[Federal Register Volume 78, Number 175 (Tuesday, September 10, 2013)]
[Rules and Regulations]
[Pages 55339-55598]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-20536]



[[Page 55339]]

Vol. 78

Tuesday,

No. 175

September 10, 2013

Part II





Federal Deposit Insurance Corporation





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12 CFR Parts 303, 308, 324, et al.





Regulatory Capital Rules: Regulatory Capital, Implementation of Basel 
III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, 
Standardized Approach for Risk-weighted Assets, Market Discipline and 
Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, 
and Market Risk Capital Rule; Interim Final Rule

Federal Register / Vol. 78 , No. 175 / Tuesday, September 10, 2013 / 
Rules and Regulations

[[Page 55340]]


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FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Parts 303, 308, 324, 327, 333, 337, 347, 349, 360, 362, 363, 
364, 365, 390, and 391

RIN 3064-AD95


Regulatory Capital Rules: Regulatory Capital, Implementation of 
Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective 
Action, Standardized Approach for Risk-weighted Assets, Market 
Discipline and Disclosure Requirements, Advanced Approaches Risk-Based 
Capital Rule, and Market Risk Capital Rule

AGENCY: Federal Deposit Insurance Corporation.

ACTION: Interim final rule with request for comments.

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SUMMARY: The Federal Deposit Insurance Corporation (FDIC) is adopting 
an interim final rule that revises its risk-based and leverage capital 
requirements for FDIC-supervised institutions. This interim final rule 
is substantially identical to a joint final rule issued by the Office 
of the Comptroller of the Currency (OCC) and the Board of Governors of 
the Federal Reserve System (Federal Reserve) (together, with the FDIC, 
the agencies). The interim final rule consolidates three separate 
notices of proposed rulemaking that the agencies jointly published in 
the Federal Register on August 30, 2012, with selected changes. The 
interim final rule implements a revised definition of regulatory 
capital, a new common equity tier 1 minimum capital requirement, a 
higher minimum tier 1 capital requirement, and, for FDIC-supervised 
institutions subject to the advanced approaches risk-based capital 
rules, a supplementary leverage ratio that incorporates a broader set 
of exposures in the denominator. The interim final rule incorporates 
these new requirements into the FDIC's prompt corrective action (PCA) 
framework. In addition, the interim final rule establishes limits on 
FDIC-supervised institutions' capital distributions and certain 
discretionary bonus payments if the FDIC-supervised institution does 
not hold a specified amount of common equity tier 1 capital in addition 
to the amount necessary to meet its minimum risk-based capital 
requirements. The interim final rule amends the methodologies for 
determining risk-weighted assets for all FDIC-supervised institutions. 
The interim final rule also adopts changes to the FDIC's regulatory 
capital requirements that meet the requirements of section 171 and 
section 939A of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act.
    The interim final rule also codifies the FDIC's regulatory capital 
rules, which have previously resided in various appendices to their 
respective regulations, into a harmonized integrated regulatory 
framework. In addition, the FDIC is amending the market risk capital 
rule (market risk rule) to apply to state savings associations.
    The FDIC is issuing these revisions to its capital regulations as 
an interim final rule. The FDIC invites comments on the interaction of 
this rule with other proposed leverage ratio requirements applicable to 
large, systemically important banking organizations. This interim final 
rule otherwise contains regulatory text that is identical to the common 
rule text adopted as a final rule by the Federal Reserve and the OCC. 
This interim final rule enables the FDIC to proceed on a unified, 
expedited basis with the other federal banking agencies pending 
consideration of other issues. Specifically, the FDIC intends to 
evaluate this interim final rule in the context of the proposed well-
capitalized and buffer levels of the supplementary leverage ratio 
applicable to large, systemically important banking organizations, as 
described in a separate Notice of Proposed Rulemaking (NPR) published 
in the Federal Register August 20, 2013.
    The FDIC is seeking commenters' views on the interaction of this 
interim final rule with the proposed rule regarding the supplementary 
leverage ratio for large, systemically important banking organizations.

DATES: Effective date: January 1, 2014. Mandatory compliance date: 
January 1, 2014 for advanced approaches FDIC-supervised institutions; 
January 1, 2015 for all other FDIC-supervised institutions. Comments on 
the interim final rule must be received no later than November 12, 
2013.

ADDRESSES: You may submit comments, identified by RIN 3064-AD95, by any 
of the following methods:
     Agency Web site: http://www.fdic.gov/regulations/laws/federal/propose.html. Follow instructions for submitting comments on 
the Agency Web site.
     Email: Comments@fdic.gov. Include the RIN 3064-AD95 on the 
subject line of the message.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments, Federal Deposit Insurance Corporation, 550 17th Street NW., 
Washington, DC 20429.
     Hand Delivery: Comments may be hand delivered to the guard 
station at the rear of the 550 17th Street Building (located on F 
Street) on business days between 7:00 a.m. and 5:00 p.m.
    Public Inspection: All comments received must include the agency 
name and RIN 3064-AD95 for this rulemaking. All comments received will 
be posted without change to http://www.fdic.gov/regulations/laws/federal/propose.html, including any personal information provided. 
Paper copies of public comments may be ordered from the FDIC Public 
Information Center, 3501 North Fairfax Drive, Room E-1002, Arlington, 
VA 22226 by telephone at (877) 275-3342 or (703) 562-2200.

FOR FURTHER INFORMATION CONTACT: Bobby R. Bean, Associate Director, 
bbean@fdic.gov; Ryan Billingsley, Chief, Capital Policy Section, 
rbillingsley@fdic.gov; Karl Reitz, Chief, Capital Markets Strategies 
Section, kreitz@fdic.gov; David Riley, Senior Policy Analyst, 
dariley@fdic.gov; Benedetto Bosco, Capital Markets Policy Analyst, 
bbosco@fdic.gov, regulatorycapital@fdic.gov, Capital Markets Branch, 
Division of Risk Management Supervision, (202) 898-6888; or Mark 
Handzlik, Counsel, mhandzlik@fdic.gov; Michael Phillips, Counsel, 
mphillips@fdic.gov; Greg Feder, Counsel, gfeder@fdic.gov; Ryan 
Clougherty, Senior Attorney, rclougherty@fdic.gov; or Rachel Jones, 
Attorney, racjones@fdic.gov, Supervision Branch, Legal Division, 
Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, 
DC 20429.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction
II. Summary of the Three Notices of Proposed Rulemaking
    A. The Basel III Notice of Proposed Rulemaking
    B. The Standardized Approach Notice of Proposed Rulemaking
    C. The Advanced Approaches Notice of Proposed Rulemaking
III. Summary of General Comments on the Basel III Notice of Proposed 
Rulemaking and on the Standardized Approach Notice of Proposed 
Rulemaking; Overview of the Interim Final Rule
    A. General Comments on the Basel III Notice of Proposed 
Rulemaking and on the Standardized Approach Notice of Proposed 
Rulemaking
    1. Applicability and Scope
    2. Aggregate Impact
    3. Competitive Concerns
    4. Costs
    B. Comments on Particular Aspects of the Basel III Notice of 
Proposed Rulemaking and on the Standardized Approach Notice of 
Proposed Rulemaking

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    1. Accumulated Other Comprehensive Income
    2. Residential Mortgages
    3. Trust Preferred Securities for Smaller FDIC-Supervised 
Institutions
    C. Overview of the Interim Final Rule
    D. Timeframe for Implementation and Compliance
IV. Minimum Regulatory Capital Ratios, Additional Capital 
Requirements, and Overall Capital Adequacy
    A. Minimum Risk-Based Capital Ratios and Other Regulatory 
Capital Provisions
    B. Leverage Ratio
    C. Supplementary Leverage Ratio for Advanced Approaches FDIC-
Supervised Institutions
    D. Capital Conservation Buffer
    E. Countercyclical Capital Buffer
    F. Prompt Corrective Action Requirements
    G. Supervisory Assessment of Overall Capital Adequacy
    H. Tangible Capital Requirement for State Savings Associations
V. Definition of Capital
    A. Capital Components and Eligibility Criteria for Regulatory 
Capital Instruments
    1. Common Equity Tier 1 Capital
    2. Additional Tier 1 Capital
    3. Tier 2 Capital
    4. Capital Instruments of Mutual FDIC-Supervised Institutions
    5. Grandfathering of Certain Capital Instruments
    6. Agency Approval of Capital Elements
    7. Addressing the Point of Non-Viability Requirements Under 
Basel III
    8. Qualifying Capital Instruments Issued by Consolidated 
Subsidiaries of an FDIC-Supervised Institution
    9. Real Estate Investment Trust Preferred Capital
    B. Regulatory Adjustments and Deductions
    1. Regulatory Deductions from Common Equity Tier 1 Capital
    a. Goodwill and Other Intangibles (other than Mortgage Servicing 
Assets)
    b. Gain-on-Sale Associated with a Securitization Exposure
    c. Defined Benefit Pension Fund Net Assets
    d. Expected Credit Loss That Exceeds Eligible Credit Reserves
    e. Equity Investments in Financial Subsidiaries
    f. Deduction for Subsidiaries of Savings Associations That 
Engage in Activities That Are Not Permissible for National Banks
    g. Identified Losses for State Nonmember Banks
    2. Regulatory Adjustments to Common Equity Tier 1 Capital
    a. Accumulated Net Gains and Losses on Certain Cash-Flow Hedges
    b. Changes in an FDIC-Supervised Institution's Own Credit Risk
    c. Accumulated Other Comprehensive Income
    d. Investments in Own Regulatory Capital Instruments
    e. Definition of Financial Institution
    f. The Corresponding Deduction Approach
    g. Reciprocal Crossholdings in the Capital Instruments of 
Financial Institutions
    h. Investments in the FDIC-Supervised Institution's Own Capital 
Instruments or in the Capital of Unconsolidated Financial 
Institutions
    i. Indirect Exposure Calculations
    j. Non-Significant Investments in the Capital of Unconsolidated 
Financial Institutions
    k. Significant Investments in the Capital of Unconsolidated 
Financial Institutions That Are Not in the Form of Common Stock
    l. Items Subject to the 10 and 15 Percent Common Equity Tier 1 
Capital Threshold Deductions
    m. Netting of Deferred Tax Liabilities Against Deferred Tax 
Assets and Other Deductible Assets
    3. Investments in Hedge Funds and Private Equity Funds Pursuant 
to Section 13 of the Bank Holding Company Act
VI. Denominator Changes Related to the Regulatory Capital Changes
VII. Transition Provisions
    A. Transitions Provisions for Minimum Regulatory Capital Ratios
    B. Transition Provisions for Capital Conservation and 
Countercyclical Capital Buffers
    C. Transition Provisions for Regulatory Capital Adjustments and 
Deductions
    1. Deductions for Certain Items Under Section 22(a) of the 
Interim Final Rule
    2. Deductions for Intangibles Other Than Goodwill and Mortgage 
Servicing Assets
    3. Regulatory Adjustments Under Section 22(b)(1) of the Interim 
Final Rule
    4. Phase-Out of Current Accumulated Other Comprehensive Income 
Regulatory Capital Adjustments
    5. Phase-Out of Unrealized Gains on Available for Sale Equity 
Securities in Tier 2 Capital
    6. Phase-In of Deductions Related to Investments in Capital 
Instruments and to the Items Subject to the 10 and 15 Percent Common 
Equity Tier 1 Capital Deduction Thresholds (Sections 22(c) and 
22(d)) of the Interim Final Rule
    D. Transition Provisions for Non-Qualifying Capital Instruments
VIII. Standardized Approach for Risk-Weighted Assets
    A. Calculation of Standardized Total Risk-Weighted Assets
    B. Risk-Weighted Assets for General Credit Risk
    1. Exposures to Sovereigns
    2. Exposures to Certain Supranational Entities and Multilateral 
Development Banks
    3. Exposures to Government-Sponsored Enterprises
    4. Exposures to Depository Institutions, Foreign Banks, and 
Credit Unions
    5. Exposures to Public-Sector Entities
    6. Corporate Exposures
    7. Residential Mortgage Exposures
    8. Pre-Sold Construction Loans and Statutory Multifamily 
Mortgages
    9. High-Volatility Commercial Real Estate
    10. Past-Due Exposures
    11. Other Assets
    C. Off-Balance Sheet Items
    1. Credit Conversion Factors
    2. Credit-Enhancing Representations and Warranties
    D. Over-the-Counter Derivative Contracts
    E. Cleared Transactions
    1. Definition of Cleared Transaction
    2. Exposure Amount Scalar for Calculating for Client Exposures
    3. Risk Weighting for Cleared Transactions
    4. Default Fund Contribution Exposures
    F. Credit Risk Mitigation
    1. Guarantees and Credit Derivatives
    a. Eligibility Requirements
    b. Substitution Approach
    c. Maturity Mismatch Haircut
    d. Adjustment for Credit Derivatives Without Restructuring as a 
Credit Event
    e. Currency Mismatch Adjustment
    f. Multiple Credit Risk Mitigants
    2. Collateralized Transactions
    a. Eligible Collateral
    b. Risk-Management Guidance for Recognizing Collateral
    c. Simple Approach
    d. Collateral Haircut Approach
    e. Standard Supervisory Haircuts
    f. Own Estimates of Haircuts
    g. Simple Value-at-Risk and Internal Models Methodology
    G. Unsettled Transactions
    H. Risk-Weighted Assets for Securitization Exposures
    1. Overview of the Securitization Framework and Definitions
    2. Operational Requirements
    a. Due Diligence Requirements
    b. Operational Requirements for Traditional Securitizations
    c. Operational Requirements for Synthetic Securitizations
    d. Clean-Up Calls
    3. Risk-Weighted Asset Amounts for Securitization Exposures
    a. Exposure Amount of a Securitization Exposure
    b. Gains-on-Sale and Credit-Enhancing Interest-Only Strips
    c. Exceptions Under the Securitization Framework
    d. Overlapping Exposures
    e. Servicer Cash Advances
    f. Implicit Support
    4. Simplified Supervisory Formula Approach
    5. Gross-Up Approach
    6. Alternative Treatments for Certain Types of Securitization 
Exposures
    a. Eligible Asset-Backed Commercial Paper Liquidity Facilities
    b. A Securitization Exposure in a Second-Loss Position or Better 
to an Asset-Backed Commercial Paper Program
    7. Credit Risk Mitigation for Securitization Exposures
    8. Nth-to-Default Credit Derivatives
IX. Equity Exposures
    A. Definition of Equity Exposure and Exposure Measurement
    B. Equity Exposure Risk Weights
    C. Non-Significant Equity Exposures
    D. Hedged Transactions
    E. Measures of Hedge Effectiveness
    F. Equity Exposures to Investment Funds
    1. Full Look-through Approach
    2. Simple Modified Look-through Approach
    3. Alternative Modified Look-Through Approach
X. Market Discipline and Disclosure Requirements

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    A. Proposed Disclosure Requirements
    B. Frequency of Disclosures
    C. Location of Disclosures and Audit Requirements
    D. Proprietary and Confidential Information
    E. Specific Public Disclosure Requirements
XI. Risk-Weighted Assets--Modifications to the Advanced Approaches
    A. Counterparty Credit Risk
    1. Recognition of Financial Collateral
    a. Financial Collateral
    b. Revised Supervisory Haircuts
    2. Holding Periods and the Margin Period of Risk
    3. Internal Models Methodology
    a. Recognition of Wrong-Way Risk
    b. Increased Asset Value Correlation Factor
    4. Credit Valuation Adjustments
    a. Simple Credit Valuation Adjustment Approach
    b. Advanced Credit Valuation Adjustment Approach
    5. Cleared Transactions (Central Counterparties)
    6. Stress Period for Own Estimates
    B. Removal of Credit Ratings
    1. Eligible Guarantor
    2. Money Market Fund Approach
    3. Modified Look-Through Approaches for Equity Exposures to 
Investment F
    C. Revisions to the Treatment of Securitization Exposures
    1. Definitions
    2. Operational Criteria for Recognizing Risk Transference in 
Traditional Securitizations
    3. The Hierarchy of Approaches
    4. Guarantees and Credit Derivatives Referencing a 
Securitization Expo
    5. Due Diligence Requirements for Securitization Exposures
    6. Nth-to-Default Credit Derivatives
    D. Treatment of Exposures Subject to Deduction
    E. Technical Amendments to the Advanced Approaches Rule
    1. Eligible Guarantees and Contingent U.S. Government Guarantees
    2. Calculation of Foreign Exposures for Applicability of the 
Advanced Approaches--Changes to Federal Financial Institutions 
Examination Council 009
    3. Applicability of the Interim Final Rule
    4. Change to the Definition of Probability of Default Related to 
Seasoning
    5. Cash Items in Process of Collection
    6. Change to the Definition of Qualifying Revolving Exposure
    7. Trade-Related Letters of Credit
    8. Defaulted Exposures That Are Guaranteed by the U.S. 
Government
    9. Stable Value Wraps
    10. Treatment of Pre-Sold Construction Loans and Multi-Family 
Residential Loans
    F. Pillar 3 Disclosures
    1. Frequency and Timeliness of Disclosures
    2. Enhanced Securitization Disclosure Requirements
    3. Equity Holdings That Are Not Covered Positions
XII. Market Risk Rule
XIII. Abbreviations
XIV. Regulatory Flexibility Act
XV. Paperwork Reduction Act
XVI. Plain Language
XVII. Small Business Regulatory Enforcement Fairness Act of 1996

I. Introduction

    On August 30, 2012, the agencies published in the Federal Register 
three joint notices of proposed rulemaking seeking public comment on 
revisions to their risk-based and leverage capital requirements and on 
methodologies for calculating risk-weighted assets under the 
standardized and advanced approaches (each, a proposal, and together, 
the NPRs, the proposed rules, or the proposals).\1\ The proposed rules, 
in part, reflected agreements reached by the Basel Committee on Banking 
Supervision (BCBS) in ``Basel III: A Global Regulatory Framework for 
More Resilient Banks and Banking Systems'' (Basel III), including 
subsequent changes to the BCBS's capital standards and recent BCBS 
consultative papers.\2\ Basel III is intended to improve both the 
quality and quantity of banking organizations' capital, as well as to 
strengthen various aspects of the international capital standards for 
calculating regulatory capital. The proposed rules also reflect aspects 
of the Basel II Standardized Approach and other Basel Committee 
standards.
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    \1\ 77 FR 52792 (August 30, 2012); 77 FR 52888 (August 30, 
2012); 77 FR 52978 (August 30, 2012).
    \2\ Basel III was published in December 2010 and revised in June 
2011. The text is available at http://www.bis.org/publ/bcbs189.htm. 
The BCBS is a committee of banking supervisory authorities, which 
was established by the central bank governors of the G-10 countries 
in 1975. More information regarding the BCBS and its membership is 
available at http://www.bis.org/bcbs/about.htm. Documents issued by 
the BCBS are available through the Bank for International 
Settlements Web site at http://www.bis.org.
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    The proposals also included changes consistent with the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act); 
\3\ would apply the risk-based and leverage capital rules to top-tier 
savings and loan holding companies (SLHCs) domiciled in the United 
States; and would apply the market risk capital rule (the market risk 
rule) \4\ to Federal and state savings associations (as appropriate 
based on trading activity).
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    \3\ Public Law 111-203, 124 Stat. 1376, 1435-38 (2010).
    \4\ The FDIC's market risk rule is at 12 CFR part 325, appendix 
C.
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    The NPR titled ``Regulatory Capital Rules: Regulatory Capital, 
Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital 
Adequacy, Transition Provisions, and Prompt Corrective Action'' \5\ 
(the Basel III NPR), provided for the implementation of the Basel III 
revisions to international capital standards related to minimum capital 
requirements, regulatory capital, and additional capital ``buffer'' 
standards to enhance the resilience of FDIC-supervised institutions to 
withstand periods of financial stress. FDIC-supervised institutions 
include state nonmember banks and state savings associations. The term 
banking organizations includes national banks, state member banks, 
state nonmember banks, state and Federal savings associations, and top-
tier bank holding companies domiciled in the United States not subject 
to the Federal Reserve's Small Bank Holding Company Policy Statement 
(12 CFR part 225, appendix C), as well as top-tier savings and loan 
holding companies domiciled in the United States, except certain 
savings and loan holding companies that are substantially engaged in 
insurance underwriting or commercial activities. The proposal included 
transition periods for many of the requirements, consistent with Basel 
III and the Dodd-Frank Act. The NPR titled ``Regulatory Capital Rules: 
Standardized Approach for Risk-weighted Assets; Market Discipline and 
Disclosure Requirements'' \6\ (the Standardized Approach NPR), would 
revise the methodologies for calculating risk-weighted assets in the 
agencies' general risk-based capital rules \7\ (the general risk-based 
capital rules), incorporating aspects of the Basel II standardized 
approach,\8\ and establish alternative standards of creditworthiness in 
place of credit ratings, consistent with section 939A of the Dodd-Frank 
Act.\9\ The proposed minimum capital requirements in section 10(a) of 
the Basel III NPR, as determined using the standardized capital ratio 
calculations in section 10(b), would establish minimum capital 
requirements that would be the ``generally applicable'' capital 
requirements for purpose of section 171 of the Dodd-Frank Act (Pub. L. 
111-203, 124 Stat. 1376, 1435-38 (2010).\10\
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    \5\ 77 FR 52792 (August 30, 2012).
    \6\ 77 FR 52888 (August 30, 2012).
    \7\ The FDIC's general risk-based capital rules is at 12 CFR 
part 325, appendix A, and 12 CFR part 390, subpart Z . The general 
risk-based capital rule is supplemented by the FDIC's market risk 
rule in 12 CFR part 325, appendix C.
    \8\ See BCBS, ``International Convergence of Capital Measurement 
and Capital Standards: A Revised Framework,'' (June 2006), available 
at http://www.bis.org/publ/bcbs128.htm (Basel II).
    \9\ See section 939A of the Dodd-Frank Act (15 U.S.C. 78o-7 
note).
    \10\ See 77 FR 52856 (August 30, 2012).
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    The NPR titled ``Regulatory Capital Rules: Advanced Approaches 
Risk-Based Capital Rule; Market Risk Capital

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Rule'' \11\ (the Advanced Approaches NPR) included proposed changes to 
the agencies' current advanced approaches risk-based capital rules (the 
advanced approaches rule) \12\ to incorporate applicable provisions of 
Basel III and the ``Enhancements to the Basel II framework'' (2009 
Enhancements) published in July 2009 \13\ and subsequent consultative 
papers, to remove references to credit ratings, to apply the market 
risk rule to savings associations and SLHCs, and to apply the advanced 
approaches rule to SLHCs meeting the scope of application of those 
rules. Taken together, the three proposals also would have restructured 
the agencies' regulatory capital rules (the general risk-based capital 
rules, leverage rules,\14\ market risk rule, and advanced approaches 
rule) into a harmonized, codified regulatory capital framework.
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    \11\ 77 FR 52978 (August 30, 2012).
    \12\ The FDIC's advanced approaches rules is at 12 CFR part 325, 
appendix D, and 12 CFR part 390, subpart Z, appendix A. The advanced 
approaches rule is supplemented by the market risk rule.
    \13\ See ``Enhancements to the Basel II framework'' (July 2009), 
available at http://www.bis.org/publ/bcbs157.htm.
    \14\ The FDIC's tier 1 leverage rules are at 12 CFR 325.3 (state 
nonmember banks) and 390.467 (state savings associations).
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    The FDIC is finalizing the Basel III NPR, Standardized Approach 
NPR, and Advanced Approaches NPR in this interim final rule, with 
certain changes to the proposals, as described further below. The OCC 
and Federal Reserve are jointly finalizing the Basel III NPR, 
Standardized Approach NPR, and Advanced Approaches NPR as a final rule, 
with identical changes to the proposals as the FDIC. This interim final 
rule applies to FDIC-supervised institutions.
    Certain aspects of this interim final rule apply only to FDIC-
supervised institutions subject to the advanced approaches rule 
(advanced approaches FDIC-supervised institutions) or to FDIC-
supervised institutions with significant trading activities, as further 
described below.
    Likewise, the enhanced disclosure requirements in the interim final 
rule apply only to FDIC-supervised institutions with $50 billion or 
more in total consolidated assets.
    As under the proposal, the minimum capital requirements in section 
10(a) of the interim final rule, as determined using the standardized 
capital ratio calculations in section 10(b), which apply to all FDIC-
supervised institutions, establish the ``generally applicable'' capital 
requirements under section 171 of the Dodd-Frank Act.\15\
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    \15\ See note 14, supra. Risk-weighted assets calculated under 
the market risk framework in subpart F of the interim final rule are 
included in calculations of risk-weighted assets both under the 
standardized approach and the advanced approaches.
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    Under the interim final rule, as under the proposal, in order to 
determine its minimum risk-based capital requirements, an advanced 
approaches FDIC-supervised institution that has completed the parallel 
run process and that has received notification from its primary Federal 
supervisor pursuant to section 324.121(d) of subpart E must determine 
its minimum risk-based capital requirements by calculating the three 
risk-based capital ratios using total risk-weighted assets under the 
standardized approach and, separately, total risk-weighted assets under 
the advanced approaches.\16\ The lower ratio for each risk-based 
capital requirement is the ratio the FDIC-supervised institution must 
use to determine its compliance with the minimum capital 
requirement.\17\ These enhanced prudential standards help ensure that 
advanced approaches FDIC-supervised institutions, which are among the 
largest and most complex FDIC-supervised institutions, have capital 
adequate to address their more complex operations and risks.
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    \16\ An advanced approaches FDIC-supervised institution must 
also use its advanced-approaches-adjusted total to determine its 
total risk-based capital ratio.
    \17\ See section 10(c) of the interim final rule.
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II. Summary of the Three Notices of Proposed Rulemaking

A. The Basel III Notice of Proposed Rulemaking

    As discussed in the proposals, the recent financial crisis 
demonstrated that the amount of high-quality capital held by banking 
organizations was insufficient to absorb the losses generated over that 
period. In addition, some non-common stock capital instruments included 
in tier 1 capital did not absorb losses to the extent previously 
expected. A lack of clear and easily understood disclosures regarding 
the characteristics of regulatory capital instruments, as well as 
inconsistencies in the definition of capital across jurisdictions, 
contributed to difficulties in evaluating a banking organization's 
capital strength. Accordingly, the BCBS assessed the international 
capital framework and, in 2010, published Basel III, a comprehensive 
reform package designed to improve the quality and quantity of 
regulatory capital and build additional capacity into the banking 
system to absorb losses in times of market and economic stress. On 
August 30, 2012, the agencies published the NPRs in the Federal 
Register to revise regulatory capital requirements, as discussed above. 
As proposed, the Basel III NPR generally would have applied to all U.S. 
banking organizations.
    Consistent with Basel III, the Basel III NPR would have required 
banking organizations to comply with the following minimum capital 
ratios: (i) A new requirement for a ratio of common equity tier 1 
capital to risk-weighted assets (common equity tier 1 capital ratio) of 
4.5 percent; (ii) a ratio of tier 1 capital to risk-weighted assets 
(tier 1 capital ratio) of 6 percent, increased from 4 percent; (iii) a 
ratio of total capital to risk-weighted assets (total capital ratio) of 
8 percent; (iv) a ratio of tier 1 capital to average total consolidated 
assets (leverage ratio) of 4 percent; and (v) for advanced approaches 
banking organizations only, an additional requirement that the ratio of 
tier 1 capital to total leverage exposure (supplementary leverage 
ratio) be at least 3 percent.
    The Basel III NPR also proposed implementation of a capital 
conservation buffer equal to 2.5 percent of risk-weighted assets above 
the minimum risk-based capital ratio requirements, which could be 
expanded by a countercyclical capital buffer for advanced approaches 
banking organizations under certain circumstances. If a banking 
organization failed to hold capital above the minimum capital ratios 
and proposed capital conservation buffer (as potentially expanded by 
the countercyclical capital buffer), it would be subject to certain 
restrictions on capital distributions and discretionary bonus payments. 
The proposed countercyclical capital buffer was designed to take into 
account the macro-financial environment in which large, internationally 
active banking organizations function. The countercyclical capital 
buffer could be implemented if the agencies determined that credit 
growth in the economy became excessive. As proposed, the 
countercyclical capital buffer would initially be set at zero, and 
could expand to as much as 2.5 percent of risk-weighted assets.
    The Basel III NPR proposed to apply a 4 percent minimum leverage 
ratio requirement to all banking organizations (computed using the new 
definition of capital), and to eliminate the exceptions for banking 
organizations with strong supervisory ratings or subject to the market 
risk rule. The Basel III NPR also

[[Page 55344]]

proposed to require advanced approaches banking organizations to 
satisfy a minimum supplementary leverage ratio requirement of 3 
percent, measured in a manner consistent with the international 
leverage ratio set forth in Basel III. Unlike the FDIC's current 
leverage ratio requirement, the proposed supplementary leverage ratio 
incorporates certain off-balance sheet exposures in the denominator.
    To strengthen the quality of capital, the Basel III NPR proposed 
more conservative eligibility criteria for regulatory capital 
instruments. For example, the Basel III NPR proposed that trust 
preferred securities (TruPS) and cumulative perpetual preferred 
securities, which were tier-1-eligible instruments (subject to limits) 
at the BHC level, would no longer be includable in tier 1 capital under 
the proposal and would be gradually phased out from tier 1 capital. The 
proposal also eliminated the existing limitations on the amount of tier 
2 capital that could be recognized in total capital, as well as the 
limitations on the amount of certain capital instruments (for example, 
term subordinated debt) that could be included in tier 2 capital.
    In addition, the proposal would have required banking organizations 
to include in common equity tier 1 capital accumulated other 
comprehensive income (AOCI) (with the exception of gains and losses on 
cash-flow hedges related to items that are not fair-valued on the 
balance sheet), and also would have established new limits on the 
amount of minority interest a banking organization could include in 
regulatory capital. The proposal also would have established more 
stringent requirements for several deductions from and adjustments to 
regulatory capital, including with respect to deferred tax assets 
(DTAs), investments in a banking organization's own capital instruments 
and the capital instruments of other financial institutions, and 
mortgage servicing assets (MSAs). The proposed revisions would have 
been incorporated into the regulatory capital ratios in the prompt 
corrective action (PCA) framework for depository institutions.

B. The Standardized Approach Notice of Proposed Rulemaking

    The Standardized Approach NPR proposed changes to the agencies' 
general risk-based capital rules for determining risk-weighted assets 
(that is, the calculation of the denominator of a banking 
organization's risk-based capital ratios). The proposed changes were 
intended to revise and harmonize the agencies' rules for calculating 
risk-weighted assets, enhance risk sensitivity, and address weaknesses 
in the regulatory capital framework identified over recent years, 
including by strengthening the risk sensitivity of the regulatory 
capital treatment for, among other items, credit derivatives, central 
counterparties (CCPs), high-volatility commercial real estate, and 
collateral and guarantees.
    In the Standardized Approach NPR, the agencies also proposed 
alternatives to credit ratings for calculating risk-weighted assets for 
certain assets, consistent with section 939A of the Dodd-Frank Act. 
These alternatives included methodologies for determining risk-weighted 
assets for exposures to sovereigns, foreign banks, and public sector 
entities, securitization exposures, and counterparty credit risk. The 
Standardized Approach NPR also proposed to include a framework for risk 
weighting residential mortgages based on underwriting and product 
features, as well as loan-to-value (LTV) ratios, and disclosure 
requirements for top-tier banking organizations domiciled in the United 
States with $50 billion or more in total assets, including disclosures 
related to regulatory capital instruments.

C. The Advanced Approaches Notice of Proposed Rulemaking

    The Advanced Approaches NPR proposed revisions to the advanced 
approaches rule to incorporate certain aspects of Basel III, the 2009 
Enhancements, and subsequent consultative papers. The proposal also 
would have implemented relevant provisions of the Dodd-Frank Act, 
including section 939A (regarding the use of credit ratings in agency 
regulations),\18\ and incorporated certain technical amendments to the 
existing requirements. In addition, the Advanced Approaches NPR 
proposed to codify the market risk rule in a manner similar to the 
codification of the other regulatory capital rules under the proposals.
---------------------------------------------------------------------------

    \18\ See section 939A of Dodd-Frank Act (15 U.S.C. 78o-7 note).
---------------------------------------------------------------------------

    Consistent with Basel III and the 2009 Enhancements, under the 
Advanced Approaches NPR, the agencies proposed further steps to 
strengthen capital requirements for internationally active banking 
organizations. This NPR would have required advanced approaches banking 
organizations to hold more appropriate levels of capital for 
counterparty credit risk, credit valuation adjustments (CVA), and 
wrong-way risk; would have strengthened the risk-based capital 
requirements for certain securitization exposures by requiring advanced 
approaches banking organizations to conduct more rigorous credit 
analysis of securitization exposures; and would have enhanced the 
disclosure requirements related to those exposures.
    The agencies proposed to apply the market risk rule to SLHCs and to 
state and Federal savings associations.

III. Summary of General Comments on the Basel III Notice of Proposed 
Rulemaking and on the Standardized Approach Notice of Proposed 
Rulemaking; Overview of the Interim Final Rule

A. General Comments on the Basel III Notice of Proposed Rulemaking and 
on the Standardized Approach Notice of Proposed Rulemaking

    Each agency received over 2,500 public comments on the proposals 
from banking organizations, trade associations, supervisory 
authorities, consumer advocacy groups, public officials (including 
members of the U.S. Congress), private individuals, and other 
interested parties. Overall, while most commenters supported more 
robust capital standards and the agencies' efforts to improve the 
resilience of the banking system, many commenters expressed concerns 
about the potential costs and burdens of various aspects of the 
proposals, particularly for smaller banking organizations. A 
substantial number of commenters also requested withdrawal of, or 
significant revisions to, the proposals. A few commenters argued that 
new capital rules were not necessary at this time. Some commenters 
requested that the agencies perform additional studies of the economic 
impact of part or all of the proposed rules. Many commenters asked for 
additional time to transition to the new requirements. A more detailed 
discussion of the comments provided on particular aspects of the 
proposals is provided in the remainder of this preamble.
1. Applicability and Scope
    The agencies received a significant number of comments regarding 
the proposed scope and applicability of the Basel III NPR and the 
Standardized Approach NPR. The majority of comments submitted by or on 
behalf of community banking organizations requested an exemption from 
the proposals. These commenters suggested basing such an exemption on a 
banking organization's asset size--for example, total assets of less 
than $500 million, $1 billion, $10 billion, $15 billion, or $50 
billion--or on its risk profile or business model. Under the latter 
approach, the

[[Page 55345]]

commenters suggested providing an exemption for banking organizations 
with balance sheets that rely less on leverage, short-term funding, or 
complex derivative transactions.
    In support of an exemption from the proposed rule for community 
banking organizations, a number of commenters argued that the proposed 
revisions to the definition of capital would be overly conservative and 
would prohibit some of the instruments relied on by community banking 
organizations from satisfying regulatory capital requirements. Many of 
these commenters stated that, in general, community banking 
organizations have less access to the capital markets relative to 
larger banking organizations and could increase capital only by 
accumulating retained earnings. Owing to slow economic growth and 
relatively low earnings among community banking organizations, the 
commenters asserted that implementation of the proposal would be 
detrimental to their ability to serve local communities while providing 
reasonable returns to shareholders. Other commenters requested 
exemptions from particular sections of the proposed rules, such as 
maintaining capital against transactions with particular 
counterparties, or based on transaction types that they considered 
lower-risk, such as derivative transactions hedging interest rate risk.
    The commenters also argued that application of the Basel III NPR 
and Standardized Approach NPR to community banking organizations would 
be unnecessary and inappropriate for the business model and risk 
profile of such organizations. These commenters asserted that Basel III 
was designed for large, internationally-active banking organizations in 
response to a financial crisis attributable primarily to those 
institutions. Accordingly, the commenters were of the view that 
community banking organizations require a different capital framework 
with less stringent capital requirements, or should be allowed to 
continue to use the general risk-based capital rules. In addition, many 
commenters, in particular minority depository institutions (MDIs), 
mutual banking organizations, and community development financial 
institutions (CDFIs), expressed concern regarding their ability to 
raise capital to meet the increased minimum requirements in the current 
environment and upon implementation of the proposed definition of 
capital. One commenter asked for an exemption from all or part of the 
proposed rules for CDFIs, indicating that the proposal would 
significantly reduce the availability of capital for low- and moderate-
income communities. Another commenter stated that the U.S. Congress has 
a policy of encouraging the creation of MDIs and expressed concern that 
the proposed rules contradicted this purpose.
    In contrast, however, a few commenters supported the proposed 
application of the Basel III NPR to all banking organizations. For 
example, one commenter stated that increasing the quality and quantity 
of capital at all banking organizations would create a more resilient 
financial system and discourage inappropriate risk-taking by forcing 
banking organizations to put more of their own ``skin in the game.'' 
This commenter also asserted that the proposed scope of the Basel III 
NPR would reduce the probability and impact of future financial crises 
and support the objectives of sustained growth and high employment. 
Another commenter favored application of the Basel III NPR to all 
banking organizations to ensure a level playing field among banking 
organizations within the same competitive market.
2. Aggregate Impact
    A majority of the commenters expressed concern regarding the 
potential aggregate impact of the proposals, together with other 
provisions of the Dodd-Frank Act. Some of these commenters urged the 
agencies to withdraw the proposals and to conduct a quantitative impact 
study (QIS) to assess the potential aggregate impact of the proposals 
on banking organizations and the overall U.S. economy. Many commenters 
argued that the proposals would have significant negative consequences 
for the financial services industry. According to the commenters, by 
requiring banking organizations to hold more capital and increase risk 
weighting on some of their assets, as well as to meet higher risk-based 
and leverage capital measures for certain PCA categories, the proposals 
would negatively affect the banking sector. Commenters cited, among 
other potential consequences of the proposals: restricted job growth; 
reduced lending or higher-cost lending, including to small businesses 
and low-income or minority communities; limited availability of certain 
types of financial products; reduced investor demand for banking 
organizations' equity; higher compliance costs; increased mergers and 
consolidation activity, specifically in rural markets, because banking 
organizations would need to spread compliance costs among a larger 
customer base; and diminished access to the capital markets resulting 
from reduced profit and from dividend restrictions associated with the 
capital buffers. The commenters also asserted that the recovery of the 
U.S. economy would be impaired by the proposals as a result of reduced 
lending by banking organizations that the commenters believed would be 
attributable to the higher costs of regulatory compliance. In 
particular, the commenters expressed concern that a contraction in 
small-business lending would adversely affect job growth and 
employment.
3. Competitive Concerns
    Many commenters raised concerns that implementation of the 
proposals would create an unlevel playing field between banking 
organizations and other financial services providers. For example, a 
number of commenters expressed concern that credit unions would be able 
to gain market share from banking organizations by offering similar 
products at substantially lower costs because of differences in 
taxation combined with potential costs from the proposals. The 
commenters also argued that other financial service providers, such as 
foreign banks with significant U.S. operations, members of the Federal 
Farm Credit System, and entities in the shadow banking industry, would 
not be subject to the proposed rule and, therefore, would have a 
competitive advantage over banking organizations. These commenters also 
asserted that the proposals could cause more consumers to choose lower-
cost financial products from the unregulated, nonbank financial sector.
4. Costs
    Commenters representing all types of banking organizations 
expressed concern that the complexity and implementation cost of the 
proposals would exceed their expected benefits. According to these 
commenters, implementation of the proposals would require software 
upgrades for new internal reporting systems, increased employee 
training, and the hiring of additional employees for compliance 
purposes. Some commenters urged the agencies to recognize that 
compliance costs have increased significantly over recent years due to 
other regulatory changes and to take these costs into consideration. As 
an alternative, some commenters encouraged the agencies to consider a 
simple increase in the minimum regulatory capital requirements, 
suggesting that such an approach would provide increased protection to 
the Deposit Insurance Fund and increase safety and soundness

[[Page 55346]]

without adding complexity to the regulatory capital framework.

B. Comments on Particular Aspects of the Basel III Notice of Proposed 
Rulemaking and on the Standardized Approach Notice of Proposed 
Rulemaking

    In addition to the general comments described above, the agencies 
received a significant number of comments on four particular elements 
of the proposals: the requirement to include most elements of AOCI in 
regulatory capital; the new framework for risk weighting residential 
mortgages; and the requirement to phase out TruPS from tier 1 capital 
for all banking organizations.
1. Accumulated Other Comprehensive Income
    AOCI generally includes accumulated unrealized gains and losses on 
certain assets and liabilities that have not been included in net 
income, yet are included in equity under U.S. generally accepted 
accounting principles (GAAP) (for example, unrealized gains and losses 
on securities designated as available-for-sale (AFS)). Under the 
agencies' general risk-based capital rules, most components of AOCI are 
not reflected in a banking organization's regulatory capital. In the 
proposed rule, consistent with Basel III, the agencies proposed to 
require banking organizations to include the majority of AOCI 
components in common equity tier 1 capital.
    The agencies received a significant number of comments on the 
proposal to require banking organizations to recognize AOCI in common 
equity tier 1 capital. Generally, the commenters asserted that the 
proposal would introduce significant volatility in banking 
organizations' capital ratios due in large part to fluctuations in 
benchmark interest rates, and would result in many banking 
organizations moving AFS securities into a held-to-maturity (HTM) 
portfolio or holding additional regulatory capital solely to mitigate 
the volatility resulting from temporary unrealized gains and losses in 
the AFS securities portfolio. The commenters also asserted that the 
proposed rules would likely impair lending and negatively affect 
banking organizations' ability to manage liquidity and interest rate 
risk and to maintain compliance with legal lending limits. Commenters 
representing community banking organizations in particular asserted 
that they lack the sophistication of larger banking organizations to 
use certain risk-management techniques for hedging interest rate risk, 
such as the use of derivative instruments.
2. Residential Mortgages
    The Standardized Approach NPR would have required banking 
organizations to place residential mortgage exposures into one of two 
categories to determine the applicable risk weight. Category 1 
residential mortgage exposures were defined to include mortgage 
products with underwriting and product features that have demonstrated 
a lower risk of default, such as consideration and documentation of a 
borrower's ability to repay, and generally excluded mortgage products 
that included terms or other characteristics that the agencies have 
found to be indicative of higher credit risk, such as deferral of 
repayment of principal. Residential mortgage exposures with higher risk 
characteristics were defined as category 2 residential mortgage 
exposures. The agencies proposed to apply relatively lower risk weights 
to category 1 residential mortgage exposures, and higher risk weights 
to category 2 residential mortgage exposures. The proposal provided 
that the risk weight assigned to a residential mortgage exposure also 
depended on its LTV ratio.
    The agencies received a significant number of comments objecting to 
the proposed treatment for one-to-four family residential mortgages and 
requesting retention of the mortgage treatment in the agencies' general 
risk-based capital rules. Commenters generally expressed concern that 
the proposed treatment would inhibit lending to creditworthy borrowers 
and could jeopardize the recovery of a still-fragile housing market. 
Commenters also criticized the distinction between category 1 and 
category 2 mortgages, asserting that the characteristics proposed for 
each category did not appropriately distinguish between lower- and 
higher-risk products and would adversely impact certain loan products 
that performed relatively well even during the recent crisis. 
Commenters also highlighted concerns regarding regulatory burden and 
the uncertainty of other regulatory initiatives involving residential 
mortgages. In particular, these commenters expressed considerable 
concern regarding the potential cumulative impact of the proposed new 
mortgage requirements combined with the Dodd-Frank Act's requirements 
relating to the definitions of qualified mortgage and qualified 
residential mortgage \19\ and asserted that when considered together 
with the proposed mortgage treatment, the combined effect could have an 
adverse impact on the mortgage industry.
---------------------------------------------------------------------------

    \19\ See, e.g., the definition of ``qualified mortgage'' in 
section 1412 of the Dodd-Frank Act (15 U.S.C. 129C) and ``qualified 
residential mortgage'' in section 941(e)(4) of the Dodd-Frank Act 
(15 U.S.C. 78o-11(e)(4)).
---------------------------------------------------------------------------

3. Trust Preferred Securities for Smaller FDIC-Supervised Institutions
    The proposed rules would have required all banking organizations to 
phase-out TruPS from tier 1 capital under either a 3- or 10-year 
transition period based on the organization's total consolidated 
assets. The proposal would have required banking organizations with 
more than $15 billion in total consolidated assets (as of December 31, 
2009) to phase-out of tier 1 capital any non-qualifying capital 
instruments (such as TruPS and cumulative preferred shares) issued 
before May 19, 2010. The exclusion of non-qualifying capital 
instruments would have taken place incrementally over a three-year 
period beginning on January 1, 2013. Section 171 provides an exception 
that permits banking organizations with total consolidated assets of 
less than $15 billion as of December 31, 2009, and banking 
organizations that were mutual holding companies as of May 19, 2010 
(2010 MHCs), to include in tier 1 capital all TruPS (and other 
instruments that could no longer be included in tier 1 capital pursuant 
to the requirements of section 171) that were issued prior to May 19, 
2010.\20\ However, consistent with Basel III and the general policy 
purpose of the proposed revisions to regulatory capital, the agencies 
proposed to require banking organizations with total consolidated 
assets less than $15 billion as of December 31, 2009 and 2010 MHCs to 
phase out their non-qualifying capital instruments from regulatory 
capital over ten years.\21\
---------------------------------------------------------------------------

    \20\ Specifically, section 171 provides that deductions of 
instruments ``that would be required'' under the section are not 
required for depository institution holding companies with total 
consolidated assets of less than $15 billion as of December 31, 2009 
and 2010 MHCs. See 12 U.S.C. 5371(b)(4)(C).
    \21\ See 12 U.S.C. 5371(b)(5)(A). While section 171 of the Dodd-
Frank Act requires the agencies to establish minimum risk-based and 
leverage capital requirements subject to certain limitations, the 
agencies retain their general authority to establish capital 
requirements under other laws and regulations, including under the 
National Bank Act, 12 U.S.C. 1, et seq., Federal Reserve Act, 
Federal Deposit Insurance Act, Bank Holding Company Act, 
International Lending Supervision Act, 12 U.S.C. 3901, et seq., and 
Home Owners Loan Act, 12 U.S.C. 1461, et seq.

---------------------------------------------------------------------------

[[Page 55347]]

    Many commenters representing community banking organizations 
criticized the proposal's phase-out schedule for TruPS and encouraged 
the agencies to grandfather TruPS in tier 1 capital to the extent 
permitted by section 171 of the Dodd-Frank Act. Commenters asserted 
that this was the intent of the U.S. Congress, including this provision 
in the statute. These commenters also asserted that this aspect of the 
proposal would unduly burden community banking organizations that have 
limited ability to raise capital, potentially impairing the lending 
capacity of these banking organizations.

C. Overview of the Interim Final Rule

    The interim final rule will replace the FDIC's general risk-based 
capital rules, advanced approaches rule, market risk rule, and leverage 
rules in accordance with the transition provisions described below. 
After considering the comments received, the FDIC has made substantial 
modifications in the interim final rule to address specific concerns 
raised by commenters regarding the cost, complexity, and burden of the 
proposals.
    During the recent financial crisis, lack of confidence in the 
banking sector increased banking organizations' cost of funding, 
impaired banking organizations' access to short-term funding, depressed 
values of banking organizations' equities, and required many banking 
organizations to seek government assistance. Concerns about banking 
organizations arose not only because market participants expected steep 
losses on banking organizations' assets, but also because of 
substantial uncertainty surrounding estimated loss rates, and thus 
future earnings. Further, heightened systemic risks, falling asset 
values, and reduced credit availability had an adverse impact on 
business and consumer confidence, significantly affecting the overall 
economy. The interim final rule addresses these weaknesses by helping 
to ensure a banking and financial system that will be better able to 
absorb losses and continue to lend in future periods of economic 
stress. This important benefit in the form of a safer, more resilient, 
and more stable banking system is expected to substantially outweigh 
any short-term costs that might result from the interim final rule.
    In this context, the FDIC is adopting most aspects of the 
proposals, including the minimum risk-based capital requirements, the 
capital conservation and countercyclical capital buffers, and many of 
the proposed risk weights. The FDIC has also decided to apply most 
aspects of the Basel III NPR and Standardized Approach NPR to all 
banking organizations, with some significant changes. Implementing the 
interim final rule in a consistent fashion across the banking system 
will improve the quality and increase the level of regulatory capital, 
leading to a more stable and resilient system for banking organizations 
of all sizes and risk profiles. The improved resilience will enhance 
their ability to continue functioning as financial intermediaries, 
including during periods of financial stress and reduce risk to the 
deposit insurance fund and to the financial system. The FDIC believes 
that, together, the revisions to the proposals meaningfully address the 
commenters' concerns regarding the potential implementation burden of 
the proposals.
    The FDIC has considered the concerns raised by commenters and 
believe that it is important to take into account and address 
regulatory costs (and their potential effect on FDIC-supervised 
institutions' role as financial intermediaries in the economy) when the 
FDIC establishes or revises regulatory requirements. In developing 
regulatory capital requirements, these concerns are considered in the 
context of the FDIC's broad goals--to enhance the safety and soundness 
of FDIC-supervised institutions and promote financial stability through 
robust capital standards for the entire banking system.
    The agencies participated in the development of a number of studies 
to assess the potential impact of the revised capital requirements, 
including participating in the BCBS's Macroeconomic Assessment Group as 
well as its QIS, the results of which were made publicly available by 
the BCBS upon their completion.\22\ The BCBS analysis suggested that 
stronger capital requirements help reduce the likelihood of banking 
crises while yielding positive net economic benefits.\23\ To evaluate 
the potential reduction in economic output resulting from the new 
framework, the analysis assumed that banking organizations replaced 
debt with higher-cost equity to the extent needed to comply with the 
new requirements, that there was no reduction in the cost of equity 
despite the reduction in the riskiness of banking organizations' 
funding mix, and that the increase in funding cost was entirely passed 
on to borrowers. Given these assumptions, the analysis concluded there 
would be a slight increase in the cost of borrowing and a slight 
decrease in the growth of gross domestic product. The analysis 
concluded that this cost would be more than offset by the benefit to 
gross domestic product resulting from a reduced likelihood of prolonged 
economic downturns associated with a banking system whose lending 
capacity is highly vulnerable to economic shocks.
---------------------------------------------------------------------------

    \22\ See ``Assessing the macroeconomic impact of the transition 
to stronger capital and liquidity requirements'' (MAG Analysis), 
Attachment E, also available at: http://www.bis.orpublIothp12.pdf. 
See also ``Results of the comprehensive quantitative impact study,'' 
Attachment F, also available at: http://www.bis.org/publ/bcbs186.pdf.
    \23\ See ``An assessment of the long-term economic impact of 
stronger capital and liquidity requirements,'' Executive Summary, 
pg. 1, Attachment G.
---------------------------------------------------------------------------

    The agencies' analysis also indicates that the overwhelming 
majority of banking organizations already have sufficient capital to 
comply with the new capital rules. In particular, the agencies estimate 
that over 95 percent of all insured depository institutions would be in 
compliance with the minimums and buffers established under the interim 
final rule if it were fully effective immediately. The interim final 
rule will help to ensure that these FDIC-supervised institutions 
maintain their capacity to absorb losses in the future. Some FDIC-
supervised institutions may need to take advantage of the transition 
period in the interim final rule to accumulate retained earnings, raise 
additional external regulatory capital, or both. As noted above, 
however, the overwhelming majority of banking organizations have 
sufficient capital to comply with the revised capital rules, and the 
FDIC believes that the resulting improvements to the stability and 
resilience of the banking system outweigh any costs associated with its 
implementation.
    The interim final rule includes some significant revisions from the 
proposals in response to commenters' concerns, particularly with 
respect to the treatment of AOCI; residential mortgages; tier 1 non-
qualifying capital instruments; and the implementation timeframes. The 
timeframes for compliance are described in the next section and more 
detailed discussions of modifications to the proposals are provided in 
the remainder of the preamble.
    Consistent with the proposed rules, the interim final rule requires 
all FDIC-supervised institutions to recognize in regulatory capital all 
components of AOCI, excluding accumulated net gains and losses on cash-
flow hedges that relate to the hedging of items that are not recognized 
at fair value on the balance sheet. However, while the FDIC believes 
that the proposed AOCI treatment results in a regulatory capital

[[Page 55348]]

measure that better reflects FDIC-supervised institutions' actual loss 
absorption capacity at a specific point in time, the FDIC recognizes 
that for many FDIC-supervised institutions, the volatility in 
regulatory capital that could result from the proposals could lead to 
significant difficulties in capital planning and asset-liability 
management. The FDIC also recognizes that the tools used by larger, 
more complex FDIC-supervised institutions for managing interest rate 
risk are not necessarily readily available for all FDIC-supervised 
institutions.
    Accordingly, under the interim final rule, and as discussed in more 
detail in section V.B of this preamble, an FDIC-supervised institution 
that is not subject to the advanced approaches rule may make a one-time 
election not to include most elements of AOCI in regulatory capital 
under the interim final rule and instead effectively use the existing 
treatment under the general risk-based capital rules that excludes most 
AOCI elements from regulatory capital (AOCI opt-out election). Such an 
FDIC-supervised institution must make its AOCI opt-out election in its 
Consolidated Reports of Condition and Income (Call Report) filed for 
the first reporting period after it becomes subject to the interim 
final rule. Consistent with regulatory capital calculations under the 
FDIC's general risk-based capital rules, an FDIC-supervised institution 
that makes an AOCI opt-out election under the interim final rule must 
adjust common equity tier 1 capital by: (1) Subtracting any net 
unrealized gains and adding any net unrealized losses on AFS 
securities; (2) subtracting any unrealized losses on AFS preferred 
stock classified as an equity security under GAAP and AFS equity 
exposures; (3) subtracting any accumulated net gains and adding any 
accumulated net losses on cash-flow hedges; (4) subtracting amounts 
recorded in AOCI attributed to defined benefit postretirement plans 
resulting from the initial and subsequent application of the relevant 
GAAP standards that pertain to such plans (excluding, at the FDIC-
supervised institution's option, the portion relating to pension assets 
deducted under section 22(a)(5) of the interim final rule); and (5) 
subtracting any net unrealized gains and adding any net unrealized 
losses on held-to-maturity securities that are included in AOCI. 
Consistent with the general risk-based capital rules, common equity 
tier 1 capital includes any net unrealized losses on AFS equity 
securities and any foreign currency translation adjustment. An FDIC-
supervised institution that makes an AOCI opt-out election may 
incorporate up to 45 percent of any net unrealized gains on AFS 
preferred stock classified as an equity security under GAAP and AFS 
equity exposures into its tier 2 capital.
    An FDIC-supervised institution that does not make an AOCI opt-out 
election on the Call Report filed for the first reporting period after 
the FDIC-supervised institution becomes subject to the interim final 
rule will be required to recognize AOCI (excluding accumulated net 
gains and losses on cash-flow hedges that relate to the hedging of 
items that are not recognized at fair value on the balance sheet) in 
regulatory capital as of the first quarter in which it calculates its 
regulatory capital requirements under the interim final rule and 
continuing thereafter.
    The FDIC has decided not to adopt the proposed treatment of 
residential mortgages. The FDIC has considered the commenters' 
observations about the burden of calculating the risk weights for FDIC-
supervised institutions' existing mortgage portfolios, and has taken 
into account the commenters' concerns that the proposal did not 
properly assess the use of different mortgage products across different 
types of markets in establishing the proposed risk weights. The FDIC is 
also particularly mindful of comments regarding the potential effect of 
the proposal and other mortgage-related rulemakings on credit 
availability. In light of these considerations, as well as others 
raised by commenters, the FDIC has decided to retain in the interim 
final rule the current treatment for residential mortgage exposures 
under the general risk-based capital rules.
    Consistent with the general risk-based capital rules, the interim 
final rule assigns a 50 or 100 percent risk weight to exposures secured 
by one-to-four family residential properties. Generally, residential 
mortgage exposures secured by a first lien on a one-to-four family 
residential property that are prudently underwritten and that are 
performing according to their original terms receive a 50 percent risk 
weight. All other one- to four-family residential mortgage loans, 
including exposures secured by a junior lien on residential property, 
are assigned a 100 percent risk weight. If an FDIC-supervised 
institution holds the first and junior lien(s) on a residential 
property and no other party holds an intervening lien, the FDIC-
supervised institution must treat the combined exposure as a single 
loan secured by a first lien for purposes of assigning a risk weight.
    The agencies also considered comments on the proposal to require 
certain depository institution holding companies to phase out their 
non-qualifying tier 1 capital instruments from regulatory capital over 
ten years. Although the agencies continue to believe that non-
qualifying instruments do not absorb losses sufficiently to be included 
in tier 1 capital as a general matter, the agencies are also sensitive 
to the difficulties community banking organizations often face when 
issuing new capital instruments and are aware of the importance their 
capacity to lend can play in local economies. Therefore, the final rule 
adopted by the Federal Reserve allows certain depository institution 
holding companies to include in regulatory capital debt or equity 
instruments issued prior to September 12, 2010 that do not meet the 
criteria for additional tier 1 or tier 2 capital instruments but that 
were included in tier 1 or tier 2 capital respectively as of September 
12, 2010 up to the percentage of the outstanding principal amount of 
such non-qualifying capital instruments.

D. Timeframe for Implementation and Compliance

    In order to give non-internationally active FDIC-supervised 
institutions more time to comply with the interim final rule and 
simplify their transition to the new regime, the interim final rule 
will require compliance from different types of organizations at 
different times. Generally, and as described in further detail below, 
FDIC-supervised institutions that are not subject to the advanced 
approaches rule must begin complying with the interim final rule on 
January 1, 2015, whereas advanced approaches FDIC-supervised 
institutions must begin complying with the interim final rule on 
January 1, 2014. The FDIC believes that advanced approaches FDIC-
supervised institutions have the sophistication, infrastructure, and 
capital markets access to implement the interim final rule earlier than 
either FDIC-supervised institutions that do not meet the asset size or 
foreign exposure threshold for application of those rules.
    A number of commenters requested that the agencies clarify the 
point at which a banking organization that meets the asset size or 
foreign exposure threshold for application of the advanced approaches 
rule becomes subject to subpart E of the proposed rule, and thus all of 
the provisions that apply to an advanced approaches banking 
organization. In particular, commenters requested that the agencies 
clarify whether subpart E of the proposed rule only applies to those 
banking organizations that have

[[Page 55349]]

completed the parallel run process and that have received notification 
from their primary Federal supervisor pursuant to section 324.121(d) of 
subpart E, or whether subpart E would apply to all banking 
organizations that meet the relevant thresholds without reference to 
completion of the parallel run process.
    The interim final rule provides that an advanced approaches FDIC-
supervised institution is one that meets the asset size or foreign 
exposure thresholds for or has opted to apply the advanced approaches 
rule, without reference to whether that FDIC-supervised institution has 
completed the parallel run process and has received notification from 
its primary Federal supervisor pursuant to section 324.121(d) of 
subpart E of the interim final rule. The FDIC has also clarified in the 
interim final rule when completion of the parallel run process and 
receipt of notification from the primary Federal supervisor pursuant to 
section 324.121(d) of subpart E is necessary for an advanced approaches 
FDIC-supervised institution to comply with a particular aspect of the 
rules. For example, only an advanced approaches FDIC-supervised 
institution that has completed parallel run and received notification 
from its primary Federal supervisor under Section 324.121(d) of subpart 
E must make the disclosures set forth under subpart E of the interim 
final rule. However, an advanced approaches FDIC-supervised institution 
must recognize most components of AOCI in common equity tier 1 capital 
and must meet the supplementary leverage ratio when applicable without 
reference to whether the FDIC-supervised institution has completed its 
parallel run process.
    Beginning on January 1, 2015, FDIC-supervised institutions that are 
not subject to the advanced approaches rule become subject to the 
revised definitions of regulatory capital, the new minimum regulatory 
capital ratios, and the regulatory capital adjustments and deductions 
according to the transition provisions.\24\ All FDIC-supervised 
institutions must begin calculating standardized total risk-weighted 
assets in accordance with subpart D of the interim final rule, and if 
applicable, the revised market risk rule under subpart F, on January 1, 
2015.\25\
---------------------------------------------------------------------------

    \24\ Prior to January 1, 2015, such FDIC-supervised institutions 
must continue to use the FDIC's general risk-based capital rules and 
tier 1 leverage rules.
    \25\ The revised PCA thresholds, discussed further in section 
IV.E. of this preamble, become effective for all insured depository 
institutions on January 1, 2015.
---------------------------------------------------------------------------

    Beginning on January 1, 2014, advanced approaches FDIC-supervised 
institutions must begin the transition period for the revised minimum 
regulatory capital ratios, definitions of regulatory capital, and 
regulatory capital adjustments and deductions established under the 
interim final rule. The revisions to the advanced approaches risk-
weighted asset calculations will become effective on January 1, 2014.
    From January 1, 2014 to December 31, 2014, an advanced approaches 
FDIC-supervised institution that is on parallel run must calculate 
risk-weighted assets using the general risk-based capital rules and 
substitute such risk-weighted assets for its standardized total risk-
weighted assets for purposes of determining its risk-based capital 
ratios. An advanced approaches FDIC-supervised institution on parallel 
run must also calculate advanced approaches total risk-weighted assets 
using the advanced approaches rule in subpart E of the interim final 
rule for purposes of confidential reporting to its primary Federal 
supervisor on the Federal Financial Institutions Examination Council's 
(FFIEC) 101 report. An advanced approaches FDIC-supervised institution 
that has completed the parallel run process and that has received 
notification from its primary Federal supervisor pursuant to section 
121(d) of subpart E will calculate its risk-weighted assets using the 
general risk-based capital rules and substitute such risk-weighted 
assets for its standardized total risk-weighted assets and also 
calculate advanced approaches total risk-weighted assets using the 
advanced approaches rule in subpart E of the interim final rule for 
purposes of determining its risk-based capital ratios from January 1, 
2014 to December 31, 2014. Regardless of an advanced approaches FDIC-
supervised institution's parallel run status, on January 1, 2015, the 
FDIC-supervised institution must begin to apply subpart D, and if 
applicable, subpart F, of the interim final rule to determine its 
standardized total risk-weighted assets.
    The transition period for the capital conservation and 
countercyclical capital buffers for all FDIC-supervised institutions 
will begin on January 1, 2016.
    An FDIC-supervised institution that is required to comply with the 
market risk rule must comply with the revised market risk rule (subpart 
F) as of the same date that it must comply with other aspects of the 
rule for determining its total risk-weighted assets.

------------------------------------------------------------------------
                                FDIC-Supervised institutions not subject
             Date                   to the advanced approaches rule*
------------------------------------------------------------------------
January 1, 2015..............  Begin compliance with the revised minimum
                                regulatory capital ratios and begin the
                                transition period for the revised
                                definitions of regulatory capital and
                                the revised regulatory capital
                                adjustments and deductions.
                               Begin compliance with the standardized
                                approach for determining risk-weighted
                                assets.
January 1, 2016..............  Begin the transition period for the
                                capital conservation and countercyclical
                                capital buffers.
------------------------------------------------------------------------


------------------------------------------------------------------------
                                  Advanced approaches FDIC-supervised
             Date                            institutions*
------------------------------------------------------------------------
January 1, 2014..............  Begin the transition period for the
                                revised minimum regulatory capital
                                ratios, definitions of regulatory
                                capital, and regulatory capital
                                adjustments and deductions.
                               Begin compliance with the revised
                                advanced approaches rule for determining
                                risk-weighted assets.
January 1, 2015..............  Begin compliance with the standardized
                                approach for determining risk-weighted
                                assets.
January 1, 2016..............  Begin the transition period for the
                                capital conservation and countercyclical
                                capital buffers.
------------------------------------------------------------------------
*If applicable, FDIC-supervised institutions must use the calculations
  in subpart F of the interim final rule (market risk) concurrently with
  the calculation of risk-weighted assets according either to subpart D
  (standardized approach) or subpart E (advanced approaches) of the
  interim final rule.


[[Page 55350]]

IV. Minimum Regulatory Capital Ratios, Additional Capital Requirements, 
and Overall Capital Adequacy

A. Minimum Risk-based Capital Ratios and Other Regulatory Capital 
Provisions

    Consistent with Basel III, the proposed rule would have required 
banking organizations to comply with the following minimum capital 
ratios: a common equity tier 1 capital to risk-weighted assets ratio of 
4.5 percent; a tier 1 capital to risk-weighted assets ratio of 6 
percent; a total capital to risk-weighted assets ratio of 8 percent; a 
leverage ratio of 4 percent; and for advanced approaches banking 
organizations only, a supplementary leverage ratio of 3 percent. The 
common equity tier 1 capital ratio is a new minimum requirement 
designed to ensure that banking organizations hold sufficient high-
quality regulatory capital that is available to absorb losses on a 
going-concern basis. The proposed capital ratios would apply to a 
banking organization on a consolidated basis.
    The agencies received a substantial number of comments on the 
proposed minimum risk-based capital requirements. Several commenters 
supported the proposal to increase the minimum tier 1 risk-based 
capital requirement. Other commenters commended the agencies for 
proposing to implement a minimum capital requirement that focuses 
primarily on common equity. These commenters argued that common equity 
is the strongest form of capital and that the proposed minimum common 
equity tier 1 capital ratio of 4.5 percent would promote the safety and 
soundness of the banking industry.
    Other commenters provided general support for the proposed 
increases in minimum risk-based capital requirements, but expressed 
concern that the proposals could present unique challenges to mutual 
institutions because they can only raise common equity through retained 
earnings. A number of commenters asserted that the objectives of the 
proposal could be achieved through regulatory mechanisms other than the 
proposed risk-based capital requirements, including enhanced safety and 
soundness examinations, more stringent underwriting standards, and 
alternative measures of capital.
    Other commenters objected to the proposed increase in the minimum 
tier 1 capital ratio and the implementation of a common equity tier 1 
capital ratio. One commenter indicated that increases in regulatory 
capital ratios would severely limit growth at many community banking 
organizations and could encourage consolidation through mergers and 
acquisitions. Other commenters stated that for banks under $750 million 
in total assets, increased compliance costs would not allow them to 
provide a reasonable return to shareholders, and thus would force them 
to consolidate. Several commenters urged the agencies to recognize 
community banking organizations' limited access to the capital markets 
and related difficulties raising capital to comply with the proposal.
    One banking organization indicated that implementation of the 
common equity tier 1 capital ratio would significantly reduce its 
capacity to grow and recommended that the proposal recognize 
differences in the risk and complexity of banking organizations and 
provide favorable, less stringent requirements for smaller and non-
complex institutions. Another commenter suggested that the proposed 
implementation of an additional risk-based capital ratio would confuse 
market observers and recommended that the agencies implement a 
regulatory capital framework that allows investors and the market to 
ascertain regulatory capital from measures of equity derived from a 
banking organization's balance sheet.
    Other commenters expressed concern that the proposed common equity 
tier 1 capital ratio would disadvantage MDIs relative to other banking 
organizations. According to the commenters, in order to retain their 
minority-owned status, MDIs historically maintain a relatively high 
percentage of non-voting preferred stockholders that provide long-term, 
stable sources of capital. Any public offering to increase common 
equity tier 1 capital levels would dilute the minority investors owning 
the common equity of the MDI and could potentially compromise the 
minority-owned status of such institutions. One commenter asserted 
that, for this reason, the implementation of the Basel III NPR would be 
contrary to the statutory mandate of section 308 of the Financial 
Institutions, Reform, Recovery and Enforcement Act (FIRREA).\26\ 
Accordingly, the commenters encouraged the agencies to exempt MDIs from 
the proposed common equity tier 1 capital ratio requirement.
---------------------------------------------------------------------------

    \26\ 12 U.S.C. 1463 note.
---------------------------------------------------------------------------

    The FDIC believes that all FDIC-supervised institutions must have 
an adequate amount of loss-absorbing capital to continue to lend to 
their communities during times of economic stress, and therefore have 
decided to implement the regulatory capital requirements, including the 
minimum common equity tier 1 capital requirement, as proposed. For the 
reasons described in the NPR, including the experience during the 
crisis with lower quality capital instruments, the FDIC does not 
believe it is appropriate to maintain the general risk-based capital 
rules or to rely on the supervisory process or underwriting standards 
alone. Accordingly, the interim final rule maintains the minimum common 
equity tier 1 capital to total risk-weighted assets ratio of 4.5 
percent. The FDIC has decided not to pursue the alternative regulatory 
mechanisms suggested by commenters, as such alternatives would be 
difficult to implement consistently across FDIC-supervised institutions 
and would not necessarily fulfill the objective of increasing the 
amount and quality of regulatory capital for all FDIC-supervised 
institutions.
    In view of the concerns expressed by commenters with respect to 
MDIs, the FDIC evaluated the risk-based and leverage capital levels of 
MDIs to determine whether the interim final rule would 
disproportionately impact such institutions. This analysis found that 
of the 178 MDIs in existence as of March 31, 2013, 12 currently are not 
well capitalized for PCA purposes, whereas (according to the FDIC's 
estimates) 14 would not be considered well capitalized for PCA purposes 
under the interim final rule if it were fully implemented without 
transition today. Accordingly, the FDIC does not believe that the 
interim final rule would disproportionately impact MDIs and are not 
adopting any exemptions or special provisions for these institutions. 
While the FDIC recognizes MDIs may face impediments in meeting the 
common equity tier 1 capital ratio, the FDIC believes that the 
improvements to the safety and soundness of these institutions through 
higher capital standards are warranted and consistent with their 
obligations under section 308 of FIRREA. As a prudential matter, the 
FDIC has a long-established regulatory policy that FDIC-supervised 
institutions should hold capital commensurate with the level and nature 
of the risks to which they are exposed, which may entail holding 
capital significantly above the minimum requirements, depending on the 
nature of the FDIC-supervised institution's activities and risk 
profile. Section IV.G of this preamble describes the requirement for 
overall capital adequacy of FDIC-supervised institutions and the

[[Page 55351]]

supervisory assessment of capital adequacy.
    Furthermore, consistent with the FDIC's authority under the general 
risk-based capital rules and the proposals, section 1(d) of the interim 
final rule includes a reservation of authority that allows FDIC to 
require the FDIC-supervised institution to hold a greater amount of 
regulatory capital than otherwise is required under the interim final 
rule, if the FDIC determines that the regulatory capital held by the 
FDIC-supervised institution is not commensurate with its credit, 
market, operational, or other risks. In exercising reservation of 
authority under the rule, the FDIC expects to consider the size, 
complexity, risk profile, and scope of operations of the FDIC-
supervised institution; and whether any public benefits would be 
outweighed by risk to an insured depository institution or to the 
financial system.

B. Leverage Ratio

    The proposals would require a banking organization to satisfy a 
leverage ratio of 4 percent, calculated using the proposed definition 
of tier 1 capital and the banking organization's average total 
consolidated assets, minus amounts deducted from tier 1 capital. The 
agencies also proposed to eliminate the exception in the agencies' 
leverage rules that provides for a minimum leverage ratio of 3 percent 
for banking organizations with strong supervisory ratings.
    The agencies received a number of comments on the proposed leverage 
ratio applicable to all banking organizations. Several of these 
commenters supported the proposed leverage ratio, stating that it 
serves as a simple regulatory standard that constrains the ability of a 
banking organization to leverage its equity capital base. Some of the 
commenters encouraged the agencies to consider an alternative leverage 
ratio measure of tangible common equity to tangible assets, which would 
exclude non-common stock elements from the numerator and intangible 
assets from the denominator of the ratio and thus, according to these 
commenters, provide a more reliable measure of a banking organization's 
viability in a crisis.
    A number of commenters criticized the proposed removal of the 3 
percent exception to the minimum leverage ratio requirement for certain 
banking organizations. One of these commenters argued that removal of 
this exception is unwarranted in view of the cumulative impact of the 
proposals and that raising the minimum leverage ratio requirement for 
the strongest banking organizations may lead to a deleveraging by the 
institutions most able to extend credit in a safe and sound manner. In 
addition, the commenters cautioned the agencies that a restrictive 
leverage measure, together with more stringent risk-based capital 
requirements, could magnify the potential impact of an economic 
downturn.
    Several commenters suggested modifications to the minimum leverage 
ratio requirement. One commenter suggested increasing the minimum 
leverage ratio requirement for all banking organizations to 6 percent, 
whereas another commenter recommended a leverage ratio requirement as 
high as 20 percent. Another commenter suggested a tiered approach, with 
minimum leverage ratio requirements of 6.25 percent and 8.5 percent for 
community banking organizations and large banking organizations, 
respectively. According to this commenter, such an approach could be 
based on the risk characteristics of a banking organization, including 
liquidity, asset quality, and local deposit levels, as well as its 
supervisory rating. Another commenter suggested a fluid leverage ratio 
requirement that would adjust based on certain macroeconomic variables. 
Under such an approach, the agencies could require banking 
organizations to meet a minimum leverage ratio of 10 percent under 
favorable economic conditions and a 6 percent leverage ratio during an 
economic contraction.
    The FDIC continues to believe that a minimum leverage ratio 
requirement of 4 percent for all FDIC-supervised institutions is 
appropriate in light of its role as a complement to the risk-based 
capital ratios. The proposed leverage ratio is more conservative than 
the current leverage ratio because it incorporates a more stringent 
definition of tier 1 capital. In addition, the FDIC believes that it is 
appropriate for all FDIC-supervised institutions, regardless of their 
supervisory rating or trading activities, to meet the same minimum 
leverage ratio requirements. As a practical matter, the FDIC generally 
has found a leverage ratio of less than 4 percent to be inconsistent 
with a supervisory composite rating of ``1.'' Modifying the scope of 
the leverage ratio measure or implementing a fluid or tiered approach 
for the minimum leverage ratio requirement would create additional 
operational complexity and variability in a minimum ratio requirement 
that is intended to place a constraint on the maximum degree to which 
an FDIC-supervised institution can leverage its equity base. 
Accordingly, the interim final rule retains the existing minimum 
leverage ratio requirement of 4 percent and removes the 3 percent 
leverage ratio exception as of January 1, 2014 for advanced approaches 
FDIC-supervised institutions and as of January 1, 2015 for all other 
FDIC-supervised institutions.

C. Supplementary Leverage Ratio for Advanced Approaches FDIC-Supervised 
Institutions

    As part of Basel III, the BCBS introduced a minimum leverage ratio 
requirement of 3 percent (the Basel III leverage ratio) as a backstop 
measure to the risk-based capital requirements, designed to improve the 
resilience of the banking system worldwide by limiting the amount of 
leverage that a banking organization may incur. The Basel III leverage 
ratio is defined as the ratio of tier 1 capital to a combination of on- 
and off-balance sheet exposures.
    As discussed in the Basel III NPR, the agencies proposed the 
supplementary leverage ratio only for advanced approaches banking 
organizations because these banking organizations tend to have more 
significant amounts of off-balance sheet exposures that are not 
captured by the current leverage ratio. Under the proposal, consistent 
with Basel III, advanced approaches banking organizations would be 
required to maintain a minimum supplementary leverage ratio of 3 
percent of tier 1 capital to on- and off-balance sheet exposures (total 
leverage exposure).
    The agencies received a number of comments on the proposed 
supplementary leverage ratio. Several commenters stated that the 
proposed supplementary leverage ratio is unnecessary in light of the 
minimum leverage ratio requirement applicable to all banking 
organizations. These commenters stated that the implementation of the 
supplementary leverage ratio requirement would create market confusion 
as to the inter-relationships among the ratios and as to which ratio 
serves as the binding constraint for an individual banking 
organization. One commenter noted that an advanced approaches banking 
organization would be required to calculate eight distinct regulatory 
capital ratios (common equity tier 1, tier 1, and total capital to 
risk-weighted assets under the advanced approaches and the standardized 
approach, as well as two leverage ratios) and encouraged the agencies 
to streamline the application of regulatory capital ratios. In 
addition, commenters suggested that the agencies postpone the 
implementation of the supplementary

[[Page 55352]]

leverage ratio until January 1, 2018, after the international 
supervisory monitoring process is complete, and to collect 
supplementary leverage ratio information on a confidential basis until 
then.
    At least one commenter encouraged the agencies to consider 
extending the application of the proposed supplementary leverage ratio 
on a case-by-case basis to banking organizations with total assets of 
between $50 billion and $250 billion, stating that such institutions 
may have significant off-balance sheet exposures and engage in a 
substantial amount of repo-style transactions. Other commenters 
suggested increasing the proposed supplementary leverage ratio 
requirement to at least 8 percent for BHCs, under the Federal Reserve's 
authority in section 165 of the Dodd-Frank Act to implement enhanced 
capital requirements for systemically important financial 
institutions.\27\
---------------------------------------------------------------------------

    \27\ See section 165 of the Dodd-Frank Act, 12 U.S.C. 5365.
---------------------------------------------------------------------------

    With respect to specific aspects of the supplementary leverage 
ratio, some commenters criticized the methodology for the total 
leverage exposure. Specifically, one commenter expressed concern that 
using GAAP as the basis for determining a banking organization's total 
leverage exposure would exclude a wide range of off-balance sheet 
exposures, including derivatives and securities lending transactions, 
as well as permit extensive netting. To address these issues, the 
commenter suggested requiring advanced approaches banking organizations 
to determine their total leverage exposure using International 
Financial Reporting Standards (IFRS), asserting that it restricts 
netting and, relative to GAAP, requires the recognition of more off-
balance sheet securities lending transactions.
    Several commenters criticized the proposed incorporation of off-
balance sheet exposures into the total leverage exposure. One commenter 
argued that including unfunded commitments in the total leverage 
exposure runs counter to the purpose of the supplementary leverage 
ratio as an on-balance sheet measure of capital that complements the 
risk-based capital ratios. This commenter was concerned that the 
proposed inclusion of unfunded commitments would result in a 
duplicative assessment against banking organizations when the 
forthcoming liquidity ratio requirements are implemented in the United 
States. The commenter noted that the proposed 100 percent credit 
conversion factor for all unfunded commitments is not appropriately 
calibrated to the vastly different types of commitments that exist 
across the industry. If the supplementary leverage ratio is retained in 
the interim final rule, the commenter requested that the agencies align 
the credit conversion factors for unfunded commitments under the 
supplementary leverage ratio and any forthcoming liquidity ratio 
requirements.
    Another commenter encouraged the agencies to allow advanced 
approaches banking organizations to exclude from total leverage 
exposure the notional amount of any unconditionally cancellable 
commitment. According to this commenter, unconditionally cancellable 
commitments are not credit exposures because they can be extinguished 
at any time at the sole discretion of the issuing entity. Therefore, 
the commenter argued, the inclusion of these commitments could 
potentially distort a banking organization's measure of total leverage 
exposure.
    A few commenters requested that the agencies exclude off-balance 
sheet trade finance instruments from the total leverage exposure, 
asserting that such instruments are based on underlying client 
transactions (for example, a shipment of goods) and are generally 
short-term. The commenters argued that trade finance instruments do not 
create excessive systemic leverage and that they are liquidated by 
fulfillment of the underlying transaction and payment at maturity. 
Another commenter requested that the agencies apply the same credit 
conversion factors to trade finance instruments as under the general 
risk-based capital rules--that is, 20 percent of the notional value for 
trade-related contingent items that arise from the movement of goods, 
and 50 percent of the notional value for transaction-related contingent 
items, including performance bonds, bid bonds, warranties, and 
performance standby letters of credit. According to this commenter, 
such an approach would appropriately consider the low-risk 
characteristics of these instruments and ensure price stability in 
trade finance.
    Several commenters supported the proposed treatment for repo-style 
transactions (including repurchase agreements, securities lending and 
borrowing transactions, and reverse repos). These commenters stated 
that securities lending transactions are fully collateralized and 
marked to market daily and, therefore, the on-balance sheet amounts 
generated by these transactions appropriately capture the exposure for 
purposes of the supplementary leverage ratio. These commenters also 
supported the proposed treatment for indemnified securities lending 
transactions and encouraged the agencies to retain this treatment in 
the interim final rule. Other commenters stated that the proposed 
measurement of repo-style transactions is not sufficiently conservative 
and recommended that the agencies implement a methodology that includes 
in total leverage exposure the notional amounts of these transactions.
    A few commenters raised concerns about the proposed methodology for 
determining the exposure amount of derivative contracts. Some 
commenters criticized the agencies for not allowing advanced approaches 
banking organizations to use the internal models methodology to 
calculate the exposure amount for derivative contracts. According to 
these commenters, the agencies should align the methods for calculating 
exposure for derivative contracts for purposes of the supplementary 
leverage ratio and the advanced approaches risk-based capital ratios to 
more appropriately reflect the risk-management activities of advanced 
approaches banking organizations and to measure these exposures 
consistently across the regulatory capital ratios. At least one 
commenter requested clarification of the proposed treatment of 
collateral received in connection with derivative contracts. This 
commenter also encouraged the agencies to permit recognition of 
eligible collateral for purposes of reducing total leverage exposure, 
consistent with proposed legislation in other BCBS member 
jurisdictions.
    The introduction of an international leverage ratio requirement in 
the Basel III capital framework is an important development that would 
provide a consistent leverage ratio measure across internationally-
active institutions. Furthermore, the supplementary leverage ratio is 
reflective of the on- and off-balance sheet activities of large, 
internationally active banking organizations. Accordingly, consistent 
with Basel III, the interim final rule implements for reporting 
purposes the proposed supplementary leverage ratio for advanced 
approaches FDIC-supervised institutions starting on January 1, 2015 and 
requires advanced approaches FDIC-supervised institutions to comply 
with the minimum supplementary leverage ratio requirement starting on 
January 1, 2018. Public reporting of the supplementary leverage ratio 
during the international supervisory monitoring period is consistent 
with the international implementation timeline and enables transparency 
and comparability of

[[Page 55353]]

reporting the leverage ratio requirement across jurisdictions.
    The FDIC is not applying the supplementary leverage ratio 
requirement to FDIC-supervised institutions that are not subject to the 
advanced approaches rule in the interim final rule. Applying the 
supplementary leverage ratio routinely could create operational 
complexity for smaller FDIC-supervised institutions that are not 
internationally active, and that generally do not have off-balance 
sheet activities that are as extensive as FDIC-supervised institutions 
that are subject to the advanced approaches rule. The FDIC notes that 
the interim final rule imposes risk-based capital requirements on all 
repo-style transactions and otherwise imposes constraints on all FDIC-
supervised institutions' off-balance sheet exposures.
    With regard to the commenters' views to require the use of IFRS for 
purposes of the supplementary leverage ratio, the FDIC notes that the 
use of GAAP in the interim final rule as a starting point to measure 
exposure of certain derivatives and repo-style transactions, has the 
advantage of maintaining consistency between regulatory capital 
calculations and regulatory reporting, the latter of which must be 
consistent with GAAP or, if another accounting principle is used, no 
less stringent than GAAP.\28\
---------------------------------------------------------------------------

    \28\ See 12 U.S.C. 1831n(a)(2).
---------------------------------------------------------------------------

    In response to the commenters' views regarding the scope of the 
total leverage exposure, the FDIC notes that the supplementary leverage 
ratio is intended to capture on- and off-balance sheet exposures of an 
FDIC-supervised institution. Commitments represent an agreement to 
extend credit and thus including commitments (both funded and unfunded) 
in the supplementary leverage ratio is consistent with its purpose to 
measure the on- and off-balance sheet leverage of an FDIC-supervised 
institution, as well as with safety and soundness principles. 
Accordingly, the FDIC believes that total leverage exposure should 
include FDIC-supervised institutions' off-balance sheet exposures, 
including all loan commitments that are not unconditionally 
cancellable, financial standby letters of credit, performance standby 
letters of credit, and commercial and other similar letters of credit.
    The proposal to include unconditionally cancellable commitments in 
the total leverage exposure recognizes that a banking organization may 
extend credit under the commitment before it is cancelled. If the 
banking organization exercises its option to cancel the commitment, its 
total leverage exposure amount with respect to the commitment will be 
limited to any extension of credit prior to cancellation. The proposal 
considered banking organizations' ability to cancel such commitments 
and, therefore, limited the amount of unconditionally cancellable 
commitments included in total leverage exposure to 10 percent of the 
notional amount of such commitments.
    The FDIC notes that the credit conversion factors used in the 
supplementary leverage ratio and in any forthcoming liquidity ratio 
requirements have been developed to serve the purposes of the 
respective frameworks and may not be identical. Similarly, the 
commenters' proposed modifications to credit conversion factors for 
trade finance transactions would be inconsistent with the purpose of 
the supplementary leverage ratio--to capture all off-balance sheet 
exposures of banking organizations in a primarily non-risk-based 
manner.
    For purposes of incorporating derivative contracts in the total 
leverage exposure, the proposal would require all advanced approaches 
banking organizations to use the same methodology to measure such 
exposures. The proposed approach provides a uniform measure of exposure 
for derivative contracts across banking organizations, without regard 
to their models. Accordingly, the FDIC does not believe an FDIC-
supervised institution should be permitted to use internal models to 
measure the exposure amount of derivative contracts for purposes of the 
supplementary leverage ratio.
    With regard to commenters requesting a modification of the proposed 
treatment for repo-style transactions, the FDIC does not believe that 
the proposed modifications are warranted at this time because 
international discussions and quantitative analysis of the exposure 
measure for repo-style transactions are still ongoing.
    The FDIC is continuing to work with the BCBS to assess the Basel 
III leverage ratio, including its calibration and design, as well as 
the impact of any differences in national accounting frameworks 
material to the denominator of the Basel III leverage ratio. The FDIC 
will consider any changes to the supplementary leverage ratio as the 
BCBS revises the Basel III leverage ratio.
    Therefore, the FDIC has adopted the proposed supplementary leverage 
ratio in the interim final rule without modification. An advanced 
approaches FDIC-supervised institution must calculate the supplementary 
leverage ratio as the simple arithmetic mean of the ratio of the FDIC-
supervised institution's tier 1 capital to total leverage exposure as 
of the last day of each month in the reporting quarter. The FDIC also 
notes that collateral may not be applied to reduce the potential future 
exposure (PFE) amount for derivative contracts.
    Under the interim final rule, total leverage exposure equals the 
sum of the following:
    (1) The balance sheet carrying value of all of the FDIC-supervised 
institution's on-balance sheet assets less amounts deducted from tier 1 
capital under section 22(a), (c), and (d) of the interim final rule;
    (2) The PFE amount for each derivative contract to which the FDIC-
supervised institution is a counterparty (or each single-product 
netting set of such transactions) determined in accordance with section 
34 of the interim final rule, but without regard to section 34(b);
    (3) 10 percent of the notional amount of unconditionally 
cancellable commitments made by the FDIC-supervised institution; and
    (4) The notional amount of all other off-balance sheet exposures of 
the FDIC-supervised institution (excluding securities lending, 
securities borrowing, reverse repurchase transactions, derivatives and 
unconditionally cancellable commitments).
    Advanced approaches FDIC-supervised institutions must maintain a 
minimum supplementary leverage ratio of 3 percent beginning on January 
1, 2018, consistent with Basel III. However, as noted above, beginning 
on January 1, 2015, advanced approaches FDIC-supervised institutions 
must calculate and report their supplementary leverage ratio.
    The FDIC is seeking commenters' views on the interaction of this 
interim final rule with the proposed rule regarding the supplementary 
leverage ratio for large, systemically important banking organizations.

D. Capital Conservation Buffer

    During the recent financial crisis, some banking organizations 
continued to pay dividends and substantial discretionary bonuses even 
as their financial condition weakened. Such capital distributions had a 
significant negative impact on the overall strength of the banking 
sector. To encourage better capital conservation by banking 
organizations and to enhance the resilience of the banking system, the 
proposed rule would have limited capital distributions and 
discretionary bonus payments for banking organizations that do not hold 
a

[[Page 55354]]

specified amount of common equity tier 1 capital in addition to the 
amount of regulatory capital necessary to meet the minimum risk-based 
capital requirements (capital conservation buffer), consistent with 
Basel III. In this way, the capital conservation buffer is intended to 
provide incentives for banking organizations to hold sufficient capital 
to reduce the risk that their capital levels would fall below their 
minimum requirements during a period of financial stress.
    The proposed rules incorporated a capital conservation buffer 
composed of common equity tier 1 capital in addition to the minimum 
risk-based capital requirements. Under the proposal, a banking 
organization would need to hold a capital conservation buffer in an 
amount greater than 2.5 percent of total risk-weighted assets (plus, 
for an advanced approaches banking organization, 100 percent of any 
applicable countercyclical capital buffer amount) to avoid limitations 
on capital distributions and discretionary bonus payments to executive 
officers, as defined in the proposal. The proposal provided that the 
maximum dollar amount that a banking organization could pay out in the 
form of capital distributions or discretionary bonus payments during 
the current calendar quarter (the maximum payout amount) would be equal 
to a maximum payout ratio, multiplied by the banking organization's 
eligible retained income, as discussed below. The proposal provided 
that a banking organization with a buffer of more than 2.5 percent of 
total risk-weighted assets (plus, for an advanced approaches banking 
organization, 100 percent of any applicable countercyclical capital 
buffer), would not be subject to a maximum payout amount. The proposal 
clarified that the agencies reserved the ability to restrict capital 
distributions under other authorities and that restrictions on capital 
distributions and discretionary bonus payments associated with the 
capital conservation buffer would not be part of the PCA framework. The 
calibration of the buffer is supported by an evaluation of the loss 
experience of U.S. banking organizations as part of an analysis 
conducted by the BCBS, as well as by evaluation of historical levels of 
capital at U.S. banking organizations.\29\
---------------------------------------------------------------------------

    \29\ ``Calibrating regulatory capital requirements and buffers: 
A top-down approach.'' Basel Committee on Banking Supervision, 
October, 2010, available at www.bis.org.
---------------------------------------------------------------------------

    The agencies received a significant number of comments on the 
proposed capital conservation buffer. In general, the commenters 
characterized the capital conservation buffer as overly conservative, 
and stated that the aggregate amount of capital that would be required 
for a banking organization to avoid restrictions on dividends and 
discretionary bonus payments under the proposed rule exceeded the 
amount required for a safe and prudent banking system. Commenters 
expressed concern that the capital conservation buffer could disrupt 
the priority of payments in a banking organization's capital structure, 
as any restrictions on dividends would apply to both common and 
preferred stock. Commenters also questioned the appropriateness of 
restricting a banking organization that fails to comply with the 
capital conservation buffer from paying dividends or bonus payments if 
it has established and maintained cash reserves to cover future 
uncertainty. One commenter supported the establishment of a formal 
mechanism for banking organizations to request agency approval to make 
capital distributions even if doing so would otherwise be restricted 
under the capital conservation buffer.
    Other commenters recommended an exemption from the proposed capital 
conservation buffer for certain types of banking organizations, such as 
community banking organizations, banking organizations organized in 
mutual form, and rural BHCs that rely heavily on bank stock loans for 
growth and expansion purposes. Commenters also recommended a wide range 
of institutions that should be excluded from the buffer based on a 
potential size threshold, such as banking organizations with total 
consolidated assets of less than $250 billion. Commenters also 
recommended that S-corporations be exempt from the proposed capital 
conservation buffer because under the U.S. Internal Revenue Code, S-
corporations are not subject to a corporate-level tax; instead, S-
corporation shareholders must report income and pay income taxes based 
on their share of the corporation's profit or loss. An S-corporation 
generally declares a dividend to help shareholders pay their tax 
liabilities that arise from reporting their share of the corporation's 
profits. According to some commenters, the proposal disadvantaged S-
corporations because shareholders of S-corporations would be liable for 
tax on the S-corporation's net income, and the S-corporation may be 
prohibited from making a dividend to these shareholders to fund the tax 
payment.
    One commenter criticized the proposed composition of the capital 
conservation buffer (which must consist solely of common equity tier 1 
capital) and encouraged the agencies to allow banking organizations to 
include noncumulative perpetual preferred stock and other tier 1 
capital instruments. Several commenters questioned the empirical basis 
for a capital conservation buffer of 2.5 percent, and encouraged the 
agencies to provide a quantitative analysis for the proposal. One 
commenter suggested application of the capital conservation buffer only 
during economic downturn scenarios, consistent with the agencies' 
objective to restrict dividends and discretionary bonus payments during 
these periods. According to this commenter, a banking organization that 
fails to maintain a sufficient capital conservation buffer during 
periods of economic stress also could be required to submit a plan to 
increase its capital.
    After considering these comments, the FDIC has decided to maintain 
common equity tier 1 capital as the basis of the capital conservation 
buffer and to apply the capital conservation buffer to all types of 
FDIC-supervised institutions at all times. Application of the buffer to 
all types of FDIC-supervised institutions and maintenance of a capital 
buffer during periods of market and economic stability is appropriate 
to encourage sound capital management and help ensure that FDIC-
supervised institutions will maintain adequate amounts of loss-
absorbing capital going forward, strengthening the ability of the 
banking system to continue serving as a source of credit to the economy 
in times of stress. A buffer framework that restricts dividends and 
discretionary bonus payments only for certain types of FDIC-supervised 
institutions or only during an economic contraction would not achieve 
these objectives. Similarly, basing the capital conservation buffer on 
the most loss-absorbent form of capital is most consistent with the 
purpose of the capital conservation buffer as it helps to ensure that 
the buffer can be used effectively by FDIC-supervised institutions at a 
time when they are experiencing losses.
    The FDIC recognizes that S-corporation FDIC-supervised institutions 
structure their tax payments differently from C corporations. However, 
the FDIC notes that this distinction results from S-corporations' pass-
through taxation, in which profits are not subject to taxation at the 
corporate level, but rather at the shareholder level. The FDIC is 
charged with evaluating the capital levels and safety and soundness of 
the FDIC-supervised institution. At the point where a decrease in the 
organization's capital triggers dividend restrictions, the

[[Page 55355]]

FDIC believes that capital should stay within the FDIC-supervised 
institution. S-corporation shareholders may receive a benefit from 
pass-through taxation, but with that benefit comes the risk that the 
corporation has no obligation to make dividend distributions to help 
shareholders pay their tax liabilities. Therefore, the interim final 
rule does not exempt S-corporations from the capital conservation 
buffer.
    Accordingly, under the interim final rule an FDIC-supervised 
institution must maintain a capital conservation buffer of common 
equity tier 1 capital in an amount greater than 2.5 percent of total 
risk-weighted assets (plus, for an advanced approaches FDIC-supervised 
institution, 100 percent of any applicable countercyclical capital 
buffer amount) to avoid being subject to limitations on capital 
distributions and discretionary bonus payments to executive officers.
    The proposal defined eligible retained income as a banking 
organization's net income (as reported in the banking organization's 
quarterly regulatory reports) for the four calendar quarters preceding 
the current calendar quarter, net of any capital distributions and 
associated tax effects not already reflected in net income. The 
agencies received a number of comments regarding the proposed 
definition of eligible retained income, which is used to calculate the 
maximum payout amount. Some commenters suggested that the agencies 
limit capital distributions based on retained earnings instead of 
eligible retained income, citing the Federal Reserve's Regulation H as 
an example of this regulatory practice.\30\ Several commenters 
representing banking organizations organized as S-corporations 
recommended revisions to the definition of eligible retained income so 
that it would be net of pass-through tax distributions to shareholders 
that have made a pass-through election for tax purposes, allowing S-
corporation shareholders to pay their tax liability notwithstanding any 
dividend restrictions resulting from failure to comply with the capital 
conservation buffer. Some commenters suggested that the definition of 
eligible retained income be adjusted for items such as goodwill 
impairment that are captured in the definition of ``net income'' for 
regulatory reporting purposes but which do not affect regulatory 
capital.
---------------------------------------------------------------------------

    \30\ See 12 CFR part 208.
---------------------------------------------------------------------------

    The interim final rule adopts the proposed definition of eligible 
retained income without change. The FDIC believes the commenters' 
suggested modifications to the definition of eligible retained income 
would add complexity to the interim final rule and in some cases may be 
counter-productive by weakening the incentives of the capital 
conservation buffer. The FDIC notes that the definition of eligible 
retained income appropriately accounts for impairment charges, which 
reduce eligible retained income but also reduces the balance sheet 
amount of goodwill that is deducted from regulatory capital. Further, 
the proposed definition of eligible retained income, which is based on 
net income as reported in the banking organization's quarterly 
regulatory reports, reflects a simple measure of a banking 
organization's recent performance upon which to base restrictions on 
capital distributions and discretionary payments to executive officers. 
For the same reasons as described above regarding the application of 
the capital conservation buffer to S-corporations generally, the FDIC 
has determined that the definition of eligible retained income should 
not be modified to address the tax-related concerns raised by 
commenters writing on behalf of S-corporations.
    The proposed rule generally defined a capital distribution as a 
reduction of tier 1 or tier 2 capital through the repurchase or 
redemption of a capital instrument or by other means; a dividend 
declaration or payment on any tier 1 or tier 2 capital instrument if 
the banking organization has full discretion to permanently or 
temporarily suspend such payments without triggering an event of 
default; or any similar transaction that the primary Federal supervisor 
determines to be in substance a distribution of capital.
    Commenters provided suggestions on the definition of ``capital 
distribution.'' One commenter requested that a ``capital distribution'' 
be defined to exclude any repurchase or redemption to the extent the 
capital repurchased or redeemed was replaced in a contemporaneous 
transaction by the issuance of capital of an equal or higher quality 
tier. The commenter maintained that the proposal would unnecessarily 
penalize banking organizations that redeem capital but 
contemporaneously replace such capital with an equal or greater amount 
of capital of an equivalent or higher quality. In response to comments, 
and recognizing that redeeming capital instruments that are replaced 
with instruments of the same or similar quality does not weaken a 
banking organization's overall capital position, the interim final rule 
provides that a redemption or repurchase of a capital instrument is not 
a distribution provided that the banking organization fully replaces 
that capital instrument by issuing another capital instrument of the 
same or better quality (that is, more subordinate) based on the interim 
final rule's eligibility criteria for capital instruments, and provided 
that such issuance is completed within the same calendar quarter the 
banking organization announces the repurchase or redemption. For 
purposes of this definition, a capital instrument is issued at the time 
that it is fully paid in. For purposes of the interim final rule, the 
FDIC changed the defined term from ``capital distribution'' to 
``distribution'' to avoid confusion with the term ``capital 
distribution'' used in the Federal Reserve's capital plan rule.\31\
---------------------------------------------------------------------------

    \31\ See 12 CFR 225.8.
---------------------------------------------------------------------------

    The proposed rule defined discretionary bonus payment as a payment 
made to an executive officer of a banking organization (as defined 
below) that meets the following conditions: The banking organization 
retains discretion as to the fact of the payment and as to the amount 
of the payment until the payment is awarded to the executive officer; 
the amount paid is determined by the banking organization without prior 
promise to, or agreement with, the executive officer; and the executive 
officer has no contractual right, express or implied, to the bonus 
payment.
    The agencies received a number of comments on the proposed 
definition of discretionary bonus payments to executive officers. One 
commenter expressed concern that the proposed definition of 
discretionary bonus payment may not be effective unless the agencies 
provided clarification as to the type of payments covered, as well as 
the timing of such payments. This commenter asked whether the proposed 
rule would prohibit the establishment of a pre-funded bonus pool with 
mandatory distributions and sought clarification as to whether non-cash 
compensation payments, such as stock options, would be considered a 
discretionary bonus payment.
    The interim final rule's definition of discretionary bonus payment 
is unchanged from the proposal. The FDIC notes that if an FDIC-
supervised institution prefunds a pool for bonuses payable under a 
contract, the bonus pool is not discretionary and, therefore, is not 
subject to the capital conservation buffer limitations. In addition, 
the definition of discretionary bonus payment does not include non-cash 
compensation payments that do not affect capital or earnings such as, 
in some cases, stock options.

