[Federal Register Volume 78, Number 198 (Friday, October 11, 2013)]
[Rules and Regulations]
[Pages 62017-62291]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-21653]



[[Page 62017]]

Vol. 78

Friday,

No. 198

October 11, 2013

Part II





Department of the Treasury





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Office of the Comptroller of the Currency





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12 CFR Parts 3, 5, 6, et al.





Federal Reserve System





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12 CFR Parts 208, 217, and 225





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; Final Rule

Federal Register / Vol. 78 , No. 198 / Friday, October 11, 2013 / 
Rules and Regulations

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Parts 3, 5, 6, 165, and 167

[Docket ID OCC-2012-0008]
RIN 1557-AD46
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FEDERAL RESERVE SYSTEM

12 CFR Parts 208, 217, and 225

[Docket No. R-1442; Regulations H, Q, and Y]
RIN 7100-AD 87


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: Office of the Comptroller of the Currency, Treasury; and the 
Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Office of the Comptroller of the Currency (OCC) and Board 
of Governors of the Federal Reserve System (Board), are adopting a 
final rule that revises their risk-based and leverage capital 
requirements for banking organizations. The final rule consolidates 
three separate notices of proposed rulemaking that the OCC, Board, and 
FDIC published in the Federal Register on August 30, 2012, with 
selected changes. The 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 
banking organizations subject to the advanced approaches risk-based 
capital rules, a supplementary leverage ratio that incorporates a 
broader set of exposures in the denominator. The final rule 
incorporates these new requirements into the agencies' prompt 
corrective action (PCA) framework. In addition, the final rule 
establishes limits on a banking organization's capital distributions 
and certain discretionary bonus payments if the banking organization 
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. Further, the final rule amends the methodologies for 
determining risk-weighted assets for all banking organizations, and 
introduces disclosure requirements that would apply to top-tier banking 
organizations domiciled in the United States with $50 billion or more 
in total assets. The final rule also adopts changes to the agencies' 
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 final rule also codifies the agencies' regulatory capital 
rules, which have previously resided in various appendices to their 
respective regulations, into a harmonized integrated regulatory 
framework. In addition, the OCC is amending the market risk capital 
rule (market risk rule) to apply to Federal savings associations, and 
the Board is amending the advanced approaches and market risk rules to 
apply to top-tier savings and loan holding companies domiciled in the 
United States, except for certain savings and loan holding companies 
that are substantially engaged in insurance underwriting or commercial 
activities, as described in this preamble.

DATES: Effective date: January 1, 2014, except that the amendments to 
Appendixes A, B and E to 12 CFR Part 208, 12 CFR 225.1, and Appendixes 
D and E to Part 225 are effective January 1, 2015, and the amendment to 
Appendix A to 12 CFR Part 225 is effective January 1, 2019. Mandatory 
compliance date: January 1, 2014 for advanced approaches banking 
organizations that are not savings and loan holding companies; January 
1, 2015 for all other covered banking organizations.

FOR FURTHER INFORMATION CONTACT:
    OCC: Margot Schwadron, Senior Risk Expert, (202) 649-6982; David 
Elkes, Risk Expert, (202) 649-6984; Mark Ginsberg, Risk Expert, (202) 
649-6983, Capital Policy; or Ron Shimabukuro, Senior Counsel; Patrick 
Tierney, Special Counsel; Carl Kaminski, Senior Attorney; or Kevin 
Korzeniewski, Attorney, Legislative and Regulatory Activities Division, 
(202) 649-5490, Office of the Comptroller of the Currency, 400 7th 
Street SW., Washington, DC 20219.
    Board: Anna Lee Hewko, Deputy Associate Director, (202) 530-6260; 
Thomas Boemio, Manager, (202) 452-2982; Constance M. Horsley, Manager, 
(202) 452-5239; Juan C. Climent, Senior Supervisory Financial Analyst, 
(202) 872-7526; or Elizabeth MacDonald, Senior Supervisory Financial 
Analyst, (202) 475-6316, Capital and Regulatory Policy, Division of 
Banking Supervision and Regulation; or Benjamin McDonough, Senior 
Counsel, (202) 452-2036; April C. Snyder, Senior Counsel, (202) 452-
3099; Christine Graham, Senior Attorney, (202) 452-3005; or David 
Alexander, Senior Attorney, (202) 452-2877, Legal Division, Board of 
Governors of the Federal Reserve System, 20th and C Streets NW., 
Washington, DC 20551. For the hearing impaired only, Telecommunication 
Device for the Deaf (TDD), (202) 263-4869.

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 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
    1. Accumulated Other Comprehensive Income
    2. Residential Mortgages
    3. Trust Preferred Securities for Smaller Banking Organizations
    4. Insurance Activities
    C. Overview of the 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 Banking 
Organizations
    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 Federal Savings Associations
V. Definition of Capital
    A. Capital Components and Eligibility Criteria for Regulatory 
Capital Instruments
    1. Common Equity Tier 1 Capital

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    2. Additional Tier 1 Capital
    3. Tier 2 Capital
    4. Capital Instruments of Mutual Banking Organizations
    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 a Banking Organization
    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
    2. Regulatory Adjustments to Common Equity Tier 1 Capital
    a. Accumulated Net Gains and Losses on Certain Cash-Flow Hedges
    b. Changes in a Banking Organization'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 Banking Organization'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 Final 
Rule
    2. Deductions for Intangibles Other Than Goodwill and Mortgage 
Servicing Assets
    3. Regulatory Adjustments Under Section 22(b)(1) of the 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 Final Rule
    D. Transition Provisions for Non-qualifying Capital Instruments
    1. Depository Institution Holding Companies With Less Than $15 
Billion in Total Consolidated Assets as of December 31, 2009 and 
2010 Mutual Holding Companies
    2. Depository Institutions
    3. Depository Institution Holding Companies With $15 Billion or 
More in Total Consolidated Assets as of December 31, 2009 That Are 
Not 2010 Mutual Holding Companies
    4. Merger and Acquisition Transition Provisions
    5. Phase-out Schedule for Surplus and Non-Qualifying Minority 
Interest
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. Insurance-related Activities
    A. Policy Loans
    B. Separate Accounts
    C. Additional Deductions--Insurance Underwriting Subsidiaries
XI. Market Discipline and Disclosure Requirements
    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
XII. Risk-Weighted Assets--Modifications to the Advanced Approaches
    A. Counterparty Credit Risk
    1. Recognition of Financial Collateral

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    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 Funds
    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 Exposure
    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--Insurance Underwriting Subsidiaries
    3. Calculation of Foreign Exposures for Applicability of the 
Advanced Approaches--Changes to Federal Financial Institutions 
Examination Council 009
    4. Applicability of the Final Rule
    5. Change to the Definition of Probability of Default Related to 
Seasoning
    6. Cash Items in Process of Collection
    7. Change to the Definition of Qualifying Revolving Exposure
    8. Trade-related Letters of Credit
    9. Defaulted Exposures That Are Guaranteed by the U.S. 
Government
    10. Stable Value Wraps
    11. 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
XIII. Market Risk Rule
XIV. Additional OCC Technical Amendments
XV. Abbreviations
XVI. Regulatory Flexibility Act
XVII. Paperwork Reduction Act
XVIII. Plain Language
XIX. OCC Unfunded Mandates Reform Act of 1995 Determinations

I. Introduction

    On August 30, 2012, the Office of the Comptroller of the Currency 
(OCC) the Board of Governors of the Federal Reserve System (Board) 
(collectively, the agencies), and the Federal Deposit Insurance 
Corporation (FDIC) 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 agencies' and the FDIC's market risk rule is at 12 CFR 
part 3, appendix B (OCC); 12 CFR parts 208 and 225, appendix E 
(Board); and 12 CFR part 325, appendix C (FDIC).
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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 banking organizations to 
withstand periods of financial stress. (Banking organizations include 
national banks, state member banks, Federal savings associations, and 
top-tier bank holding companies domiciled in the United States not 
subject to the Board'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, as described in this 
preamble.) 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' and the FDIC's 
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.\10\
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    \5\ 77 FR 52792 (August 30, 2012).
    \6\ 77 FR 52888 (August 30, 2012).
    \7\ The agencies' and the FDIC's general risk-based capital 
rules are at 12 CFR part 3, appendix A (national banks) and 12 CFR 
part 167 (Federal savings associations) (OCC); 12 CFR parts 208 and 
225, appendix A (Board); and 12 CFR part 325, appendix A, and 12 CFR 
part 390, subpart Z (FDIC). The general risk-based capital rules are 
supplemented by the market risk rule.
    \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' and the FDIC's 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' and the FDIC's 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 agencies' and the FDIC's advanced approaches rules are 
at 12 CFR part 3, appendix C (national banks) and 12 CFR part 167, 
appendix C (Federal savings associations) (OCC); 12 CFR part 208, 
appendix F, and 12 CFR part 225, appendix G (Board); 12 CFR part 
325, appendix D, and 12 CFR part 390, subpart Z, appendix A (FDIC). 
The advanced approaches rules are 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 agencies' and the FDIC's tier 1 leverage rules are at 
12 CFR 3.6(b) and 3.6(c) (national banks) and 167.6 (Federal savings 
associations) (OCC); 12 CFR part 208, appendix B, and 12 CFR part 
225, appendix D (Board); and 12 CFR 325.3, and 390.467 (FDIC).
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    The agencies are adopting the Basel III NPR, Standardized Approach 
NPR, and Advanced Approaches NPR in this final rule, with certain 
changes to the proposals, as described further below. (The Board 
approved this final rule on July 2, 2013, and the OCC approved this 
final rule on July 9, 2013. The FDIC approved a similar regulation as 
an interim final rule on July 9, 2013.) This final rule applies to all 
banking organizations currently subject to minimum capital 
requirements, including national banks, state member banks, state 
nonmember banks, state and Federal savings associations, top-tier bank 
holding companies (BHCs) that are domiciled in the United States and 
are not subject to the Board's Small Bank Holding Company Policy 
Statement, and top-tier SLHCs that are domiciled in the United States 
and that do not engage substantially in insurance underwriting or 
commercial activities, as discussed further below (together, banking 
organizations). Generally, BHCs with total consolidated assets of less 
than $500 million (small BHCs) remain subject to the Board's Small Bank 
Holding Company Policy Statement.\15\
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    \15\ See 12 CFR part 225, appendix C (Small Bank Holding Company 
Policy Statement).
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    Certain aspects of this final rule apply only to banking 
organizations subject to the advanced approaches rule (advanced 
approaches banking organizations) or to banking organizations with 
significant trading activities, as further described below.
    Likewise, the enhanced disclosure requirements in the final rule 
apply only to banking organizations with $50 billion or more in total 
consolidated assets. Consistent with section 171 of the Dodd-Frank Act, 
a BHC subsidiary of a foreign banking organization that is currently 
relying on the Board's Supervision and Regulation Letter (SR) 01-1 is 
not required to comply with the requirements of the final rule until 
July 21, 2015. Thereafter, all top-tier U.S.-domiciled BHC subsidiaries 
of foreign banking organizations will be required to comply with the 
final rule, subject to applicable transition arrangements set forth in 
subpart G of the rule.\16\ The final rule reorganizes the agencies' 
regulatory capital rules into a harmonized, codified regulatory capital 
framework.
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    \16\ See section 171(b)(4)(E) of the Dodd-Frank Act (12 U.S.C. 
5371(b)(4)(E)); see also SR 01-1 (January 5, 2001), available at 
http://www.federalreserve.gov/boarddocs/srletters/2001/sr0101.htm. 
In addition, the Board has proposed to apply specific enhanced 
capital standards to certain U.S. subsidiaries of foreign banking 
organizations beginning on July 1, 2015, under the proposed notice 
of rulemaking issued by the Board to implement sections 165 and 166 
of the Dodd-Frank Act. See 77 FR 76628, 76640, 76681-82 (December 
28, 2012).
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    As under the proposal, the minimum capital requirements in section 
10(a) of the final rule, as determined using the standardized capital 
ratio calculations in section 10(b), which apply to all banking 
organizations, establish the ``generally applicable'' capital 
requirements under section 171 of the Dodd-Frank Act.\17\
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    \17\ See note 12, supra. Risk-weighted assets calculated under 
the market risk framework in subpart F of the 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 final rule, as under the proposal, in order to determine 
its minimum risk-based capital requirements, an advanced approaches 
banking organization 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 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.\18\ The lower ratio for each risk-based capital requirement 
is the ratio the banking organization must use to determine its 
compliance with the minimum capital requirement.\19\ These enhanced 
prudential standards help ensure that advanced approaches banking 
organizations, which are among the largest and most complex banking 
organizations, have capital adequate to address their more complex 
operations and risks.
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    \18\ The banking organization must also use its advanced-
approaches-adjusted total to determine its total risk-based capital 
ratio.
    \19\ See section 10(c) of the 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 and the FDIC 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

[[Page 62022]]

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 and the FDIC 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 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 agencies' 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' and 
the FDIC's 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' and the FDIC's 
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 and the FDIC 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),\20\ 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.
---------------------------------------------------------------------------

    \20\ 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 and the FDIC 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 Board proposed to apply the advanced approaches rule to SLHCs, 
and the agencies and the FDIC proposed to apply the market risk rule to 
SLHCs and to state and Federal savings associations.

[[Page 62023]]

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 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' and the FDIC's 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 and the FDIC 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 and the FDIC 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 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.
    Comments submitted by or on behalf of banking organizations that 
are engaged primarily in insurance activities also requested an 
exemption from the Basel III NPR and the Standardized Approach NPR to 
recognize differences in their business model compared with those of 
more traditional banking organizations. According to the commenters, 
the activities of these organizations are fundamentally different from 
traditional banking organizations and have a unique risk profile. One 
commenter expressed concern that the Basel III NPR focuses primarily on 
assets in the denominator of the risk-based capital ratio as the 
primary basis for determining capital requirements, in contrast to 
capital requirements for insurance companies, which are based on the 
relationship between a company's assets and liabilities. Similarly, 
other commenters expressed concern that bank-centric rules would 
conflict with the capital requirements of state insurance regulators 
and provide regulatory incentives for unsound asset-liability 
mismatches. Several commenters argued that the U.S. Congress intended 
that banking organizations primarily engaged in insurance activities 
should be covered by different capital regulations that accounted for 
the characteristics of insurance activities. These commenters, 
therefore, encouraged the agencies and the FDIC to recognize capital 
requirements adopted by state insurance regulators. Further, commenters 
asserted that the agencies and the FDIC did not appropriately consider 
regulatory capital requirements for insurance-based banking 
organizations

[[Page 62024]]

whose banking operations are a small part of their overall operations.
    Some SLHC commenters that are substantially engaged in commercial 
activities also asserted that the proposals would be inappropriate in 
scope as proposed and asked that capital rules not be applied to them 
until an intermediate holding company regime could be established. They 
also requested that any capital regime applicable to them be tailored 
to take into consideration their commercial operations and that they be 
granted longer transition periods.
    As noted above, small BHCs are exempt from the final rule 
(consistent with the proposals and section 171 of the Dodd-Frank Act) 
and continue to be subject to the Board's Small Bank Holding Company 
Policy Statement. Comments submitted on behalf of SLHCs with assets 
less than $500 million requested an analogous exemption to that for 
small BHCs. These commenters argued that section 171 of the Dodd-Frank 
Act does not prohibit such an exemption for small SLHCs.
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 and the FDIC 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 and the FDIC 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 and the FDIC 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 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 
and the FDIC 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; the requirement to phase out TruPS 
from tier 1 capital for all banking organizations; and the application 
of the rule to BHCs and SLHCs (collectively, depository institution 
holding companies) with substantial insurance and commercial 
activities.
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' and the FDIC's 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 and the FDIC proposed to require banking organizations to 
include the majority of AOCI components in common equity tier 1 
capital.
    The agencies and the FDIC 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

[[Page 62025]]

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 and the 
FDIC 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 and the FDIC 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 and the FDIC 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' and the FDIC's 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 \21\ and asserted that when 
considered together with the proposed mortgage treatment, the combined 
effect could have an adverse impact on the mortgage industry.
---------------------------------------------------------------------------

    \21\ 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 Banking Organizations
    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.\22\ However, consistent with Basel III and the general policy 
purpose of the proposed revisions to regulatory capital, the agencies 
and the FDIC 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.\23\
---------------------------------------------------------------------------

    \22\ 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).
    \23\ 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 and the FDIC 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.
---------------------------------------------------------------------------

    Many commenters representing community banking organizations 
criticized the proposal's phase-out schedule for TruPS and encouraged 
the agencies and the FDIC 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.
4. Insurance Activities
    The agencies and the FDIC received numerous comments from SLHCs, 
trade associations, insurance companies, and members of the U.S. 
Congress on the proposed capital requirements for SLHCs, in particular 
those with significant insurance activities. As noted above, commenters 
raised concerns that the proposed requirements would apply what are 
perceived as bank-centric consolidated capital requirements to these 
entities. Commenters suggested incorporating insurance risk-based 
capital requirements established by the state insurance regulators into 
the Board's consolidated risk-based capital requirements for the 
holding company, or including certain insurance risk-based metrics 
that, in the commenters' view, would measure the risk of insurance 
activities more accurately. A few commenters asked the Board to conduct 
an additional cost-benefit analysis prior to implementing the proposed 
capital requirements for this subset of SLHCs. In addition, several 
commenters expressed concern with the burden associated with the 
proposed requirement to prepare financial statements according to GAAP, 
because a few SLHCs with substantial insurance operations only prepare 
financial statements according to Statutory Accounting Principles 
(SAP). These commenters noted that the Board has accepted non-GAAP 
financial statements from foreign entities in the past for certain non-
consolidated reporting requirements related to the foreign subsidiaries 
of U.S. banking organizations.\24\
---------------------------------------------------------------------------

    \24\ See form FR 2314.
---------------------------------------------------------------------------

    Some commenters stated that the proposal presents serious issues in 
light

[[Page 62026]]

of the McCarran-Ferguson Act.\25\ These commenters stated that section 
171 of the Dodd-Frank Act does not specifically refer to the business 
of insurance. Further, the commenters asserted that the proposal 
disregards the state-based regulatory capital and reserving regimes 
applicable to insurance companies and thus would impair the solvency 
laws enacted by the states for the purpose of regulating insurance. The 
commenters also said that the proposal would alter the risk-management 
practices and other aspects of the insurance business conducted in 
accordance with the state laws, in contravention of the McCarran-
Ferguson Act. Some commenters also cited section 502 of the Dodd-Frank 
Act, asserting that it continues the primacy of state regulation of 
insurance companies.\26\
---------------------------------------------------------------------------

    \25\ The McCarran-Ferguson Act provides that ``[N]o act of 
Congress shall be construed to invalidate, impair, or supersede any 
law enacted by any State for the purpose of regulating the business 
of insurance . . . unless such Act specifically relates to the 
business of insurance.'' 15 U.S.C. 1012.
    \26\ 31 U.S.C. 313(f).
---------------------------------------------------------------------------

C. Overview of the Final Rule

    The final rule will replace the agencies' 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 agencies have made 
substantial modifications in the 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 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 final rule.
    In this context, the agencies are 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 agencies have 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 
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 agencies 
believe that, together, the revisions to the proposals meaningfully 
address the commenters' concerns regarding the potential implementation 
burden of the proposals.
    The agencies have 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 banking organizations' 
role as financial intermediaries in the economy) when the agencies 
establish or revise regulatory requirements. In developing regulatory 
capital requirements, these concerns are considered in the context of 
the agencies' broad goals--to enhance the safety and soundness of 
banking organizations 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.\27\ The BCBS analysis suggested that 
stronger capital requirements help reduce the likelihood of banking 
crises while yielding positive net economic benefits.\28\ 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.
---------------------------------------------------------------------------

    \27\ 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.
    \28\ 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 final rule. 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 final 
rule if it were fully effective immediately. The final rule will help 
to ensure that these banking organizations maintain their capacity to 
absorb losses in the future. Some banking organizations may need to 
take advantage of the transition period in the 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 final rule, 
and the agencies believe that the resulting improvements to the 
stability and resilience of the banking system outweigh any costs 
associated with its implementation.
    The 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 such as TruPS issued by smaller 
depository institution holding companies; the applicability of the rule 
to SLHCs with substantial insurance or commercial activities; and the

[[Page 62027]]

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 final rule requires all 
banking organizations 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 agencies believe that 
the proposed AOCI treatment results in a regulatory capital measure 
that better reflects banking organizations' actual loss absorption 
capacity at a specific point in time, the agencies recognize that for 
many banking organizations, the volatility in regulatory capital that 
could result from the proposals could lead to significant difficulties 
in capital planning and asset-liability management. The agencies also 
recognize that the tools used by larger, more complex banking 
organizations for managing interest rate risk are not necessarily 
readily available for all banking organizations.
    Accordingly, under the final rule, and as discussed in more detail 
in section V.B of this preamble, a banking organization 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 
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 a banking organization 
must make its AOCI opt-out election in the banking organization's 
Consolidated Reports of Condition and Income (Call Report) or FR Y-9 
series report filed for the first reporting period after the banking 
organization becomes subject to the final rule. Consistent with 
regulatory capital calculations under the agencies' general risk-based 
capital rules, a banking organization that makes an AOCI opt-out 
election under the 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 banking organization's option, the portion relating 
to pension assets deducted under section 22(a)(5) of the 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. A banking 
organization 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.
    A banking organization that does not make an AOCI opt-out election 
on the Call Report or applicable FR Y-9 report filed for the first 
reporting period after the banking organization becomes subject to the 
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 final rule and continuing 
thereafter.
    The agencies have decided not to adopt the proposed treatment of 
residential mortgages. The agencies have considered the commenters' 
observations about the burden of calculating the risk weights for 
banking organizations' existing mortgage portfolios, and have 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 
agencies are 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 agencies have decided to retain in the 
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 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 a banking organization holds 
the first and junior lien(s) on a residential property and no other 
party holds an intervening lien, the banking organization 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 
banking organizations with total consolidated assets less than $15 
billion as of December 31, 2009, and 2010 MHCs, to phase out their non-
qualifying tier 1 capital instruments from regulatory capital over ten 
years. Although the agencies continue to believe that TruPS 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 permanently 
grandfathers non-qualifying capital instruments in the tier 1 capital 
of depository institution holding companies with total consolidated 
assets of less than $15 billion as of December 31, 2009, and 2010 MHCs 
(subject to limits). Non-qualifying capital instruments under the final 
rule include TruPS and cumulative perpetual preferred stock issued 
before May 19, 2010, that BHCs included in tier 1 capital under the 
limitations for restricted capital elements in the general risk-based 
capital rules.
    After considering the comments received from SLHCs substantially 
engaged in commercial activities or insurance underwriting activities, 
the Board has decided to consider further the development of 
appropriate capital requirements for these companies, taking into 
consideration information provided by commenters as well as information 
gained through the supervisory process. The Board will explore further 
whether and how the proposed rule should be modified for these 
companies in a manner consistent with section 171 of the Dodd-Frank Act 
and safety and soundness concerns.
    Consequently, as defined in the final rule, a covered SLHC that is 
subject to the final rule (covered SLHC) is a top-tier SLHC other than 
a top-tier SLHC that meets the exclusion criteria set forth in the 
definition. With respect to commercial activities, a top-tier SLHC that 
is a grandfathered unitary savings

[[Page 62028]]

and loan holding company (as defined in section 10(c)(9)(A) of the Home 
Owners' Loan Act (HOLA)) \29\ is not a covered SLHC if as of June 30 of 
the previous calendar year, either 50 percent or more of the total 
consolidated assets of the company or 50 percent of the revenues of the 
company on an enterprise-wide basis (as calculated under GAAP) were 
derived from activities that are not financial in nature under section 
4(k) of the Bank Holding Company Act.\30\ This exclusion is similar to 
the exemption from reporting on the form FR Y-9C for grandfathered 
unitary savings and loan holding companies with significant commercial 
activities and is designed to capture those SLHCs substantially engaged 
in commercial activities.\31\
---------------------------------------------------------------------------

    \29\ 12 U.S.C. 1461 et seq.
    \30\ 12 U.S.C. 1843(k).
    \31\ See 76 FR 81935 (December 29, 2011).
---------------------------------------------------------------------------

    The Board is excluding grandfathered unitary savings and loan 
holding companies that meet these criteria from the capital 
requirements of the final rule while it continues to contemplate a 
proposal for SLHC intermediate holding companies. Under section 626 of 
the Dodd-Frank Act, the Board may require a grandfathered unitary 
savings and loan holding company to establish and conduct all or a 
portion of its financial activities in or through an intermediate 
holding company and the intermediate holding company itself becomes an 
SLHC subject to Board supervision and regulation.\32\ The Board 
anticipates that it will release a proposal for public comment on 
intermediate holding companies in the near term that would specify the 
criteria for establishing and transferring activities to intermediate 
holding companies, consistent with section 626 of the Dodd-Frank Act, 
and propose to apply the Board's capital requirements in this final 
rule to such intermediate holding companies.
---------------------------------------------------------------------------

    \32\ See section 626 of the Dodd-Frank Act (12 U.S.C. 1467b).
---------------------------------------------------------------------------

    Under the final rule, top-tier SLHCs that are substantially engaged 
in insurance underwriting activities are also excluded from the 
definition of ``covered SLHC'' and the requirements of the final rule. 
SLHCs that are themselves insurance underwriting companies (as defined 
in the final rule) are excluded from the definition.\33\ Also excluded 
are SLHCs that, as of June 30 of the previous calendar year, held 25 
percent or more of their total consolidated assets in insurance 
underwriting subsidiaries (other than assets associated with insurance 
underwriting for credit risk). Under the final rule, the calculation of 
total consolidated assets for this purpose must generally be in 
accordance with GAAP. Many SLHCs that are substantially engaged in 
insurance underwriting activities do not calculate total consolidated 
assets under GAAP. Therefore, the Board has determined to allow 
estimated calculations at this time for the purposes of determining 
whether a company is excluded from the definition of ``covered SLHC,'' 
subject to possible review and adjustment by the Board. The Board 
expects to implement a framework for SLHCs that are not subject to the 
final rule by the time covered SLHCs must comply with the final rule in 
2015. The final rule also contains provisions applicable to insurance 
underwriting activities conducted within a BHC or covered SLHC. These 
provisions are effective as part of the final rule.
---------------------------------------------------------------------------

    \33\ The final rule defines ``insurance underwriting company'' 
to mean an insurance company, as defined in section 201 of the Dodd-
Frank Act (12 U.S.C. 5381), that engages in insurance underwriting 
activities. This definition includes companies engaged in insurance 
underwriting activities that are subject to regulation by a State 
insurance regulator and covered by a State insurance company 
insolvency law.
---------------------------------------------------------------------------

D. Timeframe for Implementation and Compliance

    In order to give covered SLHCs and non-internationally active 
banking organizations more time to comply with the final rule and 
simplify their transition to the new regime, the final rule will 
require compliance from different types of organizations at different 
times. Generally, and as described in further detail below, banking 
organizations that are not subject to the advanced approaches rule must 
begin complying with the final rule on January 1, 2015, whereas 
advanced approaches banking organizations must begin complying with the 
final rule on January 1, 2014. The agencies believe that advanced 
approaches banking organizations have the sophistication, 
infrastructure, and capital markets access to implement the final rule 
earlier than either banking organizations that do not meet the asset 
size or foreign exposure threshold for application of those rules or 
covered SLHCs that have not previously been subject to consolidated 
capital requirements.
    A number of commenters requested that the agencies and the FDIC 
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 and 
the FDIC clarify whether subpart E of the proposed rule only applies to 
those banking organizations that have completed the parallel run 
process and that have received notification from their primary Federal 
supervisor pursuant to section 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 final rule provides that an advanced approaches banking 
organization 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 banking organization has completed 
the parallel run process and has received notification from its primary 
Federal supervisor pursuant to section 121(d) of subpart E of the final 
rule. The agencies have also clarified in the final rule when 
completion of the parallel run process and receipt of notification from 
the primary Federal supervisor pursuant to section 121(d) of subpart E 
is necessary for an advanced approaches banking organization to comply 
with a particular aspect of the rules. For example, only an advanced 
approaches banking organization that has completed parallel run and 
received notification from its primary Federal supervisor under section 
121(d) of subpart E must make the disclosures set forth under subpart E 
of the final rule. However, an advanced approaches banking organization 
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 banking organization has completed its 
parallel run process.
    Beginning on January 1, 2015, banking organizations that are not 
subject to the advanced approaches rule, as well as advanced approaches 
banking organizations that are covered SLHCs, 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.\34\ All banking organizations 
must begin calculating standardized total risk-weighted assets in 
accordance with subpart D of the final rule, and if applicable, the 
revised

[[Page 62029]]

market risk rule under subpart F, on January 1, 2015.\35\
---------------------------------------------------------------------------

    \34\ Prior to January 1, 2015, such banking organizations, other 
than covered SLHCs, must continue to use the agencies' general risk-
based capital rules and tier 1 leverage rules.
    \35\ 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 banking 
organizations that are not SLHCs 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 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 
banking organization 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 banking organization on parallel run 
must also calculate advanced approaches total risk-weighted assets 
using the advanced approaches rule in subpart E of the 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 banking organization 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 final rule for purposes of determining its risk-based capital 
ratios from January 1, 2014 to December 31, 2014. Regardless of an 
advanced approaches banking organization's parallel run status, on 
January 1, 2015, the banking organization must begin to apply subpart 
D, and if applicable, subpart F, of the final rule to determine its 
standardized total risk-weighted assets.
    The transition period for the capital conservation and 
countercyclical capital buffers for all banking organizations will 
begin on January 1, 2016.
    A banking organization 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.

------------------------------------------------------------------------
                                              Banking organizations not
                                               subject to the advanced
                   Date                      approaches rule and banking
                                               organizations that are
                                                   covered SLHCs *
------------------------------------------------------------------------
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 banking
                   Date                      organizations that are not
                                                       SLHCs *
------------------------------------------------------------------------
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, banking organizations must use the calculations in
  subpart F of the 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
  final rule.

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 and the 
FDIC 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

[[Page 62030]]

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 and the FDIC 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 and the FDIC 
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).\36\ 
Accordingly, the commenters encouraged the agencies and the FDIC to 
exempt MDIs from the proposed common equity tier 1 capital ratio 
requirement.
---------------------------------------------------------------------------

    \36\ 12 U.S.C. 1463 note.
---------------------------------------------------------------------------

    The agencies believe that all banking organizations 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 agencies do 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 final rule maintains the minimum common equity tier 1 
capital to total risk-weighted assets ratio of 4.5 percent. The 
agencies have decided not to pursue the alternative regulatory 
mechanisms suggested by commenters, as such alternatives would be 
difficult to implement consistently across banking organizations and 
would not necessarily fulfill the objective of increasing the amount 
and quality of regulatory capital for all banking organizations.
    In view of the concerns expressed by commenters with respect to 
MDIs, the agencies and the FDIC evaluated the risk-based and leverage 
capital levels of MDIs to determine whether the 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 agencies' 
and the FDIC's estimates) 14 would not be considered well capitalized 
for PCA purposes under the final rule if it were fully implemented 
without transition today. Accordingly, the agencies do not believe that 
the final rule would disproportionately impact MDIs and are not 
adopting any exemptions or special provisions for these institutions. 
While the agencies recognize MDIs may face impediments in meeting the 
common equity tier 1 capital ratio, the agencies believe 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 
agencies have a long-established regulatory policy that banking 
organizations 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 banking organization's activities and risk profile. 
Section IV.G of this preamble describes the requirement for overall 
capital adequacy of banking organizations and the supervisory 
assessment of capital adequacy.
    Furthermore, consistent with the agencies' authority under the 
general risk-based capital rules and the proposals, section 1(d) of the 
final rule includes a reservation of authority that allows a banking 
organization's primary Federal supervisor to require the banking 
organization to hold a greater amount of regulatory capital than 
otherwise is required under the final rule, if the supervisor 
determines that the regulatory capital held by the banking organization 
is not commensurate with its credit, market, operational, or other 
risks. In exercising reservation of authority under the rule, the 
agencies expect to consider the size, complexity, risk profile, and 
scope of operations of the banking organization; 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 and the FDIC also proposed to eliminate the exception in the 
agencies' and the FDIC's leverage rules that provides for a minimum 
leverage ratio of 3 percent for banking organizations with strong 
supervisory ratings or BHCs that are subject to the market risk rule.
    The agencies and the FDIC 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 and the FDIC 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 and the FDIC that a 
restrictive leverage measure, together with more stringent

[[Page 62031]]

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 and the FDIC 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.
    In addition, a number of commenters encouraged the agencies and the 
FDIC to reconsider the scope of exposures that banking organizations 
include in the denominator of the leverage ratio, which is based on 
average total consolidated assets under GAAP. Several of these 
commenters criticized the proposed minimum leverage ratio requirement 
because it would not include an exemption for certain exposures that 
are unique to banking organizations engaged in insurance activities. 
Specifically, these commenters encouraged the Board to consider 
excluding assets held in separate accounts and stated that such assets 
are not available to satisfy the claims of general creditors and do not 
affect the leverage position of an insurance company. A few commenters 
asserted that the inclusion of separate account assets in the 
calculation of the leverage ratio stands in contrast to the agencies' 
and the FDIC's treatment of banking organization's trust accounts, 
bank-affiliated mutual funds, and bank-maintained common and collective 
investment funds. In addition, some of these commenters argued for a 
partial exclusion of trading account assets supporting insurance 
liabilities because, according to these commenters, the risks 
attributable to these assets accrue to contract owners.
    The agencies continue to believe that a minimum leverage ratio 
requirement of 4 percent for all banking organizations 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 agencies believe that it is 
appropriate for all banking organizations, regardless of their 
supervisory rating or trading activities, to meet the same minimum 
leverage ratio requirements. As a practical matter, the agencies 
generally have 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 a banking organization can leverage its equity base. 
Accordingly, the 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 banking 
organizations and as of January 1, 2015 for all other banking 
organizations.
    With respect to including separate account assets in the leverage 
ratio denominator, the Board continues to consider this issue together 
with other issues raised by commenters regarding the regulatory capital 
treatment of insurance activities. The final rule continues to include 
separate account assets in total assets, consistent with the proposal 
and the leverage ratio rule for BHCs.

