble.
    3. Appendix G to part 208 is amended as set forth below:
    a. Remove ``[agency]'' and add ``Federal Reserve'' in its place 
wherever it appears.
    b. Remove ``[BANK]'' and add ``bank'' in its place wherever it 
appears, and remove ``[Banks]'' and add ``Banks'' in its place wherever 
it appears.
    c. Remove ``[Appendix -- to Part --]'' and add ``Appendix G to Part 
208'' in its place wherever it appears.
    d. Remove ``[the general risk-based capital rules]'' and add ``12 
CFR part 208, appendix A'' in its place wherever it appears.
    e. Remove ``[the market risk rule]'' and add ``12 CFR part 208, 
appendix E'' in its place wherever it appears.
    f. Remove ``[the advanced approaches risk-based capital rules]'' 
and add ``12 CFR part 208, appendix F'' in its place wherever it 
appears.
    g. In section 1, revise paragraph (e) to read as follows:

Section 1. Purpose, Applicability, Election Procedures, and Reservation 
of Authority

* * * * *
    (e) Notice and response procedures. In making a determination 
under paragraphs (c)(3) or (d) of this section, the Federal Reserve 
will apply notice and response procedures in the same manner as the 
notice and response procedures in 12 CFR 263.202.
* * * * *
    h. In section 2, revise the definitions of gain-on-sale, pre-sold 
construction loan, statutory multifamily mortgage, and paragraph (7) of 
the definition of traditional securitization to read as follows:

Section 2. Definitions

* * * * *
    Gain-on-sale means an increase in the equity capital (as 
reported on Schedule RC of the Consolidated Statement of Condition 
and Income (Call Report)) of a bank that results from a 
securitization (other than an increase in equity capital that 
results from the bank's receipt of cash in connection with the 
securitization). (See also securitization.)
* * * * *
    Pre-sold construction loan means any one-to-four family 
residential pre-sold construction loan for a residence meeting the 
requirements under section 618(a)(1) or (2) of the Resolution Trust 
Corporation Refinancing, Restructuring, and Improvement Act of 1991 
(RTCRRI Act) and under 12 CFR part 208, appendix A, section III.C.3.
* * * * *
    Statutory multifamily mortgage means any multifamily residential 
mortgage meeting the requirements under section 618(b)(1) of the 
RTCRRI Act and under 12 CFR part 208, appendix A, section III.C.3.
* * * * *
    Traditional securitization * * *
    (7) The underlying exposures are not owned by a firm an 
investment in which qualifies as a community development investment 
under 12 U.S.C. 24 (Eleventh);
* * * * *
    i. In section 21, revise paragraphs (a)(1) and (2) to read as 
follows:

Section 21. Modifications to Tier 1 and Tier 2 Capital

    (a) * * *
    (1) A bank is not required to make the deductions from capital 
for CEIOs in 12 CFR part 208, appendix A, section II.B.1.e.
    (2) A bank is not required to make the deductions from capital 
for nonfinancial equity investments in 12 CFR part 208, appendix A, 
section II.B.5.
* * * * *
    j. In section 33, revise paragraphs (c)(2) and (g)(3)(iv)(B) to 
read as follows:

Section 33. General Risk Weights

* * * * *
    (c) * * *
    (2) A bank must assign a risk weight of at least 100 percent to 
an exposure to a depository institution or a foreign bank that is 
includable in the depository institution's or foreign bank's 
regulatory capital and that is not subject to deduction as a 
reciprocal holding pursuant to 12 CFR part 208, appendix A, section 
II.B.3.
* * * * *
    (g) * * *
    (3) * * *
    (iv) * * *
    (B) A bank must base all estimates of a property's value on an 
appraisal or evaluation of the property that satisfies subpart E of 
12 CFR part 208.
* * * * *
    k. Revise paragraph (i)(1)(iv) and paragraph (i)(4) of section 42 
to read as follows:

Section 42. Risk-Weighted Assets for Securitization Exposures

* * * * *
    (i) * * *
    (1) * * *
    (iv) The bank is well capitalized, as defined in the Federal 
Reserve's prompt corrective action regulation at 12 CFR part 208, 
Subpart D. For purposes of determining whether a bank is well 
capitalized for purposes of this paragraph, the bank's capital 
ratios must be calculated without regard to the capital treatment 
for transfers of small-business obligations with recourse specified 
in paragraph (i)(1) of this section.
* * * * *
    (4) The risk-based capital ratios of the bank must be calculated 
without regard to the capital treatment for transfers of small-
business obligations with recourse specified in paragraph (i)(1) of 
this section as provided in 12 CFR part 208, appendix A.
* * * * *
    l. In section 52, revise paragraph (b)(3)(i) to read as follows:

Section 52. Simple Risk-Weight Approach (SRWA)

* * * * *
    (b) * * *
    (3) * * *
    (i) Community development exposures. An equity exposure that 
qualifies as a community development investment under 12 U.S.C. 24 
(Eleventh), excluding equity exposures to an unconsolidated small

[[Page 44057]]

business investment company and equity exposures held through a 
consolidated small business investment company described in section 
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *
    m. In section 61, revise paragraph (c) to read as follows:

Section 61. Basic Indicator Approach

* * * * *
    (c) Annual gross income. A bank's annual gross income equals its 
net interest income plus its total noninterest income minus its 
underwriting income from insurance and reinsurance activities as 
reported on the bank's Call Report.
* * * * *
    n. In section 71, revise paragraph (b) to read as follows:

Section 71. Disclosure Requirements

* * * * *
    (b) A bank must comply with paragraph (c) of section 71 of 
appendix H to the Federal Reserve Board's Regulation Y (12 CFR part 
225, appendix H), including Tables 15.1-15.10, unless it is a 
consolidated subsidiary of a bank holding company or depository 
institution that is subject to these requirements.
* * * * *
    o. In section 71, remove paragraph (c) and remove Tables 15.1-
15.10.

PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL 
(REGULATION Y)

    1. The authority citation for part 225 continues to read as 
follows:

    Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-1, 
1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, and 
3909; 15 U.S.C. 6801 and 6805.

    2. New Appendix H to part 225 is added as set forth at the end of 
the common preamble.
    3. Appendix H to part 225 is amended as set forth below:
    a. Remove ``[agency]'' and add ``Federal Reserve'' in its place 
wherever it appears.
    b. Remove ``[BANK]'' and add in its place ``bank holding company'' 
wherever it appears, and remove ``[Banks]'' and add ``Bank Holding 
Companies'' in its place wherever it appears.
    c. Remove ``[Appendix -- to Part --]'' and add ``Appendix H to Part 
225'' in its place wherever it appears.
    d. Remove ``[the general risk-based capital rules]'' and add ``12 
CFR part 225, appendix A'' in its place wherever it appears.
    e. Remove ``[the market risk rule]'' and add ``12 CFR part 225, 
appendix E'' in its place wherever it appears.
    f. Remove ``[the advanced approaches risk-based capital rules]'' 
and add ``12 CFR part 225, appendix G'' in its place wherever it 
appears.
    g. In section 1, revise paragraphs (b) and (e) to read as follows:

Section 1. Purpose, Applicability, Election Procedures, and Reservation 
of Authority

* * * * *
    (b) Applicability. This appendix applies to a bank holding 
company that elects to use this appendix to calculate its risk-based 
capital requirements and that is not a consolidated subsidiary of 
another bank holding company that uses this appendix to calculate 
its risk-based capital requirements.
* * * * *
    (e) Notice and response procedures. In making a determination 
under paragraphs (c)(3) or (d) of this section, the Federal Reserve 
will apply notice and response procedures in the same manner as the 
notice and response procedures in 12 CFR 263.202.
* * * * *
    h. In section 2, revise the definitions of gain-on-sale, pre-sold 
construction loan, statutory multifamily mortgage, and paragraph (7) of 
the definition of traditional securitization to read as follows:

Section 2. Definitions

* * * * *
    Gain-on-sale means an increase in the equity capital (as 
reported on Schedule HC of the FR Y-9C Report) of a bank holding 
company that results from a securitization (other than an increase 
in equity capital that results from the bank holding company's 
receipt of cash in connection with the securitization). (See also 
securitization.)
* * * * *
    Pre-sold construction loan means any one-to-four family 
residential pre-sold construction loan for a residence meeting the 
requirements under section 618(a)(1) or (2) of the Resolution Trust 
Corporation Refinancing, Restructuring, and Improvement Act of 1991 
(RTCRRI Act) and under 12 CFR part 225, appendix A, section III.C.3.
* * * * *
    Statutory multifamily mortgage means any multifamily residential 
mortgage meeting the requirements under section 618(b)(1) of the 
RTCRRI Act and under 12 CFR part 225, appendix A, section III.C.3.
* * * * *
    Traditional securitization * * *
    (7) The underlying exposures are not owned by a firm an 
investment in which qualifies as a community development investment 
under 12 U.S.C. 24(Eleventh);
* * * * *
    i. In section 21, revise paragraphs (a)(1) and (2) and add a new 
paragraph (c)(4) to read as follows:

Section 21. Modifications to Tier 1 and Tier 2 Capital

    (a) * * *
    (1) A bank holding company is not required to make the 
deductions from capital for CEIOs in 12 CFR part 225, appendix A, 
section II.B.1.e.
    (2) A bank holding company is not required to make the 
deductions from capital for nonfinancial equity investments in 12 
CFR part 225, appendix A, section II.B.5.
* * * * *
    (c) * * *
    (4) A bank holding company must also deduct an amount equal to 
the minimum regulatory capital requirement established by the 
regulator of any insurance underwriting subsidiary of the holding 
company. For U.S.-based insurance underwriting subsidiaries, this 
amount generally would be 200 percent of the subsidiary's Authorized 
Control Level as established by the appropriate state regulator of 
the insurance company.

    j. In section 33, revise paragraph (c)(2) to read as follows:

Section 33. General Risk Weights

* * * * *
    (c) * * *
    (2) A bank holding company must assign a risk weight of at least 
100 percent to an exposure to a depository institution or a foreign 
bank that is includable in the depository institution's or foreign 
bank's regulatory capital and that is not subject to deduction as a 
reciprocal holding pursuant to 12 CFR part 225, appendix A, section 
II.B.3.
* * * * *
    k. In paragraph (k)(1) of section 33, remove ``A [BANK] may assign 
a zero percent risk weight to cash owned and held in all offices of the 
[BANK] or in transit; to gold bullion held in the [BANK]'s own vaults, 
or held in another depository institution's vaults on an allocated 
basis, to the extent the gold bullion assets are offset by gold bullion 
liabilities;'' and add in its place ``A bank holding company may assign 
a zero percent risk weight to cash owned and held in all offices of 
subsidiary depository institutions or in transit; to gold bullion held 
in either a subsidiary depository institution's own vaults, or held in 
another depository institution's vaults on an allocated basis, to the 
extent the gold bullion assets are offset by gold bullion 
liabilities;''
* * * * *
    l. Revise paragraph (i)(1)(iv) and revise paragraph (i)(4) of 
section 42 to read as follows:

Section 42. Risk-Weighted Assets for Securitization Exposures

* * * * *
    (i) * * *
    (1) * * *
    (iv) The bank holding company is well capitalized, as defined in 
the Federal Reserve's prompt corrective action regulation at 12 CFR 
part 208, Subpart D. For purposes of determining whether a bank 
holding company is well capitalized for purposes of this paragraph, 
the bank holding company's capital ratios must be calculated without 
regard to the capital treatment for transfers of

[[Page 44058]]

small-business obligations with recourse specified in paragraph 
(i)(1) of this section.
* * * * *
    (4) The risk-based capital ratios of the bank holding company 
must be calculated without regard to the capital treatment for 
transfers of small-business obligations with recourse specified in 
paragraph (i)(1) of this section as provided in 12 CFR part 225, 
appendix A.
* * * * *
    m. In section 52, revise paragraph (b)(3)(i) to read as follows:

Section 52. Simple Risk-Weight Approach (SRWA)

* * * * *
    (b) * * *
    (3) * * *
    (i) Community development exposures. An equity exposure that 
qualifies as a community development investment under 12 U.S.C. 
24(Eleventh), excluding equity exposures to an unconsolidated small 
business investment company and equity exposures held through a 
consolidated small business investment company described in section 
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *
    n. In section 61, revise paragraph (c) to read as follows:

Section 61. Basic Indicator Approach

* * * * *
    (c) Annual gross income. A bank holding company's annual gross 
income equals its net interest income plus its total noninterest 
income minus its underwriting income from insurance and reinsurance 
activities as reported on the bank holding company's Y-9C Report.
* * * * *

Federal Deposit Insurance Corporation

12 CFR Chapter III

Authority and Issuance

    For the reasons stated in the common preamble, the Federal Deposit 
Insurance Corporation amends part 325 of chapter III of Title 12, Code 
of Federal Regulations as follows:

PART 325--CAPITAL MAINTENANCE

    1. The authority citation for part 325 continues to read as 
follows:

    Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b), 
1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n), 1828(o), 
1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat. 1761, 1789, 1790 
(12 U.S.C. 1831n, note); Pub. L. 102-242, 105 Stat. 2236, 2355, 2386 
(12 U.S.C. 1828 note).

    2. New Appendix E to part 325 is added as set forth at the end of 
the common preamble.
    3. Appendix E to part 325 is amended as set forth below:
    a. Remove ``[agency]'' and add ``FDIC'' in its place wherever it 
appears.
    b. Remove ``[BANK]'' and add ``bank'' in its place wherever it 
appears, and remove ``[Banks]'' and add ``Banks'' in its place wherever 
it appears.
    c. Remove ``[Appendix -- to Part --]'' and add ``Appendix E to Part 
325'' in its place wherever it appears.
    d. Remove ``[the general risk-based capital rules]'' and add ``12 
CFR part 325, appendix A'' in its place wherever it appears.
    e. Remove ``[the market risk rule]'' and add ``12 CFR part 325, 
appendix C'' in its place wherever it appears.
    f. Remove ``[the advanced approaches risk-based capital rules]'' 
and add ``12 CFR part 325, appendix D'' in its place wherever it 
appears.
    g. In section 1, revise paragraph (e) to read as follows:

Section 1. Purpose, Applicability, Election Procedures, and Reservation 
of Authority

* * * * *
    (e) Notice and response procedures. In making a determination 
under paragraphs (c)(3) or (d) of this section, the FDIC will apply 
notice and response procedures in the same manner as the notice and 
response procedures in 12 CFR 325.6(c).
* * * * *
    h. In section 2, revise the definitions of gain-on-sale, pre-sold 
construction loan, statutory multifamily mortgage, and paragraph (7) of 
the definition of traditional securitization to read as follows:

Section 2. Definitions

* * * * *
    Gain-on-sale means an increase in the equity capital (as 
reported on Schedule RC of the Consolidated Statement of Condition 
and Income (Call Report)) of a bank that results from a 
securitization (other than an increase in equity capital that 
results from the bank's receipt of cash in connection with the 
securitization). (See also securitization.)
* * * * *
    Pre-sold construction loan means any one-to-four family 
residential pre-sold construction loan for a residence meeting the 
requirements under section 618(a)(1) or (2) of the Resolution Trust 
Corporation Refinancing, Restructuring, and Improvement Act of 1991 
(RTCRRI Act) and under 12 CFR part 325, appendix A, section II.C, 
and that is not 90 days or more past due or on nonaccrual.
* * * * *
    Statutory multifamily mortgage means any multifamily residential 
mortgage meeting the requirements under section 618(b)(1) of the 
RTCRRI Act and under 12 CFR part 325, appendix A, section II.C.
* * * * *
    Traditional securitization * * *
    (7) The underlying exposures are not owned by a firm an 
investment in which qualifies as a community development investment 
under 12 U.S.C. 24(Eleventh);
* * * * *
    i. In section 21, revise paragraph (a)(1) and (a)(2) to read as 
follows:

Section 21. Modifications to Tier 1 and Tier 2 Capital

    (a) * * *
    (1) A bank is not required to make the deductions from capital 
for CEIOs in 12 CFR part 325, appendix A, section II.B.5.
    (2) A bank is not required to make the deductions from capital 
for nonfinancial equity investments in 12 CFR part 325, appendix A, 
section II.B.
* * * * *
    j. In section 33, revise paragraphs (c)(2) and (g)(3)(iv)(B) to 
read as follows:

Section 33. General Risk Weights

* * * * *
    (c) * * *
    (2) A bank must assign a risk weight of at least 100 percent to 
an exposure to a depository institution or a foreign bank that is 
includable in the depository institution's or foreign bank's 
regulatory capital and that is not subject to deduction as a 
reciprocal holding pursuant to 12 CFR part 325, appendix A, section 
I.B.(4).
* * * * *
    (g) * * *
    (3) * * *
    (iv) * * *
    (B) A bank must base all estimates of a property's value on an 
appraisal or evaluation of the property that satisfies 12 CFR part 
323.
* * * * *
    k. Revise paragraph (i)(1)(iv) and paragraph (i)(4) of section 42 
to read as follows:

Section 42. Risk-Weighted Assets for Securitization Exposures

* * * * *
    (i) * * *
    (1) * * *
    (iv) The bank is well capitalized, as defined in the FDIC's 
prompt corrective action regulation at 12 CFR part 325, subpart B. 
For purposes of determining whether a bank is well capitalized for 
purposes of this paragraph, the bank's capital ratios must be 
calculated without regard to the capital treatment for transfers of 
small-business obligations with recourse specified in paragraph 
(i)(1) of this section.
* * * * *
    (4) The risk-based capital ratios of the bank must be calculated 
without regard to the capital treatment for transfers of small-
business obligations with recourse specified in paragraph (i)(1) of 
this section as provided in 12 CFR part 325, appendix A.
* * * * *
    l. In section 52, revise paragraph (b)(3)(i) to read as follows:

Section 52. Simple Risk-Weight Approach (SRWA)

* * * * *
    (b) * * *
    (3) * * *
    (i) Community development exposures. An equity exposure that 
qualifies as a community development investment under 12 U.S.C. 
24(Eleventh), excluding equity exposures to an unconsolidated small

[[Page 44059]]

business investment company and equity exposures held through a 
consolidated small business investment company described in section 
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *
    m. In section 61, revise paragraph (c) to read as follows:

Section 61. Basic Indicator Approach

* * * * *
    (c) Annual gross income. A bank's annual gross income equals its 
net interest income plus its total noninterest income minus its 
underwriting income from insurance and reinsurance activities as 
reported on the bank's Call Report.
* * * * *
    n. In section 71, revise paragraph (b) to read as follows:

Section 71. Disclosure Requirements

* * * * *
    (b) A bank must comply with paragraph (c) of section 71 of 
appendix H to the Federal Reserve Board's Regulation Y (12 CFR part 
225, appendix H), including Tables 15.1-15.10, unless it is a 
consolidated subsidiary of a bank holding company or depository 
institution that is subject to these requirements.
* * * * *
    o. In section 71, remove paragraph (c) and Tables 15.1-15.10.

Department of the Treasury

Office of Thrift Supervision

12 CFR Chapter V

Authority and Issuance

    For the reasons stated in the common preamble, the Office of Thrift 
Supervision amends Part 567 of chapter V of Title 12, Code of Federal 
Regulations as follows:

PART 567--CAPITAL

    1. The authority citation for part 567 continues to read as 
follows:

    Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1467a, 1828(note).

    2. In Sec.  567.0, revise paragraph (a), redesignate paragraph (b) 
as paragraph (c), add new paragraph (b), and amend redesignated 
paragraph (c) by adding a new heading and by revising paragraph 
(c)(2)(ii) to read as follows:


Sec.  567.0   Scope.