[[Page 55356]]

    Commenters representing community banking organizations maintained 
that the proposed restrictions on discretionary bonus payments would 
disproportionately impact such institutions' ability to attract and 
retain qualified employees. One commenter suggested revising the 
proposed rule so that a banking organization that fails to satisfy the 
capital conservation buffer would be restricted from making a 
discretionary bonus payment only to the extent it exceeds 15 percent of 
the employee's salary, asserting that this would prevent excessive 
bonus payments while allowing community banking organizations 
flexibility to compensate key employees. The interim final rule does 
not incorporate this suggestion. The FDIC notes that the potential 
limitations and restrictions under the capital conservation buffer 
framework do not automatically translate into a prohibition on 
discretionary bonus payments. Instead, the overall dollar amount of 
dividends and bonuses to executive officers is capped based on how 
close the banking organization's regulatory capital ratios are to its 
minimum capital ratios and on the earnings of the banking organization 
that are available for distribution. This approach provides appropriate 
incentives for capital conservation while preserving flexibility for 
institutions to decide how to allocate income available for 
distribution between discretionary bonus payments and other 
distributions.
    The proposal defined executive officer as a person who holds the 
title or, without regard to title, salary, or compensation, performs 
the function of one or more of the following positions: President, 
chief executive officer, executive chairman, chief operating officer, 
chief financial officer, chief investment officer, chief legal officer, 
chief lending officer, chief risk officer, or head of a major business 
line, and other staff that the board of directors of the banking 
organization deems to have equivalent responsibility.\32\
---------------------------------------------------------------------------

    \32\ See 76 FR 21170 (April 14, 2011) for a comparable 
definition of ``executive officer.''
---------------------------------------------------------------------------

    Commenters generally supported a more restrictive definition of 
executive officer, arguing that the definition of executive officer 
should be no broader than the definition under the Federal Reserve's 
Regulation O,\33\ which governs any extension of credit between a 
member bank and an executive officer, director, or principal 
shareholder. Some commenters, however, favored a more expansive 
definition of executive officer, with one commenter supporting the 
inclusion of directors of the banking organization or directors of any 
of the banking organization's affiliates, any other person in control 
of the banking organization or the banking organizations' affiliates, 
and any person in control of a major business line. In accordance with 
the FDIC's objective to include those individuals within an FDIC-
supervised institution with the greatest responsibility for the 
organization's financial condition and risk exposure, the interim final 
rule maintains the definition of executive officer as proposed.
---------------------------------------------------------------------------

    \33\ See 12 CFR part 215.
---------------------------------------------------------------------------

    Under the proposal, advanced approaches banking organizations would 
have calculated their capital conservation buffer (and any applicable 
countercyclical capital buffer amount) using their advanced approaches 
total risk-weighted assets. Several commenters supported this aspect of 
the proposal, and one stated that the methodologies for calculating 
risk-weighted assets under the advanced approaches rule would more 
effectively capture the individual risk profiles of such banking 
organizations, asserting further that advanced approaches banking 
organizations would face a competitive disadvantage relative to foreign 
banking organizations if they were required to use standardized total 
risk-weighted assets to determine compliance with the capital 
conservation buffer. In contrast, another commenter suggested that 
advanced approaches banking organizations be allowed to use the 
advanced approaches methodologies as the basis for calculating the 
capital conservation buffer only when it would result in a more 
conservative outcome than under the standardized approach in order to 
maintain competitive equity domestically. Another commenter expressed 
concerns that the capital conservation buffer is based only on risk-
weighted assets and recommended additional application of a capital 
conservation buffer to the leverage ratio to avoid regulatory arbitrage 
opportunities and to accomplish the agencies' stated objective of 
ensuring that banking organizations have sufficient capital to absorb 
losses.
    The interim final rule requires that advanced approaches FDIC-
supervised institutions that have completed the parallel run process 
and that have received notification from the FDIC supervisor pursuant 
to section 121(d) of subpart E use their risk-based capital ratios 
under section 10 of the interim final rule (that is, the lesser of the 
standardized and the advanced approaches ratios) as the basis for 
calculating their capital conservation buffer (and any applicable 
countercyclical capital buffer). The FDIC believes such an approach is 
appropriate because it is consistent with how advanced approaches FDIC-
supervised institutions compute their minimum risk-based capital 
ratios.
    Many commenters discussed the interplay between the proposed 
capital conservation buffer and the PCA framework. Some commenters 
encouraged the agencies to reset the buffer requirement to two percent 
of total risk-weighted assets in order to align it with the margin 
between the ``adequately-capitalized'' category and the ``well-
capitalized'' category under the PCA framework. Similarly, some 
commenters characterized the proposal as confusing because a banking 
organization could be considered well capitalized for PCA purposes, but 
at the same time fail to maintain a sufficient capital conservation 
buffer and be subject to restrictions on capital distributions and 
discretionary bonus payments. These commenters encouraged the agencies 
to remove the capital conservation buffer for purposes of the interim 
final rule, and instead use their existing authority to impose 
restrictions on dividends and discretionary bonus payments on a case-
by-case basis through formal enforcement actions. Several commenters 
stated that compliance with a capital conservation buffer that operates 
outside the traditional PCA framework adds complexity to the interim 
final rule, and suggested increasing minimum capital requirements if 
the agencies determine they are currently insufficient. Specifically, 
one commenter encouraged the agencies to increase the minimum total 
risk-based capital requirement to 10.5 percent and remove the capital 
conservation buffer from the rule.
    The capital conservation buffer has been designed to give banking 
organizations the flexibility to use the buffer while still being well 
capitalized. Banking organizations that maintain their risk-based 
capital ratios at least 50 basis points above the well capitalized PCA 
levels will not be subject to any restrictions imposed by the capital 
conservation buffer, as applicable. As losses begin to accrue or a 
banking organization's risk-weighted assets begin to grow such that the 
capital ratios of a banking organization are below the capital 
conservation buffer but above the well capitalized thresholds, the 
incremental limitations on distributions are unlikely to affect planned 
capital distributions or discretionary bonus payments but may provide a 
check on rapid expansion or other activities that

[[Page 55357]]

would weaken the organization's capital position.
    Under the interim final rule, the maximum payout ratio is the 
percentage of eligible retained income that an FDIC-supervised 
institution is allowed to pay out in the form of distributions and 
discretionary bonus payments, each as defined under the rule, during 
the current calendar quarter. The maximum payout ratio is determined by 
the FDIC-supervised institution's capital conservation buffer as 
calculated as of the last day of the previous calendar quarter.
    An FDIC-supervised institution's capital conservation buffer is the 
lowest of the following ratios: (i) The FDIC-supervised institution's 
common equity tier 1 capital ratio minus its minimum common equity tier 
1 capital ratio; (ii) the FDIC-supervised institution's tier 1 capital 
ratio minus its minimum tier 1 capital ratio; and (iii) the FDIC-
supervised institution's total capital ratio minus its minimum total 
capital ratio. If the FDIC-supervised institution's common equity tier 
1, tier 1 or total capital ratio is less than or equal to its minimum 
common equity tier 1, tier 1 or total capital ratio, respectively, the 
FDIC-supervised institution's capital conservation buffer is zero.
    The mechanics of the capital conservation buffer under the interim 
final rule are unchanged from the proposal. An FDIC-supervised 
institution's maximum payout amount for the current calendar quarter is 
equal to the FDIC-supervised institution's eligible retained income, 
multiplied by the applicable maximum payout ratio, in accordance with 
Table 1. An FDIC-supervised institution with a capital conservation 
buffer that is greater than 2.5 percent (plus, for an advanced 
approaches FDIC-supervised institution, 100 percent of any applicable 
countercyclical capital buffer) is not subject to a maximum payout 
amount as a result of the application of this provision. However, an 
FDIC-supervised institution may otherwise be subject to limitations on 
capital distributions as a result of supervisory actions or other laws 
or regulations.\34\
---------------------------------------------------------------------------

    \34\ See, e.g., 1831o(d)(1), 12 CFR 303.241, and 12 CFR part 
324, Subpart H (state nonmember banks and state savings associations 
as of January 1, 2014 for advanced approaches banks and as of 
January 1, 2015 for all other organizations).
---------------------------------------------------------------------------

    Table 1 illustrates the relationship between the capital 
conservation buffer and the maximum payout ratio. The maximum dollar 
amount that an FDIC-supervised institution is permitted to pay out in 
the form of distributions or discretionary bonus payments during the 
current calendar quarter is equal to the maximum payout ratio 
multiplied by the FDIC-supervised institution's eligible retained 
income. The calculation of the maximum payout amount is made as of the 
last day of the previous calendar quarter and any resulting 
restrictions apply during the current calendar quarter.

   Table 1--Capital Conservation Buffer and Maximum Payout Ratio \35\
------------------------------------------------------------------------
     Capital conservation buffer (as a       Maximum payout ratio (as a
  percentage of standardized or advanced       percentage of eligible
total risk-weighted assets, as applicable)        retained income)
------------------------------------------------------------------------
Greater than 2.5 percent..................  No payout ratio limitation
                                             applies.
Less than or equal to 2.5 percent, and      60 percent.
 greater than 1.875 percent.
Less than or equal to 1.875 percent, and    40 percent.
 greater than 1.25 percent.
Less than or equal to 1.25 percent, and     20 percent.
 greater than 0.625 percent.
Less than or equal to 0.625 percent.......  0 percent.
------------------------------------------------------------------------

     
---------------------------------------------------------------------------

    \35\ Calculations in this table are based on the assumption that 
the countercyclical capital buffer amount is zero.
---------------------------------------------------------------------------

    Table 1 illustrates that the capital conservation buffer 
requirements are divided into equal quartiles, each associated with 
increasingly stringent limitations on distributions and discretionary 
bonus payments to executive officers as the capital conservation buffer 
approaches zero. As described in the next section, each quartile 
expands proportionately for advanced approaches FDIC-supervised 
institutions when the countercyclical capital buffer amount is greater 
than zero. In a scenario where an FDIC-supervised institution's risk-
based capital ratios fall below its minimum risk-based capital ratios 
plus 2.5 percent of total risk-weighted assets, the maximum payout 
ratio also would decline. An FDIC-supervised institution that becomes 
subject to a maximum payout ratio remains subject to restrictions on 
capital distributions and certain discretionary bonus payments until it 
is able to build up its capital conservation buffer through retained 
earnings, raising additional capital, or reducing its risk-weighted 
assets. In addition, as a general matter, an FDIC-supervised 
institution cannot make distributions or certain discretionary bonus 
payments during the current calendar quarter if the FDIC-supervised 
institution's eligible retained income is negative and its capital 
conservation buffer was less than 2.5 percent as of the end of the 
previous quarter.
    Compliance with the capital conservation buffer is determined prior 
to any distribution or discretionary bonus payment. Therefore, an FDIC-
supervised institution with a capital buffer of more than 2.5 percent 
is not subject to any restrictions on distributions or discretionary 
bonus payments even if such distribution or payment would result in a 
capital buffer of less than or equal to 2.5 percent in the current 
calendar quarter. However, to remain free of restrictions for purposes 
of any subsequent quarter, the FDIC-supervised institution must restore 
capital to increase the buffer to more than 2.5 percent prior to any 
distribution or discretionary bonus payment in any subsequent quarter.
    In the proposal, the agencies solicited comment on the impact, if 
any, of prohibiting a banking organization that is subject to a maximum 
payout ratio of zero percent from making a penny dividend to common 
stockholders. One commenter stated that such banking organizations 
should be permitted to pay a penny dividend on their common stock 
notwithstanding the limitations imposed by the capital conservation 
buffer. This commenter maintained that the inability to pay any 
dividend on common stock could make it more difficult to attract equity 
investors such as pension funds that often are required to invest only 
in institutions that pay a quarterly dividend. While the FDIC did not 
incorporate a blanket exemption for penny dividends on common stock, 
under the interim final rule, as under the proposal, it may permit an 
FDIC-supervised institution to make a distribution or discretionary 
bonus payment if it determines that such distribution or payment would 
not be contrary to the purpose of the capital conservation buffer or 
the safety and soundness of the organization. In making such 
determinations, the FDIC would consider the nature of and circumstances 
giving rise to the request.

E. Countercyclical Capital Buffer

    The proposed rule introduced a countercyclical capital buffer 
applicable to advanced approaches banking organizations to augment the 
capital conservation buffer during periods of excessive credit growth. 
Under the proposed rule, the countercyclical capital buffer would have 
required advanced approaches banking

[[Page 55358]]

organizations to hold additional common equity tier 1 capital during 
specific, agency-determined periods in order to avoid limitations on 
distributions and discretionary bonus payments. The agencies requested 
comment on the countercyclical capital buffer and, specifically, on any 
factors that should be considered for purposes of determining whether 
to activate it. One commenter encouraged the agencies to consider 
readily available indicators of economic growth, employment levels, and 
financial sector profits. This commenter stated generally that the 
agencies should activate the countercyclical capital buffer during 
periods of general economic growth or high financial sector profits, 
instead of reserving it only for periods of ``excessive credit 
growth.''
    Other commenters did not support using the countercyclical capital 
buffer as a macroeconomic tool. One commenter encouraged the agencies 
not to include the countercyclical capital buffer in the interim final 
rule and, instead, rely on the Federal Reserve's longstanding authority 
over monetary policy to mitigate excessive credit growth and potential 
asset bubbles. Another commenter questioned the buffer's effectiveness 
and encouraged the agencies to conduct a QIS prior to its 
implementation. One commenter recommended expanding the applicability 
of the proposed countercyclical capital buffer on a case-by-case basis 
to institutions with total consolidated assets between $50 and $250 
billion. Another commenter, however, supported the application of the 
countercyclical capital buffer only to institutions with total 
consolidated assets above $250 billion.
    The Dodd-Frank Act requires the agencies to consider the use of 
countercyclical aspects of capital regulation, and the countercyclical 
capital buffer is an explicitly countercyclical element of capital 
regulation.\36\ The FDIC notes that implementation of the 
countercyclical capital buffer for advanced approaches FDIC-supervised 
institutions is an important part of the Basel III framework, which 
aims to enhance the resilience of the banking system and reduce 
systemic vulnerabilities. The FDIC believes that the countercyclical 
capital buffer is most appropriately applied only to advanced 
approaches FDIC-supervised institutions because, generally, such 
organizations are more interconnected with other financial 
institutions. Therefore, the marginal benefits to financial stability 
from a countercyclical capital buffer function should be greater with 
respect to such institutions. Application of the countercyclical 
capital buffer only to advanced approaches FDIC-supervised institutions 
also reflects the fact that making cyclical adjustments to capital 
requirements may produce smaller financial stability benefits and 
potentially higher marginal costs for smaller FDIC-supervised 
institutions. The countercyclical capital buffer is designed to take 
into account the macro-financial environment in which FDIC-supervised 
institutions function and to protect the banking system from the 
systemic vulnerabilities that may build-up during periods of excessive 
credit growth, which may potentially unwind in a disorderly way, 
causing disruptions to financial institutions and ultimately economic 
activity.
---------------------------------------------------------------------------

    \36\ Section 616(a), (b), and (c) of the Dodd-Frank Act, 
codified at 12 U.S.C. 1844(b), 1464a(g)(1), and 3907(a)(1).
    .
---------------------------------------------------------------------------

    The countercyclical capital buffer aims to protect the banking 
system and reduce systemic vulnerabilities in two ways. First, the 
accumulation of a capital buffer during an expansionary phase could 
increase the resilience of the banking system to declines in asset 
prices and consequent losses that may occur when the credit conditions 
weaken. Specifically, when the credit cycle turns following a period of 
excessive credit growth, accumulated capital buffers act to absorb the 
above-normal losses that an FDIC-supervised institution likely would 
face. Consequently, even after these losses are realized, FDIC-
supervised institutions would remain healthy and able to access 
funding, meet obligations, and continue to serve as credit 
intermediaries. Second, a countercyclical capital buffer also may 
reduce systemic vulnerabilities and protect the banking system by 
mitigating excessive credit growth and increases in asset prices that 
are not supported by fundamental factors. By increasing the amount of 
capital required for further credit extensions, a countercyclical 
capital buffer may limit excessive credit.\37\ Thus, the FDIC believes 
that the countercyclical capital buffer is an appropriate macroeconomic 
tool and is including it in the interim final rule. One commenter 
expressed concern that the proposed rule would not require the agencies 
to activate the countercyclical capital buffer pursuant to a joint, 
interagency determination. This commenter encouraged the agencies to 
adopt an interagency process for activating the buffer for purposes of 
the interim final rule. As discussed in the Basel III NPR, the agencies 
anticipate making such determinations jointly. Because the 
countercyclical capital buffer amount would be linked to the condition 
of the overall U.S. financial system and not the characteristics of an 
individual banking organization, the agencies expect that the 
countercyclical capital buffer amount would be the same at the 
depository institution and holding company levels. The agencies 
solicited comment on the appropriateness of the proposed 12-month prior 
notification period for the countercyclical capital buffer amount. One 
commenter expressed concern regarding the potential for the agencies to 
activate the countercyclical capital buffer without providing banking 
organizations sufficient notice, and specifically requested the 
implementation of a prior notification requirement of not less than 12 
months for purposes of the interim final rule.
---------------------------------------------------------------------------

    \37\ The operation of the countercyclical capital buffer is also 
consistent with sections 616(a), (b), and (c) of the Dodd-Frank Act, 
codified at 12 U.S.C. 1844(b), 1464a(g)(1), and 3907(a)(1).
---------------------------------------------------------------------------

    In general, to provide banking organizations with sufficient time 
to adjust to any changes to the countercyclical capital buffer under 
the interim final rule, the agencies expect to announce an increase in 
the U.S. countercyclical capital buffer amount with an effective date 
at least 12 months after their announcement. However, if the agencies 
determine that a more immediate implementation is necessary based on 
economic conditions, the agencies may require an earlier effective 
date. The agencies will follow the same procedures in adjusting the 
countercyclical capital buffer applicable for exposures located in 
foreign jurisdictions.
    For purposes of the interim final rule, consistent with the 
proposal, a decrease in the countercyclical capital buffer amount will 
be effective on the day following announcement of the final 
determination or the earliest date permissible under applicable law or 
regulation, whichever is later. In addition, the countercyclical 
capital buffer amount will return to zero percent 12 months after its 
effective date, unless the agencies announce a decision to maintain the 
adjusted countercyclical capital buffer amount or adjust it again 
before the expiration of the 12-month period.
    The countercyclical capital buffer augments the capital 
conservation buffer by up to 2.5 percent of an FDIC-supervised 
institution's total risk-weighted assets. Consistent with the proposal, 
the interim final rule requires an advanced approaches FDIC-

[[Page 55359]]

supervised institution to determine its countercyclical capital buffer 
amount by calculating the weighted average of the countercyclical 
capital buffer amounts established for the national jurisdictions where 
the FDIC-supervised institution has private sector credit exposures. 
The contributing weight assigned to a jurisdiction's countercyclical 
capital buffer amount is calculated by dividing the total risk-weighted 
assets for the FDIC-supervised institution's private sector credit 
exposures located in the jurisdiction by the total risk-weighted assets 
for all of the FDIC-supervised institution's private sector credit 
exposures.
    Under the proposed rule, private sector credit exposure was defined 
as an exposure to a company or an individual that is included in credit 
risk-weighted assets, not including 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 public sector entity (PSE), or a Government-
sponsored Enterprise (GSE). While the proposed definition excluded 
covered positions with specific risk under the market risk rule, the 
agencies explicitly recognized that they should be included in the 
measure of risk-weighted assets for private-sector exposures and asked 
a question regarding how to incorporate these positions in the measure 
of risk-weighted assets, particularly for positions for which an FDIC-
supervised institution uses models to measure specific risk. The 
agencies did not receive comments on this question.
    The interim final rule includes covered positions under the market 
risk rule in the definition of private sector credit exposure. Thus, a 
private sector credit exposure is an exposure to a company or an 
individual, not including 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, or a GSE. 
The interim final rule is also more specific than the proposal 
regarding how to calculate risk-weighted assets for private sector 
credit exposures, and harmonizes that calculation with the advanced 
approaches FDIC-supervised institution's determination of its capital 
conservation buffer generally. An advanced approaches FDIC-supervised 
institution is subject to the countercyclical capital buffer regardless 
of whether it has completed the parallel run process and received 
notification from the FDIC pursuant to section 121(d) of the rule. The 
methodology an advanced approaches FDIC-supervised institution must use 
for determining risk-weighted assets for private sector credit 
exposures must be the methodology that the FDIC-supervised institution 
uses to determine its risk-based capital ratios under section 10 of the 
interim final rule. Notwithstanding this provision, the risk-weighted 
asset amount for a private sector credit exposure that is a covered 
position is its specific risk add-on, as determined under the market 
risk rule's standardized measurement method for specific risk, 
multiplied by 12.5. The FDIC chose this methodology because it allows 
the specific risk of a position to be allocated to the position's 
geographic location in a consistent manner across FDIC-supervised 
institutions.
    Consistent with the proposal, under the interim final rule the 
geographic location of a private sector credit exposure (that is not a 
securitization exposure) is the national jurisdiction where the 
borrower is located (that is, where the borrower is incorporated, 
chartered, or similarly established or, if it is an individual, where 
the borrower resides). If, however, the decision to issue the private 
sector credit exposure is based primarily on the creditworthiness of a 
protection provider, the location of the non-securitization exposure is 
the location of the protection provider. The location of a 
securitization exposure is the location of the underlying exposures, 
determined by reference to the location of the borrowers on those 
exposures. If the underlying exposures are located in more than one 
national jurisdiction, the location of a securitization exposure is the 
national jurisdiction where the underlying exposures with the largest 
aggregate unpaid principal balance are located.
    Table 2 illustrates how an advanced approaches FDIC-supervised 
institution calculates its weighted average countercyclical capital 
buffer amount. In the following example, the countercyclical capital 
buffer established in the various jurisdictions in which the FDIC-
supervised institution has private sector credit exposures is reported 
in column A. Column B contains the FDIC-supervised institution's risk-
weighted asset amounts for the private sector credit exposures in each 
jurisdiction. Column C shows the contributing weight for each 
countercyclical capital buffer amount, which is calculated by dividing 
each of the rows in column B by the total for column B. Column D shows 
the contributing weight applied to each countercyclical capital buffer 
amount, calculated as the product of the corresponding contributing 
weight (column C) and the countercyclical capital buffer set by each 
jurisdiction's national supervisor (column A). The sum of the rows in 
column D shows the FDIC-supervised institution's weighted average 
countercyclical capital buffer, which is 1.4 percent of risk-weighted 
assets.

 Table 2--Example of Weighted Average Buffer Calculation for an Advanced Approaches FDIC-Supervised Institution
----------------------------------------------------------------------------------------------------------------
                                                                    (B) FDIC-
                                                      (A)          supervised                          (D)
                                                Countercyclical   institution's        (C)         Contributing
                                                 capital buffer   risk-weighted   Contributing    weight applied
                                                 amount set by     assets for        weight          to each
                                                    national     private sector    (column B/    countercyclical
                                                   supervisor        credit         column B      capital buffer
                                                   (percent)        exposures        total)      amount  (column
                                                                      ($b)                        A * column C)
----------------------------------------------------------------------------------------------------------------
Non-U.S. jurisdiction 1.......................              2.0             250            0.29              0.6
Non-U.S. jurisdiction 2.......................              1.5             100            0.12              0.2
U.S...........................................              1               500            0.59              0.6
                                               -----------------------------------------------------------------
    Total.....................................  ...............             850            1.00              1.4
----------------------------------------------------------------------------------------------------------------


[[Page 55360]]

    The countercyclical capital buffer expands an FDIC-supervised 
institution's capital conservation buffer range for purposes of 
determining the FDIC-supervised institution's maximum payout ratio. For 
instance, if an advanced approaches FDIC-supervised institution's 
countercyclical capital buffer amount is equal to zero percent of total 
risk-weighted assets, the FDIC-supervised institution must maintain a 
buffer of greater than 2.5 percent of total risk-weighted assets to 
avoid restrictions on its distributions and discretionary bonus 
payments. However, if its countercyclical capital buffer amount is 
equal to 2.5 percent of total risk-weighted assets, the FDIC-supervised 
institution must maintain a buffer of greater than 5 percent of total 
risk-weighted assets to avoid restrictions on its distributions and 
discretionary bonus payments.
    As another example, if the advanced approaches FDIC-supervised 
institution from the example in Table 2 above has a capital 
conservation buffer of 2.0 percent, and each of the jurisdictions in 
which it has private sector credit exposures sets its countercyclical 
capital buffer amount equal to zero, the FDIC-supervised institution 
would be subject to a maximum payout ratio of 60 percent. If, instead, 
each country sets its countercyclical capital buffer amount as shown in 
Table 2, resulting in a countercyclical capital buffer amount of 1.4 
percent of total risk-weighted assets, the FDIC-supervised 
institution's capital conservation buffer ranges would be expanded as 
shown in Table 3 below. As a result, the FDIC-supervised institution 
would now be subject to a stricter 40 percent maximum payout ratio 
based on its capital conservation buffer of 2.0 percent.

   Table 3--Capital Conservation Buffer and Maximum Payout Ratio \38\
------------------------------------------------------------------------
Capital conservation buffer as expanded by   Maximum payout ratio (as a
 the countercyclical capital buffer amount     percentage of eligible
               from Table 2                       retained income)
------------------------------------------------------------------------
Greater than 3.9 percent (2.5 percent +     No payout ratio limitation
 100 percent of the countercyclical          applies.
 capital buffer of 1.4).
Less than or equal to 3.9 percent, and      60 percent.
 greater than 2.925 percent (1.875 percent
 plus 75 percent of the countercyclical
 capital buffer of 1.4).
Less than or equal to 2.925 percent, and    40 percent.
 greater than 1.95 percent (1.25 percent
 plus 50 percent of the countercyclical
 capital buffer of 1.4).
Less than or equal to 1.95 percent, and     20 percent.
 greater than 0.975 percent (.625 percent
 plus 25 percent of the countercyclical
 capital buffer of 1.4).
Less than or equal to 0.975 percent.......  0 percent.
------------------------------------------------------------------------

    The countercyclical capital buffer amount under the interim final 
rule for U.S. credit exposures is initially set to zero, but it could 
increase if the agencies determine that there is excessive credit in 
the markets that could lead to subsequent wide-spread market failures. 
Generally, a zero percent countercyclical capital buffer amount will 
reflect an assessment that economic and financial conditions are 
consistent with a period of little or no excessive ease in credit 
markets associated with no material increase in system-wide credit 
risk. A 2.5 percent countercyclical capital buffer amount will reflect 
an assessment that financial markets are experiencing a period of 
excessive ease in credit markets associated with a material increase in 
system-wide credit risk.
---------------------------------------------------------------------------

    \38\ Calculations in this table are based on the assumption that 
the countercyclical capital buffer amount is 1.4 percent of risk-
weighted assets, per the example in Table 2.
---------------------------------------------------------------------------

F. Prompt Corrective Action Requirements

    All insured depository institutions, regardless of total asset size 
or foreign exposure, currently are required to compute PCA capital 
levels using the agencies' general risk-based capital rules, as 
supplemented by the market risk rule. Section 38 of the Federal Deposit 
Insurance Act directs the federal banking agencies to resolve the 
problems of insured depository institutions at the least cost to the 
Deposit Insurance Fund.\39\ To facilitate this purpose, the agencies 
have established five regulatory capital categories in the PCA 
regulations that include capital thresholds for the leverage ratio, 
tier 1 risk-based capital ratio, and the total risk-based capital ratio 
for insured depository institutions. These five PCA categories under 
section 38 of the Act and the PCA regulations are: ``well 
capitalized,'' ``adequately capitalized,'' ``undercapitalized,'' 
``significantly undercapitalized,'' and ``critically 
undercapitalized.'' Insured depository institutions that fail to meet 
these capital measures are subject to increasingly strict limits on 
their activities, including their ability to make capital 
distributions, pay management fees, grow their balance sheet, and take 
other actions.\40\ Insured depository institutions are expected to be 
closed within 90 days of becoming ``critically undercapitalized,'' 
unless their primary Federal supervisor takes such other action as that 
primary Federal supervisor determines, with the concurrence of the 
FDIC, would better achieve the purpose of PCA.\41\
---------------------------------------------------------------------------

    \39\ 12 U.S.C. 1831o.
    \40\ 12 U.S.C. 1831o(e)-(i). See 12 CFR part 325, subpart B.
    \41\ 12 U.S.C. 1831o(g)(3).
---------------------------------------------------------------------------

    The proposal maintained the structure of the PCA framework while 
increasing some of the thresholds for the PCA capital categories and 
adding the proposed common equity tier 1 capital ratio. For example, 
under the proposed rule, the thresholds for adequately capitalized 
FDIC-supervised institutions would be equal to the minimum capital 
requirements. The risk-based capital ratios for well capitalized FDIC-
supervised institutions under PCA would continue to be two percentage 
points higher than the ratios for adequately-capitalized FDIC-
supervised institutions, and the leverage ratio for well capitalized 
FDIC-supervised institutions under PCA would be one percentage point 
higher than for adequately-capitalized FDIC-supervised institutions. 
Advanced approaches FDIC-supervised institutions that are insured 
depository institutions also would be required to satisfy a 
supplementary leverage ratio of 3 percent in order to be considered 
adequately capitalized. While the proposed PCA levels do not 
incorporate the capital conservation buffer, the PCA and capital 
conservation buffer frameworks would complement each other to ensure 
that FDIC-supervised institutions hold an adequate amount of common 
equity tier 1 capital.
    The agencies received a number of comments on the proposed PCA 
framework. Several commenters suggested modifications to the proposed 
PCA levels, particularly with respect to the leverage ratio. For 
example, a few commenters encouraged the agencies to

[[Page 55361]]

increase the adequately-capitalized and well capitalized categories for 
the leverage ratio to six percent or more and eight percent or more, 
respectively. According to one commenter, such thresholds would more 
closely align with the actual leverage ratios of many state-charted 
depository institutions.
    Another commenter expressed concern regarding the operational 
complexity of the proposed PCA framework in view of the addition of the 
common equity tier 1 capital ratio and the interaction of the PCA 
framework and the capital conservation buffer. For example, under the 
proposed rule a banking organization could be well capitalized for PCA 
purposes and, at the same time, be subject to restrictions on dividends 
and bonus payments. Other banking organizations expressed concern that 
the proposed PCA levels would adversely affect their ability to lend 
and generate income. This, according to a commenter, also would reduce 
net income and return-on-equity.
    The FDIC believes the capital conservation buffer complements the 
PCA framework--the former works to keep FDIC-supervised institutions 
above the minimum capital ratios, whereas the latter imposes 
increasingly stringent consequences on depository institutions, 
particularly as they fall below the minimum capital ratios. Because the 
capital conservation buffer is designed to absorb losses in stressful 
periods, the FDIC believes it is appropriate for a depository 
institution to be able to use some of its capital conservation buffer 
without being considered less than well capitalized for PCA purposes.
    Consistent with the proposal, the interim final rule augments the 
PCA capital categories by introducing a common equity tier 1 capital 
measure for four of the five PCA categories (excluding the critically 
undercapitalized PCA category).\42\ In addition, the interim final rule 
revises the three current risk-based capital measures for four of the 
five PCA categories to reflect the interim final rule's changes to the 
minimum risk-based capital ratios, as provided in revisions to the 
FDIC's PCA regulations. All FDIC-supervised institutions will remain 
subject to leverage measure thresholds using the current leverage ratio 
in the form of tier 1 capital to average total consolidated assets. In 
addition, the interim final rule amends the PCA leverage measure for 
advanced approaches depository institutions to include the 
supplementary leverage ratio that explicitly applies to the 
``adequately capitalized'' and ``undercapitalized'' capital categories.
---------------------------------------------------------------------------

    \42\ 12 U.S.C. 1831o(c)(1)(B)(i).
---------------------------------------------------------------------------

    All insured depository institutions must comply with the revised 
PCA thresholds beginning on January 1, 2015. Consistent with transition 
provisions in the proposed rules, the supplementary leverage measure 
for advanced approaches FDIC-supervised institutions that are insured 
depository institutions becomes effective on January 1, 2018. Changes 
to the definitions of the individual capital components that are used 
to calculate the relevant capital measures under PCA are governed by 
the transition arrangements discussed in section VIII.3 below. Thus, 
the changes to these definitions, including any deductions from or 
adjustments to regulatory capital, automatically flow through to the 
definitions in the PCA framework.
    Table 4 sets forth the risk-based capital and leverage ratio 
thresholds under the interim final rule for each of the PCA capital 
categories for all insured depository institutions. For each PCA 
category except critically undercapitalized, an insured depository 
institution must satisfy a minimum common equity tier 1 capital ratio, 
in addition to a minimum tier 1 risk-based capital ratio, total risk-
based capital ratio, and leverage ratio. In addition to the 
aforementioned requirements, advanced approaches FDIC-supervised 
institutions that are insured depository institutions are also subject 
to a supplementary leverage ratio.

                                               Table 4--PCA Levels for All Insured Depository Institutions
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                          Common equity tier             Leverage measure
                                   Total risk-based   Tier 1 RBC measure     1 RBC measure   ----------------------------------------
          PCA category               Capital (RBC)    (tier 1 RBC ratio)    (common equity                           Supplementary     PCA requirements
                                  measure (total RBC       (percent)       tier 1 RBC ratio)    Leverage ratio      leverage ratio
                                   ratio) (percent)                            (percent)           (percent)          (percent)*
--------------------------------------------------------------------------------------------------------------------------------------------------------
Well capitalized................  >=10..............  >=8...............  >=6.5.............  >=5...............  Not applicable....  Unchanged from
                                                                                                                                       current rule.*
Adequately-capitalized..........  >=8...............  >=6...............  >=4.5.............  >=4...............  >3.0..............  (*).
Undercapitalized................  <8................  <6................  <4.5..............  <4................  <3.00.............  (*).
Significantly undercapitalized..  <6................  <4................  <3................  <3................  Not applicable....  (*).
                                 --------------------------------------------------------------------------------
Critically undercapitalized.....  Tangible Equity (defined as tier 1 capital plus non-tier 1 perpetual preferred  Not applicable....  (*).
                                                             stock) to Total Assets <=2
--------------------------------------------------------------------------------------------------------------------------------------------------------
* The supplementary leverage ratio as a PCA requirement applies only to advanced approaches FDIC-supervised institutions that are insured depository
  institutions. The supplementary leverage ratio also applies to advanced approaches bank holding companies, although not in the form of a PCA
  requirement.

    To be well capitalized for purposes of the interim final rule, an 
insured depository institution must maintain a total risk-based capital 
ratio of 10 percent or more; a tier 1 capital ratio of 8 percent or 
more; a common equity tier 1 capital ratio of 6.5 percent or more; and 
a leverage ratio of 5 percent or more. An adequately-capitalized 
depository institution must maintain a total risk-based capital ratio 
of 8 percent or more; a tier 1 capital ratio of 6 percent or more; a 
common equity tier 1 capital ratio of 4.5 percent or more; and a 
leverage ratio of 4 percent or more.
    An insured depository institution is undercapitalized under the 
interim final rule if its total capital ratio is less than 8 percent, 
if its tier 1 capital ratio is less than 6 percent, its common equity 
tier

[[Page 55362]]

1 capital ratio is less than 4.5 percent, or its leverage ratio is less 
than 4 percent. If an institution's tier 1 capital ratio is less than 4 
percent, or its common equity tier 1 capital ratio is less than 3 
percent, it would be considered significantly undercapitalized. The 
other numerical capital ratio thresholds for being significantly 
undercapitalized remain unchanged from the current rules.\43\
---------------------------------------------------------------------------

    \43\ Under current PCA standards, in order to qualify as well-
capitalized, an insured depository institution must not be subject 
to any written agreement, order, capital directive, or prompt 
corrective action directive issued by its primary Federal regulator 
pursuant to section 8 of the Federal Deposit Insurance Act, the 
International Lending Supervision Act of 1983, or section 38 of the 
Federal Deposit Insurance Act, or any regulation thereunder. See 12 
CFR 325.103(b)(1)(iv) (state nonmember banks) and 12 CFR 
390.453(b)(1)(iv) (state savings associations). The interim final 
rule does not change this requirement.
---------------------------------------------------------------------------

    The determination of whether an insured depository institution is 
critically undercapitalized for PCA purposes is based on its ratio of 
tangible equity to total assets.\44\ This is a statutory requirement 
within the PCA framework, and the experience of the recent financial 
crisis has confirmed that tangible equity is of critical importance in 
assessing the viability of an insured depository institution. Tangible 
equity for PCA purposes is currently defined as including core capital 
elements, which consist of: (1) common stockholder's equity, (2) 
qualifying noncumulative perpetual preferred stock (including related 
surplus), and (3) minority interest in the equity accounts of 
consolidated subsidiaries; plus outstanding cumulative preferred 
perpetual stock; minus all intangible assets except mortgage servicing 
rights to the extent permitted in tier 1 capital. The current PCA 
definition of tangible equity does not address the treatment of DTAs in 
determining whether an insured depository institution is critically 
undercapitalized.
---------------------------------------------------------------------------

    \44\ See 12 U.S.C. 1831o(c)(3)(A) and (B), which for purposes of 
the ``critically undercapitalized'' PCA category requires the ratio 
of tangible equity to total assets to be set at an amount ``not less 
than 2 percent of total assets''.
---------------------------------------------------------------------------

    Consistent with the proposal, the interim final rule revises the 
calculation of the capital measure for the critically undercapitalized 
PCA category by revising the definition of tangible equity to consist 
of tier 1 capital, plus outstanding perpetual preferred stock 
(including related surplus) not included in tier 1 capital. The revised 
definition more appropriately aligns the calculation of tangible equity 
with the calculation of tier 1 capital generally for regulatory capital 
requirements. Assets included in an FDIC-supervised institution's 
equity under GAAP, such as DTAs, are included in tangible equity only 
to the extent that they are included in tier 1 capital. The FDIC 
believes this modification promotes consistency and provides for 
clearer boundaries across and between the various PCA categories.

G. Supervisory Assessment of Overall Capital Adequacy

    Capital helps to ensure that individual banking organizations can 
continue to serve as credit intermediaries even during times of stress, 
thereby promoting the safety and soundness of the overall U.S. banking 
system. The FDIC's general risk-based capital rules indicate that the 
capital requirements are minimum standards generally based on broad 
credit-risk considerations.\45\ The risk-based capital ratios under 
these rules do not explicitly take account of the quality of individual 
asset portfolios or the range of other types of risk to which FDIC-
supervised institutions may be exposed, such as interest-rate, 
liquidity, market, or operational risks.\46\
---------------------------------------------------------------------------

    \45\ See 12 CFR 325.3(a) (state nonmember banks) and 12 CFR 
390.463 (state savings associations).
    \46\ The risk-based capital ratios of an FDIC-supervised 
institution subject to the market risk rule do include capital 
requirements for the market risk of covered positions, and the risk-
based capital ratios calculated using advanced approaches total 
risk-weighted assets for an advanced approaches FDIC-supervised 
institution that has completed the parallel run process and received 
notification from the FDIC pursuant to section 324.121(d) do include 
a capital requirement for operational risks.
---------------------------------------------------------------------------

    An FDIC-supervised institution is generally expected to have 
internal processes for assessing capital adequacy that reflect a full 
understanding of its risks and to ensure that it holds capital 
corresponding to those risks to maintain overall capital adequacy.\47\ 
The nature of such capital adequacy assessments should be commensurate 
with FDIC-supervised institutions' size, complexity, and risk-profile. 
Consistent with longstanding practice, supervisory assessment of 
capital adequacy will take account of whether an FDIC-supervised 
institution plans appropriately to maintain an adequate level of 
capital given its activities and risk profile, as well as risks and 
other factors that can affect an FDIC-supervised institution's 
financial condition, including, for example, the level and severity of 
problem assets and its exposure to operational and interest rate risk, 
and significant asset concentrations. For this reason, a supervisory 
assessment of capital adequacy may differ significantly from 
conclusions that might be drawn solely from the level of an FDIC-
supervised institution's regulatory capital ratios.
---------------------------------------------------------------------------

    \47\ The Basel framework incorporates similar requirements under 
Pillar 2 of Basel II.
---------------------------------------------------------------------------

    In light of these considerations, as a prudential matter, an FDIC-
supervised institution is generally expected to operate with capital 
positions well above the minimum risk-based ratios and to hold capital 
commensurate with the level and nature of the risks to which it is 
exposed, which may entail holding capital significantly above the 
minimum requirements. For example, FDIC-supervised institutions 
contemplating significant expansion proposals are expected to maintain 
strong capital levels substantially above the minimum ratios and should 
not allow significant diminution of financial strength below these 
strong levels to fund their expansion plans. FDIC-supervised 
institutions with high levels of risk are also expected to operate even 
further above minimum standards. In addition to evaluating the 
appropriateness of an FDIC-supervised institution's capital level given 
its overall risk profile, the supervisory assessment takes into account 
the quality and trends in an FDIC-supervised institution's capital 
composition, including the share of common and non-common-equity 
capital elements.
    Some commenters stated that they manage their capital so that they 
operate with a buffer over the minimum and that examiners expect such a 
buffer. These commenters expressed concern that examiners will expect 
even higher capital levels, such as a buffer in addition to the new 
higher minimums and capital conservation buffer (and countercyclical 
capital buffer, if applicable). Consistent with the longstanding 
approach employed by the FDIC in its supervision of FDIC-supervised 
institutions, section 10(d) of the interim final rule maintains and 
reinforces supervisory expectations by requiring that an FDIC-
supervised institution maintain capital commensurate with the level and 
nature of all risks to which it is exposed and that an FDIC-supervised 
institution have a process for assessing its overall capital adequacy 
in relation to its risk profile, as well as a comprehensive strategy 
for maintaining an appropriate level of capital.
    The supervisory evaluation of an FDIC-supervised institution's 
capital adequacy, including compliance with section 10(d), may include 
such factors as whether the FDIC-supervised institution is newly 
chartered, entering new activities, or introducing new products. The 
assessment also would consider whether an FDIC-supervised

[[Page 55363]]

institution is receiving special supervisory attention, has or is 
expected to have losses resulting in capital inadequacy, has 
significant exposure due to risks from concentrations in credit or 
nontraditional activities, or has significant exposure to interest rate 
risk, operational risk, or could be adversely affected by the 
activities or condition of an FDIC-supervised institution's holding 
company or other affiliates.
    Supervisors also evaluate the comprehensiveness and effectiveness 
of an FDIC-supervised institution's capital planning in light of its 
activities and capital levels. An effective capital planning process 
involves an assessment of the risks to which an FDIC-supervised 
institution is exposed and its processes for managing and mitigating 
those risks, an evaluation of its capital adequacy relative to its 
risks, and consideration of the potential impact on its earnings and 
capital base from current and prospective economic conditions. While 
the elements of supervisory review of capital adequacy would be similar 
across FDIC-supervised institutions, evaluation of the level of 
sophistication of an individual FDIC-supervised institution's capital 
adequacy process would be commensurate with the FDIC-supervised 
institution's size, sophistication, and risk profile, similar to the 
current supervisory practice.

H. Tangible Capital Requirement for State Savings Associations

    State savings associations currently are required to maintain 
tangible capital in an amount not less than 1.5 percent of total 
assets.\48\ This statutory requirement is implemented under the FDIC's 
current capital rules applicable to state savings associations.\49\ For 
purposes of the Basel III NPR, the FDIC also proposed to include a 
tangible capital requirement for state savings associations. The FDIC 
received no comments on this aspect of the proposal.
---------------------------------------------------------------------------

    \48\ Tangible capital is defined in section 5(t)(9)(B) of HOLA 
to mean ``core capital minus any intangible assets (as intangible 
assets are defined by the OCC for national banks).'' 12 U.S.C. 
1464(t)(9)(B). Core capital means ``core capital as defined by the 
OCC for national banks, less unidentifiable intangible assets'', 
unless the OCC prescribes a more stringent definition. 12 U.S.C. 
1464(t)(9)(A).
    \49\ 12 CFR 390.468.
---------------------------------------------------------------------------

    Concerning state savings associations, the FDIC does not believe 
that a unique regulatory definition of ``tangible capital'' is 
necessary for purposes of implementing HOLA. Accordingly, for purposes 
of the interim final rule, as of January 1, 2014 or January 1, 2015 
depending on whether the state savings associations applies the 
advanced approaches rule, the FDIC is defining ``tangible capital'' as 
the amount of tier 1 capital plus the amount of outstanding perpetual 
preferred stock (including related surplus) not included in tier 1 
capital.\50\ This definition is analogous to the definition of tangible 
capital adopted under the interim final rule for purposes of the PCA 
framework. The FDIC believes that this approach will reduce 
implementation burden associated with separate measures of tangible 
capital and is consistent with the purposes of HOLA and PCA.
---------------------------------------------------------------------------

    \50\ Until January 1, 2014 or January 1, 2015 depending on 
whether the state savings association applies the advanced 
approaches rule, the state savings association shall determine its 
tangible capital ratio as provided under 12 CFR 390.468.
---------------------------------------------------------------------------

    The FDIC notes that for purposes of the interim final rule, as of 
January 1, 2015, the term ``total adjusted assets'' in the definition 
of ``state savings associations tangible capital ratio'' has been 
replaced with the term ``total assets.'' The term total assets has the 
same definition as provided in the FDIC's PCA rules.\51\ As a result of 
this change, which should further reduce implementation burden, state 
savings associations will no longer calculate the tangible equity ratio 
using period-end total assets.
---------------------------------------------------------------------------

    \51\ See 12 CFR 324.401(g).
---------------------------------------------------------------------------

V. Definition of Capital

A. Capital Components and Eligibility Criteria for Regulatory Capital 
Instruments

1. Common Equity Tier 1 Capital
    Under the proposed rule, common equity tier 1 capital was defined 
as the sum of a banking organization's outstanding common equity tier 1 
capital instruments that satisfy the criteria set forth in section 
20(b) of the proposal, related surplus (net of treasury stock), 
retained earnings, AOCI, and common equity tier 1 minority interest 
subject to certain limitations, minus regulatory adjustments and 
deductions.
    The proposed rule set forth a list of criteria that an instrument 
would be required to meet to be included in common equity tier 1 
capital. The proposed criteria were designed to ensure that common 
equity tier 1 capital instruments do not possess features that would 
cause a banking organization's condition to further weaken during 
periods of economic and market stress. In the proposals, the agencies 
indicated that they believe most existing common stock instruments 
issued by U.S. banking organizations already would satisfy the proposed 
criteria.
    The proposed criteria also applied to instruments issued by banking 
organizations such as mutual banking organizations where ownership of 
the organization is not freely transferable or evidenced by 
certificates of ownership or stock. For these entities, the proposal 
provided that instruments issued by such organizations would be 
considered common equity tier 1 capital if they are fully equivalent to 
common stock instruments in terms of their subordination and 
availability to absorb losses, and do not possess features that could 
cause the condition of the organization to weaken as a going concern 
during periods of market stress.
    The agencies noted in the proposal that stockholders' voting rights 
generally are a valuable corporate governance tool that permits parties 
with an economic interest to participate in the decision-making process 
through votes on establishing corporate objectives and policy, and in 
electing the banking organization's board of directors. Therefore, the 
agencies believe that voting common stockholders' equity (net of the 
adjustments to and deductions from common equity tier 1 capital 
proposed under the rule) should be the dominant element within common 
equity tier 1 capital. The proposal also provided that to the extent 
that a banking organization issues non-voting common stock or common 
stock with limited voting rights, the underlying stock must be 
identical to those underlying the banking organization's voting common 
stock in all respects except for any limitations on voting rights.
    To ensure that a banking organization's common equity tier 1 
capital would be available to absorb losses as they occur, the proposed 
rule would have required common equity tier 1 capital instruments 
issued by a banking organization to satisfy the following criteria:
    (1) The instrument is paid-in, issued directly by the banking 
organization, and represents the most subordinated claim in a 
receivership, insolvency, liquidation, or similar proceeding of the 
banking organization.
    (2) The holder of the instrument is entitled to a claim on the 
residual assets of the banking organization that is proportional with 
the holder's share of the banking organization's issued capital after 
all senior claims have been satisfied in a receivership, insolvency, 
liquidation, or similar proceeding. That is, the holder has an 
unlimited and variable claim, not a fixed or capped claim.
    (3) The instrument has no maturity date, can only be redeemed via

[[Page 55364]]

discretionary repurchases with the prior approval of the banking 
organization's primary Federal supervisor, and does not contain any 
term or feature that creates an incentive to redeem.
    (4) The banking organization did not create at issuance of the 
instrument, through any action or communication, an expectation that it 
will buy back, cancel, or redeem the instrument, and the instrument 
does not include any term or feature that might give rise to such an 
expectation.
    (5) Any cash dividend payments on the instrument are paid out of 
the banking organization's net income and retained earnings and are not 
subject to a limit imposed by the contractual terms governing the 
instrument.
    (6) The banking organization has full discretion at all times to 
refrain from paying any dividends and making any other capital 
distributions on the instrument without triggering an event of default, 
a requirement to make a payment-in-kind, or an imposition of any other 
restrictions on the banking organization.
    (7) Dividend payments and any other capital distributions on the 
instrument may be paid only after all legal and contractual obligations 
of the banking organization have been satisfied, including payments due 
on more senior claims.
    (8) The holders of the instrument bear losses as they occur 
equally, proportionately, and simultaneously with the holders of all 
other common stock instruments before any losses are borne by holders 
of claims on the banking organization with greater priority in a 
receivership, insolvency, liquidation, or similar proceeding.
    (9) The paid-in amount is classified as equity under GAAP.
    (10) The banking organization, or an entity that the banking 
organization controls, did not purchase or directly or indirectly fund 
the purchase of the instrument.
    (11) The instrument is not secured, not covered by a guarantee of 
the banking organization or of an affiliate of the banking 
organization, and is not subject to any other arrangement that legally 
or economically enhances the seniority of the instrument.
    (12) The instrument has been issued in accordance with applicable 
laws and regulations. In most cases, the agencies understand that the 
issuance of these instruments would require the approval of the board 
of directors of the banking organization or, where applicable, of the 
banking organization's shareholders or of other persons duly authorized 
by the banking organization's shareholders.
    (13) The instrument is reported on the banking organization's 
regulatory financial statements separately from other capital 
instruments.
    The agencies requested comment on the proposed criteria for 
inclusion in common equity tier 1, and specifically on whether any of 
the criteria would be problematic, given the main characteristics of 
existing outstanding common stock instruments.
    A substantial number of comments addressed the criteria for common 
equity tier 1 capital. Generally, commenters stated that the proposed 
criteria could prevent some instruments currently included in tier 1 
capital from being included in the new common equity tier 1 capital 
measure. Commenters stated that this could create complicated and 
unnecessary burden for banking organizations that either would have to 
raise capital to meet the common equity tier 1 capital requirement or 
shrink their balance sheets by selling off or winding down assets and 
exposures. Many commenters stated that the burden of raising new 
capital would have the effect of reducing lending overall, and that it 
would be especially acute for smaller banking organizations that have 
limited access to capital markets.
    Many commenters asked the agencies to clarify several aspects of 
the proposed criteria. For instance, a few commenters asked the 
agencies to clarify the proposed requirement that a common equity tier 
1 capital instrument be redeemed only with prior approval by a banking 
organization's primary Federal supervisor. These commenters asked if 
this criterion would require a banking organization to note this 
restriction on the face of a regulatory capital instrument that it may 
be redeemed only with the prior approval of the banking organization's 
primary Federal supervisor.
    The FDIC notes that the requirement that common equity tier 1 
capital instruments be redeemed only with prior agency approval is 
consistent with the FDIC's rules and federal law, which generally 
provide that an FDIC-supervised institution may not reduce its capital 
by redeeming capital instruments without receiving prior approval from 
the FDIC.\52\ The interim final rule does not obligate the FDIC-
supervised institution to include this restriction explicitly in the 
common equity tier 1 capital instrument's documentation. However, 
regardless of whether the instrument documentation states that its 
redemption is subject to FDIC approval, the FDIC-supervised institution 
must receive prior approval before redeeming such instruments. The FDIC 
believes that the approval requirement is appropriate as it provides 
for the monitoring of the strength of an FDIC-supervised institution's 
capital position, and therefore, have retained the proposed requirement 
in the interim final rule.
---------------------------------------------------------------------------

    \52\ See 12 CFR 303.241 (state nonmember banks) and 12 CFR 
390.345 (state savings associations).
---------------------------------------------------------------------------

    Several commenters also expressed concern about the proposed 
requirement that dividend payments and any other distributions on a 
common equity tier 1 capital instrument may be paid only after all 
legal and contractual obligations of the banking organization have been 
satisfied, including payments due on more senior claims. Commenters 
stated that, as proposed, this requirement could be construed to 
prevent a banking organization from paying a dividend on a common 
equity tier 1 capital instrument because of obligations that have not 
yet become due or because of immaterial delays in paying trade 
creditors \53\ for obligations incurred in the ordinary course of 
business.
---------------------------------------------------------------------------

    \53\ Trade creditors, for this purpose, would include 
counterparties with whom the banking organization contracts to 
procure office space and/or supplies as well as basic services, such 
as building maintenance.
---------------------------------------------------------------------------

    The FDIC notes that this criterion should not prevent an FDIC-
supervised institution from paying a dividend on a common equity tier 1 
capital instrument where it has incurred operational obligations in the 
normal course of business that are not yet due or that are subject to 
minor delays for reasons unrelated to the financial condition of the 
FDIC-supervised institution, such as delays related to contractual or 
other legal disputes.
    A number of commenters also suggested that the proposed criteria 
providing that dividend payments may be paid only out of current and 
retained earnings potentially could conflict with state corporate law, 
including Delaware state law. According to these commenters, Delaware 
state law permits a corporation to make dividend payments out of its 
capital surplus account, even when the organization does not have 
current or retained earnings.
    The FDIC observes that requiring that dividends be paid only out of 
net income and retained earnings is consistent with federal law and the 
existing regulations applicable to insured depository institutions. 
Under applicable statutes and regulations this aspect of the proposal 
did not include any substantive changes from the

[[Page 55365]]

general risk-based capital rules.\54\ With respect to FDIC-supervised 
institutions, prior supervisory approval is required to make a 
distribution that involves a reduction or retirement of capital stock. 
Under FDIC's general risk-based capital rules, a state nonmember bank 
is prohibited from paying a dividend that reduces the amount of its 
common or preferred capital stock (which includes any surplus), or 
retiring any part of its capital notes or debentures without prior 
approval from the FDIC.
---------------------------------------------------------------------------

    \54\ 12 U.S.C. 1828(i), 12 CFR 303.241 (state nonmember banks), 
and 12 CFR 390.345 (state savings associations).
---------------------------------------------------------------------------

    Finally, several commenters expressed concerns about the potential 
impact of the proposed criteria on stock issued as part of certain 
employee stock ownership plans (ESOPs) (as defined under Employee 
Retirement Income Security Act of 1974 \55\ (ERISA) regulations at 29 
CFR 2550.407d-6). Under the proposed rule, an instrument would not be 
included in common equity tier 1 capital if the banking organization 
creates an expectation that it will buy back, cancel, or redeem the 
instrument, or if the instrument includes any term or feature that 
might give rise to such an expectation. Additionally, the criteria 
would prevent a banking organization from including in common equity 
tier 1 capital any instrument that is subject to any type of 
arrangement that legally or economically enhances the seniority of the 
instrument. Commenters noted that under ERISA, stock that is not 
publicly traded and issued as part of an ESOP must include a ``put 
option'' that requires the company to repurchase the stock. By 
exercising the put option, an employee can redeem the stock instrument 
upon termination of employment. Commenters noted that this put option 
clearly creates an expectation that the instrument will be redeemed and 
arguably enhances the seniority of the instrument. Therefore, the 
commenters stated that the put option could prevent a privately-held 
banking organization from including earned ESOP shares in its common 
equity tier 1 capital.
---------------------------------------------------------------------------

    \55\ 29 U.S.C. 1002, et seq.
---------------------------------------------------------------------------

    The FDIC does not believe that an ERISA-mandated put option should 
prohibit ESOP shares from being included in common equity tier 1 
capital. Therefore, under the interim final rule, shares issued under 
an ESOP by an FDIC-supervised institution that is not publicly-traded 
are exempt from the criteria that the shares can be redeemed only via 
discretionary repurchases and are not subject to any other arrangement 
that legally or economically enhances their seniority, and that the 
FDIC-supervised institution not create an expectation that the shares 
will be redeemed. In addition to the concerns described above, because 
stock held in an ESOP is awarded by a banking organization for the 
retirement benefit of its employees, some commenters expressed concern 
that such stock may not conform to the criterion prohibiting a banking 
organization from directly or indirectly funding a capital instrument. 
Because the FDIC believes that an FDIC-supervised institution should 
have the flexibility to provide an ESOP as a benefit for its employees, 
the interim final rule provides that ESOP stock does not violate such 
criterion. Under the interim final rule, an FDIC-supervised 
institution's common stock held in trust for the benefit of employees 
as part of an ESOP in accordance with both ERISA and ERISA-related U.S. 
tax code requirements will qualify for inclusion as common equity tier 
1 capital only to the extent that the instrument is includable as 
equity under GAAP and that it meets all other criteria of section 
20(b)(1) of the interim final rule. Stock instruments held by an ESOP 
that are unawarded or unearned by employees or reported as ``temporary 
equity'' under GAAP (in the case of U.S. Securities and Exchange 
Commission (SEC) registrants), may not be counted as equity under GAAP 
and therefore may not be included in common equity tier 1 capital.
    After reviewing the comments received, the FDIC has decided to 
finalize the proposed criteria for common equity tier 1 capital 
instruments, modified as discussed above. Although it is possible some 
currently outstanding common equity instruments may not meet the common 
equity tier 1 capital criteria, the FDIC believes that most common 
equity instruments that are currently eligible for inclusion in FDIC-
supervised institutions' tier 1 capital meet the common equity tier 1 
capital criteria, and have not received information that would support 
a different conclusion. The FDIC therefore believes that most FDIC-
supervised institutions will not be required to reissue common equity 
instruments in order to comply with the final common equity tier 1 
capital criteria. The final revised criteria for inclusion in common 
equity tier 1 capital are set forth in section 324.20(b)(1) of the 
interim final rule.
2. Additional Tier 1 Capital
    Consistent with Basel III, the agencies proposed that additional 
tier 1 capital would equal the sum of: Additional tier 1 capital 
instruments that satisfy the criteria set forth in section 20(c) of the 
proposal, related surplus, and any tier 1 minority interest that is not 
included in a banking organization's common equity tier 1 capital 
(subject to the proposed limitations on minority interest), less 
applicable regulatory adjustments and deductions. The agencies proposed 
the following criteria for additional tier 1 capital instruments in 
section 20(c):
    (1) The instrument is issued and paid-in.
    (2) The instrument is subordinated to depositors, general 
creditors, and subordinated debt holders of the banking organization in 
a receivership, insolvency, liquidation, or similar proceeding.
    (3) The instrument is not secured, not covered by a guarantee of 
the banking organization or of an affiliate of the banking 
organization, and not subject to any other arrangement that legally or 
economically enhances the seniority of the instrument.
    (4) The instrument has no maturity date and does not contain a 
dividend step-up or any other term or feature that creates an incentive 
to redeem.
    (5) If callable by its terms, the instrument may be called by the 
banking organization only after a minimum of five years following 
issuance, except that the terms of the instrument may allow it to be 
called earlier than five years upon the occurrence of a regulatory 
event (as defined in the agreement governing the instrument) that 
precludes the instrument from being included in additional tier 1 
capital or a tax event. In addition:
    (i) The banking organization must receive prior approval from its 
primary Federal supervisor to exercise a call option on the instrument.
    (ii) The banking organization does not create at issuance of the 
instrument, through any action or communication, an expectation that 
the call option will be exercised.
    (iii) Prior to exercising the call option, or immediately 
thereafter, the banking organization must either:
    (A) Replace the instrument to be called with an equal amount of 
instruments that meet the criteria under section 20(b) or (c) of the 
proposed rule (replacement can be concurrent with redemption of 
existing additional tier 1 capital instruments); or
    (B) Demonstrate to the satisfaction of its primary Federal 
supervisor that following redemption, the banking organization will 
continue to hold capital commensurate with its risk.
    (6) Redemption or repurchase of the instrument requires prior 
approval from

[[Page 55366]]

the banking organization's primary Federal supervisor.
    (7) The banking organization has full discretion at all times to 
cancel dividends or other capital distributions on the instrument 
without triggering an event of default, a requirement to make a 
payment-in-kind, or an imposition of other restrictions on the banking 
organization except in relation to any capital distributions to holders 
of common stock.
    (8) Any capital distributions on the instrument are paid out of the 
banking organization's net income and retained earnings.
    (9) The instrument does not have a credit-sensitive feature, such 
as a dividend rate that is reset periodically based in whole or in part 
on the banking organization's credit quality, but may have a dividend 
rate that is adjusted periodically independent of the banking 
organization's credit quality, in relation to general market interest 
rates or similar adjustments.
    (10) The paid-in amount is classified as equity under GAAP.
    (11) The banking organization, or an entity that the banking 
organization controls, did not purchase or directly or indirectly fund 
the purchase of the instrument.
    (12) The instrument does not have any features that would limit or 
discourage additional issuance of capital by the banking organization, 
such as provisions that require the banking organization to compensate 
holders of the instrument if a new instrument is issued at a lower 
price during a specified time frame.
    (13) If the instrument is not issued directly by the banking 
organization or by a subsidiary of the banking organization that is an 
operating entity, the only asset of the issuing entity is its 
investment in the capital of the banking organization, and proceeds 
must be immediately available without limitation to the banking 
organization or to the banking organization's top-tier holding company 
in a form which meets or exceeds all of the other criteria for 
additional tier 1 capital instruments.\56\
---------------------------------------------------------------------------

    \56\ De minimis assets related to the operation of the issuing 
entity could be disregarded for purposes of this criterion.
---------------------------------------------------------------------------

    (14) For an advanced approaches banking organization, the governing 
agreement, offering circular, or prospectus of an instrument issued 
after January 1, 2013, must disclose that the holders of the instrument 
may be fully subordinated to interests held by the U.S. government in 
the event that the banking organization enters into a receivership, 
insolvency, liquidation, or similar proceeding.
    The proposed criteria were designed to ensure that additional tier 
1 capital instruments would be available to absorb losses on a going-
concern basis. TruPS and cumulative perpetual preferred securities, 
which are eligible for limited inclusion in tier 1 capital under the 
general risk-based capital rules for bank holding companies, generally 
would not qualify for inclusion in additional tier 1 capital.\57\ As 
explained in the proposal, the agencies believe that instruments that 
allow for the accumulation of interest payable, like cumulative 
preferred securities, are not likely to absorb losses to the degree 
appropriate for inclusion in tier 1 capital. In addition, the exclusion 
of these instruments from the tier 1 capital of depository institution 
holding companies would be consistent with section 171 of the Dodd-
Frank Act.
---------------------------------------------------------------------------

    \57\ See 12 CFR part 225, appendix A, section II.A.1.
---------------------------------------------------------------------------

    The agencies noted in the proposal that under Basel III, 
instruments classified as liabilities for accounting purposes could 
potentially be included in additional tier 1 capital. However, the 
agencies proposed that an instrument classified as a liability under 
GAAP could not qualify as additional tier 1 capital, reflecting the 
agencies' view that allowing only instruments classified as equity 
under GAAP in tier 1 capital helps strengthen the loss-absorption 
capabilities of additional tier 1 capital instruments, thereby 
increasing the quality of the capital base of U.S. banking 
organizations.
    The agencies also proposed to allow banking organizations to 
include in additional tier 1 capital instruments that were: (1) Issued 
under the Small Business Jobs Act of 2010 \58\ or, prior to October 4, 
2010, under the Emergency Economic Stabilization Act of 2008,\59\ and 
(2) included in tier 1 capital under the agencies' general risk-based 
capital rules. Under the proposal, these instruments would be included 
in tier 1 capital regardless of whether they satisfied the proposed 
qualifying criteria for common equity tier 1 or additional tier 1 
capital. The agencies explained in the proposal that continuing to 
permit these instruments to be included in tier 1 capital is important 
to promote financial recovery and stability following the recent 
financial crisis.\60\
---------------------------------------------------------------------------

    \58\ Public Law 111-240, 124 Stat. 2504 (2010).
    \59\ Public Law 110-343, 122 Stat. 3765 (October 3, 2008).
    \60\ See, e.g., 73 FR 43982 (July 29, 2008); see also 76 FR 
35959 (June 21, 2011).
---------------------------------------------------------------------------

    A number of commenters addressed the proposed criteria for 
additional tier 1 capital. Consistent with comments on the criteria for 
common equity tier 1 capital, commenters generally argued that imposing 
new restrictions on qualifying regulatory capital instruments would be 
burdensome for many banking organizations that would be required to 
raise additional capital or to shrink their balance sheets to phase out 
existing regulatory capital instruments that no longer qualify as 
regulatory capital under the proposed rule.
    With respect to the proposed criteria, commenters requested that 
the agencies make a number of changes and clarifications. Specifically, 
commenters asked the agencies to clarify the use of the term 
``secured'' in criterion (3) above. In this context, a ``secured'' 
instrument is an instrument that is backed by collateral. In order to 
qualify as additional tier 1 capital, an instrument may not be 
collateralized, guaranteed by the issuing organization or an affiliate 
of the issuing organization, or subject to any other arrangement that 
legally or economically enhances the seniority of the instrument 
relative to more senior claims. Instruments backed by collateral, 
guarantees, or other arrangements that affect their seniority are less 
able to absorb losses than instruments without such enhancements. 
Therefore, instruments secured by collateral, guarantees, or other 
enhancements would not be included in additional tier 1 capital under 
the proposal. The FDIC has adopted this criterion as proposed.
    Commenters also asked the agencies to clarify whether terms 
allowing a banking organization to convert a fixed-rate instrument to a 
floating rate in combination with a call option, without any increase 
in credit spread, would constitute an ``incentive to redeem'' under 
criterion (4). The FDIC does not consider the conversion from a fixed 
rate to a floating rate (or from a floating rate to a fixed rate) in 
combination with a call option without any increase in credit spread to 
constitute an ``incentive to redeem'' for purposes of this criterion. 
More specifically, a call option combined with a change in reference 
rate where the credit spread over the second reference rate is equal to 
or less than the initial dividend rate less the swap rate (that is, the 
fixed rate paid to the call date to receive the second reference rate) 
would not be considered an incentive to redeem. For example, if the 
initial reference rate is 0.9 percent, the credit spread over the 
initial reference rate is 2 percent (that is, the initial dividend rate 
is 2.9 percent), and the swap rate to the call date is 1.2 percent, a 
credit spread over the second reference rate greater than 1.7 percent

[[Page 55367]]

(2.9 percent minus 1.2 percent) would be considered an incentive to 
redeem. The FDIC believes that the clarification above should address 
the commenters' concerns, and the FDIC is retaining this criterion in 
the interim final rule as proposed.
    Several commenters noted that the proposed requirement that a 
banking organization seek prior approval from its primary Federal 
supervisor before exercising a call option is redundant with the 
existing requirement that a banking organization seek prior approval 
before reducing regulatory capital by redeeming a capital instrument. 
The FDIC believes that the proposed requirement clarifies existing 
requirements and does not add any new substantive restrictions or 
burdens. Including this criterion also helps to ensure that the 
regulatory capital rules provide FDIC-supervised institutions a 
complete list of the requirements applicable to regulatory capital 
instruments in one location. Accordingly, the FDIC has retained this 
requirement in the interim final rule.
    Banking industry commenters also asserted that some of the proposed 
criteria could have an adverse impact on ESOPs. Specifically, the 
commenters noted that the proposed requirement that instruments not be 
callable for at least five years after issuance could be problematic 
for compensation plans that enable a company to redeem shares after 
employment is terminated. Commenters asked the agencies to exempt from 
this requirement stock issued as part of an ESOP. For the reasons 
stated above in the discussion of common equity tier 1 capital 
instruments, under the interim final rule, additional tier 1 
instruments issued under an ESOP by an FDIC-supervised institution that 
is not publicly traded are exempt from the criterion that additional 
tier 1 instruments not be callable for at least five years after 
issuance. Moreover, similar to the discussion above regarding the 
criteria for common equity tier 1 capital, the FDIC believes that 
required compliance with ERISA and ERISA-related tax code requirements 
alone should not prevent an instrument from being included in 
regulatory capital. Therefore, the FDIC is including a provision in the 
interim final rule to clarify that the criterion prohibiting an FDIC-
supervised institution from directly or indirectly funding a capital 
instrument, the criterion prohibiting a capital instrument from being 
covered by a guarantee of the FDIC-supervised institution or from being 
subject to an arrangement that enhances the seniority of the 
instrument, and the criterion pertaining to the creation of an 
expectation that the instrument will be redeemed, shall not prevent an 
instrument issued by a non-publicly traded FDIC-supervised institution 
as part of an ESOP from being included in additional tier 1 capital. In 
addition, capital instruments held by an ESOP trust that are unawarded 
or unearned by employees or reported as ``temporary equity'' under GAAP 
(in the case of U.S. SEC registrants) may not be counted as equity 
under GAAP and therefore may not be included in additional tier 1 
capital.
    Commenters also asked the agencies to add exceptions for early 
calls within five years of issuance in the case of an ``investment 
company event'' or a ``rating agency event,'' in addition to the 
proposed exceptions for regulatory and tax events. After considering 
the comments on these issues, the FDIC has decided to revise the 
interim final rule to permit an FDIC-supervised institution to call an 
instrument prior to five years after issuance in the event that the 
issuing entity is required to register as an investment company 
pursuant to the Investment Company Act of 1940.\61\ The FDIC recognizes 
that the legal and regulatory burdens of becoming an investment company 
could make it uneconomic to leave some structured capital instruments 
outstanding, and thus would permit the FDIC-supervised institution to 
call such instruments early.
---------------------------------------------------------------------------

    \61\ 15 U.S.C. 80 a-1 et seq.
---------------------------------------------------------------------------

    In order to ensure the loss-absorption capacity of additional tier 
1 capital instruments, the FDIC has decided not to revise the rule to 
permit an FDIC-supervised institution to include in its additional tier 
1 capital instruments issued on or after the effective date of the 
interim final rule that may be called prior to five years after 
issuance upon the occurrence of a rating agency event. However, 
understanding that many currently outstanding instruments have this 
feature, the FDIC has decided to revise the rule to allow an instrument 
that may be called prior to five years after its issuance upon the 
occurrence of a rating agency event to be included into additional tier 
1 capital, provided that (i) the instrument was issued and included in 
an FDIC-supervised institution's tier 1 capital prior to the effective 
date of the rule, and (ii) that such instrument meets all other 
criteria for additional tier 1 capital instruments under the interim 
final rule.
    In addition, a number of commenters reiterated the concern that 
restrictions on the payment of dividends from net income and current 
and retained earnings may conflict with state corporate laws that 
permit an organization to issue dividend payments from its capital 
surplus accounts. This criterion for additional tier 1 capital in the 
interim final rule reflects the identical final criterion for common 
equity tier 1 for the reasons discussed above with respect to common 
equity tier 1 capital.
    Commenters also noted that proposed criterion (10), which requires 
the paid-in amounts of tier 1 capital instruments to be classified as 
equity under GAAP before they may be included in regulatory capital, 
generally would prevent contingent capital instruments, which are 
classified as liabilities, from qualifying as additional tier 1 
capital. These commenters asked the agencies to revise the rules to 
provide that contingent capital instruments will qualify as additional 
tier 1 capital, regardless of their treatment under GAAP. Another 
commenter noted the challenges for U.S. banking organizations in 
devising contingent capital instruments that would satisfy the proposed 
criteria, and noted that if U.S. banking organizations develop an 
acceptable instrument, the instrument likely would initially be 
classified as debt instead of equity for GAAP purposes. Thus, in order 
to accommodate this possibility, the commenter urged the agencies to 
revise the criterion to allow the agencies to permit such an instrument 
in additional tier 1 capital through interpretive guidance or 
specifically in the case of a particular instrument.
    The FDIC continues to believe that restricting tier 1 capital 
instruments to those classified as equity under GAAP will help to 
ensure those instruments' capacity to absorb losses and further 
increase the quality of U.S. FDIC-supervised institutions' regulatory 
capital. The FDIC therefore has decided to retain this aspect of the 
proposal. To the extent that a contingent capital instrument is 
considered a liability under GAAP, an FDIC-supervised institution may 
not include the instrument in its tier 1 capital under the interim 
final rule. At such time as an instrument converts from debt to equity 
under GAAP, the instrument would then satisfy this criterion.
    In the preamble to the proposed rule, the agencies included a 
discussion regarding whether criterion (7) should be revised to require 
banking organizations to reduce the dividend payment on tier 1 capital 
instruments to a penny when a banking organization reduces dividend 
payments on a common equity tier 1 capital instrument to a penny per 
share. Such a revision would increase the capacity of

[[Page 55368]]

additional tier 1 instruments to absorb losses as it would permit a 
banking organization to reduce its capital distributions on additional 
tier 1 instruments without eliminating entirely its common stock 
dividend. Commenters asserted that such a revision would be unnecessary 
and could affect the hierarchy of subordination in capital instruments. 
Commenters also claimed the revision could prove burdensome as it could 
substantially increase the cost of raising capital through additional 
tier 1 capital instruments. In light of these comments the FDIC has 
decided to not modify criterion (7) to accommodate the issuance of a 
penny dividend as discussed in the proposal.
    Several commenters expressed concern that criterion (7) for 
additional tier 1 capital, could affect the tier 1 eligibility of 
existing noncumulative perpetual preferred stock. Specifically, the 
commenters were concerned that such a criterion would disallow 
contractual terms of an additional tier 1 capital instrument that 
restrict payment of dividends on another capital instrument that is 
pari passu in liquidation with the additional tier 1 capital instrument 
(commonly referred to as dividend stoppers). Consistent with Basel III, 
the FDIC agrees that restrictions related to capital distributions to 
holders of common stock instruments and holders of other capital 
instruments that are pari passu in liquidation with such additional 
tier 1 capital instruments are acceptable, and have amended this 
criterion accordingly for purposes of the interim final rule.
    After considering the comments on the proposal, the FDIC has 
decided to finalize the criteria for additional tier 1 capital 
instruments with the modifications discussed above. The final revised 
criteria for additional tier 1 capital are set forth in section 
324.20(c)(1) of the interim final rule. The FDIC expects that most 
outstanding noncumulative perpetual preferred stock that qualifies as 
tier 1 capital under the FDIC's general risk-based capital rules will 
qualify as additional tier 1 capital under the interim final rule.
3. Tier 2 Capital
    Consistent with Basel III, under the proposed rule, tier 2 capital 
would equal the sum of: tier 2 capital instruments that satisfy the 
criteria set forth in section 20(d) of the proposal, related surplus, 
total capital minority interest not included in a banking 
organization's tier 1 capital (subject to certain limitations and 
requirements), and limited amounts of the allowance for loan and lease 
losses (ALLL) less any applicable regulatory adjustments and 
deductions. Consistent with the general risk-based capital rules, when 
calculating its total capital ratio using the standardized approach, a 
banking organization would be permitted to include in tier 2 capital 
the amount of ALLL that does not exceed 1.25 percent of its 
standardized total risk-weighted assets which would not include any 
amount of the ALLL. A banking organization subject to the market risk 
rule would exclude its standardized market risk-weighted assets from 
the calculation.\62\ In contrast, when calculating its total capital 
ratio using the advanced approaches, a banking organization would be 
permitted to include in tier 2 capital the excess of its eligible 
credit reserves over its total expected credit loss, provided the 
amount does not exceed 0.6 percent of its credit risk-weighted assets.
---------------------------------------------------------------------------

    \62\ A banking organization would deduct the amount of ALLL in 
excess of the amount permitted to be included in tier 2 capital, as 
well as allocated transfer risk reserves, from its standardized 
total risk-weighted risk assets.
---------------------------------------------------------------------------

    Consistent with Basel III, the agencies proposed the following 
criteria for tier 2 capital instruments:
    (1) The instrument is issued and paid-in.
    (2) The instrument is subordinated to depositors and general 
creditors of the banking organization.
    (3) The instrument is not secured, not covered by a guarantee of 
the banking organization or of an affiliate of the banking 
organization, and not subject to any other arrangement that legally or 
economically enhances the seniority of the instrument in relation to 
more senior claims.
    (4) The instrument has a minimum original maturity of at least five 
years. At the beginning of each of the last five years of the life of 
the instrument, the amount that is eligible to be included in tier 2 
capital is reduced by 20 percent of the original amount of the 
instrument (net of redemptions) and is excluded from regulatory capital 
when remaining maturity is less than one year. In addition, the 
instrument must not have any terms or features that require, or create 
significant incentives for, the banking organization to redeem the 
instrument prior to maturity.
    (5) The instrument, by its terms, may be called by the banking 
organization only after a minimum of five years following issuance, 
except that the terms of the instrument may allow it to be called 
sooner upon the occurrence of an event that would preclude the 
instrument from being included in tier 2 capital, or a tax event. In 
addition:
    (i) The banking organization must receive the prior approval of its 
primary Federal supervisor to exercise a call option on the instrument.
    (ii) The banking organization does not create at issuance, through 
action or communication, an expectation the call option will be 
exercised.
    (iii) Prior to exercising the call option, or immediately 
thereafter, the banking organization must either:
    (A) Replace any amount called with an equivalent amount of an 
instrument that meets the criteria for regulatory capital under section 
20 of the proposed rule; \63\ or
---------------------------------------------------------------------------

    \63\ Replacement of tier 2 capital instruments can be concurrent 
with redemption of existing tier 2 capital instruments.
---------------------------------------------------------------------------

    (B) Demonstrate to the satisfaction of the banking organization's 
primary Federal supervisor that following redemption, the banking 
organization would continue to hold an amount of capital that is 
commensurate with its risk.
    (6) The holder of the instrument must have no contractual right to 
accelerate payment of principal or interest on the instrument, except 
in the event of a receivership, insolvency, liquidation, or similar 
proceeding of the banking organization.
    (7) The instrument has no credit-sensitive feature, such as a 
dividend or interest rate that is reset periodically based in whole or 
in part on the banking organization's credit standing, but may have a 
dividend rate that is adjusted periodically independent of the banking 
organization's credit standing, in relation to general market interest 
rates or similar adjustments.
    (8) The banking organization, or an entity that the banking 
organization controls, has not purchased and has not directly or 
indirectly funded the purchase of the instrument.
    (9) If the instrument is not issued directly by the banking 
organization or by a subsidiary of the banking organization that is an 
operating entity, the only asset of the issuing entity is its 
investment in the capital of the banking organization, and proceeds 
must be immediately available without limitation to the banking 
organization or the banking organization's top-tier holding company in 
a form that meets or exceeds all the other criteria for tier 2 capital 
instruments under this section.\64\
---------------------------------------------------------------------------

    \64\ De minimis assets related to the operation of the issuing 
entity can be disregarded for purposes of this criterion.
---------------------------------------------------------------------------

    (10) Redemption of the instrument prior to maturity or repurchase 
requires

[[Page 55369]]

the prior approval of the banking organization's primary Federal 
supervisor.
    (11) For an advanced approaches banking organization, the governing 
agreement, offering circular, or prospectus of an instrument issued 
after January 1, 2013, must disclose that the holders of the instrument 
may be fully subordinated to interests held by the U.S. government in 
the event that the banking organization enters into a receivership, 
insolvency, liquidation, or similar proceeding.
    The agencies also proposed to eliminate the inclusion of a portion 
of certain unrealized gains on AFS equity securities in tier 2 capital 
given that unrealized gains and losses on AFS securities would flow 
through to common equity tier 1 capital under the proposed rules.
    As a result of the proposed new minimum common equity tier 1 
capital requirement, higher tier 1 capital requirement, and the broader 
goal of simplifying the definition of tier 2 capital, the proposal 
eliminated the existing limitations on the amount of tier 2 capital 
that could be recognized in total capital, as well as the existing 
limitations on the amount of certain capital instruments (that is, term 
subordinated debt) that could be included in tier 2 capital.
    Finally, the agencies proposed to allow an instrument that 
qualified as tier 2 capital under the general risk-based capital rules 
and that was issued under the Small Business Jobs Act of 2010,\65\ or, 
prior to October 4, 2010, under the Emergency Economic Stabilization 
Act of 2008, to continue to be includable in tier 2 capital regardless 
of whether it met all of the proposed qualifying criteria.
---------------------------------------------------------------------------

    \65\ Public Law 111-240, 124 Stat. 2504 (2010).
---------------------------------------------------------------------------

    Several commenters addressed the proposed eligibility criteria for 
tier 2 capital. A few banking industry commenters asked the agencies to 
clarify criterion (2) above to provide that trade creditors are not 
among the class of senior creditors whose claims rank ahead of 
subordinated debt holders. In response to these comments, the FDIC 
notes that the intent of the final rule, with its requirement that tier 
2 capital instruments be subordinated to depositors and general 
creditors, is to effectively retain the subordination standards for the 
tier 2 capital subordinated debt under the general risk-based capital 
rules. Therefore, the FDIC is clarifying that under the interim final 
rule, and consistent with the FDIC's general risk-based capital rules, 
subordinated debt instruments that qualify as tier 2 capital must be 
subordinated to general creditors, which generally means senior 
indebtedness, excluding trade creditors. Such creditors include at a 
minimum all borrowed money, similar obligations arising from off-
balance sheet guarantees and direct-credit substitutes, and obligations 
associated with derivative products such as interest rate and foreign-
exchange contracts, commodity contracts, and similar arrangements, and, 
in addition, for depository institutions, depositors.
    In addition, one commenter noted that while many existing banking 
organizations' subordinated debt indentures contain subordination 
provisions, they may not explicitly include a subordination provision 
with respect to ``general creditors'' of the banking organization. 
Thus, they recommended that this aspect of the rules be modified to 
have only prospective application. The FDIC notes that if it is clear 
from an instrument's governing agreement, offering circular, or 
prospectus, that the instrument is subordinated to general creditors 
despite not specifically stating ``general creditors,'' criterion (2) 
above is satisfied (that is, criterion (2) should not be read to mean 
that the phrase ``general creditors'' must appear in the instrument's 
governing agreement, offering circular, or prospectus, as the case may 
be).
    One commenter also asked whether a debt instrument that 
automatically converts to an equity instrument within five years of 
issuance, and that satisfies all criteria for tier 2 instruments other 
than the five-year maturity requirement, would qualify as tier 2 
capital. The FDIC notes that because such an instrument would 
automatically convert to a permanent form of regulatory capital, the 
five-year maturity requirement would not apply and, thus, it would 
qualify as tier 2 capital. The FDIC has clarified the interim final 
rule in this respect.
    Commenters also expressed concern about the impact of a number of 
the proposed criteria on outstanding TruPS. For example, commenters 
stated that a strict reading of criterion (3) above could exclude 
certain TruPS under which the banking organization guarantees that any 
payments made by the banking organization to the trust will be used by 
the trust to pay its obligations to security holders. However, the 
proposed rule would not have disqualified an instrument with this type 
of guarantee, which does not enhance or otherwise alter the 
subordination level of an instrument. Additionally, the commenters 
asked the agencies to allow in tier 2 capital instruments that provide 
for default and the acceleration of principal and interest if the 
issuer banking organization defers interest payments for five 
consecutive years. Commenters stated that these exceptions would be 
necessary to accommodate existing TruPS, which generally include such 
call, default and acceleration features.
    Commenters also asked the agencies to clarify the use of the term 
``secured'' in criterion (3). As discussed above with respect to the 
criteria for additional tier 1 capital, a ``secured'' instrument is an 
instrument where payments on the instrument are secured by collateral. 
Therefore, under criterion (3), a collateralized instrument will not 
qualify as tier 2 capital. Instruments secured by collateral are less 
able to absorb losses than instruments without such enhancement.
    With respect to subordinated debt instruments included in tier 2 
capital, a commenter recommended eliminating criterion (4)'s proposed 
five-year amortization requirement, arguing that that it was 
unnecessary given other capital planning requirements that banking 
organizations must satisfy. The FDIC declined to adopt the commenter's 
recommendation, as it believes that the proposed amortization schedule 
results in a more accurate reflection of the loss-absorbency of an 
FDIC-supervised institution's tier 2 capital. The FDIC notes that if an 
FDIC-supervised institution begins deferring interest payments on a 
TruPS instrument included in tier 2 capital, such an instrument will be 
treated as having a maturity of five years at that point and the FDIC-
supervised institution must begin excluding the appropriate amount of 
the instrument from capital in accordance with section 324.20(d)(1)(iv) 
of the interim final rule.
    Similar to the comments received on the criteria for additional 
tier 1 capital, commenters asked the agencies to add exceptions to the 
prohibition against call options that could be exercised within five 
years of the issuance of a capital instrument, specifically for an 
``investment company event'' and a ``rating agency event.''
    Although the FDIC declined to permit instruments that include 
acceleration provisions in tier 2 capital in the interim final rule, 
the FDIC believes that the inclusion in tier 2 capital of existing 
TruPS, which allow for acceleration after five years of interest 
deferral, does not raise safety and soundness concerns. Although the 
majority of existing TruPS would not technically comply with the 
interim final rule's tier 2 eligibility criteria, the FDIC acknowledges 
that the

[[Page 55370]]

inclusion of existing TruPS in tier 2 capital (until they are redeemed 
or they mature) would benefit certain FDIC-supervised institutions 
until they are able to replace such instruments with new capital 
instruments that fully comply with the eligibility criteria of the 
interim final rule.
    As with additional tier 1 capital instruments, the interim final 
rule permits an FDIC-supervised institution to call an instrument prior 
to five years after issuance in the event that the issuing entity is 
required to register with the SEC as an investment company pursuant to 
the Investment Company Act of 1940, for the reasons discussed above 
with respect to additional tier 1 capital. Also for the reasons 
discussed above with respect to additional tier 1 capital instruments, 
the FDIC has decided not to permit an FDIC-supervised institution to 
include in its tier 2 capital an instrument issued on or after the 
effective date of the interim final rule that may be called prior to 
five years after its issuance upon the occurrence of a rating agency 
event. However, the FDIC has decided to allow such an instrument to be 
included in tier 2 capital, provided that the instrument was issued and 
included in an FDIC-supervised institution's tier 1 or tier 2 capital 
prior to January 1, 2014, and that such instrument meets all other 
criteria for tier 2 capital instruments under the interim final rule.
    In addition, similar to the comment above with respect to the 
proposed criteria for additional tier 1 capital instruments, commenters 
noted that the proposed criterion that a banking organization seek 
prior approval from its primary Federal supervisor before exercising a 
call option is redundant with the requirement that a banking 
organization seek prior approval before reducing regulatory capital by 
redeeming a capital instrument. Again, the FDIC believes that this 
proposed requirement restates and clarifies existing requirements 
without adding any new substantive restrictions, and that it will help 
to ensure that the regulatory capital rules provide FDIC-supervised 
institutions with a complete list of the requirements applicable to 
their regulatory capital instruments. Therefore, the FDIC is retaining 
the requirement as proposed.
    Under the proposal, an advanced approaches banking organization may 
include in tier 2 capital the excess of its eligible credit reserves 
over expected credit loss (ECL) to the extent that such amount does not 
exceed 0.6 percent of credit risk-weighted assets, rather than 
including the amount of ALLL described above. Commenters asked the 
agencies to clarify whether an advanced approaches banking organization 
that is in parallel run includes in tier 2 capital its ECL or ALLL (as 
described above). To clarify, for purposes of the interim final rule, 
an advanced approaches FDIC-supervised institution will always include 
in total capital its ALLL up to 1.25 percent of (non-market risk) risk-
weighted assets when measuring its total capital relative to 
standardized risk-weighted assets. When measuring its total capital 
relative to its advanced approaches risk-weighted assets, as described 
in section 324.10(c)(3)(ii) of the interim final rule, an advanced 
approaches FDIC-supervised institution that has completed the parallel 
run process and that has received notification from the FDIC pursuant 
to section 324.121(d) of subpart E must adjust its total capital to 
reflect its excess eligible credit reserves rather than its ALLL.
    Some commenters recommended that the agencies remove the limit on 
the amount of the ALLL includable in regulatory capital. Specifically, 
one commenter recommended allowing banking organizations to include 
ALLL in tier 1 capital equal to an amount of up to 1.25 percent of 
total risk-weighted assets, with the balance in tier 2 capital, so that 
the entire ALLL would be included in regulatory capital. Moreover, some 
commenters recommended including in tier 2 capital the entire amount of 
reserves held for residential mortgage loans sold with recourse, given 
that the proposal would require a 100 percent credit conversion factor 
for such loans. Consistent with the ALLL treatment under the general 
risk-based capital rules, for purposes of the interim final rule the 
FDIC has elected to permit only limited amounts of the ALLL in tier 2 
capital given its limited purpose of covering incurred rather than 
unexpected losses. For similar reasons, the FDIC has further elected 
not to recognize in tier 2 capital reserves held for residential 
mortgage loans sold with recourse.
    As described above, an FDIC-supervised institution that has made an 
AOCI opt-out election may incorporate up to 45 percent of any net 
unrealized gains on AFS preferred stock classified as an equity 
security under GAAP and AFS equity exposures into its tier 2 capital.
    After reviewing the comments received on this issue, the FDIC has 
determined to finalize the criteria for tier 2 capital instruments to 
include the aforementioned changes. The revised criteria for inclusion 
in tier 2 capital are set forth in section 324.20(d)(1) of the interim 
final rule.
4. Capital Instruments of Mutual FDIC-Supervised Institutions
    Under the proposed rule, the qualifying criteria for common equity 
tier 1, additional tier 1, and tier 2 capital generally would apply to 
mutual banking organizations. Mutual banking organizations and industry 
groups representing mutual banking organizations encouraged the 
agencies to expand the qualifying criteria for additional tier 1 
capital to recognize certain cumulative instruments. These commenters 
stressed that mutual banking organizations, which do not issue common 
stock, have fewer options for raising regulatory capital relative to 
other types of banking organizations.
    The FDIC does not believe that cumulative instruments are able to 
absorb losses sufficiently reliably to be included in tier 1 capital. 
Therefore, after considering these comments, the FDIC has decided not 
to include in tier 1 capital under the interim final rule any 
cumulative instrument. This would include any previously-issued mutual 
capital instrument that was included in the tier 1 capital of mutual 
FDIC-supervised institutions under the general risk-based capital 
rules, but that does not meet the eligibility requirements for tier 1 
capital under the interim final rule. These cumulative capital 
instruments will be subject to the transition provisions and phased out 
of the tier 1 capital of mutual FDIC-supervised institutions over time, 
as set forth in Table 9 of section 324.300 in the interim final rule. 
However, if a mutual FDIC-supervised institution develops a new capital 
instrument that meets the qualifying criteria for regulatory capital 
under the interim final rule, such an instrument may be included in 
regulatory capital with the prior approval of the FDIC under section 
324.20(e) of the interim final rule.
    The FDIC notes that the qualifying criteria for regulatory capital 
instruments under the interim final rule permit mutual FDIC-supervised 
institutions to include in regulatory capital many of their existing 
regulatory capital instruments (for example, non-withdrawable accounts, 
pledged deposits, or mutual capital certificates). The FDIC believes 
that the quality and quantity of regulatory capital currently 
maintained by most mutual FDIC-supervised institutions should be 
sufficient to satisfy the requirements of the interim final rule. For 
those organizations that do not currently hold enough capital to meet 
the revised minimum requirements, the transition arrangements are 
designed to ease the

[[Page 55371]]

burden of increasing regulatory capital over time.
5. Grandfathering of Certain Capital Instruments
    As described above, a substantial number of commenters objected to 
the proposed phase-out of non-qualifying capital instruments, including 
TruPS and cumulative perpetual preferred stock, from tier 1 capital. 
Community FDIC-supervised institutions in particular expressed concerns 
that the costs related to the replacement of such capital instruments, 
which they generally characterized as safe and loss-absorbent, would be 
excessive and unnecessary. Commenters noted that the proposal was more 
restrictive than section 171 of the Dodd-Frank Act, which requires the 
phase-out of non-qualifying capital instruments issued prior to May 19, 
2010, only for depository institution holding companies with $15 
billion or more in total consolidated assets as of December 31, 2009. 
Commenters argued that the agencies were exceeding Congressional intent 
by going beyond what was required under the Dodd-Frank Act Commenters 
requested that the agencies grandfather existing TruPS and cumulative 
perpetual preferred stock issued by depository institution holding 
companies with less than $15 billion and 2010 MHCs.
    Although the FDIC continues to believe that TruPS are not 
sufficiently loss-absorbing to be includable in tier 1 capital as a 
general matter, the FDIC is also sensitive to the difficulties 
community banking organizations often face when issuing new capital 
instruments and are aware of the importance their capacity to lend 
plays in local economies. Therefore the FDIC has decided in the interim 
final rule to grandfather such non-qualifying capital instruments in 
tier 1 capital subject to a limit of 25 percent of tier 1 capital 
elements excluding any non-qualifying capital instruments and after all 
regulatory capital deductions and adjustments applied to tier 1 
capital, which is substantially similar to the limit in the general 
risk-based capital rules. In addition, the FDIC acknowledges that the 
inclusion of existing TruPS in tier 2 capital would benefit certain 
FDIC-supervised institutions until they are able to replace such 
instruments with new capital instruments that fully comply with the 
eligibility criteria of the interim final rule.
6. Agency Approval of Capital Elements
    The agencies noted in the proposal that they believe most existing 
regulatory capital instruments will continue to be includable in 
banking organizations' regulatory capital. However, over time, capital 
instruments that are equivalent in quality and capacity to absorb 
losses to existing instruments may be created to satisfy different 
market needs. Therefore, the agencies proposed to create a process to 
consider the eligibility of such instruments on a case-by-case basis. 
Under the proposed rule, a banking organization must request approval 
from its primary Federal supervisor before including a capital element 
in regulatory capital, unless: (i) such capital element is currently 
included in regulatory capital under the agencies' general risk-based 
capital and leverage rules and the underlying instrument complies with 
the applicable proposed eligibility criteria for regulatory capital 
instruments; or (ii) the capital element is equivalent, in terms of 
capital quality and ability to absorb losses, to an element described 
in a previous decision made publicly available by the banking 
organization's primary Federal supervisor.
    In the preamble to the proposal, the agencies indicated that they 
intend to consult each other when determining whether a new element 
should be included in common equity tier 1, additional tier 1, or tier 
2 capital, and indicated that once one agency determines that a capital 
element may be included in a banking organization's common equity tier 
1, additional tier 1, or tier 2 capital, that agency would make its 
decision publicly available, including a brief description of the 
capital element and the rationale for the conclusion.
    The FDIC continues to believe that it is appropriate to retain the 
flexibility necessary to consider new instruments on a case-by-case 
basis as they are developed over time to satisfy different market 
needs. The FDIC has decided to move its authority in section 20(e)(1) 
of the proposal to the its reservation of authority provision included 
in section 324.1(d)(2)(ii) of the interim final rule. Therefore, the 
FDIC is adopting this aspect of the interim final rule substantively as 
proposed to create a process to consider the eligibility of such 
instruments on a permanent or temporary basis, in accordance with the 
applicable requirements in subpart C of the interim final rule (section 
324.20(e) of the interim final rule).
    Section 324.20(e)(1) of the interim final rule provides that an 
FDIC-supervised institution must receive FDIC's prior approval to 
include a capital element in its common equity tier 1 capital, 
additional tier 1 capital, or tier 2 capital unless that element: (i) 
was included in the FDIC-supervised institution's tier 1 capital or 
tier 2 capital prior to May 19, 2010 in accordance with that 
supervisor's risk-based capital rules that were effective as of that 
date and the underlying instrument continues to be includable under the 
criteria set forth in this section; or (ii) is equivalent, in terms of 
capital quality and ability to absorb credit losses with respect to all 
material terms, to a regulatory capital element determined by that 
supervisor to be includable in regulatory capital pursuant to paragraph 
(e)(3) of section 324.20. In exercising this reservation of authority, 
the FDIC expects to consider the requirements for capital elements in 
the interim final rule; the size, complexity, risk profile, and scope 
of operations of the FDIC-supervised institution, and whether any 
public benefits would be outweighed by risk to an insured depository 
institution or to the financial system.
7. Addressing the Point of Non-Viability Requirements Under Basel III
    During the recent financial crisis, the United States and foreign 
governments lent to, and made capital investments in, banking 
organizations. These investments helped to stabilize the recipient 
banking organizations and the financial sector as a whole. However, 
because of the investments, the recipient banking organizations' 
existing tier 2 capital instruments, and (in some cases) tier 1 capital 
instruments, did not absorb the banking organizations' credit losses 
consistent with the purpose of regulatory capital. At the same time, 
taxpayers became exposed to potential losses.
    On January 13, 2011, the BCBS issued international standards for 
all additional tier 1 and tier 2 capital instruments issued by 
internationally-active banking organizations to ensure that such 
regulatory capital instruments fully absorb losses before taxpayers are 
exposed to such losses (the Basel non-viability standard). Under the 
Basel non-viability standard, all non-common stock regulatory capital 
instruments issued by an internationally-active banking organization 
must include terms that subject the instruments to write-off or 
conversion to common equity at the point at which either: (1) the 
write-off or conversion of those instruments occurs; or (2) a public 
sector injection of capital would be necessary to keep the banking 
organization solvent. Alternatively, if the governing jurisdiction of 
the banking organization has established laws that require such tier 1 
and tier 2