C. Supplementary Leverage Ratio for Advanced Approaches Banking 
Organizations

    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 and the FDIC 
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 and the FDIC 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 
and the FDIC to streamline the application of regulatory capital 
ratios. In addition, commenters suggested that the agencies and the 
FDIC postpone the implementation of the supplementary 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 and the FDIC 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 Board's 
authority in section 165 of the Dodd-Frank Act to implement enhanced 
capital requirements for systemically important financial 
institutions.\37\
---------------------------------------------------------------------------

    \37\ See section 165 of the Dodd-Frank Act, 12 U.S.C. 5365.
---------------------------------------------------------------------------

    With respect to specific aspects of the supplementary leverage 
ratio, some

[[Page 62032]]

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 final rule, the commenter requested that the agencies and the FDIC 
align the credit conversion factors for unfunded commitments under the 
supplementary leverage ratio and any forthcoming liquidity ratio 
requirements.
    Another commenter encouraged the agencies and the FDIC 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 and the FDIC 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 and the FDIC 
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 and the FDIC to retain this 
treatment in the final rule. Other commenters stated that the proposed 
measurement of repo-style transactions is not sufficiently conservative 
and recommended that the agencies and the FDIC 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 and the FDIC 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 and the FDIC 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 and the FDIC 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 final rule implements for reporting purposes the 
proposed supplementary leverage ratio for advanced approaches banking 
organizations starting on January 1, 2015 and requires advanced 
approaches banking organizations 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 reporting the leverage ratio requirement across 
jurisdictions.
    The agencies are not applying the supplementary leverage ratio 
requirement to banking organizations that are not subject to the 
advanced approaches rule in the final rule. Applying the supplementary 
leverage ratio routinely could create operational complexity for 
smaller banking organizations that are not internationally active, and 
that generally do not have off-balance sheet activities that are as 
extensive as banking organizations that are subject to the advanced 
approaches rule. The agencies note that the final rule imposes risk-
based capital requirements on all repo-style transactions and otherwise 
imposes constraints on all banking organizations' off-balance sheet 
exposures.
    With regard to the commenters' views to require the use of IFRS for 
purposes of the supplementary leverage ratio, the agencies note that 
the use of GAAP in the final rule as a starting point to

[[Page 62033]]

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.\38\
---------------------------------------------------------------------------

    \38\ See 12 U.S.C. 1831n(a)(2).
---------------------------------------------------------------------------

    In response to the commenters' views regarding the scope of the 
total leverage exposure, the agencies note that the supplementary 
leverage ratio is intended to capture on- and off-balance sheet 
exposures of a banking organization. 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 a banking 
organization, as well as with safety and soundness principles. 
Accordingly, the agencies believe that total leverage exposure should 
include banking organizations' 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 agencies note 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 agencies do not believe a banking 
organization 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 agencies do 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 agencies are 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 
agencies will consider any changes to the supplementary leverage ratio 
as the BCBS revises the Basel III leverage ratio.
    Therefore, the agencies have adopted the proposed supplementary 
leverage ratio in the final rule without modification. An advanced 
approaches banking organization must calculate the supplementary 
leverage ratio as the simple arithmetic mean of the ratio of the 
banking organization's tier 1 capital to total leverage exposure as of 
the last day of each month in the reporting quarter. The agencies also 
note that collateral may not be applied to reduce the potential future 
exposure (PFE) amount for derivative contracts.
    Under the final rule, total leverage exposure equals the sum of the 
following:
    (1) The balance sheet carrying value of all of the banking 
organization's on-balance sheet assets less amounts deducted from tier 
1 capital under section 22(a), (c), and (d) of the final rule;
    (2) The PFE amount for each derivative contract to which the 
banking organization is a counterparty (or each single-product netting 
set of such transactions) determined in accordance with section 34 of 
the final rule, but without regard to section 34(b);
    (3) 10 percent of the notional amount of unconditionally 
cancellable commitments made by the banking organization; and
    (4) The notional amount of all other off-balance sheet exposures of 
the banking organization (excluding securities lending, securities 
borrowing, reverse repurchase transactions, derivatives and 
unconditionally cancellable commitments).
    Advanced approaches banking organizations 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 banking organizations must 
calculate and report their supplementary leverage ratio.

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 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)

[[Page 62034]]

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 and the FDIC 
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.\39\
---------------------------------------------------------------------------

    \39\ ``Calibrating regulatory capital requirements and buffers: 
A top-down approach.'' Basel Committee on Banking Supervision, 
October, 2010, available at www.bis.org.
---------------------------------------------------------------------------

    The agencies and the FDIC 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 and the FDIC 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 and the FDIC 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' and the FDIC's 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 agencies have 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 banking organizations at all times. Application of the buffer 
to all types of banking organizations and maintenance of a capital 
buffer during periods of market and economic stability is appropriate 
to encourage sound capital management and help ensure that banking 
organizations 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 banking organizations 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 banking organizations at a time when they are 
experiencing losses.
    The agencies recognize that S-corporation banking organizations 
structure their tax payments differently from C corporations. However, 
the agencies note 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 agencies 
are charged with evaluating the capital levels and safety and soundness 
of the banking organization. At the point where a decrease in the 
organization's capital triggers dividend restrictions, the agencies 
believe that capital should stay within the banking organization. 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 final rule does not exempt S-
corporations from the capital conservation buffer.
    Accordingly, under the final rule a banking organization 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 banking organization, 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 and the FDIC received a number of comments regarding the 
proposed

[[Page 62035]]

definition of eligible retained income, which is used to calculate the 
maximum payout amount. Some commenters suggested that the agencies and 
the FDIC limit capital distributions based on retained earnings instead 
of eligible retained income, citing the Board's Regulation H as an 
example of this regulatory practice.\40\ 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.
---------------------------------------------------------------------------

    \40\ See 12 CFR part 208.
---------------------------------------------------------------------------

    The final rule adopts the proposed definition of eligible retained 
income without change. The agencies believe the commenters' suggested 
modifications to the definition of eligible retained income would add 
complexity to the final rule and in some cases may be counter-
productive by weakening the incentives of the capital conservation 
buffer. The agencies note that the definition of eligible retained 
income appropriately accounts for impairment charges, which reduce 
eligible retained income but also reduce 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 agencies have 
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 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 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 final rule, the agencies changed the 
defined term from ``capital distribution'' to ``distribution'' to avoid 
confusion with the term ``capital distribution'' used in the Board's 
capital plan rule.\41\
---------------------------------------------------------------------------

    \41\ 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 and the FDIC 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 
and the FDIC 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 final rule's definition of discretionary bonus payment is 
unchanged from the proposal. The agencies note that if a banking 
organization 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.
    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 final rule does not 
incorporate this suggestion. The agencies note 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

[[Page 62036]]

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.\42\
---------------------------------------------------------------------------

    \42\ 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 Board's Regulation 
O,\43\ 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 agencies' 
objective to include those individuals within a banking organization 
with the greatest responsibility for the organization's financial 
condition and risk exposure, the final rule maintains the definition of 
executive officer as proposed.
---------------------------------------------------------------------------

    \43\ 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' and the FDIC's stated 
objective of ensuring that banking organizations have sufficient 
capital to absorb losses.
    The final rule requires that advanced approaches banking 
organizations that have completed the parallel run process and that 
have received notification from their primary Federal supervisor 
pursuant to section 121(d) of subpart E use their risk-based capital 
ratios under section 10 of the 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 agencies believe such an approach 
is appropriate because it is consistent with how advanced approaches 
banking organizations 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 and the FDIC 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 
and the FDIC to remove the capital conservation buffer for purposes of 
the 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 final 
rule, and suggested increasing minimum capital requirements if the 
agencies and the FDIC determine they are currently insufficient. 
Specifically, one commenter encouraged the agencies and the FDIC 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 would weaken the 
organization's capital position.
    Under the final rule, the maximum payout ratio is the percentage of 
eligible retained income that a banking organization 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 banking organization's 
capital conservation buffer as calculated as of the last day of the 
previous calendar quarter.
    A banking organization's capital conservation buffer is the lowest 
of the following ratios: (i) The banking organization's common equity 
tier 1 capital ratio minus its minimum common equity tier 1 capital 
ratio; (ii) the banking organization's tier 1 capital ratio minus its 
minimum tier 1 capital ratio; and (iii) the banking organization's 
total capital ratio minus its minimum total capital ratio. If the 
banking organization'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 banking organization's 
capital conservation buffer is zero.
    The mechanics of the capital conservation buffer under the final 
rule are unchanged from the proposal. A

[[Page 62037]]

banking organization's maximum payout amount for the current calendar 
quarter is equal to the banking organization's eligible retained 
income, multiplied by the applicable maximum payout ratio, in 
accordance with Table 1. A banking organization with a capital 
conservation buffer that is greater than 2.5 percent (plus, for an 
advanced approaches banking organization, 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, a 
banking organization may otherwise be subject to limitations on capital 
distributions as a result of supervisory actions or other laws or 
regulations.\44\
---------------------------------------------------------------------------

    \44\ See, e.g., 12 U.S.C. 56, 60, and 1831o(d)(1) and 12 CFR 
part 3, subparts H and I, 12 CFR part 5.46, 12 CFR part 5, subpart 
E, and 12 CFR part 6 (national banks) and 12 U.S.C. 1467a(f) and 
1467a(m)(B)(i)(III) and 12 CFR part 165 (Federal savings 
associations); see also 12 CFR 225.8 (Board).
---------------------------------------------------------------------------

    Table 1 illustrates the relationship between the capital 
conservation buffer and the maximum payout ratio. The maximum dollar 
amount that a banking organization 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 
banking organization'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 \45\
----------------------------------------------------------------------------------------------------------------
Capital conservation buffer (as a percentage
   of standardized or advanced total risk-    Maximum payout ratio (as a percentage of eligible retained income)
       weighted assets, as applicable)
----------------------------------------------------------------------------------------------------------------
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.
----------------------------------------------------------------------------------------------------------------

    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 banking organizations 
when the countercyclical capital buffer amount is greater than zero. In 
a scenario where a banking organization'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. A banking organization 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, a banking organization cannot make distributions 
or certain discretionary bonus payments during the current calendar 
quarter if the banking organization'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.
---------------------------------------------------------------------------

    \45\ Calculations in this table are based on the assumption that 
the countercyclical capital buffer amount is zero.
---------------------------------------------------------------------------

    Compliance with the capital conservation buffer is determined prior 
to any distribution or discretionary bonus payment. Therefore, a 
banking organization 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 banking organization 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 and the FDIC 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 
agencies did not incorporate a blanket exemption for penny dividends on 
common stock, under the final rule, as under the proposal, the primary 
Federal supervisor may permit a banking organization to make a 
distribution or discretionary bonus payment if the primary Federal 
supervisor 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 primary Federal supervisor 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 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 and the FDIC 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 and the FDIC to consider 
readily available indicators of economic growth, employment levels, and 
financial sector profits. This commenter stated generally that the 
agencies and the FDIC should activate the countercyclical capital

[[Page 62038]]

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 
and the FDIC not to include the countercyclical capital buffer in the 
final rule and, instead, rely on the Board'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 and the FDIC 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.\46\ The agencies note that implementation of the 
countercyclical capital buffer for advanced approaches banking 
organizations is an important part of the Basel III framework, which 
aims to enhance the resilience of the banking system and reduce 
systemic vulnerabilities. The agencies believe that the countercyclical 
capital buffer is most appropriately applied only to advanced 
approaches banking organizations 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 banking organizations also reflects the fact that 
making cyclical adjustments to capital requirements may produce smaller 
financial stability benefits and potentially higher marginal costs for 
smaller banking organizations. The countercyclical capital buffer is 
designed to take into account the macro-financial environment in which 
banking organizations 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.
---------------------------------------------------------------------------

    \46\ 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 a banking organization likely would face. 
Consequently, even after these losses are realized, banking 
organizations 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.\47\ Thus, the agencies believe that the countercyclical capital 
buffer is an appropriate macroeconomic tool and are including it in the 
final rule. One commenter expressed concern that the proposed rule 
would not require the agencies and the FDIC to activate the 
countercyclical capital buffer pursuant to a joint, interagency 
determination. This commenter encouraged the agencies and the FDIC to 
adopt an interagency process for activating the buffer for purposes of 
the final rule. As discussed in the Basel III NPR, the agencies and the 
FDIC 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 and the 
FDIC 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 and the FDIC 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 final rule.
---------------------------------------------------------------------------

    \47\ 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 final rule, the agencies and the FDIC 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 and the FDIC determine that a more immediate 
implementation is necessary based on economic conditions, the agencies 
may require an earlier effective date. The agencies and the FDIC will 
follow the same procedures in adjusting the countercyclical capital 
buffer applicable for exposures located in foreign jurisdictions.
    For purposes of the 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 and the FDIC 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 a banking organization's 
total risk-weighted assets. Consistent with the proposal, the final 
rule requires an advanced approaches banking organization 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 banking organization 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 banking organization's 
private sector credit exposures located in the jurisdiction by the 
total risk-weighted assets for all of the banking

[[Page 62039]]

organization'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 and the FDIC 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 a banking organization uses models to measure 
specific risk. The agencies and the FDIC did not receive comments on 
this question.
    The 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 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 banking 
organization's determination of its capital conservation buffer 
generally. An advanced approaches banking organization is subject to 
the countercyclical capital buffer regardless of whether it has 
completed the parallel run process and received notification from its 
primary Federal supervisor pursuant to section 121(d) of the rule. The 
methodology an advanced approaches banking organization must use for 
determining risk-weighted assets for private sector credit exposures 
must be the methodology that the banking organization uses to determine 
its risk-based capital ratios under section 10 of the 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 agencies 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 banking organizations.
    Consistent with the proposal, under the 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 banking organization 
calculates its weighted average countercyclical capital buffer amount. 
In the following example, the countercyclical capital buffer 
established in the various jurisdictions in which the banking 
organization has private sector credit exposures is reported in column 
A. Column B contains the banking organization'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 banking organization'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 Banking Organization
----------------------------------------------------------------------------------------------------------------
                                                                 Banking                          Contributing
                                           Countercyclical   organization's                      weight applied
                                           capital buffer     risk-weighted     Contributing         to each
                                            amount set by      assets for     weight (column B/  countercyclical
                                              national       private sector    column B total)   capital buffer
                                             supervisor     credit exposures                    amount (column A
                                              (percent)           ($b)                             * column C)
                                                       (A)               (B)               (C)               (D)
----------------------------------------------------------------------------------------------------------------
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
----------------------------------------------------------------------------------------------------------------

    The countercyclical capital buffer expands a banking organization's 
capital conservation buffer range for purposes of determining the 
banking organization's maximum payout ratio. For instance, if an 
advanced approaches banking organization's countercyclical capital 
buffer amount is equal to zero percent of total risk-weighted assets, 
the banking organization must maintain a buffer of greater than 2.5 
percent of total risk-weighted assets to avoid restrictions

[[Page 62040]]

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 banking organization 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 banking  
organization 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 banking organization 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 banking organization's 
capital conservation buffer ranges would be expanded as shown in Table 
3 below. As a result, the banking organization would now be subject to 
a stricter 40 percent maximum payout ratio based on its capital 
conservation buffer of 2.0 percent.
---------------------------------------------------------------------------

    \48\ 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.

                       Table 3--Capital Conservation Buffer and Maximum Payout Ratio \48\
----------------------------------------------------------------------------------------------------------------
 Capital conservation buffer as expanded by
  the countercyclical capital buffer amount   Maximum payout ratio (as a percentage of eligible retained income)
                from Table 2
----------------------------------------------------------------------------------------------------------------
Greater than 3.9 percent (2.5 percent + 100   No payout ratio limitation applies.
 percent of the countercyclical 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 final rule for 
U.S. credit exposures is initially set to zero, but it could increase 
if the agencies and the FDIC 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.

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' and the FDIC's 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 and 
the FDIC to resolve the problems of insured depository institutions at 
the least cost to the Deposit Insurance Fund.\49\ To facilitate this 
purpose, the agencies and the FDIC 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.\50\ 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.\51\
---------------------------------------------------------------------------

    \49\ 12 U.S.C. 1831o.
    \50\ 12 U.S.C. 1831o(e)-(i). See 12 CFR part 6 (national banks) 
and 12 CFR part 165 (Federal savings associations) (OCC); 12 CFR 
part 208, subpart D (Board).
    \51\ 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 
banking organizations would be equal to the minimum capital 
requirements. The risk-based capital ratios for well capitalized 
banking organizations under PCA would continue to be two percentage 
points higher than the ratios for adequately-capitalized banking 
organizations, and the leverage ratio for well capitalized banking 
organizations under PCA would be one percentage point higher than for 
adequately-capitalized banking organizations. Advanced approaches 
banking organizations 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 banking organizations hold an adequate amount 
of common equity tier 1 capital.
    The agencies and the FDIC 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 and the 
FDIC to increase the adequately-capitalized and well capitalized 
categories for the leverage ratio to six percent or more and eight 
percent or

[[Page 62041]]

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 agencies believe the capital conservation buffer complements 
the PCA framework--the former works to keep banking organizations 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 agencies 
believe 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.
    A few comments pertained specifically to issues affecting BHCs and 
SLHCs. A commenter encouraged the Board to require an advanced 
approaches banking organization, including a BHC, to use the advanced 
approaches rule for determining whether it is well capitalized for PCA 
purposes. This commenter maintained that neither the Bank Holding 
Company Act \52\ nor section 171 of the Dodd-Frank Act requires an 
advanced approaches banking organization to use the lower of its 
minimum ratios as calculated under the general risk-based capital rules 
and the advanced approaches rule to determine well capitalized status. 
Another commenter requested clarification from the Board that section 
171 of the Dodd-Frank Act does not apply to determinations regarding 
whether a BHC is a financial holding company under Board regulations. 
In order to elect to be a financial holding company under the Bank 
Holding Company Act, as amended by section 616 of the Dodd-Frank Act, a 
BHC and all of its depository institution subsidiaries must be well 
capitalized and well managed. The final rule does not establish the 
standards for determining whether a BHC is ``well-capitalized.''
---------------------------------------------------------------------------

    \52\ 12 U.S.C. 1841, et seq.
---------------------------------------------------------------------------

    Consistent with the proposal, the 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).\53\ In addition, the final rule revises 
the three current risk-based capital measures for four of the five PCA 
categories to reflect the final rule's changes to the minimum risk-
based capital ratios, as provided in the agency-specific revisions to 
the agencies' PCA regulations. All banking organizations that are 
insured depository 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 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.
---------------------------------------------------------------------------

    \53\ 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 banking organizations 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 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 banking organizations that are 
insured depository institutions are also subject to a supplementary 
leverage ratio.

                                                                   Table 4--PCA Levels for All Insured Depository Institutions
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                  Common equity          Leverage measure
                                                   Total risk-                     tier 1 RBC   ---------------------------------
                                                  based capital    Tier 1 RBC        measure
                  PCA category                    (RBC) measure   measure (tier  (common equity                   Supplementary                          PCA requirements
                                                   (total RBC      1 RBC ratio     tier 1 RBC    Leverage ratio   leverage ratio
                                                     ratio--       (percent))         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     Not applicable  *
                                                         perpetual preferred stock) to total assets <=2
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
* The supplementary leverage ratio as a PCA requirement applies only to advanced approaches banking organizations 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.


[[Page 62042]]

    To be well capitalized for purposes of the 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 
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 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.\54\
---------------------------------------------------------------------------

    \54\ 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 6.4(b)(1)(iv) (national banks), 12 CFR 165.4(b)(1)(iv) (Federal 
savings associations) (OCC); 12 CFR 208.43(b)(1)(iv) (Board). The 
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.\55\ 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,\56\ 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.
---------------------------------------------------------------------------

    \55\ 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.''
    \56\ The OCC notes that under the OCC's PCA rule with respect to 
national banks, the definition of tangible equity does not use the 
term ``core capital elements.'' 12 CFR 6.2(g).
---------------------------------------------------------------------------

    Consistent with the proposal, the 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 a banking organization'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 agencies believe this 
modification promotes consistency and provides for clearer boundaries 
across and between the various PCA categories.
    In addition to the changes described in this section, the OCC 
proposed to integrate its PCA rules for national banks and Federal 
savings associations. Specifically, the OCC proposed to make 12 CFR 
part 6 applicable to Federal savings associations, and to rescind the 
current PCA rules in 12 CFR part 165 governing Federal savings 
associations, with the exception of Sec.  165.8 (Procedures for 
reclassifying a federal savings association based on criteria other 
than capital), and Sec.  165.9 (Order to dismiss a director or senior 
executive officer). The OCC proposed to retain Sec. Sec.  165.8 and 
165.9 because those sections relate to enforcement procedures and the 
procedural rules in 12 CFR part 19 do not apply to Federal savings 
associations at this time. Therefore, the OCC must retain Sec. Sec.  
165.8 and 165.9. Finally, the proposal also made non-substantive, 
technical amendments to part 6 and Sec. Sec.  165.8 and 165.9.
    The OCC received no comments on these proposed changes and 
therefore is adopting these proposed amendments as final, with minor 
technical edits. The OCC notes that, consistent with the proposal, as 
part of the integration of Federal savings associations, Federal 
savings associations will now calculate tangible equity based on 
average total assets rather than period-end total assets.

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 agencies' general risk-based capital rules indicate that 
the capital requirements are minimum standards generally based on broad 
credit-risk considerations.\57\ 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 banking 
organizations may be exposed, such as interest-rate, liquidity, market, 
or operational risks.\58\
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    \57\ See 12 CFR part 3, App. A, Sec. 1(b)(1) (national banks) 
and 12 CFR part 167.3(b) and (c) (Federal savings associations) 
(OCC); 12 CFR 208.4 (state member banks).
    \58\ The risk-based capital ratios of a banking organization 
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 banking organization that has 
completed the parallel run process and received notification from 
its primary Federal supervisor pursuant to section 121(d) do include 
a capital requirement for operational risks.
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    A banking organization 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.\59\ 
The nature of such capital adequacy assessments should be commensurate 
with banking organizations' size, complexity, and risk-profile. 
Consistent with longstanding practice, supervisory assessment of 
capital adequacy will take account of whether a banking organization 
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 a banking organization'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 a banking organization's regulatory capital 
ratios.
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    \59\ The Basel framework incorporates similar requirements under 
Pillar 2 of Basel II.
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    In light of these considerations, as a prudential matter, a banking 
organization is generally expected to operate with capital positions 
well

[[Page 62043]]

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, banking organizations 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. Banking organizations with high levels 
of risk are also expected to operate even further above minimum 
standards. In addition to evaluating the appropriateness of a banking 
organization's capital level given its overall risk profile, the 
supervisory assessment takes into account the quality and trends in a 
banking organization'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 agencies in their supervision of banking 
organizations, section 10(d) of the final rule maintains and reinforces 
supervisory expectations by requiring that a banking organization 
maintain capital commensurate with the level and nature of all risks to 
which it is exposed and that a banking organization 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 a banking organization's capital 
adequacy, including compliance with section 10(d), may include such 
factors as whether the banking organization is newly chartered, 
entering new activities, or introducing new products. The assessment 
also would consider whether a banking organization 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 a banking 
organization's holding company or other affiliates.
    Supervisors also evaluate the comprehensiveness and effectiveness 
of a banking organization's capital planning in light of its activities 
and capital levels. An effective capital planning process involves an 
assessment of the risks to which a banking organization 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.\60\ While the elements of supervisory 
review of capital adequacy would be similar across banking 
organizations, evaluation of the level of sophistication of an 
individual banking organization's capital adequacy process would be 
commensurate with the banking organization's size, sophistication, and 
risk profile, similar to the current supervisory practice.
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    \60\ See, e.g., SR 09-4, Applying Supervisory Guidance and 
Regulations on the Payment of Dividends, Stock Redemptions, and 
Stock Repurchases at Bank Holding Companies (Board); see also OCC 
Bulletin 2012-16, Guidance for Evaluating Capital Planning and 
Adequacy.
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H. Tangible Capital Requirement for Federal Savings Associations

    As part of the OCC's overall effort to integrate the regulatory 
requirements for national banks and Federal savings associations, the 
OCC proposed to include a tangible capital requirement for Federal 
savings associations.\61\ Under section 5(t)(2)(B) of HOLA,\62\ Federal 
savings associations are required to maintain tangible capital in an 
amount not less than 1.5 percent of total assets.\63\ This statutory 
requirement is implemented in the OCC's current capital rules 
applicable to Federal savings associations at 12 CFR 167.9.\64\ Under 
that rule, tangible capital is defined differently from other capital 
measures, such as tangible equity in current 12 CFR part 165.
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    \61\ Under Title III of the Dodd-Frank Act, the OCC assumed all 
functions of the Office of Thrift Supervision (OTS) and the Director 
of the OTS relating to Federal savings associations. As a result, 
the OCC has responsibility for the ongoing supervision, examination 
and regulation of Federal savings associations as of the transfer 
date of July 21, 2011. The Act also transfers to the OCC the 
rulemaking authority of the OTS relating to all savings 
associations, both state and Federal for certain rules. Section 
312(b)(2)(B)(i) (codified at 12 U.S.C. 5412(b)(2)(B)(i)). The FDIC 
has rulemaking authority for the capital and PCA rules pursuant to 
section 38 of the FDI Act (12 U.S.C. 1831n) and section 5(t)(1)(A) 
of the Home Owners' Loan Act (12 U.S.C.1464(t)(1)(A)).
    \62\ 12 U.S.C. 1464(t).
    \63\ ``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 Comptroller of the Currency for 
national banks.)'' 12 U.S.C. 1464(t)(9)(B). Section 5(t)(9)(A) of 
HOLA defines ``core capital'' to mean ``core capital as defined by 
the Comptroller of the Currency for national banks, less any 
unidentifiable intangible assets [goodwill]'' unless the OCC 
prescribes a more stringent definition. 12 U.S.C. 1464(t)(9)(A).
    \64\ 54 FR 49649 (Nov. 30, 1989).
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    After reviewing HOLA, the OCC determined that a unique regulatory 
definition of tangible capital is not necessary to satisfy the 
requirement of the statute. Therefore, the OCC 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. This definition mirrors the proposed 
definition of ``tangible equity'' for PCA purposes.\65\ While the OCC 
recognizes that the terms used are not identical (``capital'' as 
compared to ``equity''), the OCC believes that this revised definition 
of tangible capital will reduce the computational burden on Federal 
savings associations in complying with this statutory mandate, as well 
as remaining consistent with both the purposes of HOLA and PCA.
---------------------------------------------------------------------------

    \65\ See 12 CFR 6.2.
---------------------------------------------------------------------------

    The final rule adopts this definition as proposed. In addition, in 
Sec.  3.10(b)(5) and (c)(5) of the proposal, the OCC defined the term 
``Federal savings association tangible capital ratio'' to mean the 
ratio of the Federal savings association's core capital (Tier 1 
capital) to total adjusted assets as calculated under subpart B of part 
3. The OCC notes that this definition is inconsistent with the proposed 
definition of the tangible equity ratio for national banks and Federal 
savings associations, at Sec.  6.4(b)(5) and (c)(5), in which the 
denominator of the ratio is quarterly average total assets. 
Accordingly, in keeping with the OCC's goal of integrating rules for 
Federal savings associations and national banks wherever possible and 
reducing implementation burden associated with a separate measure of 
tangible capital, the final rule replaces the term ``total adjusted 
assets'' in the definition of ``Federal savings association tangible 
capital ratio'' with the term ``average total assets.'' As a result of 
the changes in these definitions, Federal savings associations will no 
longer calculate the tangible capital ratio using period end total 
assets.