    (a) General. This part prescribes the minimum regulatory capital 
requirements for savings associations. Subpart B of this part applies 
to all savings associations, except as described in paragraphs (b) and 
(c) of this section.
    (b) Savings associations using the standardized approach rule. (1) 
A savings association that uses Appendix B of this part must utilize 
the methodologies in that appendix to calculate their risk based 
capital requirement and make the required disclosures described in that 
appendix.
    (2) Subpart B of this part does not apply to the computation of 
risk-based capital requirements by a savings association that uses 
Appendix B of this part. However, these savings associations:
    (i) Must compute the components of capital under Sec.  567.5 
subject to the modifications in section 21 of Appendix B of this part.
    (ii) Must meet the leverage ratio requirement described at 
Sec. Sec.  567.2(a)(2) and 567.8. Notwithstanding paragraph (b)(2)(i) 
of this section, the savings association must compute core (tier 1) 
capital under section 567.5.
    (iii) Must meet the tangible capital requirement described at 
Sec. Sec.  567.2(a)(3) and 567.9.
    (iv) Are subject to Sec. Sec.  567.3 (individual minimum capital 
requirement), 567.4 (capital directives); and 567.10 (consequences of 
failure to meet capital requirements).
    (v) Are subject to the reservations of authority at Sec.  567.11, 
which supplement the reservations of authority at section 1 of Appendix 
B of this part.
    (c) Savings associations using the advanced approaches rule.
* * * * *
    (2) * * *
    (ii) Must meet the leverage ratio requirement described at 
Sec. Sec.  567.2(a)(2) and 567.8. Notwithstanding paragraph (c)(2)(i) 
of this section, the savings association must compute core (tier 1) 
capital under section 567.5.
* * * * *
    2. Appendix B is added to part 567 as set forth at the end of the 
common preamble.
    3. Amend Appendix B of part 567 as follows:
    a. Revise the heading of Appendix B to read as follows:

Appendix B to Part 567--Risk-Based Capital Requirements--Standardized 
Framework

    b. Remove [agency] and add ``OTS'' in its place wherever it 
appears.
    c. Remove ``[BANK]'' and add ``savings association'' in its place 
wherever it appears, and remove ``[Banks]'' and add ``Savings 
Associations'' in its place wherever it appears.
    d. Remove ``[Appendix -- to Part --]'' and add ``Appendix B to Part 
567'' in its place wherever it appears.
    e. Remove ``[the general risk-based capital rules]'' and add 
``subpart B of part 567'' in its place wherever it appears.
    f. Remove ``[the market risk rule]'' and add ``any applicable 
market risk rule'' in its place wherever it appears.
    g. Remove ``[the advanced approaches risk-based capital rules] and 
add ``Appendix C to Part 567'' in its place wherever it appears.
    h. In section 1, revise paragraph (e) to read as follows:

Section 1. Purpose, Applicability, Election Procedures, and Reservation 
of Authority

* * * * *
    (e) Notice and response procedures. In making a determination 
under paragraphs (c)(3) or (d) of this section, the [agency] will 
apply notice and response procedures in the same manner as the 
notice and response procedures in 12 CFR 567.3(d).
* * * * *
    i. In section 2, revise the definitions of gain-on-sale, pre-sold 
construction loan, statutory multifamily loan, and paragraph (7) of the 
definition of traditional securitization to read as follows:

Section 2. Definitions

* * * * *
    Gain-on-sale means an increase in the equity capital (as 
reported on Schedule SC of the Thrift Financial Report) of a savings 
association that results from a securitization (other than an 
increase in equity capital that results from the savings 
association's receipt of cash in connection with the 
securitization). (See also securitization.)
* * * * *
    Pre-sold construction loan means any one-to-four family 
residential pre-sold construction loan for a residence meeting the 
requirements under section 618(a)(1) or (2) of the Resolution Trust 
Corporation Refinancing, Restructuring, and Improvement Act of 1991 
(RTCRRI Act) and 12 CFR 567.1 (definition of ``qualifying 
residential construction loan''), and that is not on nonaccrual.
* * * * *
    Statutory multifamily mortgage means any multifamily residential 
mortgage that:
    (1) Meets the requirements under section 618(b)(1) of the RTCRRI 
Act and under 12 CFR 567.1 (definition of ``qualifying multifamily 
mortgage loan'') and 12 CFR 567.6(a)(1)(iii); and
    (2) Is not on nonaccrual.
* * * * *
    Traditional securitization * * *
    (7) The underlying exposures are not owned by a firm an 
investment in which is designed primarily to promote community 
welfare, including the welfare of low- and moderate-income 
communities or families, such as by providing services or jobs.
* * * * *
    j. Revise paragraphs (a)(1) and (2) of section 21 to read as 
follows:

Section 21. Modifications to Tier 1 and Tier 2 Capital

* * * * *
    (a) * * *

[[Page 44060]]