[[Page 55372]]

capital instruments to be written off or otherwise fully absorb losses 
before taxpayers are exposed to loss, the standard is already met. If 
the governing jurisdiction has such laws in place, the Basel non-
viability standard states that documentation for such instruments 
should disclose that information to investors and market participants, 
and should clarify that the holders of such instruments would fully 
absorb losses before taxpayers are exposed to loss.\66\
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    \66\ See ``Final Elements of the Reforms to Raise the Quality of 
Regulatory Capital'' (January 2011), available at: http://www.bis.org/press/p110113.pdf.
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    U.S. law is consistent with the Basel non-viability standard. The 
resolution regime established in Title II, section 210 of the Dodd-
Frank Act provides the FDIC with the authority necessary to place 
failing financial companies that pose a significant risk to the 
financial stability of the United States into receivership.\67\ The 
Dodd-Frank Act provides that this authority shall be exercised in a 
manner that minimizes systemic risk and moral hazard, so that (1) 
creditors and shareholders will bear the losses of the financial 
company; (2) management responsible for the condition of the financial 
company will not be retained; and (3) the FDIC and other appropriate 
agencies will take steps necessary and appropriate to ensure that all 
parties, including holders of capital instruments, management, 
directors, and third parties having responsibility for the condition of 
the financial company, bear losses consistent with their respective 
ownership or responsibility.\68\ Section 11 of the Federal Deposit 
Insurance Act has similar provisions for the resolution of depository 
institutions.\69\ Additionally, under U.S. bankruptcy law, regulatory 
capital instruments issued by a company would absorb losses in 
bankruptcy before instruments held by more senior unsecured creditors.
---------------------------------------------------------------------------

    \67\ See 12 U.S.C. 5384.
    \68\ See 12 U.S.C. 5384.
    \69\ 12 U.S.C. 1821.
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    Consistent with the Basel non-viability standard, under the 
proposal, additional tier 1 and tier 2 capital instruments issued by 
advanced approaches banking organizations after the date on which such 
organizations would have been required to comply with any interim final 
rule would have been required to include a disclosure that the holders 
of the instrument may be fully subordinated to interests held by the 
U.S. government in the event that the banking organization enters into 
a receivership, insolvency, liquidation, or similar proceeding. The 
FDIC is adopting this provision of the proposed rule without change.
8. Qualifying Capital Instruments Issued by Consolidated Subsidiaries 
of an FDIC-Supervised Institution
    As highlighted during the recent financial crisis, capital issued 
by consolidated subsidiaries and not owned by the parent banking 
organization (minority interest) is available to absorb losses at the 
subsidiary level, but that capital does not always absorb losses at the 
consolidated level. Accordingly, and consistent with Basel III, the 
proposed rule revised limitations on the amount of minority interest 
that may be included in regulatory capital at the consolidated level to 
prevent highly capitalized subsidiaries from overstating the amount of 
capital available to absorb losses at the consolidated organization.
    Under the proposal, minority interest would have been classified as 
a common equity tier 1, tier 1, or total capital minority interest 
depending on the terms of the underlying capital instrument and on the 
type of subsidiary issuing such instrument. Any instrument issued by a 
consolidated subsidiary to third parties would have been required to 
satisfy the qualifying criteria under the proposal to be included in 
the banking organization's common equity tier 1, additional tier 1, or 
tier 2 capital, as appropriate. In addition, common equity tier 1 
minority interest would have been limited to instruments issued by a 
depository institution or a foreign bank that is a consolidated 
subsidiary of a banking organization.
    The proposed limits on the amount of minority interest that could 
have been included in the consolidated capital of a banking 
organization would have been based on the amount of capital held by the 
consolidated subsidiary, relative to the amount of capital the 
subsidiary would have had to hold to avoid any restrictions on capital 
distributions and discretionary bonus payments under the capital 
conservation buffer framework. For example, a subsidiary with a common 
equity tier 1 capital ratio of 8 percent that needs to maintain a 
common equity tier 1 capital ratio of more than 7 percent to avoid 
limitations on capital distributions and discretionary bonus payments 
would have been considered to have ``surplus'' common equity tier 1 
capital and, at the consolidated level, the banking organization would 
not have been able to include the portion of such surplus common equity 
tier 1 capital that is attributable to third party investors.
    In general, the amount of common equity tier 1 minority interest 
that could have been included in the common equity tier 1 capital of a 
banking organization under the proposal would have been equal to:
    (i) The common equity tier 1 minority interest of the subsidiary 
minus
    (ii) The ratio of the subsidiary's common equity tier 1 capital 
owned by third parties to the total common equity tier 1 capital of the 
subsidiary, multiplied by the difference between the common equity tier 
1 capital of the subsidiary and the lower of:
    (1) the amount of common equity tier 1 capital the subsidiary must 
hold to avoid restrictions on capital distributions and discretionary 
bonus payments, or
    (2)(a) the standardized total risk-weighted assets of the banking 
organization that relate to the subsidiary, multiplied by
    (b) The common equity tier 1 capital ratio needed by the banking 
organization subsidiary to avoid restrictions on capital distributions 
and discretionary bonus payments.
    If a subsidiary were not subject to the same minimum regulatory 
capital requirements or capital conservation buffer framework as the 
banking organization, the banking organization would have needed to 
assume, for the purposes of the calculation described above, that the 
subsidiary is in fact subject to the same minimum capital requirements 
and the same capital conservation buffer framework as the banking 
organization.
    To determine the amount of tier 1 minority interest that could be 
included in the tier 1 capital of the banking organization and the 
total capital minority interest that could be included in the total 
capital of the banking organization, a banking organization would 
follow the same methodology as the one outlined previously for common 
equity tier 1 minority interest. The proposal set forth sample 
calculations. The amount of tier 1 minority interest that could have 
been included in the additional tier 1 capital of a banking 
organization under the proposal was equivalent to the banking 
organization's tier 1 minority interest, subject to the limitations 
outlined above, less any common equity tier 1 minority interest 
included in the banking organization's common equity tier 1 capital. 
Likewise, the amount of total capital minority interest that could have 
been included in the tier 2 capital of the banking organization was 
equivalent to its total capital minority interest, subject to the 
limitations outlined above, less any tier

[[Page 55373]]

1 minority interest that is included in the banking organization's tier 
1 capital.
    Under the proposal, minority interest related to qualifying common 
or noncumulative perpetual preferred stock directly issued by a 
consolidated U.S. depository institution or foreign bank subsidiary, 
which is eligible for inclusion in tier 1 capital under the general 
risk-based capital rules without limitation, generally would qualify 
for inclusion in common equity tier 1 and additional tier 1 capital, 
respectively, subject to the proposed limits. However, under the 
proposal, minority interest related to qualifying cumulative perpetual 
preferred stock directly issued by a consolidated U.S. depository 
institution or foreign bank subsidiary, which is eligible for limited 
inclusion in tier 1 capital under the general risk-based capital rules, 
generally would not have qualified for inclusion in additional tier 1 
capital under the proposal.
    A number of commenters addressed the proposed limits on the 
inclusion of minority interest in regulatory capital. Commenters 
generally asserted that the proposed methodology for calculating the 
amount of minority interest that could be included in regulatory 
capital was overly complex, overly conservative, and would reduce 
incentives for bank subsidiaries to issue capital to third-party 
investors. Several commenters suggested that the agencies should adopt 
a more straightforward and simple approach that would provide a single 
blanket limitation on the amount of minority interest includable in 
regulatory capital. For example, one commenter suggested allowing a 
banking organization to include minority interest equal to 18 percent 
of common equity tier 1 capital. Another commenter suggested that 
minority interest where shareholders have commitments to provide 
additional capital, as well as minority interest in joint ventures 
where there are guarantees or other credit enhancements, should not be 
subject to the proposed limitations.
    Commenters also objected to any limitations on the amount of 
minority interest included in the regulatory capital of a parent 
banking organization attributable to instruments issued by a subsidiary 
when the subsidiary is a depository institution. These commenters 
stated that restricting such minority interest could create a 
disincentive for depository institutions to issue capital instruments 
directly or to maintain capital at levels substantially above 
regulatory minimums. To address this concern, commenters asked the 
agencies to consider allowing a depository institution subsidiary to 
consider a portion of its capital above its minimum as not being part 
of its ``surplus'' capital for the purpose of calculating the minority 
interest limitation. Alternatively, some commenters suggested allowing 
depository institution subsidiaries to calculate surplus capital 
independently for each component of capital.
    Several commenters also addressed the proposed minority interest 
limitation as it would apply to subordinated debt issued by a 
depository institution. Generally, these commenters stated that the 
proposed minority interest limitation either should not apply to such 
subordinated debt, or that the limitation should be more flexible to 
permit a greater amount to be included in the total capital of the 
consolidated organization.
    Finally, some commenters pointed out that the application of the 
proposed calculation for the minority interest limitation was unclear 
in circumstances where a subsidiary depository institution does not 
have ``surplus'' capital. With respect to this comment, the FDIC has 
revised the proposed rule to specifically provide that the minority 
interest limitation will not apply in circumstances where a 
subsidiary's capital ratios are equal to or below the level of capital 
necessary to meet the minimum capital requirements plus the capital 
conservation buffer. That is, in the interim final rule the minority 
interest limitation would apply only where a subsidiary has ``surplus'' 
capital.
    The FDIC continues to believe that the proposed limitations on 
minority interest are appropriate, including for capital instruments 
issued by depository institution subsidiaries, tier 2 capital 
instruments, and situations in which a depository institution holding 
company conducts the majority of its business through a single 
depository institution subsidiary. As noted above, the FDIC's 
experience during the recent financial crisis showed that while 
minority interest generally is available to absorb losses at the 
subsidiary level, it may not always absorb losses at the consolidated 
level. Therefore, the FDIC continues to believe limitations on 
including minority interest will prevent highly-capitalized 
subsidiaries from overstating the amount of capital available to absorb 
losses at the consolidated organization. The increased safety and 
soundness benefits resulting from these limitations should outweigh any 
compliance burden issues related to the complexity of the calculations. 
Therefore, the FDIC is adopting the proposed treatment of minority 
interest without change, except for the clarification described above.
9. Real Estate Investment Trust Preferred Capital
    A real estate investment trust (REIT) is a company that is required 
to invest in real estate and real estate-related assets and make 
certain distributions in order to maintain a tax-advantaged status. 
Some banking organizations have consolidated subsidiaries that are 
REITs, and such REITs may have issued capital instruments included in 
the regulatory capital of the consolidated banking organization as 
minority interest under the general risk-based capital rules.
    Under the general risk-based capital rules, preferred stock issued 
by a REIT subsidiary generally can be included in a banking 
organization's tier 1 capital as minority interest if the preferred 
stock meets the eligibility requirements for tier 1 capital.\70\ The 
agencies interpreted this to require that the REIT-preferred stock be 
exchangeable automatically into noncumulative perpetual preferred stock 
of the banking organization under certain circumstances. Specifically, 
the primary Federal supervisor may direct the banking organization in 
writing to convert the REIT preferred stock into noncumulative 
perpetual preferred stock of the banking organization because the 
banking organization: (1) became undercapitalized under the PCA 
regulations; \71\ (2) was placed into conservatorship or receivership; 
or (3) was expected to become undercapitalized in the near term.\72\
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    \70\ 12 CFR part 325, subpart B.
    \71\ 12 CFR part 325, subpart A (state nonmember banks), and 12 
CFR part 390, subpart Y (state savings associations).
    \72\ 12 CFR part 325, subpart B (state nonmember banks) and 12 
CFR part 390, subpart Y (state savings associations).
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    Under the proposed rule, the limitations described previously on 
the inclusion of minority interest in regulatory capital would have 
applied to capital instruments issued by consolidated REIT 
subsidiaries. Specifically, preferred stock issued by a REIT subsidiary 
that met the proposed definition of an operating entity (as defined 
below) would have qualified for inclusion in the regulatory capital of 
a banking organization subject to the limitations outlined in section 
21 of the proposed rule only if the REIT preferred stock met the 
criteria for additional tier 1 or tier 2 capital instruments outlined 
in section 20 of the proposed rules. Because a REIT must distribute 90 
percent of its earnings to maintain its tax-advantaged status, a 
banking organization might be reluctant to cancel dividends on the REIT 
preferred

[[Page 55374]]

stock. However, for a capital instrument to qualify as additional tier 
1 capital the issuer must have the ability to cancel dividends. In 
cases where a REIT could maintain its tax status, for example, by 
declaring a consent dividend and it has the ability to do so, the 
agencies generally would consider REIT preferred stock to satisfy 
criterion (7) of the proposed eligibility criteria for additional tier 
1 capital instruments.\73\ The FDIC notes that the ability to declare a 
consent dividend need not be included in the documentation of the REIT 
preferred instrument, but the FDIC-supervised institution must provide 
evidence to the relevant banking agency that it has such an ability. 
The FDIC does not expect preferred stock issued by a REIT that does not 
have the ability to declare a consent dividend or otherwise cancel cash 
dividends to qualify as tier 1 minority interest under the interim 
final rule; however, such an instrument could qualify as total capital 
minority interest if it meets all of the relevant tier 2 capital 
eligibility criteria under the interim final rule.
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    \73\ A consent dividend is a dividend that is not actually paid 
to the shareholders, but is kept as part of a company's retained 
earnings, yet the shareholders have consented to treat the dividend 
as if paid in cash and include it in gross income for tax purposes.
---------------------------------------------------------------------------

    Commenters requested clarification on whether a REIT subsidiary 
would be considered an operating entity for the purpose of the interim 
final rule. For minority interest issued from a subsidiary to be 
included in regulatory capital, the subsidiary must be either an 
operating entity or an entity whose only asset is its investment in the 
capital of the parent banking organization and for which proceeds are 
immediately available without limitation to the banking organization. 
Since a REIT has assets that are not an investment in the capital of 
the parent banking organization, minority interest in a REIT subsidiary 
can be included in the regulatory capital of the consolidated parent 
banking organization only if the REIT is an operating entity. For 
purposes of the interim final rule, an operating entity is defined as a 
company established to conduct business with clients with the intention 
of earning a profit in its own right. However, certain REIT 
subsidiaries currently used by FDIC-supervised institutions to raise 
regulatory capital are not actively managed for the purpose of earning 
a profit in their own right, and therefore, will not qualify as 
operating entities for the purpose of the interim final rule. Minority 
interest investments in REIT subsidiaries that are actively managed for 
purposes of earning a profit in their own right will be eligible for 
inclusion in the regulatory capital of the FDIC-supervised institution 
subject to the limits described in section 21 of the interim final 
rule. To the extent that an FDIC-supervised institution is unsure 
whether minority interest investments in a particular REIT subsidiary 
will be includable in the FDIC-supervised institution's regulatory 
capital, the organization should discuss the concern with its primary 
Federal supervisor prior to including any amount of the minority 
interest in its regulatory capital.
    Several commenters objected to the application of the limitations 
on the inclusion of minority interest resulting from noncumulative 
perpetual preferred stock issued by REIT subsidiaries. Commenters noted 
that to be included in the regulatory capital of the consolidated 
parent banking organization under the general risk-based capital rules, 
REIT preferred stock must include an exchange feature that allows the 
REIT preferred stock to absorb losses at the parent banking 
organization through the exchange of REIT preferred instruments into 
noncumulative perpetual preferred stock of the parent banking 
organization. Because of this exchange feature, the commenters stated 
that REIT preferred instruments should be included in the tier 1 
capital of the parent consolidated organization without limitation. 
Alternatively, some commenters suggested that the agencies should allow 
REIT preferred instruments to be included in the tier 2 capital of the 
consolidated parent organization without limitation. Commenters also 
noted that in light of the eventual phase-out of TruPS pursuant to the 
Dodd-Frank Act, REIT preferred stock would be the only tax-advantaged 
means for bank holding companies to raise tier 1 capital. According to 
these commenters, limiting this tax-advantaged option would increase 
the cost of doing business for many banking organizations.
    After considering these comments, the FDIC has decided not to 
create specific exemptions to the limitations on the inclusion of 
minority interest with respect to REIT preferred instruments. As noted 
above, the FDIC believes that the inclusion of minority interest in 
regulatory capital at the consolidated level should be limited to 
prevent highly-capitalized subsidiaries from overstating the amount of 
capital available to absorb losses at the consolidated organization.

B. Regulatory Adjustments and Deductions

1. Regulatory Deductions From Common Equity Tier 1 Capital
    Under the proposal, a banking organization must deduct from common 
equity tier 1 capital elements the items described in section 22 of the 
proposed rule. A banking organization would exclude the amount of these 
deductions from its total risk-weighted assets and leverage exposure. 
This section B discusses the deductions from regulatory capital 
elements as revised for purposes of the interim final rule.
a. Goodwill and Other Intangibles (Other Than Mortgage Servicing 
Assets)
    U.S. federal banking statutes generally prohibit the inclusion of 
goodwill (as it is an ``unidentified intangible asset'') in the 
regulatory capital of insured depository institutions.\74\ Accordingly, 
goodwill and other intangible assets have long been either fully or 
partially excluded from regulatory capital in the United States because 
of the high level of uncertainty regarding the ability of the banking 
organization to realize value from these assets, especially under 
adverse financial conditions.\75\ Under the proposed rule, a banking 
organization was required to deduct from common equity tier 1 capital 
elements goodwill and other intangible assets other than MSAs \76\ net 
of associated deferred tax liabilities (DTLs). For purposes of this 
deduction, goodwill would have included any goodwill embedded in the 
valuation of significant investments in the capital of an 
unconsolidated financial institution in the form of common stock. This 
deduction of embedded goodwill would have applied to investments 
accounted for under the equity method.\77\ Consistent with Basel III, 
these items would have been deducted from common equity tier 1 capital 
elements. MSAs would have been subject to a different treatment under 
Basel III and the proposal, as explained below in this section.
---------------------------------------------------------------------------

    \74\ 12 U.S.C. 1828(n).
    \75\ 54 FR 11500, 11509 (March 21, 1989).
    \76\ Examples of other intangible assets include purchased 
credit card relationships (PCCRs) and non-mortgage servicing assets.
    \77\ Under GAAP, if there is a difference between the initial 
cost basis of the investment and the amount of underlying equity in 
the net assets of the investee, the resulting difference should be 
accounted for as if the investee were a consolidated subsidiary 
(which may include imputed goodwill).
---------------------------------------------------------------------------

    One commenter sought clarification regarding the amount of goodwill 
that must be deducted from common equity tier 1 capital elements when a 
banking organization has an investment in the

[[Page 55375]]

capital of an unconsolidated financial institution that is accounted 
for under the equity method of accounting under GAAP. The FDIC has 
revised section 22(a)(1) in the interim final rule to clarify that it 
is the amount of goodwill that is embedded in the valuation of a 
significant investment in the capital of an unconsolidated financial 
institution in the form of common stock that is accounted for under the 
equity method, and reflected in the consolidated financial statements 
of the FDIC-supervised institution that an FDIC-supervised institution 
must deduct from common equity tier 1 capital elements.
    Another commenter requested clarification regarding the amount of 
embedded goodwill that a banking organization would be required to 
deduct where there are impairments to the embedded goodwill subsequent 
to the initial investment. The FDIC notes that, for purposes of the 
interim final rule, an FDIC-supervised institution must deduct from 
common equity tier 1 capital elements any embedded goodwill in the 
valuation of significant investments in the capital of an 
unconsolidated financial institution in the form of common stock net of 
any related impairments (subsequent to the initial investment) as 
determined under GAAP, not the goodwill reported on the balance sheet 
of the unconsolidated financial institution.
    The proposal did not include a transition period for the 
implementation of the requirement to deduct goodwill from common equity 
tier 1 capital. A number of commenters expressed concern that this 
could disadvantage U.S. banking organizations relative to those in 
jurisdictions that permit such a transition period. The FDIC notes that 
section 221 of FIRREA (12 U.S.C. 1828(n)) requires all unidentifiable 
intangible assets (goodwill) acquired after April 12, 1989, to be 
deducted from an FDIC-supervised institution's capital elements. The 
only exception to this requirement, permitted under 12 U.S.C. 1464(t) 
(applicable to Federal savings association), has expired. Therefore, 
consistent with the requirements of section 221 of FIRREA and the 
general risk-based capital rules, the FDIC believes that it is not 
appropriate to permit any goodwill to be included in an FDIC-supervised 
institution's capital. The interim final rule does not include a 
transition period for the deduction of goodwill.
b. Gain-on-sale Associated With a Securitization Exposure
    Under the proposal, a banking organization would deduct from common 
equity tier 1 capital elements any after-tax gain-on-sale associated 
with a securitization exposure. Under the proposal, gain-on-sale was 
defined as an increase in the equity capital of a banking organization 
resulting from a securitization (other than an increase in equity 
capital resulting from the banking organization's receipt of cash in 
connection with the securitization).
    A number of commenters requested clarification that the proposed 
deduction for gain-on-sale would not require a double deduction for 
MSAs. According to the commenters, a sale of loans to a securitization 
structure that creates a gain may include an MSA that also meets the 
proposed definition of ``gain-on-sale.'' The FDIC agrees that a double 
deduction for MSAs is not required, and the interim final rule 
clarifies in the definition of ``gain-on-sale'' that a gain-on-sale 
excludes any portion of the gain that was reported by the FDIC-
supervised institution as an MSA. The FDIC also notes that the 
definition of gain-on-sale was intended to relate only to gains 
associated with the sale of loans for the purpose of traditional 
securitization. Thus, the definition of gain-on-sale has been revised 
in the interim final rule to mean an increase in common equity tier 1 
capital of the FDIC-supervised institution resulting from a traditional 
securitization except where such an increase results from the FDIC-
supervised institution's receipt of cash in connection with the 
securitization or initial recognition of an MSA.
c. Defined Benefit Pension Fund Net Assets
    For banking organizations other than insured depository 
institutions, the proposal required the deduction of a net pension fund 
asset in calculating common equity tier 1 capital. A banking 
organization was permitted to make such deduction net of any associated 
DTLs. This deduction would be required where a defined benefit pension 
fund is over-funded due to the high level of uncertainty regarding the 
ability of the banking organization to realize value from such assets.
    The proposal provided that, with supervisory approval, a banking 
organization would not have been required to deduct defined benefit 
pension fund assets to which the banking organization had unrestricted 
and unfettered access.\78\ In this case, the proposal established that 
the banking organization would have assigned to such assets the risk 
weight they would receive if the assets underlying the plan were 
directly owned and included on the balance sheet of the banking 
organization. The proposal set forth that unrestricted and unfettered 
access would mean that a banking organization would not have been 
required to request and receive specific approval from pension 
beneficiaries each time it accessed excess funds in the plan.
---------------------------------------------------------------------------

    \78\ The FDIC has unfettered access to the pension fund assets 
of an insured depository institution's pension plan in the event of 
receivership; therefore, the FDIC determined that an insured 
depository institution would not be required to deduct a net pension 
fund asset.
---------------------------------------------------------------------------

    One commenter asked whether shares of a banking organization that 
are owned by the banking organization's pension fund are subject to 
deduction. The FDIC notes that the interim final rule does not require 
deduction of banking organization shares owned by the pension fund. 
Another commenter asked for clarification regarding the treatment of an 
overfunded pension asset at an insured depository institution if the 
pension plan sponsor is the parent BHC. The FDIC clarifies that the 
requirement to deduct a defined benefit pension plan net asset is not 
dependent upon the sponsor of the plan; rather it is dependent upon 
whether the net pension fund asset is an asset of an insured depository 
institution. The agencies also received questions regarding the 
appropriate risk-weight treatment for a pension fund asset. As 
discussed above, with the prior agency approval, a banking organization 
that is not an insured depository institution may elect to not deduct 
any defined benefit pension fund net asset to the extent such banking 
organization has unrestricted and unfettered access to the assets in 
that defined benefit pension fund. Any portion of the defined benefit 
pension fund net asset that is not deducted by the banking organization 
must be risk-weighted as if the banking organization directly holds a 
proportional ownership share of each exposure in the defined benefit 
pension fund. For example, if the banking organization has a defined 
benefit pension fund net asset of $10 and it has unfettered and 
unrestricted access to the assets of defined benefit pension fund, and 
assuming 20 percent of the defined benefit pension fund is composed of 
assets that are risk-weighted at 100 percent and 80 percent is composed 
of assets that are risk-weighted at 300 percent, the banking 
organization would risk weight $2 at 100 percent and $8 at 300 percent. 
This treatment is consistent with the full look-through approach 
described in section 53(b) of the interim final rule. If the defined 
benefit pension fund invests in the capital of a financial institution, 
including an investment in the banking organization's own capital

[[Page 55376]]

instruments, the banking organization would risk weight the 
proportional share of such exposure in accordance with the treatment 
under subparts D or E, as appropriate.
    The FDIC is adopting as final this section of the proposal with the 
changes described above.
d. Expected Credit Loss That Exceeds Eligible Credit Reserves
    The proposal required an advanced approaches banking organization 
to deduct from common equity tier 1 capital elements the amount of 
expected credit loss that exceeds the banking organization's eligible 
credit reserves.
    Commenters sought clarification that the proposed deduction would 
not apply for advanced approaches banking organizations that have not 
received the approval of their primary Federal supervisor to exit 
parallel run. The FDIC agrees that the deduction would not apply to 
FDIC-supervised institutions that have not received approval from their 
primary Federal supervisor to exit parallel run. In response, the FDIC 
has revised this provision of the interim final rule to apply to an 
FDIC-supervised institution subject to subpart E of the interim final 
rule that has completed the parallel run process and that has received 
notification from the FDIC under section 324.121(d) of the advanced 
approaches rule.
e. Equity Investments in Financial Subsidiaries
    Section 121 of the Gramm-Leach-Bliley Act allows national banks and 
insured state banks to establish entities known as financial 
subsidiaries.\79\ One of the statutory requirements for establishing a 
financial subsidiary is that a national bank or insured state bank must 
deduct any investment in a financial subsidiary from the depository 
institution's assets and tangible equity.\80\ The FDIC implemented this 
statutory requirement through regulation at 12 CFR 362.18.
---------------------------------------------------------------------------

    \79\ Public Law 106-102, 113 Stat. 1338, 1373 (Nov. 12, 1999).
    \80\ 12 U.S.C. 24a(c); 12 U.S.C. 1831w(a)(2).
---------------------------------------------------------------------------

    Under section 22(a)(7) of the proposal, investments by an insured 
state bank in financial subsidiaries would be deducted entirely from 
the bank's common equity tier 1 capital.\81\ Because common equity tier 
1 capital is a component of tangible equity, the proposed deduction 
from common equity tier 1 would have automatically resulted in a 
deduction from tangible equity. The FDIC believes that the more 
conservative treatment is appropriate for financial subsidiaries given 
the risks associated with nonbanking activities, and are finalizing 
this treatment as proposed. Therefore, under the interim final rule, an 
FDIC-supervised institution must deduct the aggregate amount of its 
outstanding equity investment in a financial subsidiary, including the 
retained earnings of a subsidiary from common equity tier 1 capital 
elements, and the assets and liabilities of the subsidiary may not be 
consolidated with those of the parent bank.
---------------------------------------------------------------------------

    \81\ The deduction provided for in the FDIC's existing 
regulations would be removed and would exist solely in the interim 
final rule.
---------------------------------------------------------------------------

f. Deduction for Subsidiaries of Savings Associations That Engage in 
Activities That Are Not Permissible for National Banks
    Section 5(t)(5) \82\ of HOLA requires a separate capital 
calculation for state savings associations for ``investments in and 
extensions of credit to any subsidiary engaged in activities not 
permissible for a national bank.'' This statutory provision was 
implemented in the state savings associations' capital rules through a 
deduction from the core (tier 1) capital of the state savings 
association for those subsidiaries that are not ``includable 
subsidiaries.'' The FDIC proposed to continue the general risk-based 
capital treatment of includable subsidiaries, with some technical 
modifications. Aside from those technical modifications, the proposal 
would have transferred, without substantive change, the current general 
regulatory treatment of deducting subsidiary investments where a 
subsidiary is engaged in activities not permissible for a national 
bank. Such treatment is consistent with how a national bank deducts its 
equity investments in financial subsidiaries. The FDIC proposed an 
identical treatment for state savings associations.\83\
---------------------------------------------------------------------------

    \82\ 12 U.S.C. 1464(t)(5).
    \83\ 12 CFR 324.22.
---------------------------------------------------------------------------

    The FDIC received no comments on this proposed deduction. The 
interim final rule adopts the proposal with one change and other minor 
technical edits, consistent with 12 U.S.C. 1464(t)(5), to clarify that 
the required deduction for a state savings association's investment in 
a subsidiary that is engaged in activities not permissible for a 
national bank includes extensions of credit to such a subsidiary.
g. Identified Losses for State Nonmember Banks
    Under its existing capital rules, the FDIC requires state nonmember 
banks to deduct from tier 1 capital elements identified losses to the 
extent that tier 1 capital would have been reduced if the appropriate 
accounting entries had been recorded on the insured depository 
institution's books. Generally, for purposes of these rules, identified 
losses are those items that an examiner from the federal or state 
supervisor for that institution determines to be chargeable against 
income, capital, or general valuation allowances. For example, 
identified losses may include, among other items, assets classified 
loss, off-balance sheet items classified loss, any expenses that are 
necessary for the institution to record in order to replenish its 
general valuation allowances to an adequate level, and estimated losses 
on contingent liabilities.
    The FDIC is revising the interim final rule to clarify that state 
nonmember banks and state savings associations remain subject to its 
long-standing supervisory procedures regarding the deduction of 
identified losses. Therefore, for purposes of the interim final rule, 
such institutions must deduct identified losses from common equity tier 
1 capital elements.
2. Regulatory Adjustments to Common Equity Tier 1 Capital
a. Accumulated Net Gains and Losses on Certain Cash-Flow Hedges
    Consistent with Basel III, under the proposal, a banking 
organization would have been required to exclude from regulatory 
capital any accumulated net gains and losses on cash-flow hedges 
relating to items that are not recognized at fair value on the balance 
sheet.
    This proposed regulatory adjustment was intended to reduce the 
artificial volatility that can arise in a situation in which the 
accumulated net gain or loss of the cash-flow hedge is included in 
regulatory capital but any change in the fair value of the hedged item 
is not. The agencies received a number of comments on this proposed 
regulatory capital adjustment. In general, the commenters noted that 
while the intent of the adjustment is to remove an element that gives 
rise to artificial volatility in common equity, the proposed adjustment 
may actually increase volatility in the measure of common equity tier 1 
capital. These commenters indicated that the proposed adjustment, 
together with the proposed treatment of net unrealized gains and losses 
on AFS debt securities, would create incentives for banking 
organizations to avoid hedges that reduce interest rate risk; shorten 
maturity of their investments in AFS securities; or move their 
investment

[[Page 55377]]

securities portfolio from AFS to HTM. To address these concerns, 
commenters suggested several alternatives, such as including all 
accumulated net gains and losses on cash-flow hedges in common equity 
tier 1 capital to match the proposal to include in common equity tier 1 
capital net unrealized gains and losses on AFS debt securities; 
retaining the provisions in the agencies' general risk-based capital 
rules that exclude most elements of AOCI from regulatory capital; or 
using a principles-based approach to accommodate variations in the 
interest rate management techniques employed by each banking 
organization.
    Under the interim final rule, the FDIC has retained the requirement 
that all FDIC-supervised institutions subject to the advanced 
approaches rule, and those FDIC-supervised institutions that elect to 
include AOCI in common equity tier 1 capital, must subtract from common 
equity tier 1 capital elements any accumulated net gains and must add 
any accumulated net losses on cash-flow hedges included in AOCI that 
relate to the hedging of items that are not recognized at fair value on 
the balance sheet. The FDIC believes that this adjustment removes an 
element that gives rise to artificial volatility in common equity tier 
1 capital as it would avoid a situation in which the changes in the 
fair value of the cash-flow hedge are reflected in capital but the 
changes in the fair value of the hedged item are not.
b. Changes in an FDIC-Supervised Institution's Own Credit Risk
    The proposal provided that a banking organization would not be 
permitted to include in regulatory capital any change in the fair value 
of a liability attributable to changes in the banking organization's 
own credit risk. In addition, the proposal would have required advanced 
approaches banking organizations to deduct the credit spread premium 
over the risk-free rate for derivatives that are liabilities. 
Consistent with Basel III, these provisions were intended to prevent a 
banking organization from recognizing increases in regulatory capital 
resulting from any change in the fair value of a liability attributable 
to changes in the banking organization's own creditworthiness. Under 
the interim final rule, all FDIC-supervised institutions not subject to 
the advanced approaches rule must deduct any cumulative gain from and 
add back to common equity tier 1 capital elements any cumulative loss 
attributed to changes in the value of a liability measured at fair 
value arising from changes in the FDIC-supervised institution's own 
credit risk. This requirement would apply to all liabilities that an 
FDIC-supervised institution must measure at fair value under GAAP, such 
as derivative liabilities, or for which the FDIC-supervised institution 
elects to measure at fair value under the fair value option.\84\
---------------------------------------------------------------------------

    \84\ 825-10-25 (former Financial Accounting Standards Board 
Statement No. 159).
---------------------------------------------------------------------------

    Similarly, advanced approaches FDIC-supervised institutions must 
deduct any cumulative gain from and add back any cumulative loss to 
common equity tier 1 capital elements attributable to changes in the 
value of a liability that the FDIC-supervised institution elects to 
measure at fair value under GAAP. For derivative liabilities, advanced 
approaches FDIC-supervised institutions must implement this requirement 
by deducting the credit spread premium over the risk-free rate.
c. Accumulated Other Comprehensive Income
    Under the agencies' general risk-based capital rules, most of the 
components of AOCI included in a company's GAAP equity are not included 
in an FDIC-supervised institution's regulatory capital. Under GAAP, 
AOCI includes unrealized gains and losses on certain assets and 
liabilities that are not included in net income. Among other items, 
AOCI includes unrealized gains and losses on AFS securities; other than 
temporary impairment on securities reported as HTM that are not credit-
related; cumulative gains and losses on cash-flow hedges; foreign 
currency translation adjustments; and amounts attributed to defined 
benefit post-retirement plans resulting from the initial and subsequent 
application of the relevant GAAP standards that pertain to such plans.
    Under the agencies' general risk-based capital rules, FDIC-
supervised institutions do not include most amounts reported in AOCI in 
their regulatory capital calculations. Instead, they exclude these 
amounts by subtracting unrealized or accumulated net gains from, and 
adding back unrealized or accumulated net losses to, equity capital. 
The only amounts of AOCI included in regulatory capital are unrealized 
losses on AFS equity securities and foreign currency translation 
adjustments, which are included in tier 1 capital. Additionally, FDIC-
supervised institutions may include up to 45 percent of unrealized 
gains on AFS equity securities in their tier 2 capital.
    In contrast, consistent with Basel III, the proposed rule required 
banking organizations to include all AOCI components in common equity 
tier 1 capital elements, except gains and losses on cash-flow hedges 
where the hedged item is not recognized on a banking organization's 
balance sheet at fair value. Unrealized gains and losses on all AFS 
securities would flow through to common equity tier 1 capital elements, 
including unrealized gains and losses on debt securities due to changes 
in valuations that result primarily from fluctuations in benchmark 
interest rates (for example, U.S. Treasuries and U.S. government agency 
debt obligations), as opposed to changes in credit risk.
    In the Basel III NPR, the agencies indicated that the proposed 
regulatory capital treatment of AOCI would better reflect an 
institution's actual risk. In particular, the agencies stated that 
while unrealized gains and losses on AFS debt securities might be 
temporary in nature and reverse over a longer time horizon (especially 
when those gains and losses are primarily attributable to changes in 
benchmark interest rates), unrealized losses could materially affect a 
banking organization's capital position at a particular point in time 
and associated risks should therefore be reflected in its capital 
ratios. In addition, the agencies observed that the proposed treatment 
would be consistent with the common market practice of evaluating a 
firm's capital strength by measuring its tangible common equity, which 
generally includes AOCI.
    However, the agencies also acknowledged that including unrealized 
gains and losses related to debt securities (especially those whose 
valuations primarily change as a result of fluctuations in a benchmark 
interest rate) could introduce substantial volatility in a banking 
organization's regulatory capital ratios. Specifically, the agencies 
observed that for some banking organizations, including unrealized 
losses on AFS debt securities in their regulatory capital calculations 
could mean that fluctuations in a benchmark interest rate could lead to 
changes in their PCA categories from quarter to quarter. Recognizing 
the potential impact of such fluctuations on regulatory capital 
management for some institutions, the agencies described possible 
alternatives to the proposed treatment of unrealized gains and losses 
on AFS debt securities, including an approach that would exclude from 
regulatory capital calculations those unrealized gains and losses that 
are related to AFS debt securities whose valuations primarily change as 
a result of fluctuations in benchmark interest rates, including U.S. 
government and

[[Page 55378]]

agency debt obligations, GSE debt obligations, and other sovereign debt 
obligations that would qualify for a zero percent risk weight under the 
standardized approach.
    A large proportion of commenters addressed the proposed treatment 
of AOCI in regulatory capital. Banking organizations of all sizes, 
banking and other industry groups, public officials (including members 
of the U.S. Congress), and other individuals strongly opposed the 
proposal to include most AOCI components in common equity tier 1 
capital.
    Specifically, commenters asserted that the agencies should not 
implement the proposal and should instead continue to apply the 
existing treatment for AOCI that excludes most AOCI amounts from 
regulatory capital. Several commenters stated that the accounting 
standards that require banking organizations to take a charge against 
earnings (and thus reduce capital levels) to reflect credit-related 
losses as part of other-than-temporary impairments already achieve the 
agencies' goal to create regulatory capital ratios that provide an 
accurate picture of a banking organization's capital position, without 
also including AOCI in regulatory capital. For unrealized gains and 
losses on AFS debt securities that typically result from changes in 
benchmark interest rates rather than changes in credit risk, most 
commenters expressed concerns that the value of such securities on any 
particular day might not be a good indicator of the value of those 
securities for a banking organization, given that the banking 
organization could hold them until they mature and realize the amount 
due in full. Most commenters argued that the inclusion of unrealized 
gains and losses on AFS debt securities in regulatory capital could 
result in volatile capital levels and adversely affect other measures 
tied to regulatory capital, such as legal lending limits, especially if 
and when interest rates rise from their current historically-low 
levels.
    Accordingly, several commenters requested that the agencies permit 
banking organizations to remove from regulatory capital calculations 
unrealized gains and losses on AFS debt securities that have low credit 
risk but experience price movements based primarily on fluctuations in 
benchmark interest rates. According to commenters, these debt 
securities would include securities issued by the United States and 
other stable sovereign entities, U.S. agencies and GSEs, as well as 
some municipal entities. One commenter expressed concern that the 
proposed treatment of AOCI would lead banking organizations to invest 
excessively in securities with low volatility. Some commenters also 
suggested that unrealized gains and losses on high-quality asset-backed 
securities and high-quality corporate securities should be excluded 
from regulatory capital calculations. The commenters argued that these 
adjustments to the proposal would allow regulatory capital to reflect 
unrealized gains or losses related to the credit quality of a banking 
organization's AFS debt securities.
    Additionally, commenters noted that, under the proposal, offsetting 
changes in the value of other items on a banking organization's balance 
sheet would not be recognized for regulatory capital purposes when 
interest rates change. For example, the commenters observed that 
banking organizations often hold AFS debt securities to hedge interest 
rate risk associated with deposit liabilities, which are not marked to 
fair value on the balance sheet. Therefore, requiring banking 
organizations to include AOCI in regulatory capital would mean that 
interest rate fluctuations would be reflected in regulatory capital 
only for one aspect of this hedging strategy, with the result that the 
proposed treatment could greatly overstate the economic impact that 
interest rate changes have on the safety and soundness of the banking 
organization.
    Several commenters used sample AFS securities portfolio data to 
illustrate how an upward shift in interest rates could have a 
substantial impact on a banking organization's capital levels 
(depending on the composition of its AFS portfolio and its defined 
benefit postretirement obligations). According to these commenters, the 
potential negative impact on capital levels that could follow a 
substantial increase in interest rates would place significant strains 
on banking organizations.
    To address the potential impact of incorporating the volatility 
associated with AOCI into regulatory capital, banking organizations 
also noted that they could increase their overall capital levels to 
create a buffer above regulatory minimums, hedge or reduce the 
maturities of their AFS debt securities, or shift more debt securities 
into their HTM portfolio. However, commenters asserted that these 
strategies would be complicated and costly, especially for smaller 
banking organizations, and could lead to a significant decrease in 
lending activity. Many community banking organization commenters 
observed that hedging or raising additional capital may be especially 
difficult for banking organizations with limited access to capital 
markets, while shifting more debt securities into the HTM portfolio 
would impair active management of interest rate risk positions and 
negatively impact a banking organization's liquidity position. These 
commenters also expressed concern that this could be especially 
problematic given the increased attention to liquidity by banking 
regulators and industry analysts.
    A number of commenters indicated that in light of the potential 
impact of the proposed treatment of AOCI on a banking organization's 
liquidity position, the agencies should, at the very least, postpone 
implementing this aspect of the proposal until after implementation of 
the BCBS's revised liquidity standards. Commenters suggested that 
postponing the implementation of the AOCI treatment would help to 
ensure that the final capital rules do not create disincentives for a 
banking organization to increase its holdings of high-quality liquid 
assets. In addition, several commenters suggested that the agencies not 
require banking organizations to include in regulatory capital 
unrealized gains and losses on assets that would qualify as ``high 
quality liquid assets'' under the BCBS's ``liquidity coverage ratio'' 
under the Basel III liquidity framework.
    Finally, several commenters addressed the inclusion in AOCI of 
actuarial gains and losses on defined benefit pension fund obligations. 
Commenters stated that many banking organizations, particularly mutual 
banking organizations, offer defined benefit pension plans to attract 
employees because they are unable to offer stock options to employees. 
These commenters noted that actuarial gains and losses on defined 
benefit obligations represent the difference between benefit 
assumptions and, among other things, actual investment experiences 
during a given year, which is influenced predominantly by the discount 
rate assumptions used to determine the value of the plan obligation. 
The discount rate is tied to prevailing long-term interest rates at a 
point in time each year, and while market returns on the underlying 
assets of the plan and the discount rates may fluctuate year to year, 
the underlying liabilities typically are longer term--in some cases 15 
to 20 years. Therefore, changing interest rate environments could lead 
to material fluctuations in the value of a banking organization's 
defined benefit post-retirement fund assets and liabilities, which in 
turn could create material swings in a banking organization's 
regulatory capital that would not be tied to changes

[[Page 55379]]

in the credit quality of the underlying assets. Commenters stated that 
the added volatility in regulatory capital could lead some banking 
organizations to reconsider offering defined benefit pension plans.
    The FDIC has considered the comments on the proposal to incorporate 
most elements of AOCI in regulatory capital, and has taken into account 
the potential effects that the proposed AOCI treatment could have on 
FDIC-supervised institutions and their function in the economy. As 
discussed in the proposal, the FDIC believes that the proposed AOCI 
treatment results in a regulatory capital measure that better reflects 
FDIC-supervised institutions' actual risk at a specific point in time. 
The FDIC also believes that AOCI is an important indicator that market 
observers use to evaluate the capital strength of an FDIC-supervised 
institution.
    However, the FDIC recognizes that for many FDIC-supervised 
institutions, the volatility in regulatory capital that could result 
from the proposal could lead to significant difficulties in capital 
planning and asset-liability management. The FDIC also recognizes that 
the tools used by advanced approaches FDIC-supervised institutions and 
other larger, more complex FDIC-supervised institutions for managing 
interest rate risk are not necessarily readily available to all FDIC-
supervised institutions.
    Therefore, in the interim final rule, the FDIC has decided to 
permit those FDIC-supervised institutions that are not subject to the 
advanced approaches risk-based capital rules to elect to calculate 
regulatory capital by using the treatment for AOCI in the FDIC's 
general risk-based capital rules, which excludes most AOCI amounts. 
Such FDIC-supervised institutions, may make a one-time, permanent 
election \85\ to effectively continue using the AOCI treatment under 
the general risk-based capital rules for their regulatory calculations 
(``AOCI opt-out election'') when filing the Call Report for the first 
reporting period after the date upon which they become subject to the 
interim final rule.
---------------------------------------------------------------------------

    \85\ This one-time, opt-out selection does not cover a merger, 
acquisition or purchase transaction involving all or substantially 
all of the assets or voting stock between two banking organizations 
of which only one made an AOCI opt-out election. The resulting 
organization may make an AOCI election with prior agency approval.
---------------------------------------------------------------------------

    Pursuant to a separate notice under the Paperwork Reduction Act, 
the agencies intend to propose revisions to the Call Report to 
implement changes in reporting items that would correspond to the 
interim final rule. These revisions will include a line item for FDIC-
supervised institutions to indicate their AOCI opt-out election in 
their first regulatory report filed after the date the FDIC-supervised 
institution becomes subject to the interim final rule. Information 
regarding the AOCI opt-out election will be made available to the 
public and will be reflected on an ongoing basis in publicly available 
regulatory reports. An FDIC-supervised institution that does not make 
an AOCI opt-out election on the Call Report filed for the first 
reporting period after the effective date of the interim final rule 
must include all AOCI components, except accumulated net gains and 
losses on cash-flow hedges related to items that are not recognized at 
fair value on the balance sheet, in regulatory capital elements 
starting the first quarter in which the FDIC-supervised institution 
calculates its regulatory capital requirements under the interim final 
rule.
    Consistent with regulatory capital calculations under the FDIC's 
general risk-based capital rules, an FDIC-supervised institution that 
makes an AOCI opt-out election under the interim final rule must adjust 
common equity tier 1 capital elements by: (1) Subtracting any net 
unrealized gains and adding any net unrealized losses on AFS 
securities; (2) subtracting any net unrealized losses on AFS preferred 
stock classified as an equity security under GAAP and AFS equity 
exposures; (3) subtracting any accumulated net gains and adding back 
any accumulated net losses on cash-flow hedges included in AOCI; (4) 
subtracting amounts attributed to defined benefit postretirement plans 
resulting from the initial and subsequent application of the relevant 
GAAP standards that pertain to such plans (excluding, at the FDIC-
supervised institution's option, the portion relating to pension assets 
deducted under section 324.22(a)(5)); and (5) subtracting any net 
unrealized gains and adding any net unrealized losses on held-to-
maturity securities that are included in AOCI. In addition, consistent 
with the general risk-based capital rules, the FDIC-supervised 
institution must incorporate into common equity tier 1 capital any 
foreign currency translation adjustment. An FDIC-supervised institution 
may also incorporate up to 45 percent of any net unrealized gains on 
AFS preferred stock classified as an equity security under GAAP and AFS 
equity exposures into its tier 2 capital elements. However, the FDIC 
may exclude all or a portion of these unrealized gains from an FDIC-
supervised institution's tier 2 capital under the reservation of 
authority provision of the interim final rule if the FDIC determines 
that such preferred stock or equity exposures are not prudently valued.
    The FDIC believes that FDIC-supervised institutions that apply the 
advanced approaches rule or that have opted to use the advanced 
approaches rule should already have the systems in place necessary to 
manage the added volatility resulting from the new AOCI treatment. 
Likewise, pursuant to the Dodd-Frank Act, these large, complex FDIC-
supervised institutions are subject to enhanced prudential standards, 
including stress-testing requirements, and therefore should be prepared 
to manage their capital levels through the types of stressed economic 
environments, including environments with shifting interest rates, that 
could lead to substantial changes in amounts reported in AOCI. 
Accordingly, under the interim final rule, advanced approaches FDIC-
supervised institutions will be required to incorporate all AOCI 
components, except accumulated net gains and losses on cash-flow hedges 
that relate to items that are not measured at fair value on the balance 
sheet, into their common equity tier 1 capital elements according to 
the transition provisions set forth in the interim final rule.
    The interim final rule additionally provides that in a merger, 
acquisition, or purchase transaction between two FDIC-supervised 
institutions that have each made an AOCI opt-out election, the 
surviving entity will be required to continue with the AOCI opt-out 
election, unless the surviving entity is an advanced approaches FDIC-
supervised institution. Similarly, in a merger, acquisition, or 
purchase transaction between two FDIC-supervised institutions that have 
each not made an AOCI opt-out election, the surviving entity must 
continue implementing such treatment going forward. If an entity 
surviving a merger, acquisition, or purchase transaction becomes 
subject to the advanced approaches rule, it is no longer permitted to 
make an AOCI opt-out election and, therefore, must include most 
elements of AOCI in regulatory capital in accordance with the interim 
final rule.
    However, following a merger, acquisition or purchase transaction 
involving all or substantially all of the assets or voting stock 
between two banking organizations of which only one made an AOCI opt-
out election (and the surviving entity is not subject to the advanced 
approaches rule), the

[[Page 55380]]

surviving entity must decide whether to make an AOCI opt-out election 
by its first regulatory reporting date following the consummation of 
the transaction.\86\ For example, if all of the equity of a banking 
organization that has made an AOCI opt-out election is acquired by a 
banking organization that has not made such an election, the surviving 
entity may make a new AOCI opt-out election in the Call Report filed 
for the first reporting period after the effective date of the merger. 
The interim final rule also provides the FDIC with discretion to allow 
a new AOCI opt-out election where a merger, acquisition or purchase 
transaction between two banking organizations that have made different 
AOCI opt-out elections does not involve all or substantially all of the 
assets or voting stock of the purchased or acquired banking 
organization. In making such a determination, the FDIC may consider the 
terms of the merger, acquisition, or purchase transaction, as well as 
the extent of any changes to the risk profile, complexity, and scope of 
operations of the banking organization resulting from the merger, 
acquisition, or purchase transaction. The FDIC may also look to the 
Bank Merger Act \87\ for guidance on the types of transactions that 
would allow the surviving entity to make a new AOCI opt-out election. 
Finally, a de novo FDIC-supervised institution formed after the 
effective date of the interim final rule is required to make a decision 
to opt out in the first Call Report it is required to file.
---------------------------------------------------------------------------

    \86\ A merger would involve ``all or substantially all'' of the 
assets or voting stock where, for example: (1) a banking 
organization buys all of the voting stock of a target banking 
organization, except for the stock of a dissenting, non-controlling 
minority shareholder; or (2) the banking organization buys all of 
the assets and major business lines of a target banking 
organization, but does not purchase a minor business line of the 
target. Circumstances in which the ``all or substantially all'' 
standard likely would not be met would be, for example: (1) a 
banking organization buys less than 80 percent of another banking 
organization; or (3) a banking organization buys only three out of 
four of another banking organization's major business lines.
    \87\ 12 U.S.C. 1828(c).
---------------------------------------------------------------------------

    The interim final rule also provides that if a top-tier depository 
institution holding company makes an AOCI opt-out election, any 
subsidiary insured depository institution that is consolidated by the 
depository institution holding company also must make an AOCI opt-out 
election. The FDIC is concerned that if some FDIC-supervised 
institutions subject to regulatory capital rules under a common parent 
holding company make an AOCI opt-out election and others do not, there 
is a potential for these organizations to engage in capital arbitrage 
by choosing to book exposures or activities in the legal entity for 
which the relevant components of AOCI are treated most favorably.
    Notwithstanding the availability of the AOCI opt-out election under 
the interim final rule, the FDIC has reserved the authority to require 
an FDIC-supervised institution to recognize all or some components of 
AOCI in regulatory capital if an agency determines it would be 
appropriate given an FDIC-supervised institution's risks under the 
FDIC's general reservation of authority under the interim final rule. 
The FDIC will continue to expect each FDIC-supervised institution to 
maintain capital appropriate for its actual risk profile, regardless of 
whether it has made an AOCI opt-out election. Therefore, the FDIC may 
determine that an FDIC-supervised institution with a large portfolio of 
AFS debt securities, or that is otherwise engaged in activities that 
expose it to high levels of interest-rate or other risks, should raise 
its common equity tier 1 capital level substantially above the 
regulatory minimums, regardless of whether that FDIC-supervised 
institution has made an AOCI opt-out election.
d. Investments in Own Regulatory Capital Instruments
    To avoid the double-counting of regulatory capital, the proposal 
would have required a banking organization to deduct the amount of its 
investments in its own capital instruments, including direct and 
indirect exposures, to the extent such instruments are not already 
excluded from regulatory capital. Specifically, the proposal would 
require a banking organization to deduct its investment in its own 
common equity tier 1, additional tier 1, and tier 2 capital instruments 
from the sum of its common equity tier 1, additional tier 1, and tier 2 
capital, respectively. In addition, under the proposal any common 
equity tier 1, additional tier 1, or tier 2 capital instrument issued 
by a banking organization that the banking organization could be 
contractually obligated to purchase also would have been deducted from 
common equity tier 1, additional tier 1, or tier 2 capital elements, 
respectively. The proposal noted that if a banking organization had 
already deducted its investment in its own capital instruments (for 
example, treasury stock) from its common equity tier 1 capital, it 
would not need to make such deductions twice.
    The proposed rule would have required a banking organization to 
look through its holdings of an index to deduct investments in its own 
capital instruments. Gross long positions in investments in its own 
regulatory capital instruments resulting from holdings of index 
securities would have been netted against short positions in the same 
underlying index. Short positions in indexes to hedge long cash or 
synthetic positions could have been decomposed to recognize the hedge. 
More specifically, the portion of the index composed of the same 
underlying exposure that is being hedged could have been used to offset 
the long position only if both the exposure being hedged and the short 
position in the index were covered positions under the market risk rule 
and the hedge was deemed effective by the banking organization's 
internal control processes which would have been assessed by the 
primary Federal supervisor of the banking organization. If the banking 
organization found it operationally burdensome to estimate the 
investment amount of an index holding, the proposal permitted the 
institution to use a conservative estimate with prior approval from its 
primary Federal supervisor. In all other cases, gross long positions 
would have been allowed to be deducted net of short positions in the 
same underlying instrument only if the short positions involved no 
counterparty risk (for example, the position was fully collateralized 
or the counterparty is a qualifying central counterparty (QCCP)).
    As discussed above, under the proposal, a banking organization 
would be required to look through its holdings of an index security to 
deduct investments in its own capital instruments. Some commenters 
asserted that the burden of the proposed look-through approach 
outweighs its benefits because it is not likely a banking organization 
would re-purchase its own stock through such indirect means. These 
commenters suggested that the agencies should not require a look-
through test for index securities on the grounds that they are not 
``covert buybacks,'' but rather are incidental positions held within a 
banking organization's trading book, often entered into on behalf of 
clients, customers or counterparties, and are economically hedged. 
However, the FDIC believes that it is important to avoid the double-
counting of regulatory capital, whether held directly or indirectly. 
Therefore, the interim final rule implements the look-through 
requirements of the proposal without change. In addition, consistent 
with the treatment for indirect investments in an FDIC-supervised 
institution's own capital instruments, the FDIC has clarified in the 
interim final rule that FDIC-supervised institutions must

[[Page 55381]]

deduct synthetic exposures related to investments in own capital 
instruments.
e. Definition of Financial Institution
    Under the proposed rule, a banking organization would have been 
required to deduct an investment in the capital of an unconsolidated 
financial institution exceeding certain thresholds, as described below. 
The proposed definition of financial institution was designed to 
include entities whose activities and primary business are financial in 
nature and therefore could contribute to interconnectedness in the 
financial system. The proposed definition covered entities whose 
primary business is banking, insurance, investing, and trading, or a 
combination thereof, and included BHCs, SLHCs, nonbank financial 
institutions supervised by the Federal Reserve under Title I of the 
Dodd-Frank Act, depository institutions, foreign banks, credit unions, 
insurance companies, securities firms, commodity pools, covered funds 
for purposes of section 13 of the Bank Holding Company Act and 
regulations issued thereunder, companies ``predominantly engaged'' in 
financial activities, non-U.S.-domiciled entities that would otherwise 
have been covered by the definition if they were U.S.-domiciled, and 
any other company that the agencies determined was a financial 
institution based on the nature and scope of its activities. The 
definition excluded GSEs and firms that were ``predominantly engaged'' 
in activities that are financial in nature but focus on community 
development, public welfare projects, and similar objectives. Under the 
proposed definition, a company would have been ``predominantly 
engaged'' in financial activities if (1) 85 percent or more of the 
total consolidated annual gross revenues (as determined in accordance 
with applicable accounting standards) of the company in either of the 
two most recent calendar years were derived, directly or indirectly, by 
the company on a consolidated basis from the activities; or (2) 85 
percent or more of the company's consolidated total assets (as 
determined in accordance with applicable accounting standards) as of 
the end of either of the two most recent calendar years were related to 
the activities.
    The proposed definition of ``financial institution'' was also 
relevant for purposes of the Advanced Approaches NPR. Specifically, the 
proposed rule would have required banking organizations to apply a 
multiplier of 1.25 to the correlation factor for wholesale exposures to 
unregulated financial institutions that generate a majority of their 
revenue from financial activities. The proposed rule also would have 
required advanced approaches banking organizations to apply a 
multiplier of 1.25 to wholesale exposures to regulated financial 
institutions with consolidated assets greater than or equal to $100 
billion.\88\
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    \88\ The definitions of regulated financial institutions and 
unregulated financial institutions are discussed in further detail 
in section XII.A of this preamble. Under the proposal, a ``regulated 
financial institution'' would include a financial institution 
subject to consolidated supervision and regulation comparable to 
that imposed on U.S. companies that are depository institutions, 
depository institution holding companies, nonbank financial 
companies supervised by the Board, broker dealers, credit unions, 
insurance companies, and designated financial market utilities.
---------------------------------------------------------------------------

    The agencies received a number of comments on the proposed 
definition of ``financial institution.'' Commenters expressed concern 
that the definition of a financial institution was overly broad and 
stated that it should not include investments in funds, commodity 
pools, or ERISA plans. Other commenters stated that the ``predominantly 
engaged'' test would impose significant operational burdens on banking 
organizations in determining what companies would be included in the 
proposed definition of ``financial institution.'' Commenters suggested 
that the agencies should risk weight such exposures, rather than 
subjecting them to a deduction from capital based on the definition of 
financial institution.
    Some of the commenters noted that many of the exposures captured by 
the financial institution definition may be risk-weighted under certain 
circumstances, and expressed concerns that overlapping regulation would 
result in confusion. For similar reasons, commenters recommended that 
the agencies limit the definition of financial institution to specific 
enumerated entities, such as regulated financial institutions, 
including insured depository institutions and holding companies, 
nonbank financial companies designated by the Financial Stability 
Oversight Council, insurance companies, securities holding companies, 
foreign banks, securities firms, futures commission merchants, swap 
dealers, and security based swap dealers. Other commenters stated that 
the definition should cover only those entities subject to consolidated 
regulatory capital requirements. Commenters also encouraged the 
agencies to adopt alternatives to the ``predominantly engaged'' test 
for identifying a financial institution, such as the use of standard 
industrial classification codes or legal entity identifiers. Other 
commenters suggested that the agencies should limit the application of 
the ``predominantly engaged'' test in the definition of ``financial 
institution'' to companies above a specified size threshold. Similarly, 
others requested that the agencies exclude any company with total 
assets of less than $50 billion. Many commenters indicated that the 
broad definition proposed by the agencies was not required by Basel III 
and was unnecessary to promote systemic stability and avoid 
interconnectivity. Some commenters stated that funds covered by Section 
13 of the Bank Holding Company Act also should be excluded. Other 
commenters suggested that the agencies should exclude investment funds 
registered with the SEC under the Investment Company Act of 1940 and 
their foreign equivalents, while some commenters suggested methods of 
narrowing the definition to cover only leveraged funds. Commenters also 
requested that the agencies clarify that investment or financial 
advisory activities include providing both discretionary and non-
discretionary investment or financial advice to customers, and that the 
definition would not capture either registered investment companies or 
investment advisers to registered funds.
    After considering the comments, the FDIC has modified the 
definition of ``financial institution'' to provide more clarity around 
the scope of the definition as well as reduce operational burden. 
Separate definitions are adopted under the advanced approaches 
provisions of the interim final rule for ``regulated financial 
institution'' and ``unregulated financial institution'' for purposes of 
calculating the correlation factor for wholesale exposures, as 
discussed in section XII.A of this preamble.
    Under the interim final rule, the first paragraph of the definition 
of a financial institution includes an enumerated list of regulated 
institutions similar to the list that appeared in the first paragraph 
of the proposed definition: A BHC; SLHC; nonbank financial institution 
supervised by the Federal Reserve under Title I of the Dodd-Frank Act; 
depository institution; foreign bank; credit union; industrial loan 
company, industrial bank, or other similar institution described in 
section 2 of the Bank Holding Company Act; national association, state 
member bank, or state nonmember bank that is not a depository 
institution; insurance company; securities holding company as defined 
in section 618 of the Dodd-Frank Act; broker or dealer registered with 
the SEC; futures commission merchant and swap dealer, each as

[[Page 55382]]

defined in the Commodity Exchange Act; or security-based swap dealer; 
or any designated financial market utility (FMU). The definition also 
includes foreign companies that would be covered by the definition if 
they are supervised and regulated in a manner similar to the 
institutions described above that are included in the first paragraph 
of the definition of ``financial institution.'' The FDIC also has 
retained in the final definition of ``financial institution'' a 
modified version of the proposed ``predominantly engaged'' test to 
capture additional entities that perform certain financial activities 
that the FDIC believes appropriately addresses those relationships 
among financial institutions that give rise to concerns about 
interconnectedness, while reducing operational burden. Consistent with 
the proposal, a company is ``predominantly engaged'' in financial 
activities for the purposes of the definition if it meets the test to 
the extent the following activities make up more than 85 percent of the 
company's total assets or gross revenues:
    (1) Lending money, securities or other financial instruments, 
including servicing loans;
    (2) Insuring, guaranteeing, indemnifying against loss, harm, 
damage, illness, disability, or death, or issuing annuities;
    (3) Underwriting, dealing in, making a market in, or investing as 
principal in securities or other financial instruments; or
    (4) Asset management activities (not including investment or 
financial advisory activities).
    In response to comments expressing concerns regarding operational 
burden and potential lack of access to necessary information in 
applying the proposed ``predominantly engaged'' test, the FDIC has 
revised that portion of the definition. Now, the FDIC-supervised 
institution would only apply the test if it has an investment in the 
GAAP equity instruments of the company with an adjusted carrying value 
or exposure amount equal to or greater than $10 million, or if it owns 
more than 10 percent of the company's issued and outstanding common 
shares (or similar equity interest). The FDIC believes that this 
modification would reduce burden on FDIC-supervised institutions with 
small exposures, while those with larger exposures should have 
sufficient information as a shareholder to conduct the predominantly 
engaged analysis.\89\
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    \89\ For advanced approaches FDIC-supervised institutions, for 
purposes of section 131 of the interim final rule, the definition of 
``unregulated financial institution'' does not include the ownership 
limitation in applying the ``predominantly engaged'' standard.
---------------------------------------------------------------------------

    In cases when an FDIC-supervised institution's investment in the 
FDIC-supervised institution exceeds one of the thresholds described 
above, the FDIC-supervised institution must determine whether the 
company is predominantly engaged in financial activities, in accordance 
with the interim final rule. The FDIC believes that this modification 
will substantially reduce operational burden for FDIC-supervised 
institutions with investments in multiple institutions. The FDIC also 
believes that an investment of $10 million in or a holding of 10 
percent of the outstanding common shares (or equivalent ownership 
interest) of an entity has the potential to create a risk of 
interconnectedness, and also makes it reasonable for the FDIC-
supervised institution to gain information necessary to understand the 
operations and activities of the company in which it has invested and 
to apply the proposed ``predominantly engaged'' test under the 
definition. The FDIC is clarifying that, consistent with the proposal, 
investment or financial advisers (whether they provide discretionary or 
non-discretionary advisory services) are not covered under the 
definition of financial institution. The revised definition also 
specifically excludes employee benefit plans. The FDIC believes, upon 
review of the comments, that employee benefit plans are heavily 
regulated under ERISA and do not present the same kind of risk of 
systemic interconnectedness that the enumerated financial institutions 
present. The revised definition also explicitly excludes investment 
funds registered with the SEC under the Investment Company Act of 1940, 
as the FDIC believes that such funds create risks of systemic 
interconnectedness largely through their investments in the capital of 
financial institutions. These investments are addressed directly by the 
interim final rule's treatment of indirect investments in financial 
institutions. Although the revised definition does not specifically 
include commodities pools, under some circumstances an FDIC-supervised 
institution's investment in a commodities pool might meet the 
requirements of the modified ``predominantly engaged'' test.
    Some commenters also requested that the agencies establish an asset 
threshold below which an entity would not be included in the definition 
of ``financial institution.'' The FDIC has not included such a 
threshold because they are concerned that it could create an incentive 
for multiple investments and aggregated exposures in smaller financial 
institutions, thereby undermining the rationale underlying the 
treatment of investments in the capital of unconsolidated financial 
institutions. The FDIC believes that the definition of financial 
institution appropriately captures both large and small entities 
engaged in the core financial activities that the FDIC believes should 
be addressed by the definition and associated deductions from capital. 
The FDIC believes, however, that the modification to the 
``predominantly engaged'' test, should serve to alleviate some of the 
burdens with which the commenters who made this point were concerned.
    Consistent with the proposal, investments in the capital of 
unconsolidated financial institutions that are held indirectly 
(indirect exposures) are subject to deduction. Under the proposal, a 
banking organization's entire investment in, for example, a registered 
investment company would have been subject to deduction from capital. 
Although those entities are excluded from the definition of financial 
institution in the interim final rule unless the ownership threshold is 
met, any holdings in the capital instruments of financial institutions 
held indirectly through investment funds are subject to deduction from 
capital. More generally, and as described later in this section of the 
preamble, the interim final rule provides an explicit mechanism for 
calculating the amount of an indirect investment subject to deduction.
f. The Corresponding Deduction Approach
    The proposals incorporated the Basel III corresponding deduction 
approach for the deductions from regulatory capital related to 
reciprocal crossholdings, non-significant investments in the capital of 
unconsolidated financial institutions, and non-common stock significant 
investments in the capital of unconsolidated financial institutions. 
Under the proposal, a banking organization would have been required to 
make any such deductions from the same component of capital for which 
the underlying instrument would qualify if it were issued by the 
banking organization itself. If a banking organization did not have a 
sufficient amount of a specific regulatory capital component against 
which to effect the deduction, the shortfall would have been deducted 
from the next higher (that is, more subordinated) regulatory

[[Page 55383]]

capital component. For example, if a banking organization did not have 
enough additional tier 1 capital to satisfy the required deduction, the 
shortfall would be deducted from common equity tier 1 capital elements.
    Under the proposal, if the banking organization invested in an 
instrument issued by an financial institution that is not a regulated 
financial institution, the banking organization would have treated the 
instrument as common equity tier 1 capital if the instrument is common 
stock (or if it is otherwise the most subordinated form of capital of 
the financial institution) and as additional tier 1 capital if the 
instrument is subordinated to all creditors of the financial 
institution except common shareholders. If the investment is in the 
form of an instrument issued by a regulated financial institution and 
the instrument does not meet the criteria for any of the regulatory 
capital components for banking organizations, the banking organization 
would treat the instrument as: (1) Common equity tier 1 capital if the 
instrument is common stock included in GAAP equity or represents the 
most subordinated claim in liquidation of the financial institution; 
(2) additional tier 1 capital if the instrument is GAAP equity and is 
subordinated to all creditors of the financial institution and is only 
senior in liquidation to common shareholders; and (3) tier 2 capital if 
the instrument is not GAAP equity but it is considered regulatory 
capital by the primary supervisor of the financial institution.
    Some commenters sought clarification on whether, under the 
corresponding deduction approach, TruPS would be deducted from tier 1 
or tier 2 capital. In response to these comments the FDIC has revised 
the interim final rule to clarify the deduction treatment for 
investments of non-qualifying capital instruments, including TruPS, 
under the corresponding deduction approach. The interim final rule 
includes a new paragraph section 22(c)(2)(iii) to provide that if an 
investment is in the form of a non-qualifying capital instrument 
described in section 300(d) of the interim final rule, the FDIC-
supervised institution must treat the instrument as a: (1) tier 1 
capital instrument if it was included in the issuer's tier 1 capital 
prior to May 19, 2010; or (2) tier 2 capital instrument if it was 
included in the issuer's tier 2 capital (but not eligible for inclusion 
in the issuer's tier 1 capital) prior to May 19, 2010.
    In addition, to avoid a potential circularity issue (related to the 
combined impact of the treatment of ALLL and the risk-weight treatment 
for threshold items that are not deducted from common equity tier 1 
capital) in the calculation of common equity tier 1 capital, the 
interim final rule clarifies that FDIC-supervised institutions must 
apply any deductions under the corresponding deduction approach 
resulting from insufficient amounts of a specific regulatory capital 
component after applying any deductions from the items subject to the 
10 and 15 percent common equity tier 1 capital deduction thresholds 
discussed further below. This was accomplished by removing proposed 
paragraph 22(c)(2)(i) from the corresponding deduction approach section 
and inserting paragraph 22(f). Under section 22(f) of the interim final 
rule, and as noted above, if an FDIC-supervised institution does not 
have a sufficient amount of a specific component of capital to effect 
the required deduction under the corresponding deduction approach, the 
shortfall must be deducted from the next higher (that is, more 
subordinated) component of regulatory capital.
g. Reciprocal Crossholdings in the Capital Instruments of Financial 
Institutions
    A reciprocal crossholding results from a formal or informal 
arrangement between two financial institutions to swap, exchange, or 
otherwise intend to hold each other's capital instruments. The use of 
reciprocal crossholdings of capital instruments to artificially inflate 
the capital positions of each of the financial institutions involved 
would undermine the purpose of regulatory capital, potentially 
affecting the stability of such financial institutions as well as the 
financial system.
    Under the agencies' general risk-based capital rules, reciprocal 
crossholdings of capital instruments of FDIC-supervised institutions 
are deducted from regulatory capital. Consistent with Basel III, the 
proposal would have required a banking organization to deduct 
reciprocal crossholdings of capital instruments of other financial 
institutions using the corresponding deduction approach. The interim 
final rule maintains this treatment.
h. Investments in the FDIC-Supervised Institution's Own Capital 
Instruments or in the Capital of Unconsolidated Financial Institutions
    In the interim final rule, the FDIC made several non-substantive 
changes to the wording in the proposal to clarify that the amount of an 
investment in the FDIC-supervised institution's own capital instruments 
or in the capital of unconsolidated financial institutions is the net 
long position (as calculated under section 22(h) of the interim final 
rule) of such investments. The interim final rule also clarifies how to 
calculate the net long position of these investments, especially for 
the case of indirect exposures. It is the net long position that is 
subject to deduction. In addition, the interim final rule generally 
harmonizes the recognition of hedging for own capital instruments and 
for investments in the capital of unconsolidated financial 
institutions. Under the interim final rule, an investment in an FDIC-
supervised institution's own capital instrument is deducted from 
regulatory capital and an investment in the capital of an 
unconsolidated financial institution is subject to deduction from 
regulatory capital if such investment exceeds certain thresholds.
    An investment in the capital of an unconsolidated financial 
institution refers to the net long position (calculated in accordance 
with section 22(h) of the interim final rule) in an instrument that is 
recognized as capital for regulatory purposes by the primary supervisor 
of an unconsolidated regulated financial institution or in an 
instrument that is part of GAAP equity of an unconsolidated unregulated 
financial institution. It includes direct, indirect, and synthetic 
exposures to capital instruments, and excludes underwriting positions 
held by an FDIC-supervised institution for fewer than five business 
days.
    An investment in the FDIC-supervised institution's own capital 
instrument means a net long position calculated in accordance with 
section 22(h) of the interim final rule in the FDIC-supervised 
institution's own common stock instrument, own additional tier 1 
capital instrument or own tier 2 capital instrument, including direct, 
indirect or synthetic exposures to such capital instruments. An 
investment in the FDIC-supervised institution's own capital instrument 
includes any contractual obligation to purchase such capital 
instrument.
    The interim final rule also clarifies that the gross long position 
for an investment in the FDIC-supervised institution's own capital 
instrument or the capital of an unconsolidated financial institution 
that is an equity exposure refers to the adjusted carrying value 
(determined in accordance with section 51(b) of the interim final 
rule). For the case of an investment in the FDIC-supervised 
institution's own capital instrument or the capital of an 
unconsolidated financial institution that is not an equity exposure, 
the gross long position is defined as the exposure amount (determined 
in accordance with section 2 of the interim final rule).

[[Page 55384]]

    Under the proposal, the agencies included the methodology for the 
recognition of hedging and for the calculation of the net long position 
regarding investments in the banking organization's own capital 
instruments and in investments in the capital of unconsolidated 
financial institutions in the definitions section. However, such 
methodology appears in section 22 of the interim final rule as the FDIC 
believes it is more appropriate to include it in the adjustments and 
deductions to regulatory capital section.
    The interim final rule provides that the net long position is the 
gross long position in the underlying instrument (including covered 
positions under the market risk rule) net of short positions in the 
same instrument where the maturity of the short position either matches 
the maturity of the long position or has a residual maturity of at 
least one year. An FDIC-supervised institution may only net a short 
position against a long position in the FDIC-supervised institution's 
own capital instrument if the short position involves no counterparty 
credit risk. The long and short positions in the same index without a 
maturity date are considered to have matching maturities. If both the 
long position and the short position do not have contractual maturity 
dates, then the positions are considered maturity-matched. For 
positions that are reported on an FDIC-supervised institution's 
regulatory report as trading assets or trading liabilities, if the 
FDIC-supervised institution has a contractual right or obligation to 
sell a long position at a specific point in time, and the counterparty 
to the contract has an obligation to purchase the long position if the 
FDIC-supervised institution exercises its right to sell, this point in 
time may be treated as the maturity of the long position. Therefore, if 
these conditions are met, the maturity of the long position and the 
short position would be deemed to be matched even if the maturity of 
the short position is less than one year.
    Gross long positions in own capital instruments or in the capital 
instruments of unconsolidated financial institutions resulting from 
positions in an index may be netted against short positions in the same 
underlying index. Short positions in indexes that are hedging long cash 
or synthetic positions may be decomposed to recognize the hedge. More 
specifically, the portion of the index that is composed of the same 
underlying exposure that is being hedged may be used to offset the long 
position, provided both the exposure being hedged and the short 
position in the index are trading assets or trading liabilities, and 
the hedge is deemed effective by the FDIC-supervised institution's 
internal control processes, which the FDIC has found not to be 
inadequate.
    An indirect exposure results from an FDIC-supervised institution's 
investment in an investment fund that has an investment in the FDIC-
supervised institution's own capital instrument or the capital of an 
unconsolidated financial institution. A synthetic exposure results from 
an FDIC-supervised institution's investment in an instrument where the 
value of such instrument is linked to the value of the FDIC-supervised 
institution's own capital instrument or a capital instrument of a 
financial institution. Examples of indirect and synthetic exposures 
include: (1) An investment in the capital of an investment fund that 
has an investment in the capital of an unconsolidated financial 
institution; (2) a total return swap on a capital instrument of the 
FDIC-supervised institution or another financial institution; (3) a 
guarantee or credit protection, provided to a third party, related to 
the third party's investment in the capital of another financial 
institution; (4) a purchased call option or a written put option on the 
capital instrument of another financial institution; (5) a forward 
purchase agreement on the capital of another financial institution; and 
(6) a trust preferred security collateralized debt obligation (TruPS 
CDO).
    Investments, including indirect and synthetic exposures, in the 
capital of unconsolidated financial institutions are subject to the 
corresponding deduction approach if they surpass certain thresholds 
described below. With the prior written approval of the FDIC, for the 
period of time stipulated by the supervisor, an FDIC-supervised 
institution is not required to deduct investments in the capital of 
unconsolidated financial institutions described in this section if the 
investment is made in connection with the FDIC-supervised institution 
providing financial support to a financial institution in distress, as 
determined by the supervisor. Likewise, an FDIC-supervised institution 
that is an underwriter of a failed underwriting can request approval 
from the FDIC to exclude underwriting positions related to such failed 
underwriting held for longer than five days.
    Some commenters requested clarification that a long position and 
short hedging position are considered ``maturity matched'' if (1) the 
maturity period of the short position extends beyond the maturity 
period of the long position or (2) both long and short positions mature 
or terminate within the same calendar quarter. The FDIC notes that they 
concur with these commenters' interpretation of the maturity matching 
of long and short hedging positions.
    For purposes of calculating the net long position in the capital of 
an unconsolidated financial institution, several commenters expressed 
concern that allowing banking organizations to net gross long positions 
with short positions only where the maturity of the short position 
either matches the maturity of the long position or has a maturity of 
at least one year is not practical, as some exposures, such as cash 
equities, have no maturity. These commenters expressed concern that 
such a maturity requirement could result in banking organizations 
deducting equities held as hedges for equity swap transactions with a 
client, making the latter transactions uneconomical and resulting in 
disruptions to market activity. Similarly, these commenters argued that 
providing customer accommodation equity swaps could become burdensome 
as a strict reading of the proposal could affect the ability of banking 
organizations to offset the equity swap with the long equity position 
because the maturity of the equity swap is typically less than one 
year. The FDIC has considered the comments and have decided to retain 
the maturity requirement as proposed. The FDIC believes that the 
proposed maturity requirements will reduce the possibility of ``cliff 
effects'' resulting from the deduction of open equity positions when an 
FDIC-supervised institution is unable to replace the hedge or sell the 
long equity position.
i. Indirect Exposure Calculations
    The proposal provided that an indirect exposure would result from a 
banking organization's investment in an unconsolidated entity that has 
an exposure to a capital instrument of a financial institution, while a 
synthetic exposure would result from the banking organization's 
investment in an instrument where the value of such instrument is 
linked to the value of a capital instrument of a financial institution. 
With the exception of index securities, the proposal did not, however, 
provide a mechanism for calculating the amount of the indirect exposure 
that is subject to deduction. The interim final rule clarifies the 
methodologies for calculating the net long position related to an 
indirect exposure (which is subject to deduction under the interim 
final rule) by

[[Page 55385]]

providing a methodology for calculating the gross long position of such 
indirect exposure. The FDIC believes that the options provided in the 
interim final rule will provide FDIC-supervised institutions with 
increased clarity regarding the treatment of indirect exposures, as 
well as increased risk-sensitivity to the FDIC-supervised institution's 
actual potential exposure.
    In order to limit the potential difficulties in determining whether 
an unconsolidated entity in fact holds the FDIC-supervised 
institution's own capital or the capital of unconsolidated financial 
institutions, the interim final rule also provides that the indirect 
exposure requirements only apply when the FDIC-supervised institution 
holds an investment in an investment fund, as defined in the rule. 
Accordingly, an FDIC-supervised institution invested in, for example, a 
commercial company is not required to determine whether the commercial 
company has any holdings of the FDIC-supervised institution's own 
capital or the capital instruments of financial institutions.
    The interim final rule provides that an FDIC-supervised institution 
may determine that its gross long position is equivalent to its 
carrying value of its investment in an investment fund that holds the 
FDIC-supervised institution's own capital or that holds an investment 
in the capital of an unconsolidated financial institution, which would 
be subject to deduction according to section 324.22(c). Recognizing, 
however, that the FDIC-supervised institution's exposure to those 
capital instruments may be less than its carrying value of its 
investment in the investment fund, the interim final rule provides two 
alternatives for calculating the gross long position of an indirect 
exposure. For an indirect exposure resulting from a position in an 
index, an FDIC-supervised institution may, with the prior approval of 
the FDIC, use a conservative estimate of the amount of its investment 
in its own capital instruments or the capital instruments of other 
financial institutions. If the investment is held through an investment 
fund, an FDIC-supervised institution may use a look-through approach 
similar to the approach used for risk weighting equity exposures to 
investment funds. Under this approach, an FDIC-supervised institution 
may multiply the carrying value of its investment in an investment fund 
by either the exact percentage of the FDIC-supervised institution's own 
capital instrument or capital instruments of unconsolidated financial 
institutions held by the investment fund or by the highest stated 
prospectus limit for such investments held by the investment fund. 
Accordingly, if an FDIC-supervised institution with a carrying value of 
$10,000 for its investment in an investment fund knows that the 
investment fund has invested 30 percent of its assets in the capital of 
financial institutions, then the FDIC-supervised institution could 
subject $3,000 (the carrying value times the percentage invested in the 
capital of financial institutions) to deduction from regulatory 
capital. The FDIC believes that the approach is flexible and benefits 
an FDIC-supervised institution that obtains and maintains information 
about its investments through investment funds. It also provides a 
simpler calculation method for an FDIC-supervised institution that 
either does not have information about the holdings of the investment 
fund or chooses not to do the more complex calculation.
j. Non-significant Investments in the Capital of Unconsolidated 
Financial Institutions
    The proposal provided that non-significant investments in the 
capital of unconsolidated financial institutions would be the net long 
position in investments where a banking organization owns 10 percent or 
less of the issued and outstanding common stock of an unconsolidated 
financial institution.
    Under the proposal, if the aggregate amount of a banking 
organization's non-significant investments in the capital of 
unconsolidated financial institutions exceeds 10 percent of the sum of 
the banking organization's own common equity tier 1 capital, minus 
certain applicable deductions and other regulatory adjustments to 
common equity tier 1 capital (the 10 percent threshold for non-
significant investments), the banking organization would have been 
required to deduct the amount of the non-significant investments that 
are above the 10 percent threshold for non-significant investments, 
applying the corresponding deduction approach.\90\
---------------------------------------------------------------------------

    \90\ The regulatory adjustments and deductions applied in the 
calculation of the 10 percent threshold for non-significant 
investments are those required under sections 22(a) through 22(c)(3) 
of the proposal. That is, the required deductions and adjustments 
for goodwill and other intangibles (other than MSAs) net of 
associated DTLs (when the banking organization has elected to net 
DTLs in accordance with section 22(e)), DTAs that arise from net 
operating loss and tax credit carryforwards net of related valuation 
allowances and DTLs (in accordance with section 22(e)), cash-flow 
hedges associated with items that are not recognized at fair value 
on the balance sheet, excess ECLs (for advanced approaches banking 
organizations only), gains-on-sale on securitization exposures, 
gains and losses due to changes in own credit risk on financial 
liabilities measured at fair value, defined benefit pension fund net 
assets for banking organizations that are not insured by the FDIC 
(net of associated DTLs in accordance with section 22(e)), 
investments in own regulatory capital instruments (not deducted as 
treasury stock), and reciprocal crossholdings.
---------------------------------------------------------------------------

    Under the proposal, the amount to be deducted from a specific 
capital component would be equal to the amount of a banking 
organization's non-significant investments in the capital of 
unconsolidated financial institutions exceeding the 10 percent 
threshold for non-significant investments multiplied by the ratio of: 
(1) The amount of non-significant investments in the capital of 
unconsolidated financial institutions in the form of such capital 
component to (2) the amount of the banking organization's total non-
significant investments in the capital of unconsolidated financial 
institutions. The amount of a banking organization's non-significant 
investments in the capital of unconsolidated financial institutions 
that does not exceed the 10 percent threshold for non-significant 
investments would, under the proposal, generally be assigned the 
applicable risk weight under section 32 or section 131, as applicable 
(in the case of non-common stock instruments), section 52 or section 
152, as applicable (in the case of common stock instruments), or 
section 53, section 154, as applicable (in the case of indirect 
investments via an investment fund), or, in the case of a covered 
position, in accordance with subpart F, as applicable.
    One commenter requested clarification that a banking organization 
would not have to take a ``double deduction'' for an investment made in 
unconsolidated financial institutions held through another 
unconsolidated financial institution in which the banking organization 
has invested. The FDIC notes that, under the interim final rule, where 
an FDIC-supervised institution has an investment in an unconsolidated 
financial institution (Institution A) and Institution A has an 
investment in another unconsolidated financial institution (Institution 
B), the FDIC-supervised institution would not be deemed to have an 
indirect investment in Institution B for purposes of the interim final 
rule's capital thresholds and deductions because the FDIC-supervised 
institution's investment in Institution A is already subject to capital 
thresholds and deductions. However, if an FDIC-supervised institution 
has an investment in an investment fund that does not meet the 
definition of a financial institution, it must consider

[[Page 55386]]

the assets of the investment fund to be indirect holdings.
    Some commenters requested clarification that the deductions for 
non-significant investments in the capital of unconsolidated financial 
institutions may be net of associated DTLs. The FDIC has clarified in 
the interim final rule that an FDIC-supervised institution must deduct 
the net long position in non-significant investments in the capital of 
unconsolidated financial institutions, net of associated DTLs in 
accordance with section 324.22(e) of the interim final rule, that 
exceeds the 10 percent threshold for non-significant investments. Under 
section 324.22(e) of the interim final rule, the netting of DTLs 
against assets that are subject to deduction or fully deducted under 
section 324.22 of the interim final rule is permitted but not required.
    Other commenters asked the agencies to confirm that the proposal 
would not require that investments in TruPS CDOs be treated as 
investments in the capital of unconsolidated financial institutions, 
but rather treat the investments as securitization exposures. The FDIC 
believes that investments in TruPS CDOs are synthetic exposures to the 
capital of unconsolidated financial institutions and are thus subject 
to deduction. Under the interim final rule, any amounts of TruPS CDOs 
that are not deducted are subject to the securitization treatment.
k. Significant Investments in the Capital of Unconsolidated Financial 
Institutions That Are Not in the Form of Common Stock
    Under the proposal, a significant investment in the capital of an 
unconsolidated financial institution would be the net long position in 
an investment where a banking organization owns more than 10 percent of 
the issued and outstanding common stock of the unconsolidated financial 
institution. Significant investments in the capital of unconsolidated 
financial institutions that are not in the form of common stock are 
investments where the banking organization owns capital of an 
unconsolidated financial institution that is not in the form of common 
stock in addition to 10 percent of the issued and outstanding common 
stock of that financial institution. Such a non-common stock investment 
would be deducted by applying the corresponding deduction approach. 
Significant investments in the capital of unconsolidated financial 
institutions that are in the form of common stock would be subject to 
10 and 15 percent common equity tier 1 capital threshold deductions 
described below in this section.
    A number of commenters sought clarification as to whether under 
section 22(c) of the proposal, a banking organization may deduct any 
significant investments in the capital of unconsolidated financial 
institutions that are not in the form of common stock net of associated 
DTLs. The interim final rule clarifies that such deductions may be net 
of associated DTLs in accordance with paragraph 324.22(e) of the 
interim final rule. Other than this revision, the interim final rule 
adopts the proposed rule.
    More generally, commenters also sought clarification on the 
treatment of investments in the capital of unconsolidated financial 
institutions (for example, the distinction between significant and non-
significant investments). Thus, the chart below summarizes the 
treatment of investments in the capital of unconsolidated financial 
institutions.
BILLING CODE 6714-01-P

[[Page 55387]]

[GRAPHIC] [TIFF OMITTED] TR10SE13.000

BILLING CODE 6714-01-C

[[Page 55388]]

l. Items Subject to the 10 and 15 Percent Common Equity Tier 1 Capital 
Threshold Deductions
    Under the proposal, a banking organization would have deducted from 
the sum of its common equity tier 1 capital elements the amount of each 
of the following items that individually exceeds the 10 percent common 
equity tier 1 capital deduction threshold described below: (1) DTAs 
arising from temporary differences that could not be realized through 
net operating loss carrybacks (net of any related valuation allowances 
and net of DTLs, as described in section 22(e) of the proposal); (2) 
MSAs, net of associated DTLs in accordance with section 22(e) of the 
proposal; and (3) significant investments in the capital of 
unconsolidated financial institutions in the form of common stock 
(referred to herein as items subject to the threshold deductions).
    Under the proposal, a banking organization would have calculated 
the 10 percent common equity tier 1 capital deduction threshold by 
taking 10 percent of the sum of a banking organization's common equity 
tier 1 elements, less adjustments to, and deductions from common equity 
tier 1 capital required under sections 22(a) through (c) of the 
proposal.
    As mentioned above in section V.B, under the proposal banking 
organizations would have been required to deduct from common equity 
tier 1 capital any goodwill embedded in the valuation of significant 
investments in the capital of unconsolidated financial institutions in 
the form of common stock. A banking organization would have been 
allowed to reduce the investment amount of such significant investment 
by the goodwill embedded in such investment. For example, if a banking 
organization has deducted $10 of goodwill embedded in a $100 
significant investment in the capital of an unconsolidated financial 
institution in the form of common stock, the banking organization would 
be allowed to reduce the investment amount of such significant 
investment by the amount of embedded goodwill (that is, the value of 
the investment would be $90 for purposes of the calculation of the 
amount that would be subject to deduction under this part of the 
proposal).
    In addition, under the proposal the aggregate amount of the items 
subject to the threshold deductions that are not deducted as a result 
of the 10 percent common equity tier 1 capital deduction threshold 
described above must not exceed 15 percent of a banking organization's 
common equity tier 1 capital, as calculated after applying all 
regulatory adjustments and deductions required under the proposal (the 
15 percent common equity tier 1 capital deduction threshold). That is, 
a banking organization would have been required to deduct in full the 
amounts of the items subject to the threshold deductions on a combined 
basis that exceed 17.65 percent (the proportion of 15 percent to 85 
percent) of common equity tier 1 capital elements, less all regulatory 
adjustments and deductions required for the calculation of the 10 
percent common equity tier 1 capital deduction threshold mentioned 
above, and less the items subject to the 10 and 15 percent deduction 
thresholds. As described below, the proposal required a banking 
organization to include the amounts of these three items that are not 
deducted from common equity tier 1 capital in its risk-weighted assets 
and assign a 250 percent risk weight to them.
    Some commenters asserted that subjecting DTAs resulting from net 
unrealized losses in an investment portfolio to the proposed 10 percent 
common equity tier 1 capital deduction threshold under section 22(d) of 
the proposal would result in a ``double deduction'' in that the net 
unrealized losses would have already been included in common equity 
tier 1 through the AOCI treatment. Under GAAP, net unrealized losses 
recognized in AOCI are reported net of tax effects (that is, taxes that 
give rise to DTAs). The tax effects related to net unrealized losses 
would reduce the amount of net unrealized losses reflected in common 
equity tier 1 capital. Given that the tax effects reduce the losses 
that would otherwise accrue to common equity tier 1 capital, the FDIC 
is of the view that subjecting these DTAs to the 10 percent limitation 
would not result in a ``double deduction.''
    More generally, several commenters noted that the proposed 10 and 
15 percent common equity tier 1 capital deduction thresholds and the 
proposed 250 percent risk-weight are unduly punitive. Commenters 
recommended several alternatives including, for example, that the 
agencies should only retain the 10 percent limit on each threshold item 
but eliminate the 15 percent aggregate limit. The FDIC believes that 
the proposed thresholds are appropriate as they increase the quality 
and loss-absorbency of regulatory capital, and are therefore adopting 
the proposed deduction thresholds as final. The FDIC realizes that 
these stricter limits on threshold items may require FDIC-supervised 
institutions to make appropriate changes in their capital structure or 
business model, and thus have provided a lengthy transition period to 
allow FDIC-supervised institutions to adequately plan for the new 
limits.
    Under section 475 of the Federal Deposit Insurance Corporation 
Improvement Act of 1991 (FDICIA) (12 U.S.C. 1828 note), the amount of 
readily marketable purchased mortgage servicing rights (PMSRs) that a 
banking organization may include in regulatory capital cannot be more 
than 90 percent of their fair value. In addition to this statutory 
requirement, the general risk-based capital rules require the same 
treatment for all MSAs, including PMSRs. Under the proposed rule, if 
the amount of MSAs a banking organization deducts after applying the 10 
percent and 15 percent common equity tier 1 deduction threshold is less 
than 10 percent of the fair value of its MSAs, then the banking 
organization would have deducted an additional amount of MSAs so that 
the total amount of MSAs deducted is at least 10 percent of the fair 
value of its MSAs.
    Some commenters requested removal of the 90 percent MSA fair value 
limitation, including for PMSRs under FDICIA. These commenters note 
that section 475(b) of FDICIA provides the agencies with authority to 
remove the 90 percent limitation on PMSRs, subject to a joint 
determination by the agencies that its removal would not have an 
adverse effect on the deposit insurance fund or the safety and 
soundness of insured depository institutions. The commenters asserted 
that removal of the 90 percent limitation would be appropriate because 
other provisions of the proposal pertaining to MSAs (including PMSRs) 
would require more capital to be retained even if the fair value 
limitation were removed.
    The FDIC agrees with these commenters and, pursuant to section 
475(b) of FDICIA, has determined that PMSRs may be valued at not more 
than 100 percent of their fair value, because the capital treatment of 
PMSRs in the interim final rule (specifically, the deduction approach 
for MSAs (including PMSRs) exceeding the 10 and 15 common equity 
deduction thresholds and the 250 percent risk weight applied to all 
MSAs not subject to deduction) is more conservative than the FDICIA 
fair value limitation and the 100 percent risk weight applied to MSAs 
under existing rules and such approach will not have an adverse effect 
on the deposit insurance fund or safety and soundness of insured 
depository institutions. For the same reasons, the

[[Page 55389]]

FDIC is also removing the 90 percent fair value limitation for all 
other MSAs.
    Commenters also provided a variety of recommendations related to 
the proposed limitations on the inclusion of MSAs in regulatory 
capital. For instance, some commenters advocated removing the proposed 
deduction provision for hedged and commercial and multifamily-related 
MSAs, as well as requested an exemption from the proposed deduction 
requirement for community banking organizations with less than $10 
billion.
    Other commenters recommended increasing the amount of MSAs 
includable in regulatory capital. For example, one commenter 
recommended that MSAs should be limited to 100 percent of tier l 
capital if the underlying loans are prudently underwritten. Another 
commenter requested that the interim final rule permit thrifts and 
commercial banking organizations to include in regulatory capital MSAs 
equivalent to 50 and 25 percent of tier 1 capital, respectively.
    Several commenters also objected to the proposed risk weights for 
MSAs, asserting that a 250 percent risk weight for an asset that is 
marked-to-fair value quarterly is unreasonably punitive and that a 100 
percent risk weight should apply; that MSAs allowable in capital should 
be increased, at a minimum, to 30 percent of tier 1 capital, with a 
risk weight of no greater than 50 percent for existing MSAs; that 
commercial MSAs should continue to be subject to the risk weighting and 
deduction methodology under the general risk-based capital rules; and 
that originated MSAs should retain the same risk weight treatment under 
the general risk-based capital rules given that the ability to 
originate new servicing to replace servicing lost to prepayment in a 
falling-rate environment provides for a substantial hedge. Another 
commenter recommended that the agencies grandfather all existing MSAs 
that are being fair valued on banking organizations' balance sheets and 
exclude MSAs from the proposed 15 percent deduction threshold.
    After considering these comments, the FDIC is adopting the proposed 
limitation on MSAs includable in common equity tier 1 capital without 
change in the interim final rule. MSAs, like other intangible assets, 
have long been either fully or partially excluded from regulatory 
capital in the United States because of the high level of uncertainty 
regarding the ability of FDIC-supervised institutions to realize value 
from these assets, especially under adverse financial conditions.
m. Netting of Deferred Tax Liabilities Against Deferred Tax Assets and 
Other Deductible Assets
    Under the proposal, banking organizations would have been permitted 
to net DTLs against assets (other than DTAs) subject to deduction under 
section 22 of the proposal, provided the DTL is associated with the 
asset and the DTL would be extinguished if the associated asset becomes 
impaired or is derecognized under GAAP. Likewise, banking organizations 
would be prohibited from using the same DTL more than once for netting 
purposes. This practice would be generally consistent with the approach 
that the agencies currently take with respect to the netting of DTLs 
against goodwill.
    With respect to the netting of DTLs against DTAs, under the 
proposal the amount of DTAs that arise from net operating loss and tax 
credit carryforwards, net of any related valuation allowances, and the 
amount of DTAs arising from temporary differences that the banking 
organization could not realize through net operating loss carrybacks, 
net of any related valuation allowances, could be netted against DTLs 
if certain conditions are met.
    The agencies received numerous comments recommending changes to and 
seeking clarification on various aspects of the proposed treatment of 
deferred taxes. Certain commenters asked whether deductions of 
significant and non-significant investments in the capital of 
unconsolidated financial institutions under section 22(c)(4) and 
22(c)(5) of the proposed rule may be net of associated DTLs. A 
commenter also recommended that a banking organization be permitted to 
net a DTA against a fair value measurement or similar adjustment to an 
asset (for example, in the case of a certain cash-flow hedges) or a 
liability (for example, in the case of changes in the fair value of a 
banking organization's liabilities attributed to changes in the banking 
organization's own credit risk) that is associated with the adjusted 
value of the asset or liability that itself is subject to a capital 
adjustment or deduction under the Basel III NPR. These DTAs would be 
derecognized under GAAP if the adjustment were reversed. Accordingly, 
one commenter recommended that proposed text in section 22(e) be 
revised to apply to netting of DTAs as well as DTLs.
    The FDIC agrees that for regulatory capital purposes, an FDIC-
supervised institution may exclude from the deduction thresholds DTAs 
and DTLs associated with fair value measurement or similar adjustments 
to an asset or liability that are excluded from common equity tier 1 
capital under the interim final rule. The FDIC notes that GAAP requires 
net unrealized gains and losses \91\ recognized in AOCI to be recorded 
net of deferred tax effects. Moreover, under the FDIC's general risk-
based capital rules and associated regulatory reporting instructions, 
FDIC-supervised institutions must deduct certain net unrealized gains, 
net of applicable taxes, and add back certain net unrealized losses, 
again, net of applicable taxes. Permitting FDIC-supervised institutions 
to exclude net unrealized gains and losses included in AOCI without 
netting of deferred tax effects would cause an FDIC-supervised 
institution to overstate the amount of net unrealized gains and losses 
excluded from regulatory capital and potentially overstate or 
understate deferred taxes included in regulatory capital.
---------------------------------------------------------------------------