[[Page 62044]]

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 
and the FDIC 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 and the FDIC 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 
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 and the FDIC 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 and the FDIC to clarify several 
aspects of the proposed criteria. For instance, a

[[Page 62045]]

few commenters asked the agencies and the FDIC 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 agencies note that the requirement that common equity tier 1 
capital instruments be redeemed only with prior agency approval is 
consistent with the agencies' rules and federal law, which generally 
provide that a banking organization may not reduce its capital by 
redeeming capital instruments without receiving prior approval from its 
primary Federal supervisor.\66\ The final rule does not obligate the 
banking organization 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 agency approval, the banking organization must 
receive prior approval before redeeming such instruments. The agencies 
believe that the approval requirement is appropriate as it provides for 
the monitoring of the strength of a banking organization's capital 
position, and therefore, have retained the proposed requirement in the 
final rule.
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    \66\ See 12 CFR 5.46 (national banks) and 12 CFR part 163, 
subpart E (Federal savings associations) (OCC); 12 CFR parts 208 and 
225, appendix A, section II(iii) (Board).
---------------------------------------------------------------------------

    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 \67\ for obligations incurred in the ordinary course of 
business.
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    \67\ 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 agencies note that this criterion should not prevent a banking 
organization 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 banking 
organization, 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 agencies observe 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, a national bank or federal 
savings association may not declare and pay dividends in any year in an 
amount that exceeds the sum of its total net income for that year plus 
its retained net income for the preceding two years (minus certain 
transfers), unless it receives prior approval from the OCC. Therefore, 
as applied to national banks and Federal savings associations, this 
aspect of the proposal did not include any substantive changes from the 
general risk-based capital rules.\68\ Accordingly, with respect to 
national banks and savings associations, the criterion does not include 
surplus.
---------------------------------------------------------------------------

    \68\ See 12 U.S.C. 60(b) and 12 CFR 5.63 and 5.64 (national 
banks) and 12 CFR 163.143 (Federal savings associations) (OCC).
---------------------------------------------------------------------------

    However, because this criterion applies to the terms of the capital 
instrument, which is governed by state law, the Board is broadening the 
criterion in the final rule to include surplus for state-chartered 
companies under its supervision that are subject to the final rule. 
However, regardless of provisions of state law, under the Federal 
Reserve Act, state member banks are subject to the same restrictions as 
national banks that relate to the withdrawal or impairment of their 
capital stock, and the Board's regulations for state member banks 
reflect these limitations on dividend payments.\69\ It should be noted 
that restrictions may be applied to BHC dividends under the Board's 
capital plan rule for companies subject to that rule.\70\
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    \69\ 12 CFR 208.5.
    \70\ See 12 CFR 225.8.
---------------------------------------------------------------------------

    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 \71\ (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.
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    \71\ 29 U.S.C. 1002, et seq.
---------------------------------------------------------------------------

    The agencies do not believe that an ERISA-mandated put option 
should prohibit ESOP shares from being included in common equity tier 1 
capital. Therefore, under the final rule, shares issued under an ESOP 
by a banking organization 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 banking 
organization 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

[[Page 62046]]

that such stock may not conform to the criterion prohibiting a banking 
organization from directly or indirectly funding a capital instrument. 
Because the agencies believe that a banking organization should have 
the flexibility to provide an ESOP as a benefit for its employees, the 
final rule provides that ESOP stock does not violate such criterion. 
Under the final rule, a banking organization'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 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 agencies have 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 agencies believe that most common 
equity instruments that are currently eligible for inclusion in banking 
organizations' tier 1 capital meet the common equity tier 1 capital 
criteria, and have not received information that would support a 
different conclusion. The agencies therefore believe that most banking 
organizations 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 20(b)(1) of the final rule.
2. Additional Tier 1 Capital
    Consistent with Basel III, the agencies and the FDIC 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 and the FDIC 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 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.\72\
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    \72\ 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

[[Page 62047]]

under the general risk-based capital rules for bank holding companies, 
generally would not qualify for inclusion in additional tier 1 
capital.\73\ 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.
---------------------------------------------------------------------------

    \73\ 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 and the FDIC proposed that an instrument classified as a 
liability under GAAP could not qualify as additional tier 1 capital, 
reflecting the agencies' and the FDIC's 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 and the FDIC 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 \74\ or, 
prior to October 4, 2010, under the Emergency Economic Stabilization 
Act of 2008,\75\ and (2) included in tier 1 capital under the agencies' 
and the FDIC's 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 and the FDIC 
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.\76\
---------------------------------------------------------------------------

    \74\ Public Law 111-240, 124 Stat. 2504 (2010).
    \75\ Public Law 110-343, 122 Stat. 3765 (October 3, 2008).
    \76\ 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 and the FDIC make a number of changes and clarifications. 
Specifically, commenters asked the agencies and the FDIC 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 agencies have adopted this criterion as 
proposed.
    Commenters also asked the agencies and the FDIC 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 agencies do 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 (2.9 percent minus 1.2 percent) would be 
considered an incentive to redeem. The agencies believe that the 
clarification above should address the commenters' concerns, and the 
agencies are retaining this criterion in the 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 agencies believe 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 banking organizations a complete list 
of the requirements applicable to regulatory capital instruments in one 
location. Accordingly, the agencies have retained this requirement in 
the 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 and the FDIC 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 final rule, additional tier 1 instruments issued 
under an ESOP by a banking organization 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 agencies believe 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 
agencies are including a provision in the final rule to clarify that 
the criterion prohibiting a banking organization from directly or 
indirectly funding a capital instrument, the criterion prohibiting a 
capital instrument from being covered by a guarantee of the banking 
organization 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 banking 
organization as

[[Page 62048]]

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 and the FDIC 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 agencies have decided to 
revise the rule to permit a banking organization 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.\77\ The agencies recognize 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 banking organization to call 
such instruments early.
---------------------------------------------------------------------------

    \77\ 15 U.S.C. 80 a-1 et seq.
---------------------------------------------------------------------------

    In order to ensure the loss-absorption capacity of additional tier 
1 capital instruments, the agencies have decided not to revise the rule 
to permit a banking organization to include in its additional tier 1 
capital instruments issued on or after the effective date of the 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 agencies have 
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 a banking 
organization'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 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 
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 and the FDIC 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 and 
the FDIC to revise the criterion to allow the agencies and the FDIC to 
permit such an instrument in additional tier 1 capital through 
interpretive guidance or specifically in the case of a particular 
instrument.
    The agencies continue 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. banking organizations' regulatory capital. 
The agencies therefore have decided to retain this aspect of the 
proposal. To the extent that a contingent capital instrument is 
considered a liability under GAAP, a banking organization may not 
include the instrument in its tier 1 capital under the 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 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 agencies have 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 agencies agree 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 final rule.
    After considering the comments on the proposal, the agencies have 
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 
20(c)(1) of the final rule. The agencies expect that most outstanding 
noncumulative perpetual preferred stock that qualifies as tier 1 
capital under the agencies' general risk-based capital rules will 
qualify as additional tier 1 capital under the 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

[[Page 62049]]

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.\78\ 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.
---------------------------------------------------------------------------

    \78\ 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 and the FDIC 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; \79\ or
---------------------------------------------------------------------------

    \79\ 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.\80\
---------------------------------------------------------------------------

    \80\ 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 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 and the FDIC 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 and the FDIC 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,\81\ 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.
---------------------------------------------------------------------------

    \81\ 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 
and the FDIC 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 
agencies note 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 tier 2 capital subordinated debt under the general risk-based 
capital rules. Therefore, the agencies are clarifying that under the 
final rule, and consistent with the agencies' 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

[[Page 62050]]

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 agencies note 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 agencies note 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 agencies have clarified the 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 and the FDIC 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 and the FDIC 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 agencies declined to adopt the 
commenter's recommendation, as they believe that the proposed 
amortization schedule results in a more accurate reflection of the 
loss-absorbency of a banking organization's tier 2 capital. The 
agencies note that if a banking organization 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 banking organization must begin excluding the appropriate 
amount of the instrument from capital in accordance with section 
20(d)(1)(iv) of the final rule.
    Similar to the comments received on the criteria for additional 
tier 1 capital, commenters asked the agencies and the FDIC 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 agencies declined to permit instruments that include 
acceleration provisions in tier 2 capital in the final rule, the 
agencies believe 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 final 
rule's tier 2 eligibility criteria, the agencies acknowledge that the 
inclusion of existing TruPS in tier 2 capital (until they are redeemed 
or they mature) would benefit certain banking organizations until they 
are able to replace such instruments with new capital instruments that 
fully comply with the eligibility criteria of the final rule. 
Accordingly, the agencies have decided to permit non-advanced 
approaches depository institution holding companies with over $15 
billion in total consolidated assets to include in tier 2 capital TruPS 
that are phased-out of tier 1 capital in tier 2 capital. However, 
advanced approaches depository institution holding companies would not 
be allowed to permanently include existing TruPS in tier 2 capital. 
Rather, these banking organizations would include in tier 2 capital 
TruPS phased out of tier 1 capital from January 1, 2014 to year-end 
2015. From January 1, 2016 to year-end 2021, these banking 
organizations would be required to phase out TruPS from tier 2 capital 
in line with Table 9 of the transitions section of the final rule.
    As with additional tier 1 capital instruments, the final rule 
permits a banking organization 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 
agencies have decided not to permit a banking organization to include 
in its tier 2 capital an instrument issued on or after the effective 
date of the final rule that may be called prior to five years after its 
issuance upon the occurrence of a rating agency event. However, the 
agencies have decided to allow such an instrument to be included in 
tier 2 capital, provided that the instrument was issued and included in 
a banking organization'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 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 agencies believe that this 
proposed requirement restates and clarifies existing requirements 
without adding any new substantive restrictions, and that it will help 
to ensure that the

[[Page 62051]]

regulatory capital rules provide banking organizations with a complete 
list of the requirements applicable to their regulatory capital 
instruments. Therefore, the agencies are 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 and the FDIC 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 final 
rule, an advanced approaches banking organization 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 10(c)(3)(ii) of the final rule, an advanced approaches 
banking organization 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 must adjust its total capital 
to reflect its excess eligible credit reserves rather than its ALLL.
    Some commenters recommended that the agencies and the FDIC 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 final rule the agencies have 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 agencies have further elected not to recognize in tier 2 capital 
reserves held for residential mortgage loans sold with recourse.
    As described above, a banking organization 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.
    Some commenters requested that the eligibility criteria for tier 2 
capital be clarified with regard to surplus notes. For example, 
commenters suggested that the requirement for approval of any payment 
of principal or interest on a surplus note by the applicable insurance 
regulator is deemed to satisfy the criterion of the tier 2 capital 
instrument for prior approval for redemption of the instrument prior to 
maturity by a Federal banking agency.
    As described under the proposal, surplus notes generally are 
financial instruments issued by insurance companies that are included 
in surplus for statutory accounting purposes as prescribed or permitted 
by state laws and regulations, and typically have the following 
features: (1) The applicable state insurance regulator approves in 
advance the form and content of the note; (2) the instrument is 
subordinated to policyholders, to claimant and beneficiary claims, and 
to all other classes of creditors other than surplus note holders; and 
(3) the applicable state insurance regulator is required to approve in 
advance any interest payments and principal repayments on the 
instrument. The Board notes that a surplus note could be eligible for 
inclusion in tier 2 capital provided that the note meets the proposed 
tier 2 capital eligibility criteria. However, the Board does not 
consider approval of payments by an insurance regulator to satisfy the 
criterion for approval by a Federal banking agency. Accordingly, the 
Board has adopted the final rule without change.
    After reviewing the comments received on this issue, the agencies 
have 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 20(d)(1) of the 
final rule.
4. Capital Instruments of Mutual Banking Organizations
    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 and the FDIC 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 agencies do 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 agencies have decided 
not to include in tier 1 capital under the final rule any cumulative 
instrument. This would include any previously-issued mutual capital 
instrument that was included in the tier 1 capital of mutual banking 
organizations under the general risk-based capital rules, but that does 
not meet the eligibility requirements for tier 1 capital under the 
final rule. These cumulative capital instruments will be subject to the 
transition provisions and phased out of the tier 1 capital of mutual 
banking organizations over time, as set forth in Table 9 of section 300 
in the final rule. However, if a mutual banking organization develops a 
new capital instrument that meets the qualifying criteria for 
regulatory capital under the final rule, such an instrument may be 
included in regulatory capital with the prior approval of the banking 
organization's primary Federal supervisor under section 20(e) of the 
final rule.
    The agencies note that the qualifying criteria for regulatory 
capital instruments under the final rule permit mutual banking 
organizations to include in regulatory capital many of their existing 
regulatory capital instruments (for example, non-withdrawable accounts, 
pledged deposits, or mutual capital certificates). The agencies believe 
that the quality and quantity of regulatory capital currently 
maintained by most mutual banking organizations should be sufficient to 
satisfy the requirements of the 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 
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 banking organizations in particular expressed concerns that 
the costs related to the replacement of such

[[Page 62052]]

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 and the FDIC were exceeding Congressional intent by going 
beyond what was required under the Dodd-Frank Act. Commenters requested 
that the agencies and the FDIC grandfather existing TruPS and 
cumulative perpetual preferred stock issued by depository institution 
holding companies with less than $15 billion and 2010 MHCs.
    The agencies agree that under the Dodd-Frank Act the agencies have 
the flexibility to permit depository institution holding companies with 
less than $15 billion in total consolidated assets as of December 31, 
2009 and banking organizations that were mutual holding companies as of 
May 19, 2010 (2010 MHCs) to include in additional tier 1 capital TruPS 
and cumulative perpetual preferred stock issued and included in tier 1 
capital prior to May 19, 2010. Although the agencies continue to 
believe that TruPS are not sufficiently loss-absorbing to be includable 
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 plays in local economies. Therefore the agencies have 
decided in the 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 agencies acknowledge that 
the inclusion of existing TruPS in tier 2 capital would benefit certain 
banking organizations until they are able to replace such instruments 
with new capital instruments that fully comply with the eligibility 
criteria of the final rule. Accordingly, the agencies have decided to 
permit depository institution holding companies not subject to the 
advanced approaches rule with over $15 billion in total consolidated 
assets to permanently include in tier 2 capital TruPS that are phased-
out of tier 1 capital in accordance with Table 8 of the transitions 
section of the final rule.
6. Agency Approval of Capital Elements
    The agencies and the FDIC 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 and the FDIC 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' and the FDIC's 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 and the FDIC 
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 agencies continue 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 agencies have decided to move the agencies' authority in 
section 20(e)(1) of the proposal to the agencies' reservation of 
authority provision included in section 1(d)(2)(ii) of the final rule. 
Therefore, the agencies are adopting this aspect of the 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 final 
rule (section 20(e) of the final rule).
    Section 20(e)(1) of the final rule provides that a banking 
organization must receive its primary Federal supervisor'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 banking organization'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 20. In exercising this reservation of authority, the 
agencies expect to consider the requirements for capital elements in 
the final rule; the size, complexity, risk profile, and scope of 
operations of the banking organization, 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

[[Page 62053]]

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 
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.\82\
---------------------------------------------------------------------------

    \82\ See ``Final Elements of the Reforms to Raise the Quality of 
Regulatory Capital'' (January 2011), available at: http://www.bis.org/press/p110113.pdf.
---------------------------------------------------------------------------

    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.\83\ 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.\84\ Section 11 of the Federal Deposit 
Insurance Act has similar provisions for the resolution of depository 
institutions.\85\ 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.
---------------------------------------------------------------------------

    \83\ See 12 U.S.C. 5384.
    \84\ See 12 U.S.C. 5384.
    \85\ 12 U.S.C. 1821.
---------------------------------------------------------------------------

    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 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 
agencies are adopting this provision of the proposed rule without 
change.
8. Qualifying Capital Instruments Issued by Consolidated Subsidiaries 
of a Banking Organization
    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

[[Page 62054]]

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 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 and the FDIC 
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 and the FDIC 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. Commenters also suggested that the agencies 
and the FDIC create an exception to the limitation for bank holding 
companies with only a single subsidiary that is a depository 
institution. These commenters indicated that the limitation should not 
apply in such a situation because a BHC that conducts all business 
through a single bank subsidiary is not exposed to losses outside of 
the activities of the subsidiary.
    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 agencies 
have 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 final rule the minority interest 
limitation would apply only where a subsidiary has ``surplus'' capital.
    The agencies continue 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 agencies' 
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 agencies continue 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 agencies are 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.\86\ The 
agencies and the FDIC 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; \87\ (2) was placed into 
conservatorship or receivership; or (3)

[[Page 62055]]

was expected to become undercapitalized in the near term.\88\
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    \86\ 12 CFR part 325, subpart B (FDIC); 12 CFR part 3, appendix 
A, Sec. 2(a)(3) (OCC); see also Comptroller's Licensing Manual, 
Capital and Dividends, p. 14 (Nov. 2007).
    \87\ 12 CFR part 3, appendix A, section 2(a)(3) (national banks) 
and 12 CFR 167.5(a)(1)(iii) (Federal savings associations) (OCC); 12 
CFR part 208, subpart D (Board); 12 CFR part 325, subpart B, 12 CFR 
part 390, subpart Y (FDIC).
    \88\ See OCC Corporate Decision No. 97-109 (December 1997) 
available at http://www.occ.gov/static/interpretations-and-precedents/dec97/cd97-109.pdf and the Comptroller's Licensing 
Manual, Capital and Dividends available at http://www.occ.gov/static/publications/capital3.pdf; (national banks) and OTS 
Examination Handbook, Section 120, appendix A, (page A7) (September 
2010), available at http://www.occ.gov/static/news-issuances/ots/exam-handbook/ots-exam-handbook-120aa.pdf (Federal savings 
associations) (OCC); 12 CFR parts 208 and 225, appendix A (Board); 
12 CFR part 325, subpart B (state nonmember banks), and 12 CFR part 
390, subpart Y (state savings associations).
---------------------------------------------------------------------------

    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 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.\89\ The agencies note that the 
ability to declare a consent dividend need not be included in the 
documentation of the REIT preferred instrument, but the banking 
organization must provide evidence to the relevant banking agency that 
it has such an ability. The agencies do 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 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 final rule.
---------------------------------------------------------------------------

    \89\ 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 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 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 
banking organizations 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 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 
banking organization subject to the limits described in section 21 of 
the final rule. To the extent that a banking organization is unsure 
whether minority interest investments in a particular REIT subsidiary 
will be includable in the banking organization'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 and the FDIC 
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 agencies have 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 agencies believe 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 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.\90\ 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

[[Page 62056]]

adverse financial conditions.\91\ 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 \92\ 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.\93\ 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.
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    \90\ 12 U.S.C. 1828(n).
    \91\ See 54 FR 4186, 4196 (January 27, 1989) (Board); 54 FR 
4168, 4175 (January 27, 1989) (OCC); 54 FR 11500, 11509 (March 21, 
1989) (FDIC).
    \92\ Examples of other intangible assets include purchased 
credit card relationships (PCCRs) and non-mortgage servicing assets.
    \93\ 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 capital of an 
unconsolidated financial institution that is accounted for under the 
equity method of accounting under GAAP. The agencies have revised 
section 22(a)(1) in the 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 banking 
organization that a banking organization 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 agencies note that, for purposes of the 
final rule, a banking organization 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 agencies note 
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 a banking organization'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 agencies believe that it 
is not appropriate to permit any goodwill to be included in a banking 
organization's capital. The 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 agencies agree that a 
double deduction for MSAs is not required, and the 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 banking organization as an 
MSA. The agencies also note 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 final rule to mean an increase in 
common equity tier 1 capital of the banking organization resulting from 
a traditional securitization except where such an increase results from 
the banking organization'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 did not require a BHC or SLHC to deduct the net pension 
fund asset of its insured depository institution subsidiary.
    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.\94\ 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.
---------------------------------------------------------------------------

    \94\ 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 agencies 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 agencies note that the 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 agencies clarify 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

[[Page 62057]]

net pension fund asset is an asset of an insured depository 
institution. The agencies and the FDIC 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 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 
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 agencies are 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 agencies agree that the deduction would not apply to 
banking organizations that have not received approval from their 
primary Federal supervisor to exit parallel run. In response, the 
agencies have revised this provision of the final rule to apply to a 
banking organization subject to subpart E of the final rule that has 
completed the parallel run process and that has received notification 
from its primary Federal supervisor under section 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.\95\ 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.\96\ The agencies implemented 
this statutory requirement through regulation at 12 CFR 5.39(h)(1) 
(OCC) and 12 CFR 208.73 (Board).
---------------------------------------------------------------------------

    \95\ Public Law 106-102, 113 Stat. 1338, 1373 (Nov. 12, 1999).
    \96\ 12 U.S.C. 24a(c); 12 U.S.C. 1831w(a)(2).
---------------------------------------------------------------------------

    Under section 22(a)(7) of the proposal, investments by a national 
bank or insured state bank in financial subsidiaries would be deducted 
entirely from the bank's common equity tier 1 capital.\97\ 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 agencies believe that 
the more conservative treatment is appropriate for financial 
subsidiaries given the risks associated with nonbanking activities, and 
are adopting this treatment as proposed. Therefore, under the final 
rule, a depository 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.
---------------------------------------------------------------------------

    \97\ The deduction provided for in the agencies' existing 
regulations would be removed and would exist solely in the final 
rule.
---------------------------------------------------------------------------

f. Deduction for Subsidiaries of Savings Associations That Engage in 
Activities That Are Not Permissible for National Banks
    Section 5(t)(5) \98\ of HOLA requires a separate capital 
calculation for Federal 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 Federal savings associations' capital rules through 
a deduction from the core (tier 1) capital of the Federal savings 
association for those subsidiaries that are not ``includable 
subsidiaries.'' \99\
---------------------------------------------------------------------------

    \98\ 12 U.S.C. 1464(t)(5).
    \99\ See 12 CFR 167.1; 12 CFR 167.5(a)(2)(iv).
---------------------------------------------------------------------------

    The OCC 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.\100\
---------------------------------------------------------------------------

    \100\ 12 CFR 324.22.
---------------------------------------------------------------------------

    The OCC received no comments on this proposed deduction. The 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 Federal 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.
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 and the FDIC 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

[[Page 62058]]

organizations to avoid hedges that reduce interest rate risk; shorten 
maturity of their investments in AFS securities; or move their 
investment 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' and the FDIC's 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 final rule, the agencies have retained the requirement 
that all banking organizations subject to the advanced approaches rule, 
and those banking organizations 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 agencies believe 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 a Banking Organization'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 final rule, all banking organizations 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 banking organization's own credit risk. This requirement 
would apply to all liabilities that a banking organization must measure 
at fair value under GAAP, such as derivative liabilities, or for which 
the banking organization elects to measure at fair value under the fair 
value option.\101\
---------------------------------------------------------------------------

    \101\ 825-10-25 (former Financial Accounting Standards Board 
Statement No. 159).
---------------------------------------------------------------------------

    Similarly, advanced approaches banking organizations 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 banking organization elects to measure at fair 
value under GAAP. For derivative liabilities, advanced approaches 
banking organizations 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 a banking organization'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, banking 
organizations 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, banking 
organizations 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 and the FDIC indicated that the 
proposed regulatory capital treatment of AOCI would better reflect an 
institution's actual risk. In particular, the agencies and the FDIC 
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 and the FDIC 
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 and the FDIC 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 and the FDIC 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 and the FDIC 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

[[Page 62059]]

related to AFS debt securities whose valuations primarily change as a 
result of fluctuations in benchmark interest rates, including U.S. 
government and 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 and the FDIC 
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' and the FDIC's 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 and the 
FDIC 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 and the FDIC 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 and the FDIC 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

[[Page 62060]]

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 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 agencies have considered the comments on the proposal to 
incorporate most elements of AOCI in regulatory capital, and have taken 
into account the potential effects that the proposed AOCI treatment 
could have on banking organizations and their function in the economy. 
As discussed in the proposal, the agencies believe that the proposed 
AOCI treatment results in a regulatory capital measure that better 
reflects banking organizations' actual risk at a specific point in 
time. The agencies also believe that AOCI is an important indicator 
that market observers use to evaluate the capital strength of a banking 
organization.
    However, the agencies recognize that for many banking 
organizations, the volatility in regulatory capital that could result 
from the proposal could lead to significant difficulties in capital 
planning and asset-liability management. The agencies also recognize 
that the tools used by advanced approaches banking organizations and 
other larger, more complex banking organizations for managing interest 
rate risk are not necessarily readily available to all banking 
organizations.
    Therefore, in the final rule, the agencies have decided to permit 
those banking organizations 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 agencies' general risk-
based capital rules, which excludes most AOCI amounts. Such banking 
organizations, may make a one-time, permanent election \102\ 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 or FR Y-9 series report for the 
first reporting period after the date upon which they become subject to 
the final rule.
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    \102\ 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 and FR Y-9 
series report to implement changes in reporting items that would 
correspond to the final rule. These revisions will include a line item 
for banking organizations to indicate their AOCI opt-out election in 
their first regulatory report filed after the date the banking 
organization becomes subject to the 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. A banking organization that does not make an AOCI opt-out 
election on the Call Report or FR Y-9 series report filed for the first 
reporting period after the effective date of the 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 banking organization calculates its regulatory 
capital requirements under the final rule.
    Consistent with regulatory capital calculations under the agencies' 
general risk-based capital rules, a banking organization that makes an 
AOCI opt-out election under the 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 banking organization's option, the 
portion relating to pension assets deducted under section 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 banking organization must incorporate into common equity 
tier 1 capital any foreign currency translation adjustment. A banking 
organization 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 primary Federal supervisor may exclude all or a 
portion of these unrealized gains from a banking organization's tier 2 
capital under the reservation of authority provision of the final rule 
if the primary Federal supervisor determines that such preferred stock 
or equity exposures are not prudently valued.
    The agencies believe that banking organizations 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 banking 
organizations 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 final rule, advanced approaches banking 
organizations 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 final rule.
    The final rule additionally provides that in a merger, acquisition, 
or purchase transaction between two banking organizations 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 banking organization. 
Similarly, in a merger, acquisition, or purchase transaction between 
two banking organizations 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 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

[[Page 62061]]

one made an AOCI opt-out election (and the surviving entity is not 
subject to the advanced approaches rule), the surviving entity must 
decide whether to make an AOCI opt-out election by its first regulatory 
reporting date following the consummation of the transaction.\103\ 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 or FR Y-9 series report filed for 
the first reporting period after the effective date of the merger. The 
final rule also provides the agencies 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 agencies 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 agencies may also look to the 
Bank Merger Act \104\ 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 banking organization formed after the effective date 
of the final rule is required to make a decision to opt out in the 
first Call Report or FR Y-9 series report it is required to file.
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    \103\ 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.
    \104\ 12 U.S.C. 1828(c).
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    The 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 agencies are concerned that if some banking organizations 
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 final rule, the agencies have reserved the authority to require a 
banking organization to recognize all or some components of AOCI in 
regulatory capital if an agency determines it would be appropriate 
given a banking organization's risks under the agency's general 
reservation of authority under the final rule. The agencies will 
continue to expect each banking organization to maintain capital 
appropriate for its actual risk profile, regardless of whether it has 
made an AOCI opt-out election. Therefore, the agencies may determine 
that a banking organization 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 banking organization 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 and the FDIC 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 agencies believe that it is important to avoid the 
double-counting of regulatory capital, whether held directly or 
indirectly. Therefore, the final rule implements the look-through 
requirements of the proposal without change. In addition, consistent 
with the treatment for indirect investments in a banking organization's 
own capital

[[Page 62062]]

instruments, the agencies have clarified in the final rule that banking 
organizations must 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 Board 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 and the FDIC 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.\105\
---------------------------------------------------------------------------

    \105\ 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 and the FDIC 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 and the FDIC 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 and the FDIC 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 and the FDIC 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 and 
the FDIC 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 and the FDIC exclude any company with total assets of less 
than $50 billion. Many commenters indicated that the broad definition 
proposed by the agencies and the FDIC 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 and the FDIC 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 and the FDIC 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 agencies have 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 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 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 Board 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

[[Page 62063]]

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 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 agencies also have 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 agencies believe 
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 agencies have 
revised that portion of the definition. Now, the banking organization 
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 agencies believe that this modification 
would reduce burden on banking organizations with small exposures, 
while those with larger exposures should have sufficient information as 
a shareholder to conduct the predominantly engaged analysis.\106\
---------------------------------------------------------------------------

    \106\ For advanced approaches banking organizations, for 
purposes of section 131 of the final rule, the definition of 
``unregulated financial institution'' does not include the ownership 
limitation in applying the ``predominantly engaged'' standard.
---------------------------------------------------------------------------

    In cases when a banking organization's investment in the banking 
organization exceeds one of the thresholds described above, the banking 
organization must determine whether the company is predominantly 
engaged in financial activities, in accordance with the final rule. The 
agencies believe that this modification will substantially reduce 
operational burden for banking organizations with investments in 
multiple institutions. The agencies also believe 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 banking organization 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 agencies are 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 agencies 
believe, 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 agencies believe 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 final rule's treatment of indirect investments in 
financial institutions. Although the revised definition does not 
specifically include commodities pools, under some circumstances a 
banking organization's investment in a commodities pool might meet the 
requirements of the modified ``predominantly engaged'' test.
    Some commenters also requested that the agencies and the FDIC 
establish an asset threshold below which an entity would not be 
included in the definition of ``financial institution.'' The agencies 
have 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 agencies believe that the 
definition of financial institution appropriately captures both large 
and small entities engaged in the core financial activities that the 
agencies believe should be addressed by the definition and associated 
deductions from capital. The agencies believe, 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 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 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

[[Page 62064]]

been deducted from the next higher (that is, more subordinated) 
regulatory 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 agencies have 
revised the final rule to clarify the deduction treatment for 
investments of non-qualifying capital instruments, including TruPS, 
under the corresponding deduction approach. The 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 final rule, the banking organization 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 final 
rule clarifies that banking organizations 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 final rule, and as noted above, if a 
banking organization 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 banking organizations 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 final rule 
maintains this treatment.
h. Investments in the Banking Organization's Own Capital Instruments or 
in the Capital of Unconsolidated Financial Institutions
    In the final rule, the agencies made several non-substantive 
changes to the wording in the proposal to clarify that the amount of an 
investment in the banking organization'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 final rule) of such 
investments. The 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 final rule generally harmonizes the recognition of 
hedging for own capital instruments and for investments in the capital 
of unconsolidated financial institutions. Under the final rule, an 
investment in a banking organization'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 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 a banking organization for fewer than five business days.
    An investment in the banking organization's own capital instrument 
means a net long position calculated in accordance with section 22(h) 
of the final rule in the banking organization'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 banking 
organization's own capital instrument includes any contractual 
obligation to purchase such capital instrument.
    The final rule also clarifies that the gross long position for an 
investment in the banking organization'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 final rule). For the case of an 
investment in the banking organization'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 final rule).
    Under the proposal, the agencies and the FDIC included the 
methodology for

[[Page 62065]]

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 final rule as the agencies 
believe it is more appropriate to include it in the adjustments and 
deductions to regulatory capital section.
    The 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. A banking organization may only net a short position against 
a long position in the banking organization'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 a banking organization's regulatory report as trading 
assets or trading liabilities, if the banking organization 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 banking organization 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 banking organization's internal 
control processes, which the banking organization's primary Federal 
supervisor has found not to be inadequate.
    An indirect exposure results from a banking organization's 
investment in an investment fund that has an investment in the banking 
organization's own capital instrument or the capital of an 
unconsolidated financial institution. A synthetic exposure results from 
a banking organization's investment in an instrument where the value of 
such instrument is linked to the value of the banking organization'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 banking 
organization 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 primary Federal 
supervisor, for the period of time stipulated by the supervisor, a 
banking organization 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 banking 
organization providing financial support to a financial institution in 
distress, as determined by the supervisor. Likewise, a banking 
organization that is an underwriter of a failed underwriting can 
request approval from its primary Federal supervisor 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 agencies note 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 agencies have considered the comments and have decided to 
retain the maturity requirement as proposed. The agencies believe that 
the proposed maturity requirements will reduce the possibility of 
``cliff effects'' resulting from the deduction of open equity positions 
when a banking organization 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 final rule clarifies the 
methodologies for calculating the net long position related to an 
indirect exposure (which is subject to deduction under the final rule) 
by providing a methodology for calculating the gross long position of 
such indirect exposure.