    (1) A savings association is not required to make the deductions 
from capital for CEIOs in 12 CFR 567.5(a)(2)(iii) and 567.12(e);
    (2) A savings association is not required to deduct equity 
securities from capital under 12 CFR 567.5(c)(2)(ii). However, it 
must continue to deduct equity investments in real estate under that 
section. See 12 CFR 567.1, which defines equity investments, 
including equity securities and equity investments in real estate.
* * * * *
    k. Revise paragraphs (c)(2) and (g)(3)(iv)(B) of section 33 to read 
as follows:

Section 33. General Risk Weights

* * * * *
    (c) * * *
    (2) A savings association must assign a risk weight of at least 
100 percent to an exposure to a depository institution or a foreign 
bank that is includable in the depository institution's or foreign 
bank's regulatory capital and that is not subject to deduction as a 
reciprocal holding pursuant to 12 CFR part 567.5(c)(2)(i).
* * * * *
    (g) * * *
    (3) * * *
    (iv) * * *
    (B) A savings association must base all estimates of a 
property's value on an appraisal or evaluation of the property that 
satisfies 12 CFR part 564.
* * * * *
    l. Revise the first sentence of paragraph (i)(1)(iv) and paragraph 
(i)(4) of section 42 to read as follows:

Section 42. Risk-Weighted Assets for Securitization Exposures

* * * * *
    (i) * * *
    (1) * * *
    (iv) The savings association is well capitalized, as defined in 
the OTS 's prompt corrective action regulation at 12 CFR part 565. * 
* *
* * * * *
    (4) The risk-based capital ratios of the savings association 
must be calculated without regard to the capital treatment for 
transfers of small-business obligations with recourse specified in 
paragraph (i)(1) of this section as provided in 12 CFR 
567.6(b)(5)(v).
* * * * *
    m. Revise paragraph (b)(3)(i) of section 52 to read as follows:

Section 52. Simple Risk-Weight Approach (SRWA)

* * * * *
    (b) * * *
    (3) * * *
    (i) Community development equity exposures. An equity exposure 
that is designed primarily to promote community welfare, including 
the welfare of low- and moderate-income communities or families, 
such as by providing services or jobs, excluding equity exposures to 
an unconsolidated small business investment company and equity 
exposures held through a consolidated small business investment 
company described in section 302 of the Small Business Investment 
Act of 1958 (15 U.S.C. 682).
* * * * *
    n. Revise paragraph (c) in section 61 to read as follows:

Section 61. Basic Indicator Approach

* * * * *
    (c) Annual gross income. Annual gross income equals a savings 
association's net interest income (expense) before provision for 
losses on interest-bearing assets, plus total noninterest income, 
minus the portion of its other fees and charges that represents 
income derived from insurance and reinsurance underwriting 
activities, minus (plus) its net income (loss) from the sale of 
assets held for sale and available-for-sale securities to include 
only the profit or loss from the disposition of available-for-sale 
securities pursuant to FASB Statement No. 115, minus (plus) its net 
income (loss) from the sale of securities held-to-maturity, all as 
reported on the savings association's year-end Thrift Financial 
Report.
* * * * *
    o. In section 71, revise paragraph (b) to read as follows:

Section 71. Disclosure Requirements

* * * * *
    (b) A savings association must comply with paragraph (c) of this 
section, unless it is a consolidated subsidiary of a bank holding 
company or depository institution that is subject to these 
requirements.
* * * * *

    Dated: July 2, 2008.
John C. Dugan,
Comptroller of the Currency.
    By order of the Board of Governors of the Federal Reserve 
System, July 10, 2008.
Jennifer J. Johnson,
Secretary of the Board.
    Dated at Washington, DC, this 25th day of June 2008.

    By order of the Board of Directors. Federal Deposit Insurance 
Corporation.
Robert E. Feldman,
Executive Secretary.
    Dated: July 2, 2008.

    By the Office of Thrift Supervision.
John M. Reich,
Director.
[FR Doc. E8-16262 Filed 7-28-08; 8:45 am]
BILLING CODE 4810-33-P, 6210-01-P, 6714-01-P, 6720-01-P