    \91\ The word ``net'' in the term ``net unrealized gains and 
losses'' refers to the netting of gains and losses before tax.
---------------------------------------------------------------------------

    Accordingly, under the interim final rule, FDIC-supervised 
institutions must make all adjustments to common equity tier 1 capital 
under section 22(b) of the interim final rule net of any associated 
deferred tax effects. In addition, FDIC-supervised institutions may 
make all deductions from common equity tier 1 capital elements under 
section 324.22(c) and (d) of the interim final rule net of associated 
DTLs, in accordance with section 324.22(e) of the interim final rule.
    Commenters also sought clarification as to whether banking 
organizations may change from reporting period to reporting period 
their decision to net DTLs against DTAs as opposed to netting DTLs 
against other assets subject to deduction. Consistent with the FDIC's 
general risk-based capital rules, the interim final rule permits, but 
does not require, an FDIC-supervised institution to net DTLs associated 
with items subject to regulatory deductions from common equity tier 1 
capital under section 22(a). The FDIC's general risk-based capital 
rules do not explicitly address whether or how often an FDIC-supervised 
institution may change its DTL netting approach for items subject to 
deduction, such as goodwill and other intangible assets.
    If an FDIC-supervised institution elects to either net DTLs against 
DTAs or to net DTLs against other assets subject to deduction, the 
interim final rule requires that it must do so consistently. For 
example, an FDIC-

[[Page 55390]]

supervised institution that elects to deduct goodwill net of associated 
DTLs will be required to continue that practice for all future 
reporting periods. Under the interim final rule, an FDIC-supervised 
institution must obtain approval from the FDIC before changing its 
approach for netting DTLs against DTAs or assets subject to deduction 
under section 324.22(a), which would be permitted, for example, in 
situations where an FDIC-supervised institution merges with or acquires 
another FDIC-supervised institution, or upon a substantial change in an 
FDIC-supervised institution's business model.
    Commenters also asked whether banking organizations would be 
permitted or required to exclude (from the amount of DTAs subject to 
the threshold deductions under section 22(d) of the proposal) deferred 
tax assets and liabilities relating to net unrealized gains and losses 
reported in AOCI that are subject to: (1) regulatory adjustments to 
common equity tier 1 capital (section 22(b) of the proposal), (2) 
deductions from regulatory capital related to investments in capital 
instruments (section 22(c) of the proposal), and (3) items subject to 
the 10 and 15 percent common equity tier 1 capital deduction thresholds 
(section 22(d) of the proposal).
    Under the FDIC's general risk-based capital rules, before 
calculating the amount of DTAs subject to the DTA limitations for 
inclusion in tier 1 capital, an FDIC-supervised institution may 
eliminate the deferred tax effects of any net unrealized gains and 
losses on AFS debt securities. An FDIC-supervised institution that 
adopts a policy to eliminate such deferred tax effects must apply that 
approach consistently in all future calculations of the amount of 
disallowed DTAs.
    For purposes of the interim final rule, the FDIC has decided to 
permit FDIC-supervised institutions to eliminate from the calculation 
of DTAs subject to threshold deductions under section 324.22(d) of the 
interim final rule the deferred tax effects associated with any items 
that are subject to regulatory adjustment to common equity tier 1 
capital under section 324.22(b). An FDIC-supervised institution that 
elects to eliminate such deferred tax effects must continue that 
practice consistently from period to period. An FDIC-supervised 
institution must obtain approval from the FDIC before changing its 
election to exclude or not exclude these amounts from the calculation 
of DTAs. Additionally, the FDIC has decided to require DTAs associated 
with any net unrealized losses or differences between the tax basis and 
the accounting basis of an asset pertaining to items (other than those 
items subject to adjustment under section 324.22(b)) that are: (1) 
subject to deduction from common equity tier 1 capital under section 
324.22(c) or (2) subject to the threshold deductions under section 
324.22(d) to be subject to the threshold deductions under section 
324.22(d) of the interim final rule.
    Commenters also sought clarification as to whether banking 
organizations would be required to compute DTAs and DTLs quarterly for 
regulatory capital purposes. In this regard, commenters stated that 
GAAP requires annual computation of DTAs and DTLs, and that more 
frequent computation requirements for regulatory capital purposes would 
be burdensome.
    Some DTA and DTL items must be adjusted at least quarterly, such as 
DTAs and DTLs associated with certain gains and losses included in 
AOCI. Therefore, the FDIC expects FDIC-supervised institutions to use 
the DTA and DTL amounts reported in the regulatory reports for balance 
sheet purposes to be used for regulatory capital calculations. The 
interim final rule does not require FDIC-supervised institutions to 
perform these calculations more often than would otherwise be required 
in order to meet quarterly regulatory reporting requirements.
    A few commenters also asked whether the agencies would continue to 
allow banking organizations to use DTLs embedded in the carrying value 
of a leveraged lease to reduce the amount of DTAs subject to the 10 
percent and 15 percent common equity tier 1 capital deduction 
thresholds contained in section 22(d) of the proposal. The valuation of 
a leveraged lease acquired in a business combination gives recognition 
to the estimated future tax effect of the remaining cash-flows of the 
lease. Therefore, any future tax liabilities related to an acquired 
leveraged lease are included in the valuation of the leveraged lease, 
and are not separately reported under GAAP as DTLs. This can 
artificially increase the amount of net DTAs reported by banking 
organizations that acquire a leveraged lease portfolio under purchase 
accounting. Accordingly, the agencies' currently allow banking 
organizations to treat future taxes payable included in the valuation 
of a leveraged lease portfolio as a reversing taxable temporary 
difference available to support the recognition of DTAs.\92\ The 
interim final rule amends the proposal by explicitly permitting an 
FDIC-supervised institution to use the DTLs embedded in the carrying 
value of a leveraged lease to reduce the amount of DTAs consistent with 
section 22(e).
---------------------------------------------------------------------------

    \92\ Temporary differences arise when financial events or 
transactions are recognized in one period for financial reporting 
purposes and in another period, or periods, for tax purposes. A 
reversing taxable temporary difference is a temporary difference 
that produces additional taxable income future periods.
---------------------------------------------------------------------------

    In addition, commenters asked the agencies to clarify whether a 
banking organization is required to deduct from the sum of its common 
equity tier 1 capital elements net DTAs arising from timing differences 
that the banking organization could realize through net operating loss 
carrybacks. The FDIC confirms that under the interim final rule, DTAs 
that arise from temporary differences that the FDIC-supervised 
institution may realize through net operating loss carrybacks are not 
subject to the 10 percent and 15 percent common equity tier 1 capital 
deduction thresholds (deduction thresholds). This is consistent with 
the FDIC's general risk-based capital rules, which do not limit DTAs 
that can potentially be realized from taxes paid in prior carryback 
years. However, consistent with the proposal, the interim final rule 
requires that FDIC-supervised institutions deduct from common equity 
tier 1 capital elements the amount of DTAs arising from temporary 
differences that the FDIC-supervised institution could not realize 
through net operating loss carrybacks that exceed the deduction 
thresholds under section 324.22(d) of the interim final rule.
    Some commenters recommended that the agencies retain the provision 
in the agencies' general risk-based capital rules that permits a 
banking organization to measure the amount of DTAs subject to inclusion 
in tier 1 capital by the amount of DTAs that the banking organization 
could reasonably be expected to realize within one year, based on its 
estimate of future taxable income.\93\ In addition, commenters argued 
that the full deduction of net operating loss and tax credit 
carryforwards from common equity tier 1 capital is an inappropriate 
reaction to concerns about DTAs as an element of capital, and that 
there are appropriate circumstances where an

[[Page 55391]]

institution should be allowed to include the value of its DTAs related 
to net operating loss carryforwards in regulatory capital.
---------------------------------------------------------------------------

    \93\ Under the FDIC's general risk-based capital rules, a 
banking organization generally must deduct from tier 1 capital DTAs 
that are dependent upon future taxable income, which exceed the 
lesser of either: (1) the amount of DTAs that the bank could 
reasonably expect to realize within one year of the quarter-end 
regulatory report, based on its estimate of future taxable income 
for that year, or (2) 10 percent of tier 1 capital, net of goodwill 
and all intangible assets other than purchased credit card 
relationships, and servicing assets. See 12 CFR part 325, appendix A 
section I.A.1.iii(a) (state nonmember banks), and 12 CFR 
390.465(a)(2)(vii) (state savings associations).
---------------------------------------------------------------------------

    The deduction thresholds for DTAs in the interim final rule are 
intended to address the concern that GAAP standards for DTAs could 
allow FDIC-supervised institutions to include in regulatory capital 
excessive amounts of DTAs that are dependent upon future taxable 
income. The concern is particularly acute when FDIC-supervised 
institutions begin to experience financial difficulty. In this regard, 
the FDIC observed that as the recent financial crisis began, many FDIC-
supervised institutions that had included DTAs in regulatory capital 
based on future taxable income were no longer able to do so because 
they projected more than one year of losses for tax purposes.
    The FDIC notes that under the proposal and interim final rule, DTAs 
that arise from temporary differences that the FDIC-supervised 
institution may realize through net operating loss carrybacks are not 
subject to the deduction thresholds and will be subject to a risk 
weight of 100 percent. Further, FDIC-supervised institutions will 
continue to be permitted to include some or all of their DTAs that are 
associated with timing differences that are not realizable through net 
operating loss carrybacks in regulatory capital. In this regard, the 
interim final rule strikes an appropriate balance between prudential 
concerns and practical considerations about the ability of FDIC-
supervised institutions to realize DTAs.
    The proposal stated: ``A [BANK] is not required to deduct from the 
sum of its common equity tier 1 capital elements net DTAs arising from 
timing differences that the [BANK] could realize through net operating 
loss carrybacks (emphasis added).'' \94\ Commenters requested that the 
agencies clarify that the word ``net'' in this sentence was intended to 
refer to DTAs ``net of valuation allowances.'' The FDIC has amended 
section 22(e) of the interim final rule text to clarify that the word 
``net'' in this instance was intended to refer to DTAs ``net of any 
related valuation allowances and net of DTLs.''
---------------------------------------------------------------------------

    \94\ See footnote 14, 77 FR 52863 (August 30, 2012).
---------------------------------------------------------------------------

    In addition, a commenter requested that the agencies remove the 
condition in section 324.22(e) of the interim final rule providing that 
only DTAs and DTLs that relate to taxes levied by the same taxing 
authority may be offset for purposes of the deduction of DTAs. This 
commenter notes that under a GAAP, a company generally calculates its 
DTAs and DTLs relating to state income tax in the aggregate by applying 
a blended state rate. Thus, FDIC-supervised institutions do not 
typically track DTAs and DTLs on a state-by-state basis for financial 
reporting purposes.
    The FDIC recognizes that under GAAP, if the tax laws of the 
relevant state and local jurisdictions do not differ significantly from 
federal income tax laws, then the calculation of deferred tax expense 
can be made in the aggregate considering the combination of federal, 
state, and local income tax rates. The rate used should consider 
whether amounts paid in one jurisdiction are deductible in another 
jurisdiction. For example, since state and local taxes are deductible 
for federal purposes, the aggregate combined rate would generally be 
(1) the federal tax rate plus (2) the state and local tax rates, minus 
(3) the federal tax effect of the deductibility of the state and local 
taxes at the federal tax rate. Also, for financial reporting purposes, 
consistent with GAAP, the FDIC allows FDIC-supervised institutions to 
offset DTAs (net of valuation allowance) and DTLs related to a 
particular tax jurisdiction. Moreover, for regulatory reporting 
purposes, consistent with GAAP, the FDIC requires separate calculations 
of income taxes, both current and deferred amounts, for each tax 
jurisdiction. Accordingly, FDIC-supervised institutions must calculate 
DTAs and DTLs on a state-by-state basis for financial reporting 
purposes under GAAP and for regulatory reporting purposes.
3. Investments in Hedge Funds and Private Equity Funds Pursuant to 
Section 13 of the Bank Holding Company Act
    Section 13 of the Bank Holding Company Act, which was added by 
section 619 of the Dodd-Frank Act, contains a number of restrictions 
and other prudential requirements applicable to any ``banking entity'' 
\95\ that engages in proprietary trading or has certain interests in, 
or relationships with, a hedge fund or a private equity fund.\96\
---------------------------------------------------------------------------

    \95\ See 12 U.S.C. 1851. The term ``banking entity'' is defined 
in section 13(h)(1) of the Bank Holding Company Act, as amended by 
section 619 of the Dodd-Frank Act. See 12 U.S.C. 1851(h)(1). The 
statutory definition includes any insured depository institution 
(other than certain limited purpose trust institutions), any company 
that controls an insured depository institution, any company that is 
treated as a bank holding company for purposes of section 8 of the 
International Banking Act of 1978 (12 U.S.C. 3106), and any 
affiliate or subsidiary of any of the foregoing.
    \96\ Section 13 of the Bank Holding Company Act defines the 
terms ``hedge fund'' and ``private equity fund'' as ``an issuer that 
would be an investment company, as defined in the Investment Company 
Act of 1940, but for section 3(c)(1) or 3(c)(7) of that Act, or such 
similar funds as the [relevant agencies] may, by rule . . . 
determine.'' See 12 U.S.C. 1851(h)(2).
---------------------------------------------------------------------------

    Section 13(d)(3) of the Bank Holding Company Act provides that the 
relevant agencies ``shall . . . adopt rules imposing additional capital 
requirements and quantitative limitations, including diversification 
requirements, regarding activities permitted under [Section 13] if the 
appropriate Federal banking agencies, the SEC, and the Commodity 
Futures Trading Commission (CFTC) determine that additional capital and 
quantitative limitations are appropriate to protect the safety and 
soundness of banking entities engaged in such activities.'' The Dodd-
Frank Act also added section 13(d)(4)(B)(iii) to the Bank Holding 
Company Act, which pertains to investments in a hedge fund or private 
equity fund organized and offered by a banking entity and provides for 
deductions from the assets and tangible equity of the banking entity 
for these investments in hedge funds or private equity funds.
    On November 7, 2011, the agencies and the SEC issued a proposal to 
implement Section 13 of the Bank Holding Company Act.\97\ The proposal 
would require a ``banking entity'' to deduct from tier 1 capital its 
investments in a hedge fund or a private equity fund that the banking 
entity organizes and offers.\98\ The FDIC intends to address this 
capital requirement, as it applies to FDIC-supervised institutions, 
within the context of its entire regulatory capital framework, so that 
its potential interaction with all other regulatory capital 
requirements can be fully assessed.
---------------------------------------------------------------------------

    \97\ See 76 FR 68846 (November 7, 2011). On February 14, 2012, 
the CFTC published a substantively similar proposed rule 
implementing section 13 of the Bank Holding Company Act. See 77 FR 
8332 (February 14, 2012).
    \98\ See Id., Sec.  324.12(d).
---------------------------------------------------------------------------

VI. Denominator Changes Related to the Regulatory Capital Changes

    Consistent with Basel III, the proposal provided a 250 percent risk 
weight for the portion of the following items that are not otherwise 
subject to deduction: (1) MSAs, (2) DTAs arising from temporary 
differences that a banking organization could not realize through net 
operating loss carrybacks (net of any related valuation allowances and 
net of DTLs, as described in section 324.22(e)

[[Page 55392]]

of the rule), and (3) significant investments in the capital of 
unconsolidated financial institutions in the form of common stock that 
are not deducted from tier 1 capital.
    Several commenters objected to the proposed 250 percent risk weight 
and stated that the agencies instead should apply a 100 percent risk 
weight to the amount of these assets below the deduction thresholds. 
Commenters stated that the relatively high risk weight would drive 
business, particularly mortgage servicing, out of the banking sector 
and into unregulated shadow banking entities.
    After considering the comments, the FDIC continues to believe that 
the 250 percent risk weight is appropriate in light of the relatively 
greater risks inherent in these assets, as described above. These risks 
are sufficiently significant that concentrations in these assets 
warrant deductions from capital, and any exposure to these assets 
merits a higher-than 100 percent risk weight. Therefore, the interim 
final rule adopts the proposed treatment without change.
    The interim final rule, consistent with the proposal, requires 
FDIC-supervised institutions to apply a 1,250 percent risk weight to 
certain exposures that were subject to deduction under the general 
risk-based capital rules. Therefore, for purposes of calculating total 
risk-weighted assets, the interim final rule requires an FDIC-
supervised institution to apply a 1,250 percent risk weight to the 
portion of a credit-enhancing interest-only strip (CEIO) that does not 
constitute an after-tax-gain-on-sale.

VII. Transition Provisions

    The proposal established transition provisions for: (i) minimum 
regulatory capital ratios; (ii) capital conservation and 
countercyclical capital buffers; (iii) regulatory capital adjustments 
and deductions; (iv) non-qualifying capital instruments; and (v) the 
supplementary leverage ratio. Most of the transition periods in the 
proposal began on January 1, 2013, and would have provided banking 
organizations between three and six years to comply with the 
requirements in the proposed rule. Among other provisions, the proposal 
would have provided a transition period for the phase-out of non-
qualifying capital instruments from regulatory capital under either a 
three- or ten-year transition period based on the organization's 
consolidated total assets. The proposed transition provisions were 
designed to give banking organizations sufficient time to adjust to the 
revised capital framework while minimizing the potential impact that 
implementation could have on their ability to lend. The transition 
provisions also were designed to ensure compliance with the Dodd-Frank 
Act. As a result, they would have been, in certain circumstances, more 
stringent than the transition arrangements set forth in Basel III.
    The agencies received multiple comments on the proposed transition 
framework. Most of the commenters characterized the proposed transition 
schedule for the minimum capital ratios as overly aggressive and 
expressed concern that banking organizations would not be able to meet 
the increased capital requirements (in accordance with the transition 
schedule) in the current economic environment. Commenters representing 
community banking organizations argued that such organizations 
generally have less access to the capital markets relative to larger 
banking organizations and, therefore, usually increase capital 
primarily by accumulating retained earnings. Accordingly, these 
commenters requested additional time to satisfy the minimum capital 
requirements under the proposed rule, and specifically asked the 
agencies to provide banking organizations until January 1, 2019 to 
comply with the proposed minimum capital requirements. Other commenters 
commenting on behalf of community banking organizations, however, 
considered the transition period reasonable. One commenter requested a 
shorter implementation timeframe for the largest banking organizations, 
asserting that these organizations already comply with the proposed 
standards. Another commenter suggested removing the transition period 
and delaying the effective date until the industry more fully recovers 
from the recent crisis. According to this commenter, the effective date 
should be delayed to ensure that implementation of the rule would not 
result in a contraction in aggregate U.S. lending capacity.
    A number of commenters suggested an effective date based on the 
publication date of the interim final rule in the Federal Register. 
According to the commenters, such an approach would provide banking 
organizations with certainty regarding the effective date of the 
interim final rule that would allow them to plan for and implement any 
required system and process changes. One commenter requested 
simultaneous implementation of all three proposals because some 
elements of the Standardized Approach NPR affect the implementation of 
the Basel III NPR. A number of commenters also requested additional 
time to comply with the proposed capital conservation buffer. According 
to these commenters, implementation of the capital conservation buffer 
would make the equity instruments of banking organizations less 
attractive to potential investors and could even encourage divestment 
among existing shareholders. Therefore, the commenters maintained, the 
proposed rule would require banking organizations to raise capital by 
accumulating retained earnings, and doing so could take considerable 
time in the current economic climate. For these reasons, the commenters 
asked the agencies to delay implementation of the capital conservation 
buffer for an additional five years to provide banking organizations 
sufficient time to increase retained earnings without curtailing 
lending activity. Other commenters requested that the agencies fully 
exempt banks with total consolidated assets of $50 billion or less from 
the capital conservation buffer, further recommending that if the 
agencies declined to make this accommodation then the phase-in period 
for the capital conservation buffer should be extended by at least 
three years to January 1, 2022, to provide community banking 
organizations with enough time to meet the new regulatory minimums.
    A number of commenters noted that Basel III phases in the deduction 
of goodwill from 2014 to 2018, and requested that the agencies adopt 
this transition for goodwill in the United States to prevent U.S. 
institutions from being disadvantaged relative to their global 
competitors.
    Many commenters objected to the proposed schedule for the phase out 
of TruPS from tier 1 capital, particularly for banking organizations 
with less than $15 billion in total consolidated assets. As discussed 
in more detail in section V.A., the commenters requested that the 
agencies grandfather existing TruPS issued by depository institution 
holding companies with less than $15 billion and 2010 MHCs, as 
permitted by section 171 of the Dodd-Frank Act. In general, these 
commenters characterized TruPS as a relatively safe, low-cost form of 
capital issued in full compliance with regulatory requirements that 
would be difficult for smaller institutions to replace in the current 
economic environment. Some commenters requested that community banking 
organizations be exempt from the phase-out of TruPS and from the phase-
out of cumulative preferred stock for these reasons. Another commenter 
requested that the agencies propose that institutions with under $5 
billion in total consolidated assets be allowed to continue to include 
TruPS in regulatory

[[Page 55393]]

capital at full value until the call or maturity of the TruPS 
instrument.
    Some commenters encouraged the agencies to adopt the ten-year 
transition schedule under Basel III for TruPS of banking organizations 
with total consolidated assets of more than $15 billion. These 
commenters asserted that the proposed transition framework for TruPS 
would disadvantage U.S. banking organizations relative to foreign 
competitors. One commenter expressed concern that the transition 
framework under the proposed rule also would disrupt payment schedules 
for TruPS CDOs.
    Commenters proposed several additional alternative transition 
frameworks for TruPS. For example, one commenter recommended a 10 
percent annual reduction in the amount of TruPS banking organizations 
with $15 billion or more of total consolidated assets may recognize in 
tier 1 capital beginning in 2013, followed by a phase-out of the 
remaining amount in 2015. According to the commenter, such a framework 
would comply with the Dodd-Frank Act and allow banking organizations 
more time to replace TruPS. Another commenter suggested that the 
interim final rule allow banking organizations to progressively reduce 
the amount of TruPS eligible for inclusion in tier 1 capital by 1.25 to 
2.5 percent per year. One commenter encouraged the agencies to avoid 
penalizing banking organizations that elect to redeem TruPS during the 
transition period. Specifically, the commenter asked the agencies to 
revise the proposed transition framework so that any TruPS redeemed 
during the transition period would not reduce the total amount of TruPS 
eligible for inclusion in tier 1 capital. Under such an approach, the 
amount of TruPS eligible for inclusion in tier 1 capital during the 
transition period would equal the lesser of: (a) the remaining 
outstanding balance or (b) the percentage decline factor times the 
balance outstanding at the time the interim final rule is published in 
the Federal Register.
    One commenter encouraged the agencies to allow a banking 
organization that grows to more than $15 billion in total assets as a 
result of merger and acquisition activity to remain subject to the 
proposed transition framework for non-qualifying capital instruments 
issued by organizations with less than $15 billion in total assets. 
According to the commenter, such an approach should apply to either the 
buyer or seller in the transaction. Other commenters asked the agencies 
to allow banking organizations whose total consolidated assets grew to 
over $15 billion just prior to May 19, 2010, and whose asset base 
subsequently declined below that amount to include all TruPS in their 
tier 1 capital during 2013 and 2014 on the same basis as institutions 
with less than $15 billion in total consolidated assets and, 
thereafter, be subject to the deductions required by section 171 of the 
Dodd-Frank Act.
    Commenters representing advanced approaches banking organizations 
generally objected to the proposed transition framework for the 
supplementary leverage ratio, and requested a delay in its 
implementation. For example, one commenter recommended the agencies 
defer implementation of the supplementary leverage ratio until the 
agencies have had an opportunity to consider whether it is likely to 
result in regulatory arbitrage and international competitive inequality 
as a result of differences in national accounting frameworks and 
standards. Another commenter asked the agencies to delay implementation 
of the supplementary leverage ratio until no earlier than January 1, 
2018, as provided in Basel III, or until the BCBS completes its 
assessment and reaches international agreement on any further 
adjustments. A few commenters, however, supported the proposed 
transition framework for the supplementary leverage ratio because it 
could be used as an important regulatory tool to ensure there is 
sufficient capital in the financial system.
    After considering the comments and the potential challenges some 
banking organizations may face in complying with the interim final 
rule, the FDIC has agreed to delay the compliance date for FDIC-
supervised institutions that are not advanced approaches FDIC-
supervised institutions until January 1, 2015. Therefore, such entities 
are not required to calculate their regulatory capital requirements 
under the interim final rule until January 1, 2015. Thereafter, these 
FDIC-supervised institutions must calculate their regulatory capital 
requirements in accordance with the interim final rule, subject to the 
transition provisions set forth in subpart G of the interim final rule.
    The interim final rule also establishes the effective date of the 
interim final rule for advanced approaches FDIC-supervised institutions 
as January 1, 2014. In accordance with Tables 5-17 below, the 
transition provisions for the regulatory capital adjustments and 
deductions in the interim final rule commence either one or two years 
later than in the proposal, depending on whether the FDIC-supervised 
institution is or is not an advanced approaches FDIC-supervised 
institution. The December 31, 2018, end-date for the transition period 
for regulatory capital adjustments and deductions is the same under the 
interim final rule as under the proposal.

A. Transitions Provisions for Minimum Regulatory Capital Ratios

    In response to the commenters' concerns, the interim final rule 
modifies the proposed transition provisions for the minimum capital 
requirements. FDIC-supervised institutions that are not advanced 
approaches FDIC-supervised institutions are not required to comply with 
the minimum capital requirements until January 1, 2015. This is a delay 
of two years from the beginning of the proposed transition period. 
Because the FDIC is not requiring compliance with the interim final 
rule until January 1, 2015 for these entities, there is no additional 
transition period for the minimum regulatory capital ratios. This 
approach should give FDIC-supervised institutions sufficient time to 
raise or accumulate any additional capital needed to satisfy the new 
minimum requirements and upgrade internal systems without adversely 
affecting their lending capacity.
    Under the interim final rule, an advanced approaches FDIC-
supervised institution must comply with minimum common equity tier 1, 
tier 1, and total capital ratio requirements of 4.0 percent, 5.5 
percent, and 8.0 percent during calendar year 2014, and 4.5 percent, 
6.0 percent, 8.0 percent, respectively, beginning January 1, 2015. 
These transition provisions are consistent with those under Basel III 
for internationally-active FDIC-supervised institutions. During 
calendar year 2014, advanced approaches FDIC-supervised institutions 
must calculate their minimum common equity tier 1, tier 1, and total 
capital ratios using the definitions for the respective capital 
components in section 20 of the interim final rule (adjusted in 
accordance with the transition provisions for regulatory adjustments 
and deductions and for the non-qualifying capital instruments for 
advanced approaches FDIC-supervised institutions described in this 
section).

B. Transition Provisions for Capital Conservation and Countercyclical 
Capital Buffers

    The FDIC has finalized transitions for the capital conservation and 
countercyclical capital buffers as proposed. The capital conservation 
buffer transition period begins in 2016,

[[Page 55394]]

a full year after FDIC-supervised institutions that are not advanced 
approaches FDIC-supervised institutions are required to comply with the 
interim final rule, and two years after advanced approaches FDIC-
supervised institutions are required to comply with the interim final 
rule. The FDIC believes that this is an adequate time frame to meet the 
buffer level necessary to avoid restrictions on capital distributions. 
Table 5 shows the regulatory capital levels advanced approaches FDIC-
supervised institutions generally must satisfy to avoid limitations on 
capital distributions and discretionary bonus payments during the 
applicable transition period, from January 1, 2016 until January 1, 
2019.

                                 Table 5--Regulatory Capital Levels for Advanced Approaches FDIC-Supervised Institutions
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                           Jan. 1, 2014    Jan. 1, 2015    Jan. 1, 2016    Jan. 1, 2017    Jan. 1, 2018    Jan. 1, 2019
                                                             (percent)       (percent)       (percent)       (percent)       (percent)       (percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Capital conservation buffer.............................  ..............  ..............           0.625            1.25           1.875             2.5
Minimum common equity tier 1 capital ratio + capital                 4.0             4.5           5.125            5.75           6.375             7.0
 conservation buffer....................................
Minimum tier 1 capital ratio + capital conservation                  5.5             6.0           6.625            7.25           7.875             8.5
 buffer.................................................
Minimum total capital ratio + capital conservation                   8.0             8.0           8.625            9.25           9.875            10.5
 buffer.................................................
Maximum potential countercyclical capital buffer........  ..............  ..............           0.625            1.25           1.875             2.5
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Table 6 shows the regulatory capital levels FDIC-supervised 
institutions that are not advanced approaches FDIC-supervised 
institutions generally must satisfy to avoid limitations on capital 
distributions and discretionary bonus payments during the applicable 
transition period, from January 1, 2016 until January 1, 2019.

           Table 6--Regulatory Capital Levels for Non-Advanced Approaches FDIC-Supervised Institutions
----------------------------------------------------------------------------------------------------------------
                                   Jan. 1, 2015    Jan. 1, 2016    Jan. 1, 2017    Jan. 1, 2018    Jan. 1, 2019
                                     (percent)       (percent)       (percent)       (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
Capital conservation buffer.....  ..............           0.625            1.25           1.875             2.5
Minimum common equity tier 1                 4.5           5.125            5.75           6.375             7.0
 capital ratio + capital
 conservation buffer............
Minimum tier 1 capital ratio +               6.0           6.625            7.25           7.875             8.5
 capital conservation buffer....
Minimum total capital ratio +                8.0           8.625            9.25           9.875            10.5
 capital conservation buffer....
----------------------------------------------------------------------------------------------------------------

    As provided in Table 5 and Table 6, the transition period for the 
capital conservation and countercyclical capital buffers does not begin 
until January 1, 2016. During this transition period, from January 1, 
2016 through December 31, 2018, all FDIC-supervised institutions are 
subject to transition arrangements with respect to the capital 
conservation buffer as outlined in more detail in Table 7. For advanced 
approaches FDIC-supervised institutions, the countercyclical capital 
buffer will be phased in according to the transition schedule set forth 
in Table 7 by proportionately expanding each of the quartiles of the 
capital conservation buffer.

          Table 7--Transition Provision for the Capital Conservation and Countercyclical Capital Buffer
----------------------------------------------------------------------------------------------------------------
                                               Capital conservation    Maximum payout ratio (as a percentage of
             Transition period                        buffer                   eligible retained income)
----------------------------------------------------------------------------------------------------------------
Calendar year 2016.........................  Greater than 0.625       No payout ratio limitation applies
                                              percent (plus 25
                                              percent of any
                                              applicable
                                              countercyclical
                                              capital buffer amount).
                                             Less than or equal to    60 percent
                                              0.625 percent (plus 25
                                              percent of any
                                              applicable
                                              countercyclical
                                              capital buffer
                                              amount), and greater
                                              than 0.469 percent
                                              (plus 18.75 percent of
                                              any applicable
                                              countercyclical
                                              capital buffer amount).
                                             Less than or equal to    40 percent
                                              0.469 percent (plus
                                              18.75 percent of any
                                              applicable
                                              countercyclical
                                              capital buffer
                                              amount), and greater
                                              than 0.313 percent
                                              (plus 12.5 percent of
                                              any applicable
                                              countercyclical
                                              capital buffer amount).
                                             Less than or equal to    20 percent
                                              0.313 percent (plus
                                              12.5 percent of any
                                              applicable
                                              countercyclical
                                              capital buffer
                                              amount), and greater
                                              than 0.156 percent
                                              (plus 6.25 percent of
                                              any applicable
                                              countercyclical
                                              capital buffer amount).
                                             Less than or equal to    0 percent
                                              0.156 percent (plus
                                              6.25 percent of any
                                              applicable
                                              countercyclical
                                              capital buffer amount).
----------------------------------------------------------------------------------------------------------------
Calendar year 2017.........................  Greater than 1.25        No payout ratio limitation applies
                                              percent (plus 50
                                              percent of any
                                              applicable
                                              countercyclical
                                              capital buffer amount).

[[Page 55395]]

 
                                             Less than or equal to    60 percent
                                              1.25 percent (plus 50
                                              percent of any
                                              applicable
                                              countercyclical
                                              capital buffer
                                              amount), and greater
                                              than 0.938 percent
                                              (plus 37.5 percent of
                                              any applicable
                                              countercyclical
                                              capital buffer amount).
                                             Less than or equal to    40 percent
                                              0.938 percent (plus
                                              37.5 percent of any
                                              applicable
                                              countercyclical
                                              capital buffer
                                              amount), and greater
                                              than 0.625 percent
                                              (plus 25 percent of
                                              any applicable
                                              countercyclical
                                              capital buffer amount).
                                             Less than or equal to    20 percent
                                              0.625 percent (plus 25
                                              percent of any
                                              applicable
                                              countercyclical
                                              capital buffer
                                              amount), and greater
                                              than 0.313 percent
                                              (plus 12.5 percent of
                                              any applicable
                                              countercyclical
                                              capital buffer amount).
                                             Less than or equal to    0 percent
                                              0.313 percent (plus
                                              12.5 percent of any
                                              applicable
                                              countercyclical
                                              capital buffer amount).
----------------------------------------------------------------------------------------------------------------
Calendar year 2018.........................  Greater than 1.875       No payout ratio limitation applies
                                              percent (plus 75
                                              percent of any
                                              applicable
                                              countercyclical
                                              capital buffer amount).
                                             Less than or equal to    60 percent
                                              1.875 percent (plus 75
                                              percent of any
                                              applicable
                                              countercyclical
                                              capital buffer
                                              amount), and greater
                                              than 1.406 percent
                                              (plus 56.25 percent of
                                              any applicable
                                              countercyclical
                                              capital buffer amount).
                                             Less than or equal to    40 percent
                                              1.406 percent (plus
                                              56.25 percent of any
                                              applicable
                                              countercyclical
                                              capital buffer
                                              amount), and greater
                                              than 0.938 percent
                                              (plus 37.5 percent of
                                              any applicable
                                              countercyclical
                                              capital buffer amount).
                                             Less than or equal to    20 percent
                                              0.938 percent (plus
                                              37.5 percent of any
                                              applicable
                                              countercyclical
                                              capital buffer
                                              amount), and greater
                                              than 0.469 percent
                                              (plus 18.75 percent of
                                              any applicable
                                              countercyclical
                                              capital buffer amount).
                                             Less than or equal to    0 percent
                                              0.469 percent (plus
                                              18.75 percent of any
                                              applicable
                                              countercyclical
                                              capital buffer amount).
----------------------------------------------------------------------------------------------------------------

C. Transition Provisions for Regulatory Capital Adjustments and 
Deductions

    To give sufficient time to FDIC-supervised institutions to adapt to 
the new regulatory capital adjustments and deductions, the interim 
final rule incorporates transition provisions for such adjustments and 
deductions that commence at the time at which the FDIC-supervised 
institution becomes subject to the interim final rule. As explained 
above, the interim final rule maintains the proposed transition 
periods, except for non-qualifying capital instruments as described 
below.
    FDIC-supervised institutions that are not advanced approaches FDIC-
supervised institutions will begin the transitions for regulatory 
capital adjustments and deductions on January 1, 2015. From January 1, 
2015, through December 31, 2017, these FDIC-supervised institutions 
will be required to make the regulatory capital adjustments to and 
deductions from regulatory capital in section 324.22 of the interim 
final rule in accordance with the proposed transition provisions for 
such adjustments and deductions outlined below. Starting on January 1, 
2018, these FDIC-supervised institutions will apply all regulatory 
capital adjustments and deductions as set forth in section 324.22 of 
the interim final rule.
    For an advanced approaches FDIC-supervised institution, the first 
year of transition for adjustments and deductions begins on January 1, 
2014. From January 1, 2014, through December 31, 2017, such FDIC-
supervised institutions will be required to make the regulatory capital 
adjustments to and deductions from regulatory capital in section 22 of 
the interim final rule in accordance with the proposed transition 
provisions for such adjustments and deductions outlined below. Starting 
on January 1, 2018, advanced approaches FDIC-supervised institutions 
will be subject to all regulatory capital adjustments and deductions as 
described in section 22 of the interim final rule.
1. Deductions for Certain Items Under Section 22(a) of the Interim 
Final Rule
    The interim final rule provides that FDIC-supervised institutions 
will deduct from common equity tier 1 capital or tier 1 capital in 
accordance with Table 8 below: (1) goodwill (section 324.22(a)(1)), (2) 
DTAs that arise from operating loss and tax credit carryforwards 
(section 22(a)(3)), (3) gain-on-sale associated with a securitization 
exposure (section 324.22(a)(4)), (4) defined benefit pension fund 
assets (section 324.22(a)(5)), (5) for an advanced approaches FDIC-
supervised institution that has completed the parallel run process and 
that has received notification from the FDIC pursuant to section 121(d) 
of subpart E of the interim final rule, expected credit loss that 
exceeds eligible credit reserves (section 324.22(a)(6)), and (6) 
financial subsidiaries (section 324.22(a)(7)). During the transition 
period, the percentage of these items that is not deducted from common 
equity tier 1 capital must be deducted from tier 1 capital.

[[Page 55396]]



 Table 8--Transition Deductions Under Section 324.22(a)(1) and Sections 324.22(a)(3)-(a)(7) of the Interim Final
                                                      Rule
----------------------------------------------------------------------------------------------------------------
                                        Transition deductions         Transition deductions under sections
                                            under section                      324.22(a)(3)-(a)(6)
                                         324.22(a)(1) and (7)  -------------------------------------------------
          Transition period           -------------------------
                                          Percentage of the        Percentage of the        Percentage of the
                                        deductions from common   deductions from common   deductions from tier 1
                                        equity tier 1 capital    equity tier 1 capital           capital
----------------------------------------------------------------------------------------------------------------
January 1, 2014 to December 31, 2014                       100                       20                       80
 (advanced approaches FDIC-supervised
 institutions only)..................
January 1, 2015 to December 31, 2015.                      100                       40                       60
January 1, 2016 to December 31, 2016.                      100                       60                       40
January 1, 2017 to December 31, 2017.                      100                       80                       20
January 1, 2018 and thereafter.......                      100                      100                        0
----------------------------------------------------------------------------------------------------------------

    Beginning on January 1, 2014, advanced approaches FDIC-supervised 
institutions will be required to deduct the full amount of goodwill 
(which may be net of any associated DTLs), including any goodwill 
embedded in the valuation of significant investments in the capital of 
unconsolidated financial institutions, from common equity tier 1 
capital. All other FDIC-supervised institutions will begin deducting 
goodwill (which may be net of any associated DTLs), including any 
goodwill embedded in the valuation of significant investments in the 
capital of unconsolidated financial institutions from common equity 
tier 1 capital, on January 1, 2015. This approach is stricter than the 
Basel III approach, which transitions the goodwill deduction from 
common equity tier 1 capital through 2017. However, as discussed in 
section V.B of this preamble, under U.S. law, goodwill cannot be 
included in an FDIC-supervised institution's regulatory capital and has 
not been included in FDIC-supervised institutions' regulatory capital 
under the general risk-based capital rules.\99\ Additionally, the FDIC 
believes that fully deducting goodwill from common equity tier 1 
capital from the date an FDIC-supervised institution must comply with 
the interim final rule will result in a more appropriate measure of 
common equity tier 1 capital.
---------------------------------------------------------------------------

    \99\ See 12 U.S.C. 1464(t)(9)(A) and 12 U.S.C. 1828(n).
---------------------------------------------------------------------------

    Beginning on January 1, 2014, a national bank or insured state bank 
subject to the advanced approaches rule will be required to deduct 100 
percent of the aggregate amount of its outstanding equity investment, 
including the retained earnings, in any financial subsidiary from 
common equity tier 1 capital. All other national and insured state 
banks will begin deducting 100 percent of the aggregate amount of their 
outstanding equity investment, including the retained earnings, in a 
financial subsidiary from common equity tier 1 capital on January 1, 
2015. The deduction from common equity tier 1 capital represents a 
change from the general risk-based capital rules, which require the 
deduction to be made from total capital. As explained in section V.B of 
this preamble, similar to goodwill, this deduction is required by 
statute and is consistent with the general risk-based capital rules. 
Accordingly, the deduction is not subject to a transition period.
    The interim final rule also retains the existing deduction for 
state savings associations' investments in, and extensions of credit 
to, non-includable subsidiaries at 12 CFR 324.22(a)(8).\100\ This 
deduction is required by statute \101\ and is consistent with the 
general risk-based capital rules. Accordingly, the deduction is not 
subject to a transition period and must be fully deducted in the first 
year that the state savings association becomes subject to the interim 
final rule.
---------------------------------------------------------------------------

    \100\ For additional information on this deduction, see section 
V.B ``Activities by savings association subsidiaries that are 
impermissible for national banks'' of this preamble.
    \101\ See 12 U.S.C. 1464(t)(5).
---------------------------------------------------------------------------

2. Deductions for Intangibles Other Than Goodwill and Mortgage 
Servicing Assets
    For deductions of intangibles other than goodwill and MSAs, 
including purchased credit-card relationships (PCCRs) (see section 
324.22(a)(2) of the interim final rule), the applicable transition 
period in the interim final rule is set forth in Table 9. During the 
transition period, any of these items that are not deducted will be 
subject to a risk weight of 100 percent. Advanced approaches FDIC-
supervised institutions will begin the transition on January 1, 2014, 
and other FDIC-supervised institutions will begin the transition on 
January 1, 2015.

  Table 9--Transition Deductions Under Section 22(a)(2) of the Proposal
------------------------------------------------------------------------
                                                  Transition deductions
                                                under section 22(a)(2)--
                                                    Percentage of the
               Transition period                 deductions from common
                                                  equity tier 1 capital
 
------------------------------------------------------------------------
January 1, 2014 to December 31, 2014 (advanced                       20
 approaches FDIC-supervised institutions only)
January 1, 2015 to December 31, 2015..........                       40
January 1, 2016 to December 31, 2016..........                       60
January 1, 2017 to December 31, 2017..........                       80
January 1, 2018 and thereafter................                      100
------------------------------------------------------------------------


[[Page 55397]]

3. Regulatory Adjustments Under Section 22(b)(1) of the Interim Final 
Rule
    During the transition period, any of the adjustments required under 
section 324.22(b)(1) that are not applied to common equity tier 1 
capital must be applied to tier 1 capital instead, in accordance with 
Table 10. Advanced approaches FDIC-supervised institutions will begin 
the transition on January 1, 2014, and other FDIC-supervised 
institutions will begin the transition on January 1, 2015.

       Table 10--Transition Adjustments Under Section 324.22(b)(1)
------------------------------------------------------------------------
                                    Transition adjustments under section
                                                324.22(b)(1)
                                   -------------------------------------
                                    Percentage of the
         Transition period              adjustment     Percentage of the
                                    applied to common      adjustment
                                      equity tier 1    applied to tier 1
                                         capital            capital
------------------------------------------------------------------------
January 1, 2014, to December 31,                   20                 80
 2014 (advanced approaches FDIC-
 supervised institutions only)....
January 1, 2015, to December 31,                   40                 60
 2015.............................
January 1, 2016, to December 31,                   60                 40
 2016.............................
January 1, 2017, to December 31,                   80                 20
 2017.............................
January 1, 2018 and thereafter....                100                  0
------------------------------------------------------------------------

4. Phase-Out of Current Accumulated Other Comprehensive Income 
Regulatory Capital Adjustments
    Under the interim final rule, the transition period for the 
inclusion of the aggregate amount of: (1) Unrealized gains on 
available-for-sale equity securities; (2) net unrealized gains or 
losses on available-for-sale debt securities; (3) any amounts recorded 
in AOCI attributed to defined benefit postretirement plans resulting 
from the initial and subsequent application of the relevant GAAP 
standards that pertain to such plans (excluding, at the FDIC-supervised 
institution's option, the portion relating to pension assets deducted 
under section 324.22(a)(5)); (4) accumulated net gains or losses on 
cash-flow hedges related to items that are reported on the balance 
sheet at fair value included in AOCI; and (5) net unrealized gains or 
losses on held-to-maturity securities that are included in AOCI 
(transition AOCI adjustment amount) only applies to advanced approaches 
FDIC-supervised institutions and other FDIC-supervised institutions 
that have not made an AOCI opt-out election under section 324.22(b)(2) 
of the rule and described in section V.B of this preamble. Advanced 
approaches FDIC-supervised institutions will begin the phase out of the 
current AOCI regulatory capital adjustments on January 1, 2014; other 
FDIC-supervised institutions that have not made the AOCI opt-out 
election will begin making these adjustments on January 1, 2015. 
Specifically, if an FDIC-supervised institution's transition AOCI 
adjustment amount is positive, it will adjust its common equity tier 1 
capital by deducting the appropriate percentage of such aggregate 
amount in accordance with Table 11 below. If such amount is negative, 
it will adjust its common equity tier 1 capital by adding back the 
appropriate percentage of such aggregate amount in accordance with 
Table 11 below. The agencies did not include net unrealized gains or 
losses on held-to-maturity securities that are included in AOCI as part 
of the transition AOCI adjustment amount in the proposal. However, the 
FDIC has decided to add such an adjustment as it reflects the FDIC's 
approach towards AOCI adjustments in the general risk-based capital 
rules.

      Table 11--Percentage of the Transition AOCI Adjustment Amount
------------------------------------------------------------------------
                                                    Percentage of the
                                                     transition AOCI
               Transition period                 adjustment amount to be
                                                     applied to common
                                                  equity tier 1 capital
------------------------------------------------------------------------
January 1, 2014, to December 31, 2014 (advanced                       80
 approaches FDIC-supervised institutions only).
January 1, 2015, to December 31, 2015 (advanced                       60
 approaches FDIC-supervised institutions and
 FDIC-supervised institutions that have not
 made an opt-out election).....................
January 1, 2016, to December 31, 2016 (advanced                       40
 approaches FDIC-supervised institutions and
 FDIC-supervised institutions that have not
 made an opt-out election).....................
January 1, 2017, to December 31, 2017 (advanced                       20
 approaches FDIC-supervised institutions and
 FDIC-supervised institutions that have not
 made an opt-out election).....................
January 1, 2018 and thereafter (advanced                               0
 approaches FDIC-supervised institutions and
 FDIC-supervised institutions that have not
 made an opt-out election).....................
------------------------------------------------------------------------

    Beginning on January 1, 2018, advanced approaches FDIC-supervised 
institutions and other FDIC-supervised institutions that have not made 
an AOCI opt-out election must include AOCI in common equity tier 1 
capital, with the exception of accumulated net gains and losses on 
cash-flow hedges related to items that are not measured at fair value 
on the balance sheet, which must be excluded from common equity tier 1 
capital.
5. Phase-Out of Unrealized Gains on Available for Sale Equity 
Securities in Tier 2 Capital
    Advanced approaches FDIC-supervised institutions and FDIC-
supervised institutions not subject to the advanced approaches rule 
that have

[[Page 55398]]

not made an AOCI opt-out election will decrease the amount of 
unrealized gains on AFS preferred stock classified as an equity 
security under GAAP and AFS equity exposures currently held in tier 2 
capital during the transition period in accordance with Table 12. An 
advanced approaches FDIC-supervised institution will begin the 
adjustments on January 1, 2014; all other FDIC-supervised institutions 
that have not made an AOCI opt-out election will begin the adjustments 
on January 1, 2015.

     Table 12--Percentage of Unrealized Gains on AFS Preferred Stock
  Classified as an Equity Security Under GAAP and AFS Equity Exposures
                 That May Be Included in Tier 2 Capital
------------------------------------------------------------------------
                                 Percentage of unrealized gains on AFS
                                preferred stock classified as an equity
      Transition period           security under GAAP and AFS equity
                               exposures that may be included in tier 2
                                                capital
------------------------------------------------------------------------
January 1, 2014, to December                                         36
 31, 2014 (advanced
 approaches FDIC-supervised
 institutions only).........
January 1, 2015, to December                                         27
 31, 2015 (advanced
 approaches FDIC-supervised
 institutions and FDIC-
 supervised institutions
 that have not made an opt-
 out election)..............
January 1, 2016, to December                                         18
 31, 2016 (advanced
 approaches FDIC-supervised
 institutions and FDIC-
 supervised institutions
 that have not made an opt-
 out election)..............
January 1, 2017, to December                                          9
 31, 2017 (advanced
 approaches FDIC-supervised
 institutions and FDIC-
 supervised institutions
 that have not made an opt-
 out election)..............
January 1, 2018 and                                                   0
 thereafter (advanced
 approaches FDIC-supervised
 institutions and FDIC-
 supervised institutions
 that have not made an opt-
 out election)..............
------------------------------------------------------------------------

6. Phase-in of Deductions Related to Investments in Capital Instruments 
and to the Items Subject to the 10 and 15 Percent Common Equity Tier 1 
Capital Deduction Thresholds (Sections 22(c) and 22(d)) of the Interim 
final rule
    Under the interim final rule, an FDIC-supervised institution must 
calculate the appropriate deductions under sections 324.22(c) and 
324.22(d) of the rule related to investments in the capital of 
unconsolidated financial institutions and to the items subject to the 
10 and 15 percent common equity tier 1 capital deduction thresholds 
(that is, MSAs, DTAs arising from temporary differences that the FDIC-
supervised institution could not realize through net operating loss 
carrybacks, and significant investments in the capital of 
unconsolidated financial institutions in the form of common stock) as 
set forth in Table 13. Advanced approaches FDIC-supervised institutions 
will apply the transition framework beginning January 1, 2014. All 
other FDIC-supervised institutions will begin applying the transition 
framework on January 1, 2015. During the transition period, an FDIC-
supervised institution will make the aggregate common equity tier 1 
capital deductions related to these items in accordance with the 
percentages outlined in Table 13 and must apply a 100 percent risk-
weight to the aggregate amount of such items that is not deducted. On 
January 1, 2018, and thereafter, each FDIC-supervised institution will 
be required to apply a 250 percent risk weight to the aggregate amount 
of the items subject to the 10 and 15 percent common equity tier 1 
capital deduction thresholds that are not deducted from common equity 
tier 1 capital.

  Table 13--Transition Deductions under Sections 22(c) and 22(d) of the
                                Proposal
------------------------------------------------------------------------
                              Transition deductions under sections 22(c)
      Transition period         and 22(d)--Percentage of the deductions
                                   from common equity tier 1 capital
------------------------------------------------------------------------
January 1, 2014, to December                                         20
 31, 2014 (advanced
 approaches FDIC-supervised
 institutions only).........
January 1, 2015, to December                                         40
 31, 2015...................
January 1, 2016, to December                                         60
 31, 2016...................
January 1, 2017, to December                                         80
 31, 2017...................
January 1, 2018 and                                                 100
 thereafter.................
------------------------------------------------------------------------

    During the transition period, FDIC-supervised institutions will 
phase in the deduction requirement for the amounts of DTAs arising from 
temporary differences that could not be realized through net operating 
loss carryback, MSAs, and significant investments in the capital of 
unconsolidated financial institutions in the form of common stock that 
exceed the 10 percent threshold in section 22(d) according to Table 13.
    During the transition period, FDIC-supervised institutions will not 
be subject to the methodology to calculate the 15 percent common equity 
deduction threshold for DTAs arising from temporary differences that 
could not be realized through net operating loss carrybacks, MSAs, and 
significant investments in the capital of unconsolidated financial 
institutions in the form of common stock described in section 324.22(d) 
of the interim final rule. During the transition period, an FDIC-
supervised institution will be required to deduct from its common 
equity tier 1 capital the percentage as set forth in Table 13 of the 
amount by which the aggregate sum of the items subject to the 10 and 15 
percent common equity tier 1 capital deduction thresholds exceeds 15 
percent of the sum of the FDIC-supervised institution's common equity 
tier 1 capital after making the deductions and adjustments required 
under sections 324.22(a) through (c).

D. Transition Provisions for Non-Qualifying Capital Instruments

    Under the interim final rule, beginning on January 1, 2014, an 
advanced approaches depository institution and beginning on January 1, 
2015, a depository institution that is not a depository institution 
subject to the advanced approaches rule may include

[[Page 55399]]

in regulatory capital debt or equity instruments issued prior to 
September 12, 2010 that do not meet the criteria for additional tier 1 
or tier 2 capital instruments in section 324.20 of the interim final 
rule, but that were included in tier 1 or tier 2 capital, respectively, 
as of September 12, 2010 (non-qualifying capital instruments issued 
prior to September 12, 2010). These instruments may be included up to 
the percentage of the outstanding principal amount of such non-
qualifying capital instruments as of the effective date of the interim 
final rule in accordance with the phase-out schedule in Table 14.
    As of January 1, 2014 for advanced approaches FDIC-supervised 
institutions, and January 1, 2015 for all other FDIC-supervised 
institutions, debt or equity instruments issued after September 12, 
2010, that do not meet the criteria for additional tier 1 or tier 2 
capital instruments in section 20 of the interim final rule may not be 
included in additional tier 1 or tier 2 capital.

 Table 14--Percentage of Non-Qualifying Capital Instruments Issued Prior
 to September 12, 2010 Includable in Additional Tier 1 or Tier 2 Capital
------------------------------------------------------------------------
                                 Percentage of non-qualifying capital
 Transition period (calendar  instruments issued prior to September 2010
            year)              includable in additional tier 1 or tier 2
                               capital for FDIC-supervised institutions
------------------------------------------------------------------------
Calendar year 2014 (advanced                                         80
 approaches FDIC-supervised
 institutions only).........
Calendar year 2015..........                                         70
Calendar year 2016..........                                         60
Calendar year 2017..........                                         50
Calendar year 2018..........                                         40
Calendar year 2019..........                                         30
Calendar year 2020..........                                         20
Calendar year 2021..........                                         10
Calendar year 2022 and                                                0
 thereafter.................
------------------------------------------------------------------------

    Under the transition provisions in the interim final rule, an FDIC-
supervised institution is allowed to include in regulatory capital a 
portion of the common equity tier 1, tier 1, or total capital minority 
interest that is disqualified from regulatory capital as a result of 
the requirements and limitations outlined in section 21 (surplus 
minority interest). If an FDIC-supervised institution has surplus 
minority interest outstanding when the interim final rule becomes 
effective, that surplus minority interest will be subject to the phase-
out schedule outlined in Table 16. Advanced approaches FDIC-supervised 
institutions must begin to phase out surplus minority interest in 
accordance with Table 16 beginning on January 1, 2014. All other FDIC-
supervised institutions will begin the phase out for surplus minority 
interest on January 1, 2015.
    During the transition period, an FDIC-supervised institution will 
also be able to include in tier 1 or total capital a portion of the 
instruments issued by a consolidated subsidiary that qualified as tier 
1 or total capital of the FDIC-supervised institution on the date the 
rule becomes effective, but that do not qualify as tier 1 or total 
capital under section 324.20 of the interim final rule (non-qualifying 
minority interest) in accordance with Table 16.

Table 16--Percentage of the Amount of Surplus or Non-Qualifying Minority
   Interest Includable in Regulatory Capital During Transition Period
------------------------------------------------------------------------
                              Percentage of the amount of surplus or non-
                               qualifying minority interest that can be
      Transition period        included in regulatory capital during the
                                           transition period
------------------------------------------------------------------------
January 1, 2014, to December                                         80
 31, 2014 (advanced
 approaches FDIC-supervised
 institutions only).........
January 1, 2015, to December                                         60
 31, 2015...................
January 1, 2016, to December                                         40
 31, 2016...................
January 1, 2017, to December                                         20
 31, 2017...................
January 1, 2018 and                                                   0
 thereafter.................
------------------------------------------------------------------------

VIII. Standardized Approach for Risk-Weighted Assets

    In the Standardized Approach NPR, the agencies proposed to revise 
methodologies for calculating risk-weighted assets. As discussed above 
and in the proposal, these revisions were intended to harmonize the 
agencies' rules for calculating risk-weighted assets and to enhance 
risk sensitivity and remediate weaknesses identified over recent 
years.\102\ The proposed revisions incorporated elements of the Basel 
II standardized approach \103\ as modified by the 2009 Enhancements, 
certain aspects of Basel III, and other proposals in recent 
consultative papers published by the BCBS.\104\ Consistent with section 
939A of the Dodd-Frank Act, the agencies also proposed alternatives to 
credit ratings for calculating risk weights for certain assets.
---------------------------------------------------------------------------

    \102\ 77 FR 52888 (August 30, 2012).
    \103\ See BCBS, ``International Convergence of Capital 
Measurement and Capital Standards: A Revised Framework,'' (June 
2006), available at http://www.bis.org/publ/bcbs128.htm.
    \104\ See, e.g., ``Basel III FAQs answered by the Basel 
Committee'' (July, October, December 2011), available at http://www.bis.org/list/press_releases/index.htm; ``Capitalization of 
Banking Organization Exposures to Central Counterparties'' (December 
2010, revised November 2011) (CCP consultative release), available 
at http://www.bis.org/publ/bcbs206.pdf.

---------------------------------------------------------------------------

[[Page 55400]]

    The proposal also included potential revisions for the recognition 
of credit risk mitigation that would allow for greater recognition of 
financial collateral and a wider range of eligible guarantors. In 
addition, the proposal set forth more risk-sensitive treatments for 
residential mortgages, equity exposures and past due loans, derivatives 
and repo-style transactions cleared through CCPs, and certain 
commercial real estate exposures that typically have higher credit 
risk, as well as operational requirements for securitization exposures. 
The agencies also proposed to apply disclosure requirements to banking 
organizations with $50 billion or more in total assets that are not 
subject to the advanced approaches rule.
    The agencies received a significant number of comments regarding 
the proposed standardized approach for risk-weighted assets. Although a 
few commenters observed that the proposals would provide a sound 
framework for determining risk-weighted assets for all banking 
organizations that would generally benefit U.S. banking organizations, 
a significant number of other commenters asserted that the proposals 
were too complex and burdensome, especially for smaller banking 
organizations, and some argued that it was inappropriate to apply the 
proposed requirements to such banking organizations because such 
institutions did not cause the recent financial crisis. Other 
commenters expressed concern that the new calculation for risk-weighted 
assets would adversely affect banking organizations' regulatory capital 
ratios and that smaller banking organizations would have difficulties 
obtaining the data and performing the calculations required by the 
proposals. A number of commenters also expressed concern about the 
burden of the proposals in the context of multiple new regulations, 
including new standards for mortgages and increased regulatory capital 
requirements generally. One commenter urged the agencies to maintain 
key aspects of the proposed risk-weighted asset treatment for community 
banking organizations, but generally requested that the agencies reduce 
the perceived complexity. The FDIC has considered these comments and, 
where applicable, have focused on simplicity, comparability, and broad 
applicability of methodologies for U.S. banking organizations under the 
standardized approach.
    Some commenters asked that the proposed requirements be optional 
for community banking organizations until the effects of the proposals 
have been studied, or that the proposed standardized approach be 
withdrawn entirely. A number of the commenters requested specific 
modifications to the proposals. For example, some requested an 
exemption for community banking organizations from the proposed due 
diligence requirements for securitization exposures. Other commenters 
requested that the agencies grandfather the risk weighting of existing 
loans, arguing that doing so would lessen the proposed rule's 
implementation burden.
    To address commenters' concerns about the standardized approach's 
burden and the accessibility of credit, the FDIC has revised elements 
of the proposed rule, as described in further detail below. In 
particular, the FDIC has modified the proposed approach to risk 
weighting residential mortgage loans to reflect the approach in the 
FDIC's general risk-based capital rules. The FDIC believes the 
standardized approach more accurately captures the risk of banking 
organizations' assets and, therefore, is applying this aspect of the 
interim final rule to all banking organizations subject to the rule.
    This section of the preamble describes in detail the specific 
proposals for the standardized treatment of risk-weighted assets, 
comments received on those proposals, and the provisions of the interim 
final rule in subpart D as adopted by the FDIC. These sections of the 
preamble discuss how subpart D of the interim final rule differs from 
the general risk-based capital rules, and provides examples for how an 
FDIC-supervised institution must calculate risk-weighted asset amounts 
under the interim final rule.
    Beginning on January 1, 2015, all FDIC-supervised institutions will 
be required to calculate risk-weighted assets under subpart D of the 
interim final rule. Until then, FDIC-supervised institutions must 
calculate risk-weighted assets using the methodologies set forth in the 
general risk-based capital rules. Advanced approaches FDIC-supervised 
institutions are subject to additional requirements, as described in 
section III. D of this preamble, regarding the timeframe for 
implementation.

A. Calculation of Standardized Total Risk-Weighted Assets

    Consistent with the Standardized Approach NPR, the interim final 
rule requires an FDIC-supervised institution to calculate its risk-
weighted asset amounts for its on- and off-balance sheet exposures and, 
for market risk banks only, standardized market risk-weighted assets as 
determined under subpart F.\105\ Risk-weighted asset amounts generally 
are determined by assigning on-balance sheet assets to broad risk-
weight categories according to the counterparty, or, if relevant, the 
guarantor or collateral. Similarly, risk-weighted asset amounts for 
off-balance sheet items are calculated using a two-step process: (1) 
Multiplying the amount of the off-balance sheet exposure by a credit 
conversion factor (CCF) to determine a credit equivalent amount, and 
(2) assigning the credit equivalent amount to a relevant risk-weight 
category.
---------------------------------------------------------------------------

    \105\ This interim final rule incorporates the market risk rule 
into the integrated regulatory framework as subpart F of part 324.
---------------------------------------------------------------------------

    An FDIC-supervised institution must determine its standardized 
total risk-weighted assets by calculating the sum of (1) its risk-
weighted assets for general credit risk, cleared transactions, default 
fund contributions, unsettled transactions, securitization exposures, 
and equity exposures, each as defined below, plus (2) market risk-
weighted assets, if applicable, minus (3) the amount of the FDIC-
supervised institution's ALLL that is not included in tier 2 capital, 
and any amounts of allocated transfer risk reserves.

B. Risk-Weighted Assets for General Credit Risk

    Consistent with the proposal, under the interim final rule total 
risk-weighted assets for general credit risk equals the sum of the 
risk-weighted asset amounts as calculated under section 324.31(a) of 
the interim final rule. General credit risk exposures include an FDIC-
supervised institution's on-balance sheet exposures (other than cleared 
transactions, default fund contributions to CCPs, securitization 
exposures, and equity exposures, each as defined in section 2 of the 
interim final rule), exposures to over-the-counter (OTC) derivative 
contracts, off-balance sheet commitments, trade and transaction-related 
contingencies, guarantees, repo-style transactions, financial standby 
letters of credit, forward agreements, or other similar transactions.
    Under the interim final rule, the exposure amount for the on-
balance sheet component of an exposure is generally the FDIC-supervised 
institution's carrying value for the exposure as determined under GAAP. 
The FDIC believes that using GAAP to determine the amount and nature of 
an exposure provides a consistent framework that can be easily applied 
across all FDIC-supervised institutions. Generally, FDIC-supervised 
institutions already use GAAP to prepare their financial statements and 
regulatory reports, and this treatment reduces potential burden that 
could otherwise result from requiring FDIC-supervised institutions to 
comply with a separate

[[Page 55401]]

set of accounting and measurement standards for risk-based capital 
calculation purposes under non-GAAP standards, such as regulatory 
accounting practices or legal classification standards.
    For purposes of the definition of exposure amount for AFS or held-
to-maturity debt securities and AFS preferred stock not classified as 
equity under GAAP that are held by an FDIC-supervised institution that 
has made an AOCI opt-out election, the exposure amount is the FDIC-
supervised institution's carrying value (including net accrued but 
unpaid interest and fees) for the exposure, less any net unrealized 
gains, and plus any net unrealized losses. For purposes of the 
definition of exposure amount for AFS preferred stock classified as an 
equity security under GAAP that is held by a banking organization that 
has made an AOCI opt-out election, the exposure amount is the banking 
organization's carrying value (including net accrued but unpaid 
interest and fees) for the exposure, less any net unrealized gains that 
are reflected in such carrying value but excluded from the banking 
organization's regulatory capital.
    In most cases, the exposure amount for an off-balance sheet 
component of an exposure is determined by multiplying the notional 
amount of the off-balance sheet component by the appropriate CCF as 
determined under section 324.33 of the interim final rule. The exposure 
amount for an OTC derivative contract or cleared transaction is 
determined under sections 34 and 35, respectively, of the interim final 
rule, whereas exposure amounts for collateralized OTC derivative 
contracts, collateralized cleared transactions, repo-style 
transactions, and eligible margin loans are determined under section 
324.37 of the interim final rule.
1. Exposures to Sovereigns
    Consistent with the proposal, the interim final rule defines a 
sovereign as a central government (including the U.S. government) or an 
agency, department, ministry, or central bank of a central government. 
In the Standardized Approach NPR, the agencies proposed to retain the 
general risk-based capital rules' risk weights for exposures to and 
claims directly and unconditionally guaranteed by the U.S. government 
or its agencies. The interim final rule adopts the proposed treatment 
and provides that exposures to the U.S. government, its central bank, 
or a U.S. government agency and the portion of an exposure that is 
directly and unconditionally guaranteed by the U.S. government, the 
U.S. central bank, or a U.S. government agency receive a zero percent 
risk weight.\106\ Consistent with the general risk-based capital rules, 
the portion of a deposit or other exposure insured or otherwise 
unconditionally guaranteed by the FDIC or the National Credit Union 
Administration also is assigned a zero percent risk weight. An exposure 
conditionally guaranteed by the U.S. government, its central bank, or a 
U.S. government agency receives a 20 percent risk weight.\107\ This 
includes an exposure that is conditionally guaranteed by the FDIC or 
the National Credit Union Administration.
---------------------------------------------------------------------------

    \106\ Similar to the general risk-based capital rules, a claim 
would not be considered unconditionally guaranteed by a central 
government if the validity of the guarantee is dependent upon some 
affirmative action by the holder or a third party, for example, 
asset servicing requirements. See 12 CFR part 325, appendix A, 
section II.C. (footnote 35) (state nonmember banks) and 12 CFR 
390.466 (state savings associations).
    \107\ Loss-sharing agreements entered into by the FDIC with 
acquirers of assets from failed institutions are considered 
conditional guarantees for risk-based capital purposes due to 
contractual conditions that acquirers must meet. The guaranteed 
portion of assets subject to a loss-sharing agreement may be 
assigned a 20 percent risk weight. Because the structural 
arrangements for these agreements vary depending on the specific 
terms of each agreement, FDIC-supervised institutions should consult 
with the FDIC to determine the appropriate risk-based capital 
treatment for specific loss-sharing agreements.
---------------------------------------------------------------------------

    The agencies proposed in the Standardized Approach NPR to revise 
the risk weights for exposures to foreign sovereigns. The agencies' 
general risk-based capital rules generally assign risk weights to 
direct exposures to sovereigns and exposures directly guaranteed by 
sovereigns based on whether the sovereign is a member of the 
Organization for Economic Co-operation and Development (OECD) and, as 
applicable, whether the exposure is unconditionally or conditionally 
guaranteed by the sovereign.\108\
---------------------------------------------------------------------------

    \108\ 12 CFR part 325, appendix A, section II.C (state nonmember 
banks) and 12 CFR 390.466 (state savings associations).
---------------------------------------------------------------------------

    Under the proposed rule, the risk weight for a foreign sovereign 
exposure would have been determined using OECD Country Risk 
Classifications (CRCs) (the CRC methodology).\109\ The CRCs reflect an 
assessment of country risk, used to set interest rate charges for 
transactions covered by the OECD arrangement on export credits. The CRC 
methodology classifies countries into one of eight risk categories (0-
7), with countries assigned to the zero category having the lowest 
possible risk assessment and countries assigned to the 7 category 
having the highest possible risk assessment. Using CRCs to risk weight 
sovereign exposures is an option that is included in the Basel II 
standardized framework. The agencies proposed to map risk weights 
ranging from 0 percent to 150 percent to CRCs in a manner consistent 
with the Basel II standardized approach, which provides risk weights 
for foreign sovereigns based on country risk scores.
---------------------------------------------------------------------------

    \109\ For more information on the OECD country risk 
classification methodology, see OECD, ``Country Risk 
Classification,'' available at http://www.oecd.org/document/49/0,3746,en_2649_34169_1901105_1_1_1_1,00.html.
---------------------------------------------------------------------------

    The agencies also proposed to assign a 150 percent risk weight to 
foreign sovereign exposures immediately upon determining that an event 
of sovereign default has occurred or if an event of sovereign default 
has occurred during the previous five years. The proposal defined 
sovereign default as noncompliance by a sovereign with its external 
debt service obligations or the inability or unwillingness of a 
sovereign government to service an existing loan according to its 
original terms, as evidenced by failure to pay principal or interest 
fully and on a timely basis, arrearages, or restructuring. 
Restructuring would include a voluntary or involuntary restructuring 
that results in a sovereign not servicing an existing obligation in 
accordance with the obligation's original terms.
    The agencies received several comments on the proposed risk weights 
for foreign sovereign exposures. Some commenters criticized the 
proposal, arguing that CRCs are not sufficiently risk sensitive and 
basing risk weights on CRCs unduly benefits certain jurisdictions with 
unstable fiscal positions. A few commenters asserted that the increased 
burden associated with tracking CRCs to determine risk weights 
outweighs any increased risk sensitivity gained by using CRCs relative 
to the general risk-based capital rules. Some commenters also requested 
that the CRC methodology be disclosed so that banking organizations 
could perform their own due diligence. One commenter also indicated 
that community banking organizations should be permitted to maintain 
the treatment under the general risk-based capital rules.
    Following the publication of the proposed rule, the OECD determined 
that certain high-income countries that received a CRC of 0 in 2012 
will no longer receive any CRC.\110\
---------------------------------------------------------------------------

    \110\ See http://www.oecd.or/tad/xcred/cat0.htm; Participants to 
the Arrangement on Officially Supported Export Credits agreed that 
the automatic classification of High Income OECD and High Income 
Euro Area countries in Country Risk Category Zero should be 
terminated. In the future, these countries will no longer be 
classified but will remain subject to the same market credit risk 
pricing disciplines that are applied to all Category Zero countries. 
This means that the change will have no practical impact on the 
rules that apply to the provision of official export credits.

---------------------------------------------------------------------------

[[Page 55402]]

    Despite the limitations associated with risk weighting foreign 
sovereign exposures using CRCs, the FDIC has decided to retain this 
methodology, modified as described below to take into account that some 
countries will no longer receive a CRC. Although the FDIC recognizes 
that the risk sensitivity provided by the CRCs is limited, it considers 
CRCs to be a reasonable alternative to credit ratings for sovereign 
exposures and the CRC methodology to be more granular and risk 
sensitive than the current risk-weighting methodology based solely on 
OECD membership. Furthermore, the OECD regularly updates CRCs and makes 
the assessments publicly available on its Web site.\111\ Accordingly, 
the FDIC believes that risk weighting foreign sovereign exposures with 
reference to CRCs (as applicable) should not unduly burden FDIC-
supervised institutions. Additionally, the 150 percent risk weight 
assigned to defaulted sovereign exposures should mitigate the concerns 
raised by some commenters that the use of CRCs assigns inappropriate 
risk weights to exposures to countries experiencing fiscal stress.
---------------------------------------------------------------------------

    \111\ For more information on the OECD country risk 
classification methodology, see OECD, ``Country Risk 
Classification,'' available at http://www.oecd.org/document/49/0,3746,en_2649_34169_1901105_1_1_1_1,00.html.
---------------------------------------------------------------------------

    The interim final rule assigns risk weights to foreign sovereign 
exposures as set forth in Table 17 below. The FDIC modified the interim 
final rule to reflect a change in OECD practice for assigning CRCs for 
certain member countries so that those member countries that no longer 
receive a CRC are assigned a zero percent risk weight. Applying a zero 
percent risk weight to exposures to these countries is appropriate 
because they will remain subject to the same market credit risk pricing 
formulas of the OECD's rating methodologies that are applied to all 
OECD countries with a CRC of 0. In other words, OECD member countries 
that are no longer assigned a CRC exhibit a similar degree of country 
risk as that of a jurisdiction with a CRC of zero. The interim final 
rule, therefore, provides a zero percent risk weight in these cases. 
Additionally, a zero percent risk weight for these countries is 
generally consistent with the risk weight they would receive under the 
FDIC's general risk-based capital rules.

             Table 17--Risk Weights for Sovereign Exposures
------------------------------------------------------------------------
 
------------------------------------------------------------------------
                                                           Risk weight
                                                           (in percent)
------------------------------------------------------------------------
CRC............................................    0-1                0
                                                     2               20
                                                     3               50
                                                   4-6              100
                                                     7              150
------------------------------------------------------------------------
OECD Member with No CRC................................               0
Non-OECD Member with No CRC............................             100
Sovereign Default......................................             150
------------------------------------------------------------------------

    Consistent with the proposal, the interim final rule provides that 
if a banking supervisor in a sovereign jurisdiction allows banking 
organizations in that jurisdiction to apply a lower risk weight to an 
exposure to the sovereign than Table 17 provides, a U.S. FDIC-
supervised institution may assign the lower risk weight to an exposure 
to the sovereign, provided the exposure is denominated in the 
sovereign's currency and the U.S. FDIC-supervised institution has at 
least an equivalent amount of liabilities in that foreign currency.
2. Exposures to Certain Supranational Entities and Multilateral 
Development Banks
    Under the general risk-based capital rules, exposures to certain 
supranational entities and MDBs receive a 20 percent risk weight. 
Consistent with the Basel II standardized framework, the agencies 
proposed to apply 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. The agencies also 
proposed to apply a zero percent risk weight to exposures to an MDB in 
accordance with the Basel framework. The proposal defined an MDB to 
include the International Bank for Reconstruction and Development, the 
Multilateral Investment Guarantee Agency, 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.
    As explained in the proposal, the agencies believe this treatment 
is appropriate in light of the generally high-credit quality of MDBs, 
their strong shareholder support, and a shareholder structure comprised 
of a significant proportion of sovereign entities with strong 
creditworthiness. The FDIC has adopted this aspect of the proposal 
without change. Exposures to regional development banks and 
multilateral lending institutions that are not covered under the 
definition of MDB generally are treated as corporate exposures assigned 
to the 100 percent risk weight category.
3. Exposures to Government-Sponsored Enterprises
    The general risk-based capital rules assign a 20 percent risk 
weight to exposures to GSEs that are not equity exposures and a 100 
percent risk weight to GSE preferred stock in the case of the Federal 
Reserve and the FDIC (the OCC has assigned a 20 percent risk weight to 
GSE preferred stock).
    The agencies proposed to continue to assign a 20 percent risk 
weight to exposures to GSEs that are not equity exposures and to also 
assign a 100 percent risk weight to preferred stock issued by a GSE. As 
explained in the proposal, the agencies believe these risk weights 
remain appropriate for the GSEs under their current circumstances, 
including those in the conservatorship of the Federal Housing Finance 
Agency and receiving capital support from the U.S. Treasury. The FDIC 
maintains that the obligations of the GSEs, as private corporations 
whose obligations are not explicitly guaranteed by the full faith and 
credit of the United States, should not receive the same treatment as 
obligations that have such an explicit guarantee.
4. Exposures to Depository Institutions, Foreign Banks, and Credit 
Unions
    The general risk-based capital rules assign a 20 percent risk 
weight to all exposures to U.S. depository institutions and foreign 
banks incorporated in an OECD country. Under the general risk-based 
capital rules, short-term exposures to foreign banks incorporated in a 
non-OECD country receive a 20 percent risk weight and long-term 
exposures to such entities receive a 100 percent risk weight.
    The proposed rule would assign a 20 percent risk weight to 
exposures to U.S. depository institutions and credit

[[Page 55403]]

unions.\112\ Consistent with the Basel II standardized framework, under 
the proposed rule, an exposure to a foreign bank would receive a risk 
weight one category higher than the risk weight assigned to a direct 
exposure to the foreign bank's home country, based on the assignment of 
risk weights by CRC, as discussed above.\113\ A banking organization 
would be required to assign a 150 percent risk weight to an exposure to 
a foreign bank immediately upon determining that an event of sovereign 
default has occurred in the foreign bank's home country, or if an event 
of sovereign default has occurred in the foreign bank's home country 
during the previous five years.
---------------------------------------------------------------------------

    \112\ A depository institution is defined in section 3 of the 
Federal Deposit Insurance Act (12 U.S.C. 1813(c)(1)). Under this 
interim final rule, a credit union refers to an insured credit union 
as defined under the Federal Credit Union Act (12 U.S.C. 1752(7)).
    \113\ Foreign bank means a foreign bank as defined in section 
211.2 of the Federal Reserve Board's Regulation K (12 CFR 211.2), 
that is not a depository institution. For purposes of the proposal, 
home country meant the country where an entity is incorporated, 
chartered, or similarly established.
---------------------------------------------------------------------------

    A few commenters asserted that the proposed 20 percent risk weight 
for exposures to U.S. banking organizations--when compared to corporate 
exposures that are assigned a 100 percent risk weight--would continue 
to encourage banking organizations to become overly concentrated in the 
financial sector. The FDIC has concluded that the proposed 20 percent 
risk weight is an appropriate reflection of risk for this exposure type 
when taking into consideration the extensive regulatory and supervisory 
frameworks under which these institutions operate. In addition, the 
FDIC notes that exposures to the capital of other financial 
institutions, including depository institutions and credit unions, are 
subject to deduction from capital if they exceed certain limits as set 
forth in section 324.22 of the interim final rule (discussed above in 
section V.B of this preamble). Therefore, the interim final rule 
retains, as proposed, the 20 percent risk weight for exposures to U.S. 
FDIC-supervised institutions.
    The FDIC has adopted the proposal with modifications to take into 
account the OECD's decision to withdraw CRCs for certain OECD member 
countries. Accordingly, exposures to a foreign bank in a country that 
does not have a CRC, but that is a member of the OECD, are assigned a 
20 percent risk weight and exposures to a foreign bank in a non-OECD 
member country that does not have a CRC continue to receive a 100 
percent risk weight.
    Additionally, the FDIC has adopted the proposed requirement that 
exposures to a financial institution that are included in the 
regulatory capital of such financial institution receive a risk weight 
of 100 percent, unless the exposure is (1) an equity exposure, (2) a 
significant investment in the capital of an unconsolidated financial 
institution in the form of common stock under section 22 of the interim 
final rule, (3) an exposure that is deducted from regulatory capital 
under section 324.22 of the interim final rule, or (4) an exposure that 
is subject to the 150 percent risk weight under Table 2 of section 
324.32 of the interim final rule.
    As described in the Standardized Approach NPR, in 2011, the BCBS 
revised certain aspects of the Basel capital framework to address 
potential adverse effects of the framework on trade finance in low-
income countries.\114\ In particular, the framework was revised to 
remove the sovereign floor for trade finance-related claims on banking 
organizations under the Basel II standardized approach.\115\ The 
proposal incorporated this revision and would have permitted a banking 
organization to assign a 20 percent risk weight to self-liquidating 
trade-related contingent items that arise from the movement of goods 
and that have a maturity of three months or less.\116\ Consistent with 
the proposal, the interim final rule permits an FDIC-supervised 
institution to assign a 20 percent risk weight to self-liquidating, 
trade-related contingent items that arise from the movement of goods 
and that have a maturity of three months or less.
---------------------------------------------------------------------------

    \114\ See BCBS, ``Treatment of Trade Finance under the Basel 
Capital Framework,'' (October 2011), available at http://www.bis.org/publ/bcbs205.pdf. ``Low income country'' is a 
designation used by the World Bank to classify economies (see World 
Bank, ``How We Classify Countries,'' available at http://data.worldbank.org/about/country-classifications).
    \115\ The BCBS indicated that it removed the sovereign floor for 
such exposures to make access to trade finance instruments easier 
and less expensive for low income countries. Absent removal of the 
floor, the risk weight assigned to these exposures, where the 
issuing banking organization is incorporated in a low income 
country, typically would be 100 percent.
    \116\ One commenter requested that the agencies confirm whether 
short-term self-liquidating trade finance instruments are considered 
exempt from the one-year maturity floor in the advances approaches 
rule. Section 324.131(d)(7) of the interim final rule provides that 
a trade-related letter of credit is exempt from the one-year 
maturity floor.
---------------------------------------------------------------------------

    As discussed in the proposal, although the Basel capital framework 
permits exposures to securities firms that meet certain requirements to 
be assigned the same risk weight as exposures to depository 
institutions, the agencies do not believe that the risk profile of 
securities firms is sufficiently similar to depository institutions to 
justify assigning the same risk weight to both exposure types. 
Therefore, the agencies proposed that banking organizations assign a 
100 percent risk weight to exposures to securities firms, which is the 
same risk weight applied to BHCs, SLHCs, and other financial 
institutions that are not insured depository institutions or credit 
unions, as described in section VIII.B of this preamble.
    Several commenters asserted that the interim final rule should be 
consistent with the Basel framework and permit lower risk weights for 
exposures to securities firms, particularly for securities firms in a 
sovereign jurisdiction with a CRC of 0 or 1. The FDIC considered these 
comments and has concluded that that exposures to securities firms 
exhibit a similar degree of risk as exposures to other financial 
institutions that are assigned a 100 percent risk weight, because of 
the nature and risk profile of their activities, which are more 
expansive and exhibit more varied risk profiles than the activities 
permissible for depository institutions and credit unions. Accordingly, 
the FDIC has adopted the 100 percent risk weight for securities firms 
without change.
5. Exposures to Public-Sector Entities
    The proposal defined a PSE as a state, local authority, or other 
governmental subdivision below the level of a sovereign, which includes 
U.S. states and municipalities. The proposed definition did not include 
government-owned commercial companies that engage in activities 
involving trade, commerce, or profit that are generally conducted or 
performed in the private sector. The agencies proposed to define a 
general obligation as a bond or similar obligation that is backed by 
the full faith and credit of a PSE, whereas a revenue obligation would 
be defined as a bond or similar obligation that is an obligation of a 
PSE, but which the PSE has committed to repay with revenues from a 
specific project rather than general tax funds. In the interim final 
rule, the FDIC is adopting these definitions as proposed.
    The agencies proposed to assign a 20 percent risk weight to a 
general obligation exposure to a PSE that is organized under the laws 
of the United States or any state or political subdivision thereof, and 
a 50 percent risk weight to a revenue obligation exposure to such a 
PSE. These are the risk weights assigned to U.S. states and 
municipalities under the general risk-based capital rules.

[[Page 55404]]

    Some commenters asserted that available default data does not 
support a differentiated treatment between revenue obligations and 
general obligations. In addition, some commenters contended that higher 
risk weights for revenue obligation bonds would needlessly and 
adversely affect state and local agencies' ability to meet the needs of 
underprivileged constituents. One commenter specifically recommended 
assigning a 20 percent risk weight to investment-grade revenue 
obligations. Another commenter recommended that exposures to U.S. PSEs 
should receive the same treatment as exposures to the U.S. government.
    The FDIC considered these comments, including with respect to 
burden on state and local programs, but concluded that the higher 
regulatory capital requirement for revenue obligations is appropriate 
because those obligations are dependent on revenue from specific 
projects and generally a PSE is not legally obligated to repay these 
obligations from other revenue sources. Although some evidence may 
suggest that there are not substantial differences in credit quality 
between general and revenue obligation exposures, the FDIC believes 
that such dependence on project revenue presents more credit risk 
relative to a general repayment obligation of a state or political 
subdivision of a sovereign. Therefore, the proposed differentiation of 
risk weights between general obligation and revenue exposures is 
retained in the interim final rule. The FDIC also continues to believe 
that PSEs collectively pose a greater credit risk than U.S. sovereign 
debt and, therefore, are appropriately assigned a higher risk weight 
under the interim final rule.
    Consistent with the Basel II standardized framework, the agencies 
proposed to require banking organizations to risk weight exposures to a 
non-U.S. PSE based on (1) the CRC assigned to the PSE's home country 
and (2) whether the exposure is a general obligation or a revenue 
obligation. The risk weights assigned to revenue obligations were 
proposed to be higher than the risk weights assigned to a general 
obligation issued by the same PSE.
    For purposes of the interim final rule, the FDIC has adopted the 
proposed risk weights for non-U.S. PSEs with modifications to take into 
account the OECD's decision to withdraw CRCs for certain OECD member 
countries (discussed above), as set forth in Table 18 below. Under the 
interim final rule, exposures to a non-U.S. PSE in a country that does 
not have a CRC and is not an OECD member receive a 100 percent risk 
weight. Exposures to a non-U.S. PSE in a country that has defaulted on 
any outstanding sovereign exposure or that has defaulted on any 
sovereign exposure during the previous five years receive a 150 percent 
risk weight.

        Table 18--Risk Weights for Exposures to Non-U.S. PSE General Obligations and Revenue Obligations
                                                  [In percent]
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                                       Risk Weight for        Risk Weight for
                                                                       Exposures to Non-      Exposures to Non-
                                                                        U.S. PSE General       U.S. PSE Revenue
                                                                             Obligations            Obligations
----------------------------------------------------------------------------------------------------------------
CRC.......................................................    0-1                     20                     50
                                                                2                     50                    100
                                                                3                    100                    100
                                                              4-7                    150                    150
----------------------------------------------------------------------------------------------------------------
OECD Member with No CRC...........................................                    20                     50
Non-OECD member with No CRC.......................................                   100                    100
Sovereign Default.................................................                   150                    150
----------------------------------------------------------------------------------------------------------------

    Consistent with the general risk-based capital rules as well as the 
proposed rule, an FDIC-supervised institution may apply a different 
risk weight to an exposure to a non-U.S. PSE if the banking 
organization supervisor in that PSE's home country allows supervised 
institutions to assign the alternative risk weight to exposures to that 
PSE. In no event, however, may the risk weight for an exposure to a 
non-U.S. PSE be lower than the risk weight assigned to direct exposures 
to the sovereign of that PSE's home country.
6. Corporate Exposures
    Generally consistent with the general risk-based capital rules, the 
agencies proposed to require banking organizations to assign a 100 
percent risk weight to all corporate exposures, including bonds and 
loans. The proposal defined a corporate exposure as an exposure to a 
company that is not an exposure to a sovereign, 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, a PSE, a GSE, a 
residential mortgage exposure, a pre-sold construction loan, a 
statutory multifamily mortgage, a high-volatility commercial real 
estate (HVCRE) exposure, a cleared transaction, a default fund 
contribution, a securitization exposure, an equity exposure, or an 
unsettled transaction. The definition also captured all exposures that 
are not otherwise included in another specific exposure category.
    Several commenters recommended differentiating the proposed risk 
weights for corporate bonds based on a bond's credit quality. Other 
commenters requested the agencies align the interim final rule with the 
Basel international standard that aligns risk weights with credit 
ratings. Another commenter contended that corporate bonds should 
receive a 50 percent risk weight, arguing that other exposures included 
in the corporate exposure category (such as commercial and industrial 
bank loans) are empirically of greater risk than corporate bonds.
    One commenter requested that the standardized approach provide a 
distinct capital treatment of a 75 percent risk weight for retail 
exposures, consistent with the international standard under Basel II. 
The FDIC has concluded that the proposed 100 percent risk weight 
assigned to retail exposures is appropriate given their risk profile in 
the United States and has retained the proposed treatment in the 
interim final rule. Consistent with the proposal, the interim final 
rule neither defines nor provides a separate

[[Page 55405]]

treatment for retail exposures in the standardized approach.
    As described in the proposal, the agencies removed the use of 
ratings from the regulatory capital framework, consistent with section 
939A of the Dodd-Frank Act. The agencies therefore evaluated a number 
of alternatives to credit ratings to provide a more granular risk 
weight treatment for corporate exposures.\117\ For example, the 
agencies considered market-based alternatives, such as the use of 
credit default and bond spreads, and use of particular indicators or 
parameters to differentiate between relative levels of credit risk. 
However, the agencies viewed each of the possible alternatives as 
having significant drawbacks, including their operational complexity, 
or insufficient development. For instance, the agencies were concerned 
that bond markets may sometimes misprice risk and bond spreads may 
reflect factors other than credit risk. The agencies also were 
concerned that such approaches could introduce undue volatility into 
the risk-based capital requirements.
---------------------------------------------------------------------------

    \117\ See, for example, 76 FR 73526 (Nov. 29, 2011) and 76 FR 
73777 (Nov. 29, 2011).
---------------------------------------------------------------------------

    The FDIC considered suggestions offered by commenters and 
understands that a 100 percent risk weight may overstate the credit 
risk associated with some high-quality bonds. However, the FDIC 
believes that a single risk weight of less than 100 percent would 
understate the risk of many corporate exposures and, as explained, has 
not yet identified an alternative methodology to credit ratings that 
would provide a sufficiently rigorous basis for differentiating the 
risk of various corporate exposures. In addition, the FDIC believes 
that, on balance, a 100 percent risk weight is generally representative 
of a well-diversified corporate exposure portfolio. The interim final 
rule retains without change the 100 percent risk weight for all 
corporate exposures as well as the proposed definition of corporate 
exposure.
    A few commenters requested clarification on the treatment for 
general-account insurance products. Under the final rule, consistent 
with the proposal, if a general-account exposure is to an organization 
that is not a banking organization, such as an insurance company, the 
exposure must receive a risk weight of 100 percent. Exposures to 
securities firms are subject to the corporate exposure treatment under 
the final rule, as described in section VIII.B of this preamble.
7. Residential Mortgage Exposures
    Under the general risk-based capital requirements, first-lien 
residential mortgages made in accordance with prudent underwriting 
standards on properties that are owner-occupied or rented typically are 
assigned to the 50 percent risk-weight category. Otherwise, residential 
mortgage exposures are assigned to the 100 percent risk weight 
category.
    The proposal would have substantially modified the risk-weight 
framework applicable to residential mortgage exposures and differed 
materially from both the general risk-based capital rules and the Basel 
capital framework. The agencies proposed to divide residential mortgage 
exposures into two categories. The proposal applied relatively low risk 
weights to residential mortgage exposures that did not have product 
features associated with higher credit risk, or ``category 1'' 
residential mortgages as defined in the proposal. The proposal defined 
all other residential mortgage exposures as ``category 2'' mortgages, 
which would receive relatively high risk weights. For both category 1 
and category 2 mortgages, the proposed risk weight assigned also would 
have depended on the mortgage exposure's LTV ratio. Under the proposal, 
a banking organization would not be able to recognize private mortgage 
insurance (PMI) when calculating the LTV ratio of a residential 
mortgage exposure. Due to the varying degree of financial strength of 
mortgage insurance providers, the agencies stated that they did not 
believe that it would be prudent to consider PMI in the determination 
of LTV ratios under the proposal.
    The agencies received a significant number of comments in 
opposition to the proposed risk weights for residential mortgages and 
in favor of retaining the risk-weight framework for residential 
mortgages in the general risk-based capital rules. Many commenters 
asserted that the increased risk weights for certain mortgages would 
inhibit lending to creditworthy borrowers, particularly when combined 
with the other proposed statutory and regulatory requirements being 
implemented under the authority of the Dodd-Frank Act, and could 
ultimately jeopardize the recovery of a still-fragile residential real 
estate market. Various commenters asserted that the agencies did not 
provide sufficient empirical support for the proposal and stated the 
proposal was overly complex and would not contribute meaningfully to 
the risk sensitivity of the regulatory capital requirements. They also 
asserted that the proposal would require some banking organizations to 
raise revenue through other, more risky activities to compensate for 
the potential increased costs.
    Commenters also indicated that the distinction between category 1 
and category 2 residential mortgages would adversely impact certain 
loan products that performed relatively well even during the recent 
crisis, such as balloon loans originated by community banking 
organizations. Other commenters criticized the proposed increased 
capital requirements for various loan products, including balloon and 
interest-only mortgages. Community banking organization commenters in 
particular asserted that such mortgage products are offered to hedge 
interest-rate risk and are frequently the only option for a significant 
segment of potential borrowers in their regions.
    A number of commenters argued that the proposal would place U.S. 
banking organizations at a competitive disadvantage relative to foreign 
banking organizations subject to the Basel II standardized framework, 
which generally assigns a 35 percent risk weight to residential 
mortgage exposures. Several commenters indicated that the proposed 
treatment would potentially undermine government programs encouraging 
residential mortgage lending to lower-income individuals and 
underserved regions. Commenters also asserted that PMI should receive 
explicit recognition in the interim final rule through a reduction in 
risk weights, given the potential negative impact on mortgage 
availability (particularly to first-time borrowers) of the proposed 
risk weights.
    In addition to comments on the specific elements of the proposal, a 
significant number of commenters alleged that the agencies did not 
sufficiently consider the potential impact of other regulatory actions 
on the mortgage industry. For instance, commenters expressed 
considerable concern regarding the new requirements associated with the 
Dodd-Frank Act's qualified mortgage definition under the Truth in 
Lending Act.\118\ Many of these commenters asserted that when combined 
with this proposal, the cumulative effect of the new regulatory 
requirements could adversely impact the residential mortgage industry.
---------------------------------------------------------------------------

    \118\ The proposal was issued prior to publication of the 
Consumer Financial Protection Bureau's final rule regarding 
qualified mortgage standards. See 78 FR 6407 (January 30, 2013).
---------------------------------------------------------------------------

    The agencies also received specific comments concerning potential 
logistical difficulties they would face

[[Page 55406]]

implementing the proposal. Many commenters argued that tracking loans 
by LTV and category would be administratively burdensome, requiring the 
development or purchase of new systems. These commenters requested 
that, at a minimum, existing mortgages continue to be assigned the risk 
weights they would receive under the general risk-based capital rules 
and exempted from the proposed rules. Many commenters also requested 
clarification regarding the method for calculating the LTV for first 
and subordinate liens, as well as how and whether a loan could be 
reclassified between the two residential mortgage categories. For 
instance, commenters raised various technical questions on how to 
calculate the LTV of a restructured mortgage and under what conditions 
a restructured loan could qualify as a category 1 residential mortgage 
exposure.
    The FDIC considered the comments pertaining to the residential 
mortgage proposal, particularly comments regarding the issuance of new 
regulations designed to improve the quality of mortgage underwriting 
and to generally reduce the associated credit risk, including the final 
definition of ``qualified mortgage'' as implemented by the Consumer 
Financial Protection Bureau (CFPB) pursuant to the Dodd-Frank Act.\119\ 
Additionally, the FDIC is mindful of the uncertain implications that 
the proposal, along with other mortgage-related rulemakings, could have 
had on the residential mortgage market, particularly regarding 
underwriting and credit availability. The FDIC also considered the 
commenters' observations about the burden of calculating the risk 
weights for FDIC-supervised institutions' existing mortgage portfolios, 
and have taken into account the commenters' concerns about the 
availability of different mortgage products across different types of 
markets.
---------------------------------------------------------------------------

    \119\ See id.
---------------------------------------------------------------------------

    In light of these considerations, the FDIC has decided to retain in 
the interim final rule the treatment for residential mortgage exposures 
that is currently set forth in its general risk-based capital rules. 
The FDIC may develop and propose changes in the treatment of 
residential mortgage exposures in the future, and in that process, it 
intends to take into consideration structural and product market 
developments, other relevant regulations, and potential issues with 
implementation across various product types.
    Accordingly, as under the general risk-based capital rules, the 
interim final rule assigns exposures secured by one-to-four family 
residential properties to either the 50 percent or the 100 percent 
risk-weight category. Exposures secured by a first-lien on an owner-
occupied or rented one-to-four family residential property that meet 
prudential underwriting standards, including standards relating to the 
loan amount as a percentage of the appraised value of the property, are 
not 90 days or more past due or carried on non-accrual status, and that 
are not restructured or modified receive a 50 percent risk weight. If 
an FDIC-supervised institution holds the first and junior lien(s) on a 
residential property and no other party holds an intervening lien, the 
FDIC-supervised institution must treat the combined exposure as a 
single loan secured by a first lien for purposes of determining the 
loan-to-value ratio and assigning a risk weight. An FDIC-supervised 
institution must assign a 100 percent risk weight to all other 
residential mortgage exposures. Under the interim final rule, a 
residential mortgage guaranteed by the federal government through the 
Federal Housing Administration (FHA) or the Department of Veterans 
Affairs (VA) generally will be risk-weighted at 20 percent.
    Consistent with the general risk-based capital rules, under the 
interim final rule, a residential mortgage exposure may be assigned to 
the 50 percent risk-weight category only if it is not restructured or 
modified. Under the interim final rule, consistent with the proposal, a 
residential mortgage exposure modified or restructured on a permanent 
or trial basis solely pursuant to the U.S. Treasury's Home Affordable 
Mortgage Program (HAMP) is not considered to be restructured or 
modified. Several commenters from community banking organizations 
encouraged the agencies to broaden this exemption and not penalize 
banking organizations for participating in other successful loan 
modification programs. As described in greater detail in the proposal, 
the FDIC believes that treating mortgage loans modified pursuant to 
HAMP in this manner is appropriate in light of the special and unique 
incentive features of HAMP, and the fact that the program is offered by 
the U.S. government to achieve the public policy objective of promoting 
sustainable loan modifications for homeowners at risk of foreclosure in 
a way that balances the interests of borrowers, servicers, and lenders.
8. Pre-Sold Construction Loans and Statutory Multifamily Mortgages
    The general risk-based capital rules assign either a 50 percent or 
a 100 percent risk weight to certain one-to-four family residential 
pre-sold construction loans and to multifamily residential loans, 
consistent with provisions of the Resolution Trust Corporation 
Refinancing, Restructuring, and Improvement Act of 1991 (RTCRRI 
Act).\120\ The proposal maintained the same general treatment as the 
general risk-based capital rules and clarified and updated the manner 
in which the general risk-based capital rules define these exposures. 
Under the proposal, a pre-sold construction loan would be subject to a 
50 percent risk weight unless the purchase contract is cancelled.
---------------------------------------------------------------------------

    \120\ 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. 12 U.S.C. 1831n, note.
---------------------------------------------------------------------------

    The FDIC is adopting this aspect of the proposal without change. 
The interim final rule defines a pre-sold construction loan, in part, 
as any one-to-four family residential construction loan to a builder 
that meets the requirements of section 618(a)(1) or (2) of the RTCRRI 
Act, and also harmonizes the FDIC's prior regulations. Under the 
interim final rule, a multifamily mortgage that does not meet the 
definition of a statutory multifamily mortgage is treated as a 
corporate exposure.
9. High-Volatility Commercial Real Estate
    Supervisory experience has demonstrated that certain acquisition, 
development, and construction loans (which are a subset of commercial 
real estate exposures) present particular risks for which the FDIC 
believes FDIC-supervised institutions should hold additional capital. 
Accordingly, the agencies proposed to require banking organizations to 
assign a 150 percent risk weight to any HVCRE exposure, which is higher 
than the 100 percent risk weight applied to such loans under the 
general risk-based capital rules. The proposal defined an HVCRE 
exposure to include any credit facility that finances or has financed 
the acquisition, development, or construction of real property, unless 
the facility finances one- to four-family residential mortgage

[[Page 55407]]

property, or commercial real estate projects that meet certain 
prudential criteria, including with respect to the LTV ratio and 
capital contributions or expense contributions of the borrower.
    Commenters criticized the proposed HVCRE definition as overly broad 
and suggested an exclusion for certain acquisition, development, or 
construction (ADC) loans, including: (1) ADC loans that are less than a 
specific dollar amount or have a debt service coverage ratio of 100 
percent (rather than 80 percent, under the agencies' lending 
standards); (2) community development projects or projects financed by 
low-income housing tax credits; and (3) certain loans secured by 
agricultural property for the sole purpose of acquiring land. Several 
commenters asserted that the proposed 150 percent risk weight was too 
high for secured loans and would hamper local commercial development. 
Another commenter recommended the agencies increase the number of HVCRE 
risk-weight categories to reflect LTV ratios.
    The FDIC has considered the comments and has decided to retain the 
150 percent risk weight for HVCRE exposures (modified as described 
below), given the increased risk of these activities when compared to 
other commercial real estate loans.\121\ The FDIC believes that 
segmenting HVCRE by LTV ratio would introduce undue complexity without 
providing a sufficient improvement in risk sensitivity. The FDIC has 
also determined not to exclude from the HVCRE definition ADC loans that 
are characterized by a specified dollar amount or loans with a debt 
service coverage ratio greater than 80 percent because an arbitrary 
threshold would likely not capture certain ADC loans with elevated 
risks. Consistent with the proposal, a commercial real estate loan that 
is not an HVCRE exposure is treated as a corporate exposure.
---------------------------------------------------------------------------

    \121\ See the definition of ``high-volatility commercial real 
estate exposure'' in section 2 of the interim final rule.
---------------------------------------------------------------------------

    Many commenters requested clarification as to whether all 
commercial real estate or ADC loans are considered HVCRE exposures. 
Consistent with the proposal, the interim final rule's HVCRE definition 
only applies to a specific subset of ADC loans and is, therefore, not 
applicable to all commercial real estate loans. Specifically, some 
commenters sought clarification on whether a facility would remain an 
HVCRE exposure for the life of the loan and whether owner-occupied 
commercial real estate loans are included in the HVCRE definition. The 
FDIC notes that when the life of the ADC project concludes and the 
credit facility is converted to permanent financing in accordance with 
the FDIC-supervised institution's normal lending terms, the permanent 
financing is not an HVCRE exposure. Thus, a loan permanently financing 
owner-occupied commercial real estate is not an HVCRE exposure. Given 
these clarifications, the FDIC believes that many concerns regarding 
the potential adverse impact on commercial development were, in part, 
driven by a lack of clarity regarding the definition of the HVCRE, and 
believes that the treatment of HVCRE exposures in the interim final 
rule appropriately reflects their risk relative to other commercial 
real estate exposures.
    Commenters also sought clarification as to whether cash or 
securities used to purchase land counts as borrower-contributed 
capital. In addition, a few commenters requested further clarification 
on what constitutes contributed capital for purposes of the interim 
final rule. Consistent with existing guidance, cash used to purchase 
land is a form of borrower contributed capital under the HVCRE 
definition.
    In response to the comments, the interim final rule amends the 
proposed HVCRE definition to exclude loans that finance the 
acquisition, development, or construction of real property that would 
qualify as community development investments. The interim final rule 
does not require an FDIC-supervised institution to have an investment 
in the real property for it to qualify for the exemption: Rather, if 
the real property is such that an investment in that property would 
qualify as a community development investment, then a facility 
financing acquisition, development, or construction of that property 
would meet the terms of the exemption. The FDIC has, however, 
determined not to give an automatic exemption from the HVCRE definition 
to all ADC loans to businesses or farms that have gross annual revenues 
of $1 million or less, although they could qualify for another 
exemption from the definition. For example, an ADC loan to a small 
business with annual revenues of under $1 million that meets the LTV 
ratio and contribution requirements set forth in paragraph (3) of the 
definition would qualify for that exemption from the definition as 
would a loan that finances real property that: Provides affordable 
housing (including multi-family rental housing) for low to moderate 
income individuals; is used in the provision of community services for 
low to moderate income individuals; or revitalizes or stabilizes low to 
moderate income geographies, designated disaster areas, or underserved 
areas specifically determined by the federal banking agencies based on 
the needs of low- and moderate-income individuals in those areas. The 
final definition also exempts ADC loans for the purchase or development 
of agricultural land, which is defined as all land known to be used or 
usable for agricultural purposes (such as crop and livestock 
production), provided that the valuation of the agricultural land is 
based on its value for agricultural purposes and the valuation does not 
consider any potential use of the land for non-agricultural commercial 
development or residential development.
10. Past-Due Exposures
    Under the general risk-based capital rules, the risk weight of a 
loan does not change if the loan becomes past due, with the exception 
of certain residential mortgage loans. The Basel II standardized 
approach provides risk weights ranging from 50 to 150 percent for 
exposures, except sovereign exposures and residential mortgage 
exposures, that are more than 90 days past due to reflect the increased 
risk of loss. Accordingly, to reflect the impaired credit quality of 
such exposures, the agencies proposed to require a banking organization 
to assign a 150 percent risk weight to an exposure that is not 
guaranteed or not secured (and that is not a sovereign exposure or a 
residential mortgage exposure) if it is 90 days or more past due or on 
nonaccrual.
    A number of commenters maintained that the proposed 150 percent 
risk weight is too high for various reasons. Specifically, several 
commenters asserted that ALLL is already reflected in the risk-based 
capital numerator, and therefore an increased risk weight double-counts 
the risk of a past-due exposure. Other commenters characterized the 
increased risk weight as procyclical and burdensome (particularly for 
community banking organizations), and maintained that it would 
unnecessarily discourage lending and loan modifications or workouts.
    The FDIC has considered the comments and have decided to retain the 
proposed 150 percent risk weight for past-due exposures in the interim 
final rule. The FDIC notes that the ALLL is intended to cover 
estimated, incurred losses as of the balance sheet date, rather than 
unexpected losses. The higher risk weight on past due exposures ensures 
sufficient regulatory capital for the increased probability of 
unexpected losses on these exposures.