[[Page 62066]]

The agencies believe that the options provided in the final rule will 
provide banking organizations with increased clarity regarding the 
treatment of indirect exposures, as well as increased risk-sensitivity 
to the banking organization's actual potential exposure.
    In order to limit the potential difficulties in determining whether 
an unconsolidated entity in fact holds the banking organization's own 
capital or the capital of unconsolidated financial institutions, the 
final rule also provides that the indirect exposure requirements only 
apply when the banking organization holds an investment in an 
investment fund, as defined in the rule. Accordingly, a banking 
organization invested in, for example, a commercial company is not 
required to determine whether the commercial company has any holdings 
of the banking organization's own capital or the capital instruments of 
financial institutions.
    The final rule provides that a banking organization may determine 
that its gross long position is equivalent to its carrying value of its 
investment in an investment fund that holds the banking organization'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 22(c). Recognizing, however, that the 
banking organization's exposure to those capital instruments may be 
less than its carrying value of its investment in the investment fund, 
the 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, a banking organization may, with the prior 
approval of its primary Federal supervisor, 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, a banking organization may use a 
look-through approach similar to the approach used for risk weighting 
equity exposures to investment funds. Under this approach, a banking 
organization may multiply the carrying value of its investment in an 
investment fund by either the exact percentage of the banking 
organization'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 a banking organization 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 banking organization could 
subject $3,000 (the carrying value times the percentage invested in the 
capital of financial institutions) to deduction from regulatory 
capital. The agencies believe that the approach is flexible and 
benefits a banking organization that obtains and maintains information 
about its investments through investment funds. It also provides a 
simpler calculation method for a banking organization 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.\107\
---------------------------------------------------------------------------

    \107\ 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 agencies note that, under the final rule, where a 
banking organization has an investment in an unconsolidated financial 
institution (Institution A) and Institution A has an investment in 
another unconsolidated financial institution (Institution B), the 
banking organization would not be deemed to have an indirect investment 
in Institution B for purposes of the final rule's capital thresholds 
and deductions because the banking organization's investment in 
Institution A is already subject to capital thresholds and deductions. 
However, if a banking organization has an investment in an investment 
fund that does not meet the definition of a financial institution, it 
must consider 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 agencies have clarified 
in the final rule that a banking organization must deduct the net long 
position in non-significant investments in the capital of 
unconsolidated financial institutions,

[[Page 62067]]

net of associated DTLs in accordance with section 22(e) of the final 
rule, that exceeds the 10 percent threshold for non-significant 
investments. Under section 22(e) of the final rule, the netting of DTLs 
against assets that are subject to deduction or fully deducted under 
section 22 of the final rule is permitted but not required.
    Other commenters asked the agencies and the FDIC 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 agencies believe that investments in TruPS CDOs are 
synthetic exposures to the capital of unconsolidated financial 
institutions and are thus subject to deduction. Under the 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 final rule clarifies that such deductions may be net of 
associated DTLs in accordance with paragraph 22(e) of the final rule. 
Other than this revision, the 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 4810-33-P

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[GRAPHIC] [TIFF OMITTED] TR11OC13.000


[[Page 62069]]


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 
agencies are 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 and the FDIC should only retain the 10 percent limit on each 
threshold item but eliminate the 15 percent aggregate limit. The 
agencies believe 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 
agencies realize that these stricter limits on threshold items may 
require banking organizations to make appropriate changes in their 
capital structure or business model, and thus have provided a lengthy 
transition period to allow banking organizations 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 and the FDIC with 
authority to remove the 90 percent limitation on PMSRs, subject to a 
joint determination by the agencies and the FDIC 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 agencies agree with these commenters and, pursuant to section 
475(b) of FDICIA, have determined that PMSRs may be valued at not more 
than 100 percent of their fair value, because the capital treatment of 
PMSRs in the 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 agencies are also

[[Page 62070]]

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 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 and the FDIC 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 agencies are adopting the 
proposed limitation on MSAs includable in common equity tier 1 capital 
without change in the 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 banking organizations 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 and the FDIC 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 agencies agree that for regulatory capital purposes, a banking 
organization 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 final rule. The agencies note that GAAP requires net 
unrealized gains and losses \108\ recognized in AOCI to be recorded net 
of deferred tax effects. Moreover, under the agencies' general risk-
based capital rules and associated regulatory reporting instructions, 
banking organizations must deduct certain net unrealized gains, net of 
applicable taxes, and add back certain net unrealized losses, again, 
net of applicable taxes. Permitting banking organizations to exclude 
net unrealized gains and losses included in AOCI without netting of 
deferred tax effects would cause a banking organization 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.
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    \108\ The word ``net'' in the term ``net unrealized gains and 
losses'' refers to the netting of gains and losses before tax.
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    Accordingly, under the final rule, banking organizations must make 
all adjustments to common equity tier 1 capital under section 22(b) of 
the final rule net of any associated deferred tax effects. In addition, 
banking organizations may make all deductions from common equity tier 1 
capital elements under section 22(c) and (d) of the final rule net of 
associated DTLs, in accordance with section 22(e) of the 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 
agencies' general risk-based capital rules, the final rule permits, but 
does not require, a banking organization to net DTLs associated with 
items subject to regulatory deductions from common equity tier 1 
capital under section 22(a). The agencies' general risk-based capital 
rules do not explicitly address whether or how often a banking 
organization may change its DTL netting approach for items subject to 
deduction, such as goodwill and other intangible assets.
    If a banking organization elects to either net DTLs against DTAs or 
to net DTLs against other assets subject to deduction, the final rule 
requires that it must do so consistently. For example, a banking 
organization that elects to deduct goodwill net of associated DTLs will 
be required to continue that

[[Page 62071]]

practice for all future reporting periods. Under the final rule, a 
banking organization must obtain approval from its primary Federal 
supervisor before changing its approach for netting DTLs against DTAs 
or assets subject to deduction under section 22(a), which would be 
permitted, for example, in situations where a banking organization 
merges with or acquires another banking organization, or upon a 
substantial change in a banking organization'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 agencies' general risk-based capital rules, before 
calculating the amount of DTAs subject to the DTA limitations for 
inclusion in tier 1 capital, a banking organization may eliminate the 
deferred tax effects of any net unrealized gains and losses on AFS debt 
securities. A banking organization 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 final rule, the agencies have decided to permit 
banking organizations to eliminate from the calculation of DTAs subject 
to threshold deductions under section 22(d) of the final rule the 
deferred tax effects associated with any items that are subject to 
regulatory adjustment to common equity tier 1 capital under section 
22(b). A banking organization that elects to eliminate such deferred 
tax effects must continue that practice consistently from period to 
period. A banking organization must obtain approval from its primary 
Federal supervisor before changing its election to exclude or not 
exclude these amounts from the calculation of DTAs. Additionally, the 
agencies have 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 22(b)) that are: (1) Subject 
to deduction from common equity tier 1 capital under section 22(c) or 
(2) subject to the threshold deductions under section 22(d) to be 
subject to the threshold deductions under section 22(d) of the 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 agencies expect banking organizations to use the 
DTA and DTL amounts reported in the regulatory reports for balance 
sheet purposes to be used for regulatory capital calculations. The 
final rule does not require banking organizations 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 and the FDIC 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.\109\ The final 
rule amends the proposal by explicitly permitting a banking 
organization to use the DTLs embedded in the carrying value of a 
leveraged lease to reduce the amount of DTAs consistent with section 
22(e).
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    \109\ 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.
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    In addition, commenters asked the agencies and the FDIC 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 agencies confirm that under the final 
rule, DTAs that arise from temporary differences that the banking 
organization 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 agencies' 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 final rule requires 
that banking organizations deduct from common equity tier 1 capital 
elements the amount of DTAs arising from temporary differences that the 
banking organization could not realize through net operating loss 
carrybacks that exceed the deduction thresholds under section 22(d) of 
the final rule.
    Some commenters recommended that the agencies and the FDIC retain 
the provision in the agencies' and the FDIC's 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.\110\ 
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

[[Page 62072]]

appropriate circumstances where an institution should be allowed to 
include the value of its DTAs related to net operating loss 
carryforwards in regulatory capital.
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    \110\ Under the agencies' 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 3, appendix A, 
section 2(c)(1)(iii) (national banks) and 12 CFR 167.12(h)(1)(i) 
(Federal savings associations (OCC); 12 CFR part 208, appendix A, 
section 2(b)(4), 12 CFR part 225, appendix A, section 2(b)(4) 
(Board); 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).
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    The deduction thresholds for DTAs in the final rule are intended to 
address the concern that GAAP standards for DTAs could allow banking 
organizations to include in regulatory capital excessive amounts of 
DTAs that are dependent upon future taxable income. The concern is 
particularly acute when banking organizations begin to experience 
financial difficulty. In this regard, the agencies and the FDIC 
observed that as the recent financial crisis began, many banking 
organizations 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 agencies note that under the proposal and final rule, DTAs that 
arise from temporary differences that the banking organization 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, banking organizations 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 final rule 
strikes an appropriate balance between prudential concerns and 
practical considerations about the ability of banking organizations 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).'' \111\ Commenters requested that the 
agencies and the FDIC clarify that the word ``net'' in this sentence 
was intended to refer to DTAs ``net of valuation allowances.'' The 
agencies have amended section 22(e) of the 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.''
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    \111\ See footnote 14, 77 FR 52863 (August 30, 2012).
---------------------------------------------------------------------------

    In addition, a commenter requested that the agencies and the FDIC 
remove the condition in section 22(e) of the 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, banking organizations do not typically 
track DTAs and DTLs on a state-by-state basis for financial reporting 
purposes.
    The agencies recognize 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 agencies allow banking organizations to 
offset DTAs (net of valuation allowance) and DTLs related to a 
particular tax jurisdiction. Moreover, for regulatory reporting 
purposes, consistent with GAAP, the agencies require separate 
calculations of income taxes, both current and deferred amounts, for 
each tax jurisdiction. Accordingly, banking organizations 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'' 
\112\ that engages in proprietary trading or has certain interests in, 
or relationships with, a hedge fund or a private equity fund.\113\
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    \112\ 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.
    \113\ 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, the FDIC, and the SEC issued a 
proposal to implement Section 13 of the Bank Holding Company Act.\114\ 
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.\115\ The agencies intend to 
address this capital requirement, as it applies to banking 
organizations, within the context of the agencies' entire regulatory 
capital framework, so that its potential interaction with all other 
regulatory capital requirements can be fully assessed.
---------------------------------------------------------------------------

    \114\ 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).
    \115\ See Id., Sec.  --.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

[[Page 62073]]

DTLs, as described in section 22(e) 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 and the FDIC 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 agencies continue 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 
final rule adopts the proposed treatment without change.
    The final rule, consistent with the proposal, requires banking 
organizations 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 final rule requires a banking organization 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 and the FDIC 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 and the FDIC 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.
    Several commenters representing SLHCs asked the agencies and the 
FDIC to delay implementation of the final rule for such organizations 
until July 21, 2015. Banking organizations not previously supervised by 
the Board, including SLHCs, become subject to the applicable 
requirements of section 171 on that date.\116\ Additionally, these 
commenters expressed concern that SLHCs would not be able to comply 
with the new minimum capital requirements before that date because they 
were not previously subject to the agencies' risk-based capital 
framework. The commenters asserted that SLHCs would therefore need 
additional time to change their capital structure, balance sheets, and 
internal systems to comply with the proposal. These commenters also 
noted that the Board provided a three-year implementation period for 
BHCs when the general risk-based capital rules were initially adopted. 
Commenters representing SLHCs with substantial insurance activity also 
requested additional time to comply with the proposal because some of 
these organizations currently operate under a different accounting 
framework and would require a longer period of time to adapt their 
systems to the proposed capital rules, which generally are based on 
GAAP.
---------------------------------------------------------------------------

    \116\ 12 U.S.C. 5371(b)(4)(D).
---------------------------------------------------------------------------

    A number of commenters suggested an effective date based on the 
publication date of the 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 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 and the FDIC 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 and the FDIC fully exempt banks with total consolidated assets 
of $50 billion or less from the capital conservation buffer, further 
recommending that if the agencies and the FDIC declined to make this 
accommodation then the phase-in period for the capital conservation 
buffer should be extended by at least

[[Page 62074]]

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 and the 
FDIC 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 and the FDIC 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 and the FDIC propose that institutions with 
under $5 billion in total consolidated assets be allowed to continue to 
include TruPS in regulatory capital at full value until the call or 
maturity of the TruPS instrument.
    Some commenters encouraged the agencies and the FDIC 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 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 and the FDIC to avoid 
penalizing banking organizations that elect to redeem TruPS during the 
transition period. Specifically, the commenter asked the agencies and 
the FDIC 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 final rule is published 
in the Federal Register.
    One commenter encouraged the agencies and the FDIC 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 and the FDIC 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 and 
the FDIC defer implementation of the supplementary leverage ratio until 
the agencies and the FDIC 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 and the FDIC 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 final rule, the 
agencies have agreed to delay the compliance date for banking 
organizations that are not advanced approaches banking organizations 
and for covered SLHCs until January 1, 2015. Therefore, such entities 
are not required to calculate their regulatory capital requirements 
under the final rule until January 1, 2015. Thereafter, these banking 
organizations must calculate their regulatory capital requirements in 
accordance with the final rule, subject to the transition provisions 
set forth in subpart G of the final rule.
    The final rule also establishes the effective date of the final 
rule for advanced approaches banking organizations that are not SLHCs 
as January 1, 2014. In accordance with Tables 5-17 below, the 
transition provisions for the regulatory capital adjustments and 
deductions in the final rule commence either one or two years later 
than in the proposal, depending on whether the banking organization is 
or is not an advanced approaches banking organization. The December 31, 
2018, end-date for the transition period for regulatory capital 
adjustments and deductions is the same under the final rule as under 
the proposal.

A. Transitions Provisions for Minimum Regulatory Capital Ratios

    In response to the commenters' concerns, the final rule modifies 
the proposed transition provisions for the minimum capital 
requirements. Banking organizations that are not advanced approaches 
banking organizations and covered SLHCs 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 agencies are not requiring compliance with the 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

[[Page 62075]]

banking organizations 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 final rule, an advanced approaches banking organization 
that is not an SLHC 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 banking organizations. During calendar year 
2014, advanced approaches banking organizations 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 final rule (adjusted in accordance with the transition provisions 
for regulatory adjustments and deductions and for the non-qualifying 
capital instruments for advanced approaches banking organizations 
described in this section).

B. Transition Provisions for Capital Conservation and Countercyclical 
Capital Buffers

    The agencies have finalized transitions for the capital 
conservation and countercyclical capital buffers as proposed. The 
capital conservation buffer transition period begins in 2016, a full 
year after banking organizations that are not advanced approaches 
banking organizations and banking organizations that are covered SLHCs 
are required to comply with the final rule, and two years after 
advanced approaches banking organizations that are not SLHCs are 
required to comply with the final rule. The agencies believe 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 banking organizations that are not 
SLHCs 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 Banking Organizations
----------------------------------------------------------------------------------------------------------------
                                      Jan. 1,      Jan. 1,      Jan. 1,      Jan. 1,      Jan. 1,      Jan. 1,
                                        2014         2015         2016         2017         2018         2019
                                     (percent)    (percent)    (percent)    (percent)    (percent)    (percent)
----------------------------------------------------------------------------------------------------------------
Capital conservation buffer.......  ...........  ...........        0.625         1.25        1.875          2.5
Minimum common equity tier 1                4.0          4.5        5.125         5.75        6.375          7.0
 capital ratio + capital
 conservation buffer..............
Minimum tier 1 capital ratio +              5.5          6.0        6.625         7.25        7.875          8.5
 capital conservation buffer......
Minimum total capital ratio +               8.0          8.0        8.625         9.25        9.875         10.5
 capital conservation buffer......
Maximum potential countercyclical   ...........  ...........        0.625         1.25        1.875          2.5
 capital buffer...................
----------------------------------------------------------------------------------------------------------------

    Table 6 shows the regulatory capital levels banking organizations 
that are not advanced approaches banking organizations and banking 
organizations that are covered SLHCs 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 Banking Organizations
----------------------------------------------------------------------------------------------------------------
                                                   Jan. 1,      Jan. 1,      Jan. 1,      Jan. 1,      Jan. 1,
                                                     2015         2016         2017         2018         2019
                                                  (percent)    (percent)    (percent)    (percent)    (percent)
----------------------------------------------------------------------------------------------------------------
Capital conservation buffer....................  ...........        0.625         1.25        1.875          2.5
Minimum common equity tier 1 capital ratio +             4.5        5.125         5.75        6.375          7.0
 capital conservation buffer...................
Minimum tier 1 capital ratio + capital                   6.0        6.625         7.25        7.875          8.5
 conservation buffer...........................
Minimum total capital ratio + capital                    8.0        8.625         9.25        9.875         10.5
 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 banking organizations are subject 
to transition arrangements with respect to the capital conservation 
buffer as outlined in more detail in Table 7. For advanced approaches 
banking organizations, 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
----------------------------------------------------------------------------------------------------------------
                                                                                      Maximum payout ratio (as a
            Transition period                     Capital conservation buffer           percentage of eligible
                                                                                           retained income)
----------------------------------------------------------------------------------------------------------------
Calendar year 2016......................  Greater than 0.625 percent (plus 25         No payout ratio limitation
                                           percent of any applicable countercyclical   applies.
                                           capital buffer amount).
                                          Less than or equal to 0.625 percent (plus   60.
                                           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).

[[Page 62076]]

 
                                          Less than or equal to 0.469 percent (plus   40.
                                           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 0.313 percent (plus   20.
                                           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 0.156 percent (plus   0.
                                           6.25 percent of any applicable
                                           countercyclical capital buffer amount).
Calendar year 2017......................  Greater than 1.25 percent (plus 50 percent  No payout ratio limitation
                                           of any applicable countercyclical capital   applies.
                                           buffer amount).
                                          Less than or equal to 1.25 percent (plus    60.
                                           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 0.938 percent (plus   40.
                                           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 0.625 percent (plus   20.
                                           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 0.313 percent (plus   0.
                                           12.5 percent of any applicable
                                           countercyclical capital buffer amount).
Calendar year 2018......................  Greater than 1.875 percent (plus 75         No payout ratio limitation
                                           percent of any applicable countercyclical   applies.
                                           capital buffer amount).
                                          Less than or equal to 1.875 percent (plus   60.
                                           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 1.406 percent (plus   40.
                                           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 0.938 percent (plus   20.
                                           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 0.469 percent (plus   0.
                                           18.75 percent of any applicable
                                           countercyclical capital buffer amount).
----------------------------------------------------------------------------------------------------------------

C. Transition Provisions for Regulatory Capital Adjustments and 
Deductions

    To give sufficient time to banking organizations to adapt to the 
new regulatory capital adjustments and deductions, the final rule 
incorporates transition provisions for such adjustments and deductions 
that commence at the time at which the banking organization becomes 
subject to the final rule. As explained above, the final rule maintains 
the proposed transition periods, except for non-qualifying capital 
instruments as described below.
    Banking organizations that are not advanced approaches banking 
organizations and banking organizations that are covered SLHCs will 
begin the transitions for regulatory capital adjustments and deductions 
on January 1, 2015. From January 1, 2015, through December 31, 2017, 
these banking organizations will be required to make the regulatory 
capital adjustments to and deductions from regulatory capital in 
section 22 of the final rule in accordance with the proposed transition 
provisions for such adjustments and deductions outlined below. Starting 
on January 1, 2018, these banking organizations will apply all 
regulatory capital adjustments and deductions as set forth in section 
22 of the final rule.
    For an advanced approaches banking organization that is not an 
SLHC, the first year of transition for adjustments and deductions 
begins on January 1, 2014. From January 1, 2014, through December 31, 
2017, such banking organizations will be required to make the 
regulatory capital adjustments to and deductions from regulatory 
capital in section 22 of the final rule in accordance with the proposed 
transition provisions for such adjustments and deductions outlined 
below. Starting on January 1, 2018, advanced approaches banking 
organizations will be subject to all regulatory capital adjustments and 
deductions as described in section 22 of the final rule.
1. Deductions for Certain Items Under Section 22(a) of the Final Rule
    The final rule provides that banking organizations will deduct from 
common equity tier 1 capital or tier 1 capital in accordance with Table 
8 below: (1) Goodwill (section 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 
22(a)(4)): (4) defined benefit pension fund assets (section 22(a)(5)); 
(5) for an advanced approaches banking organization 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 of 
the final rule, expected credit loss that exceeds eligible credit 
reserves (section 22(a)(6)); and (6) financial subsidiaries (section 
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 62077]]



      Table 8--Transition Deductions Under Section 22(a)(1) and Sections 22(a)(3)-(a)(7) of the Final Rule
----------------------------------------------------------------------------------------------------------------
                                                             Transition     Transition deductions under sections
                                                          deductions under             22(a)(3)-(a)(6)
                                                          section 22(a)(1) -------------------------------------
                                                            and (7) \1\
                   Transition period                    ------------------- Percentage of the
                                                         Percentage of the   deductions from   Percentage of the
                                                          deductions from     common equity     deductions from
                                                           common equity      tier 1 capital     tier 1 capital
                                                           tier 1 capital
----------------------------------------------------------------------------------------------------------------
January 1, 2014 to December 31, 2014 (advanced                         100                 20                 80
 approaches banking organizations 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
----------------------------------------------------------------------------------------------------------------
\1\ In addition, a FSA should deduct from common equity tier 1 non-includable subsidiaries. See 12 CFR
  3.22(a)(8).

    Beginning on January 1, 2014, advanced approaches banking 
organizations that are not SLHCs 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 banking organizations 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 a banking organization's regulatory capital and has not 
been included in banking organizations' regulatory capital under the 
general risk-based capital rules.\117\ Additionally, the agencies 
believe that fully deducting goodwill from common equity tier 1 capital 
from the date a banking organization must comply with the final rule 
will result in a more appropriate measure of common equity tier 1 
capital.
---------------------------------------------------------------------------

    \117\ 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 final rule also retains the existing deduction for Federal 
associations' investments in, and extensions of credit to, non-
includable subsidiaries at 12 CFR 3.22(a)(8).\118\ This deduction is 
required by statute \119\ 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 
Federal or state savings association becomes subject to the final rule.
---------------------------------------------------------------------------

    \118\ For additional information on this deduction, see section 
V.B ``Activities by savings association subsidiaries that are 
impermissible for national banks'' of this preamble.
    \119\ 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 
22(a)(2) of the final rule), the applicable transition period in the 
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 banking organizations that are not 
SLHCs will begin the transition on January 1, 2014, and other banking 
organizations will begin the transition on January 1, 2015.

                      Table 9--Transition Deductions Under Section 22(a)(2) of the Proposal
----------------------------------------------------------------------------------------------------------------
                                                                          Transition deductions under section
                          Transition period                             22(a)(2)--Percentage of the deductions
                                                                           from common equity tier 1 capital
----------------------------------------------------------------------------------------------------------------
January 1, 2014 to December 31, 2014 (advanced approaches banking                                            20
 organizations 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 62078]]

3. Regulatory Adjustments Under Section 22(b)(1) of the Final Rule
    During the transition period, any of the adjustments required under 
section 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 banking organizations that are not SLHCs will begin 
the transition on January 1, 2014, and other banking organizations will 
begin the transition on January 1, 2015.

                             Table 10--Transition Adjustments Under Section 22(b)(1)
----------------------------------------------------------------------------------------------------------------
                                                      Transition adjustments under section 22(b)(1)
                                       -------------------------------------------------------------------------
           Transition period                Percentage of the adjustment
                                          applied to common equity tier 1        Percentage of the adjustment
                                                      capital                     applied to tier 1 capital
----------------------------------------------------------------------------------------------------------------
January 1, 2014, to December 31, 2014                                   20                                   80
 (advanced approaches banking
 organizations only)..................
January 1, 2015, to December 31, 2015.                                  40                                   60
January 1, 2016, to December 31, 2016.                                  60                                   40
January 1, 2017, to December 31, 2017.                                  80                                   20
January 1, 2018 and thereafter........                                 100                                    0
----------------------------------------------------------------------------------------------------------------

4. Phase-out of Current Accumulated Other Comprehensive Income 
Regulatory Capital Adjustments
    Under the 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 banking organization's option, the 
portion relating to pension assets deducted under section 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 banking organizations and 
other banking organizations that have not made an AOCI opt-out election 
under section 22(b)(2) of the rule and described in section V.B of this 
preamble. Advanced approaches banking organizations that are not SLHCs 
will begin the phase out of the current AOCI regulatory capital 
adjustments on January 1, 2014; other banking organizations that have 
not made the AOCI opt-out election will begin making these adjustments 
on January 1, 2015. Specifically, if a banking organization'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 and the FDIC 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 agencies have decided to add such an 
adjustment as it reflects the agencies' 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 approaches banking                                           80
 organizations only)................................................
January 1, 2015, to December 31, 2015 (advanced approaches banking                                           60
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2016, to December 31, 2016 (advanced approaches banking                                           40
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2017, to December 31, 2017 (advanced approaches banking                                           20
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2018 and thereafter (advanced approaches banking                                                   0
 organizations and banking organizations that have not made an opt-
 out election)......................................................
----------------------------------------------------------------------------------------------------------------

    Beginning on January 1, 2018, advanced approaches banking 
organizations and other banking organizations 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 banking organizations and banking organizations 
not subject to the advanced approaches rule that have 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 banking 
organization that is not an SLHC will begin the adjustments on January 
1, 2014; all other banking organizations that have not made an

[[Page 62079]]

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 31, 2014 (advanced approaches banking                                           36
 organizations only)................................................
January 1, 2015, to December 31, 2015 (advanced approaches banking                                           27
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2016, to December 31, 2016 (advanced approaches banking                                           18
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2017, to December 31, 2017 (advanced approaches banking                                            9
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2018 and thereafter (advanced approaches banking                                                   0
 organizations and banking organizations 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 Final 
Rule
    Under the final rule, a banking organization must calculate the 
appropriate deductions under sections 22(c) and 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 banking organization 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 
banking organizations that are not SLHCs will apply the transition 
framework beginning January 1, 2014. All other banking organizations 
will begin applying the transition framework on January 1, 2015. During 
the transition period, a banking organization 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 banking 
organization 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 31, 2014...............................                                         20
(advanced approaches banking organizations 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
----------------------------------------------------------------------------------------------------------------

    During the transition period, banking organizations 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, banking organizations 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 22(d) of 
the final rule. During the transition period, a banking organization 
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 banking organization's common equity tier 1 capital after 
making the deductions and adjustments required under sections 22(a) 
through (c).

D. Transition Provisions for Non-Qualifying Capital Instruments

    Under the final rule, there are different transition provisions for 
non-qualifying capital instruments depending on the type and size of a 
banking organization as discussed below.

[[Page 62080]]

1. Depository Institution Holding Companies With Less than $15 Billion 
in Total Consolidated Assets as of December 31, 2009 and 2010 Mutual 
Holding Companies
    BHCs have historically included (subject to limits) in tier 1 
capital ``restricted core capital elements'' such as cumulative 
perpetual preferred stock and TruPS, which generally would not comply 
with the eligibility criteria for additional tier 1 capital instruments 
outlined in section 20 of the final rule. As discussed in section V.A 
of this preamble, section 171 of the Dodd-Frank Act would not require 
depository institution holding companies with less than $15 billion in 
total consolidated assets as of December 31, 2009, (depository 
institution holding companies under $15 billion) or 2010 MHCs to deduct 
these types of instruments from tier 1 capital. However, as discussed 
in section V.A of this preamble, above, because these instruments would 
no longer qualify as tier 1 capital under the proposed criteria and 
have been found to be less able to absorb losses, the agencies and the 
FDIC proposed to require depository institution holding companies under 
$15 billion and 2010 MHCs to phase these instruments out of capital 
over a 10-year period consistent with Basel III.
    For the reasons discussed in section V.A of this preamble, as 
permitted by section 171 of the Dodd-Frank Act, the agencies have 
decided not to adopt this proposal in the final rule. Depository 
institution holding companies under $15 billion and 2010 MHCs may 
continue to include non-qualifying instruments that were issued prior 
to May 19, 2010 in tier 1 or tier 2 capital in accordance with the 
general risk-based capital rules, subject to specific limitations. More 
specifically, these depository institution holding companies will be 
able to continue including outstanding tier 1 capital non-qualifying 
capital instruments in additional tier 1 capital (subject to the 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) until they redeem the 
instruments or until the instruments mature. Likewise, consistent with 
the general risk-based capital rules, any tier 1 capital instrument 
that is excluded from tier 1 because it exceeds the 25 percent limit 
referenced above can be included in tier 2 capital.\120\
---------------------------------------------------------------------------

    \120\ 12 CFR part 225, appendix A, 1(b)(3).
---------------------------------------------------------------------------

2. Depository Institutions
    Under the 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 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 20 of the 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 final rule in accordance with the phase-out 
schedule in Table 14.
    As of January 1, 2014 for advanced approaches banking organizations 
that are not SLHCs, and January 1, 2015 for all other banking 
organizations and for covered SLHCs that are advanced approaches 
organizations, 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 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
                                                                      instruments issued prior to September 2010
                  Transition Period (calendar year)                    includable in additional tier 1 or tier 2
                                                                          capital for depository institutions
----------------------------------------------------------------------------------------------------------------
Calendar year 2014 (advanced approaches banking organizations only).                                         80
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 thereafter...................................                                          0
----------------------------------------------------------------------------------------------------------------

3. Depository Institution Holding Companies With $15 Billion or More in 
Total Consolidated Assets as of December 31, 2009 That Are Not 2010 
Mutual Holding Companies
    Under the final rule, consistent with the proposal and with section 
171 of the Dodd-Frank Act, debt or equity instruments that do not meet 
the criteria for additional tier 1 or tier 2 capital instruments in 
section 20 of the final rule, but that were issued and included in tier 
1 or tier 2 capital, respectively, prior to May 19, 2010 (non-
qualifying capital instruments) and were issued by a depository 
institution holding company with total consolidated assets greater than 
or equal to $15 billion as of December 31, 2009 (depository institution 
holding company of $15 billion or more) that is not a 2010 MHC must be 
phased out as set forth in Table 15 below.\121\ More specifically, 
depository institution holding companies of $15 billion or more that 
are advanced approaches banking organizations and that are not SLHCs 
must begin to apply this phase-out on January 1, 2014; other depository 
institution holding companies of $15 billion or more, including covered 
SLHCs, must begin to apply the phase-out on January 1, 2015. 
Accordingly,

[[Page 62081]]

under the final rule, a depository institution holding company of $15 
billion or more that is an advanced approaches banking organization and 
that is not an SLHC will be allowed to include only 50 percent of non-
qualifying capital instruments in regulatory capital as of January 1, 
2014; all depository institution holding companies of $15 billion or 
more will be allowed to include only 25 percent as of January 1, 2015, 
and 0 percent as of January 1, 2016, and thereafter.
---------------------------------------------------------------------------

    \121\ Consistent with the language of the statute, this 
requirement also applies to those institutions that, for a brief 
period of time, exceeded the $15 billion threshold and then 
subsequently have fallen below it so long as their asset size was 
greater than or equal to $15 billion in total consolidated assets as 
of December 31, 2009.
---------------------------------------------------------------------------

    The agencies acknowledge that the majority of existing TruPS would 
not technically comply with the final rule's tier 2 capital eligibility 
criteria (given that existing TruPS allow for acceleration after 5 
years of interest deferral) even though these instruments are eligible 
for inclusion in tier 2 capital under the general risk-based capital 
rules. However, the agencies believe that: (1) The inclusion of 
existing TruPS in tier 2 capital (until they are redeemed or they 
mature) does not raise safety and soundness concerns, and (2) it may be 
less disruptive to the banking system to allow certain banking 
organizations to include TruPS in tier 2 capital until they are able to 
replace such instruments with new capital instruments that fully comply 
with the eligibility criteria of the final rule. Accordingly, the 
agencies have decided to permit non-advanced approaches depository 
institution holding companies with over $15 billion in total 
consolidated assets permanently to include non-qualifying capital 
instruments, including TruPS that are phased out of tier 1 capital in 
tier 2 capital and not phase-out those instruments.
    Under the final rule, advanced approaches depository institution 
holding companies will not be permitted to permanently include existing 
non-qualifying capital instruments in tier 2 capital if they do not 
meet tier 2 criteria under the final rule. Such banking organizations 
generally face fewer market obstacles in replacing non-qualifying 
capital instruments than smaller banking organizations. From January 1, 
2016, until December 31, 2021, these banking organizations will be 
required to phase out non-qualifying capital instruments from tier 2 
capital in accordance with the percentages in Table 14 above. 
Consequently, an advanced approaches depository institution holding 
company will be allowed to include in tier 2 capital in calendar year 
2016 up to 60 percent of the principal amount of TruPS that such 
banking organization had outstanding as of January 1, 2014, but will 
not be able to include any of these instruments in regulatory capital 
after year-end 2021.

  Table 15--Percentage of Non-Qualifying Capital Instruments Includable in Additional Tier 1 or Tier 2 Capital
----------------------------------------------------------------------------------------------------------------
                                                                         Percentage of non-qualifying capital
                                                                       instruments includable in additional tier
                  Transition period (calendar year)                       1 or tier 2 capital for depository
                                                                         institution holding companies of $15
                                                                                    billion or more
----------------------------------------------------------------------------------------------------------------
Calendar year 2014 (advanced approaches banking organizations only).                                         50
Calendar year 2015..................................................                                         25
Calendar year 2016 And thereafter...................................                                          0
----------------------------------------------------------------------------------------------------------------

4. Merger and Acquisition Transition Provisions
    Under the final rule, consistent with the proposal, if a depository 
institution holding company of $15 billion or more acquires a 
depository institution holding company with total consolidated assets 
of less than $15 billion as of December 31, 2009 or a 2010 MHC, the 
non-qualifying capital instruments of the resulting organization will 
be subject to the phase-out schedule outlined in Table 15, above. 
Likewise, if a depository institution holding company under $15 billion 
makes an acquisition and the resulting organization has total 
consolidated assets of $15 billion or more, its non-qualifying capital 
instruments also will be subject to the phase-out schedule outlined in 
Table 15, above. Some commenters argued that this provision could 
create disincentives for mergers and acquisitions, but the agencies 
continue to believe these provisions appropriately subject institutions 
that are larger (or that become larger) to the stricter phase-out 
requirements for non-qualifying capital instruments, consistent with 
the language and intent of section 171 of the Dodd-Frank Act. 
Depository institution holding companies under $15 billion and 2010 
MHCs that merge with or acquire other banking organizations that result 
in organizations that remain below $15 billion or remain MHCs would be 
able to continue to include non-qualifying capital instruments in 
regulatory capital.
5. Phase-Out Schedule for Surplus and Non-Qualifying Minority Interest
    Under the transition provisions in the final rule, a banking 
organization 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 a banking organization has surplus minority interest 
outstanding when the final rule becomes effective, that surplus 
minority interest will be subject to the phase-out schedule outlined in 
Table 16. Advanced approaches banking organizations that are not SLHCs 
must begin to phase out surplus minority interest in accordance with 
Table 16 beginning on January 1, 2014. All other banking organizations 
will begin the phase out for surplus minority interest on January 1, 
2015.
    During the transition period, a banking organization 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 banking organization on the date the rule becomes 
effective, but that do not qualify as tier 1 or total capital under 
section 20 of the final rule (non-qualifying minority interest) in 
accordance with Table 16.

[[Page 62082]]



   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 31, 2014 (advanced approaches banking                                           80
 organizations only)................................................
January 1, 2015, to December 31, 2015...............................                                         60
January 1, 2016, to December 31, 2016...............................                                         40
January 1, 2017, to December 31, 2017...............................                                         20
January 1, 2018 and thereafter......................................                                          0
----------------------------------------------------------------------------------------------------------------

VIII. Standardized Approach for Risk-Weighted Assets

    In the Standardized Approach NPR, the agencies and the FDIC 
proposed to revise methodologies for calculating risk-weighted assets. 
As discussed above and in the proposal, these revisions were intended 
to harmonize the agencies' and the FDIC's rules for calculating risk-
weighted assets and to enhance the risk sensitivity and remediate 
weaknesses identified over recent years.\122\ The proposed revisions 
incorporated elements of the Basel II standardized approach \123\ as 
modified by the 2009 Enhancements, certain aspects of Basel III, and 
other proposals in recent consultative papers published by the 
BCBS.\124\ Consistent with section 939A of the Dodd-Frank Act, the 
agencies and the FDIC also proposed alternatives to credit ratings for 
calculating risk weights for certain assets.
---------------------------------------------------------------------------

    \122\ 77 FR 52888 (August 30, 2012).
    \123\ See BCBS, ``International Convergence of Capital 
Measurement and Capital Standards: A Revised Framework,'' (June 
2006), available at http://www.bis.org/publ/bcbs128.htm.
    \124\ 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.
---------------------------------------------------------------------------

    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 and the FDIC also proposed to apply disclosure 
requirements to top-tier banking organizations with $50 billion or more 
in total assets that are not subject to the advanced approaches rule.
    The agencies and the FDIC 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 and the FDIC 
to maintain key aspects of the proposed risk-weighted asset treatment 
for community banking organizations, but generally requested that the 
agencies and the FDIC reduce the perceived complexity. The agencies 
have 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 and the FDIC 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 agencies have revised 
elements of the proposed rule, as described in further detail below. In 
particular, the agencies have modified the proposed approach to risk 
weighting residential mortgage loans to reflect the approach in the 
agencies general risk-based capital rules. The agencies believe the 
standardized approach more accurately captures the risk of banking 
organizations' assets and, therefore, are applying this aspect of the 
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 final 
rule in subpart D as adopted by the agencies. These sections of the 
preamble discuss how subpart D of the final rule differs from the 
general risk-based capital rules, and provides examples for how a 
banking organization must calculate risk-weighted asset amounts under 
the final rule.
    Beginning on January 1, 2015, all banking organizations will be 
required to calculate risk-weighted assets under subpart D of the final 
rule. Until then, banking organizations must calculate risk-weighted 
assets using the methodologies set forth in the general risk-based 
capital rules. Advanced approaches banking organizations are subject to 
additional requirements, as described in section III.D of this

[[Page 62083]]

preamble, regarding the timeframe for implementation.

A. Calculation of Standardized Total Risk-Weighted Assets

    Consistent with the Standardized Approach NPR, the final rule 
requires a banking organization 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.\125\ 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.
---------------------------------------------------------------------------

    \125\ This final rule incorporates the market risk rule into the 
integrated regulatory framework as subpart F.
---------------------------------------------------------------------------

    A banking organization 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 banking 
organization'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 final rule total risk-
weighted assets for general credit risk equals the sum of the risk-
weighted asset amounts as calculated under section 31(a) of the final 
rule. General credit risk exposures include a banking organization'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 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 final rule, the exposure amount for the on-balance sheet 
component of an exposure is generally the banking organization's 
carrying value for the exposure as determined under GAAP. The agencies 
believe that using GAAP to determine the amount and nature of an 
exposure provides a consistent framework that can be easily applied 
across all banking organizations. Generally, banking organizations 
already use GAAP to prepare their financial statements and regulatory 
reports, and this treatment reduces potential burden that could 
otherwise result from requiring banking organizations to comply with a 
separate 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 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, 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 33 of the final rule. The exposure amount for 
an OTC derivative contract or cleared transaction is determined under 
sections 34 and 35, respectively, of the final rule, whereas exposure 
amounts for collateralized OTC derivative contracts, collateralized 
cleared transactions, repo-style transactions, and eligible margin 
loans are determined under section 37 of the final rule.
1. Exposures to Sovereigns
    Consistent with the proposal, the 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 and the FDIC 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 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.\126\ 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.\127\ This 
includes an exposure that is conditionally guaranteed by the FDIC or 
the National Credit Union Administration.
---------------------------------------------------------------------------

    \126\ 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 3, appendix A, section 
1(c)(11) (national banks) and 12 CFR 167.6 (Federal savings 
associations) (OCC); 12 CFR parts 208 and 225, appendix A, section 
III.C.1 (Board).
    \127\ 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, institutions should consult with their 
primary Federal regulator to determine the appropriate risk-based 
capital treatment for specific loss-sharing agreements.
---------------------------------------------------------------------------

    The agencies and the FDIC 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.\128\
---------------------------------------------------------------------------

    \128\ 12 CFR part 3, appendix A, section 3 (national banks) and 
12 CFR 167.6 (Federal savings associations) (OCC); 12 CFR parts 208 
and 225, appendix A, section III.C.1 (Board).
---------------------------------------------------------------------------

    Under the proposed rule, the risk weight for a foreign sovereign 
exposure

[[Page 62084]]

would have been determined using OECD Country Risk Classifications 
(CRCs) (the CRC methodology).\129\ 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 and the FDIC 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.
---------------------------------------------------------------------------

    \129\ 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 and the FDIC 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 and the FDIC 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.\130\
---------------------------------------------------------------------------

    \130\ 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.
---------------------------------------------------------------------------

    Despite the limitations associated with risk weighting foreign 
sovereign exposures using CRCs, the agencies have decided to retain 
this methodology, modified as described below to take into account that 
some countries will no longer receive a CRC. Although the agencies 
recognize that the risk sensitivity provided by the CRCs is limited, 
they consider 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.\131\ 
Accordingly, the agencies believe that risk weighting foreign sovereign 
exposures with reference to CRCs (as applicable) should not unduly 
burden banking organizations. 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.
---------------------------------------------------------------------------

    \131\ 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 final rule assigns risk weights to foreign sovereign exposures 
as set forth in Table 17 below. The agencies modified the 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 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 agencies' 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 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. banking 
organization 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. banking organization 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 and 
the FDIC 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 
and the FDIC 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

[[Page 62085]]

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 agencies have 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 Board 
(the OCC has assigned a 20 percent risk weight to GSE preferred stock).
    The agencies and the FDIC 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 agencies maintain 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 unions.\132\ 
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.\133\ 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.
---------------------------------------------------------------------------

    \132\ A depository institution is defined in section 3 of the 
Federal Deposit Insurance Act (12 U.S.C. 1813(c)(1)). Under this 
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)).
    \133\ Foreign bank means a foreign bank as defined in Sec.  
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 agencies have 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 agencies note 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 22 of the final rule (discussed above in 
section V.B of this preamble). Therefore, the final rule retains, as 
proposed, the 20 percent risk weight for exposures to U.S. banking 
organizations.
    The agencies have 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 agencies have 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 final 
rule, (3) an exposure that is deducted from regulatory capital under 
section 22 of the final rule, or (4) an exposure that is subject to the 
150 percent risk weight under Table 2 of section 32 of the 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.\134\ 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.\135\ 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.\136\ Consistent with 
the proposal, the final rule permits a banking organization to assign a 
20 percent risk weight to self-liquidating, trade-related contingent 
items that arise from the movement of

[[Page 62086]]

goods and that have a maturity of three months or less.
---------------------------------------------------------------------------

    \134\ 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).
    \135\ 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.
    \136\ One commenter requested that the agencies and the FDIC 
confirm whether short-term self-liquidating trade finance 
instruments are considered exempt from the one-year maturity floor 
in the advances approaches rule. Section 131(d)(7) of the 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 and the FDIC 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 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 agencies considered 
these comments and have 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 agencies have 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 and the FDIC 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 
final rule, the agencies are adopting these definitions as proposed.
    The agencies and the FDIC 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.
    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 agencies 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 agencies believe 
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 final rule. The agencies also continue 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 final rule.
    Consistent with the Basel II standardized framework, the agencies 
and the FDIC 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 final rule, the agencies have 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 
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 exposures to non-    Risk weight for exposures to non-
                                            U.S. PSE general obligations         U.S.PSE revenue 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
----------------------------------------------------------------------------------------------------------------


[[Page 62087]]

    Consistent with the general risk-based capital rules as well as the 
proposed rule, a banking organization 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 and the FDIC 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 and the FDIC align the final rule 
with the Basel international standard that aligns risk weights with 
credit ratings. A few commenters asserted that a single 100 percent 
risk weight would disproportionately and adversely impact insurance 
companies that generally hold a higher share of corporate bonds in 
their investment portfolios. 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 agencies have concluded that the proposed 100 percent risk weight 
assigned to retail exposures is appropriate given their risk profile in 
the United States and have retained the proposed treatment in the final 
rule. Consistent with the proposal, the final rule neither defines nor 
provides a separate 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.\137\ 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.
---------------------------------------------------------------------------

    \137\ See, for example, 76 FR 73526 (Nov. 29, 2011) and 76 FR 
73777 (Nov. 29, 2011).
---------------------------------------------------------------------------

    The agencies considered suggestions offered by commenters and 
understand that a 100 percent risk weight may overstate the credit risk 
associated with some high-quality bonds. However, the agencies believe 
that a single risk weight of less than 100 percent would understate the 
risk of many corporate exposures and, as explained, have 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 agencies believe that, on 
balance, a 100 percent risk weight is generally representative of a 
well-diversified corporate exposure portfolio. The 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 and the FDIC 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 and the FDIC 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

[[Page 62088]]

asserted that the agencies and the FDIC 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 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 and the FDIC 
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.\138\ 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.
---------------------------------------------------------------------------

    \138\ 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 and the FDIC also received specific comments 
concerning potential logistical difficulties they would face 
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 agencies 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.\139\ 
Additionally, the agencies are 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 agencies also considered the 
commenters' observations about the burden of calculating the risk 
weights for banking organizations' existing mortgage portfolios, and 
have taken into account the commenters' concerns about the availability 
of different mortgage products across different types of markets.
---------------------------------------------------------------------------

    \139\ See id.
---------------------------------------------------------------------------

    In light of these considerations, the agencies have decided to 
retain in the final rule the treatment for residential mortgage 
exposures that is currently set forth in the general risk-based capital 
rules. The agencies may develop and propose changes in the treatment of 
residential mortgage exposures in the future, and in that process, the 
agencies intend 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 
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 a banking 
organization holds the first and junior lien(s) on a residential 
property and no other party holds an intervening lien, the banking 
organization 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. A banking organization must assign a 100 
percent risk weight to all other residential mortgage exposures. Under 
the 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 
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 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 agencies believe 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

[[Page 62089]]

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).\140\ 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.
---------------------------------------------------------------------------

    \140\ 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 agencies are adopting this aspect of the proposal without 
change. The 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 agencies' prior regulations. Under the 
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 agencies 
believe banking organizations should hold additional capital. 
Accordingly, the agencies and the FDIC 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 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' and the FDIC's 
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 and the FDIC 
increase the number of HVCRE risk-weight categories to reflect LTV 
ratios.
    The agencies have considered the comments and have 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.\141\ The agencies 
believe that segmenting HVCRE by LTV ratio would introduce undue 
complexity without providing a sufficient improvement in risk 
sensitivity. The agencies have 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.
---------------------------------------------------------------------------

    \141\ See the definition of ``high-volatility commercial real 
estate exposure'' in section 2 of the 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 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 
agencies note that when the life of the ADC project concludes and the 
credit facility is converted to permanent financing in accordance with 
the banking organization'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 agencies believe 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 
believe that the treatment of HVCRE exposures in the 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 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 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 final rule does not require a 
banking organization 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 agencies have, 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

[[Page 62090]]

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 and the FDIC 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 agencies have considered the comments and have decided to 
retain the proposed 150 percent risk weight for past-due exposures in 
the final rule. The agencies note 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. The agencies believe 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 final rule, a banking 
organization 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 
agencies have decided to adopt, as proposed, the risk weights described 
below for exposures not otherwise assigned to a specific risk weight 
category. Specifically, a banking organization must assign:
    (1) A zero percent risk weight to cash owned and held in all of a 
banking organization's offices or in transit; gold bullion held in the 
banking organization'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 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 final rule, a banking organization must assign:
    (1) A 100 percent risk weight to DTAs arising from temporary 
differences that the banking organization 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 banking organization could 
not realize through net operating loss carrybacks that are not deducted 
from common equity tier 1 capital pursuant to section 22(d).
    The agencies and the FDIC 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 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 final 
rule retains the limited flexibility to address situations where 
exposures of a banking organization that are not exposures typically 
held by depository institutions do not fit wholly within the terms of 
another risk-weight category. Under the final rule, a banking 
organization may assign such exposures to the risk-weight category 
applicable under the capital rules for BHCs or covered SLHCs, provided 
that (1) the banking organization 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 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 credit 
conversion factors (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

[[Page 62091]]

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 and the FDIC to conduct a calibration study to show that the 
proposed CCFs were appropriate.
    The agencies have decided to retain the proposed CCFs for off-
balance sheet exposures without change for purposes of the final rule. 
The agencies believe that the proposed CCFs meet the agencies' 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 agencies to monitor, as the agencies 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 agencies' stated goal of 
simplicity in its capital treatment of off-balance sheet exposures. 
Additionally, the agencies believe 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 final rule, as proposed, a banking 
organization may apply a zero percent CCF to the unused portion of 
commitments that are unconditionally cancelable by the banking 
organization. For purposes of the final rule, a commitment means any 
legally binding arrangement that obligates a banking organization to 
extend credit or to purchase assets. Unconditionally cancelable means a 
commitment for which a banking organization may, at any time, with or 
without cause, refuse to extend credit (to the extent permitted under 
applicable law). In the case of a residential mortgage exposure that is 
a line of credit, a banking organization 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 a banking organization 
provides a commitment that is structured as a syndication, the banking 
organization 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 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 final rule, the agencies are retaining the 20 
percent CCF, as it accounts for the elevated level of risk banking 
organizations face when extending short-term commitments that are not 
unconditionally cancelable. Although the agencies understand 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. A 
banking organization 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 banking organization. The 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 final rule also requires a banking organization to 
apply a 50 percent CCF to commitments with an original maturity of more 
than one year that are not unconditionally cancelable by the banking 
organization, 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 final rule, the agencies note that section 33(a)(2) 
allows banking organizations to apply the lower of the two applicable 
CCFs to the exposures related to commitments to extend letters of 
credit. Banking organizations will need to make this determination 
based upon the individual characteristics of each letter of credit.
    Under the final rule, a banking organization 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 banking organization 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 banking organization 
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 banking organization has posted as 
collateral under the transaction. In certain circumstances, a banking 
organization may instead determine the exposure amount of the 
transaction as described in section 37 of the 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 
final rule requires a banking organization to hold risk-based capital 
against all repo-style transactions, regardless of whether they 
generate on-balance sheet exposures, as described in section 37 of the 
final rule. One commenter disagreed with this treatment and requested 
an exemption from the capital treatment for off-balance sheet repo-
style exposures.

[[Page 62092]]

However, the agencies 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.\142\ 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.\143\
---------------------------------------------------------------------------

    \142\ 12 CFR part 3, appendix A, section 4(a)(11) and 12 CFR 
167.6(b) (OCC); 12 CFR parts 208 and 225 appendix A, section 
III.B.3.a.xii (Board).
    \143\ 12 CFR part 3, appendix A, section 4(a)(8) and 12 CFR 
167.6(b) (OCC); 12 CFR part 208, appendix A, section II.B.3.a.ii.1 
and 12 CFR part 225, appendix A, section III.B.3.a.ii.(1) (Board).
---------------------------------------------------------------------------

    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 and the FDIC 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 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' 
and the FDIC's 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 and the FDIC 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 agencies decided to retain in the 
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 agencies 
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 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; \144\ (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.
---------------------------------------------------------------------------

    \144\ 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 and the 
FDIC 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 agencies confirm 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 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 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 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

[[Page 62093]]

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 and the FDIC 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 and the FDIC 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 agencies considered these alternatives and have decided to 
finalize the proposed methodology for determining the capital 
requirement applied to representations and warranties without change. 
The agencies are 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 agencies believe 
that capital requirements based on past performance of a particular 
underwriter do not always adequately capture the current risks faced by 
that firm. The agencies believe that the incorporation of the 120-day 
safe harbor in the 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 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 final rule, a 
banking organization must hold capital only for the maximum contractual 
amount of the banking organization's exposure under the representations 
and warranties. In the case described by the commenters, the banking 
organization 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.\145\ Some commenters also requested that the agencies and 
the FDIC 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.
---------------------------------------------------------------------------

    \145\ See 15 U.S.C. 78o-11, et seq.
---------------------------------------------------------------------------

    The agencies have 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 agencies also 
have 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 agencies, therefore, do not believe it is 
appropriate to provide an exemption relating to risk retention in this 
final rule. In addition, while the QM rulemaking is now final,\146\ the 
agencies believe 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 final rule of the 120-day safe 
harbor addresses many of the concerns about burden.
---------------------------------------------------------------------------

    \146\ See 12 CFR part 1026.
---------------------------------------------------------------------------

    The risk-based capital treatment for off-balance sheet items in 
this 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.\147\ The 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 31, 33, 34 and 35 of the final rule.
---------------------------------------------------------------------------

    \147\ 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.

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[[Page 62094]]

D. Over-the-Counter Derivative Contracts

    In the Standardized Approach NPR, the agencies and the FDIC 
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.\148\ 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.
---------------------------------------------------------------------------

    \148\ The general risk-based capital rules for savings 
associations regarding the calculation of credit equivalent amounts 
for derivative contracts differ from the rules for other banking 
organizations. (See 12 CFR 167(a)(2) (Federal savings associations) 
and 12 CFR 390.466(a)(2) (state savings associations)). The 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 and 
national banks and BHCs.
---------------------------------------------------------------------------

    The agencies and the FDIC 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 always can be covered by taking a position in a liquid 
market.
    The agencies acknowledge that the standardized matrix of conversion 
factors may be too simplified for some banking organizations. The 
agencies believe, 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 and the 
FDIC to retain the 50 percent risk weight cap until the BCBS enhances 
the CEM to improve risk-sensitivity.
    The agencies believe 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 agencies are 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 and the FDIC allow the 
use of internal models approved by the primary Federal supervisor as an 
alternative to the proposal, consistent with Basel III. The agencies 
chose not to incorporate all of the methodologies included in the Basel 
II standardized framework in the final rule. The agencies believe that, 
given the range of banking organizations that are subject to the 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 banking organizations, the use of the internal model 
methodology and other models-based methodologies is permitted under the 
advanced approaches rule. One commenter asked the agencies and the FDIC 
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 agencies note 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 agencies believe that, in light of the 
existing international framework to enforce netting arrangements 
together with the conditions for recognizing netting that are included 
in this 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 final rule also 
continues to limit full recognition of netting for purposes of 
calculating PFE for counterparty credit risk under the standardized 
approach.\149\
---------------------------------------------------------------------------

    \149\ See section 34(a)(2) of the 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 agencies 
note 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 final rule 
retains the proposed formula for recognizing netting effects for OTC 
derivative contracts that was set out in the proposal. The agencies 
expect 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

[[Page 62095]]

protection provided on the name referenced in the credit derivative 
contract. The agencies believe that the proposed approach is 
appropriate for measuring counterparty credit risk because it reflects 
the amount a banking organization 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 agencies expect a banking organization 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 a banking organization.
    The final rule generally adopts the proposed treatment for OTC 
derivatives without change. Under the final rule, as under the general 
risk-based capital rules, a banking organization 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 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 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 final rule permits a banking organization 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 final rule, a banking organization 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 banking organization'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 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 final rule requires PFE to 
be calculated using the ``other'' conversion factor.

                                          Table 19--Conversion Factor Matrix for OTC Derivative Contracts \150\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              Credit       Credit (non-
                                                              Foreign      (investment-     investment-                      Precious
        Remaining maturity \151\           Interest rate   exchange rate       grade           grade          Equity      metals (except       Other
                                                             and gold        reference       reference                         gold)
                                                                           asset) \152\       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
--------------------------------------------------------------------------------------------------------------------------------------------------------

    For multiple OTC derivative contracts subject to a qualifying 
master netting agreement, a banking organization 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 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 final rule.
    Under the 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 final rule for most transactions, a banking 
organization may rely on sufficient legal review instead of an opinion 
on the enforceability of the netting agreement as described below.\153\ 
The final rule defines a

[[Page 62096]]

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 final rule are met.\154\ These conditions include requirements with 
respect to the banking organization'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.
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    \150\ For a derivative contract with multiple exchanges of 
principal, the conversion factor is multiplied by the number of 
remaining payments in the derivative contract.
    \151\ 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.
    \152\ A banking organization 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 banking organization must use the column labeled ``Credit 
(non-investment-grade reference asset)'' for all other credit 
derivatives.
    \153\ Under the general risk-based capital rules, to recognize 
netting benefits a banking organization 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.
    \154\ The 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 banking organizations 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 banking 
organization 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 a banking organization 
has little experience, the banking organization would be expected to 
obtain an explicit, written legal opinion from external or internal 
legal counsel addressing the particular situation.
    Under the final rule, if an OTC derivative contract is 
collateralized by financial collateral, a banking organization must 
first 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, a banking 
organization could use the simple approach for collateralized 
transactions as described in section 37(b) of the final rule. 
Alternatively, if the financial collateral is marked-to-market on a 
daily basis and subject to a daily margin maintenance requirement, a 
banking organization could adjust the exposure amount of the contract 
using the collateral haircut approach described in section 37(c) of the 
final rule.
    Similarly, if a banking organization purchases a credit derivative 
that is recognized under section 36 of the 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 banking organization 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 final rule, a banking organization 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 52 (unless the contract is a covered position 
under the market risk rule). If the banking organization risk weights a 
contract under the SRWA described in section 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, a 
banking organization either includes or excludes all of the contracts 
from any measure used to determine counterparty credit risk exposures. 
If the banking organization 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 a banking organization provides protection through 
a credit derivative that is not a covered position under subpart F of 
the 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 32 of the final rule. The 
banking organization 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 banking organization 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 banking organization 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 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 final rule, the risk weight for OTC derivative 
transactions is not subject to any specific ceiling, consistent with 
the Basel capital framework.
    Although the agencies generally adopted the proposal without 
change, the final rule has been revised to add a provision regarding 
the treatment of a clearing member banking organization's exposure to a 
clearing member client (as described below under ``Cleared 
Transactions,'' a transaction between a clearing member banking 
organization and a client is treated as an OTC derivative exposure). 
However, the final rule recognizes the shorter close-out period for 
cleared transactions that are derivative contracts, such that a 
clearing member banking organization 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 agencies support incentives designed to encourage 
clearing of derivative and repo-style transactions \155\ through a CCP 
wherever possible in order to promote transparency, multilateral 
netting, and robust risk-management practices.
---------------------------------------------------------------------------

    \155\ See section 2 of the final rule for the definition of a 
repo-style transaction.
---------------------------------------------------------------------------

    Although there are some risks associated with CCPs, as discussed 
below, the agencies believe 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

[[Page 62097]]

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.\156\ 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).\157\ 
Exposures to such entities, termed QCCPs in the final rule, would be 
subject to lower risk weights than exposures to CCPs that did not meet 
those criteria.
---------------------------------------------------------------------------

    \156\ See ``Capitalisation of Banking Organization Exposures to 
Central Counterparties'' (November 2011) (CCP consultative release), 
available at http://www.bis.org/publ/bcbs206.pdf.
    \157\ 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 and the FDIC 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 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).\158\ 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.
---------------------------------------------------------------------------

    \158\ See ``Capital requirements for bank exposures to central 
counterparties'' (July 2012), available at http://www.bis.org/publ/bcbs227.pdf.
---------------------------------------------------------------------------

    The agencies and the FDIC received a number of comments on the 
proposal relating to cleared transactions. Commenters also encouraged 
the agencies and the FDIC 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 agencies believe that a static 
list of QCCPs would not reflect the potentially dynamic nature of a 
CCP, and that banking organizations 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 agencies note 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 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 final rule has not been 
amended to include this aspect of the BCBS CCP interim framework 
because the agencies believe 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 agencies 
note that such a grace period was included in the proposed rule, and 
the final rule retains the proposed definition without substantive 
change.\159\
---------------------------------------------------------------------------

    \159\ This provision is located in sections 35 and 133 of the 
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 agencies 
agree with these commenters and have 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 and the FDIC to adopt the standards set forth in the BCBS CCP 
interim framework sought clarification of the meaning of ``highly 
likely'' in this context. The agencies clarify 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

[[Page 62098]]

definition of ``cleared transaction'' in the 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 agencies believe 
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 final rule. The 
agencies note 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 and the FDIC should 
recognize varying close-out period conventions for specific cleared 
products, specifically exchange-traded derivatives. This commenter also 
asserted that the agencies and the FDIC 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 
final rule, the agencies 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.
    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 36 and 134 would apply. The agencies 
confirm that under the final rule, a banking organization may apply the 
substitution treatment of sections 36 or 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 a banking organization purchases an eligible 
credit derivative as a hedge of an exposure and the eligible credit 
derivative qualifies as a cleared transaction, the banking organization 
may substitute the risk weight applicable to the cleared transaction 
under sections 35 or 133 of the final rule (instead of using the risk 
weight associated with the protection provider).\160\ Furthermore, the 
agencies have modified the definition of eligible guarantor to include 
a QCCP.
---------------------------------------------------------------------------

    \160\ 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 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 agencies note that, if collateral is bankruptcy remote, then 
it would not be included in the trade exposure amount calculation (see 
sections 35(b)(2) and 133(b)(2) of the final rule). The agencies also 
note that such collateral must be risk weighted in accordance with 
other sections of the final rule as appropriate, to the extent that the 
posted collateral remains an asset on a banking organization'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).\161\ 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 and the FDIC to allow banking 
organizations to use the IMM to calculate Kccp. Another 
commenter encouraged the agencies and the FDIC to continue to work with 
the BCBS to harmonize international and domestic capital rules for 
cleared transactions.
---------------------------------------------------------------------------

    \161\ See section VIII.D of this preamble for a description of 
the CEM.
---------------------------------------------------------------------------

    Although the agencies recognize that the CEM has certain 
limitations, the agencies consider 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 
agencies believe that the use of models either by the CCP, whose model 
would not be subject to review and approval by the agencies, 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 agencies recognize that 
additional work is being performed by the BCBS to revise the CCP 
capital framework and the CEM. The agencies expect to modify the 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 and the FDIC 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 agencies acknowledge 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),\162\ in part to reflect the 
increased concentration and systemic risk inherent in such 
transactions. In regards to the agency clearing model, the agencies 
note 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.
---------------------------------------------------------------------------

    \162\ See 12 CFR part 3, appendix A, section 3(b)(7)(iv) 
(national banks) and 12 CFR 167.6(a)(2)(iv)(E) (Federal savings 
associations) (OCC); 12 CFR part 208, appendix A paragraph 
III.E.1.e; 12 CFR part 225, appendix A paragraph III.E.1.e (Board).

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

[[Page 62099]]

    Another commenter suggested that the 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 agencies have clarified in the final rule that if a banking 
organization's unfunded default fund contribution to a CCP is 
unlimited, the banking organization's primary Federal supervisor 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 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 final rule to ensure a capital treatment for 
securities lending transactions that is proportional to their actual 
risks. The agencies note that the proposed rule would not have required 
securities lending transactions to be cleared. The agencies also 
acknowledge that clearing may not be widely available for securities 
lending transactions, and believe that the collateral haircut approach 
(sections 37(c) and 132(b) of the final rule) and for advanced 
approaches banking organizations, the simple value-at-risk (VaR) and 
internal models methodologies (sections 132(b)(3) and (d) of the 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 disadvantaged by the proposal. Although there may be increased 
transaction costs associated with the introduction of the CCP 
framework, the agencies believe 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 
agencies have taken in the 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 agencies agree with the need to mitigate 
disincentives for client clearing in the methodology, and have amended 
the 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 final rule until the BCBS CCP interim 
framework is finalized, implementing the BCBS CCP interim framework in 
the 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 and the FDIC 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 agencies believe that the modifications 
to capital standards for cleared transactions in the BCBS CCP interim 
framework are appropriate and believe that they would result in 
modifications that address many commenters' concerns. Furthermore, the 
agencies believe 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 agencies have incorporated the material elements of the BCBS CCP 
interim framework into the final rule. In addition, given the delayed 
effective date of the final rule, the agencies believe 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 final 
rule retains the capital requirements for cleared transaction exposures 
generally as proposed by the agencies and the FDIC. As noted in the 
proposal, the international discussions are ongoing on these issues, 
and the agencies will revisit this issue once the Basel capital 
framework is revised.
1. Definition of Cleared Transaction
    The final rule defines a cleared transaction as an exposure 
associated with an outstanding derivative contract or repo-style 
transaction that a banking organization or clearing member has entered 
into with a CCP (that is, a transaction that a CCP has accepted).\163\ 
Cleared transactions include the following: (1) A transaction between a 
CCP and a clearing member banking organization for the banking 
organization's own account; (2) a transaction between a CCP and a 
clearing member banking organization acting as a financial intermediary 
on behalf of its clearing member client; (3) a transaction between a 
client banking organization and a clearing member where the clearing 
member acts on behalf of the client banking organization 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 
banking organization guarantees the performance of the clearing member 
client to the CCP. Such transactions must also satisfy additional 
criteria provided in section 3 of the final rule, including bankruptcy 
remoteness of collateral, transferability criteria, and portability of 
the clearing member client's position. As explained above, the agencies 
have modified the definition in the final rule to specify that 
regulated omnibus accounts to meet the requirement for bankruptcy 
remoteness.
---------------------------------------------------------------------------

    \163\ For example, the agencies expect 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.
---------------------------------------------------------------------------

    A banking organization is required to calculate risk-weighted 
assets for all of its cleared transactions, whether the banking 
organization 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

[[Page 62100]]

resubmit the transaction and it is accepted, the transaction would then 
be a cleared transaction. A cleared transaction does not include an 
exposure of a banking organization that is a clearing member to its 
clearing member client where the banking organization is either acting 
as a financial intermediary and enters into an offsetting transaction 
with a CCP or where the banking organization 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 
34(e) of the final rule or a repo-style transaction with the exposure 
amount calculated according to section 37(c) of the 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 132(c)(8) or (d)(5)(iii)(C) of the final rule or 
a repo-style transaction with the exposure amount calculated according 
to sections 132(b) or (d) of the final rule.
2. Exposure Amount Scalar for Calculating for Client Exposures
    Under the proposal, a transaction between a clearing member banking 
organization and a client was treated as an OTC derivative exposure, 
with the exposure amount calculated according to sections 34 or 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 provided alternatives to 
address the incentive concern.
    Consistent with comments and the BCBS CCP interim framework, under 
the final rule, a clearing member banking organization must treat its 
counterparty credit risk exposure to clients as an OTC derivative 
contract, irrespective of whether the clearing member banking 
organization 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 banking 
organization 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 banking organization 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. A banking organization's primary 
Federal supervisor may require a clearing member banking organization 
to set a longer holding period if the primary Federal supervisor 
determines that a longer period is commensurate with the risks 
associated with the transaction. The agencies believe 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 final rule, to determine the risk-weighted asset amount 
for a cleared transaction, a clearing member client banking 
organization or a clearing member banking organization 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 34 or 132(c) of the final rule) or for 
advanced approaches banking organizations that use the IMM, under 
section 132(d) of the final rule), plus the fair value of the 
collateral posted by the clearing member client banking organization 
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 section 37(c) and 
132(b) of the final rule) (or for advanced approaches banking 
organizations the IMM under section 132(d) of the final rule) plus the 
fair value of the collateral posted by the clearing member client 
banking organization 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 banking organization or clearing member 
banking organization that is held by a custodian in a manner that is 
bankruptcy remote \164\ 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 
banking organization 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 32 or 
131 of the 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 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.
---------------------------------------------------------------------------

    \164\ Under the 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 banking organization must apply a 2 percent risk 
weight to its trade exposure amount to a QCCP. A banking organization 
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 banking 
organization 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 banking organization 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

[[Page 62101]]

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 banking 
organization must apply a risk weight of 4 percent to the trade 
exposure amount.
    Under the final rule, as under the proposal, for a cleared 
transaction with a CCP that is not a QCCP, a clearing member banking 
organization and a clearing member client banking organization must 
risk weight the trade exposure amount to the CCP according to the risk 
weight applicable to the CCP under section 32 of the final rule 
(generally, 100 percent). Collateral posted by a clearing member 
banking organization 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 final rule provides additional 
specificity regarding the risk-weighting methodologies for certain 
exposures of clearing member banking organizations. The final rule 
provides that a clearing member banking organization 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 banking organization's exposure to the 
QCCP. The diagrams below demonstrate the various potential transactions 
and exposure treatment in the final rule. Table 21 sets out how the 
transactions illustrated in the diagrams below are risk-weighted under 
the 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 banking organization entering into cleared 
transactions for its own account (T1), a clearing member 
banking organization entering into cleared transactions on behalf of a 
client (T2 through T7), and a banking 
organization 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 4810-33-P

[[Page 62102]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.001

BILLING CODE 4810-33-C

[[Page 62103]]



                             Table 21--Risk Weights for Various Cleared Transactions
----------------------------------------------------------------------------------------------------------------
                                                                                        Risk-weighting treatment
                                        Exposure to                  Description          under the 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.\165\ CCPs independently determine default fund 
contributions that are required from members. The BCBS therefore 
established, and the final rule adopts, a risk-sensitive approach for 
risk weighting a banking organization's exposure to a default fund.
---------------------------------------------------------------------------

    \165\ 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 final rule adopt both methods contained in the BCBS 
CCP interim framework.
    Accordingly, under the final rule, a banking organization 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 banking 
organization or the primary Federal supervisor, 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 
banking organization'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 banking 
organization's primary Federal supervisor based on factors described 
above.
    Consistent with the BCBS CCP interim framework, the final rule 
requires a banking organization to calculate a risk-weighted asset 
amount for its default fund contribution using one of two methods. 
Method one requires a clearing member banking organization to use a 
three-step process. The first step is for the clearing member banking 
organization to calculate the QCCP's hypothetical capital requirement 
(KCCP), unless the QCCP has already disclosed it, in which 
case the banking organization must rely on that disclosed figure, 
unless the banking organization 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 a banking organization, 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 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 a banking 
organization's primary Federal supervisor 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 corresponding change in the price of the underlying asset).
    In the second step of method one, the final rule requires a banking 
organization 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 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 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 banking organization multiplies its allocated capital