[[Page 55408]]

The FDIC believes that any increased capital burden, potential rise in 
procyclicality, or impact on lending associated with the 150 percent 
risk weight is justified given the overall objective of better 
capturing the risk associated with the impaired credit quality of these 
exposures.
    One commenter requested clarification as to whether a banking 
organization could reduce the risk weight for past-due exposures from 
150 percent when the carrying value is charged down to the amount 
expected to be recovered. For the purposes of the interim final rule, 
an FDIC-supervised institution must apply a 150 percent risk weight to 
all past-due exposures, including any amount remaining on the balance 
sheet following a charge-off, to reflect the increased uncertainty as 
to the recovery of the remaining carrying value.
11. Other Assets
    Generally consistent with the general risk-based capital rules, the 
FDIC has decided to adopt, as proposed, the risk weights described 
below for exposures not otherwise assigned to a specific risk weight 
category. Specifically, an FDIC-supervised institution must assign:
    (1) A zero percent risk weight to cash owned and held in all of an 
FDIC-supervised institution's offices or in transit; gold bullion held 
in the FDIC-supervised institution's 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 
exposures that arise from the settlement of cash transactions (such as 
equities, fixed income, spot foreign exchange and spot commodities) 
with a CCP where there is no assumption of ongoing counterparty credit 
risk by the CCP after settlement of the trade and associated default 
fund contributions;
    (2) A 20 percent risk weight to cash items in the process of 
collection; and
    (3) A 100 percent risk weight to all assets not specifically 
assigned a different risk weight under the interim final rule (other 
than exposures that would be deducted from tier 1 or tier 2 capital), 
including deferred acquisition costs (DAC) and value of business 
acquired (VOBA).
    In addition, subject to the proposed transition arrangements under 
section 300 of the interim final rule, an FDIC-supervised institution 
must assign:
    (1) A 100 percent risk weight to DTAs arising from temporary 
differences that the FDIC-supervised institution could realize through 
net operating loss carrybacks; and
    (2) A 250 percent risk weight to the portion of MSAs and DTAs 
arising from temporary differences that the FDIC-supervised institution 
could not realize through net operating loss carrybacks that are not 
deducted from common equity tier 1 capital pursuant to section 
324.22(d).
    The agencies received a few comments on the treatment of DAC and 
VOBA. DAC represents certain costs incurred in the acquisition of a new 
contract or renewal insurance contract that are capitalized pursuant to 
GAAP. VOBA refers to assets that reflect revenue streams from insurance 
policies purchased by an insurance company. One commenter asked for 
clarification on risk weights for other types of exposures that are not 
assigned a specific risk weight under the proposal. Consistent with the 
proposal, under the interim final rule these assets receive a 100 
percent risk weight, together with other assets not specifically 
assigned a different risk weight under the NPR.
    Consistent with the general risk-based capital rules, the interim 
final rule retains the limited flexibility to address situations where 
exposures of an FDIC-supervised institution that are not exposures 
typically held by depository institutions do not fit wholly within the 
terms of another risk-weight category. Under the interim final rule, an 
FDIC-supervised institution may assign such exposures to the risk-
weight category applicable under the capital rules for BHCs or covered 
SLHCs, provided that (1) the FDIC-supervised institution is not 
authorized to hold the asset under applicable law other than debt 
previously contracted or similar authority; and (2) the risks 
associated with the asset are substantially similar to the risks of 
assets that are otherwise assigned to a risk-weight category of less 
than 100 percent under subpart D of the interim final rule.

C. Off-Balance Sheet Items

1. Credit Conversion Factors
    Under the proposed rule, as under the general risk-based capital 
rules, a banking organization would calculate the exposure amount of an 
off-balance sheet item by multiplying the off-balance sheet component, 
which is usually the contractual amount, by the applicable CCF. This 
treatment would apply to all off-balance sheet items, such as 
commitments, contingent items, guarantees, certain repo-style 
transactions, financial standby letters of credit, and forward 
agreements. The proposed rule, however, introduced new CCFs applicable 
to certain exposures, such as a higher CCF for commitments with an 
original maturity of one year or less that are not unconditionally 
cancelable.
    Commenters offered a number of suggestions for revising the 
proposed CCFs that would be applied to off-balance sheet exposures. 
Commenters generally asked for lower CCFs that, according to the 
commenters, are more directly aligned with a particular off-balance 
sheet exposure's loss history. In addition, some commenters asked the 
agencies to conduct a calibration study to show that the proposed CCFs 
were appropriate.
    The FDIC has decided to retain the proposed CCFs for off-balance 
sheet exposures without change for purposes of the interim final rule. 
The FDIC believes that the proposed CCFs meet its goals of improving 
risk sensitivity and implementing higher capital requirements for 
certain exposures through a simple methodology. Furthermore, 
alternatives proposed by commenters, such as exposure measures tied 
directly to a particular exposure's loss history, would create 
significant operational burdens for many small- and mid-sized banking 
organizations, by requiring them to keep accurate historical records of 
losses and continuously adjust their capital requirements for certain 
exposures to account for new loss data. Such a system would be 
difficult for the FDIC to monitor, as the FDIC would need to verify the 
accuracy of historical loss data and ensure that capital requirements 
are properly applied across institutions. Incorporation of additional 
factors, such as loss history or increasing the number of CCF 
categories, would detract from the FDIC's stated goal of simplicity in 
its capital treatment of off-balance sheet exposures. Additionally, the 
FDIC believes that the CCFs, as proposed, were properly calibrated to 
reflect the risk profiles of the exposures to which they are applied 
and do not believe a calibration study is required.
    Accordingly, under the interim final rule, as proposed, an FDIC-
supervised institution may apply a zero percent CCF to the unused 
portion of commitments that are unconditionally cancelable by the FDIC-
supervised institution. For purposes of the interim final rule, a 
commitment means any legally binding arrangement that obligates an 
FDIC-supervised institution to extend credit or to purchase assets. 
Unconditionally cancelable means a commitment for which an FDIC-
supervised institution may, at any time, with or without cause, refuse 
to extend credit (to the extent permitted under applicable law). In the 
case of a

[[Page 55409]]

residential mortgage exposure that is a line of credit, an FDIC-
supervised institution can unconditionally cancel the commitment if it, 
at its option, may prohibit additional extensions of credit, reduce the 
credit line, and terminate the commitment to the full extent permitted 
by applicable law. If an FDIC-supervised institution provides a 
commitment that is structured as a syndication, the FDIC-supervised 
institution is only required to calculate the exposure amount for its 
pro rata share of the commitment.
    The proposed rule provided a 20 percent CCF for commitments with an 
original maturity of one year or less that are not unconditionally 
cancelable by a banking organization, and for self-liquidating, trade-
related contingent items that arise from the movement of goods with an 
original maturity of one year or less.
    Some commenters argued that the proposed designation of a 20 
percent CCF for certain exposures was too high. For example, they 
requested that the interim final rule continue the current practice of 
applying a zero percent CCF to all unfunded lines of credit with less 
than one year maturity, regardless of the lender's ability to 
unconditionally cancel the line of credit. They also requested a CCF 
lower than 20 percent for the unused portions of letters of credit 
extended to a small, mid-market, or trade finance company with 
durations of less than one year or less. These commenters asserted that 
current market practice for these lines have covenants based on 
financial ratios, and any increase in riskiness that violates the 
contractual minimum ratios would prevent the borrower from drawing down 
the unused portion.
    For purposes of the interim final rule, the FDIC is retaining the 
20 percent CCF, as it accounts for the elevated level of risk FDIC-
supervised institutions face when extending short-term commitments that 
are not unconditionally cancelable. Although the FDIC understands 
certain contractual provisions are common in the market, these 
practices are not static, and it is more appropriate from a regulatory 
standpoint to base a CCF on whether a commitment is unconditionally 
cancellable. An FDIC-supervised institution must apply a 20 percent CCF 
to a commitment with an original maturity of one year or less that is 
not unconditionally cancellable by the FDIC-supervised institution. The 
interim final rule also maintains the 20 percent CCF for self-
liquidating, trade-related contingent items that arise from the 
movement of goods with an original maturity of one year or less. The 
interim final rule also requires an FDIC-supervised institution to 
apply a 50 percent CCF to commitments with an original maturity of more 
than one year that are not unconditionally cancelable by the FDIC-
supervised institution, and to transaction-related contingent items, 
including performance bonds, bid bonds, warranties, and performance 
standby letters of credit.
    Some commenters requested clarification regarding the treatment of 
commitments to extend letters of credit. They argued that these 
commitments are no more risky than commitments to extend loans and 
should receive similar treatment (20 percent or 50 percent CCF). For 
purposes of the interim final rule, the FDIC notes that section 
33(a)(2) allows FDIC-supervised institutions to apply the lower of the 
two applicable CCFs to the exposures related to commitments to extend 
letters of credit. FDIC-supervised institutions will need to make this 
determination based upon the individual characteristics of each letter 
of credit.
    Under the interim final rule, an FDIC-supervised institution must 
apply a 100 percent CCF to off-balance sheet guarantees, repurchase 
agreements, credit-enhancing representations and warranties that are 
not securitization exposures, securities lending or borrowing 
transactions, financial standby letters of credit, and forward 
agreements, and other similar exposures. The off-balance sheet 
component of a repurchase agreement equals the sum of the current fair 
values of all positions the FDIC-supervised institution has sold 
subject to repurchase. The off-balance sheet component of a securities 
lending transaction is the sum of the current fair values of all 
positions the FDIC-supervised institution has lent under the 
transaction. For securities borrowing transactions, the off-balance 
sheet component is the sum of the current fair values of all non-cash 
positions the FDIC-supervised institution has posted as collateral 
under the transaction. In certain circumstances, an FDIC-supervised 
institution may instead determine the exposure amount of the 
transaction as described in section 37 of the interim final rule.
    In contrast to the general risk-based capital rules, which require 
capital for securities lending and borrowing transactions and 
repurchase agreements that generate an on-balance sheet exposure, the 
interim final rule requires an FDIC-supervised institution to hold 
risk-based capital against all repo-style transactions, regardless of 
whether they generate on-balance sheet exposures, as described in 
section 324.37 of the interim final rule. One commenter disagreed with 
this treatment and requested an exemption from the capital treatment 
for off-balance sheet repo-style exposures. However, the FDIC adopted 
this approach because banking organizations face counterparty credit 
risk when engaging in repo-style transactions, even if those 
transactions do not generate on-balance sheet exposures, and thus 
should not be exempt from risk-based capital requirements.
2. Credit-Enhancing Representations and Warranties
    Under the general risk-based capital rules, a banking organization 
is subject to a risk-based capital requirement when it provides credit-
enhancing representations and warranties on assets sold or otherwise 
transferred to third parties as such positions are considered recourse 
arrangements.\122\ However, the general risk-based capital rules do not 
impose a risk-based capital requirement on assets sold or transferred 
with representations and warranties that (1) contain early default 
clauses or similar warranties that permit the return of, or premium 
refund clauses covering, one-to-four family first-lien residential 
mortgage loans for a period not to exceed 120 days from the date of 
transfer; and (2) contain premium refund clauses that cover assets 
guaranteed, in whole or in part, by the U.S. government, a U.S. 
government agency, or a U.S. GSE, provided the premium refund clauses 
are for a period not to exceed 120 days; or (3) permit the return of 
assets in instances of fraud, misrepresentation, or incomplete 
documentation.\123\
---------------------------------------------------------------------------

    \122\ 12 CFR part 325, appendix A, section II.B.5(a) (state 
nonmember banks) and 12 CFR 390.466(b) (state savings associations).
    \123\ 12 CFR part 325, appendix A, section II.B.5(a) (state 
nonmember banks) and 12 CFR 390.466(b) (state savings associations).
---------------------------------------------------------------------------

    In contrast, under the proposal, if a banking organization provides 
a credit-enhancing representation or warranty on assets it sold or 
otherwise transferred to third parties, including early default clauses 
that permit the return of, or premium refund clauses covering, one-to-
four family residential first mortgage loans, the banking organization 
would treat such an arrangement as an off-balance sheet guarantee and 
apply a 100 percent CCF to determine the exposure amount, provided the 
exposure does not meet the definition of a securitization exposure. The 
agencies proposed a different treatment than the one under the general 
risk-based capital rules because of the risk to which banking 
organizations are exposed while credit-enhancing representations and

[[Page 55410]]

warranties are in effect. Some commenters asked for clarification on 
what qualifies as a credit-enhancing representation and warranty, and 
commenters made numerous suggestions for revising the proposed 
definition. In particular, they disagreed with the agencies' proposal 
to remove the exemptions related to early default clauses and premium 
refund clauses since these representations and warranties generally are 
considered to be low risk exposures and banking organizations are not 
currently required to hold capital against these representations and 
warranties.
    Some commenters encouraged the agencies to retain the 120-day safe 
harbor from the general risk-based capital rules, which would not 
require holding capital against assets sold with certain early default 
clauses of 120 days or less. These commenters argued that the proposal 
to remove the 120-day safe harbor would impede the ability of banking 
organizations to make loans and would increase the cost of credit to 
borrowers. Furthermore, certain commenters asserted that removal of the 
120-day safe harbor was not necessary for loan portfolios that are well 
underwritten, those for which put-backs are rare, and where the banking 
organization maintains robust buyback reserves.
    After reviewing the comments, the FDIC decided to retain in the 
interim final rule the 120-day safe harbor in the definition of credit-
enhancing representations and warranties for early default and premium 
refund clauses on one-to-four family residential mortgages that qualify 
for the 50 percent risk weight as well as for premium refund clauses 
that cover assets guaranteed, in whole or in part, by the U.S. 
government, a U.S. government agency, or a U.S. GSE. The FDIC 
determined that retaining the safe harbor would help to address 
commenters' confusion about what qualifies as a credit-enhancing 
representation and warranty. Therefore, consistent with the general 
risk-based capital rules, under the interim final rule, credit-
enhancing representations and warranties will not include (1) early 
default clauses and similar warranties that permit the return of, or 
premium refund clauses covering, one-to-four family first-lien 
residential mortgage loans that qualify for a 50 percent risk weight 
for a period not to exceed 120 days from the date of transfer; \124\ 
(2) premium refund clauses that cover assets guaranteed by the U.S. 
government, a U.S. Government agency, or a GSE, provided the premium 
refund 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.
---------------------------------------------------------------------------

    \124\ These warranties may cover only those loans that were 
originated within 1 year of the date of transfer.
---------------------------------------------------------------------------

    Some commenters requested clarification from the agencies regarding 
representations made about the value of the underlying collateral of a 
sold loan. For example, many purchasers of mortgage loans originated by 
banking organizations require that the banking organization repurchase 
the loan if the value of the collateral is other than as stated in the 
documentation provided to the purchaser or if there were any material 
misrepresentations in the appraisal process. The FDIC confirms that 
such representations meets the ``misrepresentation, fraud, or 
incomplete documentation'' exclusion in the definition of credit-
enhancing representations and warranties and is not subject to capital 
treatment.
    A few commenters also requested clarification regarding how the 
definition of credit-enhancing representations and warranties in the 
proposal interacts with Federal Home Loan Mortgage Corporation (FHLMC), 
Federal National Mortgage Association (FNMA), and Government National 
Mortgage Association (GNMA) sales conventions. These same commenters 
also requested verification in the interim final rule that mortgages 
sold with representations and warranties would all receive a 100 
percent risk weight, regardless of the characteristics of the mortgage 
exposure. First, the definition of credit-enhancing representations and 
warranties described in this interim final rule is separate from the 
sales conventions required by FLHMA, FNMA, and GNMA. Those entities 
will continue to set their own requirements for secondary sales, 
including representation and warranty requirements. Second, the risk 
weights applied to mortgage exposures themselves are not affected by 
the inclusion of representations and warranties. Mortgage exposures 
will continue to receive either a 50 or 100 percent risk weight, as 
outlined in section 32(g) of this interim final rule, regardless of the 
inclusion of representations and warranties when they are sold in the 
secondary market. If such representations and warranties meet the 
rule's definition of credit-enhancing representations and warranties, 
then the institution must maintain regulatory capital against the 
associated credit risk.
    Some commenters disagreed with the proposed methodology for 
determining the capital requirement for representations and warranties, 
and offered alternatives that they argued would conform to existing 
market practices and better incentivize high-quality underwriting. Some 
commenters indicated that many originators already hold robust buyback 
reserves and argued that the agencies should require originators to 
hold adequate liquidity in their buyback reserves, instead of requiring 
a duplicative capital requirement. Other commenters asked that any 
capital requirement be directly aligned to that originator's history of 
honoring representation and warranty claims. These commenters stated 
that originators who underwrite high-quality loans should not be 
required to hold as much capital against their representations and 
warranties as originators who exhibit what the commenters referred to 
as ``poor underwriting standards.'' Finally, a few commenters requested 
that the agencies completely remove, or significantly reduce, capital 
requirements for representations and warranties. They argue that the 
market is able to regulate itself, as a banking organization will not 
be able to sell its loans in the secondary market if they are 
frequently put back by the buyers.
    The FDIC considered these alternatives and has decided to finalize 
the proposed methodology for determining the capital requirement 
applied to representations and warranties without change. The FDIC is 
concerned that buyback reserves could be inadequate, especially if the 
housing market enters another prolonged downturn. Robust and clear 
capital requirements, in addition to separate buyback reserves held by 
originators, better ensure that representation and warranty claims will 
be fulfilled in times of stress. Furthermore, capital requirements 
based upon originators' historical representation and warranty claims 
are not only operationally difficult to implement and monitor, but they 
can also be misleading. Underwriting standards at firms are not static 
and can change over time. The FDIC believes that capital requirements 
based on past performance of a particular underwriter do not always 
adequately capture the current risks faced by that firm. The FDIC 
believes that the incorporation of the 120-day safe harbor in the 
interim final rule as discussed above addresses many of the commenters' 
concerns.
    Some commenters requested clarification on the duration of the 
capital treatment for credit-enhancing

[[Page 55411]]

representations and warranties. For instance, some commenters 
questioned whether capital is required for credit-enhancing 
representations and warranties after the contractual life of the 
representations and warranties has expired or whether capital has to be 
held for the life of the asset. Banking organizations are not required 
to hold capital for any credit-enhancing representation and warranty 
after the expiration of the representation or warranty, regardless of 
the maturity of the underlying loan.
    Additionally, commenters indicated that market practice for some 
representations and warranties for sold mortgages stipulates that 
originators only need to refund the buyer any servicing premiums and 
other earned fees in cases of early default, rather than requiring 
putback of the underlying loan to the seller. These commenters sought 
clarification as to whether the proposal would have required them to 
hold capital against the value of the underlying loan or only for the 
premium or fees that could be subject to a refund, as agreed upon in 
their contract with the buyer. For purposes of the interim final rule, 
an FDIC-supervised institution must hold capital only for the maximum 
contractual amount of the FDIC-supervised institution's exposure under 
the representations and warranties. In the case described by the 
commenters, the FDIC-supervised institution would hold capital against 
the value of the servicing premium and other earned fees, rather than 
the value of the underlying loan, for the duration specified in the 
representations and warranties agreement.
    Some commenters also requested exemptions from the proposed 
treatment of representations and warranties for particular originators, 
types of transactions, or asset categories. In particular, many 
commenters asked for an exemption for community banking organizations, 
claiming that the proposed treatment would lessen credit availability 
and increase the costs of lending. One commenter argued that bona fide 
mortgage sale agreements should be exempt from capital requirements. 
Other commenters requested an exemption for the portion of any off-
balance sheet asset that is subject to a risk retention requirement 
under section 941 of the Dodd-Frank Act and any regulations promulgated 
thereunder.\125\ Some commenters also requested that the agencies delay 
action on the proposal until the risk retention rule is finalized. 
Other commenters also requested exemptions for qualified mortgages (QM) 
and ``prime'' mortgage loans.
---------------------------------------------------------------------------

    \125\ See 15 U.S.C. 78o-11, et seq.
---------------------------------------------------------------------------

    The FDIC has decided not to adopt any of the specific exemptions 
suggested by the commenters. Although community banking organizations 
are critical to ensure the flow of credit to small businesses and 
individual borrowers, providing them with an exemption from the 
proposed treatment of credit-enhancing representations and warranties 
would be inconsistent with safety and soundness because the risks from 
these exposures to community banking organizations are no different 
than those to other banking organizations. The FDIC also has not 
provided exemptions in this rulemaking to portions of off-balance sheet 
assets subject to risk retention, QM, and ``prime loans.'' The relevant 
agencies have not yet adopted a final rule implementing the risk 
retention provisions of section 941 of the Dodd-Frank Act, and the 
FDIC, therefore, does not believe it is appropriate to provide an 
exemption relating to risk retention in this interim final rule. In 
addition, while the QM rulemaking is now final,\126\ the FDIC believes 
it is appropriate to first evaluate how the QM designation affects the 
mortgage market before requiring less capital to be held against off-
balance sheet assets that cover these loans. As noted above, the 
incorporation in the interim final rule of the 120-day safe harbor 
addresses many of the concerns about burden.
---------------------------------------------------------------------------

    \126\ See 12 CFR Part 1026.
---------------------------------------------------------------------------

    The risk-based capital treatment for off-balance sheet items in 
this interim final rule is consistent with section 165(k) of the Dodd-
Frank Act which provides that, in the case of a BHC with $50 billion or 
more in total consolidated assets, the computation of capital, for 
purposes of meeting capital requirements, shall take into account any 
off-balance-sheet activities of the company.\127\ The interim final 
rule complies with the requirements of section 165(k) of the Dodd-Frank 
Act by requiring a BHC to hold risk-based capital for its off-balance 
sheet exposures, as described in sections 324.31, 324.33, 324.34 and 
324.35 of the interim final rule.
---------------------------------------------------------------------------

    \127\ Section 165(k) of the Dodd-Frank Act (12 U.S.C. 5365(k)). 
This section defines an off-balance sheet activity as an existing 
liability of a company that is not currently a balance sheet 
liability, but may become one upon the happening of some future 
event. Such transactions may include direct credit substitutes in 
which a banking organization substitutes its own credit for a third 
party; irrevocable letters of credit; risk participations in 
bankers' acceptances; sale and repurchase agreements; asset sales 
with recourse against the seller; interest rate swaps; credit swaps; 
commodities contracts; forward contracts; securities contracts; and 
such other activities or transactions as the Board may define 
through a rulemaking.
---------------------------------------------------------------------------

D. Over-the-Counter Derivative Contracts

    In the Standardized Approach NPR, the agencies proposed generally 
to retain the treatment of OTC derivatives provided under the general 
risk-based capital rules, which is similar to the current exposure 
method (CEM) for determining the exposure amount for OTC derivative 
contracts contained in the Basel II standardized framework.\128\ 
Proposed revisions to the treatment of the OTC derivative contracts 
included an updated definition of an OTC derivative contract, a revised 
conversion factor matrix for calculating the PFE, a revision of the 
criteria for recognizing the netting benefits of qualifying master 
netting agreements and of financial collateral, and the removal of the 
50 percent risk weight cap for OTC derivative contracts.
---------------------------------------------------------------------------

    \128\ The general risk-based capital rules for state savings 
associations regarding the calculation of credit equivalent amounts 
for derivative contracts differ from the rules for other banking 
organizations. (See 12 CFR 390.466(a)(2)). The state savings 
association rules address only interest rate and foreign exchange 
rate contracts and include certain other differences. Accordingly, 
the description of the general risk-based capital rules in this 
preamble primarily reflects the rules applicable to state banks.
---------------------------------------------------------------------------

    The agencies received a number of comments on the proposed CEM 
relating to OTC derivatives. These comments generally focused on the 
revised conversion factor matrix, the proposed removal of the 50 
percent cap on risk weights for OTC derivative transactions in the 
general risk-based capital rules, and commenters' view that there is a 
lack of risk sensitivity in the calculation of the exposure amount of 
OTC derivatives and netting benefits. A specific discussion of the 
comments on particular aspects of the proposal follows.
    One commenter asserted that the proposed conversion factors for 
common interest rate and foreign exchange contracts, and risk 
participation agreements (a simplified form of credit default swaps) 
(set forth in Table 19 below), combined with the removal of the 50 
percent risk weight cap, would drive up banking organizations' capital 
requirements associated with these routine transactions and result in 
much higher transaction costs for small businesses. Another commenter 
asserted that the zero percent conversion factor assigned to interest 
rate derivatives with a remaining maturity of one year or less is not 
appropriate as the PFE incorrectly assumes all interest rate 
derivatives

[[Page 55412]]

always can be covered by taking a position in a liquid market.
    The FDIC acknowledges that the standardized matrix of conversion 
factors may be too simplified for some FDIC-supervised institutions. 
The FDIC believes, however, that the matrix approach appropriately 
balances the policy goals of simplicity and risk-sensitivity, and that 
the conversion factors themselves have been appropriately calibrated 
for the products to which they relate.
    Some commenters supported retention of the 50 percent risk weight 
cap for derivative exposures under the general risk-based capital 
rules. Specifically, one commenter argued that the methodology for 
calculating the exposure amount without the 50 percent risk weight cap 
would result in inappropriately high capital charge unless the 
methodology were amended to recognize the use of netting and 
collateral. Accordingly, the commenter encouraged the agencies to 
retain the 50 percent risk weight cap until the BCBS enhances the CEM 
to improve risk-sensitivity.
    The FDIC believes that as the market for derivatives has developed, 
the types of counterparties acceptable to participants have expanded to 
include counterparties that merit a risk weight greater than 50 
percent. In addition, the FDIC is aware of the ongoing work of the BCBS 
to improve the current exposure method and expect to consider any 
necessary changes to update the exposure amount calculation when the 
BCBS work is completed.
    Some commenters suggested that the agencies allow the use of 
internal models approved by the primary Federal supervisor as an 
alternative to the proposal, consistent with Basel III. The FDIC chose 
not to incorporate all of the methodologies included in the Basel II 
standardized framework in the interim final rule. The FDIC believes 
that, given the range of FDIC-supervised institutions that are subject 
to the interim final rule in the United States, it is more appropriate 
to permit only the proposed non-models based methodology for 
calculating OTC derivatives exposure amounts under the standardized 
approach. For larger and more complex FDIC-supervised institutions, the 
use of the internal model methodology and other models-based 
methodologies is permitted under the advanced approaches rule. One 
commenter asked the agencies to provide a definition for ``netting,'' 
as the meaning of this term differs widely under various master netting 
agreements used in industry practice. Another commenter asserted that 
net exposures are likely to understate actual exposures and the risk of 
early close-out posed to banking organizations facing financial 
difficulties, that the conversion factors for PFE are inappropriate, 
and that a better measure of risk tied to gross exposure is needed. 
With respect to the definition of netting, the FDIC notes that the 
definition of ``qualifying master netting agreement'' provides a 
functional definition of netting. With respect to the use of net 
exposure for purposes of determining PFE, the FDIC believes that, in 
light of the existing international framework to enforce netting 
arrangements together with the conditions for recognizing netting that 
are included in this interim final rule, the use of net exposure is 
appropriate in the context of a risk-based counterparty credit risk 
charge that is specifically intended to address default risk. The 
interim final rule also continues to limit full recognition of netting 
for purposes of calculating PFE for counterparty credit risk under the 
standardized approach.\129\
---------------------------------------------------------------------------

    \129\ See section 324.34(a)(2) of the interim final rule.
---------------------------------------------------------------------------

    Other commenters suggested adopting broader recognition of netting 
under the PFE calculation for netting sets, using a factor of 85 
percent rather than 60 percent in the formula for recognizing netting 
effects to be consistent with the BCBS CCP interim framework (which is 
defined and discussed in section VIII.E of this preamble, below). 
Another commenter suggested implementing a 15 percent haircut on the 
calculated exposure amount for failure to recognize risk mitigants and 
portfolio diversification. With respect to the commenters' request for 
greater recognition of netting in the calculation of PFE, the FDIC 
notes that the BCBS CCP interim framework's use of 85 percent 
recognition of netting was limited to the calculation of the 
hypothetical capital requirement of the QCCP for purposes of 
determining a clearing member banking organization's risk-weighted 
asset amount for its default fund contribution. As such, the interim 
final rule retains the proposed formula for recognizing netting effects 
for OTC derivative contracts that was set out in the proposal. The FDIC 
expects to consider whether it would be necessary to propose any 
changes to the CEM once BCBS discussions on this topic are complete.
    The proposed rule placed a cap on the PFE of sold credit 
protection, equal to the net present value of the amount of unpaid 
premiums. One commenter questioned the appropriateness of the proposed 
cap, and suggested that a seller's exposure be measured as the gross 
exposure amount of the credit protection provided on the name 
referenced in the credit derivative contract. The FDIC believes that 
the proposed approach is appropriate for measuring counterparty credit 
risk because it reflects the amount an FDIC-supervised institution may 
lose on its exposure to the counterparty that purchased protection. The 
exposure amount on a sold credit derivative would be calculated 
separately under section 34(a).
    Another commenter asserted that current credit exposure (netted and 
unnetted) understates or ignores the risk that the mark is inaccurate. 
Generally, the FDIC expects an FDIC-supervised institution to have in 
place policies and procedures regarding the valuation of positions, and 
that those processes would be reviewed in connection with routine and 
periodic supervisory examinations of an FDIC-supervised institution.
    The interim final rule generally adopts the proposed treatment for 
OTC derivatives without change. Under the interim final rule, as under 
the general risk-based capital rules, an FDIC-supervised institution is 
required to hold risk-based capital for counterparty credit risk for an 
OTC derivative contract. As defined in the rule, a derivative contract 
is 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. A derivative contract includes an interest rate, 
exchange rate, equity, or a commodity derivative contract, a credit 
derivative, 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. This 
applies, for example, to mortgage-backed securities (MBS) transactions 
that the GSEs conduct in the To-Be-Announced market.
    Under the interim final rule, an OTC derivative contract does not 
include a derivative contract that is a cleared transaction, which is 
subject to a specific treatment as described in section VIII.E of this 
preamble. However, an OTC derivative contract includes an exposure of a 
banking organization that is a clearing member banking organization to 
its clearing member client where the clearing member banking 
organization is either acting as a financial intermediary and

[[Page 55413]]

enters into an offsetting transaction with a CCP or where the clearing 
member banking organization provides a guarantee to the CCP on the 
performance of the client. The rationale for this treatment is the 
banking organization's continued exposure directly to the risk of the 
clearing member client. In recognition of the shorter close-out period 
for these transactions, however, the interim final rule permits an 
FDIC-supervised institution to apply a scaling factor to recognize the 
shorter holding period as discussed in section VIII.E of this preamble.
    To determine the risk-weighted asset amount for an OTC derivative 
contract under the interim final rule, an FDIC-supervised institution 
must first determine its exposure amount for the contract and then 
apply to that amount a risk weight based on the counterparty, eligible 
guarantor, or recognized collateral.
    For a single OTC derivative contract that is not subject to a 
qualifying master netting agreement (as defined further below in this 
section), the rule requires the exposure amount to be the sum of (1) 
the FDIC-supervised institution's current credit exposure, which is the 
greater of the fair value or zero, and (2) PFE, which is calculated by 
multiplying the notional principal amount of the OTC derivative 
contract by the appropriate conversion factor, in accordance with Table 
19 below.
    Under the interim final rule, the conversion factor matrix includes 
the additional categories of OTC derivative contracts as illustrated in 
Table 19. For an OTC derivative contract that does not fall within one 
of the specified categories in Table 19, the interim final rule 
requires PFE to be calculated using the ``other'' conversion factor.

                                          Table 19--Conversion Factor Matrix for OTC Derivative Contracts \130\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              Credit       Credit (non-
                                                              Foreign      (investment-     investment-                      Precious
        Remaining maturity \131\           Interest rate   exchange rate       grade           grade          Equity      metals (except       Other
                                                             and gold        reference       reference                         gold)
                                                                           asset) \132\       asset)
--------------------------------------------------------------------------------------------------------------------------------------------------------
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
--------------------------------------------------------------------------------------------------------------------------------------------------------

     
---------------------------------------------------------------------------

    \130\ For a derivative contract with multiple exchanges of 
principal, the conversion factor is multiplied by the number of 
remaining payments in the derivative contract.
    \131\ For a 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.
    \132\ A FDIC-supervised institution must use the column labeled 
``Credit (investment-grade reference asset)'' for a credit 
derivative whose reference asset is an outstanding unsecured long-
term debt security without credit enhancement that is investment 
grade. A FDIC-supervised institution must use the column labeled 
``Credit (non-investment-grade reference asset)'' for all other 
credit derivatives.
---------------------------------------------------------------------------

    For multiple OTC derivative contracts subject to a qualifying 
master netting agreement, an FDIC-supervised institution must calculate 
the exposure amount by adding the net current credit exposure and the 
adjusted sum of the PFE amounts for all OTC derivative contracts 
subject to the qualifying master netting agreement. Under the interim 
final rule, the net current credit exposure is the greater of zero and 
the net sum of all positive and negative fair values of the individual 
OTC derivative contracts subject to the qualifying master netting 
agreement. The adjusted sum of the PFE amounts must be calculated as 
described in section 34(a)(2)(ii) of the interim final rule.
    Under the interim final rule, to recognize the netting benefit of 
multiple OTC derivative contracts, the contracts must be subject to a 
qualifying master netting agreement; however, unlike under the general 
risk-based capital rules, under the interim final rule for most 
transactions, an FDIC-supervised institution may rely on sufficient 
legal review instead of an opinion on the enforceability of the netting 
agreement as described below.\133\ The interim final rule defines a 
qualifying master netting agreement as any written, legally enforceable 
netting agreement that creates a single legal obligation for all 
individual transactions covered by the agreement upon an event of 
default (including receivership, insolvency, liquidation, or similar 
proceeding) provided that certain conditions set forth in section 3 of 
the interim final rule are met.\134\ These conditions include 
requirements with respect to the FDIC-supervised institution's right to 
terminate the contract and liquidate collateral and meeting certain 
standards with respect to legal review of the agreement to ensure its 
meets the criteria in the definition.
---------------------------------------------------------------------------

    \133\ Under the general risk-based capital rules, to recognize 
netting benefits an FDIC-supervised institution must enter into a 
bilateral master netting agreement with its counterparty and obtain 
a written and well-reasoned legal opinion of the enforceability of 
the netting agreement for each of its netting agreements that cover 
OTC derivative contracts.
    \134\ The interim final rule adds a new section 3: Operational 
requirements for counterparty credit risk. This section organizes 
substantive requirements related to cleared transactions, eligible 
margin loans, qualifying cross-product master netting agreements, 
qualifying master netting agreements, and repo-style transactions in 
a central place to assist FDIC-supervised institutions in 
determining their legal responsibilities. These substantive 
requirements are consistent with those included in the proposal.
---------------------------------------------------------------------------

    The legal review must be sufficient so that the FDIC-supervised 
institution may conclude with a well-founded basis that, among other 
things, the contract would be found legal, binding, and enforceable 
under the law of the relevant jurisdiction and that the contract meets 
the other requirements of the definition. 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 jurisdictions where an FDIC-supervised 
institution has little experience, the FDIC-supervised institution 
would be expected to obtain an explicit, written legal opinion from 
external or internal legal counsel addressing the particular situation.
    Under the interim final rule, if an OTC derivative contract is 
collateralized by financial collateral, an FDIC-supervised institution 
must first

[[Page 55414]]

determine the exposure amount of the OTC derivative contract as 
described in this section of the preamble. Next, to recognize the 
credit risk mitigation benefits of the financial collateral, an FDIC-
supervised institution could use the simple approach for collateralized 
transactions as described in section 324.37(b) of the interim final 
rule. Alternatively, if the financial collateral is marked-to-market on 
a daily basis and subject to a daily margin maintenance requirement, an 
FDIC-supervised institution could adjust the exposure amount of the 
contract using the collateral haircut approach described in section 
324.37(c) of the interim final rule.
    Similarly, if an FDIC-supervised institution purchases a credit 
derivative that is recognized under section 324.36 of the interim final 
rule as a credit risk mitigant for an exposure that is not a covered 
position under subpart F, it is not required to compute a separate 
counterparty credit risk capital requirement for the credit derivative, 
provided it does so consistently for all such credit derivative 
contracts. Further, where these credit derivative contracts are subject 
to a qualifying master netting agreement, the FDIC-supervised 
institution must either include them all or exclude them all from any 
measure used to determine the counterparty credit risk exposure to all 
relevant counterparties for risk-based capital purposes.
    Under the interim final rule, an FDIC-supervised institution must 
treat an equity derivative contract as an equity exposure and compute 
its risk-weighted asset amount according to the simple risk-weight 
approach (SRWA) described in section 324.52 (unless the contract is a 
covered position under the market risk rule). If the FDIC-supervised 
institution risk weights a contract under the SRWA described in section 
324.52, it may choose not to hold risk-based capital against the 
counterparty risk of the equity contract, so long as it does so for all 
such contracts. Where the OTC equity contracts are subject to a 
qualified master netting agreement, an FDIC-supervised institution 
either includes or excludes all of the contracts from any measure used 
to determine counterparty credit risk exposures. If the FDIC-supervised 
institution is treating an OTC equity derivative contract as a covered 
position under subpart F, it also must calculate a risk-based capital 
requirement for counterparty credit risk of the contract under this 
section.
    In addition, if an FDIC-supervised institution provides protection 
through a credit derivative that is not a covered position under 
subpart F of the interim final rule, it must treat the credit 
derivative as an exposure to the underlying reference asset and compute 
a risk-weighted asset amount for the credit derivative under section 
324.32 of the interim final rule. The FDIC-supervised institution is 
not required to compute a counterparty credit risk capital requirement 
for the credit derivative, as long as it does so consistently for all 
such OTC credit derivative contracts. Further, where these credit 
derivative contracts are subject to a qualifying master netting 
agreement, the FDIC-supervised institution must either include all or 
exclude all such credit derivatives from any measure used to determine 
counterparty credit risk exposure to all relevant counterparties for 
risk-based capital purposes.
    Where the FDIC-supervised institution provides protection through a 
credit derivative treated as a covered position under subpart F, it 
must compute a supplemental counterparty credit risk capital 
requirement using an amount determined under section 324.34 for OTC 
credit derivative contracts or section 35 for credit derivatives that 
are cleared transactions. In either case, the PFE of the protection 
provider would be capped at the net present value of the amount of 
unpaid premiums.
    Under the interim final rule, the risk weight for OTC derivative 
transactions is not subject to any specific ceiling, consistent with 
the Basel capital framework.
    Although the FDIC generally adopted the proposal without change, 
the interim final rule has been revised to add a provision regarding 
the treatment of a clearing member FDIC-supervised institution's 
exposure to a clearing member client (as described below under 
``Cleared Transactions,'' a transaction between a clearing member FDIC-
supervised institution and a client is treated as an OTC derivative 
exposure). However, the interim final rule recognizes the shorter 
close-out period for cleared transactions that are derivative 
contracts, such that a clearing member FDIC-supervised institution can 
reduce its exposure amount to its client by multiplying the exposure 
amount by a scaling factor of no less than 0.71. See section VIII.E of 
this preamble, below, for additional discussion.

E. Cleared Transactions

    The BCBS and the FDIC support incentives designed to encourage 
clearing of derivative and repo-style transactions \135\ through a CCP 
wherever possible in order to promote transparency, multilateral 
netting, and robust risk-management practices.
---------------------------------------------------------------------------

    \135\ See section 324.2 of the interim final rule for the 
definition of a repo-style transaction.
---------------------------------------------------------------------------

    Although there are some risks associated with CCPs, as discussed 
below, the FDIC believes that CCPs generally help improve the safety 
and soundness of the derivatives and repo-style transactions markets 
through the multilateral netting of exposures, establishment and 
enforcement of collateral requirements, and the promotion of market 
transparency.
    As discussed in the proposal, when developing Basel III, the BCBS 
recognized that as more transactions move to central clearing, the 
potential for risk concentration and systemic risk increases. To 
address these concerns, in the period preceding the proposal, the BCBS 
sought comment on a more risk-sensitive approach for determining 
capital requirements for banking organizations' exposures to CCPs.\136\ 
In addition, to encourage CCPs to maintain strong risk-management 
procedures, the BCBS sought comment on a proposal for lower risk-based 
capital requirements for derivative and repo-style transaction 
exposures to CCPs that meet the standards established by the Committee 
on Payment and Settlement Systems (CPSS) and International Organization 
of Securities Commissions (IOSCO).\137\ Exposures to such entities, 
termed QCCPs in the interim final rule, would be subject to lower risk 
weights than exposures to CCPs that did not meet those criteria.
---------------------------------------------------------------------------

    \136\ See ``Capitalisation of Banking Organization Exposures to 
Central Counterparties'' (November 2011) (CCP consultative release), 
available at http://www.bis.org/publ/bcbs206.pdf.
    \137\ See CPSS-IOSCO, ``Recommendations for Central 
Counterparties'' (November 2004), available at http://www.bis.org/publ/cpss64.pdf?noframes=1.
---------------------------------------------------------------------------

    Consistent with the BCBS proposals and the CPSS-IOSCO standards, 
the agencies sought comment on specific risk-based capital requirements 
for cleared derivative and repo-style transactions that are designed to 
incentivize the use of CCPs, help reduce counterparty credit risk, and 
promote strong risk management of CCPs to mitigate their potential for 
systemic risk. In contrast to the general risk-based capital rules, 
which permit a banking organization to exclude certain derivative 
contracts traded on an exchange from the risk-based capital 
calculation, the proposal would have required a banking organization to 
hold risk-based capital for an outstanding derivative contract or a 
repo-style

[[Page 55415]]

transaction that has been cleared through a CCP, including an exchange.
    The proposal also included a capital requirement for default fund 
contributions to CCPs. In the case of non-qualifying CCPs (that is, 
CCPs that do not meet the risk-management, supervision, and other 
standards for QCCPs outlined in the proposal), the risk-weighted asset 
amount for default fund contributions to such CCPs would be equal to 
the sum of the banking organization's default fund contributions to the 
CCPs multiplied by 1,250 percent. In the case of QCCPs, the risk-
weighted asset amount would be calculated according to a formula based 
on the hypothetical capital requirement for a QCCP, consistent with the 
Basel capital framework. The proposal included a formula with inputs 
including the exposure amount of transactions cleared through the QCCP, 
collateral amounts, the number of members of the QCCP, and default fund 
contributions.
    Following issuance of the proposal, the BCBS issued an interim 
framework for the capital treatment of bank exposures to CCPs (BCBS CCP 
interim framework).\138\ The BCBS CCP interim framework reflects 
several key changes from the CCP consultative release, including: (1) A 
provision to allow a clearing member banking organization to apply a 
scalar when using the CEM (as described below) in the calculation of 
its exposure amount to a client (or use a reduced margin period of risk 
when using the internal models methodology (IMM) to calculate exposure 
at default (EAD) under the advanced approaches rule); (2) revisions to 
the risk weights applicable to a clearing member banking organization's 
exposures when such clearing member banking organization guarantees 
QCCP performance; (3) a provision to permit clearing member banking 
organizations to choose from one of two formulaic methodologies for 
determining the capital requirement for default fund contributions; and 
(4) revisions to the CEM formula to recognize netting to a greater 
extent for purposes of calculating the capital requirement for default 
fund contributions.
---------------------------------------------------------------------------

    \138\ See ``Capital requirements for bank exposures to central 
counterparties'' (July 2012), available at http://www.bis.org/publ/bcbs227.pdf.
---------------------------------------------------------------------------

    The agencies received a number of comments on the proposal relating 
to cleared transactions. Commenters also encouraged the agencies to 
revise certain aspects of the proposal in a manner consistent with the 
BCBS CCP interim framework.
    Some commenters asserted that the definition of QCCP should be 
revised, specifically by including a definitive list of QCCPs rather 
than requiring each banking organization to demonstrate that a CCP 
meets certain qualifying criteria. The FDIC believes that a static list 
of QCCPs would not reflect the potentially dynamic nature of a CCP, and 
that FDIC-supervised institutions are situated to make this 
determination on an ongoing basis.
    Some commenters recommended explicitly including derivatives 
clearing organizations (DCOs) and securities-based swap clearing 
agencies in the definition of a QCCP. Commenters also suggested 
including in the definition of QCCP any CCP that the CFTC or SEC 
exempts from registration because it is deemed by the CFTC or SEC to be 
subject to ``comparable, comprehensive supervision'' by another 
regulator. The FDIC notes that such registration (or exemption from 
registration based on being subject to ``comparable, comprehensive 
supervision'') does not necessarily mean that the CCP is subject to, or 
in compliance with, the standards established by the CPSS and IOSCO. In 
contrast, a designated FMU, which is included in the definition of 
QCCP, is subject to regulation that corresponds to such standards.
    Another commenter asserted that, consistent with the BCBS CCP 
interim framework, the interim final rule should provide for the 
designation of a QCCP by the agencies in the absence of a national 
regime for authorization and licensing of CCPs. The interim final rule 
has not been amended to include this aspect of the BCBS CCP interim 
framework because the FDIC believes a national regime for authorizing 
and licensing CCPs is a critical mechanism to ensure the compliance and 
ongoing monitoring of a CCP's adherence to internationally recognized 
risk-management standards. Another commenter requested that a three-
month grace period apply for CCPs that cease to be QCCPs. The FDIC 
notes that such a grace period was included in the proposed rule, and 
the interim final rule retains the proposed definition without 
substantive change.\139\
---------------------------------------------------------------------------

    \139\ This provision is located in sections 324.35 and 324.133 
of the interim final rule.
---------------------------------------------------------------------------

    With respect to the proposed definition of cleared transaction, 
some commenters asserted that the definition should recognize omnibus 
accounts because their collateral is bankruptcy-remote. The FDIC agrees 
with these commenters and has revised the operational requirements for 
cleared transactions to include an explicit reference to such accounts.
    The BCBS CCP interim framework requires trade portability to be 
``highly likely,'' as a condition of whether a trade satisfies the 
definition of cleared transaction. One commenter who encouraged the 
agencies to adopt the standards set forth in the BCBS CCP interim 
framework sought clarification of the meaning of ``highly likely'' in 
this context. The FDIC clarifies that, consistent with the BCBS CCP 
interim framework, if there is clear precedent for transactions to be 
transferred to a non-defaulting clearing member upon the default of 
another clearing member (commonly referred to as ``portability'') and 
there are no indications that such practice will not continue, then 
these factors should be considered, when assessing whether client 
positions are portable. The definition of ``cleared transaction'' in 
the interim final rule is discussed in further detail below.
    Another commenter sought clarification on whether reasonable 
reliance on a commissioned legal opinion for foreign financial 
jurisdictions could satisfy the ``sufficient legal review'' requirement 
for bankruptcy remoteness of client positions. The FDIC believes that 
reasonable reliance on a commissioned legal opinion could satisfy this 
requirement. Another commenter expressed concern that the proposed 
framework for cleared transactions would capture securities 
clearinghouses, and encouraged the agencies to clarify their intent 
with respect to such entities for purposes of the interim final rule. 
The FDIC notes that the definition of ``cleared transaction'' refers 
only to OTC derivatives and repo-style transactions. As a result, 
securities clearinghouses are not within the scope of the cleared 
transactions framework.
    One commenter asserted that the agencies should recognize varying 
close-out period conventions for specific cleared products, 
specifically exchange-traded derivatives. This commenter also asserted 
that the agencies should adjust the holding period assumptions or allow 
CCPs to use alternative methods to compute the appropriate haircut for 
cleared transactions. For purposes of this interim final rule, the FDIC 
retained a standard close-out period in the interest of avoiding 
unnecessary complexity, and note that cleared transactions with QCCPs 
attract extremely low risk weights (generally, 2 or 4 percent), which, 
in part, is in recognition of the shorter close-out period involved in 
cleared transactions.

[[Page 55416]]

    Another commenter requested confirmation that the risk weight 
applicable to the trade exposure amount for a cleared credit default 
swap (CDS) could be substituted for the risk weight assigned to an 
exposure that was hedged by the cleared CDS, that is, the substitution 
treatment described in sections 324.36 and 324.134 would apply. The 
FDIC confirms that under the interim final rule, an FDIC-supervised 
institution may apply the substitution treatment of sections 324.36 or 
324.134 to recognize the credit risk mitigation benefits of a cleared 
CDS as long as the CDS is an eligible credit derivative and meets the 
other criteria for recognition. Thus, if an FDIC-supervised institution 
purchases an eligible credit derivative as a hedge of an exposure and 
the eligible credit derivative qualifies as a cleared transaction, the 
FDIC-supervised institution may substitute the risk weight applicable 
to the cleared transaction under sections 324.35 or 324.133 of the 
interim final rule (instead of using the risk weight associated with 
the protection provider).\140\ Furthermore, the FDIC has modified the 
definition of eligible guarantor to include a QCCP.
---------------------------------------------------------------------------

    \140\ See ``Basel III counterparty credit risk and exposures to 
central counterparties--Frequently asked questions'' (December 2012 
(update of FAQs published in November 2012)), available at http://www.bis.org/publ/bcbs237.pdf.
---------------------------------------------------------------------------

    Another commenter asserted that the interim final rule should 
decouple the risk weights applied to collateral exposure and those 
assigned to other components of trade exposure to recognize the 
separate components of risk. The FDIC notes that, if collateral is 
bankruptcy remote, then it would not be included in the trade exposure 
amount calculation (see sections 324.35(b)(2) and 324.133(b)(2) of the 
interim final rule). The FDIC also notes that such collateral must be 
risk weighted in accordance with other sections of the interim final 
rule as appropriate, to the extent that the posted collateral remains 
an asset on an FDIC-supervised institution's balance sheet.
    A number of commenters addressed the use of the CEM for purposes of 
calculating a capital requirement for a default fund contribution to a 
CCP (Kccp).\141\ Some commenters asserted that the CEM is 
not appropriate for determining the hypothetical capital requirement 
for a QCCP (Kccp) under the proposed formula because it 
lacks risk sensitivity and sophistication, and was not developed for 
centrally-cleared transactions. Another commenter asserted that the use 
of CEM should be clarified in the clearing context, specifically, 
whether the modified CEM approach would permit the netting of 
offsetting positions booked under different ``desk IDs'' or ``hub 
accounts'' for a given clearing member banking organization. Another 
commenter encouraged the agencies to allow banking organizations to use 
the IMM to calculate Kccp. Another commenter encouraged the 
agencies to continue to work with the BCBS to harmonize international 
and domestic capital rules for cleared transactions.
---------------------------------------------------------------------------

    \141\ See section VIII.D of this preamble for a description of 
the CEM.
---------------------------------------------------------------------------

    Although the FDIC recognizes that the CEM has certain limitations, 
it considers the CEM, as modified for cleared transactions, to be a 
reasonable approach that would produce consistent results across 
banking organizations. Regarding the commenter's request for 
clarification of netting positions across ``desk IDs'' or ``hub 
accounts,'' the CEM would recognize netting across such transactions if 
such netting is legally enforceable upon a CCP's default. Moreover, the 
FDIC believes that the use of models either by the CCP, whose model 
would not be subject to review and approval by the FDIC, or by the 
banking organizations, whose models may vary significantly, likely 
would produce inconsistent results that would not serve as a basis for 
comparison across banking organizations. The FDIC recognizes that 
additional work is being performed by the BCBS to revise the CCP 
capital framework and the CEM. The FDIC expects to modify the interim 
final rule to incorporate the BCBS improvements to the CCP capital 
framework and CEM through the normal rulemaking process.
    Other commenters suggested that the agencies not allow preferential 
treatment for clearinghouses, which they asserted are systemically 
critical institutions. In addition, some of these commenters argued 
that the agency clearing model should receive a more favorable capital 
requirement because the agency relationship facilitates protection and 
portability of client positions in the event of a clearing member 
default, compared to the back-to-back principal model. As noted above, 
the FDIC acknowledges that as more transactions move to central 
clearing, the potential for risk concentration and systemic risk 
increases. As noted in the proposal, the risk weights applicable to 
cleared transactions with QCCPs (generally 2 or 4 percent) represent an 
increase for many cleared transactions as compared to the general risk-
based capital rules (which exclude from the risk-based ratio 
calculations exchange rate contracts with an original maturity of 
fourteen or fewer calendar days and derivative contracts traded on 
exchanges that require daily receipt and payment of cash variation 
margin),\142\ in part to reflect the increased concentration and 
systemic risk inherent in such transactions. In regards to the agency 
clearing model, the FDIC notes that a clearing member banking 
organization that acts as an agent for a client and that guarantees the 
client's performance to the QCCP would have no exposure to the QCCP to 
risk weight. The exposure arising from the guarantee would be treated 
as an OTC derivative with a reduced holding period, as discussed below.
---------------------------------------------------------------------------

    \142\ See 12 CFR part 325, appendix A, section II.E.2.
---------------------------------------------------------------------------

    Another commenter suggested that the interim final rule address the 
treatment of unfunded default fund contribution amounts and potential 
future contributions to QCCPs, noting that the treatment of these 
potential exposures is not addressed in the BCBS CCP interim framework. 
The FDIC has clarified in the interim final rule that if an FDIC-
supervised institution's unfunded default fund contribution to a CCP is 
unlimited, the FDIC will determine the risk-weighted asset amount for 
such default fund contribution based on factors such as the size, 
structure, and membership of the CCP and the riskiness of its 
transactions. The interim final rule does not contemplate unlimited 
default fund contributions to QCCPs because defined default fund 
contribution amounts are a prerequisite to being a QCCP.
    Another commenter asserted that it is unworkable to require 
securities lending transactions to be conducted through a CCP, and that 
it would be easier and more sensible to make the appropriate 
adjustments in the interim final rule to ensure a capital treatment for 
securities lending transactions that is proportional to their actual 
risks. The FDIC notes that the proposed rule would not have required 
securities lending transactions to be cleared. The FDIC also 
acknowledges that clearing may not be widely available for securities 
lending transactions, and believes that the collateral haircut approach 
(sections 324.37(c) and 324.132(b) of the interim final rule) and for 
advanced approaches FDIC-supervised institutions, the simple value-at-
risk (VaR) and internal models methodologies (sections 324.132(b)(3) 
and (d) of the interim final rule) are an appropriately risk-sensitive 
exposure measure for non-cleared securities lending exposures.
    One commenter asserted that end users and client-cleared trades 
would be

[[Page 55417]]

disadvantaged by the proposal. Although there may be increased 
transaction costs associated with the introduction of the CCP 
framework, the FDIC believes that the overall risk mitigation that 
should result from the capital requirements generated by the framework 
will help promote financial stability, and that the measures the FDIC 
has taken in the interim final rule to incentivize client clearing are 
aimed at addressing the commenters' concerns. Several commenters 
suggested that the proposed rule created a disincentive for client 
clearing because of the clearing member banking organization's exposure 
to the client. The FDIC agrees with the need to mitigate disincentives 
for client clearing in the methodology, and has amended the interim 
final rule to reflect a lower margin period of risk, or holding period, 
as applicable, as discussed further below.
    Commenters suggested delaying implementation of a cleared 
transactions framework in the interim final rule until the BCBS CCP 
interim framework is finalized, implementing the BCBS CCP interim 
framework in the interim final rule pending finalization of the BCBS 
interim framework, or providing a transition period for banking 
organizations to be able to comply with some of the requirements. A 
number of commenters urged the agencies to incorporate all substantive 
changes of the BCBS CCP interim framework, ranging from minor 
adjustments to more material modifications.
    After considering the comments and reviewing the standards in the 
BCBS CCP interim framework, the FDIC believes that the modifications to 
capital standards for cleared transactions in the BCBS CCP interim 
framework are appropriate and believes that they would result in 
modifications that address many commenters' concerns. Furthermore, the 
FDIC believes that it is prudent to implement the BCBS CCP interim 
framework, rather than wait for the final framework, because the 
changes in the BCBS CCP interim framework represent a sound approach to 
mitigating the risks associated with cleared transactions. Accordingly, 
the FDIC has incorporated the material elements of the BCBS CCP interim 
framework into the interim final rule. In addition, given the delayed 
effective date of the interim final rule, the FDIC believes that an 
additional transition period, as suggested by some commenters, is not 
necessary.
    The material changes to the proposed rule to incorporate the CCP 
interim rule are described below. Other than these changes, the interim 
final rule retains the capital requirements for cleared transaction 
exposures generally as proposed by the agencies. As noted in the 
proposal, the international discussions are ongoing on these issues, 
and the FDIC will revisit this issue once the Basel capital framework 
is revised.
1. Definition of Cleared Transaction
    The interim final rule defines a cleared transaction as an exposure 
associated with an outstanding derivative contract or repo-style 
transaction that an FDIC-supervised institution or clearing member has 
entered into with a CCP (that is, a transaction that a CCP has 
accepted).\143\ Cleared transactions include the following: (1) A 
transaction between a CCP and a clearing member FDIC-supervised 
institution for the FDIC-supervised institution's own account; (2) a 
transaction between a CCP and a clearing member FDIC-supervised 
institution acting as a financial intermediary on behalf of its 
clearing member client; (3) a transaction between a client FDIC-
supervised institution and a clearing member where the clearing member 
acts on behalf of the client FDIC-supervised institution and enters 
into an offsetting transaction with a CCP; and (4) a transaction 
between a clearing member client and a CCP where a clearing member 
FDIC-supervised institution guarantees the performance of the clearing 
member client to the CCP. Such transactions must also satisfy 
additional criteria provided in section 3 of the interim final rule, 
including bankruptcy remoteness of collateral, transferability 
criteria, and portability of the clearing member client's position. As 
explained above, the FDIC has modified the definition in the interim 
final rule to specify that regulated omnibus accounts meet the 
requirement for bankruptcy remoteness.
---------------------------------------------------------------------------

    \143\ For example, the FDIC expects that a transaction with a 
derivatives clearing organization (DCO) would meet the criteria for 
a cleared transaction. A DCO is a clearinghouse, clearing 
association, clearing corporation, or similar entity that enables 
each party to an agreement, contract, or transaction to substitute, 
through novation or otherwise, the credit of the DCO for the credit 
of the parties; arranges or provides, on a multilateral basis, for 
the settlement or netting of obligations; or otherwise provides 
clearing services or arrangements that mutualize or transfer credit 
risk among participants. To qualify as a DCO, an entity must be 
registered with the U.S. Commodity Futures Trading Commission and 
comply with all relevant laws and procedures.
---------------------------------------------------------------------------

    An FDIC-supervised institution is required to calculate risk-
weighted assets for all of its cleared transactions, whether the FDIC-
supervised institution acts as a clearing member (defined as a member 
of, or direct participant in, a CCP that is entitled to enter into 
transactions with the CCP) or a clearing member client (defined as a 
party to a cleared transaction associated with a CCP in which a 
clearing member acts either as a financial intermediary with respect to 
the party or guarantees the performance of the party to the CCP).
    Derivative transactions that are not cleared transactions because 
they do not meet all the criteria are OTC derivative transactions. For 
example, if a transaction submitted to the CCP is not accepted by the 
CCP because the terms of the transaction submitted by the clearing 
members do not match or because other operational issues are identified 
by the CCP, the transaction does not meet the definition of a cleared 
transaction and is an OTC derivative transaction. If the counterparties 
to the transaction resolve the issues and resubmit the transaction and 
it is accepted, the transaction would then be a cleared transaction. A 
cleared transaction does not include an exposure of an FDIC-supervised 
institution that is a clearing member to its clearing member client 
where the FDIC-supervised institution is either acting as a financial 
intermediary and enters into an offsetting transaction with a CCP or 
where the FDIC-supervised institution provides a guarantee to the CCP 
on the performance of the client. Under the standardized approach, as 
discussed below, such a transaction is an OTC derivative transaction 
with the exposure amount calculated according to section 324.34(e) of 
the interim final rule or a repo-style transaction with the exposure 
amount calculated according to section 324.37(c) of the interim final 
rule. Under the advanced approaches rule, such a transaction is treated 
as either an OTC derivative transaction with the exposure amount 
calculated according to sections 324.132(c)(8) or (d)(5)(iii)(C) of the 
interim final rule or a repo-style transaction with the exposure amount 
calculated according to sections 324.132(b) or (d) of the interim final 
rule.
2. Exposure Amount Scalar for Calculating for Client Exposures
    Under the proposal, a transaction between a clearing member FDIC-
supervised institution and a client was treated as an OTC derivative 
exposure, with the exposure amount calculated according to sections 
324.34 or 324.132 of the proposal. The agencies acknowledged in the 
proposal that this treatment could have created disincentives for 
banking organizations to facilitate client clearing. Commenters' 
feedback and the BCBS CCP interim framework's treatment on this subject

[[Page 55418]]

provided alternatives to address the incentive concern.
    Consistent with comments and the BCBS CCP interim framework, under 
the interim final rule, a clearing member FDIC-supervised institution 
must treat its counterparty credit risk exposure to clients as an OTC 
derivative contract, irrespective of whether the clearing member FDIC-
supervised institution guarantees the transaction or acts as an 
intermediary between the client and the QCCP. Consistent with the BCBS 
CCP interim framework, to recognize the shorter close-out period for 
cleared transactions, under the standardized approach a clearing member 
FDIC-supervised institution may calculate its exposure amount to a 
client by multiplying the exposure amount, calculated using the CEM, by 
a scaling factor of no less than 0.71, which represents a five-day 
holding period. A clearing member FDIC-supervised institution must use 
a longer holding period and apply a larger scaling factor to its 
exposure amount in accordance with Table 20 if it determines that a 
holding period longer than five days is appropriate. The FDIC may 
require a clearing member FDIC-supervised institution to set a longer 
holding period if it determines that a longer period is commensurate 
with the risks associated with the transaction. The FDIC believes that 
the recognition of a shorter close-out period appropriately captures 
the risk associated with such transactions while furthering the policy 
goal of promoting central clearing.

              Table 20--Holding Periods and Scaling Factors
------------------------------------------------------------------------
                Holding period (days)                    Scaling factor
------------------------------------------------------------------------
5....................................................               0.71
6....................................................               0.77
7....................................................               0.84
8....................................................               0.89
9....................................................               0.95
10...................................................               1.00
------------------------------------------------------------------------

3. Risk Weighting for Cleared Transactions
    Under the interim final rule, to determine the risk-weighted asset 
amount for a cleared transaction, a clearing member client FDIC-
supervised institution or a clearing member FDIC-supervised institution 
must multiply the trade exposure amount for the cleared transaction by 
the appropriate risk weight, determined as described below. The trade 
exposure amount is calculated as follows:
    (1) For a cleared transaction that is a derivative contract or a 
netting set of derivatives contracts, the trade exposure amount is 
equal to the exposure amount for the derivative contract or netting set 
of derivative contracts, calculated using the CEM for OTC derivative 
contracts (described in sections 324.34 or 324.132(c) of the interim 
final rule) or for advanced approaches FDIC-supervised institutions 
that use the IMM, under section 324.132(d) of the interim final rule), 
plus the fair value of the collateral posted by the clearing member 
client FDIC-supervised institution and held by the CCP or clearing 
member in a manner that is not bankruptcy remote; and
    (2) For a cleared transaction that is a repo-style transaction or a 
netting set of repo-style transactions, the trade exposure amount is 
equal to the exposure amount calculated under the collateral haircut 
approach used for financial collateral (described in sections 324.37(c) 
and 324.132(b) of the interim final rule) (or for advanced approaches 
FDIC-supervised institutions the IMM under section 324.132(d) of the 
interim final rule) plus the fair value of the collateral posted by the 
clearing member client FDIC-supervised institution that is held by the 
CCP or clearing member in a manner that is not bankruptcy remote.
    The trade exposure amount does not include any collateral posted by 
a clearing member client FDIC-supervised institution or clearing member 
FDIC-supervised institution that is held by a custodian in a manner 
that is bankruptcy remote \144\ from the CCP, clearing member, other 
counterparties of the clearing member, and the custodian itself. In 
addition to the capital requirement for the cleared transaction, the 
FDIC-supervised institution remains subject to a capital requirement 
for any collateral provided to a CCP, a clearing member, or a custodian 
in connection with a cleared transaction in accordance with section 
324.32 or 324.131 of the interim final rule. Consistent with the BCBS 
CCP interim framework, the risk weight for a cleared transaction 
depends on whether the CCP is a QCCP. Central counterparties that are 
designated FMUs and foreign entities regulated and supervised in a 
manner equivalent to designated FMUs are QCCPs. In addition, a CCP 
could be a QCCP under the interim final rule if it is in sound 
financial condition and meets certain standards that are consistent 
with BCBS expectations for QCCPs, as set forth in the QCCP definition.
---------------------------------------------------------------------------

    \144\ Under the interim final rule, bankruptcy remote, with 
respect to an entity or asset, means that the entity or asset would 
be excluded from an insolvent entity's estate in a receivership, 
insolvency or similar proceeding.
---------------------------------------------------------------------------

    A clearing member FDIC-supervised institution must apply a 2 
percent risk weight to its trade exposure amount to a QCCP. An FDIC-
supervised institution that is a clearing member client may apply a 2 
percent risk weight to the trade exposure amount only if:
    (1) The collateral posted by the clearing member client FDIC-
supervised institution to the QCCP or clearing member is subject to an 
arrangement that prevents any losses to the clearing member client due 
to the joint default or a concurrent insolvency, liquidation, or 
receivership proceeding of the clearing member and any other clearing 
member clients of the clearing member, and
    (2) The clearing member client FDIC-supervised institution has 
conducted sufficient legal review to conclude with a well-founded basis 
(and maintains sufficient written documentation of that legal review) 
that in the event of a legal challenge (including one resulting from 
default or a liquidation, insolvency, or receivership proceeding) the 
relevant court and administrative authorities would find the 
arrangements to be legal, valid, binding, and enforceable under the law 
of the relevant jurisdiction.
    If the criteria above are not met, a clearing member client FDIC-
supervised institution must apply a risk weight of 4 percent to the 
trade exposure amount.
    Under the interim final rule, as under the proposal, for a cleared 
transaction with a CCP that is not a QCCP, a clearing member FDIC-
supervised institution and a clearing member client FDIC-supervised 
institution must risk weight the trade exposure amount to the CCP 
according to the risk weight applicable to the CCP under section 324.32 
of the interim final rule (generally, 100 percent). Collateral posted 
by a clearing member FDIC-supervised institution that is held by a 
custodian in a manner that is bankruptcy remote from the CCP is not 
subject to a capital requirement for counterparty credit risk. 
Similarly, collateral posted by a clearing member client that is held 
by a custodian in a manner that is bankruptcy remote from the CCP, 
clearing member, and other clearing member clients of the clearing 
member is not be subject to a capital requirement for counterparty 
credit risk.
    The proposed rule was silent on the risk weight that would apply 
where a clearing member banking organization acts for its own account 
or guarantees a QCCP's performance to a client. Consistent with the 
BCBS CCP interim framework, the interim final rule provides additional 
specificity regarding the risk-weighting methodologies for certain 
exposures of clearing member

[[Page 55419]]

banking organizations. The interim final rule provides that a clearing 
member FDIC-supervised institution that (i) acts for its own account, 
(ii) is acting as a financial intermediary (with an offsetting 
transaction or a guarantee of the client's performance to a QCCP), or 
(iii) guarantees a QCCP's performance to a client would apply a two 
percent risk weight to the FDIC-supervised institution's exposure to 
the QCCP. The diagrams below demonstrate the various potential 
transactions and exposure treatment in the interim final rule. Table 21 
sets out how the transactions illustrated in the diagrams below are 
risk-weighted under the interim final rule.
    In the diagram, ``T'' refers to a transaction, and the arrow 
indicates the direction of the exposure. The diagram describes the 
appropriate risk weight treatment for exposures from the perspective of 
a clearing member FDIC-supervised institution entering into cleared 
transactions for its own account (T1), a clearing member 
FDIC-supervised institution entering into cleared transactions on 
behalf of a client (T2 through T7), and an FDIC-
supervised institution entering into cleared transactions as a client 
of a clearing member (T8 and T9). Table 21 shows 
for each trade whom the exposure is to, a description of the type of 
trade, and the risk weight that would apply based on the risk of the 
counterparty.
BILLING CODE 6714-01-P

[[Page 55420]]

[GRAPHIC] [TIFF OMITTED] TR10SE13.001


[[Page 55421]]


[GRAPHIC] [TIFF OMITTED] TR10SE13.002

BILLING CODE 6714-01-C

                             Table 21--Risk Weights for Various Cleared Transactions
----------------------------------------------------------------------------------------------------------------
                                                                                        Risk-weighting treatment
                                        Exposure to                  Description         under the interim final
                                                                                                  rule
----------------------------------------------------------------------------------------------------------------
T1...........................  QCCP.........................  Own account.............  2% risk weight on trade
                                                                                         exposure amount.
T2...........................  Client.......................  Financial intermediary    OTC derivative with CEM
                                                               with offsetting trade     scalar.**
                                                               to QCCP.
T3...........................  QCCP.........................  Financial intermediary    2% risk weight on trade
                                                               with offsetting trade     exposure amount.
                                                               to QCCP.
T4...........................  Client.......................  Agent with guarantee of   OTC derivative with CEM
                                                               client performance.       scalar.**
T5...........................  QCCP.........................  Agent with guarantee of   No exposure.
                                                               client performance.
T6...........................  Client.......................  Guarantee of QCCP         OTC derivative with CEM
                                                               performance.              scalar.**
T7...........................  QCCP.........................  Guarantee of QCCP         2% risk weight on trade
                                                               performance.              exposure amount.
T8...........................  CM...........................  CM financial              2% or 4%* risk weight on
                                                               intermediary with         trade exposure amount.
                                                               offsetting trade to
                                                               QCCP.
T9...........................  QCCP.........................  CM agent with guarantee   2% or 4%* risk weight on
                                                               of client performance.    trade exposure amount.
----------------------------------------------------------------------------------------------------------------

4. Default Fund Contribution Exposures
    There are several risk mitigants available when a party clears a 
transaction through a CCP rather than on a bilateral basis: The 
protection provided to the CCP clearing members by the margin 
requirements imposed by the CCP; the CCP members' default fund 
contributions; and the CCP's own capital and contribution to the 
default fund, which are an important source of collateral in case of 
counterparty default.\145\ CCPs independently determine default fund 
contributions that are required from members. The BCBS therefore 
established, and the interim final rule adopts, a risk-sensitive 
approach for risk weighting an FDIC-supervised institution's exposure 
to a default fund.
---------------------------------------------------------------------------

    \145\ Default funds are also known as clearing deposits or 
guaranty funds.
---------------------------------------------------------------------------

    Under the proposed rule, there was only one method that a clearing 
member banking organization could use to calculate its risk-weighted 
asset amount for default fund contributions. The BCBS CCP interim 
framework added a second method to better reflect the lower risks 
associated with exposures to those clearinghouses that have relatively 
large default funds with a significant amount unfunded. Commenters 
requested that the interim final rule adopt both methods contained in 
the BCBS CCP interim framework.
    Accordingly, under the interim final rule, an FDIC-supervised 
institution that is a clearing member of a CCP must calculate the risk-
weighted asset amount for its default fund contributions at least 
quarterly or more frequently if there is a material change, in the 
opinion of the FDIC-supervised institution or FDIC, in the financial 
condition of the CCP. A default fund contribution means the funds 
contributed or commitments made by a clearing member to a CCP's 
mutualized loss-sharing arrangement. If the CCP is not a QCCP, the 
FDIC-supervised institution's risk-weighted asset amount for its 
default fund contribution is either the sum of the default fund 
contributions multiplied by 1,250 percent, or in cases where the 
default fund contributions may be unlimited, an amount as determined by 
the FDIC based on factors described above.
    Consistent with the BCBS CCP interim framework, the interim final 
rule requires an FDIC-supervised institution to calculate a risk-
weighted asset amount for its default fund contribution using one of 
two methods. Method one requires a clearing member FDIC-supervised 
institution to use a three-step process. The first step is for the 
clearing member FDIC-supervised institution to calculate the QCCP's 
hypothetical capital requirement (KCCP), unless the QCCP has 
already disclosed it, in which case the FDIC-supervised institution 
must rely on that disclosed figure, unless the FDIC-supervised 
institution determines that a higher figure is appropriate based on the 
nature, structure, or characteristics of the QCCP. KCCP is 
defined as the capital that a QCCP is required to hold if it were an 
FDIC-supervised institution, and is calculated using the CEM for OTC 
derivatives or the collateral haircut approach for repo-style 
transactions, recognizing the risk-mitigating effects of collateral 
posted by and default fund contributions received from the QCCP 
clearing members.
    The interim final rule provides several modifications to the 
calculation of KCCP to adjust for certain features that are 
unique to QCCPs. Namely, the modifications permit: (1) A clearing 
member to offset its exposure to a QCCP with actual default fund 
contributions, and (2) greater recognition of netting when using the 
CEM to calculate KCCP described below. Additionally, the 
risk weight of all clearing members is set at 20 percent, except when 
the FDIC has determined that a higher risk weight is appropriate based 
on the specific characteristics of the QCCP and its clearing members. 
Finally, for derivative contracts that are options, the PFE amount 
calculation is adjusted by multiplying the notional principal amount of 
the derivative contract by the appropriate conversion factor and the 
absolute value of the option's delta (that is, the ratio of the change 
in the value of the derivative contract to the

[[Page 55422]]

corresponding change in the price of the underlying asset).
    In the second step of method one, the interim final rule requires 
an FDIC-supervised institution to compare KCCP to the funded 
portion of the default fund of a QCCP, and to calculate the total of 
all the clearing members' capital requirements (K*cm). If 
the total funded default fund of a QCCP is less than KCCP, 
the interim final rule requires additional capital to be assessed 
against the shortfall because of the small size of the funded portion 
of the default fund relative to KCCP. If the total funded 
default fund of a QCCP is greater than KCCP, but the QCCP's 
own funded contributions to the default fund are less than 
KCCP (so that the clearing members' default fund 
contributions are required to achieve KCCP), the clearing 
members' default fund contributions up to KCCP are risk-
weighted at 100 percent and a decreasing capital factor, between 1.6 
percent and 0.16 percent, is applied to the clearing members' funded 
default fund contributions above KCCP. If the QCCP's own 
contribution to the default fund is greater than KCCP, then 
only the decreasing capital factor is applied to the clearing members' 
default fund contributions.
    In the third step of method one, the interim final rule requires 
(K*cm) to be allocated back to each individual clearing 
member. This allocation is proportional to each clearing member's 
contribution to the default fund but adjusted to reflect the impact of 
two average-size clearing members defaulting as well as to account for 
the concentration of exposures among clearing members. A clearing 
member FDIC-supervised institution multiplies its allocated capital 
requirement by 12.5 to determine its risk-weighted asset amount for its 
default fund contribution to the QCCP.
    As the alternative, an FDIC-supervised institution is permitted to 
use method two, which is a simplified method under which the risk-
weighted asset amount for its default fund contribution to a QCCP 
equals 1,250 percent multiplied by the default fund contribution, 
subject to an overall cap. The cap is based on an FDIC-supervised 
institution's trade exposure amount for all of its transactions with a 
QCCP. An FDIC-supervised institution's risk-weighted asset amount for 
its default fund contribution to a QCCP is either a 1,250 percent risk 
weight applied to its default fund contribution to that QCCP or 18 
percent of its trade exposure amount to that QCCP. Method two subjects 
an FDIC-supervised institution to an overall cap on the risk-weighted 
assets from all its exposures to the CCP equal to 20 percent times the 
trade exposures to the CCP. This 20 percent cap is arrived at as the 
sum of the 2 percent capital requirement for trade exposure plus 18 
percent for the default fund portion of an FDIC-supervised 
institution's exposure to a QCCP.
    To address commenter concerns that the CEM underestimates the 
multilateral netting benefits arising from a QCCP, the interim final 
rule recognizes the larger diversification benefits inherent in a 
multilateral netting arrangement for purposes of measuring the QCCP's 
potential future exposure associated with derivative contracts. 
Consistent with the BCBS CCP interim framework, and as mentioned above, 
the interim final rule replaces the proposed factors (0.3 and 0.7) in 
the formula to calculate Anet with 0.15 and 0.85, in sections 
324.35(d)(3)(i)(A)(1) and 324.133(d)(3)(i)(A)(1) of the interim final 
rule, respectively.

F. Credit Risk Mitigation

    Banking organizations use a number of techniques to mitigate credit 
risks. For example, a banking organization may collateralize exposures 
with cash or securities; a third party may guarantee an exposure; a 
banking organization may buy a credit derivative to offset an 
exposure's credit risk; or a banking organization may net exposures 
with a counterparty under a netting agreement. The general risk-based 
capital rules recognize these techniques to some extent. This section 
of the preamble describes how the interim final rule allows FDIC-
supervised institutions to recognize the risk-mitigation effects of 
guarantees, credit derivatives, and collateral for risk-based capital 
purposes. In general, the interim final rule provides for a greater 
variety of credit risk mitigation techniques than the general risk-
based capital rules.
    Similar to the general risk-based capital rules, under the interim 
final rule an FDIC-supervised institution generally may use a 
substitution approach to recognize the credit risk mitigation effect of 
an eligible guarantee from an eligible guarantor and the simple 
approach to recognize the effect of collateral. To recognize credit 
risk mitigants, all FDIC-supervised institutions must have 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. An FDIC-supervised institution should conduct 
sufficient legal review to reach a well-founded conclusion that the 
documentation meets this standard as well as conduct additional reviews 
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, or market risk. Accordingly, an FDIC-supervised 
institution should employ robust procedures and processes to control 
risks, including roll-off and concentration risks, and monitor and 
manage the implications of using credit risk mitigants for the FDIC-
supervised institution's overall credit risk profile.
1. Guarantees and Credit Derivatives
a. Eligibility Requirements
    Consistent with the Basel capital framework, the agencies proposed 
to recognize a wider range of eligible guarantors than permitted under 
the general risk-based capital rules, including sovereigns, the Bank 
for International Settlements, the International Monetary Fund, the 
European Central Bank, the European Commission, Federal Home Loan Banks 
(FHLB), Federal Agricultural Mortgage Corporation (Farmer Mac), MDBs, 
depository institutions, BHCs, SLHCs, credit unions, and foreign banks. 
Eligible guarantors would also include entities that are not special 
purpose entities that have issued and outstanding unsecured debt 
securities without credit enhancement that are investment grade and 
that meet certain other requirements.\146\
---------------------------------------------------------------------------

    \146\ Under the proposed and interim final rule, an exposure is 
``investment grade'' if the entity to which the FDIC-supervised 
institution is exposed through a loan or security, or the reference 
entity with respect to a credit derivative, has adequate capacity to 
meet financial commitments for the projected life of the asset or 
exposure. Such an entity or reference entity has adequate capacity 
to meet financial commitments if the risk of its default is low and 
the full and timely repayment of principal and interest is expected.
---------------------------------------------------------------------------

    Some commenters suggested modifying the proposed definition of 
eligible guarantor to remove the investment-grade requirement. 
Commenters also suggested that the agencies potentially include as 
eligible guarantors other entities, such as financial guaranty and 
private mortgage insurers. The FDIC believes that guarantees issued by 
these types of entities can exhibit significant wrong-way risk and 
modifying the definition of eligible guarantor to accommodate these 
entities or entities that are not investment grade would be contrary to 
one of the key objectives of the capital framework, which is to 
mitigate interconnectedness and systemic vulnerabilities within the 
financial

[[Page 55423]]

system. Therefore, the FDIC has not included the recommended entities 
in the interim final rule's definition of ``eligible guarantor.'' The 
FDIC has, however, amended the definition of eligible guarantor in the 
interim final rule to include QCCPs to accommodate use of the 
substitution approach for credit derivatives that are cleared 
transactions. The FDIC believes that QCCPs, as supervised entities 
subject to specific risk-management standards, are appropriately 
included as eligible guarantors under the interim final rule.\147\ In 
addition, the FDIC clarifies one commenter's concern and confirms that 
re-insurers that are engaged predominantly in the business of providing 
credit protection do not qualify as an eligible guarantor under the 
interim final rule.
---------------------------------------------------------------------------

    \147\ See the definition of ``eligible guarantor'' in section 2 
of the interim final rule.
---------------------------------------------------------------------------

    Under the interim final rule, guarantees and credit derivatives are 
required to meet specific eligibility requirements to be recognized for 
credit risk mitigation purposes. Consistent with the proposal, under 
the interim final rule, an eligible guarantee is defined as a guarantee 
from an eligible guarantor that is written and meets certain standards 
and conditions, including with respect to its enforceability. An 
eligible credit derivative is defined as a credit derivative in the 
form of a CDS, nth-to-default swap, total return swap, or any other 
form of credit derivative approved by the FDIC, provided that the 
instrument meets the standards and conditions set forth in the 
definition. See the definitions of ``eligible guarantee'' and 
``eligible credit derivative'' in section 324.2 of the interim final 
rule.
    Under the proposal, a banking organization would have been 
permitted to recognize the credit risk mitigation benefits of 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 if (1) the reference exposure ranks pari 
passu with or is subordinated to the hedged exposure; (2) the reference 
exposure and the hedged exposure are to the same legal entity; and (3) 
legally-enforceable cross-default or cross-acceleration clauses are in 
place to assure payments under the credit derivative are triggered when 
the issuer fails to pay under the terms of the hedged exposure.
    In addition to these two exceptions, one commenter encouraged the 
agencies to revise the interim final rule to recognize a proxy hedge as 
an eligible credit derivative even though such a transaction hedges an 
exposure that differs from the credit derivative's reference exposure. 
A proxy hedge was characterized by the commenter as a hedge of an 
exposure supported by a sovereign using a credit derivative on that 
sovereign. The FDIC does not believe there is sufficient justification 
to include proxy hedges in the definition of eligible credit derivative 
because it has concerns regarding the ability of the hedge to 
sufficiently mitigate the risk of the underlying exposure. The FDIC 
has, therefore, adopted the definition of eligible credit derivative as 
proposed.
    In addition, under the interim final rule, consistent with the 
proposal, when an FDIC-supervised institution has a group of hedged 
exposures with different residual maturities that are covered by a 
single eligible guarantee or eligible credit derivative, it must treat 
each hedged exposure as if it were fully covered by a separate eligible 
guarantee or eligible credit derivative.
b. Substitution Approach
    The FDIC is adopting the substitution approach for eligible 
guarantees and eligible credit derivatives in the interim final rule 
without change. Under the substitution approach, if the protection 
amount (as defined below) of an eligible guarantee or eligible credit 
derivative is greater than or equal to the exposure amount of the 
hedged exposure, an FDIC-supervised institution substitutes the risk 
weight applicable to the guarantor or credit derivative protection 
provider for the risk weight applicable to 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, an FDIC-supervised institution must treat the hedged exposure 
as two separate exposures (protected and unprotected) to recognize the 
credit risk mitigation benefit of the guarantee or credit derivative. 
In such cases, an FDIC-supervised institution calculates the risk-
weighted asset amount for the protected exposure under section 36 of 
the interim final rule (using a risk weight applicable to the guarantor 
or credit derivative protection provider and an exposure amount equal 
to the protection amount of the guarantee or credit derivative). The 
FDIC-supervised institution calculates its risk-weighted asset amount 
for the unprotected exposure under section 32 of the interim final rule 
(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).
    Under the interim final rule, the protection amount of an eligible 
guarantee or eligible credit derivative means the effective notional 
amount of the guarantee or credit derivative reduced to reflect any, 
maturity mismatch, lack of restructuring coverage, or currency mismatch 
as described below. The effective notional amount for an eligible 
guarantee or eligible credit derivative is 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 is $40.
c. Maturity Mismatch Haircut
    The FDIC is adopting the proposed haircut for maturity mismatch in 
the interim final rule without change. Under the interim final rule, 
the FDIC has adopted the requirement that an FDIC-supervised 
institution that recognizes an eligible guarantee or eligible credit 
derivative 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. A maturity mismatch occurs when the 
residual maturity of a credit risk mitigant is less than that of the 
hedged exposure(s).\148\
---------------------------------------------------------------------------

    \148\ As noted above, when an FDIC-supervised institution has a 
group of hedged exposures with different residual maturities that 
are covered by a single eligible guarantee or eligible credit 
derivative, an FDIC-supervised institution treats 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 FDIC-supervised institution 
assesses 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 is the longest possible 
remaining time before the obligated party of the hedged exposure is 
scheduled to fulfil its obligation on the hedged exposure. An FDIC-
supervised institution is required to take into account any embedded 
options that may reduce the term of the credit risk mitigant so that 
the shortest possible residual maturity for the credit risk mitigant is 
used to determine the potential maturity mismatch. 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

[[Page 55424]]

FDIC-supervised institution purchasing the protection, but the terms of 
the arrangement at origination of the credit risk mitigant contain a 
positive incentive for the FDIC-supervised institution to call the 
transaction before contractual maturity, the remaining time to the 
first call date is the residual maturity of the credit risk mitigant. 
An FDIC-supervised institution is permitted, under the interim final 
rule, to recognize a credit risk mitigant with a maturity mismatch only 
if its original maturity is greater than or equal to one year and the 
residual maturity is greater than three months.
    Assuming that the credit risk mitigant may be recognized, an FDIC-
supervised institution is required to apply the following adjustment to 
reduce the effective notional amount of the credit risk mitigant to 
recognize the maturity mismatch: Pm = E x [(t-0.25)/(T-0.25)], where:
    (1) Pm equals effective notional amount of the credit risk 
mitigant, adjusted for maturity mismatch;
    (2) E equals effective notional amount of the credit risk mitigant;
    (3) t equals the lesser of T or residual maturity of the credit 
risk mitigant, expressed in years; and
    (4) T equals the lesser of five or the residual maturity of the 
hedged exposure, expressed in years.
d. Adjustment for Credit Derivatives Without Restructuring as a Credit 
Event
    The FDIC is adopting in the interim final rule the proposed 
adjustment for credit derivatives without restructuring as a credit 
event. Consistent with the proposal, under the interim final rule, an 
FDIC-supervised institution that seeks to recognize an eligible credit 
derivative that does not include a restructuring of the hedged exposure 
as a credit event under the derivative must reduce the effective 
notional amount of the credit derivative recognized for credit risk 
mitigation purposes by 40 percent. For purposes of the credit risk 
mitigation framework, a restructuring may involve 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 these instances, the FDIC-
supervised institution is required to apply the following adjustment to 
reduce the effective notional amount of the credit derivative: Pr 
equals Pm x 0.60, where:
    (1) Pr equals effective notional amount of the credit risk 
mitigant, adjusted for lack of a restructuring event (and maturity 
mismatch, if applicable); and
    (2) Pm equals effective notional amount of the credit risk mitigant 
(adjusted for maturity mismatch, if applicable).
e. Currency Mismatch Adjustment
    Consistent with the proposal, under the interim final rule, if an 
FDIC-supervised institution 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 FDIC-
supervised institution must apply the following formula to the 
effective notional amount of the guarantee or credit derivative: 
PC equals Pr x (1-HFX), where:
    (1) PC equals effective notional amount of the credit 
risk mitigant, adjusted for currency mismatch (and maturity mismatch 
and lack of restructuring event, if applicable);
    (2) Pr equals effective notional amount of the credit risk mitigant 
(adjusted for maturity mismatch and lack of restructuring event, if 
applicable); and
    (3) HFX equals haircut appropriate for the currency 
mismatch between the credit risk mitigant and the hedged exposure.
    An FDIC-supervised institution is required to use a standard 
supervisory haircut of 8 percent for HFX (based on a ten-
business-day holding period and daily marking-to-market and 
remargining). Alternatively, an FDIC-supervised institution has the 
option to use internally estimated haircuts of HFX based on 
a ten-business-day holding period and daily marking-to-market if the 
FDIC-supervised institution qualifies to use the own-estimates of 
haircuts in section 324.37(c)(4) of the interim final rule. In either 
case, the FDIC-supervised institution is required to scale the haircuts 
up using the square root of time formula if the FDIC-supervised 
institution revalues the guarantee or credit derivative less frequently 
than once every 10 business days. The applicable haircut 
(HM) is calculated using the following square root of time 
formula:
[GRAPHIC] [TIFF OMITTED] TR10SE13.003

where TM equals the greater of 10 or the number of days 
between revaluation.
f. Multiple Credit Risk Mitigants
    Consistent with the proposal, under the interim final rule, if 
multiple credit risk mitigants cover a single exposure, an FDIC-
supervised institution may disaggregate the exposure into portions 
covered by each credit risk mitigant (for example, the portion covered 
by each guarantee) and calculate separately a risk-based capital 
requirement for each portion, consistent with the Basel capital 
framework. In addition, when a single credit risk mitigant covers 
multiple exposures, an FDIC-supervised institution must treat each 
hedged exposure as covered by a single credit risk mitigant and must 
calculate separate risk-weighted asset amounts for each exposure using 
the substitution approach described in section 324.36(c) of the interim 
final rule.
2. Collateralized Transactions
a. Eligible Collateral
    Under the proposal, the agencies would recognize an expanded range 
of financial collateral as credit risk mitigants that may reduce the 
risk-based capital requirements associated with a collateralized 
transaction, consistent with the Basel capital framework. The agencies 
proposed that a banking organization could recognize the risk-
mitigating effects of financial collateral using the ``simple 
approach'' for any exposure provided that the collateral meets certain 
requirements. For repo-style transactions, eligible margin loans, 
collateralized derivative contracts, and single-product netting sets of 
such transactions, a banking organization could alternatively use the 
collateral haircut approach. The proposal required a banking 
organization to use the same approach for similar exposures or 
transactions.
    The commenters generally agreed with this aspect of the proposal; 
however, a few commenters encouraged the agencies to expand the 
definition of financial collateral to include precious metals and 
certain residential mortgages that collateralize warehouse lines of 
credit. Several commenters asserted that the interim final rule should 
recognize as financial collateral conforming residential mortgages (or 
at least those collateralizing warehouse lines of credit) and/or those 
insured by the FHA or VA. They noted that by not including conforming 
residential mortgages in the definition of financial collateral, the 
proposed rule would require banking organizations providing warehouse 
lines to treat warehouse facilities as commercial loan exposures, thus 
preventing such entities from looking through to the underlying 
collateral in calculating the appropriate risk weighting. Others argued 
that a ``look through'' approach for a repo-style structure to the 
financial collateral held therein should be allowed. Another commenter 
argued that the interim final

[[Page 55425]]

rule should allow recognition of intangible assets as financial 
collateral because they have real value. The FDIC believes that the 
collateral types suggested by the commenters are not appropriate forms 
of financial collateral because they exhibit increased variation and 
credit risk, and are relatively more speculative than the recognized 
forms of financial collateral under the proposal. For example, 
residential mortgages can be highly idiosyncratic in regards to payment 
features, interest rate provisions, lien seniority, and maturities. The 
FDIC believes that the proposed definition of financial collateral, 
which is broader than the collateral recognized under the general risk-
based capital rules, included those collateral types of sufficient 
liquidity and asset quality to recognize as credit risk mitigants for 
risk-based capital purposes. As a result, the FDIC has retained the 
definition of financial collateral as proposed. Therefore, consistent 
with the proposal, the interim final rule defines financial collateral 
as collateral in the form of: (1) Cash on deposit with the FDIC-
supervised institution (including cash held for the FDIC-supervised 
institution by a third-party custodian or trustee); (2) gold bullion; 
(3) short- and long-term debt securities that are not resecuritization 
exposures and that are investment grade; (4) equity securities that are 
publicly-traded; (5) convertible bonds that are publicly-traded; or (6) 
money market fund shares and other mutual fund shares if a price for 
the shares is publicly quoted daily. With the exception of cash on 
deposit, the FDIC-supervised institution is also required to have a 
perfected, first-priority security interest or, outside of the United 
States, the legal equivalent thereof, notwithstanding the prior 
security interest of any custodial agent. Even if an FDIC-supervised 
institution has the legal right, it still must ensure it monitors or 
has a freeze on the account to prevent a customer from withdrawing cash 
on deposit prior to defaulting. An FDIC-supervised institution is 
permitted to recognize partial collateralization of an exposure.
    Under the interim final rule, the FDIC requires that an FDIC-
supervised institution to recognize the risk-mitigating effects of 
financial collateral using the simple approach described below, where: 
the collateral is subject to a collateral agreement for at least the 
life of the exposure; the collateral is revalued at least every six 
months; and the collateral (other than gold) and the exposure is 
denominated in the same currency. For repo-style transactions, eligible 
margin loans, collateralized derivative contracts, and single-product 
netting sets of such transactions, an FDIC-supervised institution could 
alternatively use the collateral haircut approach described below. The 
interim final rule, like the proposal, requires an FDIC-supervised 
institution to use the same approach for similar exposures or 
transactions.
b. Risk-Management Guidance for Recognizing Collateral
    Before an FDIC-supervised institution recognizes collateral for 
credit risk mitigation purposes, it should: (1) Conduct sufficient 
legal review to ensure, at the inception of the collateralized 
transaction and on an ongoing basis, that all documentation used in the 
transaction is binding on all parties and legally enforceable in all 
relevant jurisdictions; (2) consider the correlation between risk of 
the underlying direct exposure and collateral in the transaction; and 
(3) 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.
    An FDIC-supervised institution also should ensure that the legal 
mechanism under which the collateral is pledged or transferred ensures 
that the FDIC-supervised institution 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 counterparty and, where applicable, the custodian holding the 
collateral.
    In addition, an FDIC-supervised institution should ensure that it 
(1) has taken all steps necessary to fulfill any legal requirements to 
secure its interest in the collateral so that it has and maintains an 
enforceable security interest; (2) has set up clear and robust 
procedures to ensure satisfaction of any legal conditions required for 
declaring the default of the borrower and prompt liquidation of the 
collateral in the event of default; (3) has established procedures and 
practices for conservatively estimating, on a regular ongoing basis, 
the fair 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 (4) 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 FDIC is adopting the simple approach without change for 
purposes of the interim final rule. Under the interim final rule, the 
collateralized portion of the exposure receives the risk weight 
applicable to the collateral. The collateral is required to meet the 
definition of financial collateral. For repurchase agreements, reverse 
repurchase agreements, and securities lending and borrowing 
transactions, the collateral would be the instruments, gold, and cash 
that an FDIC-supervised institution has borrowed, purchased subject to 
resale, or taken as collateral from the counterparty under the 
transaction. As noted above, in all cases, (1) the collateral must be 
subject to a collateral agreement for at least the life of the 
exposure; (2) the FDIC-supervised institution must revalue the 
collateral at least every six months; and (3) the collateral (other 
than gold) and the exposure must be denominated in the same currency.
    Generally, the risk weight assigned to the collateralized portion 
of the exposure must be no less than 20 percent. However, the 
collateralized portion of an exposure may be assigned a risk weight of 
less than 20 percent for the following exposures. OTC derivative 
contracts that are marked to fair value on a daily basis and subject to 
a daily margin maintenance agreement, may receive (1) a zero percent 
risk weight to the extent that contracts are collateralized by cash on 
deposit, or (2) a 10 percent risk weight to the extent that the 
contracts are collateralized by an exposure to a sovereign that 
qualifies for a zero percent risk weight under section 32 of the 
interim final rule. In addition, an FDIC-supervised institution may 
assign a zero percent risk weight to the collateralized portion of an 
exposure where the financial collateral is cash on deposit; or the 
financial collateral is an exposure to a sovereign that qualifies for a 
zero percent risk weight under section 32 of the interim final rule, 
and the FDIC-supervised institution has discounted the fair value of 
the collateral by 20 percent.
d. Collateral Haircut Approach
    Consistent with the proposal, in the interim final rule, an FDIC-
supervised institution may use the collateral haircut approach to 
recognize the credit risk mitigation benefits of financial collateral 
that secures an eligible margin loan, repo-style transaction, 
collateralized derivative contract, or single-product netting set of 
such transactions. In addition, the FDIC-supervised institution may use 
the

[[Page 55426]]

collateral haircut approach with respect to any collateral that secures 
a repo-style transaction that is included in the FDIC-supervised 
institution's VaR-based measure under subpart F of the interim final 
rule, even if the collateral does not meet the definition of financial 
collateral.
    To apply the collateral haircut approach, an FDIC-supervised 
institution must determine the exposure amount and the relevant risk 
weight for the counterparty or guarantor.
    The exposure amount for an eligible margin loan, repo-style 
transaction, collateralized derivative contract, or a netting set of 
such transactions is equal to the greater of zero and the sum of the 
following three quantities:
    (1) The value of the exposure less the value of the collateral. For 
eligible margin loans, repo-style transactions and netting sets 
thereof, the value of the exposure is the sum of the current market 
values of all instruments, gold, and cash the FDIC-supervised 
institution has lent, sold subject to repurchase, or posted as 
collateral to the counterparty under the transaction or netting set. 
For collateralized OTC derivative contracts and netting sets thereof, 
the value of the exposure is the exposure amount that is calculated 
under section 34 of the interim final rule. The value of the collateral 
equals the sum of the current market values of all instruments, gold 
and cash the FDIC-supervised institution has borrowed, purchased 
subject to resale, or taken as collateral from the counterparty under 
the transaction or netting set;
    (2) 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 
FDIC-supervised institution 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 that the FDIC-supervised 
institution 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
    (3) 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 FDIC-supervised 
institution 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 FDIC-supervised 
institution has borrowed, purchased subject to resale, or taken as 
collateral from the counterparty) multiplied by the haircut appropriate 
to the currency mismatch.
    For purposes of the collateral haircut approach, a given instrument 
includes, 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.
e. Standard Supervisory Haircuts
    When determining the exposure amount, the FDIC-supervised 
institution must apply a haircut for price market volatility and 
foreign exchange rates, determined either using standard supervisory 
market price volatility haircuts and a standard haircut for exchange 
rates or, with prior approval of the agency, an FDIC-supervised 
institution's own estimates of volatilities of market prices and 
foreign exchange rates.
    The standard supervisory market price volatility haircuts set a 
specified market price volatility haircut for various categories of 
financial collateral. These standard haircuts are based on the ten-
business-day holding period for eligible margin loans and derivative 
contracts. For repo-style transactions, an FDIC-supervised institution 
may multiply the standard supervisory haircuts by the square root of 
\1/2\ to scale them for a holding period of five business days. Several 
commenters argued that the proposed haircuts were too conservative and 
insufficiently risk-sensitive, and that FDIC-supervised institutions 
should be allowed to compute their own haircuts. Some commenters 
proposed limiting the maximum haircut for non-sovereign issuers that 
receive a 100 percent risk weight to 12 percent and, more specifically, 
assigning a lower haircut than 25 percent for financial collateral in 
the form of an investment-grade corporate debt security that has a 
shorter residual maturity. The commenters asserted that these haircuts 
conservatively correspond to the existing rating categories and result 
in greater alignment with the Basel framework.
    In the interim final rule, the FDIC has revised from 25.0 percent 
the standard supervisory market price volatility haircuts for financial 
collateral issued by non-sovereign issuers with a risk weight of 100 
percent to 4.0 percent for maturities of less than one year, 8.0 
percent for maturities greater than one year but less than or equal to 
five years, and 16.0 percent for maturities greater than five years, 
consistent with Table 22 below. The FDIC believes that the revised 
haircuts better reflect the collateral's credit quality and an 
appropriate differentiation based on the collateral's residual 
maturity.
    An FDIC-supervised institution using the standard currency mismatch 
haircut is required to use an 8 percent haircut for each currency 
mismatch for transactions subject to a 10 day holding period, as 
adjusted for different required holding periods. One commenter asserted 
that the proposed adjustment for currency mismatch was unwarranted 
because in securities lending transactions, the parties typically 
require a higher collateral margin than in transactions where there is 
no mismatch. In the alternative, the commenter argued that the agencies 
should align the currency mismatch haircut more closely with a given 
currency combination and suggested those currencies of countries with a 
more favorable CRC from the OECD should receive a smaller haircut. The 
FDIC has decided to adopt this aspect of the proposal without change in 
the interim final rule. The FDIC believes that the own internal 
estimates for haircuts methodology described below allows FDIC-
supervised institutions appropriate flexibility to more granularly 
reflect individual currency combinations, provided they meet certain 
criteria.