[[Page 62104]]

requirement by 12.5 to determine its risk-weighted asset amount for its 
default fund contribution to the QCCP.
    As the alternative, a banking organization 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 a banking organization's trade 
exposure amount for all of its transactions with a QCCP. A banking 
organization'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 a banking 
organization 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 a banking organization's exposure to a QCCP.
    To address commenter concerns that the CEM underestimates the 
multilateral netting benefits arising from a QCCP, the 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 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 
35(d)(3)(i)(A)(1) and 133(d)(3)(i)(A)(1) of the 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 final rule allows banking 
organizations to recognize the risk-mitigation effects of guarantees, 
credit derivatives, and collateral for risk-based capital purposes. In 
general, the 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 final 
rule a banking organization 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 banking 
organizations 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. A banking 
organization 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, a banking 
organization 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 banking 
organization's overall credit risk profile.
1. Guarantees and Credit Derivatives
a. Eligibility Requirements
    Consistent with the Basel capital framework, the agencies and the 
FDIC 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.\166\
---------------------------------------------------------------------------

    \166\ Under the proposed and final rule, an exposure is 
``investment grade'' if the entity to which the banking organization 
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 and the FDIC potentially 
include as eligible guarantors other entities, such as financial 
guaranty and private mortgage insurers. The agencies believe 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 system. Therefore, the agencies 
have not included the recommended entities in the final rule's 
definition of ``eligible guarantor.'' The agencies have, however, 
amended the definition of eligible guarantor in the final rule to 
include QCCPs to accommodate use of the substitution approach for 
credit derivatives that are cleared transactions. The agencies believe 
that QCCPs, as supervised entities subject to specific risk-management 
standards, are appropriately included as eligible guarantors under the 
final rule.\167\ In addition, the agencies clarify one commenter's 
concern and confirm that re-insurers that are engaged predominantly in 
the business of providing credit protection do not qualify as an 
eligible guarantor under the final rule.
---------------------------------------------------------------------------

    \167\ See the definition of ``eligible guarantor'' in section 2 
of the final rule.
---------------------------------------------------------------------------

    Under the 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 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 primary Federal supervisor, 
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 2 of the final rule.
    Under the proposal, a banking organization would have been 
permitted to recognize the credit risk mitigation

[[Page 62105]]

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 and the FDIC to revise the 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 agencies do not believe there is sufficient 
justification to include proxy hedges in the definition of eligible 
credit derivative because they have concerns regarding the ability of 
the hedge to sufficiently mitigate the risk of the underlying exposure. 
The agencies have, therefore, adopted the definition of eligible credit 
derivative as proposed.
    In addition, under the final rule, consistent with the proposal, 
when a banking organization has a group of hedged exposures with 
different residual maturities that are covered by a single eligible 
guarantee or eligible credit derivative, 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 agencies are adopting the substitution approach for eligible 
guarantees and eligible credit derivatives in the 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, 
a banking organization 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, a banking organization 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, a banking organization calculates the risk-weighted asset amount 
for the protected exposure under section 36 of the 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 banking organization calculates 
its risk-weighted asset amount for the unprotected exposure under 
section 32 of the 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 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 agencies are adopting the proposed haircut for maturity 
mismatch in the final rule without change. Under the final rule, the 
agencies have adopted the requirement that a banking organization 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).\168\
---------------------------------------------------------------------------

    \168\ As noted above, when a banking organization has a group of 
hedged exposures with different residual maturities that are covered 
by a single eligible guarantee or eligible credit derivative, a 
banking organization 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 banking organization 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. A banking 
organization 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 banking organization purchasing the protection, but 
the terms of the arrangement at origination of the credit risk mitigant 
contain a positive incentive for the banking organization to call the 
transaction before contractual maturity, the remaining time to the 
first call date is the residual maturity of the credit risk mitigant. A 
banking organization is permitted, under the 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, a banking 
organization 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 = effective notional amount of the credit risk mitigant, 
adjusted for maturity mismatch;
(2) E = effective notional amount of the credit risk mitigant;
(3) t = the lesser of T or residual maturity of the credit risk 
mitigant, expressed in years; and
(4) T = 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 agencies are adopting in the final rule the proposed adjustment 
for credit derivatives without restructuring as a credit event. 
Consistent with the proposal, under the final rule, a banking 
organization 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

[[Page 62106]]

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 banking organization is required to apply the 
following adjustment to reduce the effective notional amount of the 
credit derivative:

Pr = Pm x 0.60,

where:

(1) Pr = effective notional amount of the credit risk mitigant, 
adjusted for lack of a restructuring event (and maturity mismatch, 
if applicable); and
(2) Pm = effective notional amount of the credit risk mitigant 
(adjusted for maturity mismatch, if applicable).
e. Currency Mismatch Adjustment
    Consistent with the proposal, under the final rule, if a banking 
organization 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 banking organization must 
apply the following formula to the effective notional amount of the 
guarantee or credit derivative:

PC = Pr x (1-HFX),

where:

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

    A banking organization 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, a banking organization 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 banking organization 
qualifies to use the own-estimates of haircuts in section 37(c)(4) of 
the final rule. In either case, the banking organization is required to 
scale the haircuts up using the square root of time formula if the 
banking organization 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] TR11OC13.002


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 final rule, if multiple 
credit risk mitigants cover a single exposure, a banking organization 
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, a banking organization 
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 
36(c) of the final rule.
2. Collateralized Transactions
a. Eligible Collateral
    Under the proposal, the agencies and the FDIC 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 and the FDIC 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 and the FDIC 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 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 final rule should allow recognition of intangible 
assets as financial collateral because they have real value. The 
agencies believe 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 agencies believe 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 agencies have retained the definition of 
financial collateral as proposed. Therefore, consistent with the 
proposal, the final rule defines financial collateral as collateral in 
the form of: (1) Cash on deposit with the banking organization 
(including cash held for the banking organization 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 
banking organization 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 a banking organization 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. A 
banking organization is permitted to recognize partial 
collateralization of an exposure.

[[Page 62107]]

    Under the final rule, the agencies require that a banking 
organization could 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, a banking organization could alternatively use the 
collateral haircut approach described below. The final rule, like the 
proposal, requires a banking organization to use the same approach for 
similar exposures or transactions.
b. Risk-Management Guidance for Recognizing Collateral
    Before a banking organization 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.
    A banking organization also should ensure that the legal mechanism 
under which the collateral is pledged or transferred ensures that the 
banking organization has the right to liquidate or take legal 
possession of the collateral in a timely manner in the event of the 
default, insolvency, or bankruptcy (or other defined credit event) of 
the counterparty and, where applicable, the custodian holding the 
collateral.
    In addition, a banking organization 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 agencies are adopting the simple approach without change for 
purposes of the final rule. Under the 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 a banking 
organization 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 banking 
organization 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 final 
rule. In addition, a banking organization 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 final rule, and the banking organization 
has discounted the fair value of the collateral by 20 percent.
d. Collateral Haircut Approach
    Consistent with the proposal, in the final rule, a banking 
organization 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 banking organization may use the collateral haircut 
approach with respect to any collateral that secures a repo-style 
transaction that is included in the banking organization's VaR-based 
measure under subpart F of the final rule, even if the collateral does 
not meet the definition of financial collateral.
    To apply the collateral haircut approach, a banking organization 
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 banking organization has 
lent, sold subject to repurchase, or posted as collateral to the 
counterparty under the transaction or netting set. For collateralized 
OTC derivative contracts and netting sets thereof, the value of the 
exposure is the exposure amount that is calculated under section 34 of 
the final rule. The value of the collateral equals the sum of the 
current market values of all instruments, gold and cash the banking 
organization has borrowed, purchased subject to resale, or taken as 
collateral from the counterparty under the transaction or netting set;
    (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 
banking organization has lent, sold subject to repurchase, or posted as 
collateral to the counterparty minus the sum of the current market 
values of that same instrument or gold that the banking organization 
has borrowed, purchased subject to resale, or taken as collateral from 
the counterparty) multiplied by the market price volatility haircut 
appropriate to the instrument or gold; and
    (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

[[Page 62108]]

banking organization has lent, sold subject to repurchase, or posted as 
collateral to the counterparty minus the sum of the current market 
values of any instruments or cash in the currency the banking 
organization has borrowed, purchased subject to resale, or taken as 
collateral from the counterparty) 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 banking organization 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, a banking organization'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, a banking organization 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 banking organizations 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 final rule, the agencies have 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 agencies believe that the revised 
haircuts better reflect the collateral's credit quality and an 
appropriate differentiation based on the collateral's residual 
maturity.
    A banking organization 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 and the FDIC 
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 
agencies have decided to adopt this aspect of the proposal without 
change in the final rule. The agencies believe that the own internal 
estimates for haircuts methodology described below allows banking 
organizations appropriate flexibility to more granularly reflect 
individual currency combinations, provided they meet certain criteria.

                                           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.   --.32 \2\                under Sec.   --.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 final rule requires that a banking organization 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

[[Page 62109]]

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 final rule requires a banking 
organization 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 final rule. Consistent with 
the Basel capital framework, a banking organization 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, a banking organization 
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 and the FDIC 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 banking organizations to apply sound practices such as 
risk diversification.
    The agencies note 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 agencies continue to believe that the threshold of 
5,000 is a reasonable indicator of the complexity of a close-out. 
Therefore, the 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 agencies note 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.\169\
---------------------------------------------------------------------------

    \169\ In the event that the agent banking organization 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 banking organization 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 final rule does not require a banking 
organization to recognize any piece of collateral as a risk mitigant. 
Accordingly, if a banking organization 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, a banking organization 
could create a separate netting set that would preserve the holding 
period for the original netting set of easily replaced transactions. 
Accordingly, the final rule adopts this aspect of the proposal without 
change.
    One commenter asserted that the 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 final rule, a banking organization 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). A banking organization is not required to make a daily 
determination of liquidity under the final rule; rather, banking 
organizations 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 agencies continue 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 agencies expect that the determination as to 
whether a dispute constitutes a margin dispute for purposes of the 
final rule will depend solely on the timing of the resolution. That is 
to say, if collateral is not

[[Page 62110]]

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 final rule, where a dispute is subject to a recognized 
industry dispute resolution protocol, the agencies expect 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 final rule, consistent with the proposal, banking 
organizations may calculate market price volatility and foreign 
exchange volatility using own internal estimates with prior written 
approval of the banking organization's primary Federal supervisor. To 
receive approval to calculate haircuts using its own internal 
estimates, a banking organization must meet certain minimum qualitative 
and quantitative standards set forth in the final rule, including the 
requirements that a banking organization: (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 banking organization'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. A 
banking organization estimates the volatilities of exposures, the 
collateral, and foreign exchange rates and should not take into account 
the correlations between them.
    The 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 final rule, a banking organization is required to have 
policies and procedures that describe how it determines the period of 
significant financial stress used to calculate the banking 
organization'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 banking organization links the period of 
significant financial stress used to calculate the own internal 
estimates to the composition and directional bias of the banking 
organization's current portfolio; and (2) the banking organization'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 banking organization's current portfolio. The banking 
organization is required to obtain the prior approval of its primary 
Federal supervisor for these policies and procedures and notify its 
primary Federal supervisor if the banking organization makes any 
material changes to them. A banking organization's primary Federal 
supervisor may require it to use a different period of significant 
financial stress in the calculation of the banking organization's own 
internal estimates.
    Under the final rule, a banking organization 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 banking 
organization has lent, sold subject to repurchase, posted as 
collateral, borrowed, purchased subject to resale, or taken as 
collateral. In determining relevant categories, the banking 
organization 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; and (4) the interest rate sensitivity of the 
security.
    A banking organization must calculate a separate internally 
estimated haircut for each individual non-investment-grade debt 
security and for each individual equity security. In addition, a 
banking organization 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 and the FDIC 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 and the FDIC 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 final rule to better 
capture the risk of counterparty credit exposures. The agencies have 
considered these comments and, have concluded that the increased 
complexity and limited applicability of these models-based approaches 
is inconsistent with the agencies' overall focus in the standardized 
approach on simplicity, comparability, and broad applicability of 
methodologies for U.S. banking organizations. Therefore, consistent 
with the proposal, the 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 agencies believe that it is important for a banking 
organization 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 agencies are adopting the risk-weighting requirements as 
proposed.
    Consistent with the proposal, the 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 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

[[Page 62111]]

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).\170\ In the case of a 
system-wide failure of a settlement, clearing system, or central 
counterparty, the banking organization's primary Federal supervisor may 
waive risk-based capital requirements for unsettled and failed 
transactions until the situation is rectified.
---------------------------------------------------------------------------

    \170\ Such transactions are treated as derivative contracts as 
provided in section 34 or section 35 of the final rule.
---------------------------------------------------------------------------

    The 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 final rule, a banking 
organization is required to hold risk-based capital against a DvP or 
PvP transaction with a normal settlement period if the banking 
organization's counterparty has not made delivery or payment within 
five business days after the settlement date. The banking organization 
determines its risk-weighted asset amount for such a transaction by 
multiplying the positive current exposure of the transaction for the 
banking organization by the appropriate risk weight in Table 23. The 
positive current exposure from an unsettled transaction of a banking 
organization 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 
banking organization 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
------------------------------------------------------------------------

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

H. Risk-Weighted Assets for Securitization Exposures

    In the proposal, the agencies and the FDIC 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' and the FDIC's market risk rule.\171\ 
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.
---------------------------------------------------------------------------

    \171\ 77 FR 53060 (August 30, 2012).
---------------------------------------------------------------------------

    In addition, the agencies and the FDIC 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 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 agencies 
believe 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 agencies have decided to finalize the

[[Page 62112]]

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 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 
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 CEIOs. Securitization 
exposures also include assets sold with retained tranches.
    The agencies believe 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 agencies also consider 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 
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 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 final rule, banking organizations 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 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 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 and the FDIC 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 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 agencies 
believe that an exemption for such government plans is appropriate 
because they are subject to substantial regulation. Commenters also 
requested that the agencies and the FDIC 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 
agencies believe that exposures that meet the definition of traditional 
securitization, regardless of product type or maturity, would fall 
under the securitization framework. Accordingly, the agencies have not 
provided for any such exemptions under the final rule.\172\
---------------------------------------------------------------------------

    \172\ The 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' and the FDIC's 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 
agencies have retained this discretionary provision in the final rule 
without change. In determining whether to exclude an investment firm 
from the securitization framework, the agencies will consider a number 
of factors, including the assessment of the transaction's leverage, 
risk profile, and economic substance. This supervisory exclusion gives 
the primary Federal supervisor 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-

[[Page 62113]]

balance sheet exposures, are eligible for the exclusion from the 
definition of traditional securitization under this provision. The 
agencies do not consider managed collateralized debt obligation 
vehicles, structured investment vehicles, and similar structures, which 
allow considerable management discretion regarding asset composition 
but are subject to substantial restrictions regarding capital 
structure, to have substantially unfettered control. Thus, such 
transactions meet the definition of traditional securitization under 
the 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, the primary Federal 
supervisor 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 agencies will 
consider the economic substance, leverage, and risk profile of a 
transaction to ensure that an appropriate risk-based capital treatment 
is applied. The agencies 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 agencies have decided to 
finalize the definition of synthetic securitization largely as 
proposed, but have also clarified in the 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 
and the FDIC 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 
agencies believe 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 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 and the FDIC 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 and 
the FDIC 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 agencies 
believe 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 agencies believe 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 final rule has been refined 
to clarify that resecuritizations do not include exposures comprised of 
a single asset that has been retranched. The agencies note that for 
purposes of the 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 final rule.
    Under the final rule, if a transaction involves a traditional 
multi-seller ABCP conduit, a banking organization 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

[[Page 62114]]

conduit is highly-rated, a banking organization 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 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 banking organization. When the sponsoring 
banking organization 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 banking organization 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 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 and the FDIC 
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 agencies note that the proposed due diligence requirements are 
generally consistent with the goal of the agencies' investment 
permissibility requirements, which provide that banking organizations 
must be able to determine the risk of loss is low, even under adverse 
economic conditions. The agencies acknowledge potential restrictions on 
data availability and believe 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 agencies note that, where appropriate, pool-level data 
could be used to meet certain of the due diligence requirements. As a 
result, the agencies are adopting 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 and the FDIC 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 and the FDIC assign progressively increasing risk weights 
based on the severity and duration of infringements of due diligence 
requirements, to allow the agencies and the FDIC to differentiate 
between minor gaps in due diligence requirements and more serious 
violations.
    The agencies believe 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 agencies recognize the importance of

[[Page 62115]]

consistent and uniform application of the standards across banking 
organizations and will endeavor to ensure that supervisors consistently 
review banking organizations' due diligence on securitization 
exposures. The agencies believe that these efforts will mitigate 
concerns that the 1,250 percent risk weight will be applied 
inappropriately to banking organizations' failure to meet the due 
diligence requirements. At the same time, the agencies believe that the 
requirement that a banking organization's analysis be commensurate with 
the complexity and materiality of the securitization exposure provides 
the banking organization with sufficient flexibility to mitigate the 
potential for undue burden. As a result, the agencies are adopting 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 agencies are adopting these operational 
requirements as proposed.
    In a traditional securitization, an originating banking 
organization typically transfers a portion of the credit risk of 
exposures to third parties by selling them to a securitization special 
purpose entity (SPE).\173\ Consistent with the proposal, the final rule 
defines a banking organization to be an originating banking 
organization 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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    \173\ The 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 final rule, consistent with the proposal, a banking 
organization 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 banking 
organization's consolidated balance sheet under GAAP; (2) the banking 
organization 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).\174\
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    \174\ Commenters asked the agencies and the FDIC to consider the 
interaction between the proposed non-consolidation condition and the 
agencies' and the FDIC's 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 
agencies acknowledge 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 banking organization that meets these conditions 
must hold risk-based capital against any credit risk it retains or 
acquires in connection with the securitization. An originating banking 
organization 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 banking 
organization 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.\175\ The agencies believe that this treatment is 
appropriate given the lack of risk transference in securitizations of 
revolving underlying exposures with early amortization provisions.
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    \175\ 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 a banking organization's capital needs if new 
draws on the revolving credit facilities need to be financed by the 
banking organization 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 a banking organization to a greater risk of loss than in 
other securitization transactions. The 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 banking organization (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 agencies are adopting 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 final rule the agencies have 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 a banking organization 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 banking organization to hold risk-based 
capital against the underlying exposures as if they had not been 
synthetically securitized. A banking organization 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

[[Page 62116]]

the general credit risk framework. A banking organization 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 
banking organization 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 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 banking 
organization 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 agencies 
acknowledge these concerns and, to reduce arbitrage opportunities, have 
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 and the FDIC 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 agencies 
are not placing restrictions on the ability of banking organizations to 
switch from the SSFA to the gross-up approach, the agencies do not 
anticipate there should be a need for frequent changes in methodology 
by a banking organization absent significant change in the nature of 
the banking organization's securitization activities, and expect 
banking organizations to be able to provide a rationale for changing 
methodologies to their primary Federal supervisors 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 and the FDIC more time to 
calibrate the SSFA in accordance with international standards that rely 
on ratings. The agencies again observe that in accordance with section 
939A of the Dodd-Frank Act, they are required to remove any references 
to, or reliance on, ratings in regulations. Accordingly, the final rule 
does not include any references to, or reliance on, credit ratings. The 
agencies have 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 agencies have decided to retain the 
proposed 1,250 percent risk weight in the 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 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 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. A banking 
organization 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.

[[Page 62117]]

a. Exposure Amount of a Securitization Exposure
    Under the 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 banking organization's carrying value of 
the exposure. The final rule modifies the proposed treatment for 
determining exposure amounts under the securitization framework to 
reflect the ability of a banking organization 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 a banking organization 
that has made an AOCI opt-out election is the banking organization'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 banking organization 
could be required to fund given the ABCP program's current underlying 
assets (calculated without regard to the current credit quality of 
those assets). Thus, if $100 is the maximum amount that could be drawn 
given the current volume and current credit quality of the program's 
assets, but the maximum potential draw against these same assets could 
increase to as much as $200 under some scenarios if their credit 
quality were to 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 and the FDIC 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 agencies believe 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 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 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 34 or section 37 of the final rule, as applicable.
b. Gains-On-Sale and Credit-Enhancing Interest-Only Strips
    Consistent with the proposal, under the final rule a banking 
organization 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 agencies believe 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 banking organization's risk-based capital requirement 
following a securitization, the agencies believe that such anomalies 
are rare where a securitization transfers significant credit risk from 
the originating banking organization 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.\176\ The agencies believe 
that the proposed securitization approaches would be more appropriate 
in capturing the risks provided by structured transactions, including 
those backed by QM. The final rule does not provide an exclusion for 
such exposures.
---------------------------------------------------------------------------

    \176\ 78 FR 6408 (Jan. 30, 2013).
---------------------------------------------------------------------------

    Under the 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, a 
banking organization is required to assign a risk weight of at least 
100 percent to an interest-only MBS. The agencies believe that a 
minimum risk weight of 100 percent is prudent in light of the 
uncertainty implied by the substantial price volatility of these 
securities. Second, as required by federal statute, a special set of 
rules continues to apply to securitizations of small-business loans

[[Page 62118]]

and leases on personal property transferred with retained contractual 
exposure by well-capitalized depository institutions.\177\ 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), a banking 
organization may choose to set the risk-weighted asset amount of the 
exposure equal to the amount of the exposure.
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    \177\ 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 final rule does not expressly provide that the 
agencies may permit adequately-capitalized banking organizations to 
use the small business recourse rule on a case-by-case basis because 
the agencies may make such a determination under the general 
reservation of authority in section 1 of the final rule.
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d. Overlapping Exposures
    Consistent with the proposal, the final rule includes provisions to 
limit the double counting of risks in situations involving overlapping 
securitization exposures. If a banking organization has multiple 
securitization exposures that provide duplicative coverage to the 
underlying exposures of a securitization (such as when a banking 
organization provides a program-wide credit enhancement and multiple 
pool-specific liquidity facilities to an ABCP program), the banking 
organization is not required to hold duplicative risk-based capital 
against the overlapping position. Instead, the banking organization 
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 final rule a banking 
organization 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 agencies are clarifying the terminology 
in the final rule to specify that a banking organization that is a 
servicer under a non-eligible servicer cash advance facility must hold 
risk-based capital against the amount of all potential 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 final rule requires a 
banking organization 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.\178\ In addition, the 
banking organization must disclose publicly (i) that it has provided 
implicit support to the securitization, and (ii) the risk-based capital 
impact to the banking organization of providing such implicit support. 
The agencies note that under the reservations of authority set forth in 
the final rule, the banking organization's primary Federal supervisor 
also could require the banking organization to hold risk-based capital 
against all the underlying exposures associated with some or all the 
banking organization'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.
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    \178\ The 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 
OCC Bulletin 2002-20 (national banks) (OCC); and SR letter 02-15 
(Board).
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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 agencies acknowledge that 
there may be differences in capital requirements under the SSFA and the 
ratings-based approach in the Basel capital framework. As explained 
previously, section 939A of the Dodd-Frank Act requires the agencies to 
use alternative standards of creditworthiness and prohibits the 
agencies from including references to, or reliance upon, credit ratings 
in their regulations. Any alternative standard developed by the 
agencies may not generate the same result as a ratings-based capital 
framework under every circumstance. However, the agencies have 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 agencies will monitor implementation of 
the SSFA and, based

[[Page 62119]]

on supervisory experience, consider what modifications, if any, may be 
necessary to improve the SSFA in the future.
    The agencies have 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, banking organizations 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 agencies 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 final rule 
had those exposures been held directly by a banking organization. In 
addition, the agencies are 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 agencies believe 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 banking 
organization held every tranche of a securitization, its overall 
capital requirement would be greater than if the banking organization 
held the underlying assets in portfolio. The agencies believe 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 agencies amended this requirement in the 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 final rule requires the data to be no 
more than 91 calendar days old.
    Under the final rule, to use the SSFA, a banking organization must 
obtain or determine the weighted-average risk weight of the underlying 
exposures (KG), as well as the attachment and detachment 
points for the banking organization'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 banking organization may recognize the relative seniority of the 
exposure, as well as all cash funded enhancements, in determining 
attachment and detachment points. In addition, a banking organization 
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 proxy data to implement the SSFA 
when a parameter is not readily available, especially for 
securitizations of mortgage exposures. As previously discussed, the 
agencies are retaining in the final rule the existing mortgage 
treatment under the general risk-based capital rules. Accordingly, the 
agencies believe that banking organizations 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 and the FDIC 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 final rule, the agencies 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 agencies believe 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 agencies have 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 = (1 - 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 and the FDIC 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

[[Page 62120]]

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 agencies have 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 agencies believe 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 agencies have eliminated the term ``securitized pool'' 
from the final rule. The calculation of parameter W includes all 
underlying exposures of a securitization transaction.
    The agencies believe 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 final rule is as follows:
[GRAPHIC] [TIFF OMITTED] TR11OC13.003

    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] TR11OC13.004

    The values A of 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 banking organization to the current 
dollar amount of all underlying exposures.
    Commenters requested that the agencies and the FDIC recognize 
unfunded forms of 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 agencies believe 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 agencies do 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 banking organization'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] TR11OC13.005


[[Page 62121]]


    For resecuritizations, banking organizations 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 is 0.08. Finally, assume that none of the underlying 
mortgage exposures of either the hypothetical tranche or the underlying 
securitization exposure meet the 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,securitizaiton)
    To calculate the value of KG,securitization a banking organization 
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, a banking 
organization 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, a banking organization 
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 a banking 
organization 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 final rule, consistent with the proposal, banking 
organizations 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 final rule, which 
is similar to an existing approach provided under the general risk-
based capital rules. If the banking organization 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 44 and 45 of the final rule.
    The gross-up approach assigns risk-weighted asset amounts based on 
the full amount of the credit-enhanced assets for which the banking 
organization directly or indirectly assumes credit risk. To calculate 
risk-weighted assets under the gross-up approach, a banking 
organization 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 banking organization'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, a banking organization is required to 
calculate the credit equivalent amount, which equals the sum of (1) the 
exposure of the banking organization'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, a banking organization 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 agencies recognize that different capital 
requirements are likely to result from the application of the gross-up 
approach as compared to the SSFA. However, the agencies believe 
allowing smaller, less complex banking organizations 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 banking 
organizations.
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 final rule, consistent with the proposal and the Basel 
capital framework, a banking organization 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 final rule and consistent with the proposal, a banking 
organization 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

[[Page 62122]]

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 banking organization holding the exposure does not retain 
or provide protection for the first-loss position.
    The agencies believe 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 
agencies are adopting this aspect of the proposal, without change, for 
purposes of the final rule.
7. Credit Risk Mitigation for Securitization Exposures
    Under the 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, 
a banking organization that purchases credit protection uses the 
approaches for collateralized transactions under section 37 of the 
final rule or the substitution treatment for guarantees and credit 
derivatives described in section 36 of the final rule. In cases of 
maturity or currency mismatches, or, if applicable, lack of a 
restructuring event trigger, the banking organization must make any 
applicable adjustments to the protection amount of an eligible 
guarantee or credit derivative as required by section 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 
banking organization 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 final rule, the agencies are clarifying that a 
banking organization 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, a banking organization must calculate 
counterparty credit risk if the OTC credit derivative is a covered 
position under the market risk rule.
    Consistent with the proposal, a banking organization 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 banking organization does so 
consistently for all such credit derivatives. The banking organization 
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 a banking 
organization cannot, or chooses not to, recognize a credit derivative 
that is a securitization exposure as a credit risk mitigant, the 
banking organization must determine the exposure amount of the credit 
derivative under the treatment for OTC derivatives in section 34. In 
the final rule, the agencies are clarifying that if the banking 
organization purchases the credit protection from a counterparty that 
is a securitization, the banking organization must determine the risk 
weight for counterparty credit risk according to the securitization 
framework. If the banking organization purchases credit protection from 
a counterparty that is not a securitization, the banking organization 
must determine the risk weight for counterparty credit risk according 
to general risk weights under section 32. A banking organization that 
provides protection in the form of a guarantee or credit derivative 
(other than an nth-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. Nth-to-Default Credit Derivatives
    Under the final rule and consistent with the proposal, the capital 
requirement for credit protection provided through an nth-
to-default credit derivative is determined either by using the SSFA, or 
applying a 1,250 percent risk weight.
    A banking organization providing credit protection must determine 
its exposure to an nth-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 banking organization'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 banking organization'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 banking organization'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 
banking organization's exposure to the total notional amount of the 
underlying exposures. A banking organization 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, a 
banking organization 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 36(b) of the final rule must determine its risk-based 
capital requirement for the underlying exposures as if the banking 
organization synthetically securitized the underlying exposure with the 
smallest risk-weighted asset amount and had obtained no credit risk 
mitigant on the other underlying exposures. A banking organization must 
calculate a risk-based capital requirement for counterparty credit risk 
according to section 34 of the final rule for a first-to-default credit 
derivative that does not meet the rules of recognition of section 
36(b).
    For second-or-subsequent-to-default credit derivatives, a banking 
organization 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 36(b) of the final rule (other than a 
first-to-default credit derivative) may recognize the credit risk 
mitigation benefits of the derivative only if the banking organization 
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 a banking 
organization satisfies these requirements, the banking organization 
determines its risk-based capital requirement for the underlying 
exposures as if the banking organization

[[Page 62123]]

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 36(b), a banking organization must calculate a risk-based 
capital requirement for counterparty credit risk according to the 
treatment of OTC derivatives under section 34 of the final rule. The 
agencies are adopting this aspect of the proposal without change for 
purposes of the final rule.

IX. Equity Exposures

    The proposal significantly revised the general risk-based capital 
rules' treatment for equity exposures. To improve risk sensitivity, the 
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 final rule 
requires a banking organization 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 agencies are adopting the proposed definition of equity 
exposures, without change, for purposes of the final rule.\179\ Under 
the final rule, a banking organization 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 banking organization has made an AOCI opt-out election 
under section 22(b)(2) of the final rule, the adjusted carrying value 
is a banking organization's carrying value of the exposure. For the on-
balance sheet component of an equity exposure that is classified as AFS 
where the banking organization has made an AOCI opt-out election under 
section 22(b)(2) of the final rule, the adjusted carrying value of the 
exposure is the banking organization's carrying value of the exposure 
less any net gains on the exposure that are reflected in the carrying 
value but excluded from the banking organization'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-balance sheet component of 
the exposure.
---------------------------------------------------------------------------

    \179\ See the definition of ``equity exposure'' in section 2 of 
the final rule. However, as described above in section VIII.A of 
this preamble, the agencies have adjusted the definition of 
``exposure amount'' in line with certain requirements necessary for 
banking organizations that make an AOCI opt-out election.
---------------------------------------------------------------------------

    The agencies 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 banking organizations to measure the 
on-balance sheet equivalent of an off-balance sheet exposure. For 
example, if the value of a derivative contract referencing the common 
stock of company X changes the same amount as the value of 150 shares 
of common stock of company X, for a small 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 
agencies have adopted without change in the final rule. Therefore, 
under the final rule, a banking organization 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 52 of the final rule. A banking organization 
determines the risk-weighted asset amount for an equity exposure to an 
investment fund under section 53 of the final rule. A banking 
organization 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 agencies have decided to retain the proposed risk weights in 
the final rule because they do 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 agencies believe 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 agencies have agreed to 
finalize the SRWA risk weights as proposed, which are summarized below 
in Table 24.