[[Page 55427]]



                                           Table 22--Standard Supervisory Market Price Volatility Haircuts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                               Haircut (in percent) assigned based on:
                                                              ------------------------------------------------------------------------  Investment-grade
                                                                  Sovereign issuers risk weight     Non-sovereign issuers risk weight    securitization
                      Residual maturity                              under Sec.   324.32 \2\               under Sec.   324.32           exposures  (in
                                                              ------------------------------------------------------------------------      percent)
                                                                  Zero      20 or 50       100         20          50          100
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than or equal to 1 year.................................         0.5         1.0        15.0         1.0         2.0         4.0                4.0
Greater than 1 year and less than or equal to 5 years........         2.0         3.0        15.0         4.0         6.0         8.0               12.0
Greater than 5 years.........................................         4.0         6.0        15.0         8.0        12.0        16.0               24.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Main index equities (including convertible bonds) and gold..........................15.0.........
Other publicly-traded equities (including convertible bonds)........................25.0.........
Mutual funds....................................................Highest haircut applicable to any security in
                                                                          which the fund can invest
Cash collateral held................................................................Zero.........
Other exposure types................................................................25.0.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircuts in Table 22 are based on a 10 business-day holding period.
\2\ Includes a foreign PSE that receives a zero percent risk weight.

    The interim final rule requires that an FDIC-supervised institution 
increase the standard supervisory haircut for transactions involving 
large netting sets. As noted in the proposed rule, during the recent 
financial crisis, many financial institutions experienced significant 
delays in settling or closing-out collateralized transactions, such as 
repo-style transactions and collateralized OTC derivatives. The assumed 
holding period for collateral in the collateral haircut approach under 
Basel II proved to be inadequate for certain transactions and netting 
sets and did not reflect the difficulties and delays that institutions 
had when settling or liquidating collateral during a period of 
financial stress.
    Thus, consistent with the proposed rule, for netting sets where: 
(1) the number of trades exceeds 5,000 at any time during the quarter; 
(2) one or more trades involves illiquid collateral posted by the 
counterparty; or (3) the netting set includes any OTC derivatives that 
cannot be easily replaced, the interim final rule requires an FDIC-
supervised institution to assume a holding period of 20 business days 
for the collateral under the collateral haircut approach. The formula 
and methodology for increasing the haircut to reflect the longer 
holding period is described in section 37(c) of the interim final rule. 
Consistent with the Basel capital framework, an FDIC-supervised 
institution is not required to adjust the holding period upward for 
cleared transactions. When determining whether collateral is illiquid 
or whether an OTC derivative cannot be easily replaced for these 
purposes, an FDIC-supervised institution should assess whether, during 
a period of stressed market conditions, it could obtain multiple price 
quotes within two days or less for the collateral or OTC derivative 
that would not move the market or represent a market discount (in the 
case of collateral) or a premium (in the case of an OTC derivative).
    One commenter requested the agencies clarify whether the 5,000-
trade threshold applies on a counterparty-by-counterparty (rather than 
aggregate) basis, and only will be triggered in the event there are 
5,000 open trades with a single counterparty within a single netting 
set in a given quarter. Commenters also asked whether the threshold 
would be calculated on an average basis or whether a de minimis number 
of breaches could be permitted without triggering the increased holding 
period or margin period of risk. One commenter suggested eliminating 
the threshold because it is ineffective as a measure of risk, and 
combined with other features of the proposals (for example, collateral 
haircuts, margin disputes), could create a disincentive for FDIC-
supervised institutions to apply sound practices such as risk 
diversification.
    The FDIC notes that the 5,000-trade threshold applies to a netting 
set, which by definition means a group of transactions with a single 
counterparty that are subject to a qualifying master netting agreement. 
The 5,000 trade calculation threshold was proposed as an indicator that 
a set of transactions may be more complex, or require a lengthy period, 
to close out in the event of a default of a counterparty. The FDIC 
continues to believe that the threshold of 5,000 is a reasonable 
indicator of the complexity of a close-out. Therefore, the interim 
final rule retains the 5,000 trade threshold as proposed, without any 
de minimis exception.
    One commenter asked the agencies to clarify how trades would be 
counted in the context of an indemnified agency securities lending 
relationship. In such transactions, an agent banking organization acts 
as an intermediary for, potentially, multiple borrowers and lenders. 
The banking organization is acting as an agent with no exposure to 
either the securities lenders or borrowers except for an 
indemnification to the securities lenders in the event of a borrower 
default. The indemnification creates an exposure to the securities 
borrower, as the agent banking organization could suffer a loss upon 
the default of a borrower. In these cases, each transaction between the 
agent and a borrower would count as a trade. The FDIC notes that a 
trade in this instance consists of an order by the borrower, and not 
the number of securities lenders providing shares to fulfil the order 
or the number of shares underlying such order.\149\
---------------------------------------------------------------------------

    \149\ In the event that the agent FDIC-supervised institution 
reinvests the cash collateral proceeds on behalf of the lender and 
provides an explicit or implicit guarantee of the value of the 
collateral in such pool, the FDIC-supervised institution should hold 
capital, as appropriate, against the risk of loss of value of the 
collateral pool.
---------------------------------------------------------------------------

    The commenters also addressed the longer holding period for trades 
involving illiquid collateral posted by the counterparty. Some 
commenters asserted that one illiquid exposure or one illiquid piece of 
collateral should not taint the entire netting set. Other commenters 
recommended applying a materiality threshold (for example, 1 percent) 
below which one or more illiquid exposures would not trigger the longer 
holding period, or allowing banking organizations to define 
``materiality'' based on experience.
    Regarding the potential for an illiquid exposure to ``taint'' an 
entire netting set, the interim final rule does not require

[[Page 55428]]

an FDIC-supervised institution to recognize any piece of collateral as 
a risk mitigant. Accordingly, if an FDIC-supervised institution elects 
to exclude the illiquid collateral from the netting set for purposes of 
calculating risk-weighted assets, then such illiquid collateral does 
not result in an increased holding period for the netting set. With 
respect to a derivative that may not be easily replaced, an FDIC-
supervised institution could create a separate netting set that would 
preserve the holding period for the original netting set of easily 
replaced transactions. Accordingly, the interim final rule adopts this 
aspect of the proposal without change.
    One commenter asserted that the interim final rule should not 
require a banking organization to determine whether an instrument is 
liquid on a daily basis, but rather should base the timing of such 
determination by product category and on long-term liquidity data. 
According to the commenter, such an approach would avoid potential 
confusion, volatility and destabilization of the funding markets. For 
purposes of determining whether collateral is illiquid or an OTC 
derivative contract is easily replaceable under the interim final rule, 
an FDIC-supervised institution may assess whether, during a period of 
stressed market conditions, it could obtain multiple price quotes 
within two days or less for the collateral or OTC derivative that would 
not move the market or represent a market discount (in the case of 
collateral) or a premium (in the case of an OTC derivative). An FDIC-
supervised institution is not required to make a daily determination of 
liquidity under the interim final rule; rather, FDIC-supervised 
institutions should have policies and procedures in place to evaluate 
the liquidity of their collateral as frequently as warranted.
    Under the proposed rule, a banking organization would increase the 
holding period for a netting set if over the two previous quarters more 
than two margin disputes on a netting set have occurred that lasted 
longer than the holding period. However, consistent with the Basel 
capital framework, a banking organization would not be required to 
adjust the holding period upward for cleared transactions. Several 
commenters requested further clarification on the meaning of ``margin 
disputes.'' Some of these commenters suggested restricting ``margin 
disputes'' to formal legal action. Commenters also suggested 
restricting ``margin disputes'' to disputes resulting in the creation 
of an exposure that exceeded any available overcollateralization, or 
establishing a materiality threshold. One commenter suggested that 
margin disputes were not an indicator of an increased risk and, 
therefore, should not trigger a longer holding period.
    The FDIC continues to believe that an increased holding period is 
appropriate regardless of whether the dispute exceeds applicable 
collateral requirements and regardless of whether the disputes exceed a 
materiality threshold. The FDIC expects that the determination as to 
whether a dispute constitutes a margin dispute for purposes of the 
interim final rule will depend solely on the timing of the resolution. 
That is to say, if collateral is not delivered within the time period 
required under an agreement, and such failure to deliver is not 
resolved in a timely manner, then such failure would count toward the 
two-margin-dispute limit. For the purpose of the interim final rule, 
where a dispute is subject to a recognized industry dispute resolution 
protocol, the FDIC expects to consider the dispute period to begin 
after a third-party dispute resolution mechanism has failed.
    For comments and concerns that are specific to the parallel 
provisions in the advanced approaches rule, reference section XII.A of 
this preamble.
    f. Own Estimates of Haircuts
    Under the interim final rule, consistent with the proposal, FDIC-
supervised institutions may calculate market price volatility and 
foreign exchange volatility using own internal estimates with prior 
written approval of the FDIC. To receive approval to calculate haircuts 
using its own internal estimates, an FDIC-supervised institution must 
meet certain minimum qualitative and quantitative standards set forth 
in the interim final rule, including the requirements that an FDIC-
supervised institution: (1) uses 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; (2) adjusts holding periods upward where 
and as appropriate to take into account the illiquidity of an 
instrument; (3) selects a historical observation period that reflects a 
continuous 12-month period of significant financial stress appropriate 
to the FDIC-supervised institution's current portfolio; and (4) updates 
its data sets and compute haircuts no less frequently than quarterly, 
as well as any time market prices change materially. An FDIC-supervised 
institution estimates the volatilities of exposures, the collateral, 
and foreign exchange rates and should not take into account the 
correlations between them.
    The interim final rule provides a formula for converting own-
estimates of haircuts based on a holding period different from the 
minimum holding period under the rule to haircuts consistent with the 
rule's minimum holding periods. The minimum holding periods for netting 
sets with more than 5,000 trades, netting sets involving illiquid 
collateral or an OTC derivative that cannot easily be replaced, and 
netting sets involving more than two margin disputes over the previous 
two quarters described above also apply for own-estimates of haircuts.
    Under the interim final rule, an FDIC-supervised institution is 
required to have policies and procedures that describe how it 
determines the period of significant financial stress used to calculate 
the FDIC-supervised institution's own internal estimates, and to be 
able to provide empirical support for the period used. These policies 
and procedures must address (1) how the FDIC-supervised institution 
links the period of significant financial stress used to calculate the 
own internal estimates to the composition and directional bias of the 
FDIC-supervised institution's current portfolio; and (2) the FDIC-
supervised institution's process for selecting, reviewing, and updating 
the period of significant financial stress used to calculate the own 
internal estimates and for monitoring the appropriateness of the 12-
month period in light of the FDIC-supervised institution's current 
portfolio. The FDIC-supervised institution is required to obtain the 
prior approval of the FDIC for these policies and procedures and notify 
the FDIC if it makes any material changes to them. The FDIC may require 
it to use a different period of significant financial stress in the 
calculation of its own internal estimates.
    Under the interim final rule, an FDIC-supervised institution is 
allowed to calculate internally estimated haircuts for categories of 
debt securities that are investment-grade exposures. The haircut for a 
category of securities must be representative of the internal 
volatility estimates for securities in that category that the FDIC-
supervised institution has lent, sold subject to repurchase, posted as 
collateral, borrowed, purchased subject to resale, or taken as 
collateral. In determining relevant categories, the FDIC-supervised 
institution must, at a minimum, take into account (1) the type of 
issuer of the security; (2) the credit quality of the security; (3) the 
maturity of the security;

[[Page 55429]]

and (4) the interest rate sensitivity of the security.
    An FDIC-supervised institution must calculate a separate internally 
estimated haircut for each individual non-investment-grade debt 
security and for each individual equity security. In addition, an FDIC-
supervised institution must 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.
g. Simple Value-at-Risk and Internal Models Methodology
    In the NPR, the agencies did not propose a simple VaR approach to 
calculate exposure amounts for eligible margin loans and repo-style 
transactions or IMM to calculate the exposure amount for the 
counterparty credit exposure for OTC derivatives, eligible margin 
loans, and repo-style transactions. These methodologies are included in 
the advanced approaches rule. The agencies sought comment on whether to 
implement the simple VaR approach and IMM in the standardized approach. 
Several commenters asserted that the IMM and simple VaR approach should 
be implemented in the interim final rule to better capture the risk of 
counterparty credit exposures. The FDIC has considered these comments 
and has concluded that the increased complexity and limited 
applicability of these models-based approaches is inconsistent with the 
FDIC's overall focus in the standardized approach on simplicity, 
comparability, and broad applicability of methodologies for U.S. FDIC-
supervised institutions. Therefore, consistent with the proposal, the 
interim final rule does not include the simple VaR approach or the IMM 
in the standardized approach.

G. Unsettled Transactions

    Under the proposed rule, a banking organization would be required 
to hold capital against the risk of certain unsettled transactions. One 
commenter expressed opposition to assigning a risk weight to unsettled 
transactions where previously none existed, because it would require a 
significant and burdensome tracking process without commensurate 
benefit. The FDIC believes that it is important for an FDIC-supervised 
institution to have procedures to identify and track a delayed or 
unsettled transaction of the types specified in the rule. Such 
procedures capture the resulting risks associated with such delay. As a 
result, the FDIC is adopting the risk-weighting requirements as 
proposed.
    Consistent with the proposal, the interim final rule provides for a 
separate risk-based capital requirement for transactions involving 
securities, foreign exchange instruments, and commodities that have a 
risk of delayed settlement or delivery. Under the interim final rule, 
the capital requirement does not, however, apply to certain types of 
transactions, including: (1) cleared transactions that are marked-to-
market daily and subject to 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 the proposal defined as the 
lesser of the market standard for the particular instrument or five 
business days).\150\ In the case of a system-wide failure of a 
settlement, clearing system, or central counterparty, the FDIC may 
waive risk-based capital requirements for unsettled and failed 
transactions until the situation is rectified.
---------------------------------------------------------------------------

    \150\ Such transactions are treated as derivative contracts as 
provided in section 34 or section 35 of the interim final rule.
---------------------------------------------------------------------------

    The interim final rule provides separate treatments for delivery-
versus-payment (DvP) and payment-versus-payment (PvP) transactions with 
a normal settlement period, and non-DvP/non-PvP transactions with a 
normal settlement period. A DvP transaction refers to 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 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. A transaction is 
considered to have 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.
    Consistent with the proposal, under the interim final rule, an 
FDIC-supervised institution is required to hold risk-based capital 
against a DvP or PvP transaction with a normal settlement period if the 
FDIC-supervised institution's counterparty has not made delivery or 
payment within five business days after the settlement date. The FDIC-
supervised institution determines its risk-weighted asset amount for 
such a transaction by multiplying the positive current exposure of the 
transaction for the FDIC-supervised institution by the appropriate risk 
weight in Table 23. The positive current exposure from an unsettled 
transaction of an FDIC-supervised institution 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 FDIC-supervised institution to the counterparty.

      Table 23--Risk Weights for Unsettled DvP and PvP Transactions
------------------------------------------------------------------------
                                                       Risk weight to be
                                                           applied to
 Number of business days after contractual settlement   positive current
                         date                            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
------------------------------------------------------------------------

    An FDIC-supervised institution must hold risk-based capital against 
any non-DvP/non-PvP transaction with a normal settlement period if the 
FDIC-supervised institution 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 FDIC-supervised 
institution must continue to hold risk-based capital against the 
transaction until it has received the corresponding deliverables. From 
the business day after the FDIC-supervised institution has made its 
delivery until five business days after the counterparty delivery is 
due, the FDIC-supervised institution must calculate the risk-weighted 
asset amount for the transaction by risk weighting the current fair 
value of the deliverables owed to the FDIC-supervised institution, 
using the risk weight appropriate for an exposure to the counterparty 
in accordance with section 32. If an FDIC-supervised institution has 
not received its deliverables by the fifth business day after the 
counterparty delivery due date, the FDIC-supervised institution must 
assign a 1,250 percent risk weight to the current market value of the 
deliverables owed.

[[Page 55430]]

H. Risk-Weighted Assets for Securitization Exposures

    In the proposal, the agencies proposed to significantly revise the 
risk-based capital framework for securitization exposures. These 
proposed revisions included removing references to and reliance on 
credit ratings to determine risk weights for these exposures and using 
alternative standards of creditworthiness, as required by section 939A 
of the Dodd-Frank Act. These alternative standards were designed to 
produce capital requirements that generally would be consistent with 
those under the BCBS securitization framework and were consistent with 
those incorporated into the agencies' market risk rule.\151\ They would 
have replaced both the ratings-based approach and an approach that 
permits banking organizations to use supervisor-approved internal 
systems to replicate external ratings processes for certain unrated 
exposures in the general risk-based capital rules.
---------------------------------------------------------------------------

    \151\ 77 FR 53060 (August 30, 2012).
---------------------------------------------------------------------------

    In addition, the agencies proposed to update the terminology for 
the securitization framework, include a definition of securitization 
exposure that encompasses a wider range of exposures with similar risk 
characteristics, and implement new due diligence requirements for 
securitization exposures.
1. Overview of the Securitization Framework and Definitions
    The proposed securitization framework was designed to address the 
credit risk of exposures that involve the tranching of credit risk of 
one or more underlying financial exposures. Consistent with the 
proposal, the interim final rule defines a securitization exposure as 
an on- or off-balance sheet credit exposure (including credit-enhancing 
representations and warranties) that arises from a traditional or 
synthetic securitization (including a resecuritization), or an exposure 
that directly or indirectly references a securitization exposure. 
Commenters expressed concerns that the proposed scope of the 
securitization framework was overly broad and requested that the 
definition of securitizations be narrowed to exposures that tranche the 
credit risk associated with a pool of assets. However, the FDIC 
believes that limiting the securitization framework to exposures backed 
by a pool of assets would exclude tranched credit risk exposures that 
are appropriately captured under the securitization framework, such as 
certain first loss or other tranched guarantees provided to a single 
underlying exposure.
    In the proposal a traditional securitization was defined, in part, 
as a transaction in which credit risk of one or more underlying 
exposures has been transferred to one or more third parties (other than 
through the use of credit derivatives or guarantees), where the credit 
risk associated with the underlying exposures has been separated into 
at least two tranches reflecting different levels of seniority. The 
definition included certain other conditions, such as requiring all or 
substantially all of the underlying exposures to be financial 
exposures. The FDIC has decided to finalize the definition of 
traditional securitization largely as proposed, with some revisions (as 
discussed below), that reflect certain comments regarding exclusions 
under the framework and other modifications to the interim final rule.
    Both the designation of exposures as securitization exposures (or 
resecuritization exposures, as described below) and the calculation of 
risk-based capital requirements for securitization exposures under the 
interim final rule are guided by the economic substance of a 
transaction rather than its legal form. Provided there is tranching of 
credit risk, securitization exposures could include, among other 
things, ABS and MBS, 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 credit-
enhancing interest-only strips (CEIOs). Securitization exposures also 
include assets sold with retained tranches.
    The FDIC believes that requiring all or substantially all of the 
underlying exposures of a securitization to be financial exposures 
creates an important boundary between the general credit risk framework 
and the securitization framework. Examples of financial exposures 
include loans, commitments, credit derivatives, guarantees, 
receivables, asset-backed securities, mortgage-backed securities, other 
debt securities, or equity securities. Based on their cash flow 
characteristics, the FDIC also considers asset classes such as lease 
residuals and entertainment royalties to be financial assets. The 
securitization framework is not designed, however, to apply to tranched 
credit exposures to commercial or industrial companies or nonfinancial 
assets or to amounts deducted from capital under section 22 of the 
interim final rule. Accordingly, 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 proposal, under the interim final rule, an 
operating company does not fall under the definition of a traditional 
securitization (even if substantially all of its assets are financial 
exposures). Operating companies generally refer to companies that are 
established to conduct business with clients with the intention of 
earning a profit in their own right and generally produce goods or 
provide services beyond the business of investing, reinvesting, 
holding, or trading in financial assets. Accordingly, an equity 
investment in an operating company generally would be an equity 
exposure. Under the interim final rule, FDIC-supervised institutions 
are operating companies and do not fall under the definition of a 
traditional securitization. However, investment firms that 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 under the interim final rule and would not qualify 
for this general exclusion from the definition of traditional 
securitization.
    Under the proposed rule, paragraph (10) of the definition of 
traditional securitization specifically excluded exposures to 
investment funds (as defined in the proposal) and collective investment 
and pension funds (as defined in relevant regulations and set forth in 
the proposed definition of ``traditional securitization''). These 
specific exemptions served to narrow the potential scope of the 
securitization framework. Investment funds, collective investment 
funds, pension funds regulated under ERISA and their foreign 
equivalents, and transactions registered with the SEC under the 
Investment Company Act of 1940 and their foreign equivalents would be 
exempted from the definition because these entities and transactions 
are regulated and subject to strict leverage requirements. The proposal 
defined an investment fund as a company (1) where all or substantially 
all of the assets of the fund are financial assets; and (2) that has no 
material liabilities. In addition, the agencies explained in the 
proposal that the capital requirements for an extension of credit to, 
or an equity holding in, these

[[Page 55431]]

transactions are more appropriately calculated under the rules for 
corporate and equity exposures, and that the securitization framework 
was not intended to apply to such transactions.
    Commenters generally agreed with the proposed exemptions from the 
definition of traditional securitization and requested that the 
agencies provide exemptions for exposures to a broader set of 
investment firms, such as pension funds operated by state and local 
governments. In view of the comments regarding pension funds, the 
interim final rule provides an additional exclusion from the definition 
of traditional securitization for a ``governmental plan'' (as defined 
in 29 U.S.C. 1002(32)) that complies with the tax deferral 
qualification requirements provided in the Internal Revenue Code. The 
FDIC believes that an exemption for such government plans is 
appropriate because they are subject to substantial regulation. 
Commenters also requested that the agencies provide exclusions for 
certain products provided to investment firms, such as extensions of 
short-term credit that support day-to-day investment-related 
activities. The FDIC believes that exposures that meet the definition 
of traditional securitization, regardless of product type or maturity, 
would fall under the securitization framework. Accordingly, the FDIC 
has not provided for any such exemptions under the interim final 
rule.\152\
---------------------------------------------------------------------------

    \152\ The interim final rule also clarifies that the portion of 
a synthetic exposure to the capital of a financial institution that 
is deducted from capital is not a traditional securitization.
---------------------------------------------------------------------------

    To address the treatment of investment firms that are not 
specifically excluded from the securitization framework, the proposed 
rule provided discretion to the primary Federal supervisor of a banking 
organization to exclude from the definition of a traditional 
securitization those transactions 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. While the commenters supported the 
agencies' recognition that certain investment firms may warrant an 
exemption from the securitization framework, some expressed concern 
that the process for making such a determination may present 
significant implementation burden.
    To maintain sufficient flexibility to provide an exclusion for 
certain investment firms from the securitization framework, the FDIC 
has retained this discretionary provision in the interim final rule 
without change. In determining whether to exclude an investment firm 
from the securitization framework, the FDIC will consider a number of 
factors, including the assessment of the transaction's leverage, risk 
profile, and economic substance. This supervisory exclusion gives the 
FDIC discretion to distinguish structured finance transactions, to 
which the securitization framework is designed to apply, from those of 
flexible investment firms, such as certain 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, are 
eligible for the exclusion from the definition of traditional 
securitization under this provision. The FDIC does 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 meet the definition of 
traditional securitization under the interim final rule.
    The line between securitization exposures and non-securitization 
exposures may be difficult to identify in some circumstances. In 
addition to the supervisory exclusion from the definition of 
traditional securitization described above, FDIC may expand the scope 
of the securitization framework to include other transactions if doing 
so is justified by the economics of the transaction. Similar to the 
analysis for excluding an investment firm from treatment as a 
traditional securitization, the FDIC will consider the economic 
substance, leverage, and risk profile of a transaction to ensure that 
an appropriate risk-based capital treatment is applied. The FDIC will 
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.
    Under the proposal, a synthetic securitization was defined as 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). The FDIC has decided to 
finalize the definition of synthetic securitization largely as 
proposed, but has also clarified in the interim final rule that 
transactions in which a portion of credit risk has been retained, not 
just transferred, through the use of credit derivatives is subject to 
the securitization framework.
    In response to the proposal, commenters requested that the agencies 
provide an exemption for guarantees that tranche credit risk under 
certain mortgage partnership finance programs, such as certain programs 
provided by the FHLBs, whereby participating member banking 
organizations provide credit enhancement to a pool of residential 
mortgage loans that have been delivered to the FHLB. The FDIC believes 
that these exposures that tranche credit risk meet the definition of a 
synthetic securitization and that the risk of such exposures would be 
appropriately captured under the securitization framework. In contrast, 
mortgage-backed pass-through securities (for example, those guaranteed 
by FHLMC or FNMA) that feature various maturities but do not involve 
tranching of credit risk do not meet the definition of a securitization 
exposure. Only those MBS that involve tranching of credit risk are 
considered to be securitization exposures.
    Consistent with the 2009 Enhancements, the proposed rule defined a 
resecuritization exposure as an on- or off-balance sheet exposure to a 
resecuritization; or an exposure that directly or indirectly references 
a resecuritization exposure. A resecuritization would have meant a 
securitization in which one or more of the underlying exposures is a 
securitization exposure. An exposure to an asset-backed commercial 
paper (ABCP) program would not have been a resecuritization exposure if 
either: (1) the program-wide credit enhancement does not meet the 
definition of a resecuritization exposure; or (2) the entity sponsoring 
the program fully

[[Page 55432]]

supports the commercial paper through the provision of liquidity so 
that the commercial paper holders effectively are exposed to the 
default risk of the sponsor instead of the underlying exposures.
    Commenters asked the agencies to narrow the definition of 
resecuritization by exempting resecuritizations in which a minimal 
amount of underlying assets are securitization exposures. According to 
commenters, the proposed definition would have a detrimental effect on 
certain collateralized loan obligation exposures, which typically 
include a small amount of securitization exposures as part of the 
underlying pool of assets in a securitization. Specifically, the 
commenters requested that resecuritizations be defined as a 
securitization in which five percent or more of the underlying 
exposures are securitizations. Commenters also asked the agencies to 
consider employing a pro rata treatment by only applying a higher 
capital surcharge to the portion of a securitization exposure that is 
backed by underlying securitization exposures. The FDIC believes that 
the introduction of securitization exposures into a pool of securitized 
exposures significantly increases the complexity and correlation risk 
of the exposures backing the securities issued in the transaction, and 
that the resecuritization framework is appropriate for applying risk-
based capital requirements to exposures to pools that contain 
securitization exposures.
    Commenters sought clarification as to whether the proposed 
definition of resecuritization would include a single exposure that has 
been retranched, such as a resecuritization of a real estate mortgage 
investment conduit (Re-REMIC). The FDIC believes that the increased 
capital surcharge, or p factor, for resecuritizations was meant to 
address the increased correlation risk and complexity resulting from 
retranching of multiple underlying exposures and was not intended to 
apply to the retranching of a single underlying exposure. As a result, 
the definition of resecuritization in the interim final rule has been 
refined to clarify that resecuritizations do not include exposures 
comprised of a single asset that has been retranched. The FDIC notes 
that for purposes of the interim final rule, a resecuritization does 
not include pass-through securities that have been pooled together and 
effectively re-issued as tranched securities. This is because the pass-
through securities do not tranche credit protection and, as a result, 
are not considered securitization exposures under the interim final 
rule.
    Under the interim final rule, if a transaction involves a 
traditional multi-seller ABCP conduit, an FDIC-supervised institution 
must determine whether the transaction should be considered a 
resecuritization exposure. For example, assume that an ABCP conduit 
acquires securitization exposures where the underlying assets consist 
of wholesale loans and no securitization exposures. As is typically the 
case in multi-seller ABCP conduits, each seller provides first-loss 
protection by over-collateralizing the conduit to which it sells loans. 
To ensure that the commercial paper issued by each conduit is highly-
rated, an FDIC-supervised institution sponsor provides either a pool-
specific liquidity facility or a program-wide credit enhancement such 
as a guarantee to cover a portion of the losses above the seller-
provided protection.
    The pool-specific liquidity facility generally is not a 
resecuritization exposure under the interim final rule because the 
pool-specific liquidity facility represents a tranche of a single asset 
pool (that is, the applicable pool of wholesale exposures), which 
contains no securitization exposures. However, a sponsor's program-wide 
credit enhancement that does not cover all losses above the seller-
provided credit enhancement across the various pools generally 
constitutes tranching of risk of a pool of multiple assets containing 
at least one securitization exposure, and, therefore, is a 
resecuritization exposure.
    In addition, if the conduit in this example funds itself entirely 
with a single class of commercial paper, then the commercial paper 
generally is not a resecuritization exposure if, as noted above, either 
(1) the program-wide credit enhancement does not meet the definition of 
a resecuritization exposure or (2) the commercial paper is fully 
supported by the sponsoring FDIC-supervised institution. When the 
sponsoring FDIC-supervised institution fully supports the commercial 
paper, the commercial paper holders effectively are exposed to default 
risk of the sponsor instead of the underlying exposures, and the 
external rating of the commercial paper is expected to be based 
primarily on the credit quality of the FDIC-supervised institution 
sponsor, thus ensuring that the commercial paper does not represent a 
tranched risk position.
2. Operational Requirements
a. Due Diligence Requirements
    During the recent financial crisis, it became apparent that many 
banking organizations relied exclusively on ratings issued by 
Nationally Recognized Statistical Rating Organizations (NRSROs) and did 
not perform internal credit analysis of their securitization exposures. 
Consistent with the Basel capital framework and the agencies' general 
expectations for investment analysis, the proposal required banking 
organizations to satisfy specific due diligence requirements for 
securitization exposures. Specifically, under the proposal a banking 
organization would be required to demonstrate, to the satisfaction of 
its primary Federal supervisor, a comprehensive understanding of the 
features of a securitization exposure that would materially affect its 
performance. The banking organization's analysis would have to be 
commensurate with the complexity of the exposure and the materiality of 
the exposure in relation to capital of the banking organization. On an 
ongoing basis (no less frequently than quarterly), the banking 
organization must evaluate, review, and update as appropriate the 
analysis required under section 41(c)(1) of the proposed rule for each 
securitization exposure. The analysis of the risk characteristics of 
the exposure prior to acquisition, and periodically thereafter, would 
have to consider:
    (1) Structural features of the securitization that materially 
impact the performance of the exposure, for example, the contractual 
cash-flow waterfall, waterfall-related triggers, credit enhancements, 
liquidity enhancements, market value triggers, the performance of 
organizations that service the position, and deal-specific definitions 
of default;
    (2) Relevant information regarding the performance of the 
underlying credit exposure(s), for example, the percentage of loans 30, 
60, and 90 days past due; default rates; prepayment rates; loans in 
foreclosure; property types; occupancy; average credit score or other 
measures of creditworthiness; average LTV ratio; and industry and 
geographic diversification data on the underlying exposure(s);
    (3) Relevant market data of the securitization, for example, bid-
ask spread, most recent sales price and historical price volatility, 
trading volume, implied market rating, and size, depth and 
concentration level of the market for the securitization; and
    (4) For resecuritization exposures, performance information on the 
underlying securitization exposures, for example, the issuer name and 
credit quality, and the characteristics and performance of the 
exposures underlying the securitization exposures.
    Commenters expressed concern that many banking organizations would 
be

[[Page 55433]]

unable to perform the due diligence necessary to meet the requirements 
and, as a result, would no longer purchase privately-issued 
securitization exposures and would increase their holdings of GSE-
guaranteed securities, thereby increasing the size of the GSEs. 
Commenters also expressed concerns regarding banking organizations' 
ability to obtain relevant market data for certain exposures, such as 
foreign exposures and exposures that are traded in markets that are 
typically illiquid, as well as their ability to obtain market data 
during periods of general market illiquidity. Commenters also stated 
concerns that uneven application of the requirements by supervisors may 
result in disparate treatment for the same exposure held at different 
banking organizations due to perceived management deficiencies. For 
these reasons, many commenters requested that the agencies consider 
removing the market data requirement from the due diligence 
requirements. In addition, some commenters suggested that the due 
diligence requirements be waived provided that all of the underlying 
loans meet certain underwriting standards.
    The FDIC notes that the proposed due diligence requirements are 
generally consistent with the goal of the its investment permissibility 
requirements, which provide that FDIC-supervised institutions must be 
able to determine the risk of loss is low, even under adverse economic 
conditions. The FDIC acknowledges potential restrictions on data 
availability and believes that the standards provide sufficient 
flexibility so that the due diligence requirements, such as relevant 
market data requirements, would be implemented as applicable. In 
addition, the FDIC notes that, where appropriate, pool-level data could 
be used to meet certain of the due diligence requirements. As a result, 
the FDIC is finalizing the due diligence requirements as proposed.
    Under the proposal, if a banking organization is not able to meet 
these due diligence requirements and demonstrate a comprehensive 
understanding of a securitization exposure to the satisfaction of its 
primary Federal supervisor, the banking organization would be required 
to assign a risk weight of 1,250 percent to the exposure. Commenters 
requested that the agencies adopt a more flexible approach to due 
diligence requirements rather than requiring a banking organization to 
assign a risk weight of 1,250 percent for violation of those 
requirements. For example, some commenters recommended that the 
agencies assign progressively increasing risk weights based on the 
severity and duration of infringements of due diligence requirements, 
to allow the agencies to differentiate between minor gaps in due 
diligence requirements and more serious violations.
    The FDIC believes that the requirement to assign a 1,250 percent 
risk weight, rather than applying a lower risk weight, to exposures for 
violation of these requirements is appropriate given that such 
information is required to monitor appropriately the risk of the 
underlying assets. The FDIC recognizes the importance of consistent and 
uniform application of the standards across FDIC-supervised 
institutions and will endeavor to ensure that the FDIC consistently 
reviews FDIC-supervised institutions' due diligence on securitization 
exposures. The FDIC believes that these efforts will mitigate concerns 
that the 1,250 percent risk weight will be applied inappropriately to 
FDIC-supervised institutions' failure to meet the due diligence 
requirements. At the same time, the FDIC believes that the requirement 
that an FDIC-supervised institution's analysis be commensurate with the 
complexity and materiality of the securitization exposure provides the 
FDIC-supervised institution with sufficient flexibility to mitigate the 
potential for undue burden. As a result, the FDIC is finalizing the 
risk weight requirements related to due diligence requirements as 
proposed.
b. Operational Requirements for Traditional Securitizations
    The proposal outlined certain operational requirements for 
traditional securitizations that had to be met in order to apply the 
securitization framework. The FDIC is finalizing these operational 
requirements as proposed.
    In a traditional securitization, an originating FDIC-supervised 
institution typically transfers a portion of the credit risk of 
exposures to third parties by selling them to a securitization special 
purpose entity (SPE).\153\ Consistent with the proposal, the interim 
final rule defines an FDIC-supervised institution to be an originating 
FDIC-supervised institution with respect to a securitization if it (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.
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    \153\ The interim final rule defines a securitization SPE as 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.
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    Under the interim final rule, consistent with the proposal, an 
FDIC-supervised institution that transfers exposures it has originated 
or purchased to a securitization SPE or other third party in connection 
with a traditional securitization can exclude the underlying exposures 
from the calculation of risk-weighted assets only if each of the 
following conditions are met: (1) The exposures are not reported on the 
FDIC-supervised institution's consolidated balance sheet under GAAP; 
(2) the FDIC-supervised institution 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 (as discussed below).\154\
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    \154\ Commenters asked the agencies to consider the interaction 
between the proposed non-consolidation condition and the agencies' 
proposed rules implementing section 941 of the Dodd-Frank Act 
regarding risk retention, given concerns that satisfaction of 
certain of the proposed risk retention requirements would affect the 
accounting treatment for certain transactions. The FDIC acknowledges 
these concerns and will take into consideration any effects on the 
securitization framework as they continue to develop the risk 
retention rules.
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    An originating FDIC-supervised institution that meets these 
conditions must hold risk-based capital against any credit risk it 
retains or acquires in connection with the securitization. An 
originating FDIC-supervised institution that fails to meet these 
conditions is required to hold risk-based capital against the 
transferred exposures as if they had not been securitized and must 
deduct from common equity tier 1 capital any after-tax gain-on-sale 
resulting from the transaction.
    In addition, if a securitization (1) 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 (2) 
contains an early amortization provision, the originating FDIC-
supervised institution is required to hold risk-based capital against 
the transferred exposures as if they had not been securitized and 
deduct from common equity tier 1 capital any after-tax gain-on-sale 
resulting from the transaction.\155\ The FDIC believes that

[[Page 55434]]

this treatment is appropriate given the lack of risk transference in 
securitizations of revolving underlying exposures with early 
amortization provisions.
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    \155\ Many securitizations of revolving credit facilities (for 
example, credit card receivables) contain provisions that require 
the securitization to be wound down and investors to be repaid if 
the excess spread falls below a certain threshold. 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 an FDIC-supervised institution capital needs if 
new draws on the revolving credit facilities need to be financed by 
the FDIC-supervised institution using on-balance sheet sources of 
funding. The payment allocations used to distribute principal and 
finance charge collections during the amortization phase of these 
transactions also can expose the FDIC-supervised institution to a 
greater risk of loss than in other securitization transactions. The 
interim final rule defines an early amortization provision 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 (1) is solely triggered by events not 
related to the performance of the underlying exposures or the 
originating FDIC-supervised institution (such as material changes in 
tax laws or regulations), or (2) leaves investors fully exposed to 
future draws by borrowers on the underlying exposures even after the 
provision is triggered.
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c. Operational Requirements for Synthetic Securitizations
    In general, the proposed operational requirements for synthetic 
securitizations were similar to those proposed for traditional 
securitizations. The operational requirements for synthetic 
securitizations, however, were more detailed to ensure that the 
originating banking organization has truly transferred credit risk of 
the underlying exposures to one or more third parties. Under the 
proposal, an originating banking organization would have been able to 
recognize for risk-based capital purposes the use of a credit risk 
mitigant to hedge underlying exposures only if each of the conditions 
in the proposed definition of ``synthetic securitization'' was 
satisfied. The FDIC is finalizing the operational requirements largely 
as proposed. However, to ensure that synthetic securitizations created 
through tranched guarantees and credit derivatives are properly 
included in the framework, in the interim final rule the FDIC has 
amended the operational requirements to recognize guarantees that meet 
all of the criteria set forth in the definition of eligible guarantee 
except the criterion under paragraph (3) of the definition. 
Additionally, the operational criteria recognize a credit derivative 
provided that the credit derivative meets all of the criteria set forth 
in the definition of eligible credit derivative except for paragraph 3 
of the definition of eligible guarantee. As a result, a guarantee or 
credit derivative that provides a tranched guarantee would not be 
excluded by the operational requirements for synthetic securitizations.
    Failure to meet these operational requirements for a synthetic 
securitization prevents an FDIC-supervised institution that has 
purchased tranched credit protection referencing one or more of its 
exposures from using the securitization framework with respect to the 
reference exposures and requires the FDIC-supervised institution to 
hold risk-based capital against the underlying exposures as if they had 
not been synthetically securitized. An FDIC-supervised institution that 
holds a synthetic securitization as a result of purchasing credit 
protection may use the securitization framework to determine the risk-
based capital requirement for its exposure. Alternatively, it may 
instead choose to disregard the credit protection and use the general 
credit risk framework. An FDIC-supervised institution that provides 
tranched credit protection in the form of a synthetic securitization or 
credit protection to a synthetic securitization must use the 
securitization framework to compute risk-based capital requirements for 
its exposures to the synthetic securitization even if the originating 
FDIC-supervised institution fails to meet one or more of the 
operational requirements for a synthetic securitization.
d. Clean-Up Calls
    Under the proposal, 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 would need to be an eligible clean-up call. The proposed 
rule defined a clean-up call as a contractual provision that permits an 
originating banking organization or servicer to call securitization 
exposures before their stated maturity or call date. In the case of a 
traditional securitization, a clean-up call generally is 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.
    The interim final rule retains the proposed treatment for clean-up 
calls, and defines an eligible clean-up call as a clean-up call that 
(1) is exercisable solely at the discretion of the originating FDIC-
supervised institution 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 (for example, to purchase non-performing underlying 
exposures); and (3) 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, 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 meets criteria (3) of the definition of ``eligible clean-
up call'' as long as the outstanding principal amount in that series or 
tranche was 10 percent or less of its original amount at the inception 
of the series.
3. Risk-Weighted Asset Amounts for Securitization Exposures
    The proposed framework for assigning risk-based capital 
requirements to securitization exposures required banking organizations 
generally to calculate a risk-weighted asset amount for a 
securitization exposure by applying either (i) the simplified 
supervisory formula approach (SSFA), described in section VIII.H of the 
preamble, or (ii) if the banking organization is not subject to the 
market risk rule, a gross-up approach similar to an approach provided 
under the general risk-based capital rules. A banking organization 
would be required to apply either the SSFA or the gross-up approach 
consistently across all of its securitization exposures. However, a 
banking organization could choose to assign a 1,250 percent risk weight 
to any securitization exposure.
    Commenters expressed concerns regarding the potential differences 
in risk weights for similar exposures when using the gross-up approach 
compared to the SSFA, and the potential for capital arbitrage depending 
on the outcome of capital treatment under the framework. The FDIC 
acknowledges these concerns and, to reduce arbitrage opportunities, has 
required that a banking organization apply either the gross-up approach 
or the SSFA consistently across all of its securitization exposures. 
Commenters also asked the agencies to clarify how often and under what 
circumstances a banking organization is allowed to switch between the 
SSFA and the gross-up approach. While the FDIC is not placing 
restrictions on the ability of

[[Page 55435]]

FDIC-supervised institutions to switch from the SSFA to the gross-up 
approach, the FDIC does not anticipate there should be a need for 
frequent changes in methodology by an FDIC-supervised institution 
absent significant change in the nature of the FDIC-supervised 
institution's securitization activities, and expect FDIC-supervised 
institutions to be able to provide a rationale for changing 
methodologies to the FDIC if requested.
    Citing potential disadvantages of the proposed securitization 
framework as compared to standards to be applied to international 
competitors that rely on the use of credit ratings, some commenters 
requested that banking organizations be able to continue to implement a 
ratings-based approach to allow the agencies more time to calibrate the 
SSFA in accordance with international standards that rely on ratings. 
The FDIC again observes that the use of ratings in FDIC regulations is 
inconsistent with section 939A of the Dodd-Frank Act. Accordingly, the 
interim final rule does not include any references to, or reliance on, 
credit ratings. The FDIC has determined that the SSFA is an appropriate 
substitute standard to credit ratings that can be used to measure risk-
based capital requirements and may be implemented uniformly across 
institutions.
    Under the proposed securitization framework, banking organizations 
would have been required or could choose to assign a risk weight of 
1,250 percent to certain securitization exposures. Commenters stated 
that the 1,250 percent risk weight required under certain circumstances 
in the securitization framework would penalize banking organizations 
that hold capital above the total risk-based capital minimum and could 
require a banking organization to hold more capital against the 
exposure than the actual exposure amount at risk. As a result, 
commenters requested that the amount of risk-based capital required to 
be held against a banking organization's exposure be capped at the 
exposure amount. The FDIC has decided to retain the proposed 1,250 
percent risk weight in the interim final rule, consistent with their 
overall goals of simplicity and comparability, to provide for 
comparability in risk-weighted asset amounts for the same exposure 
across institutions.
    Consistent with the proposal, the interim final rule provides for 
alternative treatment of securitization exposures to ABCP programs and 
certain gains-on-sale and CEIO exposures. Specifically, similar to the 
general risk-based capital rules, the interim final rule includes a 
minimum 100 percent risk weight for interest-only mortgage-backed 
securities and exceptions to the securitization framework for certain 
small-business loans and certain derivatives as described below. An 
FDIC-supervised institution may use the securitization credit risk 
mitigation rules to adjust the capital requirement under the 
securitization framework for an exposure to reflect certain collateral, 
credit derivatives, and guarantees, as described in more detail below.
a. Exposure Amount of a Securitization Exposure
    Under the interim final rule, the exposure amount of an on-balance 
sheet securitization exposure that is not a repo-style transaction, 
eligible margin loan, OTC derivative contract or derivative that is a 
cleared transaction is generally the FDIC-supervised institution's 
carrying value of the exposure. The interim final rule modifies the 
proposed treatment for determining exposure amounts under the 
securitization framework to reflect the ability of an FDIC-supervised 
institution not subject to the advanced approaches rule to make an AOCI 
opt-out election. As a result, the exposure amount of an on-balance 
sheet securitization exposure that is an available-for-sale debt 
security or an available-for-sale debt security transferred to held-to-
maturity held by an FDIC-supervised institution that has made an AOCI 
opt-out election is the FDIC-supervised institution's carrying value 
(including net accrued but unpaid interest and fees), less any net 
unrealized gains on the exposure and plus any net unrealized losses on 
the exposure.
    The exposure amount of an off-balance sheet securitization exposure 
that is not an eligible ABCP liquidity facility, a repo-style 
transaction, eligible margin loan, an OTC derivative contract (other 
than a credit derivative), or a derivative that is a cleared 
transaction (other than a credit derivative) is the notional amount of 
the exposure. The treatment for OTC credit derivatives is described in 
more detail below.
    For purposes of calculating the exposure amount of an off-balance 
sheet exposure to an ABCP securitization exposure, such as a liquidity 
facility, consistent with the proposed rule, the notional amount may be 
reduced to the maximum potential amount that the FDIC-supervised 
institution 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 improve, then the exposure amount is $200. An 
ABCP program is defined as a program established primarily for the 
purpose of issuing commercial paper that is investment grade and backed 
by underlying exposures held in a securitization SPE. An eligible ABCP 
liquidity facility is defined as a liquidity facility supporting ABCP, 
in form or in substance, which 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. Notwithstanding these eligibility 
requirements, 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 that qualifies for a 20 percent risk weight or lower.
    Commenters, citing accounting changes that require certain ABCP 
securitization exposures to be consolidated on banking organizations 
balance sheets, asked the agencies to consider capping the amount of an 
off-balance sheet securitization exposure to the maximum potential 
amount that the banking organization could be required to fund given 
the securitization SPE's current underlying assets. These commenters 
stated that the downward adjustment of the notional amount of a banking 
organization's off-balance sheet securitization exposure to the amount 
of the available asset pool generally should be permitted regardless of 
whether the exposure to a customer SPE is made directly through a 
credit commitment by the banking organization to the SPE or indirectly 
through a funding commitment that the banking organization makes to an 
ABCP conduit. The FDIC believes that the requirement to hold risk-based 
capital against the full amount that may be drawn more accurately 
reflects the risks of potential draws under these exposures and have 
decided not to provide a separate provision for off-balance sheet 
exposures to customer-sponsored SPEs that are not ABCP conduits.
    Under the interim final rule, consistent with the proposal, the 
exposure amount of an eligible ABCP liquidity facility that is subject 
to the SSFA equals the notional amount of the exposure multiplied by a 
100 percent CCF. The exposure amount of an eligible ABCP liquidity 
facility that is not subject to the SSFA is the notional

[[Page 55436]]

amount of the exposure multiplied by a 50 percent CCF. The exposure 
amount of a securitization exposure that is a repo-style transaction, 
eligible margin loan, an OTC derivative contract (other than a 
purchased credit derivative), or derivative that is a cleared 
transaction (other than a purchased credit derivative) is the exposure 
amount of the transaction as calculated under section 324.34 or section 
324.37 of the interim final rule, as applicable.
b. Gains-on-Sale and Credit-Enhancing Interest-Only Strips
    Consistent with the proposal, under the interim final rule an FDIC-
supervised institution must deduct from common equity tier 1 capital 
any after-tax gain-on-sale resulting from a securitization and must 
apply a 1,250 percent risk weight to the portion of a CEIO that does 
not constitute an after-tax gain-on-sale. The FDIC believes this 
treatment is appropriate given historical supervisory concerns with the 
subjectivity involved in valuations of gains-on-sale and CEIOs. 
Furthermore, although the treatments for gains-on-sale and CEIOs can 
increase an originating FDIC-supervised institution's risk-based 
capital requirement following a securitization, the FDIC believes that 
such anomalies are rare where a securitization transfers significant 
credit risk from the originating FDIC-supervised institution to third 
parties.
c. Exceptions Under the Securitization Framework
    Commenters stated concerns that the proposal would inhibit demand 
for private label securitization by making it more difficult for 
banking organizations, especially community banking organizations, to 
purchase private label mortgage-backed securities. Instead of 
implementing the SSFA and the gross-up approach, commenters suggested 
allowing banking organizations to assign a 20 percent risk weight to 
securitization exposures that are backed by mortgage exposures that 
would be ``qualified mortgages'' under the Truth in Lending Act and 
implementing regulations issued by the CFPB.\156\ The FDIC believes 
that the proposed securitization approaches would be more appropriate 
in capturing the risks provided by structured transactions, including 
those backed by QM. The interim final rule does not provide an 
exclusion for such exposures.
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    \156\ 78 FR 6408 (Jan. 30, 2013).
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    Under the interim final rule, consistent with the proposal, there 
are several exceptions to the general provisions in the securitization 
framework that parallel the general risk-based capital rules. First, an 
FDIC-supervised institution is required to assign a risk weight of at 
least 100 percent to an interest-only MBS. The FDIC believes 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, as required by federal statute, a special set of 
rules continues to apply to securitizations of small-business loans and 
leases on personal property transferred with retained contractual 
exposure by well-capitalized depository institutions.\157\ Finally, if 
a securitization exposure is an OTC derivative contract or derivative 
contract that is a cleared transaction (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), an FDIC-
supervised institution may choose to set the risk-weighted asset amount 
of the exposure equal to the amount of the exposure.
---------------------------------------------------------------------------

    \157\ See 12 U.S.C. 1835. This provision places a cap on the 
risk-based capital requirement applicable to a well-capitalized 
depository institution that transfers small-business loans with 
recourse. The interim final rule does not expressly provide that the 
FDIC may permit adequately-capitalized FDIC-supervised institutions 
to use the small business recourse rule on a case-by-case basis 
because the FDIC may make such a determination under the general 
reservation of authority in section 1 of the interim final rule.
---------------------------------------------------------------------------

d. Overlapping Exposures
    Consistent with the proposal, the interim final rule includes 
provisions to limit the double counting of risks in situations 
involving overlapping securitization exposures. If an FDIC-supervised 
institution has multiple securitization exposures that provide 
duplicative coverage to the underlying exposures of a securitization 
(such as when an FDIC-supervised institution provides a program-wide 
credit enhancement and multiple pool-specific liquidity facilities to 
an ABCP program), the FDIC-supervised institution is not required to 
hold duplicative risk-based capital against the overlapping position. 
Instead, the FDIC-supervised institution must apply to the overlapping 
position the applicable risk-based capital treatment under the 
securitization framework that results in the highest risk-based capital 
requirement.
e. 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. Servicing banking organizations often provide a 
facility to the securitization under which the servicing banking 
organization 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. These servicer cash advance 
facilities are securitization exposures.
    Consistent with the proposal, under the interim final rule an FDIC-
supervised institution must apply the SSFA or the gross-up approach, as 
described below, or a 1,250 percent risk weight to a servicer cash 
advance facility. The treatment of the undrawn portion of the facility 
depends on whether the facility is an eligible servicer cash advance 
facility. An eligible servicer cash advance facility is 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 securitization if the servicer concludes 
the advances are unlikely to be repaid.
    Under the proposal, a banking organization that is a servicer under 
an eligible servicer cash advance facility is not required to hold 
risk-based capital against potential future cash advanced payments that 
it may be required to provide under the contract governing the 
facility. A banking organization that provides a non-eligible servicer 
cash advance facility would determine its risk-based capital 
requirement for the notional amount of the undrawn portion of the 
facility in the same manner as the banking organization would determine 
its risk-based capital requirement for other off-balance sheet 
securitization exposures. The FDIC is clarifying the terminology in the 
interim final rule to specify that an FDIC-supervised institution that 
is a servicer under a non-eligible servicer cash advance facility must 
hold risk-based capital against the amount of all potential

[[Page 55437]]

future cash advance payments that it may be contractually required to 
provide during the subsequent 12-month period under the contract 
governing the facility.
f. Implicit Support
    Consistent with the proposed rule, the interim final rule requires 
an FDIC-supervised institution that provides support to a 
securitization in excess of its predetermined contractual obligation 
(implicit support) to include in risk-weighted assets all of the 
underlying exposures associated with the securitization as if the 
exposures had not been securitized, and deduct from common equity tier 
1 capital any after-tax gain-on-sale resulting from the 
securitization.\158\ In addition, the FDIC-supervised institution must 
disclose publicly (i) that it has provided implicit support to the 
securitization, and (ii) the risk-based capital impact to the FDIC-
supervised institution of providing such implicit support. The FDIC 
notes that under the reservations of authority set forth in the interim 
final rule, the FDIC also could require the FDIC-supervised institution 
to hold risk-based capital against all the underlying exposures 
associated with some or all the FDIC-supervised institution's other 
securitizations as if the underlying exposures had not been 
securitized, and to deduct from common equity tier 1 capital any after-
tax gain-on-sale resulting from such securitizations.
---------------------------------------------------------------------------

    \158\ The interim final rule is consistent with longstanding 
guidance on the treatment of implicit support, entitled, 
``Interagency Guidance on Implicit Recourse in Asset 
Securitizations,'' (May 23, 2002). See FIL-52-2002.
---------------------------------------------------------------------------

4. Simplified Supervisory Formula Approach
    The proposed rule incorporated the SSFA, a simplified version of 
the supervisory formula approach (SFA) in the advanced approaches rule, 
to assign risk weights to securitization exposures. Many of the 
commenters focused on the burden of implementing the SSFA given the 
complexity of the approach in relation to the proposed treatment of 
mortgages exposures. Commenters also stated concerns that 
implementation of the SSFA would generally restrict credit growth and 
create competitive equity concerns with other jurisdictions 
implementing ratings-based approaches. The FDIC acknowledges that there 
may be differences in capital requirements under the SSFA and the 
ratings-based approach in the Basel capital framework. As explained 
previously, the use of alternative standards of creditworthiness in 
FDIC regulations is consistent with section 939A of the Dodd-Frank Act. 
Any alternative standard developed by the FDIC may not generate the 
same result as a ratings-based capital framework under every 
circumstance. However, the FDIC, together with the other agencies, has 
designed the SSFA to result in generally comparable capital 
requirements to those that would be required under the Basel ratings-
based approach without undue complexity. The FDIC will monitor 
implementation of the SSFA and, based on supervisory experience, 
consider what modifications, if any, may be necessary to improve the 
SSFA in the future.
    The FDIC has adopted the proposed SSFA largely as proposed, with a 
revision to the delinquency parameter (parameter W) that will increase 
the risk sensitivity of the approach and clarify the operation of the 
formula when the contractual terms of the exposures underlying a 
securitization permit borrowers to defer payments of principal and 
interest, as described below. To limit potential burden of implementing 
the SSFA, FDIC-supervised institutions that are not subject to the 
market risk rule may also choose to use as an alternative the gross-up 
approach described in section VIII.H.5 below, provided that they apply 
the gross-up approach to all of their securitization exposures.
    Similar to the SFA under the advanced approaches rule, the SSFA is 
a formula that starts with a baseline derived from the capital 
requirements that apply to all exposures underlying the securitization 
and then assigns risk weights based on the subordination level of an 
exposure. The FDIC designed the SSFA to apply relatively higher capital 
requirements to the more risky junior tranches of a securitization that 
are the first to absorb losses, and relatively lower requirements to 
the most senior exposures.
    The SSFA applies a 1,250 percent risk weight to securitization 
exposures that absorb losses up to the amount of capital that is 
required for the underlying exposures under subpart D of the interim 
final rule had those exposures been held directly by an FDIC-supervised 
institution. In addition, the FDIC is implementing a supervisory risk-
weight floor or minimum risk weight for a given securitization of 20 
percent. While some commenters requested that the floor be lowered for 
certain low-risk securitization exposures, the FDIC believes that a 20 
percent floor is prudent given the performance of many securitization 
exposures during the recent crisis.
    At the inception of a securitization, the SSFA requires more 
capital on a transaction-wide basis than would be required if the 
underlying assets had not been securitized. That is, if the FDIC-
supervised institution held every tranche of a securitization, its 
overall capital requirement would be greater than if the FDIC-
supervised institution held the underlying assets in portfolio. The 
FDIC believes this overall outcome is important in reducing the 
likelihood of regulatory capital arbitrage through securitizations.
    The proposed rule required banking organizations to use data to 
assign the SSFA parameters that are not more than 91 days old. 
Commenters requested that the data requirement be amended to account 
for securitizations of underlying assets with longer payment periods, 
such as transactions featuring annual or biannual payments. In 
response, the FDIC amended this requirement in the interim final rule 
so that data used to determine SSFA parameters must be the most 
currently available data. However, for exposures that feature payments 
on a monthly or quarterly basis, the interim final rule requires the 
data to be no more than 91 calendar days old.
    Under the interim final rule, to use the SSFA, an FDIC-supervised 
institution must obtain or determine the weighted-average risk weight 
of the underlying exposures (KG), as well as the attachment 
and detachment points for the FDIC-supervised institution's position 
within the securitization structure. ``KG,'' is calculated 
using the risk-weighted asset amounts in the standardized approach and 
is expressed as a decimal value between zero and 1 (that is, an average 
risk weight of 100 percent means that KG would equal 0.08). 
The FDIC-supervised institution may recognize the relative seniority of 
the exposure, as well as all cash funded enhancements, in determining 
attachment and detachment points. In addition, an FDIC-supervised 
institution must be able to determine the credit performance of the 
underlying exposures.
    The commenters expressed concerns that certain types of data that 
would be required to calculate KG may not be readily 
available, particularly data necessary to calculate the weighted-
average capital requirement of residential mortgages according to the 
proposed rule's standardized approach for residential mortgages. Some 
commenters therefore asked to be able to use the risk weights under the 
general risk-based capital rules for residential mortgages in the 
calculation of KG. Commenters also requested the use of 
alternative estimates or conservative

[[Page 55438]]

proxy data to implement the SSFA when a parameter is not readily 
available, especially for securitizations of mortgage exposures. As 
previously discussed, the FDIC is retaining in the interim final rule 
the existing mortgage treatment under the general risk-based capital 
rules. Accordingly, the FDIC believes that FDIC-supervised institutions 
should generally have access to the data necessary to calculate the 
SSFA parameters for mortgage exposures.
    Commenters characterized the KG parameter as not 
sufficiently risk sensitive and asked the agencies to provide more 
recognition under the SSFA with respect to the credit quality of the 
underlying assets. Some commenters observed that the SSFA did not take 
into account sequential pay structures. As a result, some commenters 
requested that banking organizations be allowed to implement cash-flow 
models to increase risk sensitivity, especially given that the SSFA 
does not recognize the various types of cash-flow waterfalls for 
different transactions.
    In developing the interim final rule, the FDIC considered the 
trade-offs between added risk sensitivity, increased complexity that 
would result from reliance on cash-flow models, and consistency with 
standardized approach risk weights. The FDIC believes it is important 
to calibrate capital requirements under the securitization framework in 
a manner that is consistent with the calibration used for the 
underlying assets of the securitization to reduce complexity and best 
align capital requirements under the securitization framework with 
requirements for credit exposures under the standardized approach. As a 
result, the FDIC has decided to finalize the KG parameter as 
proposed.
    To make the SSFA more risk-sensitive and forward-looking, the 
parameter KG is modified based on delinquencies among the 
underlying assets of the securitization. The resulting adjusted 
parameter is labeled KA. KA is set equal to the 
weighted average of the KG value and a fixed parameter equal 
to 0.5.

KA - C1 - W) [middot] KG + (0.5 
[middot] W)
    Under the proposal, the W parameter equaled the ratio of the sum of 
the dollar amounts of any underlying exposures of the securitization 
that are 90 days or more past due, subject to a bankruptcy or 
insolvency proceeding, in the process of foreclosure, held as real 
estate owned, in default, or have contractually deferred interest for 
90 days or more divided by the ending balance, measured in dollars, of 
the underlying exposures. Commenters expressed concern that the 
proposal would require additional capital for payment deferrals that 
are unrelated to the creditworthiness of the borrower, and encouraged 
the agencies to amend the proposal so that the numerator of the W 
parameter would not include deferrals of interest that are unrelated to 
the performance of the loan or the borrower, as is the case for certain 
federally-guaranteed student loans or certain consumer credit 
facilities that allow the borrower to defer principal and interest 
payments for the first 12 months following the purchase of a product or 
service. Some commenters also asserted that the proposed SSFA would not 
accurately calibrate capital requirements for those student loans with 
a partial government guarantee. Another commenter also asked for 
clarification on which exposures are in the securitized pool.
    In response to these concerns, the FDIC has decided to explicitly 
exclude from the numerator of parameter W loans with deferral of 
principal or interest for (1) federally-guaranteed student loans, in 
accordance with the terms of those programs, or (2) for consumer loans, 
including non-federally-guaranteed student loans, provided that such 
payments are deferred pursuant to provisions included in the contract 
at the time funds are disbursed that provide for period(s) of deferral 
that are not initiated based on changes in the creditworthiness of the 
borrower. The FDIC believes that the SSFA appropriately reflects 
partial government guarantees because such guarantees are reflected in 
KG in the same manner that they are reflected in capital 
requirements for loans held on balance sheet. For clarity, the FDIC has 
eliminated the term ``securitized pool'' from the interim final rule. 
The calculation of parameter W includes all underlying exposures of a 
securitization transaction.
    The FDIC believes that, with the parameter W calibration set equal 
to 0.5, the overall capital requirement produced by the SSFA is 
sufficiently responsive and prudent to ensure sufficient capital for 
pools that demonstrate credit weakness. The entire specification of the 
SSFA in the interim final rule is as follows:
[GRAPHIC] [TIFF OMITTED] TR10SE13.005

    KSSFA is the risk-based capital requirement for the 
securitization exposure and is a function of three variables, labeled 
a, u, and l. The constant e is the base of the natural logarithms 
(which equals 2.71828). The variables a, u, and l have the following 
definitions:
[GRAPHIC] [TIFF OMITTED] TR10SE13.006

    The values of A and D denote the attachment and detachment points, 
respectively, for the tranche. Specifically, A is the attachment point 
for the tranche that contains the securitization exposure and 
represents the threshold at which credit losses will first be allocated 
to the exposure. This input is the ratio, as expressed as a decimal 
value between zero and one, of the dollar amount of the securitization 
exposures that are subordinated to the tranche that contains the 
securitization exposure held by the FDIC-supervised institution to the 
current dollar amount of all underlying exposures.
    Commenters requested that the agencies recognize unfunded forms of

[[Page 55439]]

credit support, such as excess spread, in the calculation of A. 
Commenters also stated that where the carrying value of an exposure is 
less than its par value, the discount to par for a particular exposure 
should be recognized as additional credit protection. However, the FDIC 
believes it is prudent to recognize only funded credit enhancements, 
such as overcollateralization or reserve accounts funded by accumulated 
cash flows, in the calculation of parameter A. Discounts and write-
downs can be related to credit risk or due to other factors such as 
interest rate movements or liquidity. As a result, the FDIC does not 
believe that discounts or write-downs should be factored into the SSFA 
as credit enhancement.
    Parameter D is the detachment point for the tranche that contains 
the securitization exposure and represents the threshold at which 
credit losses allocated to the securitization exposure would result in 
a total loss of principal. This input, which is a decimal value between 
zero and one, equals the value of parameter A plus the ratio of the 
current dollar amount of the securitization exposures that are pari 
passu with the FDIC-supervised institution's securitization exposure 
(that is, have equal seniority with respect to credit risk) to the 
current dollar amount of all underlying exposures. The SSFA 
specification is completed by the constant term p, which is set equal 
to 0.5 for securitization exposures that are not resecuritizations, or 
1.5 for resecuritization exposures, and the variable KA, 
which is described above.
    When parameter D for a securitization exposure is less than or 
equal to KA, the exposure must be assigned a risk weight of 
1,250 percent. When A for a securitization exposure is greater than or 
equal to KA, the risk weight of the exposure, expressed as a 
percent, would equal KSSFA times 1,250. When A is less than 
KA and D is greater than KA, the applicable risk 
weight is a weighted average of 1,250 percent and 1,250 percent times 
KSSFA. As suggested by commenters, in order to make the 
description of the SSFA formula clearer, the term ``l'' has been 
redefined to be the maximum of 0 and A-KA, instead of the 
proposed A-KA. The risk weight would be determined according 
to the following formula:
[GRAPHIC] [TIFF OMITTED] TR10SE13.007

    For resecuritizations, FDIC-supervised institutions must use the 
SSFA to measure the underlying securitization exposure's contribution 
to KG. For example, consider a hypothetical securitization tranche that 
has an attachment point at 0.06 and a detachment point at 0.07. Then 
assume that 90 percent of the underlying pool of assets were mortgage 
loans that qualified for a 50 percent risk weight and that the 
remaining 10 percent of the pool was a tranche of a separate 
securitization (where the underlying exposures consisted of mortgages 
that also qualified for a 50 percent weight). An exposure to this 
hypothetical tranche would meet the definition of a resecuritization 
exposure. Next, assume that the attachment point A of the underlying 
securitization that is the 10 percent share of the pool is 0.06 and the 
detachment point D is 0.08. Finally, assume that none of the underlying 
mortgage exposures of either the hypothetical tranche or the underlying 
securitization exposure meet the interim final rule definition of 
``delinquent.''
    The value of KG for the resecuritization exposure equals 
the weighted average of the two distinct KG values. For the 
mortgages that qualify for the 50 percent risk weight and represent 90 
percent of the resecuritization, KG equals 0.04 (that is, 50 
percent of the 8 percent risk-based capital standard). 
KG,re-securitization = (0.9 [middot] 0.04) + (0.1 [middot] 
KG,securitization)
    To calculate the value of KG,securitization, an FDIC-
supervised institution would use the attachment and detachment points 
of 0.06 and 0.08, respectively. Applying those input parameters to the 
SSFA (together with p = 0.5 and KG = 0.04) results in a 
KG,securitization equal to 0.2325.
    Substituting this value into the equation yields:

KG,re-securitization = (0.9 [middot] 0.04) + (0.1 [middot] 
0.2325) = 0.05925
    This value of 0.05925 for KG,re-securitization, would 
then be used in the calculation of the risk-based capital requirement 
for the tranche of the resecuritization (where A = 0.06, B = 0.07, and 
p = 1.5). The result is a risk weight of 1,172 percent for the tranche 
that runs from 0.06 to 0.07. Given that the attachment point is very 
close to the value of KG,re-securitization the capital 
charge is nearly equal to the maximum risk weight of 1,250 percent.
    To apply the securitization framework to a single tranched exposure 
that has been re-tranched, such as some Re-REMICs, an FDIC-supervised 
institution must apply the SSFA or gross-up approach to the retranched 
exposure as if it were still part of the structure of the original 
securitization transaction. Therefore, an FDIC-supervised institution 
implementing the SSFA or the gross-up approach would calculate 
parameters for those approaches that would treat the retranched 
exposure as if it were still embedded in the original structure of the 
transaction while still recognizing any added credit enhancement 
provided by retranching. For example, under the SSFA an FDIC-supervised 
institution would calculate the approach using hypothetical attachment 
and detachment points that reflect the seniority of the retranched 
exposure within the original deal structure, as well as any additional 
credit enhancement provided by retranching of the exposure. Parameters 
that depend on pool-level characteristics, such as the W parameter 
under the SSFA, would be calculated based on the characteristics of the 
total underlying exposures of the initial securitization transaction, 
not just the retranched exposure.
5. Gross-Up Approach
    Under the interim final rule, consistent with the proposal, FDIC-
supervised institutions that are not subject to the market risk rule 
may assign risk-weighted asset amounts to securitization exposures by 
implementing the gross-up approach described in section 43 of the 
interim final rule, which is similar to an existing approach provided 
under the general risk-based capital rules. If the FDIC-supervised 
institution chooses to apply the gross-up approach, it is required to 
apply this approach to all of its securitization exposures, except as 
otherwise provided for certain securitization exposures under sections 
324.44 and 324.45 of the interim final rule.
    The gross-up approach assigns risk-weighted asset amounts based on 
the full amount of the credit-enhanced assets for which the FDIC-
supervised institution directly or indirectly assumes credit risk. To 
calculate risk-weighted assets under the gross-up

[[Page 55440]]

approach, an FDIC-supervised institution determines four inputs: the 
pro rata share, the exposure amount, the enhanced amount, and the 
applicable risk weight. The pro rata share is the par value of the 
FDIC-supervised institution's exposure as a percentage of the par value 
of the tranche in which the securitization exposure resides. The 
enhanced amount is the par value of all the tranches that are more 
senior to the tranche in which the exposure resides. The applicable 
risk weight is the weighted-average risk weight of the underlying 
exposures in the securitization as calculated under the standardized 
approach.
    Under the gross-up approach, an FDIC-supervised institution is 
required to calculate the credit equivalent amount, which equals the 
sum of (1) the exposure of the FDIC-supervised institution's 
securitization exposure and (2) the pro rata share multiplied by the 
enhanced amount. To calculate risk-weighted assets for a securitization 
exposure under the gross-up approach, an FDIC-supervised institution is 
required to assign the applicable risk weight to the gross-up credit 
equivalent amount. As noted above, in all cases, the minimum risk 
weight for securitization exposures is 20 percent.
    As discussed above, the FDIC recognizes that different capital 
requirements are likely to result from the application of the gross-up 
approach as compared to the SSFA. However, the FDIC believes allowing 
smaller, less complex FDIC-supervised institutions not subject to the 
market risk rule to use the gross up approach (consistent with past 
practice under the existing general risk-based capital rules) is 
appropriate and should reduce operational burden for many FDIC-
supervised institutions.
6. Alternative Treatments for Certain Types of Securitization Exposures
    Under the proposal, a banking organization generally would assign a 
1,250 percent risk weight to any securitization exposure to which the 
banking organization does not apply the SSFA or the gross-up approach. 
However, the proposal provided alternative treatments for certain types 
of securitization exposures described below, provided that the banking 
organization knows the composition of the underlying exposures at all 
times.
a. Eligible Asset-Backed Commercial Paper Liquidity Facilities
    Under the interim final rule, consistent with the proposal and the 
Basel capital framework, an FDIC-supervised institution is permitted to 
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 Securitization Exposure in a Second-Loss Position or Better to an 
Asset-Backed Commercial Paper Program
    Under the interim final rule and consistent with the proposal, an 
FDIC-supervised institution may determine the risk-weighted asset 
amount of a securitization exposure that is in a second-loss position 
or better to an ABCP program by multiplying the exposure amount by the 
higher of 100 percent and the highest risk weight applicable to any of 
the individual underlying exposures of the ABCP program, provided the 
exposure meets the following criteria:
    (1) The exposure is not an eligible ABCP liquidity facility;
    (2) The exposure is economically in a second-loss position or 
better, and the first-loss position provides significant credit 
protection to the second-loss position;
    (3) The exposure qualifies as investment grade; and
    (4) The FDIC-supervised institution holding the exposure does not 
retain or provide protection for the first-loss position.
    The FDIC believes that this approach, which is consistent with the 
Basel capital framework, appropriately and conservatively assesses the 
credit risk of non-first-loss exposures to ABCP programs. The FDIC is 
adopting this aspect of the proposal, without change, for purposes of 
the interim final rule.
7. Credit Risk Mitigation for Securitization Exposures
    Under the interim final rule, and consistent with the proposal, the 
treatment of credit risk mitigation for securitization exposures would 
differ slightly from the treatment for other exposures. To recognize 
the risk mitigating effects of financial collateral or an eligible 
guarantee or an eligible credit derivative from an eligible guarantor, 
an FDIC-supervised institution that purchases credit protection uses 
the approaches for collateralized transactions under section 324.37 of 
the interim final rule or the substitution treatment for guarantees and 
credit derivatives described in section 3324.6 of the interim final 
rule. In cases of maturity or currency mismatches, or, if applicable, 
lack of a restructuring event trigger, the FDIC-supervised institution 
must make any applicable adjustments to the protection amount of an 
eligible guarantee or credit derivative as required by section 324.36 
for any hedged securitization exposure. In addition, for synthetic 
securitizations, when an eligible guarantee or eligible credit 
derivative covers multiple hedged exposures that have different 
residual maturities, the FDIC-supervised institution is required to use 
the longest residual maturity of any of the hedged exposures as the 
residual maturity of all the hedged exposures. In the interim final 
rule, the FDIC is clarifying that an FDIC-supervised institution is not 
required to compute a counterparty credit risk capital requirement for 
the credit derivative provided that this treatment is applied 
consistently for all of its OTC credit derivatives. However, an FDIC-
supervised institution must calculate counterparty credit risk if the 
OTC credit derivative is a covered position under the market risk rule.
    Consistent with the proposal, an FDIC-supervised institution that 
purchases an OTC credit derivative (other than an n\th\-to-default 
credit derivative) that is recognized as a credit risk mitigant for a 
securitization exposure that is not a covered position under the market 
risk rule is not required to compute a separate counterparty credit 
risk capital requirement provided that the FDIC-supervised institution 
does so consistently for all such credit derivatives. The FDIC-
supervised institution must either include all or exclude 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. If an FDIC-supervised institution cannot, or chooses not to, 
recognize a credit derivative that is a securitization exposure as a 
credit risk mitigant, the FDIC-supervised institution must determine 
the exposure amount of the credit derivative under the treatment for 
OTC derivatives in section 34. In the interim final rule, the FDIC is 
clarifying that if the FDIC-supervised institution purchases the credit 
protection from a counterparty that is a securitization, the FDIC-
supervised institution must determine the risk weight for counterparty 
credit risk according to the securitization framework. If the FDIC-
supervised institution purchases credit protection from a counterparty 
that is not a securitization, the FDIC-supervised institution must 
determine the risk weight for counterparty credit risk according to 
general risk weights

[[Page 55441]]

under section 32. An FDIC-supervised institution that provides 
protection in the form of a guarantee or credit derivative (other than 
an n\th\-to-default credit derivative) that covers the full amount or a 
pro rata share of a securitization exposure's principal and interest 
must risk weight the guarantee or credit derivative as if it holds the 
portion of the reference exposure covered by the guarantee or credit 
derivative.
8. N\th\-to-Default Credit Derivatives
    Under the interim final rule and consistent with the proposal, the 
capital requirement for credit protection provided through an n\th\-to-
default credit derivative is determined either by using the SSFA, or 
applying a 1,250 percent risk weight.
    An FDIC-supervised institution providing credit protection must 
determine its exposure to an n\th\-to-default credit derivative as the 
largest notional amount of all the underlying exposures. When applying 
the SSFA, the attachment point (parameter A) is the ratio of the sum of 
the notional amounts of all underlying exposures that are subordinated 
to the FDIC-supervised institution's exposure to the total notional 
amount of all underlying exposures. In the case of a first-to-default 
credit derivative, there are no underlying exposures that are 
subordinated to the FDIC-supervised institution's exposure. In the case 
of a second-or-subsequent-to default credit derivative, the smallest 
(n-1) underlying exposure(s) are subordinated to the FDIC-supervised 
institution's exposure.
    Under the SSFA, the detachment point (parameter D) is the sum of 
the attachment point and the ratio of the notional amount of the FDIC-
supervised institution's exposure to the total notional amount of the 
underlying exposures. An FDIC-supervised institution that does not use 
the SSFA to calculate a risk weight for an n\th\-to-default credit 
derivative would assign a risk weight of 1,250 percent to the exposure.
    For protection purchased through a first-to-default derivative, an 
FDIC-supervised institution that obtains credit protection on a group 
of underlying exposures through a first-to-default credit derivative 
that meets the rules of recognition for guarantees and credit 
derivatives under section 324.36(b) of the interim final rule must 
determine its risk-based capital requirement for the underlying 
exposures as if the FDIC-supervised institution synthetically 
securitized the underlying exposure with the smallest risk-weighted 
asset amount and had obtained no credit risk mitigant on the other 
underlying exposures. An FDIC-supervised institution must calculate a 
risk-based capital requirement for counterparty credit risk according 
to section 324.34 of the interim final rule for a first-to-default 
credit derivative that does not meet the rules of recognition of 
section 324.36(b).
    For second-or-subsequent-to-default credit derivatives, an FDIC-
supervised institution that obtains credit protection on a group of 
underlying exposures through a n\th\-to-default credit derivative that 
meets the rules of recognition of section 324.36(b) of the interim 
final rule (other than a first-to-default credit derivative) may 
recognize the credit risk mitigation benefits of the derivative only if 
the FDIC-supervised institution also has 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. If an FDIC-supervised institution satisfies these 
requirements, the FDIC-supervised institution determines its risk-based 
capital requirement for the underlying exposures as if the FDIC-
supervised institution had only synthetically securitized the 
underlying exposure with the n\th\ smallest risk-weighted asset amount 
and had obtained no credit risk mitigant on the other underlying 
exposures. For a n\th\-to-default credit derivative that does not meet 
the rules of recognition of section 324.36(b), an FDIC-supervised 
institution must calculate a risk-based capital requirement for 
counterparty credit risk according to the treatment of OTC derivatives 
under section 324.34 of the interim final rule. The FDIC is adopting 
this aspect of the proposal without change for purposes of the interim 
final rule.

IX. Equity Exposures

    The proposal significantly revised the general risk-based capital 
rules' treatment for equity exposures. To improve risk sensitivity, the 
interim final rule generally follows the same approach to equity 
exposures as the proposal, while providing clarification on investments 
in a separate account as detailed below. In particular, the interim 
final rule requires an FDIC-supervised institution to apply the SRWA 
for equity exposures that are not exposures to an investment fund and 
apply certain look-through approaches to assign risk-weighted asset 
amounts to equity exposures to an investment fund. These approaches are 
discussed in greater detail below.

A. Definition of Equity Exposure and Exposure Measurement

    The FDIC is adopting the proposed definition of equity exposures, 
without change, for purposes of the interim final rule.\159\ Under the 
interim final rule, an FDIC-supervised institution is required to 
determine the adjusted carrying value for each equity exposure based on 
the approaches described below. For the on-balance sheet component of 
an equity exposure, other than an equity exposure that is classified as 
AFS where the FDIC-supervised institution has made an AOCI opt-out 
election under section 324.22(b)(2) of the interim final rule, the 
adjusted carrying value is an FDIC-supervised institution's carrying 
value of the exposure. For the on-balance sheet component of an equity 
exposure that is classified as AFS where the FDIC-supervised 
institution has made an AOCI opt-out election under section 
324.22(b)(2) of the interim final rule, the adjusted carrying value of 
the exposure is the FDIC-supervised institution's carrying value of the 
exposure less any net gains on the exposure that are reflected in the 
carrying value but excluded from the FDIC-supervised institution's 
regulatory capital components. For a commitment to acquire an equity 
exposure that is unconditional, the adjusted carrying value is the 
effective notional principal amount of the exposure multiplied by a 100 
percent conversion factor. For a commitment to acquire an equity 
exposure that is conditional, the adjusted carrying value is the 
effective notional principal amount of the commitment multiplied by (1) 
a 20 percent conversion factor, for a commitment with an original 
maturity of one year or less or (2) a 50 percent conversion factor, for 
a commitment with an original maturity of over one year. For the off-
balance sheet component of an equity exposure that is not an equity 
commitment, the adjusted carrying value is 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-

[[Page 55442]]

balance sheet component of the exposure.
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    \159\ See the definition of ``equity exposure'' in section 324.2 
of the interim final rule. However, as described above in section 
VIII.A of this preamble, the FDIC has adjusted the definition of 
``exposure amount'' in line with certain requirements necessary for 
FDIC-supervised institutions that make an AOCI opt-out election.
---------------------------------------------------------------------------

    The FDIC included the concept of the effective notional principal 
amount of the off-balance sheet portion of an equity exposure to 
provide a uniform method for FDIC-supervised institutions 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 change (for example, 1.0 
percent) 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.

B. Equity Exposure Risk Weights

    The proposal set forth a SRWA for equity exposures, which the FDIC 
has adopted without change in the interim final rule. Therefore, under 
the interim final rule, an FDIC-supervised institution determines 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 below, by the lowest 
applicable risk weight in section 324.52 of the interim final rule. An 
FDIC-supervised institution determines the risk-weighted asset amount 
for an equity exposure to an investment fund under section 324.53 of 
the interim final rule. An FDIC-supervised institution sums risk-
weighted asset amounts for all of its equity exposures to calculate its 
aggregate risk-weighted asset amount for its equity exposures.
    Some commenters asserted that mutual banking organizations, which 
are more highly exposed to equity exposures than traditional depository 
institutions, should be permitted to assign a 100 percent risk weight 
to their equity exposures rather than the proposed 300 percent risk 
weight for publicly-traded equity exposures or 400 percent risk weight 
for non-publicly traded equity exposures. Some commenters also argued 
that a banking organization's equity investment in a banker's bank 
should get special treatment, for instance, exemption from the 400 
percent risk weight or deduction as an investment in the capital of an 
unconsolidated financial institution.
    The FDIC has decided to retain the proposed risk weights in the 
interim final rule because it does not believe there is sufficient 
justification for a lower risk weight solely based on the nature of the 
institution (for example, mutual banking organization) holding the 
exposure. In addition, the FDIC believes that a 100 percent risk weight 
does not reflect the inherent risk for equity exposures that fall under 
the proposed 300 percent and 400 percent risk-weight categories or that 
are subject to deduction as investments in unconsolidated financial 
institutions. The FDIC has agreed to finalize the SRWA risk weights as 
proposed, which are summarized below in Table 24.

                  Table 24--Simple Risk-Weight Approach
------------------------------------------------------------------------
Risk weight  (in percent)                 Equity exposure
------------------------------------------------------------------------
0........................  An equity exposure to a sovereign, the Bank
                            for International Settlements, the European
                            Central Bank, the European Commission, the
                            International Monetary Fund, an MDB, and any
                            other entity whose credit exposures receive
                            a zero percent risk weight under section
                            324.32 of the interim final rule.
20.......................  An equity exposure to a PSE, Federal Home
                            Loan Bank or Farmer Mac.
100......................   Community development equity
                            exposures.\160\
                            The effective portion of a hedge
                            pair.
                            Non-significant equity exposures to
                            the extent that the aggregate adjusted
                            carrying value of the exposures does not
                            exceed 10 percent of tier 1 capital plus
                            tier 2 capital.
250......................  A significant investment in the capital of an
                            unconsolidated financial institution in the
                            form of common stock that is not deducted
                            under section 324.22 of the interim final
                            rule.
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
                            (i) would meet the definition of a
                            traditional securitization were it not for
                            the FDIC's application of paragraph (8) of
                            that definition and (ii) has greater than
                            immaterial leverage.
------------------------------------------------------------------------

     
---------------------------------------------------------------------------

    \160\ The interim final rule generally defines these exposures 
as exposures that 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). Under the proposal, a savings 
association's community development equity exposure investments was 
defined to mean an equity exposure 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 FDIC has determined that a separate 
definition for a savings association's community development equity 
exposure is not necessary and, therefore, the interim final rule 
applies one definition of community development equity exposure to 
all types of covered FDIC-supervised institutions.
---------------------------------------------------------------------------

    Consistent with the proposal, the interim final rule defines 
publicly traded as 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 is registered with, or approved by, a national 
securities regulatory authority and that provides a liquid, two-way 
market for the instrument in question. A two-way market refers to a 
market where there are independent bona fide offers to buy and sell so 
that a price reasonably related to the last sales price or current bona 
fide competitive bid and offer quotations can be determined within one 
day and settled at that price within a relatively short time frame 
conforming to trade custom.

[[Page 55443]]

C. Non-Significant Equity Exposures

    Under the interim final rule, and as proposed, an FDIC-supervised 
institution may apply a 100 percent risk weight to certain equity 
exposures deemed non-significant. Non-significant equity exposures 
means an equity exposure to the extent that the aggregate adjusted 
carrying value of the exposures does not exceed 10 percent of the FDIC-
supervised institution's total capital.\161\ To compute the aggregate 
adjusted carrying value of an FDIC-supervised institution's equity 
exposures for determining their non-significance, the FDIC-supervised 
institution may exclude (1) equity exposures that receive less than a 
300 percent risk weight under the SRWA (other than equity exposures 
determined to be non-significant); (2) the equity exposure in a hedge 
pair with the smaller adjusted carrying value; and (3) 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. If an 
FDIC-supervised institution does not know the actual holdings of the 
investment fund, the FDIC-supervised institution 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 FDIC-supervised institution must assume that the 
investment fund invests to the maximum extent possible in equity 
exposures.
---------------------------------------------------------------------------

    \161\ The definition excludes exposures to an investment firm 
that (1) meet the definition of traditional securitization were it 
not for the primary Federal regulator's application of paragraph (8) 
of the definition of a traditional securitization and (2) has 
greater than immaterial leverage.
---------------------------------------------------------------------------

    To determine which of an FDIC-supervised institution's equity 
exposures qualify for a 100 percent risk weight based on non-
significance, the FDIC-supervised institution first must 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. 
Next, it must include publicly-traded equity exposures (including those 
held indirectly through investment funds), and then it must include 
non-publicly-traded equity exposures (including those held indirectly 
through investment funds).\162\
---------------------------------------------------------------------------

    \162\ See 15 U.S.C. 682.
---------------------------------------------------------------------------

    One commenter proposed that certain exposures, including those to 
small-business investment companies, should not be subject to the 10 
percent capital limitation for non-significant equity exposures and 
should receive a 100 percent risk weight, consistent with the treatment 
of community development investments. The FDIC reflected upon this 
comment and determined to retain the proposed 10 percent limit on an 
FDIC-supervised institution's total capital in the interim final rule 
given the inherent credit and concentration risks associated with these 
exposures.

D. Hedged Transactions

    Under the proposal, to determine risk-weighted assets under the 
SRWA, a banking organization could identify hedge pairs, which would be 
defined as two equity exposures that form an effective hedge, as long 
as each equity exposure is publicly traded or has a return that is 
primarily based on a publicly traded equity exposure. A banking 
organization would 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. A few commenters requested 
that non-publicly traded equities be recognized in a hedged transaction 
under the rule. Equities that are not publicly traded are subject to 
considerable valuation uncertainty due to a lack of transparency and 
are generally far less liquid than publicly traded equities. The FDIC 
has therefore determined that given the potential increased risk 
associated with equities that are not publicly traded, recognition of 
these instruments as hedges under the rule is not appropriate. One 
commenter indicated that the test of hedge effectiveness used in the 
calculation of publicly traded equities should be more risk sensitive 
in evaluating all components of the transaction to better determine the 
appropriate risk weight. The examples the commenter highlighted 
indicated dissatisfaction with the assignment of a 100 percent risk 
weight to the effective portion of all hedge pairs. As described 
further below, the proposed rule contained three methodologies for 
identifying the measure of effectiveness of an equity hedge 
relationship, methodologies which recognize less-than-perfect hedges. 
The proposal assigns a 100 percent risk weight to the effective portion 
of a hedge pair because some hedge pairs involve residual risks. In 
developing the standardized approach the agencies sought to balance 
complexity and risk sensitivity, which limits the degree of granularity 
in hedge recognition. On balance, the FDIC believes that it is more 
reflective of an FDIC-supervised institutions risk profile to recognize 
a broader range of hedge pairs and assign all hedge pairs a 100 percent 
risk weight than to recognize only perfect hedges and assign a lower 
risk weight. Accordingly, the FDIC is finalizing the proposed treatment 
without change.
    Under the interim final rule, 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 FDIC-supervised institution acquires at least one of the 
equity exposures); the documentation specifies the measure of 
effectiveness (E) the FDIC-supervised institution uses for the hedge 
relationship throughout the life of the transaction; and the hedge 
relationship has an E greater than or equal to 0.8. An FDIC-supervised 
institution measures E at least quarterly and uses one of three 
measures of E described in the next section: the dollar-offset method, 
the variability-reduction method, or the regression method.
    It is possible that only part of an FDIC-supervised institution's 
exposure to a particular equity instrument is part of a hedge pair. For 
example, assume an FDIC-supervised institution has equity exposure A 
with a $300 adjusted carrying value and chooses to hedge a portion of 
that exposure with 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 FDIC-supervised 
institution treats $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 is calculated as E multiplied by the greater of 
the adjusted carrying values of the equity exposures forming the hedge 
pair. The ineffective portion of a hedge pair is calculated as (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 is 0.8 x $100 = $80, and the ineffective 
portion of the hedge pair is (1-0.8) x $100 = $20.

E. Measures of Hedge Effectiveness

    As stated above, an FDIC-supervised institution could determine 
effectiveness using any one of three

[[Page 55444]]

methods: the dollar-offset method, the variability-reduction method, or 
the regression method. Under the dollar-offset method, an FDIC-
supervised institution determines the ratio of the cumulative sum of 
the changes in value of one equity exposure to the cumulative sum of 
the changes in 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 is -1. 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 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.
    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 in the equation below) 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 is computed 
as:
[GRAPHIC] [TIFF OMITTED] TR10SE13.008

    The value of t ranges 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 equals 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. Accordingly, E is higher when 
the relationship between the values of the two exposures is closer.

F. Equity Exposures to Investment Funds

    Under the 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 
proposal included an additional option, referred to in the NPR as the 
full look-through approach. The agencies proposed this separate 
treatment for equity exposures to an investment fund to ensure that the 
regulatory capital treatment for these exposures is commensurate with 
the risk. Thus, the risk-based capital requirement for equity exposures 
to investment funds that hold only low-risk assets would be relatively 
low, whereas high-risk exposures held through investment funds would be 
subject to a higher capital requirement. The interim final rule 
implements these three approaches as proposed and clarifies that the 
risk-weight for any equity exposure to an investment fund must be no 
less than 20 percent.
    In addition, the interim final rule clarifies, generally consistent 
with prior agency guidance, that an FDIC-supervised institution must 
treat an investment in a separate account, such as bank-owned life 
insurance, as if it were an equity exposure to an investment fund.\163\ 
An FDIC-supervised institution must use one of the look-through 
approaches provided in section 53 and, if applicable, section 154 of 
the interim final rule to determine the risk-weighted asset amount for 
such investments. An FDIC-supervised institution that purchases stable 
value protection on its investment in a separate account must treat the 
portion of the carrying value of its investment in the separate account 
attributable to the stable value protection as an exposure to the 
provider of the protection and the remaining portion as an equity 
exposure to an investment fund. Stable value protection means a 
contract where the provider of the contract pays to the policy owner of 
the separate account an amount equal to the shortfall between the fair 
value and cost basis of the separate account when the policy owner of 
the separate account surrenders the policy. It also includes a contract 
where the provider of the contract pays to the beneficiary an amount 
equal to the shortfall between the fair value and book value of a 
specified portfolio of assets.
---------------------------------------------------------------------------

    \163\ Interagency Statement on the Purchase and Risk Management 
of Life Insurance, pp. 19-20, http://www.federalreserve.gov/boarddocs/srletters/2004/SR0419a1.pdf.
---------------------------------------------------------------------------

    An FDIC-supervised institution that provides stable value 
protection, such as through a stable value wrap that has provisions and 
conditions that minimize the wrap's exposure to credit risk of the 
underlying assets in the fund, must treat the exposure as if it were an 
equity derivative on an investment fund and determine the adjusted 
carrying value of the exposure as the sum of the adjusted carrying 
values of any on-balance sheet asset component determined according to 
section 324.51(b)(1), and the off-balance sheet component determined 
according to section 324.51(b)(3). That is, the adjusted carrying value 
is 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

[[Page 55445]]

same change in fair value (measured in dollars) given a small change in 
the price of the underlying equity instrument without subtracting the 
adjusted carrying value of the on-balance sheet component of the 
exposure as calculated under the same paragraph. Risk-weighted assets 
for such an exposure is determined by applying one of the three look-
through approaches as provided in section 324.53 and, if applicable, 
section 324.154 of the interim final rule.
    As discussed further below, under the interim final rule, an FDIC-
supervised institution determines the risk-weighted asset amount for 
equity exposures to investment funds using one of three approaches: the 
full look-through approach, the simple modified look-through approach, 
or the alternative modified look-through approach, unless the equity 
exposure to an investment fund is a community development equity 
exposure. The risk-weighted asset amount for such community development 
equity exposures is the exposure's adjusted carrying value. If an FDIC-
supervised institution does not use the full look-through approach, and 
an equity exposure to an investment fund is part of a hedge pair, an 
FDIC-supervised institution must 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 is equal to its adjusted carrying value. An 
FDIC-supervised institution could choose which approach to apply for 
each equity exposure to an investment fund.
1. Full Look-Through Approach
    An FDIC-supervised institution may use the full look-through 
approach only if the FDIC-supervised institution is able to calculate a 
risk-weighted asset amount for each of the exposures held by the 
investment fund. Under the interim final rule, an FDIC-supervised 
institution using the full look-through approach is required to 
calculate the risk-weighted asset amount for its proportionate 
ownership share of each of the exposures held by the investment fund 
(as calculated under subpart D of the interim final rule) as if the 
proportionate ownership share of the adjusted carrying value of each 
exposures were held directly by the FDIC-supervised institution. The 
FDIC-supervised institution's risk-weighted asset amount for the 
exposure to the fund is equal to (1) the aggregate risk-weighted asset 
amount of the exposures held by the fund as if they were held directly 
by the FDIC-supervised institution multiplied by (2) the FDIC-
supervised institution's proportional ownership share of the fund.
2. Simple Modified Look-Through Approach
    Under the simple modified look-through approach, an FDIC-supervised 
institution sets 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 applicable risk weight under 
subpart D of the interim final rule to any exposure the fund is 
permitted to hold under the prospectus, partnership agreement, or 
similar agreement that defines the fund's permissible investments. The 
FDIC-supervised institution 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.
3. Alternative Modified Look-Through Approach
    Under the alternative modified look-through approach, an FDIC-
supervised institution 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 subpart D of the interim final rule 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 FDIC-supervised 
institution's equity exposure to the investment fund is equal to the 
sum of each portion of the adjusted carrying value assigned to an 
exposure type multiplied by the applicable risk weight. If the sum of 
the investment limits for all permissible investments within the fund 
exceeds 100 percent, the FDIC-supervised institution must assume that 
the fund invests to the maximum extent permitted under its investment 
limits in the exposure type with the highest applicable risk weight 
under subpart D and continues to make investments in the order of the 
exposure category with the next highest risk weight until the maximum 
total investment level is reached. If more than one exposure category 
applies to an exposure, the FDIC-supervised institution must use the 
highest applicable risk weight. An FDIC-supervised institution 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.
    Commenters expressed concerns regarding the application of the 
look-through approaches where an investment fund holds securitization 
exposures. Specifically, the commenters indicated a banking 
organization would be forced to apply a 1,250 percent risk weight to 
investment funds that hold securitization exposures if the banking 
organization does not have the information required to use one of the 
two applicable methods under subpart D to calculate the risk weight 
applicable to a securitization exposure: gross-up treatment or the 
SSFA. According to the commenters, such an outcome would be overly 
punitive and inconsistent with the generally diversified composition of 
investment funds. The FDIC acknowledges that an FDIC-supervised 
institution may have some difficulty obtaining all the information 
needed to use the gross-up treatment or SSFA, but believes that the 
proposed approach provides strong incentives for FDIC-supervised 
institutions to obtain such information. As a result, the FDIC is 
finalizing the treatment as proposed.

X. Market Discipline and Disclosure Requirements

A. Proposed Disclosure Requirements

    The FDIC has long supported meaningful public disclosure by FDIC-
supervised institutions with the objective of improving market 
discipline and encouraging sound risk-management practices. The BCBS 
introduced public disclosure requirements under Pillar 3 of Basel II, 
which is designed to complement the minimum capital requirements and 
the supervisory review process by encouraging market discipline through 
enhanced and meaningful public disclosure.\164\ The BCBS introduced 
additional disclosure requirements in Basel III, which, under the 
interim final rule, apply to banking organizations as discussed 
herein.\165\
---------------------------------------------------------------------------

    \164\ The agencies incorporated the BCBS disclosure requirements 
into the advanced approaches rule in 2007. See 72 FR 69288, 69432 
(December 7, 2007).
    \165\ In June 2012, the BCBS adopted Pillar 3 disclosure 
requirements in a paper titled ``Composition of Capital Disclosure 
Requirements,'' available at http://www.bis.org/publ/bcbs221.pdf. 
The FDIC anticipates incorporating these disclosure requirements 
through a separate notice and comment period.
---------------------------------------------------------------------------

    The agencies received a limited number of comments on the proposed 
disclosure requirements. The commenters expressed some concern that the 
proposed requirements would be extended to apply to smaller banking 
organizations. As discussed further below, the agencies proposed the

[[Page 55446]]

disclosure requirements for banking organizations with $50 billion or 
more in assets and believe they are most appropriate for these 
companies. The FDIC believes that the proposed disclosure requirements 
strike the appropriate balance between the market benefits of 
disclosure and the additional burden to an FDIC-supervised institution 
that provides the disclosures, and therefore has adopted the 
requirements as proposed, with minor clarification with regard to 
timing of disclosures as discussed further below.
    The public disclosure requirements under section 62 of the interim 
final rule apply only to FDIC-supervised institutions with total 
consolidated assets of $50 billion or more that are not a consolidated 
subsidiary of a BHC, covered SLHC, or depository institution that is 
subject to these disclosure requirements or a subsidiary of a non-U.S. 
FDIC-supervised institution that is subject to comparable public 
disclosure requirements in its home jurisdiction or an advanced 
approaches FDIC-supervised institution making public disclosures 
pursuant to section 172 of the interim final rule. An advanced 
approaches FDIC-supervised institution that meets the $50 billion asset 
threshold, but that has not received approval from the FDIC to exit 
parallel run, must make the disclosures described in sections 324.62 
and 324.63 of the interim final rule. The FDIC notes that the asset 
threshold of $50 billion is consistent with the threshold established 
by section 165 of the Dodd-Frank Act relating to enhanced supervision 
and prudential standards for certain FDIC-supervised institutions.\166\ 
An FDIC-supervised institution may be able to fulfill some of the 
disclosure requirements by relying on similar disclosures made in 
accordance with federal securities law requirements. In addition, an 
FDIC-supervised institution may use information provided in regulatory 
reports to fulfill certain disclosure requirements. In these 
situations, an FDIC-supervised institution is required to explain any 
material differences between the accounting or other disclosures and 
the disclosures required under the interim final rule.
---------------------------------------------------------------------------

    \166\ See section 165(a) of the Dodd-Frank Act (12 U.S.C. 
5365(a)). The Dodd-Frank Act provides that the Board may, upon the 
recommendation of the Financial Stability Oversight Council, 
increase the $50 billion asset threshold for the application of the 
resolution plan, concentration limit, and credit exposure report 
requirements. See 12 U.S.C. 5365(a)(2)(B).
---------------------------------------------------------------------------

    An FDIC-supervised institution's exposure to risks 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 FDIC-supervised institution. Accordingly, an 
FDIC-supervised institution must have a formal disclosure policy 
approved by its board of directors that addresses the FDIC-supervised 
institution's approach for determining the disclosures it should make. 
The policy should address the associated internal controls, disclosure 
controls, and procedures. The board of directors and senior management 
should ensure the appropriate review of the disclosures and that 
effective internal controls, disclosure controls, and procedures are 
maintained. One or more senior officers of the FDIC-supervised 
institution must attest that the disclosures meet the requirements of 
this interim final rule.
    An FDIC-supervised institution must decide the relevant disclosures 
based on a materiality concept. Information is regarded as material for 
purposes of the disclosure requirements in the interim final rule if 
the information's 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.

B. Frequency of Disclosures

    Consistent with the FDIC's longstanding requirements for robust 
quarterly disclosures in regulatory reports, and considering the 
potential for rapid changes in risk profiles, the interim final rule 
requires that an FDIC-supervised institution provide timely public 
disclosures after each calendar quarter. However, qualitative 
disclosures that provide a general summary of an FDIC-supervised 
institution's risk-management objectives and policies, reporting 
system, and definitions may be disclosed annually after the end of the 
fourth calendar quarter, provided any significant changes are disclosed 
in the interim. The FDIC acknowledges that the timing of disclosures 
under the federal banking laws may not always coincide with the timing 
of disclosures required under other federal laws, including disclosures 
required under the federal securities laws and their implementing 
regulations by the SEC. For calendar quarters that do not correspond to 
fiscal year end, the FDIC considers those disclosures that are made 
within 45 days of the end of the calendar quarter (or within 60 days 
for the limited purpose of the FDIC-supervised institution's first 
reporting period in which it is subject to the rule's disclosure 
requirements) as timely. In general, where an FDIC-supervised 
institution's fiscal year-end coincides with the end of a calendar 
quarter, the FDIC considers qualitative and quantitative disclosures to 
be timely if they are made no later than the applicable SEC disclosure 
deadline for the corresponding Form 10-K annual report. In cases where 
an institution's fiscal year end does not coincide with the end of a 
calendar quarter, the FDIC would consider the timeliness of disclosures 
on a case-by-case basis. In some cases, management may determine that a 
significant change has occurred, such that the most recent reported 
amounts do not reflect the FDIC-supervised institution's capital 
adequacy and risk profile. In those cases, an FDIC-supervised 
institution needs to disclose the general nature of these changes and 
briefly describe how they are likely to affect public disclosures going 
forward. An FDIC-supervised institution should make these interim 
disclosures as soon as practicable after the determination that a 
significant change has occurred.

C. Location of Disclosures and Audit Requirements

    The disclosures required under the interim final rule must be 
publicly available (for example, included on a public Web site) for 
each of the last three years or such shorter time period beginning when 
the FDIC-supervised institution became subject to the disclosure 
requirements. For example, an FDIC-supervised institution that begins 
to make public disclosures in the first quarter of 2015 must make all 
of its required disclosures publicly available until the first quarter 
of 2018, after which it must make its required disclosures for the 
previous three years publicly available. Except as discussed below, 
management has some discretion to determine the appropriate medium and 
location of the disclosure. Furthermore, an FDIC-supervised institution 
has flexibility in formatting its public disclosures.
    The FDIC encourages management to provide all of the required 
disclosures in one place on the entity's public Web site and the FDIC 
anticipates that the public Web site address would be reported in an 
FDIC-supervised institution's regulatory report. However, an FDIC-
supervised institution may provide the disclosures in more than one 
public financial report or other regulatory reports (for example, in 
Management's Discussion and Analysis included in SEC filings), provided 
that the FDIC-supervised institution publicly provides a summary table 
specifically indicating the location(s) of all such disclosures (for 
example, regulatory

[[Page 55447]]

report schedules, page numbers in annual reports). The FDIC expects 
that disclosures of common equity tier 1, tier 1, and total capital 
ratios would be tested by external auditors as part of the financial 
statement audit.

D. Proprietary and Confidential Information

    The FDIC believes that the disclosure requirements strike an 
appropriate balance between the need for meaningful disclosure and the 
protection of proprietary and confidential information.\167\ 
Accordingly, the FDIC believes that FDIC-supervised institutions would 
be able to provide all of these disclosures without revealing 
proprietary and confidential information. Only in rare circumstances 
might disclosure of certain items of information required by the 
interim final rule compel an FDIC-supervised institution to reveal 
confidential and proprietary information. In these unusual situations, 
if an FDIC-supervised institution believes that disclosure of specific 
commercial or financial information would compromise its position by 
making public information that is either proprietary or confidential in 
nature, the FDIC-supervised institution will not be required to 
disclose those specific items under the rule's periodic disclosure 
requirement. Instead, the FDIC-supervised institution 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 applies only to 
those disclosures included in this interim final rule and does not 
apply to disclosure requirements imposed by accounting standards, other 
regulatory agencies, or under other requirements of the FDIC.
---------------------------------------------------------------------------

    \167\ Proprietary information encompasses information that, if 
shared with competitors, would render an FDIC-supervised 
institution'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.
---------------------------------------------------------------------------

E. Specific Public Disclosure Requirements

    The public disclosure requirements are designed to provide 
important information to market participants on the scope of 
application, capital, risk exposures, risk assessment processes, and, 
thus, the capital adequacy of the institution. The FDIC notes that the 
substantive content of the tables is the focus of the disclosure 
requirements, not the tables themselves. The table numbers below refer 
to the table numbers in section 63 of the interim final rule. An FDIC-
supervised institution must make the disclosures described in Tables 1 
through 10.\168\
---------------------------------------------------------------------------

    \168\ Other public disclosure requirements would continue to 
apply, such as federal securities law, and regulatory reporting 
requirements for FDIC-supervised institutions.
---------------------------------------------------------------------------

    Table 1 disclosures, ``Scope of Application,'' name the top 
corporate entity in the group to which subpart D of the interim final 
rule applies and include a brief description of the differences in the 
basis for consolidating entities for accounting and regulatory 
purposes, as well as a description of any restrictions, or other major 
impediments, on transfer of funds or total capital within the group. 
These disclosures provide the basic context underlying regulatory 
capital calculations.
    Table 2 disclosures, ``Capital Structure,'' provide summary 
information on the terms and conditions of the main features of 
regulatory capital instruments, which allow for an evaluation of the 
quality of the capital available to absorb losses within an FDIC-
supervised institution. An FDIC-supervised institution also must 
disclose the total amount of common equity tier 1, tier 1 and total 
capital, with separate disclosures for deductions and adjustments to 
capital. The FDIC expects that many of these disclosure requirements 
would be captured in revised regulatory reports.
    Table 3 disclosures, ``Capital Adequacy,'' provide information on 
an FDIC-supervised institution's approach for categorizing and risk 
weighting its exposures, as well as the amount of total risk-weighted 
assets. The Table also includes common equity tier 1, and tier 1 and 
total risk-based capital ratios for the top consolidated group, and for 
each depository institution subsidiary.
    Table 4 disclosures, ``Capital Conservation Buffer,'' require an 
FDIC-supervised institution to disclose the capital conservation 
buffer, the eligible retained income and any limitations on capital 
distributions and certain discretionary bonus payments, as applicable.
    Disclosures in Tables 5, ``Credit Risk: General Disclosures,'' 6, 
``General Disclosure for Counterparty Credit Risk-Related Exposures,'' 
and 7, ``Credit Risk Mitigation,'' relate to credit risk, counterparty 
credit risk and credit risk mitigation, respectively, and provide 
market participants with insight into different types and 
concentrations of credit risk to which an FDIC-supervised institution 
is exposed and the techniques it uses to measure, monitor, and mitigate 
those risks. These disclosures are intended to enable market 
participants to assess the credit risk exposures of the FDIC-supervised 
institution without revealing proprietary information.
    Table 8 disclosures, ``Securitization,'' provide information to 
market participants on the amount of credit risk transferred and 
retained by an FDIC-supervised institution through securitization 
transactions, the types of products securitized by the organization, 
the risks inherent in the organization's securitized assets, the 
organization's policies regarding credit risk mitigation, and the names 
of any entities that provide external credit assessments of a 
securitization. These disclosures provide a better understanding of how 
securitization transactions impact the credit risk of an FDIC-
supervised institution. For purposes of these disclosures, ``exposures 
securitized'' include underlying exposures transferred into a 
securitization by an FDIC-supervised institution, whether originated by 
the FDIC-supervised institution or purchased from third parties, and 
third-party exposures included in sponsored programs. Securitization 
transactions in which the originating FDIC-supervised institution does 
not retain any securitization exposure are shown separately and are 
only reported for the year of inception of the transaction.
    Table 9 disclosures, ``Equities Not Subject to Subpart F of this 
Part,'' provide market participants with an understanding of the types 
of equity securities held by the FDIC-supervised institution and how 
they are valued. These disclosures also provide information on the 
capital allocated to different equity products and the amount of 
unrealized gains and losses.
    Table 10 disclosures, ``Interest Rate Risk for Non-trading 
Activities,'' require an FDIC-supervised institution to provide certain 
quantitative and qualitative disclosures regarding the FDIC-supervised 
institution's management of interest rate risks.

XI. Risk-Weighted Assets--Modifications to the Advanced Approaches

    In the Advanced Approaches NPR, the agencies proposed revisions to 
the advanced approaches rule to incorporate certain aspects of Basel 
III, as well as the requirements introduced by the BCBS in the 2009

[[Page 55448]]

Enhancements \169\ and subsequent consultative papers. In accordance 
with Basel III, the proposal sought to require advanced approaches 
banking organizations to hold more appropriate levels of capital for 
counterparty credit risk, CVA, and wrong-way risk. Consistent with the 
2009 Enhancements, the agencies proposed to strengthen the risk-based 
capital requirements for certain securitization exposures by requiring 
banking organizations that are subject to the advanced approaches rule 
to conduct more rigorous credit analysis of securitization exposures 
and to enhance the disclosure requirements related to those exposures.
---------------------------------------------------------------------------

    \169\ See ``Enhancements to the Basel II framework'' (July 
2009), available at http://www.bis.org/publ/bcbs157.htm.
---------------------------------------------------------------------------

    The agencies also proposed revisions to the advanced approaches 
rule that are consistent with the requirements of section 939A of the 
Dodd-Frank Act.\170\ The agencies proposed to remove references to 
ratings from certain defined terms under the advanced approaches rule, 
as well as the ratings-based approach for securitization exposures, and 
replace these provisions with alternative standards of 
creditworthiness. The proposed rule also contained a number of proposed 
technical amendments to clarify or adjust existing requirements under 
the advanced approaches rule.
---------------------------------------------------------------------------

    \170\ See section 939A of Dodd-Frank Act (15 U.S.C. 78o-7 note).
---------------------------------------------------------------------------

    This section of the preamble describes the proposals in the 
Advanced Approaches NPR, comments received on those proposals, and the 
revisions to the advanced approaches rule reflected in the interim 
final rule.
    In many cases, the comments received on the Standardized Approach 
NPR were also relevant to the proposed changes to the advanced 
approaches framework. The FDIC generally took a consistent approach 
towards addressing the comments with respect to the standardized 
approach and the advanced approaches rule. Banking organizations that 
are or would be subject to the advanced approaches rule should refer to 
the relevant sections of the discussion of the standardized approach 
for further discussion of these comments.
    One commenter raised concerns about the use of models in 
determining regulatory capital requirements and encouraged the agencies 
to conduct periodic validation of banking organizations' models for 
capital adequacy and require modification if necessary. Consistent with 
the current advanced approaches rule, the interim final rule requires 
an FDIC-supervised institution to validate its models used to determine 
regulatory capital requirements on an ongoing basis. This validation 
must include an evaluation of conceptual soundness; an ongoing 
monitoring process that includes verification of processes and 
benchmarking; and an outcomes analysis process that includes 
backtesting. Under section 324.123 of the interim final rule, the FDIC 
may require the FDIC-supervised institution to calculate its advanced 
approaches risk-weighted assets according to modifications provided by 
the FDIC if the FDIC determines that the FDIC-supervised institution's 
advanced approaches total risk-weighted assets are not commensurate 
with its credit, market, operational or other risks.
    Other commenters suggested that the agencies interpret section 171 
of the Dodd-Frank Act narrowly with regard to the advanced approaches 
framework. The FDIC has adopted the approach taken in the proposed rule 
because it believes that the approach provides clear, consistent 
minimum requirements across institutions that comply with the 
requirements of section 171.

A. Counterparty Credit Risk

    The recent financial crisis highlighted certain aspects of the 
treatment of counterparty credit risk under the Basel II framework that 
were inadequate, and of banking organizations' risk management of 
counterparty credit risk that were insufficient. The Basel III 
revisions were intended to address both areas of weakness by ensuring 
that all material on- and off-balance sheet counterparty risks, 
including those associated with derivative-related exposures, are 
appropriately incorporated into banking organizations' risk-based 
capital ratios. In addition, new risk-management requirements in Basel 
III strengthen the oversight of counterparty credit risk exposures. The 
proposed rule included counterparty credit risk revisions in a manner 
generally consistent with the Basel III revisions to international 
standards, modified to incorporate alternative standards to the use of 
credit ratings. The discussion below highlights the proposed revisions, 
industry comments, and outcome of the interim final rule.
1. Recognition of Financial Collateral
a. Financial Collateral
    The EAD adjustment approach under section 132 of the proposed rules 
permitted a banking organization to recognize the credit risk 
mitigation benefits of financial collateral by adjusting the EAD rather 
than the loss given default (LGD) of the exposure for repo-style 
transactions, eligible margin loans and OTC derivative contracts. The 
permitted methodologies for recognizing such benefits included the 
collateral haircut approach, simple VaR approach and the IMM.
    Consistent with Basel III, the Advanced Approaches NPR proposed 
certain modifications to the definition of financial collateral. For 
example, the definition of financial collateral was modified so that 
resecuritizations would no longer qualify as financial collateral.\171\ 
Thus, resecuritization collateral could not be used to adjust the EAD 
of an exposure. The FDIC believes that this treatment is appropriate 
because resecuritizations have been shown to have more market value 
volatility than other types of financial collateral.
---------------------------------------------------------------------------

    \171\ Under the proposed rule, a securitization in which one or 
more of the underlying exposures is a securitization position would 
be a resecuritization. A resecuritization position under the 
proposal meant an on- or off-balance sheet exposure to a 
resecuritization, or an exposure that directly or indirectly 
references a securitization exposure.
---------------------------------------------------------------------------

    The proposed rule also removed conforming residential mortgages 
from the definition of financial collateral. As a result, a banking 
organization would no longer be able to recognize the credit risk 
mitigation benefit of such instruments through an adjustment to EAD. 
Consistent with the Basel III framework, the agencies proposed to 
exclude all debt securities that are not investment grade from the 
definition of financial collateral. As discussed in section VII.F of 
this preamble, the proposed rule revised the definition of ``investment 
grade'' for the advanced approaches rule and proposed conforming 
changes to the market risk rule.
    As discussed in section VIII.F of the preamble, the FDIC believes 
that the additional collateral types suggested by commenters are not 
appropriate forms of financial collateral because they exhibit 
increased variation and credit risk, and are relatively more 
speculative than the recognized forms of financial collateral under the 
proposal. In some cases, the assets suggested by commenters for 
eligibility as financial collateral were precisely the types of assets 
that became illiquid during the recent financial crisis. As a result, 
the FDIC has retained the definition of financial collateral as 
proposed.

[[Page 55449]]

b. Revised Supervisory Haircuts
    Securitization exposures have increased levels of volatility 
relative to other types of financial collateral. To address this issue, 
consistent with Basel III, the proposal incorporated new standardized 
supervisory haircuts for securitization exposures in the EAD adjustment 
approach based on the credit quality of the exposure. Consistent with 
section 939A of the Dodd-Frank Act, the proposed rule set out an 
alternative approach to assigning standard supervisory haircuts for 
securitization exposures, and amended the standard supervisory haircuts 
for other types of financial collateral to remove the references to 
credit ratings.
    Some commenters proposed limiting the maximum haircut for non-
sovereign issuers that receive a 100 percent risk weight to 12 percent, 
and more specifically assigning a lower haircut than 25 percent for 
financial collateral in the form of an investment-grade corporate debt 
security that has a shorter residual maturity. The commenters asserted 
that these haircuts conservatively correspond to the existing rating 
categories and result in greater alignment with the Basel framework. As 
discussed in section VIII.F of the preamble, in the interim final rule, 
the FDIC has revised the standard supervisory market price volatility 
haircuts for financial collateral issued by non-sovereign issuers with 
a risk weight of 100 percent from 25.0 percent to 4.0 percent for 
maturities of less than one year, 8.0 percent for maturities greater 
than one year but less than or equal to five years, and 16.0 percent 
for maturities greater than five years, consistent with Table 25 below. 
The FDIC believes that the revised haircuts better reflect the 
collateral's credit quality and an appropriate differentiation based on 
the collateral's residual maturity.
    Consistent with the proposal, under the interim final rule, 
supervisory haircuts for exposures to sovereigns, GSEs, public sector 
entities, depository institutions, foreign banks, credit unions, and 
corporate issuers are calculated based upon the risk weights for such 
exposures described under section 324.32 of the interim final rule. The 
interim final rule also clarifies that if an FDIC-supervised 
institution lends instruments that do not meet the definition of 
financial collateral, such as non-investment-grade corporate debt 
securities or resecuritization exposures, the haircut applied to the 
exposure must be 25 percent.

                                           Table 25--Standard Supervisory Market Price Volatility Haircuts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                            Haircut (in percent) assigned based on:
                                                     ------------------------------------------------------------------------------------   Investment-
                                                         Sovereign issuers risk weight under     Non-sovereign issuers risk weight under       grade
                  Residual maturity                          section 32 \2\ (in percent)                 section 32 (in percent)          securitization
                                                     ------------------------------------------------------------------------------------  exposures (in
                                                          Zero        20 or 50         100           20            50            100         percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than or equal to 1 year........................           0.5           1.0          15.0           1.0           2.0           4.0            4.0
Greater than 1 year and less than or equal to 5                2.0           3.0          15.0           4.0           6.0           8.0           12.0
 years..............................................
Greater than 5 years................................           4.0           6.0          15.0           8.0          12.0          16.0           24.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
                  Main index equities (including convertible bonds) and gold   15.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
                 Other publicly traded equities (including convertible bonds)  25.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                         Mutual funds   Highest haircut applicable to any security in which
                                                                       the fund can invest.
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                     Cash collateral held                      Zero
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                     Other exposure types                      25.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircuts in Table 25 are based on a 10 business-day holding period.
\2\ Includes a foreign PSE that receives a zero percent risk weight.

2. Holding Periods and the Margin Period of Risk
    As noted in the proposal, during the recent financial crisis, many 
financial institutions experienced significant delays in settling or 
closing out collateralized transactions, such as repo-style 
transactions and collateralized OTC derivative contracts. The assumed 
holding period for collateral in the collateral haircut and simple VaR 
approaches and the margin period of risk in the IMM proved to be 
inadequate for certain transactions and netting sets.\172\ It also did 
not reflect the difficulties and delays experienced by institutions 
when settling or liquidating collateral during a period of financial 
stress.
---------------------------------------------------------------------------

    \172\ Under the advanced approaches rule, the margin period of 
risk means, with respect to a netting set subject to a collateral 
agreement, the time period from the most recent exchange of 
collateral with a counterparty until the next required exchange of 
collateral plus the period of time required to sell and realize the 
proceeds of the least liquid collateral that can be delivered under 
the terms of the collateral agreement and, where applicable, the 
period of time required to re-hedge the resulting market risk, upon 
the default of the counterparty.
---------------------------------------------------------------------------

    Consistent with Basel III, the proposed rule would have amended the 
advanced approaches rule to incorporate adjustments to the holding 
period in the collateral haircut and simple VaR approaches, and to the 
margin period of risk in the IMM that a banking organization may use to 
determine its capital requirement for repo-style transactions, OTC 
derivative transactions, and eligible margin loans, with respect to 
large netting sets, netting sets involving illiquid collateral or 
including OTC derivatives that could not easily be replaced, or two 
margin disputes within a netting set over the previous two quarters 
that last for a certain length of time. For cleared transactions, which 
are discussed below, the agencies proposed not to require a banking 
organization to adjust the holding period or margin period of risk 
upward when determining the capital requirement for its counterparty 
credit risk exposures to the CCP, which is also consistent with Basel 
III.

[[Page 55450]]

    One commenter asserted that the proposed triggers for the increased 
margin period of risk were not in the spirit of the advanced approaches 
rule, which is intended to be more risk sensitive than the general 
risk-based capital rules. Another commenter asserted that banking 
organizations should be permitted to increase the holding period or 
margin period of risk by one or more business days, but not be required 
to increase it to the full period required under the proposal (20 
business days or at least double the margin period of risk).
    The FDIC believes the triggers set forth in the proposed rule, as 
well as the increased holding period or margin period of risk are 
empirical indicators of increased risk of delay or failure of close-out 
on the default of a counterparty. The goal of risk sensitivity would 
suggest that modifying these indicators is not warranted and could lead 
to increased risks to the banking system. Accordingly, the interim 
final rule adopts these features as proposed.
3. Internal Models Methodology
    Consistent with Basel III, the proposed rule would have amended the 
advanced approaches rule so that the capital requirement for IMM 
exposures is equal to the larger of the capital requirement for those 
exposures calculated using data from the most recent three-year period 
and data from a three-year period that contains a period of stress 
reflected in the credit default spreads of the banking organization's 
counterparties. The proposed rule defined an IMM exposure as a repo-
style transaction, eligible margin loan, or OTC derivative contract for 
which a banking organization calculates EAD using the IMM.
    The proposed rule would have required a banking organization to 
demonstrate to the satisfaction of the banking organization's primary 
Federal supervisor at least quarterly that the stress period it uses 
for the IMM coincides with increased CDS or other credit spreads of its 
counterparties and to have procedures in place to evaluate the 
effectiveness of its stress calibration. These procedures would have 
been required to include a process for using benchmark portfolios that 
are vulnerable to the same risk factors as the banking organization's 
portfolio. In addition, under the proposal, the primary Federal 
supervisor could require a banking organization to modify its stress 
calibration if the primary Federal supervisor believes that another 
calibration better reflects the actual historic losses of the 
portfolio.
    Consistent with Basel III and the current advanced approaches rule, 
the proposed rule would have required a banking organization to 
establish a process for initial validation and annual review of its 
internal models. As part of the process, the proposed rule would have 
required a banking organization to have a backtesting program for its 
model that includes a process by which unacceptable model performance 
is identified and remedied. In addition, a banking organization would 
have been required to multiply the expected positive exposure (EPE) of 
a netting set by the default scaling factor alpha (set equal to 1.4) in 
calculating EAD. The primary Federal supervisor could require the 
banking organization to set a higher default scaling factor based on 
the past performance of the banking organization's internal model.
    The proposed rule would have required a banking organization to 
have policies for the measurement, management, and control of 
collateral, including the reuse of collateral and margin amounts, as a 
condition of using the IMM. Under the proposal, a banking organization 
would have been required to have a comprehensive stress testing program 
for the IMM that captures all credit exposures to counterparties and 
incorporates stress testing of principal market risk factors and the 
creditworthiness of its counterparties.
    Basel III provided that a banking organization could capture within 
its internal model the effect on EAD of a collateral agreement that 
requires receipt of collateral when the exposure to the counterparty 
increases. Basel II also contained a ``shortcut'' method to provide a 
banking organization whose internal model did not capture the effects 
of collateral agreements with a method to recognize some benefit from 
the collateral agreement. Basel III modifies the ``shortcut'' method 
for capturing the effects of collateral agreements by setting effective 
EPE to a counterparty as the lesser of the following two exposure 
calculations: (1) The exposure without any held or posted margining 
collateral, plus any collateral posted to the counterparty independent 
of the daily valuation and margining process or current exposure, or 
(2) an add-on that reflects the potential increase of exposure over the 
margin period of risk plus the larger of (i) the current exposure of 
the netting set reflecting all collateral received or posted by the 
banking organization excluding any collateral called or in dispute; or 
(ii) the largest net exposure (including all collateral held or posted 
under the margin agreement) that would not trigger a collateral call. 
The add-on would be computed as the largest expected increase in the 
netting set's exposure over any margin period of risk in the next year. 
The proposed rule included the Basel III modification of the 
``shortcut'' method.
    The interim final rule adopts all the proposed requirements 
discussed above with two modifications. With respect to the proposed 
requirement that an FDIC-supervised institution must demonstrate on a 
quarterly basis to the FDIC the appropriateness of its stress period, 
under the interim final rule, the FDIC-supervised institution must 
instead demonstrate at least quarterly that the stress period coincides 
with increased CDS or other credit spreads of the FDIC-supervised 
institution's counterparties, and must maintain documentation of such 
demonstration. In addition, the formula for the ``shortcut'' method has 
been modified to clarify that the add-on is computed as the expected 
increase in the netting set's exposure over the margin period of risk.
a. Recognition of Wrong-Way Risk
    The recent financial crisis highlighted the interconnectedness of 
large financial institutions through an array of complex transactions. 
In recognition of this interconnectedness and to mitigate the risk of 
contagion from the banking sector to the broader financial system and 
the general economy, Basel III includes enhanced requirements for the 
recognition and treatment of wrong-way risk in the IMM. The proposed 
rule defined wrong-way risk as the risk that arises when an exposure to 
a particular counterparty is positively correlated with the probability 
of default of that counterparty.
    The proposed rule provided enhancements to the advanced approaches 
rule that require banking organizations' risk-management procedures to 
identify, monitor, and control wrong-way risk throughout the life of an 
exposure. The proposed rule required these risk-management procedures 
to include the use of stress testing and scenario analysis. In 
addition, where a banking organization has identified an IMM exposure 
with specific wrong-way risk, the banking organization would be 
required to treat that transaction as its own netting set. The proposed 
rule defined specific wrong-way risk as a type of wrong-way risk that 
arises when either the counterparty and issuer of the collateral 
supporting the transaction, or the counterparty and the reference asset 
of the transaction, are affiliates or are the same entity.
    In addition, under the proposal, where a banking organization has

[[Page 55451]]

identified an OTC derivative transaction, repo-style transaction, or 
eligible margin loan with specific wrong-way risk for which the banking 
organization otherwise applies the IMM, the banking organization would 
set the probability of default (PD) of the counterparty and a LGD equal 
to 100 percent. The banking organization would then enter these 
parameters into the appropriate risk-based capital formula specified in 
Table 1 of section 131 of the proposed rule, and multiply the output of 
the formula (K) by an alternative EAD based on the transaction type, as 
follows:
    (1) For a purchased credit derivative, EAD would be the fair value 
of the underlying reference asset of the credit derivative contract;
    (2) For an OTC equity derivative,\173\ EAD would be the maximum 
amount that the banking organization could lose if the fair value of 
the underlying reference asset decreased to zero;
---------------------------------------------------------------------------

    \173\ Under the interim final rule, equity derivatives that are 
call options are not subject to a counterparty credit risk capital 
requirement for specific wrong-way risk.
---------------------------------------------------------------------------

    (3) For an OTC bond derivative (that is, a bond option, bond 
future, or any other instrument linked to a bond that gives rise to 
similar counterparty credit risks), EAD would be the smaller of the 
notional amount of the underlying reference asset and the maximum 
amount that the banking organization could lose if the fair value of 
the underlying reference asset decreased to zero; and
    (4) For repo-style transactions and eligible margin loans, EAD 
would be calculated using the formula in the collateral haircut 
approach of section 132 of the interim final rule and with the 
estimated value of the collateral substituted for the parameter C in 
the equation.
    The interim final rule adopts the proposed requirements regarding 
wrong-way risk discussed above.
b. Increased Asset Value Correlation Factor
    To recognize the correlation of financial institutions' 
creditworthiness attributable to similar sensitivities to common risk 
factors, the agencies proposed to incorporate the Basel III increase in 
the correlation factor used in the formulas provided in Table 1 of 
section 131 of the proposed rule for certain wholesale exposures. Under 
the proposed rule, banking organizations would apply a multiplier of 
1.25 to the correlation factor for wholesale exposures to unregulated 
financial institutions that generate a majority of their revenue from 
financial activities, regardless of asset size. This category would 
include highly leveraged entities, such as hedge funds and financial 
guarantors. The proposal also included a definition of ``regulated 
financial institution,'' meaning a financial institution subject to 
consolidated supervision and regulation comparable to that imposed on 
certain U.S. financial institutions, namely depository institutions, 
depository institution holding companies, nonbank financial companies 
supervised by the Federal Reserve, designated FMUs, securities broker-
dealers, credit unions, or insurance companies. Banking organizations 
would apply a multiplier of 1.25 to the correlation factor for 
wholesale exposures to regulated financial institutions with 
consolidated assets of greater than or equal to $100 billion.
    Several commenters pointed out that in the proposed formulas for 
wholesale exposures to unregulated and regulated financial 
institutions, the 0.18 multiplier should be revised to 0.12 in order to 
be consistent with Basel III. The FDIC has corrected this aspect of 
both formulas in the interim final rule.
    Another comment asserted that the 1.25 multiplier for the 
correlation factor for wholesale exposures to unregulated financial 
institutions or regulated financial institutions with more than $100 
billion in assets is an overly blunt tool and is not necessary as 
single counterparty credit limits already address interconnectivity 
risk. Consistent with the concerns about systemic risk and 
interconnectedness surrounding these classes of institutions, the FDIC 
continues to believe that the 1.25 multiplier appropriately reflects 
the associated additional risk. Therefore, the interim final rule 
retains the 1.25 multiplier. In addition, the interim final rule also 
adopts the definition of ``regulated financial institution'' without 
change from the proposal. As discussed in section V.B, above, the FDIC 
received significant comment on the definition of ``financial 
institution'' in the context of deductions of investments in the 
capital of unconsolidated financial institutions. That definition also, 
under the proposal, defined the universe of ``unregulated'' financial 
institutions as companies meeting the definition of ``financial 
institution'' that were not regulated financial institutions. For the 
reasons discussed in section V.B of the preamble, the FDIC has modified 
the definition of ``financial institution,'' including by introducing 
an ownership interest threshold to the ``predominantly engaged'' test 
to determine if an FDIC-supervised institution must subject a 
particular unconsolidated investment in a company that may be a 
financial institution to the relevant deduction thresholds under 
subpart C of the interim final rule. While commenters stated that it 
would be burdensome to determine whether an entity falls within the 
definition of financial institution using the predominantly engaged 
test, the FDIC believes that advanced approaches FDIC-supervised 
institutions should have the systems and resources to identify the 
activities of their wholesale counterparties. Accordingly, under the 
interim final rule, the FDIC has adopted a definition of ``unregulated 
financial institution'' that does not include the ownership interest 
threshold test but otherwise incorporates revisions to the definition 
of ``financial institution.'' Under the interim final rule, an 
``unregulated financial institution'' is a financial institution that 
is not a regulated financial institution and that meets the definition 
of ``financial institution'' under the interim final rule without 
regard to the ownership interest thresholds set forth in paragraph 
(4)(i) of that definition. The FDIC believes the ``unregulated 
financial institution'' definition is necessary to maintain an 
appropriate scope for the 1.25 multiplier consistent with the proposal 
and Basel III.
4. Credit Valuation Adjustments
    After the recent financial crisis, the BCBS reviewed the treatment 
of counterparty credit risk and found that roughly two-thirds of 
counterparty credit risk losses during the crisis were due to fair 
value losses from CVA (that is, the fair value adjustment to reflect 
counterparty credit risk in the valuation of an OTC derivative 
contract), whereas one-third of counterparty credit risk losses 
resulted from actual defaults. The internal ratings-based approach in 
Basel II addressed counterparty credit risk as a combination of default 
risk and credit migration risk. Credit migration risk accounts for fair 
value losses resulting from deterioration of counterparties' credit 
quality short of default and is addressed in Basel II via the maturity 
adjustment multiplier. However, the maturity adjustment multiplier in 
Basel II was calibrated for loan portfolios and may not be suitable for 
addressing CVA risk. Basel III therefore includes an explicit capital 
requirement for CVA risk. Accordingly, consistent with Basel III and 
the proposal, the interim final rule requires FDIC-supervised 
institutions to calculate risk-weighted assets for CVA risk.

[[Page 55452]]

    Consistent with the Basel III CVA capital requirement and the 
proposal, the interim final rule reflects in risk-weighted assets a 
potential increase of the firm-wide CVA due to changes in 
counterparties' credit spreads, assuming fixed expected exposure (EE) 
profiles. The proposed and interim final rules provide two approaches 
for calculating the CVA capital requirement: the simple approach and 
the advanced CVA approach. However, unlike Basel III, they do not 
include references to credit ratings.
    Consistent with the proposal and Basel III, the simple CVA approach 
in the interim final rule permits calculation of the CVA capital 
requirement (KCVA) based on a formula described in more 
detail below, with a modification consistent with section 939A of the 
Dodd-Frank Act. Under the advanced CVA approach in the interim final 
rule, consistent with the proposal, an FDIC-supervised institution 
would use the VaR model that it uses to calculate specific risk under 
section 324.207(b) of subpart F or another model that meets the 
quantitative requirements of sections 324.205(b) and 324.207(b)(1) of 
subpart F to calculate its CVA capital requirement for its entire 
portfolio of OTC derivatives that are subject to the CVA capital 
requirement \174\ by modeling the impact of changes in the 
counterparties' credit spreads, together with any recognized CVA hedges 
on the CVA for the counterparties. To convert the CVA capital 
requirement to a risk-weighted asset amount, an FDIC-supervised 
institution must multiply its CVA capital requirement by 12.5. The CVA 
risk-weighted asset amount is not a component of credit risk-weighted 
assets and therefore is not subject to the 1.06 multiplier for credit 
risk-weighted assets under the interim final rule. Consistent with the 
proposal, the interim final rule provides that only an FDIC-supervised 
institution that is subject to the market risk rule and had obtained 
prior approval from the FDIC to calculate (1) the EAD for OTC 
derivative contracts using the IMM described in section 324.132, and 
(2) the specific risk add-on for debt positions using a specific risk 
model described in section 324.207(b) of subpart F is eligible to use 
the advanced CVA approach. An FDIC-supervised institution that receives 
such approval would be able to continue to use the advanced CVA 
approach until it notifies the FDIC in writing that it expects to begin 
calculating its CVA capital requirement using the simple CVA approach. 
Such notice must include an explanation from the FDIC-supervised 
institution as to why it is choosing to use the simple CVA approach and 
the date when the FDIC-supervised institution would begin to calculate 
its CVA capital requirement using the simple CVA approach.
---------------------------------------------------------------------------

    \174\ Certain CDS may be exempt from inclusion in the portfolio 
of OTC derivatives that are subject to the CVA capital requirement. 
For example, a CDS on a loan that is recognized as a credit risk 
mitigant and receives substitution treatment under section 134 would 
not be included in the portfolio of OTC derivatives that are subject 
to the CVA capital requirement.
---------------------------------------------------------------------------

    Consistent with the proposal, under the interim final rule, when 
calculating a CVA capital requirement, an FDIC-supervised institution 
may recognize the hedging benefits of single name CDS, single name 
contingent CDS, any other equivalent hedging instrument that references 
the counterparty directly, and index CDS (CDSind), provided 
that the equivalent hedging instrument is managed as a CVA hedge in 
accordance with the FDIC-supervised institution's hedging policies. A 
tranched or n\th\-to-default CDS would not qualify as a CVA hedge. In 
addition, any position that is recognized as a CVA hedge would not be a 
covered position under the market risk rule, except in the case where 
the FDIC-supervised institution is using the advanced CVA approach, the 
hedge is a CDSind, and the VaR model does not capture the 
basis between the spreads of the index that is used as the hedging 
instrument and the hedged counterparty exposure over various time 
periods, as discussed in further detail below. The agencies received 
several comments on the proposed CVA capital requirement. One commenter 
asserted that there was ambiguity in the ``total CVA risk-weighted 
assets'' definition which could be read as indicating that 
KCVA is calculated for each counterparty and then summed. 
The FDIC agrees that KCVA relates to an FDIC-supervised 
institution's entire portfolio of OTC derivatives contracts, and the 
interim final rule reflects this clarification.
    A commenter asserted that the proposed CVA treatment should not 
apply to central banks, MDBs and other similar counterparties that have 
very low credit risk, such as the Bank for International Settlements 
and the European Central Bank, as well as U.S. PSEs. Another commenter 
pointed out that the proposal in the European Union to implement Basel 
III excludes sovereign, pension fund, and corporate counterparties from 
the proposed CVA treatment. Another commenter argued that the proposed 
CVA treatment should not apply to transactions executed with end-users 
when hedging business risk because the resulting increase in pricing 
will disproportionately impact small- and medium-sized businesses.
    The interim final rule does not exempt the entities suggested by 
commenters. However, the FDIC anticipates that a counterparty that is 
exempt from the 0.03 percent PD floor under Sec.  324.131(d)(2) and 
receives a zero percent risk weight under Sec.  324.32 (that is, 
central banks, MDBs, the Bank for International Settlements and 
European Central Bank) likely would attract a minimal CVA requirement 
because the credit spreads associated with these counterparties have 
very little variability. Regarding the other entities mentioned by 
commenters (U.S. public sector entities, pension funds and corporate 
end-users), the FDIC believes it is appropriate for CVA to apply as 
these counterparty types exhibit varying degrees of credit risk.
    Some commenters asked that the agencies clarify that interest rate 
hedges of CVA are not covered positions as defined in subpart F and, 
therefore, not subject to a market risk capital requirement. In 
addition, some commenters asserted that the overall capital 
requirements for CVA are more appropriately addressed as a trading book 
issue in the context of the BCBS Fundamental Review of the Trading 
Book.\175\ Another commenter asserted that CVA rates hedges (to the 
extent they might be covered positions) should be excluded from the 
market-risk rule capital requirements until supervisors are ready to 
approve allowing CVA rates sensitivities to be incorporated into a 
banking organization's general market risk VaR.
---------------------------------------------------------------------------

    \175\ See ``Fundamental review of the trading book'' (May 2012) 
available at http://www.bis.org/publ/bcbs219.pdf.
---------------------------------------------------------------------------

    The FDIC recognizes that CVA is not a covered position under the 
market risk rule. Hence, as elaborated in the market risk rule, hedges 
of non-covered positions that are not themselves trading positions also 
are not eligible to be a covered position under the market risk rule. 
Therefore, the FDIC clarifies that non-credit risk hedges (market risk 
hedges or exposure hedges) of CVA generally are not covered positions 
under the market risk rule, but rather are assigned risk-weighted asset 
amounts under subparts D and E of the interim final rule.\176\ Once the 
BCBS Fundamental Review of the Trading

[[Page 55453]]

Book is complete, the agencies will review the BCBS findings and 
consider whether they are appropriate for U.S. banking organizations.
---------------------------------------------------------------------------

    \176\ The FDIC believes that an FDIC-supervised institution 
needs to demonstrate rigorous risk management and the efficacy of 
its CVA hedges and should follow the risk management principles of 
the Interagency Supervisory Guidance on Counterparty Credit Risk 
Management (2011) and identification of covered positions as in the 
FDIC's market risk rule, see 77 FR 53060 (August 30, 2012).
---------------------------------------------------------------------------

    One commenter asserted that observable LGDs for credit derivatives 
do not represent the best estimation of LGD for calculating CVA under 
the advanced CVA approach, and that a final rule should instead 
consider a number of parameters, including market observable recovery 
rates on unsecured bonds and structural components of the derivative. 
Another commenter argued that banking organizations should be permitted 
greater flexibility in determining market-implied loss given default 
(LGDMKT) and credit spread factors for VaR.
    Consistent with the BCBS's frequently asked question (BCBS FAQ) on 
this topic,\177\ the FDIC recognizes that while there is often limited 
market information of LGDMKT (or equivalently the market 
implied recovery rate), the FDIC considers the use of LGDMKT 
to be the most appropriate approach to quantify CVA. It is also the 
market convention to use a fixed recovery rate for CDS pricing 
purposes; FDIC-supervised institutions may use that information for 
purposes of the CVA capital requirement in the absence of other 
information. In cases where a netting set of OTC derivative contracts 
has a different seniority than those derivative contracts that trade in 
the market from which LGDMKT is inferred, an FDIC-supervised 
institution may adjust LGDMKT to reflect this difference in 
seniority. Where no market information is available to determine 
LGDMKT, an FDIC-supervised institution may propose a method 
for determining LGDMKT based upon data collected by the 
FDIC-supervised institution that would be subject to approval by the 
FDIC. The interim final rule has been amended to include this 
alternative.
---------------------------------------------------------------------------

    \177\ See ``Basel III counterparty credit risk and exposures to 
central counterparties--Frequently asked questions (December 2012 
(update of FAQs published November 2012)) at http://www.bis.org/publ/bcbs237.pdf.
---------------------------------------------------------------------------

    Regarding the proposed CVA EAD calculation assumptions in the 
advanced CVA approach, one commenter asserted that EE constant 
treatment is inappropriate, and that it is more appropriate to use the 
weighted average maturity of the portfolio rather than the netting set. 
Another commenter asserted that maturity should equal the weighted 
average maturity of all transactions in the netting set, rather than 
the greater of the notional weighted average maturity and the maximum 
of half of the longest maturity occurring in the netting set. The FDIC 
notes that this issue is relevant only where an FDIC-supervised 
institution utilized the current exposure method or the ``shortcut'' 
method, rather than IMM, for any immaterial portfolios of OTC 
derivatives contracts. As a result, the interim final rule retains the 
requirement to use the greater of the notional weighted average 
maturity (WAM) and the maximum of half of the longest maturity in the 
netting set when calculating EE constant treatment in the advanced CVA 
approach.
    One commenter asked the agencies to clarify that section 132(c)(3) 
would exempt the purchased CDS from the proposed CVA capital 
requirements in section 132(e) of a final rule. Consistent with the 
BCBS FAQ on this topic, the FDIC agrees that purchased credit 
derivative protection against a wholesale exposure that is subject to 
the double default framework or the PD substitution approach and where 
the wholesale exposure itself is not subject to the CVA capital 
requirement, will not be subject to the CVA capital requirement in the 
interim final rule. Also consistent with the BCBS FAQ, the purchased 
credit derivative protection may not be recognized as a hedge for any 
other exposure under the interim final rule.
    Another commenter asserted that single-name proxy CDS trades should 
be allowed as hedges in the advanced CVA approach CVA VaR calculation. 
Under the interim final rule, an FDIC-supervised institution is 
permitted to recognize the hedging benefits of single name CDS, single 
name contingent CDS, any other equivalent hedging instrument that 
references the counterparty directly, and CDSind, provided 
that the hedging instrument is managed as a CVA hedge in accordance 
with the FDIC-supervised institution's hedging policies. The interim 
final rule does not permit the use of single-name proxy CDS. The FDIC 
believes this is an important limitation because of the significant 
basis risk that could arise from the use of a single-name proxy.
    Additionally, the interim final rule reflects several clarifying 
amendments to the proposed rule. First, the interim final rule divides 
the Advanced CVA formulas in the proposed rule into two parts: Formula 
3 and Formula 3a. The FDIC believes that this clarification is 
important to reflect the different purposes of the two formulas: the 
first formula (Formula 3) is for the CVA VaR calculation, whereas the 
second formula (Formula 3a) is for calculating CVA for each credit 
spread simulation scenario. The interim final rule includes a 
description that clarifies each formula's purpose. In addition, the 
notations in proposed Formula 3 have been changed from 
CVAstressedVaR and CVAunstressedVaR to 
VaRCVAstressed and 
VaRCVAunstressed. The definitions of these terms 
have not changed in the interim final rule. Finally, the subscript 
``j'' in Formula 3a has been defined as referring either to 
stressed or unstressed calibrations. These formulas are discussed in 
the interim final rule description below.
a. Simple Credit Valuation Adjustment approach
    Under the interim final rule, an FDIC-supervised institution 
without approval to use the advanced CVA approach must use formula 1 to 
calculate its CVA capital requirement for its entire portfolio of OTC 
derivative contracts. The simple CVA approach is based on an analytical 
approximation derived from a general CVA VaR formulation under a set of 
simplifying assumptions:
    (1) All credit spreads have a flat term structure;
    (2) All credit spreads at the time horizon have a lognormal 
distribution;
    (3) Each single name credit spread is driven by the combination of 
a single systematic factor and an idiosyncratic factor;
    (4) The correlation between any single name credit spread and the 
systematic factor is equal to 0.5;
    (5) All credit indices are driven by the single systematic factor; 
and
    (6) The time horizon is short (the square root of time scaling to 1 
year is applied). The approximation is based on the linearization of 
the dependence of both CVA and CDS hedges on credit spreads. Given the 
assumptions listed above, a measure of CVA VaR has a closed-form 
analytical solution. The formula of the simple CVA approach is obtained 
by applying certain standardizations, conservative adjustments, and 
scaling to the analytical CVA VaR result.
    An FDIC-supervised institution calculates KCVA, where:

[[Page 55454]]

[GRAPHIC] [TIFF OMITTED] TR10SE13.009

    In Formula 1, wi refers to the weight applicable to counterparty i 
assigned according to Table 26 below.\178\ In Basel III, the BCBS 
assigned wi based on the external rating of the counterparty. However, 
consistent with the proposal and section 939A of the Dodd-Frank Act, 
the interim final rule assigns wi based on the relevant PD of the 
counterparty, as assigned by the FDIC-supervised institution. Quantity 
wind in Formula 1 refers to the weight applicable to the 
CDSind based on the average weight under Table 26 of the 
underlying reference names that comprise the index.
---------------------------------------------------------------------------

    \178\ These weights represent the assumed values of the product 
of a counterparties' current credit spread and the volatility of 
that credit spread.

    Table 26--Assignment of Counterparty Weight Under the Simple CVA
------------------------------------------------------------------------
                                                           Weight wi (in
                Internal PD  (in percent)                    percent)
------------------------------------------------------------------------
0.00-0.07...............................................            0.70
>0.07-0.15..............................................            0.80
>0.15-0.40..............................................            1.00
>0.4-2.00...............................................            2.00
>2.0-6.00...............................................            3.00
>6.0....................................................           10.00
------------------------------------------------------------------------

    EADi total in Formula 1 refers to the sum of the EAD for all 
netting sets of OTC derivative contracts with counterparty i calculated 
using the current exposure methodology described in section 132(c) of 
the interim final rule, as adjusted by Formula 2 or the IMM described 
in section 132(d) of the interim final rule. When the FDIC-supervised 
institution calculates EAD using the IMM, EADi 
total equals EADunstressed.
[GRAPHIC] [TIFF OMITTED] TR10SE13.010

    The term ``exp'' is the exponential function. Quantity Mi in 
Formulas 1 and 2 refers to the EAD-weighted average of the effective 
maturity of each netting set with counterparty i (where each netting 
set's M cannot be smaller than one). Quantity Mi hedge in Formula 1 
refers to the notional weighted average maturity of the hedge 
instrument. Quantity Mind in Formula 1 equals the maturity of the 
CDSind or the notional weighted average maturity of any 
CDSind purchased to hedge CVA risk of counterparty i.
    Quantity Bi in Formula 1 refers to the sum of the notional amounts 
of any purchased single name CDS referencing counterparty i that is 
used to hedge CVA risk to counterparty i multiplied by (1-exp(-0.05 x 
Mi hedge))/(0.05 x Mi hedge). Quantity Bind in Formula 1 refers to the 
notional amount of one or more CDSind purchased as 
protection to hedge CVA risk for counterparty i multiplied by (1-exp(-
0.05 x Mind))/(0.05 x Mind). If counterparty i is part of an index used 
for hedging, an FDIC-supervised institution is allowed to treat the 
notional amount in an index attributable to that counterparty as a 
single name hedge of counterparty i (Bi,) when calculating 
KCVA and subtract the notional amount of Bi from the 
notional amount of the CDSind. The CDSind hedge 
with the notional amount reduced by Bi can still be treated as a CVA 
index hedge.
b. Advanced Credit Valuation Adjustment approach
    The interim final rule requires that the VaR model incorporate only 
changes in the counterparties' credit spreads, not changes in other 
risk factors; it does not require an FDIC-supervised institution to 
capture jump-to-default risk in its VaR model.
    In order for an FDIC-supervised institution to receive approval to 
use the advanced CVA approach under the interim final rule, the FDIC-
supervised institution needs to have the systems capability to 
calculate the CVA capital requirement on a daily basis but is not 
expected or required to calculate the CVA capital requirement on a 
daily basis.
    The CVA capital requirement under the advanced CVA approach is 
equal to the general market risk capital requirement of the CVA 
exposure using the ten-business-day time horizon of the market risk 
rule. The capital requirement does not include the incremental risk 
requirement of subpart F. If an FDIC-supervised institution uses the 
current exposure methodology to calculate the EAD of any immaterial OTC 
derivative portfolio, under the interim final rule the FDIC-supervised 
institution must use this EAD as a constant EE in the formula for the 
calculation of CVA. Also, the FDIC-supervised institution must set the 
maturity equal to the greater of half of the longest maturity occurring 
in the netting set and the notional weighted average maturity of all 
transactions in the netting set.
    The interim final rule requires an FDIC-supervised institution to 
use the formula for the advanced CVA approach to calculate 
KCVA as follows:

[[Page 55455]]

[GRAPHIC] [TIFF OMITTED] TR10SE13.011

VaRj is the 99 percent VaR reflecting changes of CVAj and fair value of 
eligible hedges (aggregated across all counterparties and eligible 
hedges) resulting from simulated changes of credit spreads over a ten-
day time horizon.\179\ CVAj for a given counterparty must be calculated 
according to
---------------------------------------------------------------------------

    \179\ For purposes of this formula, the subscript 
``j'' refers either to a stressed or unstressed 
calibration as described in section 133(e)(6)(iv) and (v) of the 
interim final rule.
[GRAPHIC] [TIFF OMITTED] TR10SE13.012

In Formula 3a:
    (A) ti equals the time of the i-th revaluation time bucket starting 
from t0 = 0.
    (B) tT equals the longest contractual maturity across the OTC 
derivative contracts with the counterparty.
    (C) si equals the CDS spread for the counterparty at tenor 
ti used to calculate the CVA for the counterparty. If a CDS 
spread is not available, the FDIC-supervised institution must use a 
proxy spread based on the credit quality, industry and region of the 
counterparty.
    (D) LGDMKT equals the loss given default of the counterparty based 
on the spread of a publicly traded debt instrument of the counterparty, 
or, where a publicly traded debt instrument spread is not available, a 
proxy spread based on the credit quality, industry and region of the 
counterparty.
    (E) EEi equals the sum of the expected exposures for all netting 
sets with the counterparty at revaluation time ti calculated 
using the IMM.
    (F) Di equals the risk-free discount factor at time ti, 
where D0 = 1.
    (G) The function exp is the exponential function.
    (H) The subscript j refers either to a stressed or an unstressed 
calibration as described in section 324.132(e)(6)(iv) and (v) of the 
interim final rule.
    Under the interim final rule, if an FDIC-supervised institution's 
VaR model is not based on full repricing, the FDIC-supervised 
institution must use either Formula 4 or Formula 5 to calculate credit 
spread sensitivities. If the VaR model is based on credit spread 
sensitivities for specific tenors, the FDIC-supervised institution must 
calculate each credit spread sensitivity according to Formula 4:

[[Page 55456]]

[GRAPHIC] [TIFF OMITTED] TR10SE13.013

    Under the interim final rule, an FDIC-supervised institution must 
calculate VaR\CVA\unstressed using 
CVAUnstressed and VaR\CVA\stressed 
using CVAStressed. To calculate the CVAUnstressed 
measure in Formula 3a, an FDIC-supervised institution must use the EE 
for a counterparty calculated using current market data to compute 
current exposures and estimate model parameters using the historical 
observation period required under section 205(b)(2) of subpart F. 
However, if an FDIC-supervised institution uses the ``shortcut'' method 
described in section 324.132(d)(5) of the interim final rule to capture 
the effect of a collateral agreement when estimating EAD using the IMM, 
the FDIC-supervised institution must calculate the EE for the 
counterparty using that method and keep that EE constant with the 
maturity equal to the maximum of half of the longest maturity occurring 
in the netting set, and the notional weighted average maturity of all 
transactions in the netting set.
    To calculate the CVAStressed measure in Formula 3a, the interim 
final rule requires an FDIC-supervised institution to use the EE for a 
counterparty calculated using the stress calibration of the IMM. 
However, if an FDIC-supervised institution uses the ``shortcut'' method 
described in section 324.132(d)(5) of the interim final rule to capture 
the effect of a collateral agreement when estimating EAD using the IMM, 
the FDIC-supervised institution must calculate the EE for the 
counterparty using that method and keep that EE constant with the 
maturity equal to the greater of half of the longest maturity occurring 
in the netting set with the notional amount equal to the weighted 
average maturity of all transactions in the netting set. Consistent 
with Basel III, the interim final rule requires an FDIC-supervised 
institution to calibrate the VaR model inputs to historical data from 
the most severe twelve-month stress period contained within the three-
year stress period used to calculate EE. However, the FDIC retains the 
flexibility to require an FDIC-supervised institution to use a 
different period of significant financial stress in the calculation of 
the CVAStressed measure that better reflects actual historic losses of 
the portfolio.
    Under the interim final rule, an FDIC-supervised institution's VaR 
model is required to capture the basis between the spreads of the index 
that is used as the hedging instrument and the hedged counterparty 
exposure over various time periods, including benign and stressed 
environments. If the VaR model does not capture that basis, the FDIC-
supervised institution is permitted to reflect only 50 percent of the 
notional amount of the CDSind hedge in the VaR model.
5. Cleared Transactions (Central Counterparties)
    As discussed more fully in section VIII.E of this preamble on 
cleared transactions under the standardized approach, CCPs help improve 
the safety and soundness of the derivatives and repo-style transaction 
markets through the multilateral netting of exposures, establishment 
and enforcement of collateral requirements, and market transparency. 
Similar to the changes to the cleared transaction treatment in the 
subpart D of the interim final rule, the requirements regarding the 
cleared transaction framework in the subpart E has been revised to 
reflect the material changes from the BCBS CCP interim framework. Key 
changes from the CCP interim framework, include: (1) Allowing a 
clearing member FDIC-supervised institution to use a reduced

[[Page 55457]]

margin period of risk when using the IMM or a scaling factor of no less 
than 0.71 \180\ when using the CEM in the calculation of its EAD for 
client-facing derivative trades; (2) updating the risk weights 
applicable to a clearing member FDIC-supervised institution's exposures 
when the clearing member FDIC-supervised institution guarantees QCCP 
performance; (3) permitting clearing member FDIC-supervised 
institutions to choose from one of two approaches for determining the 
capital requirement for exposures to default fund contributions; and 
(4) updating the CEM formula to recognize netting to a greater extent 
for purposes of calculating its risk-weighted asset amount for default 
fund contributions.
---------------------------------------------------------------------------

    \180\ See Table 20 in section VIII.E of this preamble. 
Consistent with the scaling factor for the CEM in Table 20, an 
advanced approaches FDIC-supervised institution may reduce the 
margin period of risk when using the IMM to no shorter than 5 days.
---------------------------------------------------------------------------

    Additionally, changes in response to comments received on the 
proposal, as discussed in detail in section VIII.E of this preamble 
with respect to cleared transactions in the standardized approach, are 
also reflected in the interim final rule for advanced approaches. FDIC-
supervised institutions seeking more information on the changes 
relating to the material elements of the BCBS CCP interim framework and 
the comments received should refer to section VIII.E of this preamble.
6. Stress Period for Own Estimates
    During the recent financial crisis, increased volatility in the 
value of collateral led to higher counterparty exposures than estimated 
by banking organizations. Under the collateral haircut approach in the 
advanced approaches interim final rule, consistent with the proposal, 
an FDIC-supervised institution that receives prior approval from the 
FDIC may calculate market price and foreign exchange volatility using 
own internal estimates. In response to the increased volatility 
experienced during the crisis, however, the interim final rule modifies 
the quantitative standards for approval by requiring FDIC-supervised 
institutions to base own internal estimates of haircuts on a historical 
observation period that reflects a continuous 12-month period of 
significant financial stress appropriate to the security or category of 
securities. As described in section VIII.F of this preamble with 
respect to the standardized approach, an FDIC-supervised institution is 
also required to have policies and procedures that describe how it 
determines the period of significant financial stress used to calculate 
the FDIC-supervised institution's own internal estimates, and must be 
able to provide empirical support for the period used. To ensure an 
appropriate level of conservativeness, in certain circumstances the 
FDIC may require an FDIC-supervised institution to use a different 
period of significant financial stress in the calculation of own 
internal estimates for haircuts. The FDIC is adopting this aspect of 
the proposal without change.

B. Removal of Credit Ratings

    Consistent with the proposed rule and section 939A of the Dodd-
Frank Act, the interim final rule includes a number of changes to 
definitions in the advanced approaches rule that currently reference 
credit ratings.\181\ These changes are consistent with the alternative 
standards included in the Standardized Approach and alternative 
standards that already have been implemented in the FDIC's market risk 
rule. In addition, the interim final rule includes necessary changes to 
the hierarchy for risk weighting securitization exposures necessitated 
by the removal of the ratings-based approach, as described further 
below.
---------------------------------------------------------------------------

    \181\ See 76 FR 79380 (Dec. 21, 2011).
---------------------------------------------------------------------------

    In certain instances, the interim final rule uses an ``investment 
grade'' standard that does not rely on credit ratings. Under the 
interim final rule and consistent with the market risk rule, investment 
grade means that the entity to which the FDIC-supervised institution is 
exposed through a loan or security, or the reference entity with 
respect to a credit derivative, has adequate capacity to meet financial 
commitments for the projected life of the asset or exposure. Such an 
entity or reference entity has adequate capacity to meet financial 
commitments if the risk of its default is low and the full and timely 
repayment of principal and interest is expected.
    The FDIC is largely finalizing the proposed alternatives to ratings 
as proposed. Consistent with the proposal, the FDIC is retaining the 
standards used to calculate the PFE for derivative contracts (as set 
forth in Table 2 of the interim final rule), which are based in part on 
whether the counterparty satisfies the definition of investment grade 
under the interim final rule. The FDIC is also finalizing as proposed 
the term ``eligible double default guarantor,'' which is used for 
purposes of determining whether an FDIC-supervised institution may 
recognize a guarantee or credit derivative under the credit risk 
mitigation framework. In addition, the FDIC is finalizing the proposed 
requirements for qualifying operational risk mitigants, which among 
other criteria, must be provided by an unaffiliated company that the 
FDIC-supervised institution deems to have strong capacity to meet its 
claims payment obligations and the obligor rating category to which the 
FDIC-supervised institution assigns the company is assigned a PD equal 
to or less than 10 basis points.
1. Eligible Guarantor
    Previously, to be an eligible securitization guarantor under the 
advanced approaches rule, a guarantor was required to meet a number of 
criteria. For example, the guarantor must have issued and 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. The interim final rule replaces the 
term ``eligible securitization guarantor'' with the term ``eligible 
guarantor,'' which includes certain entities that have issued and 
outstanding unsecured debt securities without credit enhancement that 
are investment grade. Comments and modifications to the definition of 
eligible guarantor are discussed below and in section VIII.F of this 
preamble.
2. Money Market Fund Approach
    Previously, under the money market fund approach in the advanced 
approaches rule, banking organizations were permitted to assign a 7 
percent risk weight to exposures to money market funds that were 
subject to SEC rule 2a-7 and that had an applicable external rating in 
the highest investment grade rating category. The proposed rule 
eliminated the money market fund approach. Commenters stated that the 
elimination of the existing 7 percent risk weight for equity exposures 
to money market funds would result in an overly stringent treatment for 
those exposures under the remaining look-through approaches. However, 
during the recent financial crisis, several money market funds 
demonstrated elevated credit risk that is not consistent with a low 7 
percent risk weight. Accordingly, the FDIC believes it is appropriate 
to eliminate the preferential risk weight for money market fund 
investments. As a result of the changes, an FDIC-supervised institution 
must use one of the three alternative approaches under section 154 of 
the interim final rule to determine the risk weight for its exposures 
to a money market fund.

[[Page 55458]]

3. Modified Look-Through Approaches for Equity Exposures to Investment 
Funds
    Under the proposal, risk weights for equity exposures under the 
simple modified look-through approach would have been based on the 
highest risk weight assigned to the exposure under the standardized 
approach (subpart D) based on the investment limits in the fund's 
prospectus, partnership agreement, or similar contract that defines the 
fund's permissible investments. As discussed in the preamble regarding 
the standardized approach, commenters expressed concerns regarding 
their ability to implement the look-through approaches for investment 
funds that hold securitization exposures. However, the FDIC believes 
that FDIC-supervised institutions should be aware of the nature of the 
investments in a fund in which the organization invests. To the extent 
that information is not available, the treatment in the interim final 
rule will create incentives for FDIC-supervised institutions to obtain 
the information necessary to compute risk-based capital requirements 
under the approach. These incentives are consistent with the FDIC's 
supervisory aim that FDIC-supervised institutions have sufficient 
understanding of the characteristics and risks of their investments.

C. Revisions to the Treatment of Securitization Exposures

1. Definitions
    As discussed in section VIII.H of this preamble with respect to the 
standardized approach, the proposal introduced a new definition for 
resecuritization exposures consistent with the 2009 Enhancements and 
broadened the definition of a securitization exposure. In addition, the 
agencies proposed to amend the existing definition of traditional 
securitization in order to exclude certain types of investment firms 
from treatment under the securitization framework. Consistent with the 
approach taken with respect to the standardized approach, the proposed 
definitions under the securitization framework in the advanced approach 
are largely included in the interim final rule as proposed, except for 
changes described below. Banking organizations should refer to part 
VIII.H of this preamble for further discussion of these comments.
    In response to the proposed definition of traditional 
securitization, commenters generally agreed with the proposed 
exemptions from the definition and requested that the agencies provide 
exemptions for exposures to a broader set of investment firms, such as 
pension funds operated by state and local governments. In view of the 
comments regarding pension funds, the interim final rule, as described 
in part VIII.H of this preamble, excludes from the definition of 
traditional securitization a ``governmental plan'' (as defined in 29 
U.S.C. 1002(32)) that complies with the tax deferral qualification 
requirements provided in the Internal Revenue Code. In response to the 
proposed definition of resecuritization, commenters requested 
clarification regarding its potential scope of application to exposures 
that they believed should not be considered resecuritizations. In 
response, the FDIC has amended the definition of resecuritization by 
excluding securitizations that feature re-tranching of a single 
exposure. In addition, the FDIC notes that for purposes of the interim 
final rule, a resecuritization does not include pass-through securities 
that have been pooled together and effectively re-issued as tranched 
securities. This is because the pass-through securities do not tranche 
credit protection and, as a result, are not considered securitization 
exposures under the interim final rule.
    Previously, under the advanced approaches rule issued in 2007, the 
definition of eligible securitization guarantor included, among other 
entities, any entity (other than a securitization SPE) that 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, or has a PD 
assigned by the banking organization that is lower than or equal to the 
PD associated with a long-term external rating in the third highest 
investment-grade category. The interim final rule removes the existing 
references to ratings from the definition of an eligible guarantor (the 
new term for an eligible securitization guarantor) and finalizes the 
requirements as proposed, as described in section VIII.F of this 
preamble.
    During the recent financial crisis, certain guarantors of 
securitization exposures had difficulty honoring those guarantees as 
the financial condition of the guarantors deteriorated at the same time 
as the guaranteed exposures experienced losses. Consistent with the 
proposal, a guarantor is not an eligible guarantor under the interim 
final rule if the guarantor's creditworthiness is positively correlated 
with the credit risk of the exposures for which it has provided 
guarantees. In addition, insurance companies engaged predominately in 
the business of providing credit protection are not eligible 
guarantors. Further discussion can be found in section VIII.F of this 
preamble.
2. Operational Criteria for Recognizing Risk Transference in 
Traditional Securitizations
    The proposal outlined certain operational requirements for 
traditional securitizations that had to be met in order to apply the 
securitization framework. Consistent with the standardized approach as 
discussed in section VIII.H of this preamble, the interim final rule 
includes the operational criteria for recognizing risk transference in 
traditional securitizations largely as proposed.
3. The Hierarchy of Approaches
    Consistent with section 939A of the Dodd-Frank Act, the proposed 
rule removed the ratings-based approach (RBA) and internal assessment 
approach for securitization exposures. The interim final rule includes 
the hierarchy largely as proposed. Under the interim final rule, the 
hierarchy for securitization exposures is as follows:
    (1) An FDIC-supervised institution is required to deduct from 
common equity tier 1 capital any after-tax gain-on-sale resulting from 
a securitization and apply a 1,250 percent risk weight to the portion 
of a CEIO that does not constitute after-tax gain-on-sale.
    (2) If a securitization exposure does not require deduction, an 
FDIC-supervised institution is required to assign a risk weight to the 
securitization exposure using the SFA. The FDIC expects FDIC-supervised 
institutions to use the SFA rather than the SSFA in all instances where 
data to calculate the SFA is available.
    (3) If the FDIC-supervised institution cannot apply the SFA because 
not all the relevant qualification criteria are met, it is allowed to 
apply the SSFA. An FDIC-supervised institution should be able to 
explain and justify (for example, based on data availability) to the 
FDIC any instances in which the FDIC-supervised institution uses the 
SSFA rather than the SFA for its securitization exposures.
    The SSFA, described in detail in part VIII.H of this preamble, is 
similar in construct and function to the SFA. An FDIC-supervised 
institution needs several inputs to calculate the SSFA. The first input 
is the weighted-average capital requirement calculated under the 
standardized approach that applies to the underlying exposures as if 
they are held directly by the FDIC-supervised

[[Page 55459]]

institution. The second and third inputs indicate the position's level 
of subordination and relative size within the securitization. The 
fourth input is the level of delinquencies experienced on the 
underlying exposures. An FDIC-supervised institution must apply the 
hierarchy of approaches in section 142 of this interim final rule to 
determine which approach it applies to a securitization exposure. The 
SSFA is included in this interim final rule as proposed, with the 
exception of some modifications to the delinquency parameter, as 
discussed in part VIII.H of this preamble.
4. Guarantees and Credit Derivatives Referencing a Securitization 
Exposure
    The current advanced approaches rule includes methods for 
calculating risk-weighted assets for nth-to-default credit 
derivatives, including first-to-default credit derivatives and second-
or-subsequent-to-default credit derivatives.\182\ The current advanced 
approaches rule, however, does not specify how to treat guarantees or 
credit derivatives (other than nth-to-default credit 
derivatives) purchased or sold that reference a securitization 
exposure. Accordingly, the proposal included specific treatment for 
credit protection purchased or provided in the form of a guarantee or 
credit derivative (other than an nth-to-default credit 
derivative) that references a securitization exposure.
---------------------------------------------------------------------------

    \182\ 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. See 12 CFR part 325, appendix D, section 42(l) (state 
nonmember banks), and 12 CFR part 390, subpart Z, appendix A, 
section 42(l) (state savings associations).
---------------------------------------------------------------------------

    For a guarantee or credit derivative (other than an nth-
to-default credit derivative) where the FDIC-supervised institution has 
provided protection, the interim final rule requires an FDIC-supervised 
institution providing credit protection to determine the risk-based 
capital requirement for the guarantee or credit derivative as if it 
directly holds the portion of the reference exposure covered by the 
guarantee or credit derivative. The FDIC-supervised institution 
calculates its risk-based capital requirement for the guarantee or 
credit derivative by applying either (1) the SFA as provided in section 
324.143 of the interim final rule to the reference exposure if the 
FDIC-supervised institution and the reference exposure qualify for the 
SFA; or (2) the SSFA as provided in section 324.144 of the interim 
final rule. If the guarantee or credit derivative and the reference 
securitization exposure do not qualify for the SFA, or the SSFA, the 
FDIC-supervised institution is required to assign a 1,250 percent risk 
weight to the notional amount of protection provided under the 
guarantee or credit derivative.
    The interim final rule also clarifies how an FDIC-supervised 
institution may recognize a guarantee or credit derivative (other than 
an nth-to-default credit derivative) purchased as a credit 
risk mitigant for a securitization exposure held by the FDIC-supervised 
institution. An FDIC-supervised institution that purchases an OTC 
credit derivative (other than an nth-to-default credit 
derivative) that is recognized as a credit risk mitigant for a 
securitization exposure that is not a covered position under the market 
risk rule is not required to compute a separate counterparty credit 
risk capital requirement provided that the FDIC-supervised institution 
does so consistently for all such credit derivatives. The FDIC-
supervised institution must either include all or exclude 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. If an FDIC-supervised institution cannot, or chooses not to, 
recognize a credit derivative that is a securitization exposure as a 
credit risk mitigant, the FDIC-supervised institution must determine 
the exposure amount of the credit derivative under the treatment for 
OTC derivatives in section 324.132. If the FDIC-supervised institution 
purchases the credit protection from a counterparty that is a 
securitization, the FDIC-supervised institution must determine the risk 
weight for counterparty credit risk according to the securitization 
framework. If the FDIC-supervised institution purchases credit 
protection from a counterparty that is not a securitization, the FDIC-
supervised institution must determine the risk weight for counterparty 
credit risk according to general risk weights under section 324.131.
5. Due Diligence Requirements for Securitization Exposures
    As the recent financial crisis unfolded, weaknesses in exposures 
underlying securitizations became apparent and resulted in NRSROs 
downgrading many securitization exposures held by banking 
organizations. The agencies found that many banking organizations 
relied on NRSRO ratings as a proxy for the credit quality of 
securitization exposures they purchased and held without conducting 
their own sufficient independent credit analysis. As a result, some 
banking organizations did not have sufficient capital to absorb the 
losses attributable to these exposures. Accordingly, consistent with 
the 2009 Enhancements, the proposed rule introduced due diligence 
requirements that banking organizations would be required to undertake 
to use the SFA or SSFA. Comments received regarding the proposed due 
diligence requirements and the rationale for adopting the proposed 
treatment in the interim final rule are discussed in part VIII of the 
preamble.
6. Nth-to-Default Credit Derivatives
    Consistent with the proposal, the interim final rule provides that 
an FDIC-supervised institution that provides credit protection through 
an nth-to-default derivative must assign a risk weight to 
the derivative using the SFA or the SSFA. In the case of credit 
protection sold, an FDIC-supervised institution must determine its 
exposure in the nth-to-default credit derivative as the 
largest notional dollar amount of all the underlying exposures.
    When applying the SSFA to protection provided in the form of an 
nth-to-default credit derivative, the attachment point 
(parameter A) is the ratio of the sum of the notional amounts of all 
underlying exposures that are subordinated to the FDIC-supervised 
institution's exposure to the total notional amount of all underlying 
exposures. For purposes of applying the SFA, parameter A is set equal 
to the credit enhancement level (L) used in the SFA formula. In the 
case of a first-to-default credit derivative, there are no underlying 
exposures that are subordinated to the FDIC-supervised institution's 
exposure. In the case of a second-or-subsequent-to default credit 
derivative, the smallest (n-1) underlying exposure(s) are subordinated 
to the FDIC-supervised institution's exposure.
    Under the SSFA, the detachment point (parameter D) is the sum of 
the attachment point and the ratio of the notional amount of the FDIC-
supervised institution's exposure to the total notional amount of the 
underlying exposures. Under the SFA, Parameter D is set to equal L plus 
the thickness of the tranche (T) under the SFA formula. An FDIC-
supervised institution that does not use the SFA or SSFA to calculate a 
risk weight for an nth-to-default credit derivative must 
assign a risk weight of 1,250 percent to the exposure.
    For the treatment of protection purchased through a first-to-
default credit derivative, an FDIC-supervised institution must 
determine its risk-based capital requirement for the underlying

[[Page 55460]]

exposures as if the FDIC-supervised institution had synthetically 
securitized the underlying exposure with the lowest risk-based capital 
requirement and had obtained no credit risk mitigant on the other 
underlying exposures. An FDIC-supervised institution must calculate a 
risk-based capital requirement for counterparty credit risk according 
to section 132 of the interim final rule for a first-to-default credit 
derivative that does not meet the rules of recognition for guarantees 
and credit derivatives under section 324.134(b).
    For second-or-subsequent-to default credit derivatives, an FDIC-
supervised institution that obtains credit protection on a group of 
underlying exposures through a nth-to-default credit 
derivative that meets the rules of recognition of section 324.134(b) of 
the interim final rule (other than a first-to-default credit 
derivative) is permitted to recognize the credit risk mitigation 
benefits of the derivative only if the FDIC-supervised institution also 
has 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. If an FDIC-supervised 
institution satisfies these requirements, the FDIC-supervised 
institution determines its risk-based capital requirement for the 
underlying exposures as if the FDIC-supervised institution had only 
synthetically securitized the underlying exposure with the 
nth smallest risk-based capital requirement and had obtained 
no credit risk mitigant on the other underlying exposures. An FDIC-
supervised institution that does not fulfill these requirements must 
calculate a risk-based capital requirement for counterparty credit risk 
according to section 132 of the interim final rule for a 
nth-to-default credit derivative that does not meet the 
rules of recognition of section 134(b) of the interim final rule.

D. Treatment of Exposures Subject to Deduction

    Under the current advanced approaches rule, an FDIC-supervised 
institution is required to deduct certain exposures from total capital, 
including securitization exposures such as CEIOs, low-rated 
securitization exposures, and high-risk securitization exposures 
subject to the SFA; eligible credit reserves shortfall; and certain 
failed capital markets transactions. Consistent with Basel III, the 
proposed rule required a banking organization to assign a 1,250 percent 
risk weight to many exposures that previously were deducted from 
capital.
    In the proposal, the agencies noted that such treatment would not 
be equivalent to a deduction from tier 1 capital, as the effect of a 
1,250 percent risk weight would depend on an individual banking 
organization's current risk-based capital ratios. Specifically, when a 
risk-based capital ratio (either tier 1 or total risk-based capital) 
exceeds 8.0 percent, the effect on that risk-based capital ratio of 
assigning an exposure a 1,250 percent risk weight would be more 
conservative than a deduction from total capital. The more a risk-based 
capital ratio exceeds 8.0 percent, the harsher is the effect of a 1,250 
percent risk weight on risk-based capital ratios. Commenters 
acknowledged these points and asked the agencies to replace the 1,250 
percent risk weight with the maximum risk weight that would correspond 
with deduction. Commenters also stated that the agencies should 
consider the effect of the 1,250 percent risk weight given that the 
Basel III proposals, over time, would require banking organizations to 
maintain a total risk-based capital ratio of at least 10.5 percent to 
meet the minimum required capital ratio plus the capital conservation 
buffer.
    The FDIC is finalizing the requirements as proposed, in order to 
provide for comparability in risk-weighted asset measurements across 
institutions. The FDIC did not propose to apply a 1,250 percent risk 
weight to those exposures currently deducted from tier 1 capital under 
the advanced approaches rule. For example, the agencies proposed that 
an after-tax gain-on-sale that is deducted from tier 1 under the 
advanced approaches rule be deducted from common equity tier 1 under 
the proposed rule. In this regard, the agencies also clarified that any 
asset deducted from common equity tier 1, tier 1, or tier 2 capital 
under the advanced approaches rule would not be included in the measure 
of risk-weighted assets under the advanced approaches rule. The interim 
final rule includes these requirements as proposed.

E. Technical Amendments to the Advanced Approaches Rule

    In the proposed rule, the agencies introduced a number of 
amendments to the advanced approaches rule that were designed to refine 
and clarify certain aspects of the rule's implementation. The interim 
final rule includes each of these technical amendments as proposed. 
Additionally, in the interim final rule, the FDIC is amending the 
treatment of defaulted exposures that are covered by government 
guarantees. Each of these revisions is described below.
1. Eligible Guarantees and Contingent U.S. Government Guarantees
    In order to be recognized as an eligible guarantee under the 
advanced approaches rule, the guarantee, among other criteria, must be 
unconditional. The FDIC notes that this definition would exclude 
certain guarantees provided by the U.S. Government or its agencies that 
would require some action on the part of the FDIC-supervised 
institution or some other third party. However, based on their risk 
characteristics, the FDIC believes that these guarantees should be 
recognized as eligible guarantees. Therefore, the FDIC is amending the 
definition of eligible guarantee so that it explicitly includes a 
contingent obligation of the U.S. Government or an agency of the U.S. 
Government, the validity of which is dependent on some affirmative 
action on the part of the beneficiary or a third party (for example, 
servicing requirements) irrespective of whether such contingent 
obligation is otherwise considered a conditional guarantee.
    Related to the change to the eligible guarantee definition, the 
FDIC has amended the provision in the advanced approaches rule 
pertaining to the 10 percent floor on the LGD for residential mortgage 
exposures. Currently, the rule provides that the LGD for each segment 
of residential mortgage exposures (other than segments of residential 
mortgage exposures for which all or substantially all of the principal 
of each exposure is directly and unconditionally guaranteed by the full 
faith and credit of a sovereign entity) may not be less than 10 
percent. The provision would therefore require a 10 percent LGD floor 
on segments of residential mortgage exposures for which all or 
substantially all of the principal are conditionally guaranteed by the 
U.S. government. The interim final rule allows an exception from the 10 
percent floor in such cases.
2. Calculation of Foreign Exposures for Applicability of the Advanced 
Approaches--Changes to Federal Financial Institutions Economic Council 
009
    The FDIC is revising the advanced approaches rule to comport with 
changes to the FFIEC's Country Exposure Report (FFIEC 009) that 
occurred after the issuance of the advanced approaches rule in 2007. 
Specifically, the FFIEC 009 replaced the term ``local country claims'' 
with the term ``foreign-office claims.'' Accordingly, the FDIC has made 
a similar change under section 100, the

[[Page 55461]]

section of the interim final rule that makes the rules applicable to an 
FDIC-supervised institution that has consolidated total on-balance 
sheet foreign exposures equal to $10 billion or more. As a result, to 
determine total on-balance sheet foreign exposure, an FDIC-supervised 
institution sums its adjusted cross-border claims, local country 
claims, and cross-border revaluation gains calculated in accordance 
with FFIEC 009. Adjusted cross-border claims equal total cross-border 
claims less claims with the head office or guarantor located in another 
country, plus redistributed guaranteed amounts to the country of the 
head office or guarantor.
3. Applicability of the Interim Final Rule
    The FDIC believes that once an FDIC-supervised institution reaches 
the asset size or level of foreign activity that causes it to become 
subject to the advanced approaches that it should remain subject to the 
advanced approaches rule even if it subsequently drops below the asset 
or foreign exposure threshold. The FDIC believes that it is appropriate 
for it to evaluate whether an FDIC-supervised institution's business or 
risk exposure has changed after dropping below the thresholds in a 
manner that it would no longer be appropriate for the FDIC-supervised 
institution to be subject to the advanced approaches. As a result, 
consistent with the proposal, the interim final rule clarifies that 
once an FDIC-supervised institution is subject to the advanced 
approaches rule under subpart E, it remains subject to subpart E until 
the FDIC determines that application of the rule would not be 
appropriate in light of the FDIC-supervised institution's asset size, 
level of complexity, risk profile, or scope of operations. In 
connection with the consideration of an FDIC-supervised institution's 
level of complexity, risk profile, and scope of operations, the FDIC 
also may consider an FDIC-supervised institution's interconnectedness 
and other relevant risk-related factors.
4. Change to the Definition of Probability of Default Related to 
Seasoning
    The advanced approaches rule requires an upward adjustment to 
estimated PD for segments of retail exposures for which seasoning 
effects are material. The rationale underlying this requirement was the 
seasoning pattern displayed by some types of retail exposures--that is, 
the exposures have very low default rates in their first year, rising 
default rates in the next few years, and declining default rates for 
the remainder of their terms. Because of the one-year internal ratings-
based (IRB) default horizon, capital based on the very low PDs for 
newly originated, or ``unseasoned,'' loans would be insufficient to 
cover the elevated risk in subsequent years. The upward seasoning 
adjustment to PD was designed to ensure that banking organizations 
would have sufficient capital when default rates for such segments rose 
predictably beginning in year two.
    Since the issuance of the advanced approaches rule, the FDIC has 
found the seasoning provision to be problematic. First, it is difficult 
to ensure consistency across institutions, given that there is no 
guidance or criteria for determining when seasoning is ``material'' or 
what magnitude of upward adjustment to PD is ``appropriate.'' Second, 
the advanced approaches rule lacks flexibility by requiring an upward 
PD adjustment whenever there is a significant relationship between a 
segment's default rate and its age (since origination). For example, 
the upward PD adjustment may be inappropriate in cases where (1) the 
outstanding balance of a segment is falling faster over time (due to 
defaults and prepayments) than the default rate is rising; (2) the age 
(since origination) distribution of a portfolio is stable over time; or 
(3) where the loans in a segment are intended, with a high degree of 
certainty, to be sold or securitized within a short time period.
    Therefore, consistent with the proposal, the FDIC is deleting the 
regulatory seasoning provision and will instead consider seasoning when 
evaluating an FDIC-supervised institution's assessment of its capital 
adequacy from a supervisory perspective. In addition to the 
difficulties in applying the advanced approaches rule's seasoning 
requirements discussed above, the FDIC believes that seasoning is more 
appropriately considered from a supervisory perspective. First, 
seasoning involves the determination of minimum required capital for a 
period in excess of the 12-month time horizon implicit in the advanced 
approaches risk-based capital ratio calculations. It thus falls more 
appropriately under longer-term capital planning and capital adequacy, 
which are major focal points of the internal capital adequacy 
assessment process. Second, seasoning is a major issue only where an 
FDIC-supervised institution has a concentration of unseasoned loans. 
The risk-based capital ratios do not take concentrations of any kind 
into account; however, they are an explicit factor in the internal 
capital adequacy assessment process.
5. Cash Items in Process of Collection
    Under the current advanced approaches rule, cash items in the 
process of collection are not assigned a risk-based capital treatment 
and, as a result, are subject to a 100 percent risk weight. Under the 
interim final rule, consistent with the proposal, the FDIC is revising 
the advanced approaches rule to risk weight cash items in the process 
of collection at 20 percent of the carrying value, as the FDIC believes 
that this treatment is more commensurate with the risk of these 
exposures. A corresponding provision is included in section 324.32 of 
the interim final rule.
6. Change to the Definition of Qualifying Revolving Exposure
    The agencies proposed modifying the definition of qualifying 
revolving exposure (QRE) such that certain unsecured and 
unconditionally cancellable exposures where a banking organization 
consistently imposes in practice an upper exposure limit of $100,000 
and requires payment in full every cycle would qualify as QRE. Under 
the previous definition in the advanced approaches rule, only unsecured 
and unconditionally cancellable revolving exposures with a pre-
established maximum exposure amount of $100,000 or less (such as credit 
cards) were classified as QRE. Unsecured, unconditionally cancellable 
exposures that require payment in full and have no communicated maximum 
exposure amount (often referred to as ``charge cards'') were instead 
classified as ``other retail.'' For risk-based capital purposes, this 
classification was material and generally results in substantially 
higher minimum required capital to the extent that the exposure's asset 
value correlation (AVC) would differ if classified as QRE (where it is 
assigned an AVC of 4 percent) or other retail (where AVC varies 
inversely with through-the-cycle PD estimated at the segment level and 
can go as high as almost 16 percent for very low PD segments).
    Under the proposed definition, certain charge card products would 
qualify as QRE. Charge card exposures may be viewed as revolving in 
that there is an ability to borrow despite a requirement to pay in 
full. Commenters agreed that charge cards should be included as QRE 
because, compared to credit cards, they generally exhibit lower loss 
rates and loss volatility. Where an FDIC-supervised institution 
consistently imposes in practice an

[[Page 55462]]

upper exposure limit of $100,000 the FDIC believes that charge cards 
are more closely aligned from a risk perspective with credit cards than 
with any type of ``other retail'' exposure and is therefore amending 
the definition of QRE in order to more appropriately capture such 
products under the definition of QRE. With respect to a product with a 
balance that the borrower is required to pay in full every month, the 
exposure would qualify as QRE under the interim final rule as long as 
its balance does not in practice exceed $100,000. If the balance of an 
exposure were to exceed that amount, it would represent evidence that 
such a limit is not maintained in practice for the segment of exposures 
in which that exposure is placed for risk parameter estimation 
purposes. As a result, that segment of exposures would not qualify as 
QRE over the next 24 month period. In addition, the FDIC believes that 
the definition of QRE should be sufficiently flexible to encompass 
products with new features that were not envisioned at the time of 
finalizing the advanced approaches rule, provided, however, that the 
FDIC-supervised institution can demonstrate to the satisfaction of the 
FDIC that the performance and risk characteristics (in particular the 
volatility of loss rates over time) of the new product are consistent 
with the definition and requirements of QRE portfolios.
7. Trade-Related Letters of Credit
    In 2011, the BCBS revised the Basel II advanced internal ratings-
based approach to remove the one-year maturity floor for trade finance 
instruments. Consistent with this revision, the proposed rule specified 
that an exposure's effective maturity must be no greater than five 
years and no less than one year, except that an exposure's effective 
maturity must be no less than one day if the exposure is a trade-
related letter of credit, or if the exposure has an original maturity 
of less than one year and is not part of a banking organization's 
ongoing financing of the obligor. Commenters requested clarification on 
whether short-term self-liquidating trade finance instruments would be 
considered exempt from the one-year maturity floor, as they do not 
constitute an ongoing financing of the obligor. In addition, commenters 
stated that applying the proposed framework for AVCs to trade-related 
letters of credit would result in banking organizations maintaining 
overly conservative capital requirements in relation to the risk of 
trade finance exposures, which could reduce the availability of trade 
finance and increase the cost of providing trade finance for businesses 
globally. As a result, commenters requested that trade finance 
exposures be assigned a separate AVC that would better reflect the 
product's low default rates and low correlation.
    The FDIC believes that, in light of the removal of the one-year 
maturity floor, the proposed requirements for trade-related letters of 
credit are appropriate without a separate AVC. The interim final rule 
includes the treatment of trade-related letters of credit as proposed. 
Under the interim final rule, trade finance exposures that meet the 
stated requirements above may be assigned a maturity lower than one 
year. Section 324.32 of the interim final rule includes a provision 
that similarly recognizes the low default rates of these exposures.
8. Defaulted Exposures That Are Guaranteed by the U.S. Government
    Under the current advanced approaches rule, a banking organization 
is required to apply an 8.0 percent capital requirement to the EAD for 
each wholesale exposure to a defaulted obligor and for each segment of 
defaulted retail exposures. The advanced approaches rule does not 
recognize yet-to-be paid protection in the form of guarantees or 
insurance on defaulted exposures. For example, under certain programs, 
a U.S. government agency that provides a guarantee or insurance is not 
required to pay on claims on exposures to defaulted obligors or 
segments of defaulted retail exposures until the collateral is sold. 
The time period from default to sale of collateral can be significant 
and the exposure amount covered by such U.S. sovereign guarantees or 
insurance can be substantial.
    In order to make the treatment for exposures to defaulted obligors 
and segments of defaulted retail exposures more risk sensitive, the 
FDIC has decided to amend the advanced approaches rule by assigning a 
1.6 percent capital requirement to the portion of the EAD for each 
wholesale exposure to a defaulted obligor and each segment of defaulted 
retail exposures that is covered by an eligible guarantee from the U.S. 
government. The portion of the exposure amount for each wholesale 
exposure to a defaulted obligor and each segment of defaulted retail 
exposures not covered by an eligible guarantee from the U.S. government 
continues to be assigned an 8.0 percent capital requirement.
9. Stable Value Wraps
    The FDIC is clarifying that an FDIC-supervised institution that 
provides stable value protection, such as through a stable value wrap 
that has provisions and conditions that minimize the wrap's exposure to 
credit risk of the underlying assets in the fund, must treat the 
exposure as if it were an equity derivative on an investment fund and 
determine the adjusted carrying value of the exposure as the sum of the 
adjusted carrying values of any on-balance sheet asset component 
determined according to section 324.151(b)(1) and the off-balance sheet 
component determined according to section 324.151(b)(2). That is, the 
adjusted carrying value is 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) given a 
small change in the price of the underlying equity instrument without 
subtracting the adjusted carrying value of the on-balance sheet 
component of the exposure as calculated under the same paragraph. Risk-
weighted assets for such an exposure is determined by applying one of 
the three look-through approaches as provided in section 324.154 of the 
interim final rule.
10. Treatment of Pre-Sold Construction Loans and Multi-Family 
Residential Loans
    The interim final rule assigns either a 50 percent or a 100 percent 
risk weight to certain one-to-four family residential pre-sold 
construction loans under the advanced approaches rule, consistent with 
provisions of the RTCRRI Act.\183\ This treatment is consistent with 
the treatment under the general risk-based capital rules and under the 
standardized approach.
---------------------------------------------------------------------------

    \183\ See 12 U.S.C. 1831n, note.
---------------------------------------------------------------------------

F. Pillar 3 Disclosures

1. Frequency and Timeliness of Disclosures
    For purposes of the interim final rule, an FDIC-supervised 
institution is required to provide certain qualitative and quantitative 
public disclosures on a quarterly, or in some cases, annual basis, and 
these disclosures must be ``timely.'' Qualitative disclosures that 
provide a general summary of an FDIC-supervised institution's risk-
management objectives and policies, reporting system, and definitions 
may be disclosed annually after the end of the fourth calendar quarter, 
provided any significant changes are disclosed in the interim. In the 
preamble to the advanced approaches rule, the FDIC

[[Page 55463]]

indicated that quarterly disclosures would be timely if they were 
provided within 45 days after calendar quarter-end. The preamble did 
not specify expectations regarding annual disclosures.
    The FDIC acknowledges that timing of disclosures required under the 
federal banking laws may not always coincide with the timing of 
disclosures under other federal laws, including federal securities laws 
and their implementing regulations by the SEC. The FDIC also indicated 
that an FDIC-supervised institution may use disclosures made pursuant 
to SEC, regulatory reporting, and other disclosure requirements to help 
meet its public disclosure requirements under the advanced approaches 
rule. For calendar quarters that do not correspond to fiscal year end, 
the FDIC considers those disclosures that are made within 45 days of 
the end of the calendar quarter (or within 60 days for the limited 
purpose of the FDIC-supervised institution's first reporting period in 
which it is subject to the public disclosure requirements) as timely. 
In general, where an FDIC-supervised institution's fiscal year-end 
coincides with the end of a calendar quarter, the FDIC considers 
qualitative and quantitative disclosures to be timely if they are made 
no later than the applicable SEC disclosure deadline for the 
corresponding Form 10-K annual report. In cases where an institution's 
fiscal year end does not coincide with the end of a calendar quarter, 
the FDIC would consider the timeliness of disclosures on a case-by-case 
basis. In some cases, management may determine that a significant 
change has occurred, such that the most recent reported amounts do not 
reflect the FDIC-supervised institution's capital adequacy and risk 
profile. In those cases, an FDIC-supervised institution needs to 
disclose the general nature of these changes and briefly describe how 
they are likely to affect public disclosures going forward. An FDIC-
supervised institution should make these interim disclosures as soon as 
practicable after the determination that a significant change has 
occurred.
2. Enhanced Securitization Disclosure Requirements
    In view of the significant market uncertainty during the recent 
financial crisis caused by the lack of disclosures regarding banking 
organizations' securitization-related exposures, the FDIC believes that 
enhanced disclosure requirements are appropriate. Consistent with the 
disclosures introduced by the 2009 Enhancements, the proposal amended 
the qualitative section for Table 9 disclosures (Securitization) under 
section 324.173 to include the following:
    [ssquf] The nature of the risks inherent in a banking 
organization's securitized assets,
    [ssquf] A description of the policies that monitor changes in the 
credit and market risk of a banking organization's securitization 
exposures,
    [ssquf] A description of a banking organization's policy regarding 
the use of credit risk mitigation for securitization exposures,
    [ssquf] A list of the special purpose entities a banking 
organization uses to securitize exposures and the affiliated entities 
that a bank manages or advises and that invest in securitization 
exposures or the referenced SPEs, and
    [ssquf] A summary of the banking organization's accounting policies 
for securitization activities.
    To the extent possible, the FDIC is implementing the disclosure 
requirements included in the 2009 Enhancements in the interim final 
rule. However, consistent with section 939A of the Dodd-Frank Act, the 
tables do not include those disclosure requirements that are tied to 
the use of ratings.
3. Equity Holdings That Are Not Covered Positions
    The current advanced approaches rule requires banking organizations 
to include in their public disclosures a discussion of ``important 
policies covering the valuation of and accounting for equity holdings 
in the banking book.'' Since ``banking book'' is not a defined term 
under the interim final rule, the FDIC refers to such exposures as 
equity holdings that are not covered positions in the interim final 
rule.