[[Page 62124]]



                  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 32 of
                           the final rule.
20......................  An equity exposure to a PSE, Federal Home Loan
                           Bank or Farmer Mac.
                           Community development equity
                           exposures.\180\
                           The effective portion of a hedge
                           pair.
100.....................   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 22 of the 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 primary Federal supervisor's application
                           of paragraph (8) of that definition and (ii)
                           has greater than immaterial leverage.
------------------------------------------------------------------------

    Consistent with the proposal, the 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.
---------------------------------------------------------------------------

    \180\ The 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 agencies have determined that a 
separate definition for a savings association's community 
development equity exposure is not necessary and, therefore, the 
final rule applies one definition of community development equity 
exposure to all types of covered banking organizations.
---------------------------------------------------------------------------

C. Non-significant Equity Exposures

    Under the final rule, and as proposed, a banking organization 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 banking organization's 
total capital.\181\ To compute the aggregate adjusted carrying value of 
a banking organization's equity exposures for determining their non-
significance, the banking organization 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 a banking organization does not know the actual holdings 
of the investment fund, the banking organization may calculate the 
proportion of the assets of the fund that are not equity exposures 
based on the terms of the prospectus, partnership agreement, or similar 
contract that defines the fund's permissible investments. If the sum of 
the investment limits for all exposure classes within the fund exceeds 
100 percent, the banking organization must assume that the investment 
fund invests to the maximum extent possible in equity exposures.
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    \181\ 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 a banking organization's equity exposures 
qualify for a 100 percent risk weight based on non-significance, the 
banking organization 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).\182\
---------------------------------------------------------------------------

    \182\ 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 agencies reflected upon this 
comment and determined to retain the proposed 10 percent limit on a 
banking organization's total capital in the 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

[[Page 62125]]

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 agencies have 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 
and the FDIC sought to balance complexity and risk sensitivity, which 
limits the degree of granularity in hedge recognition. On balance, the 
agencies believe that it is more reflective of a banking organization's 
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 agencies are 
adopting the proposed treatment without change.
    Under the 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 
banking organization acquires at least one of the equity exposures); 
the documentation specifies the measure of effectiveness (E) the 
banking organization 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. A banking organization 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 a banking organization's exposure 
to a particular equity instrument is part of a hedge pair. For example, 
assume a banking organization 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 banking organization 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, a banking organization could determine 
effectiveness using any one of three methods: The dollar-offset method, 
the variability-reduction method, or the regression method. Under the 
dollar-offset method, a banking organization 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] TR11OC13.007

    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

[[Page 62126]]

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 and the FDIC 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 
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 final rule clarifies, generally consistent with 
prior agency guidance, that a banking organization 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.\183\ A banking 
organization must use one of the look-through approaches provided in 
section 53 and, if applicable, section 154 of the final rule to 
determine the risk-weighted asset amount for such investments. A 
banking organization 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.
---------------------------------------------------------------------------

    \183\ Interagency Statement on the Purchase and Risk Management 
of Life Insurance, pp. 19-20, http://www.federalreserve.gov/boarddocs/srletters/2004/SR0419a1.pdf.
---------------------------------------------------------------------------

    A banking organization 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 51(b)(1) and the 
off-balance sheet component determined according to section 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 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 53 and, if applicable, section 154 of the final rule.
    As discussed further below, under the final rule, a banking 
organization 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 a 
banking organization does not use the full look-through approach, and 
an equity exposure to an investment fund is part of a hedge pair, a 
banking organization 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. A 
banking organization could choose which approach to apply for each 
equity exposure to an investment fund.
1. Full Look-Through Approach
    A banking organization may use the full look-through approach only 
if the banking organization is able to calculate a risk-weighted asset 
amount for each of the exposures held by the investment fund. Under the 
final rule, a banking organization 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 final rule) as if 
the proportionate ownership share of the adjusted carrying value of 
each exposures were held directly by the banking organization. The 
banking organization'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 
banking organization multiplied by (2) the banking organization's 
proportional ownership share of the fund.
2. Simple Modified Look-Through Approach
    Under the simple modified look-through approach, a banking 
organization 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 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 banking 
organization 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, a banking 
organization 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 final rule based on the 
investment limits in the fund's prospectus, partnership agreement, or

[[Page 62127]]

similar contract that defines the fund's permissible investments.
    The risk-weighted asset amount for the banking organization'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 banking organization 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 banking organization must use the highest applicable risk 
weight. A banking organization 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 agencies acknowledge that a banking organization 
may have some difficulty obtaining all the information needed to use 
the gross-up treatment or SSFA, but believe that the proposed approach 
provides strong incentives for banking organizations to obtain such 
information. As a result, the agencies are adopting the treatment as 
proposed.

X. Insurance-Related Activities

    The Board proposed to apply consolidated regulatory capital 
requirements to SLHCs, consistent with the transfer of supervisory 
responsibilities to the Board under Title III of the Dodd-Frank Act, as 
well as the requirements in section 171 of the Dodd-Frank Act.
    Under the proposal, the consolidated regulatory capital 
requirements for SLHCs would be generally the same as those proposed 
for BHCs.\184\ In addition, the proposed regulatory capital 
requirements would be based on GAAP consolidated financial statements. 
Through this approach, the Board sought to take into consideration the 
unique characteristics, risks, and activities of SLHCs, while ensuring 
compliance with the requirements of the Dodd-Frank Act. Further, as 
explained in the proposal, a uniform approach for all holding companies 
was intended to help mitigate potential competitive equity issues, 
limit opportunities for regulatory arbitrage, and facilitate comparable 
treatment of similar risks across depository institution holding 
companies.
---------------------------------------------------------------------------

    \184\ See also the Notice of Intent published by the Board in 
April, 2011, 76 FR 22662 (April 22, 2011), in which the Board 
discussed the possibility of applying the same consolidated 
regulatory capital requirements to savings and holding companies as 
those proposed for bank holding companies.
---------------------------------------------------------------------------

    The proposal included special provisions related to the 
determination of risk-weighted assets for nonbanking exposures unique 
to insurance underwriting activities. The NPR extended the approach the 
agencies and the FDIC implemented in 2011 in the general risk-based 
capital rules for depository institutions, whereby certain low-risk 
exposures that are generally not held by depository institutions may 
receive the capital treatment applicable under the capital guidelines 
for BHCs under limited circumstances.\185\ This approach is consistent 
with section 171 of the Dodd-Frank Act, which requires that BHCs be 
subject to capital requirements that are no less stringent than those 
applied to insured depository institutions. The agencies and the FDIC 
solicited comments on all aspects of the proposed rule, including the 
treatment of insurance underwriting activities.
---------------------------------------------------------------------------

    \185\ See 76 FR 37620 (June 28, 2011).
---------------------------------------------------------------------------

    As described above, the final rule does not apply to SLHCs that are 
not covered SLHCs because the Board will give further consideration to 
a framework for consolidated regulatory capital requirements for SLHCs 
that are not covered SLHCs due to the scope of their insurance 
underwriting and commercial activities. Some BHCs and covered SLHCs 
currently conduct insurance underwriting activities, however, and the 
final rule for depository institution holding companies provides a more 
risk-sensitive approach to policy loans, non-guaranteed separate 
accounts, and insurance underwriting risk than that explicitly provided 
in the standardized approach for depository institutions. The 
insurance-specific provisions of the proposed and final rules and 
related comments are discussed below.

A. Policy Loans

    The proposal defined a policy loan as a loan to policyholders under 
the provisions of an insurance contract that is secured by the cash 
surrender value or collateral assignment of the related policy or 
contract. Under the proposal, a policy loan would include: (1) A cash 
loan, including a loan resulting from early payment or accelerated 
payment benefits, on an insurance contract when the terms of contract 
specify that the payment is a policy loan secured by the policy; and 
(2) an automatic premium loan, which is a loan made in accordance with 
policy provisions that provide that delinquent premium payments are 
automatically paid from the cash value at the end of the established 
grace period for premium payments. The proposal assigned a risk weight 
of 20 percent to policy loans.
    Several commenters suggested that a policy loan should be assigned 
a zero percent risk weight because an insurance company that provides a 
loan generally retains a right of setoff for the value of the principal 
and interest payments of the policy loan against the related policy 
benefits. The Board does not believe that a zero percent risk weight is 
appropriate for policy loans and continues to believe they should be 
treated in a similar manner to a loan secured by cash collateral, which 
is assigned a 20 percent risk weight. The Board believes assigning a 
preferential but non-zero risk weight to a policy loan is appropriate 
in light of the fact that should a borrower default, the resulting loss 
to the insurance company is mitigated by the right to access the cash 
surrender value or collateral assignment of the related policy. 
Therefore, the final rule adopts the proposed treatment without change.

B. Separate Accounts

    The proposal provided a specific treatment for non-guaranteed 
separate accounts. Separate accounts are legally segregated pools of 
assets owned and held by an insurance company and maintained separately 
from its general account assets for the benefit of an individual 
contract holder, subject to certain conditions. Under the proposal, to 
qualify as a separate account, the following conditions would have to 
be met: (1) The account must be legally recognized under applicable 
law; (2) the assets in the account must be insulated from general 
liabilities of the insurance company under applicable law and

[[Page 62128]]

protected from the insurance company's general creditors in the event 
of the insurer's insolvency; (3) the insurance company must invest the 
funds within the account as directed by the contract holder in 
designated investment alternatives or in accordance with specific 
investment objectives or policies; and (4) all investment performance, 
net of contract fees and assessments, must be passed through to the 
contract holder, provided that contracts may specify conditions under 
which there may be a minimum guarantee, but not a ceiling.
    The proposal distinguished between guaranteed and non-guaranteed 
separate accounts. Under the proposal, to qualify as a non-guaranteed 
separate account, the insurance company could not contractually 
guarantee a minimum return or account value to the contract holder, and 
the insurance company must not be required to hold reserves for these 
separate account assets pursuant to its contractual obligations on an 
associated policy. The proposal provided for a zero percent risk weight 
for assets held in non-guaranteed separate accounts where all the 
losses are passed on to the contract holders and the insurance company 
does not bear the risk of the assets. The proposal provided that assets 
held in a separate account that does not qualify as a non-guaranteed 
separate account (that is, a guaranteed separate account) would be 
assigned risk weights in the same manner as other on-balance sheet 
assets.
    The NPR requested comments on this proposal, including the 
interaction of the proposed definition of a separate account with the 
state laws and the nature of the implications of any differences.
    A number of commenters stated that the proposed definition of a 
non-guaranteed separate account, including the proposed criterion that 
an insurance company would not be required to hold reserves for 
separate account assets pursuant to its contractual obligations on an 
associated policy, is too broad because, as commenters asserted, state 
laws require insurance companies to hold general account reserves for 
all contractual commitments. Accordingly, the commenters suggested that 
the capital requirement for guaranteed separate accounts should be 
based on the value of the guarantee, and not on the value of the 
underlying assets, because of what they characterized as an inverse 
relationship between the value of the underlying assets and the 
potential risk of a guarantee being realized.
    The Board continues to believe that it is appropriate to provide a 
preferential risk-based capital treatment to assets held in non-
guaranteed separate accounts and is adopting the treatment of these 
accounts as proposed. The criteria for non-guaranteed separate accounts 
ensure that a zero percent risk weight is applied only to those assets 
for which contract holders, and not the consolidated banking 
organization, would bear all the losses. Consistent with the proposal 
and with the general risk-based capital rules, the Board is not at this 
time providing a preferential treatment to assets held in guaranteed 
separate accounts. The Board believes that it is consistent with safety 
and soundness and with the risk profiles of banking organizations 
subject to the final rule to provide preferential capital treatment to 
non-guaranteed separate accounts while it considers whether and how to 
provide a unique treatment to guaranteed separate accounts. The Board 
notes that SLHCs that are not subject to the final rule because they 
meet the exclusion criteria in the definition of ``covered SLHC'' 
typically have the most material concentrations of guaranteed separate 
accounts of all depository institution holding companies.

C. Additional Deductions--Insurance Underwriting Subsidiaries

    Consistent with the treatment under the advanced approaches rule, 
the Basel III NPR provided that bank holding companies and SLHCs would 
consolidate and deduct the minimum regulatory capital requirement of 
insurance underwriting subsidiaries (generally 200 percent of the 
subsidiary's authorized control level as established by the appropriate 
state insurance regulator) from total capital to reflect the capital 
needed to cover insurance risks. The proposed deduction would be 50 
percent from tier 1 capital and 50 percent from tier 2 capital.
    A number of commenters stated that the proposed deduction is not 
appropriate for holding companies that are predominantly engaged in 
insurance activities where insurance underwriting companies contribute 
the predominant amount of regulatory capital and assets. In addition, 
the commenters asserted that the insurance risk-based capital 
requirements are designed to measure several specific categories of 
risk and that the proposed deduction should not include asset-specific 
risks to avoid double-counting of regulatory capital. Accordingly, 
commenters suggested that the proposed deduction be eliminated or 
modified to include only insurance regulatory capital for non-asset 
risks, such as insurance risk and business risk for life insurers and 
underwriting risk for casualty and property insurers. Further, the 
commenters stated that the proposal did not impose a similar deduction 
for other wholly-owned subsidiaries that are subject to capital 
requirements by functional regulators, such as insured depository 
institutions or broker-dealers.
    In response to these comments, the Board has modified the deduction 
required for insurance activities to more closely address insurance 
underwriting risk. Specifically, the final rule requires a banking 
organization to deduct an amount equal to the regulatory capital 
requirement for insurance underwriting risks established by the 
regulator of any insurance underwriting activities of the company 50 
percent from tier 1 capital and 50 percent from tier 2 capital. 
Accordingly, banking organizations that calculate their regulatory 
capital for insurance underwriting activities using the National 
Association of Insurance Commissioners' risk-based capital formulas are 
required to deduct regulatory capital attributable to the categories of 
the insurance risk-based capital that do not measure asset-specific 
risks. For example, for companies using the life risk-based capital 
formula, banking organizations must deduct the regulatory capital 
requirement related to insurance risk and business risk. For companies 
using the property and casualty risk-based formula, banking 
organizations must deduct the regulatory capital requirement related to 
underwriting risk--reserves and underwriting risk--net written 
premiums. For companies using the health risk-based formula, banking 
organizations must deduct the regulatory capital requirement related to 
underwriting risk and business risk. In no case may a banking 
organization reduce the capital requirement for underwriting risk to 
reflect any diversification with other risks.

XI. Market Discipline and Disclosure Requirements

A. Proposed Disclosure Requirements

    The agencies have long supported meaningful public disclosure by 
banking organizations 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

[[Page 62129]]

meaningful public disclosure.\186\ The BCBS introduced additional 
disclosure requirements in Basel III, which, under the final rule, 
apply to banking organizations as discussed herein.\187\
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    \186\ The agencies and the FDIC incorporated the BCBS disclosure 
requirements into the advanced approaches rule in 2007. See 72 FR 
69288, 69432 (December 7, 2007).
    \187\ 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 agencies anticipate incorporating these disclosure requirements 
through a separate notice and comment period.
---------------------------------------------------------------------------

    The agencies and the FDIC 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 
and the FDIC proposed the disclosure requirements for banking 
organizations with $50 billion or more in assets and believe they are 
most appropriate for these companies. The agencies believe that the 
proposed disclosure requirements strike the appropriate balance between 
the market benefits of disclosure and the additional burden to a 
banking organization that provides the disclosures, and therefore have 
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 final 
rule apply only to banking organizations 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. banking 
organization that is subject to comparable public disclosure 
requirements in its home jurisdiction or an advanced approaches banking 
organization making public disclosures pursuant to section 172 of the 
final rule. An advanced approaches banking organization that meets the 
$50 billion asset threshold, but that has not received approval from 
its primary Federal supervisor to exit parallel run, must make the 
disclosures described in sections 62 and 63 of the final rule. The 
agencies note 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 
banking organizations.\188\ A banking organization 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, a banking organization may use information 
provided in regulatory reports to fulfill certain disclosure 
requirements. In these situations, a banking organization is required 
to explain any material differences between the accounting or other 
disclosures and the disclosures required under the final rule.
---------------------------------------------------------------------------

    \188\ 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).
---------------------------------------------------------------------------

    A banking organization'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 banking organization. Accordingly, a banking organization must 
have a formal disclosure policy approved by its board of directors that 
addresses the banking organization's approach for determining the 
disclosures it should make. The policy should address the associated 
internal controls, 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 banking organization must attest that the disclosures meet the 
requirements of this final rule.
    A banking organization must decide the relevant disclosures based 
on a materiality concept. Information is regarded as material for 
purposes of the disclosure requirements in the 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 agencies' longstanding requirements for robust 
quarterly disclosures in regulatory reports, and considering the 
potential for rapid changes in risk profiles, the final rule requires 
that a banking organization provide timely public disclosures after 
each calendar quarter. However, qualitative disclosures that provide a 
general summary of a banking organization's risk-management objectives 
and policies, reporting system, and definitions may be disclosed 
annually after the end of the fourth calendar quarter, provided any 
significant changes are disclosed in the interim. The agencies 
acknowledge 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 
agencies consider 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 banking organization's first reporting period in which it is 
subject to the rule's disclosure requirements) as timely. In general, 
where a banking organization's fiscal year-end coincides with the end 
of a calendar quarter, the agencies consider 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 primary Federal 
supervisor 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 banking organization's capital adequacy and risk profile. 
In those cases, a banking organization needs to disclose the general 
nature of these changes and briefly describe how they are likely to 
affect public disclosures going forward. A banking organization 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 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 banking 
organization became subject to the disclosure requirements. For 
example, a banking organization 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, a banking organization has

[[Page 62130]]

flexibility in formatting its public disclosures.
    The agencies encourage management to provide all of the required 
disclosures in one place on the entity's public Web site and the 
agencies anticipate that the public Web site address would be reported 
in a banking organization's regulatory report. However, a banking 
organization 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 banking organization publicly provides a summary table 
specifically indicating the location(s) of all such disclosures (for 
example, regulatory report schedules, page numbers in annual reports). 
The agencies expect 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 agencies believe that the disclosure requirements strike an 
appropriate balance between the need for meaningful disclosure and the 
protection of proprietary and confidential information.\189\ 
Accordingly, the agencies believe that banking organizations 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 final rule 
compel a banking organization to reveal confidential and proprietary 
information. In these unusual situations, if a banking organization 
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 banking 
organization will not be required to disclose those specific items 
under the rule's periodic disclosure requirement. Instead, the banking 
organization must disclose more general information about the subject 
matter of the requirement, together with the fact that, and the reason 
why, the specific items of information have not been disclosed. This 
provision applies only to those disclosures included in this final rule 
and does not apply to disclosure requirements imposed by accounting 
standards, other regulatory agencies, or under other requirements of 
the agencies.
---------------------------------------------------------------------------

    \189\ Proprietary information encompasses information that, if 
shared with competitors, would render a banking organization's 
investment in these products/systems less valuable, and, hence, 
could undermine its competitive position. Information about 
customers is often confidential, in that it is provided under the 
terms of a legal agreement or counterparty relationship.
---------------------------------------------------------------------------

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 agencies note 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 final rule. A banking 
organization must make the disclosures described in Tables 1 through 
10.\190\
---------------------------------------------------------------------------

    \190\ Other public disclosure requirements would continue to 
apply, such as federal securities law, and regulatory reporting 
requirements for banking organizations.
---------------------------------------------------------------------------

    Table 1 disclosures, ``Scope of Application,'' name the top 
corporate entity in the group to which subpart D of the 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 a banking 
organization. A banking organization 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 agencies 
expect that many of these disclosure requirements would be captured in 
revised regulatory reports.
    Table 3 disclosures, ``Capital Adequacy,'' provide information on a 
banking organization'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 a 
banking organization 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 a banking organization 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 banking 
organization without revealing proprietary information.
    Table 8 disclosures, ``Securitization,'' provide information to 
market participants on the amount of credit risk transferred and 
retained by a banking organization 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 a banking organization. For 
purposes of these disclosures, ``exposures securitized'' include 
underlying exposures transferred into a securitization by a banking 
organization, whether originated by the banking organization or 
purchased from third parties, and third-party exposures included in 
sponsored programs. Securitization transactions in which the 
originating banking organization 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 banking organization 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 a banking organization to provide certain 
quantitative and qualitative disclosures regarding the banking

[[Page 62131]]

organization's management of interest rate risks.

XII. Risk-weighted Assets--Modifications to the Advanced Approaches

    In the Advanced Approaches NPR, the agencies and the FDIC 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 Enhancements \191\ 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 and the FDIC 
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.
---------------------------------------------------------------------------

    \191\ See ``Enhancements to the Basel II framework'' (July 
2009), available at http://www.bis.org/publ/bcbs157.htm.
---------------------------------------------------------------------------

    The agencies and the FDIC also proposed revisions to the advanced 
approaches rule that are consistent with the requirements of section 
939A of the Dodd-Frank Act.\192\ The agencies and the FDIC 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. The Board also 
proposed to apply the advanced approaches rule and the market risk rule 
to SLHCs, and the FDIC and OCC proposed to apply the market risk rule 
to state and Federal savings associations, respectively.
---------------------------------------------------------------------------

    \192\ 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 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 agencies 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 
and the FDIC to conduct periodic validation of banking organizations' 
models for capital adequacy and require modification if necessary. 
Consistent with the current advanced approaches rule, the final rule 
requires a banking organization 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 123 of the final rule, a banking 
organization's primary Federal supervisor may require the banking 
organization to calculate its advanced approaches risk-weighted assets 
according to modifications provided by the supervisor if the supervisor 
determines that the banking organization's advanced approaches total 
risk-weighted assets are not commensurate with its credit, market, 
operational or other risks.
    Other commenters suggested that the agencies and the FDIC interpret 
section 171 of the Dodd-Frank Act narrowly with regard to the advanced 
approaches framework. The agencies have adopted the approach taken in 
the proposed rule because they believe 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 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.\193\ 
Thus, resecuritization collateral could not be used to adjust the EAD 
of an exposure. The agencies believe that this treatment is appropriate 
because resecuritizations have been shown to have more market value 
volatility than other types of financial collateral.
---------------------------------------------------------------------------

    \193\ 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 and the FDIC 
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 agencies 
believe that the

[[Page 62132]]

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 agencies have 
retained the definition of financial collateral as proposed.
    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 final rule, the 
agencies have 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 agencies believe 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 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 32 of the final rule. The final rule also 
clarifies that if a banking organization 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-grade
                                                                   Sovereign issuers risk weight     Non-sovereign issuers risk weight   securitization
                       Residual maturity                         under section 32 \2\ (in percent)     under section 32 (in percent)      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 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.\194\ It also did 
not reflect the difficulties and delays experienced by institutions 
when settling or liquidating collateral during a period of financial 
stress.
---------------------------------------------------------------------------

    \194\ 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

[[Page 62133]]

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 and the FDIC 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.
    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 agencies believe 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 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 final rule adopts all the proposed requirements discussed above 
with two modifications. With respect to the proposed requirement that a 
banking organization must demonstrate on a quarterly basis to its 
primary Federal supervisor the appropriateness of its stress period, 
under the final rule, the banking organization must instead demonstrate 
at least quarterly that the stress period coincides with increased CDS 
or other credit spreads of the banking organization'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

[[Page 62134]]

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 
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,\195\ EAD would be the maximum 
amount that the banking organization could lose if the fair value of 
the underlying reference asset decreased to zero;
---------------------------------------------------------------------------

    \195\ Under the final rule, equity derivatives that are call 
options are not be 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 final rule and with the estimated value 
of the collateral substituted for the parameter C in the equation.
    The 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 and the FDIC 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 Board, 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 agencies have corrected this aspect 
of both formulas in the 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 
agencies continue to believe that the 1.25 multiplier appropriately 
reflects the associated additional risk. Therefore, the final rule 
retains the 1.25 multiplier. In addition, the final rule also adopts 
the definition of ``regulated financial institution'' without change 
from the proposal. As discussed in section V.B, above, the agencies and 
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 agencies have 
modified the definition of ``financial institution,'' including by 
introducing an ownership interest threshold to the ``predominantly 
engaged'' test to determine if a banking organization 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 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 
agencies believe that advanced approaches banking organizations should 
have the systems and resources to identify the activities of their 
wholesale counterparties. Accordingly, under the final rule, the 
agencies have 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 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 final rule without regard to the 
ownership interest thresholds set forth in paragraph (4)(i) of that 
definition. The agencies believe 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

[[Page 62135]]

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 final rule 
requires banking organizations to calculate risk-weighted assets for 
CVA risk.
    Consistent with the Basel III CVA capital requirement and the 
proposal, the 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 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 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 final rule, consistent with the 
proposal, a banking organization would use the VaR model that it uses 
to calculate specific risk under section 207(b) of subpart F or another 
model that meets the quantitative requirements of sections 205(b) and 
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 \196\ 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, a banking organization 
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 final rule. Consistent with the proposal, the 
final rule provides that only a banking organization that is subject to 
the market risk rule and had obtained prior approval from its primary 
Federal supervisor to calculate (1) the EAD for OTC derivative 
contracts using the IMM described in section 132, and (2) the specific 
risk add-on for debt positions using a specific risk model described in 
section 207(b) of subpart F is eligible to use the advanced CVA 
approach. A banking organization that receives such approval would be 
able to continue to use the advanced CVA approach until it notifies its 
primary Federal supervisor 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 banking organization 
as to why it is choosing to use the simple CVA approach and the date 
when the banking organization would begin to calculate its CVA capital 
requirement using the simple CVA approach.
---------------------------------------------------------------------------

    \196\ 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 final rule, when 
calculating a CVA capital requirement, a banking organization 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 banking organization's hedging policies. A tranched 
or nth-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 banking organization 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 and the FDIC 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 agencies agree that KCVA relates to a banking 
organization's entire portfolio of OTC derivatives contracts, and the 
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 final rule does not exempt the entities suggested by 
commenters. However, the agencies anticipate that a counterparty that 
is exempt from the 0.03 percent PD floor under Sec.  --.131(d)(2) and 
receives a zero percent risk weight under Sec.  --.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 agencies believe it is appropriate for CVA to apply as 
these counterparty types exhibit varying degrees of credit risk.
    Some commenters asked that the agencies and the FDIC 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.\197\ 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.
---------------------------------------------------------------------------

    \197\ See ``Fundamental review of the trading book'' (May 2012) 
available at http://www.bis.org/publ/bcbs219.pdf.
---------------------------------------------------------------------------

    The agencies recognize 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 agencies clarify 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

[[Page 62136]]

final rule.\198\ Once the BCBS Fundamental Review of the Trading Book 
is complete, the agencies will review the BCBS findings and consider 
whether they are appropriate for U.S. banking organizations.
---------------------------------------------------------------------------

    \198\ The agencies believe that a banking organization 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 
agencies' 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 the 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,\199\ the agencies recognize that while there is often 
limited market information of LGDMKT (or equivalently the 
market implied recovery rate), the agencies consider 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; banking organizations 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, a banking 
organization may adjust LGDMKT to reflect this difference in 
seniority. Where no market information is available to determine 
LGDMKT, a banking organization may propose a method for 
determining LGDMKT based upon data collected by the banking 
organization that would be subject to approval by its primary Federal 
supervisor. The final rule has been amended to include this 
alternative.
---------------------------------------------------------------------------

    \199\ 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 
agencies note that this issue is relevant only where a banking 
organization utilized the current exposure method or the ``shortcut'' 
method, rather than IMM, for any immaterial portfolios of OTC 
derivatives contracts. As a result, the 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 and the FDIC to clarify that 
section 132(c)(3) would exempt the purchased CDS from the proposed CVA 
capital requirements in section 132(e) of the final rule. Consistent 
with the BCBS FAQ on this topic, the agencies agree 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 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 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 final rule, a banking organization 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 banking 
organization's hedging policies. The final rule does not permit the use 
of single-name proxy CDS. The agencies believe this is an important 
limitation because of the significant basis risk that could arise from 
the use of a single-name proxy.
    Additionally, the final rule reflects several clarifying amendments 
to the proposed rule. First, the final rule divides the Advanced CVA 
formulas in the proposed rule into two parts: Formula 3 and Formula 3a. 
The agencies believe 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 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 VaR\CVA\stressed and VaR\CVA\unstressed. The 
definitions of these terms have not changed in the 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 final rule description below.
a. Simple Credit Valuation Adjustment Approach
    Under the final rule, a banking organization 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.
    A banking organization calculates KCVA, where:

[[Page 62137]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.008

    In Formula 1, wi refers to the weight applicable to counterparty i 
assigned according to Table 26 below.\200\ 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 final rule assigns wi based on the relevant PD of the counterparty, 
as assigned by the banking organization. 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.
---------------------------------------------------------------------------

    \200\ 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
------------------------------------------------------------------------

    EADitotal 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 
final rule, as adjusted by Formula 2 or the IMM described in section 
132(d) of the final rule. When the banking organization calculates EAD 
using the IMM, EADitotal equals 
EADunstressed.
[GRAPHIC] [TIFF OMITTED] TR11OC13.009

    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 Mihedge 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 Mihedge). Quantity B ind 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, a banking organization 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 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 a banking organization to capture jump-to-
default risk in its VaR model.
    In order for a banking organization to receive approval to use the 
advanced CVA approach under the final rule, the banking organization 
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 a banking organization uses the current 
exposure methodology to calculate the EAD of any immaterial OTC 
derivative portfolio, under the final rule the banking organization 
must use this EAD as a constant EE in the formula for the calculation 
of CVA. Also, the banking organization 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.

[[Page 62138]]

    The final rule requires a banking organization to use the formula 
for the advanced CVA approach to calculate KCVA as follows:
[GRAPHIC] [TIFF OMITTED] TR11OC13.010

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.\201\ CVAj for a given counterparty must be calculated 
according to
---------------------------------------------------------------------------

    \201\ 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 
final rule.
[GRAPHIC] [TIFF OMITTED] TR11OC13.011

---------------------------------------------------------------------------
In Formula 3a:

    (A) ti = the time of the i-th revaluation time bucket 
starting from t0 = 0.
    (B) tT = the longest contractual maturity across the 
OTC derivative contracts with the counterparty.
    (C) si = 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 banking organization must use a 
proxy spread based on the credit quality, industry and region of the 
counterparty.
    (D) LGDMKT = 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 = the sum of the expected exposures for all netting sets 
with the counterparty at revaluation time ti calculated 
using the IMM.
    (F) Di = 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 132(e)(6)(iv) and (v) of the 
final rule.