XII. Market Risk Rule

    On August 30, 2012, the agencies revised their respective market 
risk rules to better capture positions subject to market risk, reduce 
pro-cyclicality in market risk capital requirements, enhance the rule's 
sensitivity to risks that were not adequately captured under the prior 
regulatory measurement methodologies, and increase transparency through 
enhanced disclosures.\184\
---------------------------------------------------------------------------

    \184\ See 77 FR 53060 (August 30, 2012).
---------------------------------------------------------------------------

    As noted in the introduction of this preamble, the agencies 
proposed to expand the scope of the market risk rule to include state 
savings associations, and to codify the market risk rule in a manner 
similar to the other regulatory capital rules in the three proposals. 
In the interim final rule, consistent with the proposal, the FDIC has 
also merged definitions and made appropriate technical changes.
    As a general matter, an FDIC-supervised institution that is subject 
to the market risk rule will continue to exclude covered positions 
(other than certain foreign exchange and commodities positions) when 
calculating its risk-weighted assets under the other risk-based capital 
rules. Instead, the FDIC-supervised institution must determine an 
appropriate capital requirement for such positions using the 
methodologies set forth in the final market risk rule. The banking 
organization then must multiply its market risk capital requirement by 
12.5 to determine a risk-weighted asset amount for its market risk 
exposures and include that amount in its standardized approach risk-
weighted assets and for an advanced approaches banking organization's 
advanced approaches risk-weighted assets.
    The market risk rule is designed to determine capital requirements 
for trading assets based on general and specific market risk associated 
with these assets. General market risk is the risk of loss in the 
market value of positions resulting from broad market movements, such 
as changes in the general level of interest rates, equity prices, 
foreign exchange rates, or commodity prices. Specific market risk is 
the risk of loss from changes in the fair value of a position due to 
factors other than broad market movements, including event risk 
(changes in market price due to unexpected events specific to a 
particular obligor or position) and default risk.
    The agencies proposed to apply the market risk rule to state 
savings associations. Consistent with the proposal, the FDIC in this 
interim final rule has expanded the scope of the market risk rule to 
state savings associations that meet the stated thresholds. The market 
risk rule applies to any state savings association whose trading 
activity (the gross sum of its trading assets and trading liabilities) 
is equal to 10 percent or more of its total assets or $1 billion or 
more. The FDIC retains the authority to apply its respective market 
risk rule to any entity under its jurisdiction, regardless of whether 
it meets either of the thresholds described above, if the agency deems 
it necessary or appropriate for safe and sound banking practices.
    Application of the market risk rule to all banking organizations 
with material exposure to market risk is particularly important because 
of banking organizations' increased exposure to

[[Page 55464]]

traded credit products, such as CDSs, asset-backed securities and other 
structured products, as well as other less liquid products. In fact, 
many of the August 2012 revisions to the market risk rule were made in 
response to concerns that arose during the recent financial crisis when 
banking organizations holding certain trading assets suffered 
substantial losses. For example, in addition to a market risk capital 
requirement to account for general market risk, the revised rules apply 
more conservative standardized specific risk capital requirements to 
most securitization positions and implement an additional incremental 
risk capital requirement for a banking organization that models 
specific risk for one or more portfolios of debt or, if applicable, 
equity positions. Additionally, to address concerns about the 
appropriate treatment of traded positions that have limited price 
transparency, a banking organization subject to the market risk rule 
must have a well-defined valuation process for all covered positions.
    The FDIC received comments on the market risk rule. One commenter 
asserted that the agencies should establish standardized capital 
requirements for trading operations rather than relying on risk 
modeling techniques because there is no way for regulators or market 
participants to judge whether bank calculations of market risk are 
meaningful. Regarding the use of standardized requirements for trading 
operations rather than reliance on risk modeling, banking 
organizations' models are subject to initial approval and ongoing 
review under the market risk rule. The FDIC is aware that the BCBS is 
considering, among other options, greater use of standardized 
approaches for market risk. The FDIC would consider modifications to 
the international market risk framework when and if it is revised.
    Another commenter asserted that the effective date for application 
of the market risk rule (and the advanced approaches rule) to SLHCs 
should be deferred until at least July 21, 2015. This commenter also 
asserted that SLHCs with substantial insurance operations should be 
exempt from the advanced approaches and market risk rules if their 
subsidiary bank or savings association comprised less than 5 percent or 
10 percent of the total assets of the SLHC. As a general matter, 
savings associations and SLHCs do not engage in trading activity to a 
substantial degree. However, the FDIC believes that any state savings 
association whose trading activity grows to the extent that it meets 
either of the thresholds should hold capital commensurate with the risk 
of the trading activity and should have in place the prudential risk-
management systems and processes required under the market risk rule. 
Therefore, it is appropriate to expand the scope of the market risk 
rule to apply to state savings associations as of January 1, 2015.
    Another commenter asserted that regulations should increase the 
cost of excessive use of short-term borrowing to fund long maturity 
assets. The FDIC is considering the implications of short-term funding 
from several perspectives outside of the regulatory capital framework. 
Specifically, the FDIC expects short-term funding risks would be a 
potential area of focus in forthcoming Basel III liquidity and enhanced 
prudential standards regulations.
    The FDIC also has adopted conforming changes to certain elements of 
the market risk rule to reflect changes that are being made to other 
aspects of the regulatory capital framework. These changes are designed 
to correspond to the changes to the CRC references and treatment of 
securitization exposures under subparts D and E of the interim final 
rule, which are discussed more fully in the standardized and advanced 
approaches sections. See sections VIII.B and XII.C of this preamble for 
a discussion of these changes.
    More specifically, the market risk rule is being amended to 
incorporate a revised definition of parameter W in the SSFA. The 
agencies received comment on the existing definition, which assessed a 
capital penalty if borrowers exercised contractual rights to defer 
payment of principal or interest for more than 90 days on exposures 
underlying a securitization. In response to commenters, the FDIC is 
modifying this definition to exclude all loans issued under Federally-
guaranteed student loan programs, and certain consumer loans (including 
non-Federally guaranteed student loans) from being included in this 
component of parameter W.
    The FDIC has made a technical amendment to the market risk rule 
with respect to the covered position definition. Previously, the 
definition of covered position excluded equity positions that are not 
publicly traded. The FDIC has refined this exception such that a 
covered position may include a position in a non-publicly traded 
investment company, as defined in and registered with the SEC under the 
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) (or its non-
U.S. equivalent), provided that all the underlying equities held by the 
investment company are publicly traded. The FDIC believes that a 
``look-through'' approach is appropriate in these circumstances because 
of the liquidity of the underlying positions, so long as the other 
conditions of a covered position are satisfied.
    The FDIC also has clarified where an FDIC-supervised institution 
subject to the market risk rule must make its required market risk 
disclosures and require that these disclosures be timely. The FDIC-
supervised institution must provide its quantitative disclosures after 
each calendar quarter. In addition, the interim final rule clarifies 
that an FDIC-supervised institution must provide its qualitative 
disclosures at least annually, after the end of the fourth calendar 
quarter, provided any significant changes are disclosed in the interim.
    The FDIC acknowledges that the timing of disclosures under the 
federal banking laws may not always coincide with the timing of 
disclosures required under other federal laws, including disclosures 
required under the federal securities laws and their implementing 
regulations by the SEC. For calendar quarters that do not correspond to 
fiscal year end, the FDIC considers those disclosures that are made 
within 45 days of the end of the calendar quarter (or within 60 days 
for the limited purpose of the FDIC-supervised institution's first 
reporting period in which it is subject to the rule) as timely. In 
general, where an FDIC-supervised institution's fiscal year-end 
coincides with the end of a calendar quarter, the FDIC considers 
qualitative and quantitative disclosures to be timely if they are made 
no later than the applicable SEC disclosure deadline for the 
corresponding Form 10-K annual report. In cases where an institution's 
fiscal year end does not coincide with the end of a calendar quarter, 
the FDIC would consider the timeliness of disclosures on a case-by-case 
basis. In some cases, management may determine that a significant 
change has occurred, such that the most recent reported amounts do not 
reflect the FDIC-supervised institution's capital adequacy and risk 
profile. In those cases, an FDIC-supervised institution needs to 
disclose the general nature of these changes and briefly describe how 
they are likely to affect public disclosures going forward. An FDIC-
supervised institution should make these interim disclosures as soon as 
practicable after the determination that a significant change has 
occurred.
    The interim final rule also clarifies that an FDIC-supervised 
institution's management may provide all of the disclosures required by 
the market risk

[[Page 55465]]

rule in one place on the FDIC-supervised institution's public Web site 
or may provide the disclosures in more than one public financial report 
or other regulatory reports, provided that the FDIC-supervised 
institution publicly provides a summary table specifically indicating 
the location(s) of all such disclosures.

XIII. Abbreviations

ABCP Asset-Backed Commercial Paper
ADC Acquisition, Development, or Construction
AFS Available For Sale
ALLL Allowance for Loan and Lease Losses
AOCI Accumulated Other Comprehensive Income
AVC Asset Value Correlation
BCBS Basel Committee on Banking Supervision
BCBS FAQ Basel Committee on Banking Supervision Frequently Asked 
Questions
BHC Bank Holding Company
CCF Credit Conversion Factor
CCP Central Counterparty
CDFI Community Development Financial Institution
CDS Credit Default Swap
CDSind Index Credit Default Swap
CEIO Credit-Enhancing Interest-Only Strip
CEM Current Exposure Method
CFR Code of Federal Regulations
CFPB Consumer Financial Protection Bureau
CFTC Commodity Futures Trading Commission
CPSS Committee on Payment and Settlement Systems
CRC Country Risk Classifications
CUSIP Committee on Uniform Securities Identification Procedures
CVA Credit Valuation Adjustment
DAC Deferred Acquisition Cost
DCO Derivatives Clearing Organizations
DTA Deferred Tax Asset
DTL Deferred Tax Liability
DvP Delivery-versus-Payment
E Measure of Effectiveness
EAD Exposure at Default
ECL Expected Credit Loss
EE Expected Exposure
EPE Expected Positive Exposure
ERISA Employee Retirement Income Security Act of 1974
ESOP Employee Stock Ownership Plan
FDIC Federal Deposit Insurance Corporation
FDICIA Federal Deposit Insurance Corporation Improvement Act of 1991
FFIEC Federal Financial Institutions Examination Council
FHA Federal Housing Administration
FHLB Federal Home Loan Bank
FHLMC Federal Home Loan Mortgage Corporation
FIRREA Financial Institutions, Reform, Recovery and Enforcement Act
FMU Financial Market Utility
FNMA Federal National Mortgage Association
FRFA Final Regulatory Flexibility Act
GAAP U.S. Generally Accepted Accounting Principles
GNMA Government National Mortgage Association
GSE Government-sponsored Enterprise
HAMP Home Affordable Mortgage Program
HOLA Home Owners' Loan Act
HTM Held-To-Maturity
HVCRE High-Volatility Commercial Real Estate
IFRS International Financial Reporting Standards
IMM Internal Models Methodology
IOSCO International Organization of Securities Commissions
IRB Internal Ratings-Based
IRFA Initial Regulatory Flexibility Analysis
LGD Loss Given Default
LTV Loan-to-Value Ratio
M Effective Maturity
MBS Mortgage-backed Security
MDB Multilateral Development Bank
MDI Minority Depository Institution
MHC Mutual Holding Company
MSA Mortgage Servicing Assets
NPR Notice of Proposed Rulemaking
NRSRO Nationally Recognized Statistical Rating Organization
OCC Office of the Comptroller of the Currency
OECD Organization for Economic Co-operation and Development
OMB Office of Management and Budget
OTC Over-the-Counter
OTS Office of Thrift Supervision
PCA Prompt Corrective Action
PCCR Purchased Credit Card Relationship
PD Probability of Default
PFE Potential Future Exposure
PMI Private Mortgage Insurance
PMSR Purchased Mortgage Servicing Right
PRA Paperwork Reduction Act of 1995
PSE Public Sector Entities
PvP Payment-versus-Payment
QCCP Qualifying Central Counterparty
QIS Quantitative Impact Study
QM Qualified Mortgages
QRE Qualifying Revolving Exposure
RBA Ratings-Based Approach
RBC Risk-Based Capital
REIT Real Estate Investment Trust
Re-REMIC Resecuritization of Real Estate Mortgage Investment Conduit
RFA Regulatory Flexibility Act
RTCRRI Act Resolution Trust Corporation Refinancing, Restructuring, 
and Improvement Act of 1991
RVC Ratio of Value Change
SAP Statutory Accounting Principles
SEC U.S. Securities and Exchange Commission
SFA Supervisory Formula Approach
SLHC Savings and Loan Holding Company
SPE Special Purpose Entity
SR Supervision and Regulation Letter
SRWA Simple Risk-Weight Approach
SSFA Simplified Supervisory Formula Approach
TruPS Trust Preferred Security
TruPS CDO Trust Preferred Security Collateralized Debt Obligation
UMRA Unfunded Mandates Reform Act of 1995
U.S.C. United States Code
VA Veterans Administration
VaR Value-at-Risk
VOBA Value of Business Acquired
WAM Weighted Average Maturity

XIV. Regulatory Flexibility Act

    In general, section 4 of the Regulatory Flexibility Act (5 U.S.C. 
604) (RFA) requires an agency to prepare a final regulatory flexibility 
analysis (FRFA), for a final rule unless the agency certifies that the 
rule will not, if promulgated, have a significant economic impact on a 
substantial number of small entities (defined for purposes of the RFA 
to include banking entities with total assets of $175 million or less 
and after July 22, 2013, total assets of $500 million or less). 
Pursuant to the RFA, the agency must make the FRFA available to members 
of the public and must publish the FRFA, or a summary thereof, in the 
Federal Register. In accordance with section 4 of the RFA, the FDIC is 
publishing the following summary of its FRFA.\185\
---------------------------------------------------------------------------

    \185\ The FDIC published a summary of its initial regulatory 
flexibility analysis (IRFA) in connection with each of the proposed 
rules in accordance with Section 3(a) of the Regulatory Flexibility 
Act, 5 U.S.C. 603 (RFA). In the IRFAs provided in connection with 
the proposed rules, the FDIC requested comment on all aspects of the 
IRFAs, and, in particular, on any significant alternatives to the 
proposed rules applicable to covered small FDIC-supervised 
institutions that would minimize their impact on those entities. In 
the IRFA provided by the FDIC in connection with the advanced 
approach proposed rule, the FDIC determined that there would not be 
a significant economic impact on a substantial number of small FDIC-
supervised institutions and published a certification and a short 
explanatory statement pursuant to section 605(b) of the RFA.
---------------------------------------------------------------------------

    For purposes of the FRFA, the FDIC analyzed the potential economic 
impact on the entities it regulates with total assets of $175 million 
or less and $500 million or less, including state nonmember banks and 
state savings associations (small FDIC-supervised institutions).
    As discussed in more detail in section E, below, the FDIC believes 
that this interim final rule may have a significant economic impact on 
a substantial number of the small entities under its jurisdiction. 
Accordingly, the FDIC has prepared the following FRFA pursuant to the 
RFA.

A. Statement of the Need for, and Objectives of, the Interim Final Rule

    As discussed in the Supplementary Information of the preamble to 
this interim final rule, the FDIC is revising its regulatory capital 
requirements to promote safe and sound banking practices, implement 
Basel III and other aspects of the Basel capital framework, harmonize 
capital requirements between types of FDIC-supervised institutions, and 
codify capital requirements.
    Additionally, this interim final rule satisfies certain 
requirements under the

[[Page 55466]]

Dodd-Frank Act by: (1) Revising regulatory capital requirements to 
remove references to, and requirements of reliance on, credit 
ratings,\186\ and (2) imposing new or revised minimum capital 
requirements on certain FDIC-supervised institutions.\187\
---------------------------------------------------------------------------

    \186\ See 15 U.S.C. 78o-7, note.
    \187\ See 12 U.S.C. 5371.
---------------------------------------------------------------------------

    Under section 38(c)(1) of the Federal Deposit Insurance Act, the 
FDIC may prescribe capital standards for depository institutions that 
it regulates.\188\ The FDIC also must establish capital requirements 
under the International Lending Supervision Act for institutions that 
it regulates.\189\
---------------------------------------------------------------------------

    \188\ See 12 U.S.C. 1831o(c).
    \189\ See 12 U.S.C. 3907.
---------------------------------------------------------------------------

B. Summary and Assessment of Significant Issues Raised by Public 
Comments in Response to the IRFAs, and a Statement of Changes Made as a 
Result of These Comments

    The FDIC received three public comments directly addressing the 
IRFAs. One commenter questioned the FDIC's assumption that risk-
weighted assets would increase only 10 percent and questioned reliance 
on Call Report data for this assumption, as the commenter asserted that 
existing Call Report data does not contain the information required to 
accurately analyze the proposal's impact on risk-weighted assets (for 
example, under the Standardized Approach NPR, an increase in the risk 
weights for 1-4 family residential mortgage exposures that are balloon 
mortgages). The commenters also expressed general concern that the FDIC 
was underestimating the compliance cost of the proposed rules. For 
instance, one commenter questioned whether small banking organizations 
would have the information required to determine the applicable risk 
weights for residential mortgage exposures, and stated that the cost of 
applying the proposed standards to existing exposures was 
underestimated. Another commenter stated that the FDIC did not 
adequately consider the additional costs relating to new reporting 
systems, assimilating data, and preparing reports required under the 
proposed rules.
    To measure the potential impact on small entities for the purposes 
of its IRFAs, the FDIC used the most current reporting data available 
and, to address information gaps, applied conservative assumptions. The 
FDIC considered the comments it received on the potential impact of the 
proposed rules, and, as discussed in Item F, below, made significant 
revisions to the interim final rule in response to the concerns 
expressed regarding the potential burden on small FDIC-supervised 
institutions.
    Commenters expressed concern that the FDIC, along with the OCC and 
Federal Reserve, did not use a uniform methodology for conducting their 
IRFAs and suggested that the agencies should have compared their 
analyses prior to publishing the proposed rules. The agencies 
coordinated closely in conducting the IRFAs to maximize consistency 
among the methodologies used for determining the potential impact on 
the entities regulated by each agency. However, the analyses differed 
as appropriate in light of the different entities each agency 
supervises. For their respective FRFAs, the agencies continued to 
coordinate closely in order to ensure maximum consistency and 
comparability.
    One commenter questioned the alternatives described in the IRFAs. 
This commenter asserted that the alternatives were counter-productive 
and added complexity to the capital framework without any meaningful 
benefit. As discussed throughout the preamble and in Item F, below, the 
FDIC has responded to commenters' concerns and sought to reduce the 
compliance burden on FDIC-supervised institutions throughout this 
interim final rule.
    The FDIC also received a number of more general comments regarding 
the overall burden of the proposed rules. For example, many commenters 
expressed concern that the complexity and implementation cost of the 
proposed rules would exceed the expected benefit. According to these 
commenters, implementation of the proposed rules would require software 
upgrades for new internal reporting systems, increased employee 
training, and the hiring of additional employees for compliance 
purposes.
    A few commenters also urged the FDIC to recognize that compliance 
costs have increased significantly over recent years due to other 
regulatory changes. As discussed throughout the preamble and in Item F, 
below, the FDIC recognizes the potential compliance costs associated 
with the proposals. Accordingly, for purposes of the interim final rule 
the FDIC modified certain requirements of the proposals to reduce the 
compliance burden on small FDIC-supervised institutions. The FDIC 
believes the interim final rule maintains its objectives regarding the 
implementation of the Basel III framework while reducing costs for 
small FDIC-supervised institutions.

C. Response to Comments Filed by the Chief Counsel for Advocacy of the 
Small Business Administration, and Statement of Changes Made as a 
Result of the Comment

    The Chief Counsel for Advocacy of the Small Business Administration 
(CCA) filed a letter with the FDIC providing comments on the proposed 
rules. The CCA generally commended the FDIC for the IRFAs provided with 
the proposed rules, and specifically commended the FDIC for considering 
the cumulative economic impact of the proposals on small FDIC-
supervised institutions. The CCA acknowledged that the FDIC provided 
lists of alternatives being considered, but encouraged the FDIC to 
provide more detailed discussion of these alternatives and the 
potential burden reductions associated with the alternatives. The CCA 
acknowledged that the FDIC had certified that the advanced approaches 
proposed rule would not have a significant economic impact on a 
substantial number of small FDIC-supervised institutions.
    The CCA stated that small FDIC-supervised institutions should be 
able to continue to use the current regulatory capital framework to 
compute their capital requirements. The FDIC recognizes that the new 
regulatory capital framework will carry costs, but believes that the 
supervisory interest in improved and uniform capital standards, and the 
resulting improvements in the safety and soundness of the U.S. banking 
system, outweighs the increased burden.
    The CCA also urged the FDIC to give careful consideration to 
comments discussing the impact of the proposed rules on small FDIC-
supervised institutions and to analyze possible alternatives to reduce 
this impact. The FDIC gave careful consideration to all comments 
received, in particular the comments that discussed the potential 
impact of the proposed rules on small FDIC-supervised institutions and 
made certain changes to reduce the potential impact of the interim 
final rule, as discussed throughout the preamble and in Item F, below.
    The CCA expressed concern that aspects of the proposals could be 
problematic and onerous for small FDIC-supervised institutions. The CCA 
stated that the proposed rules were designed for large, international 
banks and not adapted to the circumstances of small FDIC-supervised 
institutions. Specifically, the CCA expressed concern over higher risk 
weights for certain products, which, the CCA argued, could drive small 
FDIC-supervised institutions

[[Page 55467]]

into products carrying additional risks. The CCA also noted heightened 
compliance and technology costs associated with implementing the 
proposed rules and raised the possibility that small FDIC-supervised 
institutions may exit the mortgage market. As discussed throughout the 
preamble and in Item F below, the FDIC has made significant revisions 
to the proposed rules that address the concerns raised in the CCA's 
comment.

D. Description and Estimate of Small FDIC-Supervised Institutions 
Affected by the Interim Final Rule

    Under regulations issued by the Small Business Administration,\190\ 
a small entity includes a depository institution with total assets of 
$175 million or less and beginning July 22, 2013, total assets of $500 
million or less.
---------------------------------------------------------------------------

    \190\ See 13 CFR 121.201.
---------------------------------------------------------------------------

    As of March 31, 2013, the FDIC supervised approximately 2,453 small 
depository institutions with total assets of $175 million or less. 
2,295 are small state nonmember banks, 112 are small state savings 
banks, and 46 are small state savings associations. As of March 31, 
2013, the FDIC supervised approximately 3,711 small depository 
institutions with total assets of $500 million or less. 3,398 are small 
state nonmember banks, 259 are small state savings banks, and 54 are 
small state savings associations.

E. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The interim final rule may impact small FDIC-supervised 
institutions in several ways. The interim final rule affects small 
FDIC-supervised institutions' regulatory capital requirements by 
changing the qualifying criteria for regulatory capital, including 
required deductions and adjustments, and modifying the risk weight 
treatment for some exposures. The interim final rule also requires 
small FDIC-supervised institutions to meet new minimum common equity 
tier 1 to risk-weighted assets ratio of 4.5 percent and an increased 
minimum tier 1 capital to risk-weighted assets risk-based capital ratio 
of 6 percent. Under the interim final rule, all FDIC-supervised 
institutions would remain subject to a 4 percent minimum tier 1 
leverage ratio.\191\ The interim final rule imposes limitations on 
capital distributions and discretionary bonus payments for small FDIC-
supervised institutions that do not hold a buffer of common equity tier 
1 capital above the minimum ratios.
---------------------------------------------------------------------------

    \191\ FDIC-supervised institutions subject to the advanced 
approaches rule also would be required in 2018 to achieve a minimum 
tier 1 capital to total leverage exposure ratio (the supplementary 
leverage ratio) of 3 percent. Advanced approaches banking 
organizations should refer to section 10 of subpart B of the interim 
final rule and section II.B of the preamble for a more detailed 
discussion of the applicable minimum capital ratios.
---------------------------------------------------------------------------

    The interim final rule also includes changes to the general risk-
based capital requirements that address the calculation of risk-
weighted assets. The interim final rule:
     Introduces a higher risk weight for certain past due 
exposures and acquisition and development real estate loans;
     Provides a more risk sensitive approach to exposures to 
non-U.S. sovereigns and non-U.S. public sector entities;
     Replaces references to credit ratings with new measures of 
creditworthiness; \192\
---------------------------------------------------------------------------

    \192\ Section 939A of the Dodd-Frank Act addresses the use of 
credit ratings in regulations of the FDIC. Accordingly, the interim 
final rule introduces alternative measures of creditworthiness for 
foreign debt, securitization positions, and resecuritization 
positions.
---------------------------------------------------------------------------

     Provides more comprehensive recognition of collateral and 
guarantees; and
     Provides a more favorable capital treatment for 
transactions cleared through qualifying central counterparties.
    As a result of the new requirements, some small FDIC-supervised 
institutions may have to alter their capital structure (including by 
raising new capital or increasing retention of earnings) in order to 
achieve compliance.
    The FDIC has excluded from its analysis any burden associated with 
changes to the Consolidated Reports of Income and Condition for small 
FDIC-supervised institutions (FFIEC 031 and 041; OMB Nos. 7100-0036, 
3064-0052, 1557-0081). The FDIC is proposing information collection 
changes to reflect the requirements of the interim final rule, and is 
publishing separately for comment on the regulatory reporting 
requirements that will include associated estimates of burden. Further 
analysis of the projected reporting requirements imposed by the interim 
final rule is located in the Paperwork Reduction Act section, below.
    Most small FDIC-supervised institutions hold capital in excess of 
the minimum leverage and risk-based capital requirements set forth in 
the interim final rule. Although the capital requirements under the 
interim final rule are not expected to significantly impact the capital 
structure of these institutions, the FDIC expects that some may change 
internal capital allocation policies and practices to accommodate the 
requirements of the interim final rule. For example, an institution may 
elect to raise capital to return its excess capital position to the 
levels maintained prior to implementation of the interim final rule.
    A comparison of the capital requirements in the interim final rule 
on a fully-implemented basis to the minimum requirements under the 
general risk-based capital rules shows that approximately 57 small 
FDIC-supervised institutions with total assets of $175 million or less 
currently do not hold sufficient capital to satisfy the requirements of 
the interim final rule. Those institutions, which represent 
approximately two percent of small FDIC-supervised institutions, 
collectively would need to raise approximately $83 million in 
regulatory capital to meet the minimum capital requirements under the 
interim final rule.
    A comparison of the capital requirements in the interim final rule 
on a fully-implemented basis to the minimum requirements under the 
general risk-based capital rules shows that approximately 96 small 
FDIC-supervised institutions with total assets of $500 million or less 
currently do not hold sufficient capital to satisfy the requirements of 
the interim final rule. Those institutions, which represent 
approximately three percent of small FDIC-supervised institutions, 
collectively would need to raise approximately $445 million in 
regulatory capital to meet the minimum capital requirements under the 
interim final rule.
    To estimate the cost to FDIC-supervised institutions of the new 
capital requirement, the FDIC examined the effect of this requirement 
on capital structure and the overall cost of capital.\193\ The cost of 
financing an FDIC-supervised institution is the weighted average cost 
of its various financing sources, which amounts to a weighted average 
cost of capital reflecting many different types of debt and equity 
financing. Because interest payments on debt are tax deductible, a more 
leveraged capital structure reduces corporate taxes, thereby lowering 
funding costs, and the weighted average cost of financing tends to 
decline as leverage increases. Thus, an increase in required equity 
capital would--all else equal--increase the cost of capital for that 
institution. This effect could be offset to some extent if the 
additional capital protection caused the risk-premium demanded by the 
institution's

[[Page 55468]]

counterparties to decline sufficiently. The FDIC did not try to measure 
this effect. This increased cost in the most burdensome year would be 
tax benefits foregone: The capital requirement, multiplied by the 
interest rate on the debt displaced and by the effective marginal tax 
rate for the FDIC-supervised institutions affected by the interim final 
rule. The effective marginal corporate tax rate is affected not only by 
the statutory federal and state rates, but also by the probability of 
positive earnings and the offsetting effects of personal taxes on 
required bond yields. Graham (2000) considers these factors and 
estimates a median marginal tax benefit of $9.40 per $100 of 
interest.\194\ So, using an estimated interest rate on debt of 6 
percent, the FDIC estimated that for institutions with total assets of 
$175 million or less, the annual tax benefits foregone on $83 million 
of capital switching from debt to equity is approximately $469,000 per 
year ($83 million * 0.06 (interest rate) * 0.094 (median marginal tax 
savings)). Averaged across 57 institutions, the cost is approximately 
$8,000 per institution per year. Similarly, for institutions with total 
assets of $500 million or less, the annual tax benefits foregone on 
$445 million of capital switching from debt to equity is approximately 
$2.5 million per year ($445 million * 0.06 (interest rate) * 0.094 
(median marginal tax savings)). Averaged across 96 institutions, the 
cost is approximately $26,000 per institution per year.
---------------------------------------------------------------------------

    \193\ See Merton H. Miller, (1995), ``Do the M & M propositions 
apply to banks?'' Journal of Banking & Finance, Vol. 19, pp. 483-
489.
    \194\ See John R. Graham, (2000), How Big Are the Tax Benefits 
of Debt?, Journal of Finance, Vol. 55, No. 5, pp. 1901-1941. Graham 
points out that ignoring the offsetting effects of personal taxes 
would increase the median marginal tax rate to $31.5 per $100 of 
interest.
---------------------------------------------------------------------------

    Working with the other agencies, the FDIC also estimated the direct 
compliance costs related to financial reporting as a result of the 
interim final rule. This aspect of the interim final rule likely will 
require additional personnel training and expenses related to new 
systems (or modification of existing systems) for calculating 
regulatory capital ratios, in addition to updating risk weights for 
certain exposures. The FDIC assumes that small FDIC-supervised 
institutions will spend approximately $43,000 per institution to update 
reporting system and change the classification of existing exposures. 
Based on comments from the industry, the FDIC increased this estimate 
from the $36,125 estimate used in the proposed rules. The FDIC believes 
that this revised cost estimate is more conservative because it has 
increased even though many of the labor-intensive provisions of the 
interim final rule have been excluded. For example, small FDIC-
supervised institutions have the option to maintain the current 
reporting methodology for gains and losses classified as Available for 
Sale (AFS) thus eliminating the need to update systems. Additionally 
the exposures where the risk-weights are changing typically represent a 
small portion of assets (less than 5 percent) on institutions' balance 
sheets. Additionally, small FDIC-supervised institutions can maintain 
existing risk-weights for residential mortgage exposures, eliminating 
the need for those institutions to reclassify existing exposure. This 
estimate of direct compliance costs is the same under both the $175 
million and $500 million size thresholds.
    The FDIC estimates that the $43,000 in direct compliance costs will 
represent a significant burden for approximately 37 percent of small 
FDIC-supervised institutions with total assets of $175 million or less. 
The FDIC estimates that the $43,000 in direct compliance costs will 
represent a burden for approximately 25 percent of small FDIC-
supervised institutions with total assets of $500 million or less. For 
purposes of this interim final rule, the FDIC defines significant 
burden as an estimated cost greater than 2.5 percent of total non-
interest expense or 5 percent of annual salaries and employee benefits. 
The direct compliance costs are the most significant cost since few 
small FDIC-supervised institutions will need to raise capital to meet 
the minimum ratios, as noted above.

 F. Steps Taken To Minimize the Economic Impact on Small FDIC-
Supervised Institutions; Significant Alternatives

    In response to commenters' concerns about the potential 
implementation burden on small FDIC-supervised institutions, the FDIC 
has made several significant revisions to the proposals for purposes of 
the interim final rule. Under the interim final rule, non-advanced 
approaches FDIC-supervised institutions will be permitted to elect to 
exclude amounts reported as accumulated other comprehensive income 
(AOCI) when calculating regulatory capital, to the same extent 
currently permitted under the general risk-based capital rules.\195\ In 
addition, for purposes of calculating risk-weighted assets under the 
standardized approach, the FDIC is not adopting the proposed treatment 
for 1-4 family residential mortgages, which would have required small 
FDIC-supervised institutions to categorize residential mortgage loans 
into one of two categories based on certain underwriting standards and 
product features, and then risk-weight each loan based on its loan-to-
value ratio. The FDIC also is retaining the 120-day safe harbor from 
recourse treatment for loans transferred pursuant to an early default 
provision. The FDIC believes that these changes will meaningfully 
reduce the compliance burden of the interim final rule for small FDIC-
supervised institutions. For instance, in contrast to the proposal, the 
interim final rule does not require small FDIC-supervised institutions 
to review existing mortgage loan files, purchase new software to track 
loan-to-value ratios, train employees on the new risk-weight 
methodology, or hold more capital for exposures that would have been 
deemed category 2 under the proposed rule, removing the proposed 
distinction between risk weights for category 1 and 2 residential 
mortgage exposures. Similarly, the option to elect to retain the 
current treatment of AOCI will reduce the burden associated with 
managing the volatility in regulatory capital resulting from changes in 
the value of an FDIC-supervised institutions' AFS debt securities 
portfolio due to shifting interest rate environments. The FDIC believes 
these modifications to the proposed rule will substantially reduce 
compliance burden for small FDIC-supervised institutions.
---------------------------------------------------------------------------

    \195\ For most non-advanced approaches banking organizations, 
this will be a one-time only election. However, in certain limited 
circumstances, such as a merger of organizations that have made 
different elections, the FDIC may permit the resultant entity to 
make a new election.
---------------------------------------------------------------------------

XV. Paperwork Reduction Act

    In accordance with the requirements of the Paperwork Reduction Act 
(PRA) of 1995 (44 U.S.C. 3501-3521), the FDIC 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.
    In conjunction with the proposed rules, the FDIC submitted the 
information collection requirements contained therein to OMB for 
review. In response, OMB filed comments with the FDIC in accordance 
with 5 CFR 1320.11(c) withholding PRA approval and instructing that the 
collection should be resubmitted to OMB at the interim final rule 
stage. As instructed by OMB, the information collection requirements 
contained in this interim final rule have been submitted by the FDIC to 
OMB for review under the PRA, under OMB Control No. 3064-0153.

[[Page 55469]]

    The interim final rule contains information collection requirements 
subject to the PRA. They are found in sections 324.3, 324.22, 324.35, 
324.37, 324.41, 324.42, 324.62, 324.63 (including tables), 324.121, 
through 324.124, 324.132, 324.141, 324.142, 324.153, 324.173 (including 
tables). The information collection requirements contained in sections 
324.203, through 324.210, and 324.212 concerning market risk are 
approved by OMB under Control No. 3604-0178.
    A total of nine comments were received concerning paperwork. Seven 
expressed concern regarding the increase in paperwork resulting from 
the rule. They addressed the concept of paperwork generally and not 
within the context of the PRA.
    One comment addressed cost, competitiveness, and qualitative impact 
statements, and noted the lack of cost estimates. It was unclear 
whether the commenter was referring to cost estimates for regulatory 
burden, which are included in the preamble to the rule, or cost 
estimates regarding the PRA burden, which are included in the 
submissions (information collection requests) made to OMB by the 
agencies regarding the interim final rule. All of the agencies' 
submissions are publicly available at www.reginfo.gov.
    One commenter seemed to indicate that the agencies' burden 
estimates are overstated. The commenter stated that, for their 
institution, the PRA burden will parallel that of interest rate risk 
(240 hours per year). The agencies' estimates far exceed that figure, 
so no change to the estimates would be necessary. The FDIC continues to 
believe that its estimates are reasonable averages that are not 
overstated.
    The FDIC has an ongoing interest in your comments. 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 start-up costs and costs of operation, 
maintenance, and purchase of services to provide information.

XVI. Plain Language

    Section 722 of the Gramm-Leach-Bliley Act requires the FDIC to use 
plain language in all proposed and rules published after January 1, 
2000. The agencies have sought to present the proposed rule in a simple 
and straightforward manner and did not receive any comments on the use 
of plain language.

XVII. Small Business Regulatory Enforcement Fairness Act of 1996

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' the FDIC must advise the OMB as to whether 
the interim final rule constitutes a ``major'' rule.\196\ If a rule is 
major, its effectiveness will generally be delayed for 60 days pending 
congressional review.
---------------------------------------------------------------------------

    \196\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------

    In accordance with SBREFA, the FDIC has advised the OMB that this 
interim final rule is a major rule for the purpose of congressional 
review. Following OMB's review, the FDIC will file the appropriate 
reports with Congress and the Government Accountability Office so that 
the final rule may be reviewed.

List of Subjects

12 CFR Part 303

    Administrative practice and procedure, Banks, banking, Bank merger, 
Branching, Foreign investments, Golden parachute payments, Insured 
branches, Interstate branching, Reporting and recordkeeping 
requirements, Savings associations.

12 CFR Part 308

    Administrative practice and procedure, Banks, banking, Claims, 
Crime; Equal access to justice, Ex parte communications, Hearing 
procedure, Lawyers, Penalties, State nonmember banks.

12 CFR Part 324

    Administrative practice and procedure, Banks, banking, Capital 
adequacy, Reporting and recordkeeping requirements, Savings 
associations, State non-member banks.

12 CFR Part 327

    Bank deposit insurance, Banks, banking, Savings associations.

12 CFR Part 333

    Banks, banking, Corporate powers.

12 CFR Part 337

    Banks, banking, Reporting and recordkeeping requirements, Savings 
associations, Securities.

12 CFR Part 347

    Authority delegations (Government agencies), Bank deposit 
insurance, Banks, banking, Credit, Foreign banking, Investments, 
Reporting and recordkeeping requirements, United States investments 
abroad.

12 CFR Part 349

    Foreign banking, Banks, banking.

12 CFR Part 360

    Banks, banking, Investments.

12 CFR Part 362

    Administrative practice and procedure, Authority delegations 
(Government agencies), Bank deposit insurance, Banks, banking, 
Investments, Reporting and recordkeeping requirements.

12 CFR Part 363

    Accounting, Administrative practice and procedure, Banks, banking, 
Reporting and recordkeeping requirements.

12 CFR Part 364

    Administrative practice and procedure, Bank deposit insurance, 
Banks, banking, Reporting and recordkeeping requirements, Safety and 
soundness.

12 CFR Part 365

    Banks, banking, Mortgages.

12 CFR Part 390

    Administrative practice and procedure, Advertising, Aged, Credit, 
Civil rights, Conflicts of interest, Crime, Equal employment 
opportunity, Ethics, Fair housing' Governmental employees, Home 
mortgage disclosure, Individuals with disabilities, OTS employees, 
Reporting and recordkeeping requirements, Savings associations.

12 CFR Part 391

    Administrative practice and procedure, Advertising, Aged, Credit, 
Civil rights, Conflicts of interest, Crime, Equal employment 
opportunity, Ethics, Fair housing, Governmental employees, Home 
mortgage disclosure, Individuals with disabilities, OTS employees, 
Reporting and recordkeeping requirements, Savings associations.

Authority and Issuance

    For the reasons set forth in the preamble, the Federal Deposit 
Insurance Corporation amends chapter III of title

[[Page 55470]]

12 of the Code of Federal Regulations as follows:

PART 303--FILING PROCEDURES

0
1. The authority citation for part 303 continues to read as follows:

    Authority: 12 U.S.C. 378, 1464, 1813, 1815, 1817, 1818, 1819 
(Seventh and Tenth), 1820, 1823, 1828, 1831a, 1831e, 1831o, 1831p-1, 
1831w, 1835a, 1843(l), 3104, 3105, 3108, 3207; 15 U.S.C. 1601-1607.

0
2. Section 303.2 is amended by revising paragraphs (b), (ee), and (ff) 
to read as follows:


Sec.  303.2  Definitions.

* * * * *
    (b) Adjusted part 325 total assets means adjusted 12 CFR part 325 
or part 324, as applicable, total assets as calculated and reflected in 
the FDIC's Report of Examination.
* * * * *
    (ee) Tier 1 capital shall have the same meaning as provided in 
Sec.  325.2(v) of this chapter (12 CFR 325.2(v)) or Sec.  324.2, as 
applicable.
    (ff) Total assets shall have the same meaning as provided in Sec.  
325.2(x) of this chapter (12 CFR 325.2(x)) or Sec.  324.401(g), as 
applicable.
* * * * *

0
3. Section 303.64 is amended by revising paragraph (a)(4)(i) to read as 
follows:


Sec.  303.64  Processing.

    (a) * * *
    (4) * * *
    (i) Immediately following the merger transaction, the resulting 
institution will be ``well-capitalized'' pursuant to subpart B of part 
325 of this chapter (12 CFR part 325) or subpart H of part 324 of this 
chapter (12 CFR part 324), as applicable; and
* * * * *

0
4. Section 303.181 is amended by revising paragraph (c)(4) to read as 
follows:


Sec.  303.181  Definitions.

* * * * *
    (c) * * *
    (4) Is well-capitalized as defined in subpart B of part 325 of this 
chapter or subpart H of part 324 of this chapter, as applicable; and
* * * * *

0
5. Section 303.184 is amended by revising paragraph (d)(1)(ii) to read 
as follows:


Sec.  303.184  Moving an insured branch of a foreign bank.

* * * * *
    (d) * * *
    (1) * * *
    (ii) The applicant is at least adequately capitalized as defined in 
subpart B of part 325 of this chapter or subpart H of part 324 of this 
chapter, as applicable;
* * * * *

0
6. Section 303.200 is amended by revising paragraphs (a)(2) and (b) to 
read as follows:


Sec.  303.200  Scope.

    (a) * * *
    (2) Definitions of the capital categories referenced in this Prompt 
Corrective Action subpart may be found in subpart B of part 325 of this 
chapter, Sec.  325.103(b) for state nonmember banks and Sec.  
325.103(c) for insured branches of foreign banks, or subpart H of part 
324 of this chapter, Sec.  324.403(b) for state nonmember banks and 
Sec.  324.403(c) for insured branches of foreign banks, as applicable.
    (b) Institutions covered. Restrictions and prohibitions contained 
in subpart B of part 325 of this chapter, and subpart H of part 324 of 
this chapter, as applicable, apply primarily to state nonmember banks 
and insured branches of foreign banks, as well as to directors and 
senior executive officers of those institutions. Portions of subpart B 
of part 325 of this chapter or subpart H of part 324 of this chapter, 
as applicable, also apply to all insured depository institutions that 
are deemed to be critically undercapitalized.

0
7. Section 303.207 is amended by revising paragraph (b)(2) to read as 
follows:


Sec.  303.207  Restricted activities for critically undercapitalized 
institutions.

* * * * *
    (b) * * *
    (2) Extend credit for any highly leveraged transaction. A highly 
leveraged transaction means an extension of credit to or investment in 
a business by an insured depository institution where the financing 
transaction involves a buyout, acquisition, or recapitalization of an 
existing business and one of the following criteria is met:
    (i) The transaction results in a liabilities-to-assets leverage 
ratio higher than 75 percent; or
    (ii) The transaction at least doubles the subject company's 
liabilities and results in a liabilities-to-assets leverage ratio 
higher than 50 percent; or
    (iii) The transaction is designated an highly leverage transaction 
by a syndication agent or a federal bank regulator.
    (iv) Loans and exposures to any obligor in which the total 
financing package, including all obligations held by all participants 
is $20 million or more, or such lower level as the FDIC may establish 
by order on a case-by-case basis, will be excluded from this 
definition.
* * * * *

0
8. Section 303.241 is amended by revising paragraph (c)(4) to read as 
follows:


Sec.  303.241  Reduce or retire capital stock or capital debt 
instruments.

* * * * *
    (c) * * *
    (4) If the proposal involves a series of transactions affecting 
Tier 1 capital components which will be consummated over a period of 
time which shall not exceed twelve months, the application shall 
certify that the insured depository institution will maintain itself as 
a well-capitalized institution as defined in part 325 of this chapter 
or part 324 of this chapter, as applicable, both before and after each 
of the proposed transactions;
* * * * *

PART 308--RULES OF PRACTICE AND PROCEDURE

0
9. The authority citation for part 308 continues to read as follows:

    Authority: 5 U.S.C. 504, 554-557; 12 U.S.C. 93(b), 164, 505, 
1815(e), 1817, 1818, 1820, 1828, 1829, 1829b, 1831i, 1831m(g)(4), 
1831o, 1831p-1, 1832(c), 1884(b), 1972, 3102, 3108(a), 3349, 3909, 
4717, 15 U.S.C. 78(h) and (i), 78o-4(c), 78o-5, 78q-1, 78s, 78u, 
78u-2, 78u-3, and 78w, 6801(b), 6805(b)(1); 28 U.S.C. 2461 note; 31 
U.S.C. 330, 5321; 42 U.S.C. 4012a; Sec. 3100(s), Pub. L. 104-134, 
110 Stat. 1321-358; and Pub. L. 109-351.


0
10. Section 308.200 is revised to read as follows:


Sec.  308.200  Scope.

    The rules and procedures set forth in this subpart apply to banks, 
insured branches of foreign banks and senior executive officers and 
directors of banks that are subject to the provisions of section 38 of 
the Federal Deposit Insurance Act (section 38) (12 U.S.C. 1831o) and 
subpart B of part 325 of this chapter or subpart H of part 324 of this 
chapter, as applicable.

0
11. Section 308.202 is amended by revising paragraphs (a)(1)(i)(A) 
introductory text and (a)(1)(ii) to read as follows:


Sec.  308.202  Procedures for reclassifying a bank based on criteria 
other than capital.

    (a) * * *
    (1) * * *
    (i) Grounds for reclassification. (A) Pursuant to Sec.  325.103(d) 
of this chapter

[[Page 55471]]

or Sec.  324.403(d) of this chapter, as applicable, the FDIC may 
reclassify a well-capitalized bank as adequately capitalized or subject 
an adequately capitalized or undercapitalized institution to the 
supervisory actions applicable to the next lower capital category if:
* * * * *
    (ii) Prior notice to institution. Prior to taking action pursuant 
to Sec.  325.103(d) of this chapter or Sec.  324.403(d) of this 
chapter, as applicable, the FDIC shall issue and serve on the bank a 
written notice of the FDIC's intention to reclassify it.
* * * * *

0
12. Section 308.204 is amended by revising paragraphs (b)(2) and (c) to 
read as follows:


Sec.  308.204  Enforcement of directives.

* * * * *
    (b) * * *
    (2) Failure to implement capital restoration plan. The failure of a 
bank to implement a capital restoration plan required under section 38, 
or subpart B of part 325 of this chapter or subpart H of part 324 of 
this chapter, as applicable, or the failure of a company having control 
of a bank to fulfill a guarantee of a capital restoration plan made 
pursuant to section 38(e)(2) of the FDI Act shall subject the bank to 
the assessment of civil money penalties pursuant to section 8(i)(2)(A) 
of the FDI Act.
    (c) Other enforcement action. In addition to the actions described 
in paragraphs (a) and (b) of this section, the FDIC may seek 
enforcement of the provisions of section 38 or subpart B of part 325 of 
this chapter or subpart H of part 324 of this chapter, as applicable, 
through any other judicial or administrative proceeding authorized by 
law.

0
13. Part 324 is added to read as follows:

PART 324--CAPITAL ADEQUACY OF FDIC-SUPERVISED INSTITUTIONS

Subpart A--General Provisions
Sec.
324.1 Purpose, applicability, reservations of authority, and timing.
324.2 Definitions.
324.3 Operational requirements for counterparty credit risk.
324.4 Inadequate capital as an unsafe or unsound practice or 
condition.
324.5 Issuance of directives.
324.6 through 324.9 [Reserved]
Subpart B--Capital Ratio Requirements and Buffers
324.10 Minimum capital requirements.
324.11 Capital conservation buffer and countercyclical capital 
buffer amount.
324.12 through 324.19 [Reserved]
Subpart C--Definition of Capital
324.20 Capital components and eligibility criteria for regulatory 
capital instruments.
324.21 Minority interest.
324.22 Regulatory capital adjustments and deductions.
324.23 through 324.29 [Reserved]
Subpart D--Risk-Weighted Assets--Standardized Approach
324.30 Applicability.

Risk-Weighted Assets for General Credit Risk

324.31 Mechanics for calculating risk-weighted assets for general 
credit risk.
324.32 General risk weights.
324.33 Off-balance sheet exposures.
324.34 OTC derivative contracts.
324.35 Cleared transactions.
324.36 Guarantees and credit derivatives: substitution treatment.
324.37 Collateralized transactions.

Risk-Weighted Assets for Unsettled Transactions

324.38 Unsettled transactions.
324.39 through 324.40 [Reserved]

Risk-Weighted Assets for Securitization Exposures

324.41 Operational requirements for securitization exposures.
324.42 Risk-weighted assets for securitization exposures.
324.43 Simplified supervisory formula approach (SSFA) and the gross-
up approach.
324.44 Securitization exposures to which the SSFA and gross-up 
approach do not apply.
324.45 Recognition of credit risk mitigants for securitization 
exposures.
324.46 through 324.50 [Reserved]

Risk-Weighted Assets for Equity Exposures

324.51 Introduction and exposure measurement.
324.52 Simple risk-weight approach (SRWA).
324.53 Equity exposures to investment funds.
324.54 through 324.60 [Reserved]

Disclosures

324.61 Purpose and scope.
324.62 Disclosure requirements.
324.63 Disclosures by FDIC-supervised institutions described in 
Sec.  324.61.
324.64 through 324.99 [Reserved]
Subpart E--Risk-Weighted Assets--Internal Ratings-Based and Advanced 
Measurement Approaches
324.100 Purpose, applicability, and principle of conservatism.
324.101 Definitions.
324.102 through 324.120 [Reserved]

Qualification

324.121 Qualification process.
324.122 Qualification requirements.
324.123 Ongoing qualification.
324.124 Merger and acquisition transitional arrangements.
324.125 through 324.130 [Reserved]

Risk-Weighted Assets for General Credit Risk

324.131 Mechanics for calculating total wholesale and retail risk-
weighted assets.
324.132 Counterparty credit risk of repo-style transactions, 
eligible margin loans, and OTC derivative contracts.
324.133 Cleared transactions.
324.134 Guarantees and credit derivatives: PD substitution and LGD 
adjustment approaches.
324.135 Guarantees and credit derivatives: double default treatment.
324.136 Unsettled transactions.
324.137 through 324.140 [Reserved]

Risk-Weighted Assets for Securitization Exposures

324.141 Operational criteria for recognizing the transfer of risk.
324.142 Risk-weighted assets for securitization exposures.
324.143 Supervisory formula approach (SFA).
324.144 Simplified supervisory formula approach (SSFA).
324.145 Recognition of credit risk mitigants for securitization 
exposures.
324.146 through 324.150 [Reserved]

Risk-Weighted Assets for Equity Exposures

324.151 Introduction and exposure measurement.
324.152 Simple risk weight approach (SRWA).
324.153 Internal models approach (IMA).
324.154 Equity exposures to investment funds.
324.155 Equity derivative contracts.
324.156 through 324.160 [Reserved]

Risk-Weighted Assets for Operational Risk

324.161 Qualification requirements for incorporation of operational 
risk mitigants.
324.162 Mechanics of risk-weighted asset calculation.
324.163 through 324.170 [Reserved]

Disclosures

324.171 Purpose and scope.
324.172 Disclosure requirements.
324.173 Disclosures by certain advanced approaches FDIC-supervised 
institutions.
324.174 through 324.200 [Reserved]
Subpart F--Risk-Weighted Assets--Market Risk
324.201 Purpose, applicability, and reservation of authority.
324.202 Definitions.
324.203 Requirements for application of this subpart F.
324.204 Measure for market risk.
324.205 VaR-based measure.
324.206 Stressed VaR-based measure.
324.207 Specific risk.
324.208 Incremental risk.
324.209 Comprehensive risk.
324.210 Standardized measurement method for specific risk.

[[Page 55472]]

324.211 Simplified supervisory formula approach (SSFA).
324.212 Market risk disclosures.
324.213 through 324.299 [Reserved]
Subpart G--Transition Provisions
324.300 Transitions.
324.301 through 324.399 [Reserved]
Subpart H--Prompt Corrective Action
324.401 Authority, purpose, scope, other supervisory authority, 
disclosure of capital categories, and transition procedures.
324.402 Notice of capital category.
324.403 Capital measures and capital category definitions.
324.404 Capital restoration plans.
324.405 Mandatory and discretionary supervisory actions.
324.406 through 324.999 [Reserved]

    Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b), 
1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n), 
1828(o), 1831o, 1835, 3907, 3909, 4808; 5371; 5412; Pub. L. 102-233, 
105 Stat. 1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 
105 Stat. 2236, 2355, as amended by Pub. L. 103-325, 108 Stat. 2160, 
2233 (12 U.S.C. 1828 note); Pub. L. 102-242, 105 Stat. 2236, 2386, 
as amended by Pub. L. 102-550, 106 Stat. 3672, 4089 (12 U.S.C. 1828 
note); Pub. L. 111-203, 124 Stat. 1376, 1887 (15 U.S.C. 78o-7 note).

Subpart A--General Provisions


Sec.  324.1  Purpose, applicability, reservations of authority, and 
timing.

    (a) Purpose. This part 324 establishes minimum capital requirements 
and overall capital adequacy standards for FDIC-supervised 
institutions. This part 324 includes methodologies for calculating 
minimum capital requirements, public disclosure requirements related to 
the capital requirements, and transition provisions for the application 
of this part 324.
    (b) Limitation of authority. Nothing in this part 324 shall be read 
to limit the authority of the FDIC to take action under other 
provisions of law, including action to address unsafe or unsound 
practices or conditions, deficient capital levels, or violations of law 
or regulation, under section 8 of the Federal Deposit Insurance Act.
    (c) Applicability. Subject to the requirements in paragraphs (d) 
and (f) of this section:
    (1) Minimum capital requirements and overall capital adequacy 
standards. Each FDIC-supervised institution must calculate its minimum 
capital requirements and meet the overall capital adequacy standards in 
subpart B of this part.
    (2) Regulatory capital. Each FDIC-supervised institution must 
calculate its regulatory capital in accordance with subpart C of this 
part.
    (3) Risk-weighted assets. (i) Each FDIC-supervised institution must 
use the methodologies in subpart D of this part (and subpart F of this 
part for a market risk FDIC-supervised institution) to calculate 
standardized total risk-weighted assets.
    (ii) Each advanced approaches FDIC-supervised institution must use 
the methodologies in subpart E (and subpart F of this part for a market 
risk FDIC-supervised institution) to calculate advanced approaches 
total risk-weighted assets.
    (4) Disclosures. (i) Except for an advanced approaches FDIC-
supervised institution that is making public disclosures pursuant to 
the requirements in subpart E of this part, each FDIC-supervised 
institution with total consolidated assets of $50 billion or more must 
make the public disclosures described in subpart D of this part.
    (ii) Each market risk FDIC-supervised institution must make the 
public disclosures described in subpart F of this part.
    (iii) Each advanced approaches FDIC-supervised institution must 
make the public disclosures described in subpart E of this part.
    (d) Reservation of authority. (1) Additional capital in the 
aggregate. The FDIC may require an FDIC-supervised institution to hold 
an amount of regulatory capital greater than otherwise required under 
this part if the FDIC determines that the FDIC-supervised institution's 
capital requirements under this part are not commensurate with the 
FDIC-supervised institution's credit, market, operational, or other 
risks.
    (2) Regulatory capital elements. (i) If the FDIC determines that a 
particular common equity tier 1, additional tier 1, or tier 2 capital 
element has characteristics or terms that diminish its ability to 
absorb losses, or otherwise present safety and soundness concerns, the 
FDIC may require the FDIC-supervised institution to exclude all or a 
portion of such element from common equity tier 1 capital, additional 
tier 1 capital, or tier 2 capital, as appropriate.
    (ii) Notwithstanding the criteria for regulatory capital 
instruments set forth in subpart C of this part, the FDIC may find that 
a capital element may be included in an FDIC-supervised institution's 
common equity tier 1 capital, additional tier 1 capital, or tier 2 
capital on a permanent or temporary basis consistent with the loss 
absorption capacity of the element and in accordance with Sec.  
324.20(e).
    (3) Risk-weighted asset amounts. If the FDIC determines that the 
risk-weighted asset amount calculated under this part by the FDIC-
supervised institution for one or more exposures is not commensurate 
with the risks associated with those exposures, the FDIC may require 
the FDIC-supervised institution to assign a different risk-weighted 
asset amount to the exposure(s) or to deduct the amount of the 
exposure(s) from its regulatory capital.
    (4) Total leverage. If the FDIC determines that the leverage 
exposure amount, or the amount reflected in the FDIC-supervised 
institution's reported average total consolidated assets, for an on- or 
off-balance sheet exposure calculated by an FDIC-supervised institution 
under Sec.  324.10 is inappropriate for the exposure(s) or the 
circumstances of the FDIC-supervised institution, the FDIC may require 
the FDIC-supervised institution to adjust this exposure amount in the 
numerator and the denominator for purposes of the leverage ratio 
calculations.
    (5) Consolidation of certain exposures. The FDIC may determine that 
the risk-based capital treatment for an exposure or the treatment 
provided to an entity that is not consolidated on the FDIC-supervised 
institution's balance sheet is not commensurate with the risk of the 
exposure or the relationship of the FDIC-supervised institution to the 
entity. Upon making this determination, the FDIC may require the FDIC-
supervised institution to treat the exposure or entity as if it were 
consolidated on the balance sheet of the FDIC-supervised institution 
for purposes of determining the FDIC-supervised institution's risk-
based capital requirements and calculating the FDIC-supervised 
institution's risk-based capital ratios accordingly. The FDIC will look 
to the substance of, and risk associated with, the transaction, as well 
as other relevant factors the FDIC deems appropriate in determining 
whether to require such treatment.
    (6) Other reservation of authority. With respect to any deduction 
or limitation required under this part, the FDIC may require a 
different deduction or limitation, provided that such alternative 
deduction or limitation is commensurate with the FDIC-supervised 
institution's risk and consistent with safety and soundness.
    (e) Notice and response procedures. In making a determination under 
this section, the FDIC will apply notice and response procedures in the 
same manner as the notice and response procedures in Sec.  324.5(c).
    (f) Timing. (1) Subject to the transition provisions in subpart G 
of this part, an advanced approaches FDIC-supervised

[[Page 55473]]

institution that is not a savings and loan holding company must:
    (i) Except as described in paragraph (f)(1)(ii) of this section, 
beginning on January 1, 2014, calculate advanced approaches total risk-
weighted assets in accordance with subpart E and, if applicable, 
subpart F of this part and, beginning on January 1, 2015, calculate 
standardized total risk-weighted assets in accordance with subpart D 
and, if applicable, subpart F of this part;
    (ii) From January 1, 2014 to December 31, 2014:
    (A) Calculate risk-weighted assets in accordance with the general 
risk-based capital rules under 12 CFR part 325, appendix A, and, if 
applicable appendix C (state nonmember banks), or 12 CFR part 390, 
subpart Z and, if applicable, 12 CFR part 325, appendix C (state 
savings associations) \1\ and substitute such risk-weighted assets for 
standardized total risk-weighted assets for purposes of Sec.  324.10;
---------------------------------------------------------------------------

    \1\ For the purpose of calculating its general risk-based 
capital ratios from January 1, 2014 to December 31, 2014, an 
advanced approaches FDIC-supervised institution shall adjust, as 
appropriate, its risk-weighted asset measure (as that amount is 
calculated under 12 CFR part 325, appendix A, (state nonmember 
banks), and 12 CFR part 390, subpart Z (state savings associations) 
in the general risk-based capital rules) by excluding those assets 
that are deducted from its regulatory capital under Sec.  324.22.
---------------------------------------------------------------------------

    (B) If applicable, calculate general market risk equivalent assets 
in accordance with 12 CFR part 325, appendix C, section 4(a)(3) and 
substitute such general market risk equivalent assets for standardized 
market risk-weighted assets for purposes of Sec.  324.20(d)(3); and
    (C) Substitute the corresponding provision or provisions of 12 CFR 
part 325, appendix A, and, if applicable, appendix C (state nonmember 
banks), and 12 CFR part 390, subpart Z and, if applicable, 12 CFR part 
325, appendix C (state savings associations) for any reference to 
subpart D of this part in: Sec.  324.121(c); Sec.  324.124(a) and (b); 
Sec.  324.144(b); Sec.  324.154(c) and (d); Sec.  324.202(b) 
(definition of covered position in paragraph (b)(3)(iv)); and Sec.  
324.211(b); \2\
---------------------------------------------------------------------------

    \2\ In addition, for purposes of Sec.  324.201(c)(3), from 
January 1, 2014 to December 31, 2014, for any circumstance in which 
the FDIC may require an FDIC-supervised institution to calculate 
risk-based capital requirements for specific positions or portfolios 
under subpart D of this part, the FDIC will instead require the 
FDIC-supervised institution to make such calculations according to 
12 CFR part 325, appendix A, and, if applicable, appendix C (state 
nonmember banks), or 12 CFR part 390, subpart Z and, if applicable, 
12 CFR part 325, appendix C (state savings associations).
---------------------------------------------------------------------------

    (iii) Beginning on January 1, 2014, calculate and maintain minimum 
capital ratios in accordance with subparts A, B, and C of this part, 
provided, however, that such FDIC-supervised institution must:
    (A) From January 1, 2014 to December 31, 2014, maintain a minimum 
common equity tier 1 capital ratio of 4 percent, a minimum tier 1 
capital ratio of 5.5 percent, a minimum total capital ratio of 8 
percent, and a minimum leverage ratio of 4 percent; and
    (B) From January 1, 2015 to December 31, 2017, an advanced 
approaches FDIC-supervised institution:
    (1) Is not required to maintain a supplementary leverage ratio; and
    (2) Must calculate a supplementary leverage ratio in accordance 
with Sec.  324.10(c), and must report the calculated supplementary 
leverage ratio on any applicable regulatory reports.
    (2) Subject to the transition provisions in subpart G of this part, 
an FDIC-supervised institution that is not an advanced approaches FDIC-
supervised institution or a savings and loan holding company that is an 
advanced approaches FDIC-supervised institution must:
    (i) Beginning on January 1, 2015, calculate standardized total 
risk-weighted assets in accordance with subpart D, and if applicable, 
subpart F of this part; and
    (ii) Beginning on January 1, 2015, calculate and maintain minimum 
capital ratios in accordance with subparts A, B and C of this part, 
provided, however, that from January 1, 2015, to December 31, 2017, a 
savings and loan holding company that is an advanced approaches FDIC-
supervised institution:
    (A) Is not required to maintain a supplementary leverage ratio; and
    (B) Must calculate a supplementary leverage ratio in accordance 
with Sec.  324.10(c), and must report the calculated supplementary 
leverage ratio on any applicable regulatory reports.
    (3) Beginning on January 1, 2016, and subject to the transition 
provisions in subpart G of this part, an FDIC-supervised institution is 
subject to limitations on distributions and discretionary bonus 
payments with respect to its capital conservation buffer and any 
applicable countercyclical capital buffer amount, in accordance with 
subpart B of this part.


Sec.  324.2  Definitions.

    As used in this part:
    Additional tier 1 capital is defined in Sec.  324.20(c).
    Advanced approaches FDIC-supervised institution means an FDIC-
supervised institution that is described in Sec.  324.100(b)(1).
    Advanced approaches total risk-weighted assets means:
    (1) The sum of:
    (i) Credit-risk-weighted assets;
    (ii) Credit valuation adjustment (CVA) risk-weighted assets;
    (iii) Risk-weighted assets for operational risk; and
    (iv) For a market risk FDIC-supervised institution only, advanced 
market risk-weighted assets; minus
    (2) Excess eligible credit reserves not included in the FDIC-
supervised institution's tier 2 capital.
    Advanced market risk-weighted assets means the advanced measure for 
market risk calculated under Sec.  324.204 multiplied by 12.5.
    Affiliate with respect to a company, means any company that 
controls, is controlled by, or is under common control with, the 
company.
    Allocated transfer risk reserves means reserves that have been 
established in accordance with section 905(a) of the International 
Lending Supervision Act, against certain assets whose value U.S. 
supervisory authorities have found to be significantly impaired by 
protracted transfer risk problems.
    Allowances for loan and lease losses (ALLL) means valuation 
allowances that have been established through a charge against earnings 
to cover estimated credit losses on loans, lease financing receivables 
or other extensions of credit as determined in accordance with GAAP. 
ALLL excludes ``allocated transfer risk reserves.'' For purposes of 
this part, ALLL includes allowances that have been established through 
a charge against earnings to cover estimated credit losses associated 
with off-balance sheet credit exposures as determined in accordance 
with GAAP.
    Asset-backed commercial paper (ABCP) program means a program 
established primarily for the purpose of issuing commercial paper that 
is investment grade and backed by underlying exposures held in a 
bankruptcy-remote special purpose entity (SPE).
    Asset-backed commercial paper (ABCP) program sponsor means an FDIC-
supervised institution 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.
    Assets classified loss means:

[[Page 55474]]

    (1) When measured as of the date of examination of an FDIC-
supervised institution, those assets that have been determined by an 
evaluation made by a state or Federal examiner as of that date to be a 
loss; and
    (2) When measured as of any other date, those assets:
    (i) That have been determined--
    (A) By an evaluation made by a state or Federal examiner at the 
most recent examination of an FDIC-supervised institution to be a loss; 
or
    (B) By evaluations made by the FDIC-supervised institution since 
its most recent examination to be a loss; and
    (ii) That have not been charged off from the FDIC-supervised 
institution's books or collected.
    Bank means an FDIC-insured, state-chartered commercial or savings 
bank that is not a member of the Federal Reserve System and for which 
the FDIC is the appropriate Federal banking agency pursuant to section 
3(q) of the Federal Deposit Insurance Act (12 U.S.C. 1813(q)).
    Bank holding company means a bank holding company as defined in 
section 2 of the Bank Holding Company Act.
    Bank Holding Company Act means the Bank Holding Company Act of 
1956, as amended (12 U.S.C. 1841 et seq.).
    Bankruptcy remote means, with respect to an entity or asset, that 
the entity or asset would be excluded from an insolvent entity's estate 
in receivership, insolvency, liquidation, or similar proceeding.
    Call Report means Consolidated Reports of Condition and Income.
    Carrying value means, with respect to an asset, the value of the 
asset on the balance sheet of the FDIC-supervised institution, 
determined in accordance with GAAP.
    Central counterparty (CCP) means a counterparty (for example, a 
clearing house) that facilitates trades between counterparties in one 
or more financial markets by either guaranteeing trades or novating 
contracts.
    CFTC means the U.S. Commodity Futures Trading Commission.
    Clean-up call means a contractual provision that permits an 
originating FDIC-supervised institution or servicer to call 
securitization exposures before their stated maturity or call date.
    Cleared transaction means an exposure associated with an 
outstanding derivative contract or repo-style transaction that an FDIC-
supervised institution or clearing member has entered into with a 
central counterparty (that is, a transaction that a central 
counterparty has accepted).
    (1) The following transactions are cleared transactions:
    (i) A transaction between a CCP and an FDIC-supervised institution 
that is a clearing member of the CCP where the FDIC-supervised 
institution enters into the transaction with the CCP for the FDIC-
supervised institution's own account;
    (ii) A transaction between a CCP and an FDIC-supervised institution 
that is a clearing member of the CCP where the FDIC-supervised 
institution is acting as a financial intermediary on behalf of a 
clearing member client and the transaction offsets another transaction 
that satisfies the requirements set forth in Sec.  324.3(a);
    (iii) A transaction between a clearing member client FDIC-
supervised institution and a clearing member where the clearing member 
acts as a financial intermediary on behalf of the clearing member 
client and enters into an offsetting transaction with a CCP, provided 
that the requirements set forth in Sec.  324.3(a) are met; or
    (iv) A transaction between a clearing member client FDIC-supervised 
institution and a CCP where a clearing member guarantees the 
performance of the clearing member client FDIC-supervised institution 
to the CCP and the transaction meets the requirements of Sec.  
324.3(a)(2) and (3).
    (2) The exposure of an FDIC-supervised institution that is a 
clearing member to its clearing member client is not a cleared 
transaction where the FDIC-supervised institution is either acting as a 
financial intermediary and enters into an offsetting transaction with a 
CCP or where the FDIC-supervised institution provides a guarantee to 
the CCP on the performance of the client.\3\
---------------------------------------------------------------------------

    \3\ For the standardized approach treatment of these exposures, 
see Sec.  324.34(e) (OTC derivative contracts) or Sec.  324.37(c) 
(repo-style transactions). For the advanced approaches treatment of 
these exposures, see Sec.  324.132(c)(8) and (d) (OTC derivative 
contracts) or Sec.  324.132(b) and 324.132(d) (repo-style 
transactions) and for calculation of the margin period of risk, see 
Sec.  324.132(d)(5)(iii)(C) (OTC derivative contracts) and Sec.  
324.132(d)(5)(iii)(A) (repo-style transactions).
---------------------------------------------------------------------------

    Clearing member means a member of, or direct participant in, a CCP 
that is entitled to enter into transactions with the CCP.
    Clearing member client means a party to a cleared transaction 
associated with a CCP in which a clearing member acts either as a 
financial intermediary with respect to the party or guarantees the 
performance of the party to the CCP.
    Collateral agreement means a legal contract that specifies the time 
when, and circumstances under which, a counterparty is required to 
pledge collateral to an FDIC-supervised institution for a single 
financial contract or for all financial contracts in a netting set and 
confers upon the FDIC-supervised institution a perfected, first-
priority security interest (notwithstanding the prior security interest 
of any custodial agent), or the legal equivalent thereof, in the 
collateral posted by the counterparty under the agreement. This 
security interest must provide the FDIC-supervised institution with a 
right to close out the financial positions and liquidate the collateral 
upon an event of default of, or failure to perform by, the counterparty 
under the collateral agreement. A contract would not satisfy this 
requirement if the FDIC-supervised institution's exercise of rights 
under the agreement may be stayed or avoided under applicable law in 
the relevant jurisdictions, other than in receivership, 
conservatorship, resolution under the Federal Deposit Insurance Act, 
Title II of the Dodd-Frank Act, or under any similar insolvency law 
applicable to GSEs.
    Commitment means any legally binding arrangement that obligates an 
FDIC-supervised institution 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.
    Commodity Exchange Act means the Commodity Exchange Act of 1936 (7 
U.S.C. 1 et seq.)
    Common equity tier 1 capital is defined in Sec.  324.20(b).
    Common equity tier 1 minority interest means the common equity tier 
1 capital of a depository institution or foreign bank that is:
    (1) A consolidated subsidiary of an FDIC-supervised institution; 
and
    (2) Not owned by the FDIC-supervised institution.
    Company means a corporation, partnership, limited liability 
company, depository institution, business trust, special purpose 
entity, 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.
    Core capital means Tier 1 capital, as defined in Sec.  324.2 of 
subpart A of this part.
    Corporate exposure means an exposure to a company that is not:
    (1) An exposure to a sovereign, the Bank for International 
Settlements, the European Central Bank, the European

[[Page 55475]]

Commission, the International Monetary Fund, a multi-lateral 
development bank (MDB), a depository institution, a foreign bank, a 
credit union, or a public sector entity (PSE);
    (2) An exposure to a GSE;
    (3) A residential mortgage exposure;
    (4) A pre-sold construction loan;
    (5) A statutory multifamily mortgage;
    (6) A high volatility commercial real estate (HVCRE) exposure;
    (7) A cleared transaction;
    (8) A default fund contribution;
    (9) A securitization exposure;
    (10) An equity exposure; or
    (11) An unsettled transaction.
    Country risk classification (CRC) with respect to a sovereign, 
means the most recent consensus CRC published by the Organization for 
Economic Cooperation and Development (OECD) as of December 31st of the 
prior calendar year that provides a view of the likelihood that the 
sovereign will service its external debt.
    Covered savings and loan holding company means a top-tier savings 
and loan holding company other than:
    (1) A top-tier savings and loan holding company that is:
    (i) A grandfathered unitary savings and loan holding company as 
defined in section 10(c)(9)(A) of HOLA; and
    (ii) As of June 30 of the previous calendar year, derived 50 
percent or more of its total consolidated assets or 50 percent of its 
total revenues on an enterprise-wide basis (as calculated under GAAP) 
from activities that are not financial in nature under section 4(k) of 
the Bank Holding Company Act (12 U.S.C. 1842(k));
    (2) A top-tier savings and loan holding company that is an 
insurance underwriting company; or
    (3)(i) A top-tier savings and loan holding company that, as of June 
30 of the previous calendar year, held 25 percent or more of its total 
consolidated assets in subsidiaries that are insurance underwriting 
companies (other than assets associated with insurance for credit 
risk); and
    (ii) For purposes of paragraph 3(i) of this definition, the company 
must calculate its total consolidated assets in accordance with GAAP, 
or if the company does not calculate its total consolidated assets 
under GAAP for any regulatory purpose (including compliance with 
applicable securities laws), the company may estimate its total 
consolidated assets, subject to review and adjustment by the Federal 
Reserve.
    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(s)) to another party (the protection 
provider) for a certain period of time.
    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 of the CEIO 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 an FDIC-supervised institution 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 counterparties 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 covering, 1-4 family residential 
first mortgage loans that qualify for a 50 percent risk weight for a 
period not to exceed 120 days from the date of transfer. These 
warranties may cover only those loans that were originated within 1 
year of the date of transfer;
    (2) Premium refund clauses that cover assets guaranteed, in whole 
or in part, by the U.S. Government, a U.S. Government agency or a GSE, 
provided the premium refund 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.
    Credit-risk-weighted assets means 1.06 multiplied by the sum of:
    (1) Total wholesale and retail risk-weighted assets as calculated 
under Sec.  324.131;
    (2) Risk-weighted assets for securitization exposures as calculated 
under Sec.  324.142; and
    (3) Risk-weighted assets for equity exposures as calculated under 
Sec.  324.151.
    Credit union means an insured credit union as defined under the 
Federal Credit Union Act (12 U.S.C. 1751 et seq.).
    Current exposure means, with respect to a netting set, the larger 
of zero or the fair value of a transaction or portfolio of transactions 
within the netting set that would be lost upon default of the 
counterparty, assuming no recovery on the value of the transactions. 
Current exposure is also called replacement cost.
    Current exposure methodology means the method of calculating the 
exposure amount for over-the-counter derivative contracts in Sec.  
324.34(a) and exposure at default (EAD) in Sec.  324.132(c)(5) or (6), 
as applicable.
    Custodian means a financial institution that has legal custody of 
collateral provided to a CCP.
    Default fund contribution means the funds contributed or 
commitments made by a clearing member to a CCP's mutualized loss 
sharing arrangement.
    Depository institution means a depository institution as defined in 
section 3 of the Federal Deposit Insurance Act.
    Depository institution holding company means a bank holding company 
or savings and loan holding company.
    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.
    Discretionary bonus payment means a payment made to an executive 
officer of an FDIC-supervised institution, where:
    (1) The FDIC-supervised institution retains discretion as to 
whether to make, and the amount of, the payment until the payment is 
awarded to the executive officer;
    (2) The amount paid is determined by the FDIC-supervised 
institution without

[[Page 55476]]

prior promise to, or agreement with, the executive officer; and
    (3) The executive officer has no contractual right, whether express 
or implied, to the bonus payment.
    Distribution means:
    (1) A reduction of tier 1 capital through the repurchase of a tier 
1 capital instrument or by other means, except when an FDIC-supervised 
institution, within the same quarter when the repurchase is announced, 
fully replaces a tier 1 capital instrument it has repurchased by 
issuing another capital instrument that meets the eligibility criteria 
for:
    (i) A common equity tier 1 capital instrument if the instrument 
being repurchased was part of the FDIC-supervised institution's common 
equity tier 1 capital, or
    (ii) A common equity tier 1 or additional tier 1 capital instrument 
if the instrument being repurchased was part of the FDIC-supervised 
institution's tier 1 capital;
    (2) A reduction of tier 2 capital through the repurchase, or 
redemption prior to maturity, of a tier 2 capital instrument or by 
other means, except when an FDIC-supervised institution, within the 
same quarter when the repurchase or redemption is announced, fully 
replaces a tier 2 capital instrument it has repurchased by issuing 
another capital instrument that meets the eligibility criteria for a 
tier 1 or tier 2 capital instrument;
    (3) A dividend declaration or payment on any tier 1 capital 
instrument;
    (4) A dividend declaration or interest payment on any tier 2 
capital instrument if the FDIC-supervised institution has full 
discretion to permanently or temporarily suspend such payments without 
triggering an event of default; or
    (5) Any similar transaction that the FDIC determines to be in 
substance a distribution of capital.
    Dodd-Frank Act means the Dodd-Frank Wall Street Reform and Consumer 
Protection Act of 2010 (Pub. L. 111-203, 124 Stat. 1376).
    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 FDIC-
supervised institution (such as material changes in tax laws or 
regulations); or
    (2) Leaves investors fully exposed to future draws by borrowers on 
the underlying exposures even after the provision is triggered.
    Effective notional amount means for an eligible guarantee or 
eligible credit derivative, the lesser of the contractual notional 
amount of the credit risk mitigant and the exposure amount (or EAD for 
purposes of subpart E of this part) of the hedged exposure, multiplied 
by the percentage coverage of the credit risk mitigant.
    Eligible 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. Notwithstanding the 
preceding sentence, 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 that qualifies for a 20 percent risk weight or lower.
    Eligible clean-up call means a clean-up call that:
    (1) Is exercisable solely at the discretion of the originating 
FDIC-supervised institution 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 FDIC, 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) Receivership, insolvency, liquidation, conservatorship or 
inability of the reference exposure issuer 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 FDIC-
supervised institution records net payments received on the swap as net 
income, the FDIC-supervised institution records offsetting 
deterioration in the value of the hedged exposure (either through 
reductions in fair value or by an addition to reserves).
    Eligible credit reserves means all general allowances that have 
been established through a charge against earnings to cover estimated 
credit losses associated with on- or off-balance sheet wholesale and 
retail exposures, including the ALLL associated with such exposures, 
but excluding allocated transfer risk reserves established pursuant to 
12 U.S.C. 3904 and other specific reserves created against recognized 
losses.
    Eligible guarantee means a guarantee from an eligible guarantor 
that:
    (1) Is written;
    (2) Is either:
    (i) Unconditional, or

[[Page 55477]]

    (ii) A contingent obligation of the U.S. government or its 
agencies, the enforceability of which is dependent upon some 
affirmative action on the part of the beneficiary of the guarantee or a 
third party (for example, meeting servicing requirements);
    (3) Covers all or a pro rata portion of all contractual payments of 
the obligated party 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) Except for a guarantee by a sovereign, 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 obligated party 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 FDIC-supervised 
institution, unless the affiliate is an insured depository institution, 
foreign bank, securities broker or dealer, or insurance company that:
    (i) Does not control the FDIC-supervised institution; and
    (ii) Is subject to consolidated supervision and regulation 
comparable to that imposed on depository institutions, U.S. securities 
broker-dealers, or U.S. insurance companies (as the case may be).
    Eligible guarantor means:
    (1) A sovereign, the Bank for International Settlements, the 
International Monetary Fund, the European Central Bank, the European 
Commission, a Federal Home Loan Bank, Federal Agricultural Mortgage 
Corporation (Farmer Mac), a multilateral development bank (MDB), a 
depository institution, a bank holding company, a savings and loan 
holding company, a credit union, a foreign bank, or a qualifying 
central counterparty; or
    (2) An entity (other than a special purpose entity):
    (i) That at the time the guarantee is issued or anytime thereafter, 
has issued and outstanding an unsecured debt security without credit 
enhancement that is investment grade;
    (ii) Whose creditworthiness is not positively correlated with the 
credit risk of the exposures for which it has provided guarantees; and
    (iii) That is not an insurance company engaged predominately in the 
business of providing credit protection (such as a monoline bond 
insurer or re-insurer).
    Eligible margin loan means:
    (1) An extension of credit where:
    (i) The extension of credit is collateralized exclusively by liquid 
and readily marketable debt or equity securities, or gold;
    (ii) The collateral is marked to fair value daily, and the 
transaction is subject to daily margin maintenance requirements; and
    (iii) The extension of credit is conducted under an agreement that 
provides the FDIC-supervised institution 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 receivership, insolvency, liquidation, conservatorship, 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, other than in 
receivership, conservatorship, resolution under the Federal Deposit 
Insurance Act, Title II of the Dodd-Frank Act, or under any similar 
insolvency law applicable to GSEs.\4\
---------------------------------------------------------------------------

    \4\ 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, or netting contracts 
between or among financial institutions under sections 401-407 of 
the Federal Deposit Insurance Corporation Improvement Act or the 
Federal Reserve Board's Regulation EE (12 CFR part 231).
---------------------------------------------------------------------------

    (2) In order to recognize an exposure as an eligible margin loan 
for purposes of this subpart, an FDIC-supervised institution must 
comply with the requirements of Sec.  324.3(b) with respect to that 
exposure.
    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 securitization if the servicer concludes the advances 
are unlikely to be repaid.
    Employee stock ownership plan has the same meaning as in 29 CFR 
2550.407d-6.
    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 an 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 FDIC-supervised 
institution under GAAP;
    (ii) The FDIC-supervised institution is required to deduct the 
ownership interest from tier 1 or tier 2 capital under this part;
    (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.
    ERISA means the Employee Retirement Income and Security Act of 1974 
(29 U.S.C. 1001 et seq.).
    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.
    Executive officer means a person who holds the title or, without 
regard to title, salary, or compensation, performs the function of one 
or more of the following positions: president, chief executive officer, 
executive chairman, chief

[[Page 55478]]

operating officer, chief financial officer, chief investment officer, 
chief legal officer, chief lending officer, chief risk officer, or head 
of a major business line, and other staff that the board of directors 
of the FDIC-supervised institution deems to have equivalent 
responsibility.
    Expected credit loss (ECL) means:
    (1) For a wholesale exposure to a non-defaulted obligor or segment 
of non-defaulted retail exposures that is carried at fair value with 
gains and losses flowing through earnings or that is classified as 
held-for-sale and is carried at the lower of cost or fair value with 
losses flowing through earnings, zero.
    (2) For all other wholesale exposures to non-defaulted obligors or 
segments of non-defaulted retail exposures, the product of the 
probability of default (PD) times the loss given default (LGD) times 
the exposure at default (EAD) for the exposure or segment.
    (3) For a wholesale exposure to a defaulted obligor or segment of 
defaulted retail exposures, the FDIC-supervised institution's 
impairment estimate for allowance purposes for the exposure or segment.
    (4) Total ECL is the sum of expected credit losses for all 
wholesale and retail exposures other than exposures for which the FDIC-
supervised institution has applied the double default treatment in 
Sec.  324.135.
    Exposure amount means:
    (1) For the on-balance sheet component of an exposure (other than 
an available-for-sale or held-to-maturity security, if the FDIC-
supervised institution has made an AOCI opt-out election (as defined in 
Sec.  324.22(b)(2)); an OTC derivative contract; a repo-style 
transaction or an eligible margin loan for which the FDIC-supervised 
institution determines the exposure amount under Sec.  324.37; a 
cleared transaction; a default fund contribution; or a securitization 
exposure), the FDIC-supervised institution's carrying value of the 
exposure.
    (2) For a security (that is not a securitization exposure, an 
equity exposure, or preferred stock classified as an equity security 
under GAAP) classified as available-for-sale or held-to-maturity if the 
FDIC-supervised institution has made an AOCI opt-out election (as 
defined in Sec.  324.22(b)(2)), the FDIC-supervised institution's 
carrying value (including net accrued but unpaid interest and fees) for 
the exposure less any net unrealized gains on the exposure and plus any 
net unrealized losses on the exposure.
    (3) For available-for-sale preferred stock classified as an equity 
security under GAAP if the FDIC-supervised institution has made an AOCI 
opt-out election (as defined in Sec.  324.22(b)(2)), the FDIC-
supervised institution's carrying value of the exposure less any net 
unrealized gains on the exposure that are reflected in such carrying 
value but excluded from the FDIC-supervised institution's regulatory 
capital components.
    (4) 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 FDIC-supervised institution calculates the 
exposure amount under Sec.  324.37; a cleared transaction; a default 
fund contribution; or a securitization exposure), the notional amount 
of the off-balance sheet component multiplied by the appropriate credit 
conversion factor (CCF) in Sec.  324.33.
    (5) For an exposure that is an OTC derivative contract, the 
exposure amount determined under Sec.  324.34;
    (6) For an exposure that is a cleared transaction, the exposure 
amount determined under Sec.  324.35.
    (7) For an exposure that is an eligible margin loan or repo-style 
transaction for which the FDIC-supervised institution calculates the 
exposure amount as provided in Sec.  324.37, the exposure amount 
determined under Sec.  324.37.
    (8) For an exposure that is a securitization exposure, the exposure 
amount determined under Sec.  324.42.
    FDIC-supervised institution means any bank or state savings 
association.
    Federal Deposit Insurance Act means the Federal Deposit Insurance 
Act (12 U.S.C. 1811 et seq.).
    Federal Deposit Insurance Corporation Improvement Act means the 
Federal Deposit Insurance Corporation Improvement Act of 1991 ((Pub. L. 
102-242, 105 Stat. 2236).
    Federal Reserve means the Board of Governors of the Federal Reserve 
System.
    Financial collateral means collateral:
    (1) In the form of:
    (i) Cash on deposit with the FDIC-supervised institution (including 
cash held for the FDIC-supervised institution by a third-party 
custodian or trustee);
    (ii) Gold bullion;
    (iii) Long-term debt securities that are not resecuritization 
exposures and that are investment grade;
    (iv) Short-term debt instruments that are not resecuritization 
exposures and that are investment grade;
    (v) Equity securities that are publicly traded;
    (vi) Convertible bonds that are publicly traded; or
    (vii) Money market fund shares and other mutual fund shares if a 
price for the shares is publicly quoted daily; and
    (2) In which the FDIC-supervised institution 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 institution means:
    (1) A bank holding company; savings and loan holding company; 
nonbank financial institution supervised by the Federal Reserve under 
Title I of the Dodd-Frank Act; depository institution; foreign bank; 
credit union; industrial loan company, industrial bank, or other 
similar institution described in section 2 of the Bank Holding Company 
Act; national association, state member bank, or state non-member bank 
that is not a depository institution; insurance company; securities 
holding company as defined in section 618 of the Dodd-Frank Act; broker 
or dealer registered with the SEC under section 15 of the Securities 
Exchange Act; futures commission merchant as defined in section 1a of 
the Commodity Exchange Act; swap dealer as defined in section 1a of the 
Commodity Exchange Act; or security-based swap dealer as defined in 
section 3 of the Securities Exchange Act;
    (2) Any designated financial market utility, as defined in section 
803 of the Dodd-Frank Act;
    (3) Any entity not domiciled in the United States (or a political 
subdivision thereof) that is supervised and regulated in a manner 
similar to entities described in paragraphs (1) or (2) of this 
definition; or
    (4) Any other company:
    (i) Of which the FDIC-supervised institution owns:
    (A) An investment in GAAP equity instruments of the company with an 
adjusted carrying value or exposure amount equal to or greater than $10 
million; or
    (B) More than 10 percent of the company's issued and outstanding 
common shares (or similar equity interest), and
    (ii) Which is predominantly engaged in the following activities:
    (A) Lending money, securities or other financial instruments, 
including servicing loans;
    (B) Insuring, guaranteeing, indemnifying against loss, harm, 
damage, illness, disability, or death, or issuing annuities;
    (C) Underwriting, dealing in, making a market in, or investing as 
principal in securities or other financial instruments; or
    (D) Asset management activities (not including investment or 
financial advisory activities).

[[Page 55479]]

    (5) For the purposes of this definition, a company is 
``predominantly engaged'' in an activity or activities if:
    (i) 85 percent or more of the total consolidated annual gross 
revenues (as determined in accordance with applicable accounting 
standards) of the company is either of the two most recent calendar 
years were derived, directly or indirectly, by the company on a 
consolidated basis from the activities; or
    (ii) 85 percent or more of the company's consolidated total assets 
(as determined in accordance with applicable accounting standards) as 
of the end of either of the two most recent calendar years were related 
to the activities.
    (6) Any other company that the FDIC may determine is a financial 
institution based on activities similar in scope, nature, or operation 
to those of the entities included in (1) through (4).
    (7) For purposes of this part, ``financial institution'' does not 
include the following entities:
    (i) GSEs;
    (ii) Small business investment companies, as defined in section 102 
of the Small Business Investment Act of 1958 (15 U.S.C. 661 et seq.);
    (iii) Entities designated as Community Development Financial 
Institutions (CDFIs) under 12 U.S.C. 4701 et seq. and 12 CFR part 1805;
    (iv) Entities registered with the SEC under the Investment Company 
Act or foreign equivalents thereof;
    (v) Entities to the extent that the FDIC-supervised institution's 
investment in such entities would qualify as a community development 
investment under section 24 (Eleventh) of the National Bank Act; and
    (vi) An employee benefit plan as defined in paragraphs (3) and (32) 
of section 3 of ERISA, a ``governmental plan'' (as defined in 29 U.S.C. 
1002(32)) that complies with the tax deferral qualification 
requirements provided in the Internal Revenue Code, or any similar 
employee benefit plan established under the laws of a foreign 
jurisdiction.
    First-lien residential mortgage exposure means a residential 
mortgage exposure secured by a first lien.
    Foreign bank means a foreign bank as defined in Sec.  211.2 of the 
Federal Reserve's Regulation K (12 CFR 211.2) (other than a depository 
institution).
    Forward agreement means a legally binding contractual obligation to 
purchase assets with certain drawdown at a specified future date, not 
including commitments to make residential mortgage loans or forward 
foreign exchange contracts.
    GAAP means generally accepted accounting principles as used in the 
United States.
    Gain-on-sale means an increase in the equity capital of an FDIC-
supervised institution (as reported on Schedule RC of the Call Report) 
resulting from a traditional securitization (other than an increase in 
equity capital resulting from the FDIC-supervised institution's receipt 
of cash in connection with the securitization or reporting of a 
mortgage servicing asset on Schedule RC of the Call Report.
    General obligation means a bond or similar obligation that is 
backed by the full faith and credit of a public sector entity (PSE).
    Government-sponsored enterprise (GSE) means an entity established 
or chartered by the U.S. government to serve public purposes specified 
by the U.S. Congress but whose debt obligations are not explicitly 
guaranteed by the full faith and credit of the U.S. government.
    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).
    High volatility commercial real estate (HVCRE) exposure means a 
credit facility that, prior to conversion to permanent financing, 
finances or has financed the acquisition, development, or construction 
(ADC) of real property, unless the facility finances:
    (1) One- to four-family residential properties;
    (2) Real property that:
    (i) Would qualify as an investment in community development under 
12 U.S.C. 338a or 12 U.S.C. 24 (Eleventh), as applicable, or as a 
``qualified investment'' under 12 CFR part 345, and
    (ii) Is not an ADC loan to any entity described in 12 CFR 
345.12(g)(3), unless it is otherwise described in paragraph (1), 
(2)(i), (3) or (4) of this definition;
    (3) The purchase or development of agricultural land, which 
includes all land known to be used or usable for agricultural purposes 
(such as crop and livestock production), provided that the valuation of 
the agricultural land is based on its value for agricultural purposes 
and the valuation does not take into consideration any potential use of 
the land for non-agricultural commercial development or residential 
development; or
    (4) Commercial real estate projects in which:
    (i) The loan-to-value ratio is less than