    Under the final rule, if a banking organization's VaR model is not 
based on full repricing, the banking organization 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 banking organization must calculate each credit spread sensitivity 
according to Formula 4:

[[Page 62139]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.012

    Under the final rule, a banking organization must calculate 
VaRCVAunstressed using CVAUnstressed and 
VaRCVAstressed using CVAStressed. To calculate 
the CVAUnstressed measure in Formula 3a, a banking organization 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 a banking organization uses the ``shortcut'' 
method described in section 132(d)(5) of the final rule to capture the 
effect of a collateral agreement when estimating EAD using the IMM, the 
banking organization 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 final rule 
requires a banking organization to use the EE for a counterparty 
calculated using the stress calibration of the IMM. However, if a 
banking organization uses the ``shortcut'' method described in section 
132(d)(5) of the final rule to capture the effect of a collateral 
agreement when estimating EAD using the IMM, the banking organization 
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 final rule requires a 
banking organization 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 
agencies retain the flexibility to require a banking organization 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 final rule, a banking organization'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 banking organization 
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 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 
banking organization to use a reduced margin period of risk when using 
the IMM or a scaling factor of no less than 0.71 \202\ 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 banking 
organization's exposures when the

[[Page 62140]]

clearing member banking organization guarantees QCCP performance; (3) 
permitting clearing member banking organizations 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.
---------------------------------------------------------------------------

    \202\ See Table 20 in section VIII.E of this preamble. 
Consistent with the scaling factor for the CEM in Table 20, an 
advanced approaches banking organization 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 final rule for advanced approaches. Banking 
organizations 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 final rule, consistent with the proposal, a banking 
organization that receives prior approval from its primary Federal 
supervisor may calculate market price and foreign exchange volatility 
using own internal estimates. In response to the increased volatility 
experienced during the crisis, however, the final rule modifies the 
quantitative standards for approval by requiring banking organizations 
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, a banking organization is also required to have 
policies and procedures that describe how it determines the period of 
significant financial stress used to calculate the banking 
organization'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 a primary Federal 
supervisor may require a banking organization to use a different period 
of significant financial stress in the calculation of own internal 
estimates for haircuts. The agencies are 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 final rule includes a number of changes to definitions 
in the advanced approaches rule that currently reference credit 
ratings.\203\ These changes are consistent with the alternative 
standards included in the Standardized Approach and alternative 
standards that already have been implemented in the agencies' market 
risk rule. In addition, the 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.
---------------------------------------------------------------------------

    \203\ See 76 FR 79380 (Dec. 21, 2011).
---------------------------------------------------------------------------

    In certain instances, the final rule uses an ``investment grade'' 
standard that does not rely on credit ratings. Under the final rule and 
consistent with the market risk rule, investment grade means that the 
entity to which the banking organization 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 agencies are largely adopting the proposed alternatives to 
ratings as proposed. Consistent with the proposal, the agencies are 
retaining the standards used to calculate the PFE for derivative 
contracts (as set forth in Table 2 of the final rule), which are based 
in part on whether the counterparty satisfies the definition of 
investment grade under the final rule. The agencies are also adopting 
as proposed the term ``eligible double default guarantor,'' which is 
used for purposes of determining whether a banking organization may 
recognize a guarantee or credit derivative under the credit risk 
mitigation framework. In addition, the agencies are adopting the 
proposed requirements for qualifying operational risk mitigants, which 
among other criteria, must be provided by an unaffiliated company that 
the banking organization deems to have strong capacity to meet its 
claims payment obligations and the obligor rating category to which the 
banking organization 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 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 agencies believe it is 
appropriate to eliminate the preferential risk weight for money market 
fund investments. As a result of the changes, a banking organization 
must use one of the three alternative approaches under section 154 of 
the final rule to determine the risk weight for its exposures to a 
money market fund.
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

[[Page 62141]]

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 agencies believe that banking 
organizations 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 final rule will create 
incentives for banking organizations to obtain the information 
necessary to compute risk-based capital requirements under the 
approach. These incentives are consistent with the agencies' 
supervisory aim that banking organizations 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 and the FDIC 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 finalized 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 and the 
FDIC 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 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 agencies have amended the definition of resecuritization 
by excluding securitizations that feature re-tranching of a single 
exposure. In addition, the agencies note that for purposes of the 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 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 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 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 agencies are adopting 
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 agencies are adopting the 
hierarchy largely as proposed. Under the final rule, the hierarchy for 
securitization exposures is as follows:
    (1) A banking organization 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, a 
banking organization is required to assign a risk weight to the 
securitization exposure using the SFA. The agencies expect banking 
organizations to use the SFA rather than the SSFA in all instances 
where data to calculate the SFA is available.
    (3) If the banking organization cannot apply the SFA because not 
all the relevant qualification criteria are met, it is allowed to apply 
the SSFA. A banking organization should be able to explain and justify 
(for example, based on data availability) to its primary Federal 
supervisor any instances in which the banking organization 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. A banking organization 
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 banking organization. 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. A banking organization must 
apply the hierarchy of approaches in section 142 of this final rule to 
determine which approach it applies to a securitization exposure. The 
SSFA has been finalized as proposed, with the exception of some 
modifications to the delinquency

[[Page 62142]]

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.\204\ 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.
---------------------------------------------------------------------------

    \204\ 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 3, appendix C, section 42(l) (national banks) and 12 CFR 
part 167, appendix C, section 42(l) (Federal savings associations) 
(OCC); 12 CFR part 208, appendix F, and 12 CFR part 225, appendix G 
(Board).
---------------------------------------------------------------------------

    For a guarantee or credit derivative (other than an nth-
to-default credit derivative) where the banking organization has 
provided protection, the final rule requires a banking organization 
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 banking organization calculates its risk-based 
capital requirement for the guarantee or credit derivative by applying 
either (1) the SFA as provided in section 143 of the final rule to the 
reference exposure if the banking organization and the reference 
exposure qualify for the SFA; or (2) the SSFA as provided in section 
144 of the final rule. If the guarantee or credit derivative and the 
reference securitization exposure do not qualify for the SFA, or the 
SSFA, the banking organization is required to assign a 1,250 percent 
risk weight to the notional amount of protection provided under the 
guarantee or credit derivative.
    The final rule also clarifies how a banking organization 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 banking 
organization. A banking organization 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 banking organization does so consistently 
for all such credit derivatives. The banking organization 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 a banking 
organization cannot, or chooses not to, recognize a credit derivative 
that is a securitization exposure as a credit risk mitigant, the bank 
must determine the exposure amount of the credit derivative under the 
treatment for OTC derivatives in section 132. If the banking 
organization purchases the credit protection from a counterparty that 
is a securitization, the banking must determine the risk weight for 
counterparty credit risk according to the securitization framework. If 
the banking organization purchases credit protection from a 
counterparty that is not a securitization, the banking organization 
must determine the risk weight for counterparty credit risk according 
to general risk weights under section 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 final rule are discussed in part VIII of the preamble.
6. Nth-to-Default Credit Derivatives
    Consistent with the proposal, the final rule provides that a 
banking organization 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, a banking organization 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 banking 
organization'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 banking organization'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 banking 
organization'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 
banking organization'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. A banking 
organization 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, a banking organization must determine its 
risk-based capital requirement for the underlying exposures as if the 
banking organization 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. A 
banking organization must calculate a risk-based capital requirement 
for counterparty credit risk according to section 132 of the final rule 
for a first-to-default credit derivative that does not meet the rules 
of recognition for guarantees and credit derivatives under section 
134(b).
    For second-or-subsequent-to default credit derivatives, a banking 
organization 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 134(b) of the final

[[Page 62143]]

rule (other than a first-to-default credit derivative) is permitted to 
recognize the credit risk mitigation benefits of the derivative only if 
the banking organization 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 a banking organization satisfies these requirements, the 
banking organization determines its risk-based capital requirement for 
the underlying exposures as if the banking organization 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. A banking 
organization that does not fulfill these requirements must calculate a 
risk-based capital requirement for counterparty credit risk according 
to section 132 of the final rule for a nth-to-default credit 
derivative that does not meet the rules of recognition of section 
134(b) of the final rule.

D. Treatment of Exposures Subject to Deduction

    Under the current advanced approaches rule, a banking organization 
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, except for 
deductions from total capital of insurance underwriting subsidiaries of 
BHCs.
    In the proposal, the agencies and the FDIC 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 and the 
FDIC to replace the 1,250 percent risk weight with the maximum risk 
weight that would correspond with deduction. Commenters also stated 
that the agencies and the FDIC 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 agencies are adopting the requirements as proposed, in order to 
provide for comparability in risk-weighted asset measurements across 
institutions. The agencies and 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 and the FDIC 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 and the FDIC 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 agencies have finalized 
these requirements as proposed.

E. Technical Amendments to the Advanced Approaches Rule

    In the proposed rule, the agencies and the FDIC 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 
agencies are adopting each of these technical amendments as proposed. 
Additionally, in the final rule, the agencies are 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 agencies note 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 banking organization or 
some other third party. However, based on their risk characteristics, 
the agencies believe that these guarantees should be recognized as 
eligible guarantees. Therefore, the agencies are 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 
agencies have 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 of the principal are conditionally guaranteed by the U.S. 
government. The agencies have amended the final rule to allow an 
exception from the 10 percent floor in such cases.
2. Calculation of Foreign Exposures for Applicability of the Advanced 
Approaches--Insurance Underwriting Subsidiaries
    A banking organization is subject to the advanced approaches rule 
if it has consolidated assets greater than or equal to $250 billion, or 
if it has total consolidated on-balance sheet foreign exposures of at 
least $10 billion.\205\ For bank holding companies, in particular, the 
advanced approaches rule provides that the $250 billion threshold 
criterion excludes assets held by an insurance underwriting subsidiary. 
However, a similar provision does not exist for the $10 billion 
foreign-exposure threshold criterion. Therefore, for bank holding 
companies and covered SLHCs, the Board is excluding assets held by 
insurance underwriting subsidiaries from the $10 billion in total 
foreign exposures threshold. The Board believes such a parallel 
provision results in a more appropriate scope of application for the 
advanced approaches rule.
---------------------------------------------------------------------------

    \205\ See 12 CFR part 3, appendix C (national banks) and 12 CFR 
part 167, appendix C (Federal savings associations) (OCC); 12 CFR 
part 208, appendix F, and 12 CFR part 225, appendix G (Board).

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

[[Page 62144]]

3. Calculation of Foreign Exposures for Applicability of the Advanced 
Approaches--Changes to Federal Financial Institutions Economic Council 
009
    The agencies are 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 agencies have 
made a similar change under section 100, the section of the final rule 
that makes the rules applicable to a banking organization 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, a banking organization 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.
4. Applicability of the Final Rule
    The agencies believe that once a banking organization 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 agencies believe that it is 
appropriate for the primary Federal supervisor to evaluate whether a 
banking organization's business or risk exposure has changed after 
dropping below the thresholds in a manner that it would no longer be 
appropriate for the banking organization to be subject to the advanced 
approaches. As a result, consistent with the proposal, the final rule 
clarifies that once a banking organization is subject to the advanced 
approaches rule under subpart E, it remains subject to subpart E until 
its primary Federal supervisor determines that application of the rule 
would not be appropriate in light of the banking organization's asset 
size, level of complexity, risk profile, or scope of operations. In 
connection with the consideration of a banking organization's level of 
complexity, risk profile, and scope of operations, the agencies also 
may consider a banking organization's interconnectedness and other 
relevant risk-related factors.
5. 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 agencies 
have 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 agencies are deleting 
the regulatory seasoning provision and will instead consider seasoning 
when evaluating a firm'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 agencies believe 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 a banking organization 
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.
6. 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 
final rule, consistent with the proposal, the agencies are revising the 
advanced approaches rule to risk weight cash items in the process of 
collection at 20 percent of the carrying value, as the agencies believe 
that this treatment is more commensurate with the risk of these 
exposures. A corresponding provision is included in section 32 of the 
final rule.
7. Change to the Definition of Qualifying Revolving Exposure
    The agencies and the FDIC 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

[[Page 62145]]

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 a banking organization consistently 
imposes in practice an upper exposure limit of $100,000 the agencies 
believe that charge cards are more closely aligned from a risk 
perspective with credit cards than with any type of ``other retail'' 
exposure and are 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 
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 agencies believe that the definition of QRE should be sufficiently 
flexible to encompass products with new features that were not 
envisioned at the time of adopting the advanced approaches rule, 
provided, however, that the banking organization can demonstrate to the 
satisfaction of the primary Federal supervisor 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.
8. 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 agencies believe 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. In the final rule, the 
agencies are adopting the treatment of trade-related letters of credit 
as proposed. Under the final rule, trade finance exposures that meet 
the stated requirements above may be assigned a maturity lower than one 
year. Section 32 of the final rule includes a provision that similarly 
recognizes the low default rates of these exposures.
9. 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 
agencies have 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.
10. Stable Value Wraps
    The agencies are clarifying that a banking organization 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 151(b)(1) and the off-balance sheet 
component determined according to section 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 154 of the 
final rule.
11. Treatment of Pre-Sold Construction Loans and Multi-Family 
Residential Loans
    The 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.\206\ This treatment is consistent with the treatment 
under the general risk-based capital rules and under the standardized 
approach.
---------------------------------------------------------------------------

    \206\ See 12 U.S.C. 1831n, note.
---------------------------------------------------------------------------

F. Pillar 3 Disclosures

1. Frequency and Timeliness of Disclosures
    For purposes of the final rule, a banking organization is required 
to

[[Page 62146]]

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 a banking organization'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 agencies 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 agencies acknowledge 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 agencies also 
indicated that a banking organization 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 agencies consider 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 banking organization's first reporting period in which 
it is subject to the public disclosure requirements) as timely. In 
general, where a banking organization's fiscal year-end coincides with 
the end of a calendar quarter, the agencies consider 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 primary Federal 
supervisor 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 banking organization's capital adequacy and risk profile. 
In those cases, a banking organization needs to disclose the general 
nature of these changes and briefly describe how they are likely to 
affect public disclosures going forward. A banking organization 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 agencies believe 
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 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 agencies are implementing the 
disclosure requirements included in the 2009 Enhancements in the 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 final rule, the agencies refer to such exposures as equity 
holdings that are not covered positions in the final rule.

XIII. Market Risk Rule

    On August 30, 2012, the agencies and the FDIC 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.\207\
---------------------------------------------------------------------------

    \207\ See 77 FR 53060 (August 30, 2012).
---------------------------------------------------------------------------

    As noted in the introduction of this preamble, the agencies and the 
FDIC proposed to expand the scope of the market risk rule to include 
savings associations and SLHCs, and to codify the market risk rule in a 
manner similar to the other regulatory capital rules in the three 
proposals. In the final rule, consistent with the proposal, the 
agencies have also merged definitions and made appropriate technical 
changes.
    As a general matter, a banking organization 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 banking organization 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 and the FDIC proposed to apply the market risk rule to 
savings associations and SLHCs. Consistent with the proposal, the 
agencies in this final rule have expanded the scope of the market risk 
rule to savings associations and covered SLHCs that meet the stated 
thresholds. The market risk rule applies to any savings association or 
covered SLHC whose trading activity (the gross sum of its

[[Page 62147]]

trading assets and trading liabilities) is equal to 10 percent or more 
of its total assets or $1 billion or more. Each agency 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 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 agencies and the FDIC received comments on the market risk 
rule. One 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 agencies believe that any savings association or covered 
SLHC 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 savings associations and covered SLHCs as of January 
1, 2015.
    Another commenter asserted that the agencies and the FDIC 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 agencies 
are aware that the BCBS is considering, among other options, greater 
use of standardized approaches for market risk. The agencies would 
consider modifications to the international market risk framework when 
and if it is revised.
    One commenter asserted that regulations should increase the cost of 
excessive use of short-term borrowing to fund long maturity assets. The 
agencies are considering the implications of short-term funding from 
several perspectives outside of the regulatory capital framework. 
Specifically, the agencies expect short-term funding risks would be a 
potential area of focus in forthcoming Basel III liquidity and enhanced 
prudential standards regulations.
    The agencies also have 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 
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. As 
discussed above, the agencies and the FDIC 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 agencies are 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 agencies have made a technical amendment to the rule with 
respect to the covered position definition. Previously, the definition 
of covered position excluded equity positions that are not publicly 
traded. The agencies have 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. 80 a-1 et seq.) (or its non-U.S. 
equivalent), provided that all the underlying equities held by the 
investment company are publicly traded. The agencies believe that a 
``look-through'' approach is appropriate in these circumstances because 
of the of the liquidity of the underlying positions, so long as the 
other conditions of a covered position are satisfied.
    The agencies also have clarified where a banking organization 
subject to the market risk rule must make its required market risk 
disclosures and require that these disclosures be timely. The banking 
organization must provide its quantitative disclosures after each 
calendar quarter. In addition, the final rule clarifies that a banking 
organization 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 agencies acknowledge 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 agencies consider 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 banking organization's first reporting 
period in which it is subject to the rule) as timely. In general, where 
a banking organization's fiscal year-end coincides with the end of a 
calendar quarter, the agencies consider 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 primary Federal supervisor would 
consider the timeliness of disclosures on a case-by-case basis. In some 
cases, management may determine that a significant change has occurred,

[[Page 62148]]

such that the most recent reported amounts do not reflect the banking 
organization's capital adequacy and risk profile. In those cases, a 
banking organization needs to disclose the general nature of these 
changes and briefly describe how they are likely to affect public 
disclosures going forward. A banking organization should make these 
interim disclosures as soon as practicable after the determination that 
a significant change has occurred.
    The final rule also clarifies that a banking organization's 
management may provide all of the disclosures required by the market 
risk rule in one place on the banking organization's public Web site or 
may provide the disclosures in more than one public financial report or 
other regulatory reports, provided that the banking organization 
publicly provides a summary table specifically indicating the 
location(s) of all such disclosures.
    The Board also is issuing a notice of proposed rulemaking 
concurrently with this final rule. The notice of proposed rulemaking 
would revise the current market risk rule in Appendix E to incorporate 
the changes to the CRC references and parameter W, as discussed above.

XIV. Additional OCC Technical Amendments

    In addition to the changes described above, the OCC proposed to 
redesignate subpart C (Establishment of Minimum Capital Ratios for an 
Individual Bank), subpart D (Enforcement), and subpart E (Issuance of a 
Directive), as subparts H, I, and J, respectively. The OCC also 
proposed to redesignate section 3.100 (Capital and Surplus), as subpart 
K. The OCC proposed to carry over redesignated subpart K, which 
includes definitions of the terms ``capital'' and ``surplus'' and 
related definitions that are used for determining statutory limits 
applicable to national banks that are based on capital and surplus. In 
addition, the OCC proposed to remove appendices A, B, and C to part 3 
because they would be replaced with the new proposed framework. 
Finally, as part of the integration of the rules governing national 
banks and Federal savings associations, the OCC proposed to make part 3 
applicable to Federal savings associations, make other non-substantive, 
technical amendments, and rescind part 167 (including appendix C) 
(Capital).
    The OCC received no comments on these proposed changes and 
therefore is adopting the proposal as final, except for the following 
changes. The final rule retains the existing 12 CFR part 3, appendices 
A and B for national banks and part 167 (excluding appendix C) for 
Federal savings associations. Because the impact of many of the 
deductions and adjustments to the revised definition of capital are 
phased in over several years, national banks and Federal savings 
associations will need to use the existing rules at 12 CFR part 3, 
appendix A and 12 CFR part 167 (excluding appendix C), respectively, 
pertaining to the definition of capital to determine certain baseline 
regulatory capital amounts. Additionally, because the standardized 
approach risk-weighted asset calculations will not become effective 
until January 1, 2015, national banks and Federal savings associations 
that are not subject to the advanced approaches risk-based capital 
rules will be required to continue using the risk-weighted asset 
calculations set forth at 12 CFR part 3, appendix A and 12 CFR part 167 
(excluding appendix C), respectively, from January 1, 2014, until 
December 31, 2014. National banks that are subject to the market risk 
rule (12 CFR part 3, appendix B), but not the advanced approaches risk-
based capital rules, will need to use the 12 CFR part 3, appendix B, 
from January 1, 2014, until December 31, 2014. Finally, as noted 
earlier in this preamble, national banks and Federal savings 
associations that are subject to the advanced approaches risk-based 
rules must calculate their risk-based capital floor using the risk-
weighted asset calculations set forth at 12 CFR part 3, appendix A, and 
12 CFR part 167 (excluding appendix C), respectively, through December 
31, 2014. Beginning on January 1, 2015, national banks and Federal 
savings associations subject to the advanced approaches risk-based 
capital rules will use the standardized approach risk-weighted asset 
calculations, set forth in new subpart D, when determining their risk-
based capital floor.
    The final rule also removes existing 12 CFR part 167, appendix C 
(Risk-Based Capital Requirements--Internal-Ratings-Based and Advanced 
Measurement Approaches) because it is being replaced with new subpart 
E.
    Finally, as described in section IV.H of this preamble, in 12 CFR 
6.4(b)(5) and (c)(5) this final rule replaces the phrase ``total 
adjusted assets'' with the phrase ``average total assets'' in 12 CFR 
6.4(b)(5) and (c)(5).
    The OCC may need to make additional technical and conforming 
amendments to other OCC rules, such as Sec.  5.46, subordinated debt, 
which contains cross references to part 3 that are being changed 
pursuant to this final rule. The OCC intends to issue a separate 
rulemaking to amend other non-capital regulations that contain cross-
references to provisions of the existing capital rules at 12 CFR part 3 
and appendices A, B, or C (national banks) and 12 CFR part 167 and 
appendix C (Federal savings associations), as necessary, to reference 
the appropriate corresponding provisions of the revised rules.
    With the adoption of this final rule, as a result of the 
integration of the rules governing national banks and Federal savings 
association, all of part 3 will be applicable to Federal savings 
associations, except for subpart K (Interpretations). Thus, under the 
final rule, a Federal savings association will comply with redesignated 
subpart H (Establishment of minimum capital ratios for an individual 
bank or individual Federal savings association), subpart I 
(Enforcement), and subpart J (Issuance of a directive), rather than 12 
CFR 167.3 (Individual minimum capital requirements) and 167.4 (Capital 
directives). The provisions of subparts H, I, and J are substantively 
the same as 12 CFR 167.3 and 167.4, with a few exceptions. Sections 
3.402 (Applicability) and 167.3(b) (Appropriate considerations for 
establishing individual minimum capital requirements) both state that 
the OCC may require higher minimum capital ratios for an individual 
bank in view of its circumstances and provide examples of such 
circumstances. Likewise, both sections 3.403 (Standards for determining 
individual minimum capital ratios) and 167.3(c) (Standards for 
determination of appropriate minimum capital requirements) explain that 
the determination of the appropriate minimum capital level for an 
individual national bank or Federal savings association, respectively, 
is in part a subjective judgment based on agency expertise and these 
sections of the respective national bank and Federal savings 
association regulations provide a list factors that may be considered. 
The list of examples in sections 3.402 and 167.3(b) and in sections 
3.403 and 167.3(c) are similar, but not identical in all respects; and 
consistent with the proposal, the final rule makes no change to the 
list of examples in sections 3.402 and 3.403. The OCC notes that, while 
the final rule omits some of the examples in sections 167.3(b) and (c), 
because the list of examples is illustrative and not exclusive, the OCC 
retains the ability to consider those omitted examples and all other 
relevant items when determining individual minimum capital 
requirements.
    The procedures in Sec.  167.3(d) for responding to a notice of 
proposed

[[Page 62149]]

minimum capital ratios provide that the OCC may shorten the 30-day 
response period for good cause and limit good cause to three specific 
situations. A Federal savings association should be aware that, in 
addition to listing specific circumstances when the OCC may shorten the 
response time, the comparable provision in Sec.  3.404(b)(1) of the 
final rule provides that the OCC, in its discretion, may shorten the 
30-day response time. Thus, there may be additional circumstances in 
which the OCC may shorten the response time for a Federal savings 
association.
    Section 167.3(d)(3) (Decision) states that the OCC's written 
decision on the individual minimum capital requirement with respect to 
a Federal savings association represents final agency action. 
Consistent with the proposal, Sec.  3.404(c) (Decision) of the final 
rule does not include this statement. The OCC notes that inclusion of 
this statement is unnecessary because internal appeals of informal OCC 
enforcement actions, such as a decision on a Federal savings 
association's minimum capital requirement, are reviewable by the OCC's 
Ombudsman's Office. Therefore, omitting this statement in Sec.  
3.404(c) will have no substantive effect.
    Sections 3.601 (Purpose and scope) and Sec.  167.4(a) (Issuance of 
a capital directive), both of which address issuance of a capital 
directive, are very similar but not identical. The final rule adopts 
Sec.  3.601 as proposed. In some cases Sec.  167.4(a) includes more 
detail than Sec.  3.601, and in some cases Sec.  3.601 includes more 
detail than Sec.  167.4(a). For example, Sec.  3.601(b) states that 
violation of a directive may result in assessment of civil money 
penalties in accordance with 12 U.S.C. 3909(d), whereas Sec.  167.4(a) 
does not include such a statement. However, because the International 
Lending Supervision Act (ILSA) applies to Federal savings associations 
and 12 U.S.C. 3909(d) states that the violation of any rule, regulation 
or order issued under the ILSA may result in a civil money penalty, the 
OCC has concluded that inclusion of this language in Sec.  3.601 will 
have no substantive impact on Federal savings associations. 
Furthermore, the OCC has concluded that, notwithstanding any other 
minor differences between Sec.  3.601 and Sec.  167.4(a), those changes 
will have no substantive impact on Federal savings associations.

XV. 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

XVI. 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 as of July 2, 2013, for 
purposes of the RFA to include banking entities with total assets of 
$175 million or less, and beginning on July 22, 2013, to include

[[Page 62150]]

banking entities with total assets of $500 million or less). Pursuant 
to the RFA, the agency must make the final regulatory flexibility 
analysis available to members of the public and must publish the final 
regulatory flexibility analysis, or a summary thereof, in the Federal 
Register. In accordance with section 4 of the RFA, the agencies are 
publishing the following summary of their final regulatory flexibility 
analyses.\208\
---------------------------------------------------------------------------

    \208\ Each agency published separate summaries of their initial 
regulatory flexibility analyses (IRFAs) with each of the proposed 
rules in the three NPRs in accordance with Section 3(a) of the 
Regulatory Flexibility Act, 5 U.S.C. 603. In the IRFAs provided in 
connection with the proposed rules, each agency requested comment on 
all aspects of the IRFAs, and, in particular, on any significant 
alternatives to the proposed rules applicable to covered small 
banking organizations that would minimize their impact on those 
entities. In the IRFAs provided by the OCC and the FDIC in 
connection with the advanced approach proposed rule, the OCC and the 
FDIC determined that there would not be a significant economic 
impact on a substantial number of small banking organizations and 
published a certification and a short explanatory statement pursuant 
to section 605(b) of the RFA. In the IRFA provided by the Board in 
connection with the advanced approach proposed rule, the Board 
provided the information required by section 603(a) of the RFA and 
concluded that there would not be a significant economic impact on a 
substantial number of small banking organizations.
---------------------------------------------------------------------------

    For purposes of their respective FRFAs, the OCC analyzed the 
potential economic impact of the final rule on the small entities it 
regulates, including small national banks and small Federal savings 
associations; and the Board analyzed the potential economic impact on 
the small entities it regulates including small state member banks, 
small bank holding companies and small savings and loan holding 
companies.
    As discussed in more detail in section E, below, this final rule 
may have a significant economic impact on a substantial number of the 
small entities under their respective jurisdictions. Accordingly, the 
agencies have prepared the following FRFA pursuant to the RFA.

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

    As discussed in the SUPPLEMENTARY INFORMATION of the preamble to 
this final rule, the agencies are revising their regulatory capital 
requirements to promote safe and sound banking practices, implement 
Basel III and other aspects of the Basel capital framework, harmonize 
capital requirements across different types of insured depository 
institutions and depository institution holding companies, and codify 
capital requirements.
    Additionally, this final rule satisfies certain requirements under 
the Dodd-Frank Act by (1) revising regulatory capital requirements to 
remove all references to, and requirements of reliance on, credit 
ratings,\209\ and (2) imposing new or revised minimum capital 
requirements on certain insured depository institutions and depository 
institution holding companies.\210\
---------------------------------------------------------------------------

    \209\ See 15 U.S.C. 78o-7, note.
    \210\ See 12 U.S.C. 5371.
---------------------------------------------------------------------------

    Under section 38(c)(1) of the Federal Deposit Insurance Act, the 
agencies are required to prescribe capital standards for insured 
depository institutions that they regulate.\211\ The agencies also must 
``cause banking institutions to achieve and maintain adequate capital 
by establishing minimum levels of capital for such banking 
institutions'' under the International Lending Supervision Act.\212\ In 
addition, among other authorities, the Board may establish capital 
requirements for member banks under the Federal Reserve Act,\213\ for 
bank holding companies under the Bank Holding Company Act,\214\ and for 
savings and loan holding companies under the Home Owners Loan Act.\215\
---------------------------------------------------------------------------

    \211\ See 12 U.S.C. 1831o(c).
    \212\ See 12 U.S.C. 3907.
    \213\ See 12 U.S.C. 321-338.
    \214\ See 12 U.S.C. 1844.
    \215\ See 12 U.S.C 1467a(g)(1).
---------------------------------------------------------------------------

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 agencies and the FDIC received three public comments directly 
addressing the initial regulatory flexibility analyses (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 
agencies and the FDIC were 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 
agencies and 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 their respective IRFAs, the agencies used the most current 
regulatory reporting data available and, to address information gaps, 
they applied conservative assumptions. The agencies considered the 
comments they received on the potential impact of the proposed rules, 
and, as discussed in Item F, below, made significant revisions to the 
final rule in response to the concerns expressed regarding the 
potential burden on small banking organizations.
    Commenters expressed concern that the agencies and the FDIC did not 
use a uniform methodology for conducting their IRFAs and suggested that 
the agencies and the FDIC should have compared their analyses prior to 
publishing the proposed rules.
    The agencies and the FDIC 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 agencies and the FDIC prepared the individual 
analyses in recognition of the differences among the organizations that 
each agency supervises. In preparing their respective FRFAs, the 
agencies and the FDIC 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 
agencies have responded to commenters' concerns and sought to mitigate 
the potential compliance burden on community banking organizations 
throughout the final rule.
    The agencies and 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.

[[Page 62151]]

    A few commenters also urged the agencies and 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 agencies recognize the potential compliance 
costs associated with the proposals. Accordingly, for purposes of the 
final rule the agencies modified certain requirements of the proposals, 
such as the proposed mortgage treatment, to help to reduce the 
compliance burden on small banking organizations.

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 agencies and the FDIC providing comments 
on the proposed rules. The CCA generally commended the agencies and the 
FDIC for the IRFAs provided with the proposed rules, and specifically 
commended the agencies and the FDIC for considering the cumulative 
economic impact of the proposals on small banking organizations. The 
CCA acknowledged that the agencies and the FDIC provided lists of 
alternatives being considered, but encouraged the agencies and the FDIC 
to provide more detailed discussion of these alternatives and the 
potential burden reductions associated with the alternatives.
    The CCA acknowledged that the OCC and the FDIC had certified that 
the advanced approaches proposed rule would not have a significant 
economic impact on a substantial number of small banking organizations. 
The CCA noted that the Board did not provide such a certification for 
the advanced approaches proposed rule and suggested that the Board 
either provide the certification for the advanced approaches proposed 
rule or publish a more detailed IRFA, if public comments indicated that 
the advanced approaches proposed rule would have a significant economic 
impact on a substantial number of small banking organizations.
    The CCA encouraged ``the agencies to allow small banks to continue 
under the current framework of Basel I.'' The CCA also urged the 
agencies and the FDIC to give careful consideration to comments 
discussing the impact of the proposed rules on small financial 
institutions and to analyze possible alternatives to reduce this 
impact.
    The CCA expressed concern that aspects of the proposals could be 
problematic and onerous for small community banking organizations. The 
CCA stated that the proposed rules were designed for large, 
international banks and not adapted to the circumstances of community 
banking organizations. Specifically, the CCA expressed concern over 
higher risk weights for certain products, which, the CCA argued, could 
drive community banking organizations 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 community banking organizations may exit the mortgage 
market.
    Although the new regulatory capital framework will carry costs, the 
supervisory interest in improved and uniform capital standards at the 
level of individual banking organizations, as well as the expected 
improvements in the safety and soundness of the U.S. banking system, 
should outweigh the increased burden on small banking organizations. 
The agencies carefully considered all comments received and, in 
particular, the comments that addressed the potential impact of the 
proposed rules on small banking organizations. As discussed throughout 
the preamble and in Item F below, the agencies have made significant 
revisions to the proposed rules that address the concerns raised in the 
CCA's comment, including with respect to the treatment of AOCI, trust 
preferred securities issued by depository holding companies with less 
than $15 billion in total consolidated assets as of December 31, 2009, 
and mortgages.

D. Description and Estimate of Small Entities Affected by the Final 
Rule

    Under regulations issued by the Small Business Administration, a 
small entity includes a depository institution, bank holding company, 
or savings and loan holding company with total assets of $175 million 
or less and beginning July 22, 2013, total assets of $500 million or 
less (a small banking organization).\216\
---------------------------------------------------------------------------

    \216\ See 13 CFR 121.201. Effective July 22, 2013, the Small 
Business Administration revised the size standards for banking 
organizations to $500 million in assets from $175 million in assets. 
78 FR 37409 (June 20, 2013).
---------------------------------------------------------------------------

    As of March 31, 2013, the Board supervised approximately 636 small 
state member banks. As of December 31, 2012, there were approximately 
3,802 small bank holding companies and approximately 290 small savings 
and loan holding companies.\217\ The final rule does not apply to small 
bank holding companies that are not engaged in significant nonbanking 
activities, do not conduct significant off-balance sheet activities, 
and do not have a material amount of debt or equity securities 
outstanding that are registered with the SEC. These small bank holding 
companies remain subject to the Board's Small Bank Holding Company 
Policy Statement.\218\ Small state member banks and small savings and 
loan holding companies would be subject to the proposals in this rule.
---------------------------------------------------------------------------

    \217\ Under the prior Small Business Administration threshold of 
$175 million in assets, as of March 31, 2013 the Board supervised 
approximately 369 small state member banks. As of December 31, 2012, 
there were approximately 2,259 small bank holding companies and 
approximately 145 small savings and loan holding companies.
    \218\ See 12 CFR part 225, appendix C. Section 171 of the Dodd-
Frank provides an exemption from its requirements for bank holding 
companies subject to the Small Bank Holding Company Policy Statement 
(as in effect on May 19, 2010). Section 171 does not provide a 
similar exemption for small savings and loan holding companies and 
they are therefore subject to the proposals. 12 U.S.C. 
5371(b)(5)(C).
---------------------------------------------------------------------------

    Under the $175 million threshold, as of December 31, 2012, the OCC 
regulates 737 small entities. Under the $500 million threshold, the OCC 
regulates 1,291 small entities.\219\
---------------------------------------------------------------------------

    \219\ The OCC has calculated the number of small entities based 
on the SBA's size thresholds for commercial banks and savings 
institutions, and trust companies. Consistent with the General 
Principles of Affiliation 13 CFR Sec.  121.103(a), the OCC counts 
the assets of affiliated financial institutions when determining if 
the OCC should classify a bank the OCC supervises as a small entity. 
The OCC used December 31, 2012 to determine size because a 
``financial institution's assets are determined by averaging the 
assets reported on its four quarterly financial statements for the 
preceding year.'' See footnote 8 of the U.S. Small Business 
Administration's Table of Size Standards.
---------------------------------------------------------------------------

E. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The final rule may impact covered small banking organizations in 
several ways. The final rule affects covered small banking 
organizations' regulatory capital requirements by changing the 
qualifying criteria for regulatory capital, including mandatory 
deductions and adjustments, and modifying the risk weight treatment for 
some exposures. The rule also requires covered small banking 
organizations to meet a 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 final rule, all banking organizations would remain subject to 
a minimum tier 1 leverage ratio of no more than 4 percent and an 8 
percent total capital ratio.\220\ The rule

[[Page 62152]]

imposes limitations on capital distributions and discretionary bonus 
payments for covered small banking organizations that do not hold a 
buffer of common equity tier 1 capital above the minimum ratios.
---------------------------------------------------------------------------

    \220\ Banking organizations subject to the advanced approaches 
rules 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 proposed rule and 
section II.B of the preamble for a more detailed discussion of the 
applicable minimum capital ratios.
---------------------------------------------------------------------------

    For those covered small banking organizations that do not engage in 
securitization activities, derivatives activities, and do not have 
exposure to foreign sovereigns or equities, there would be limited 
changes to the way these small banking organizations are required to 
calculate risk-weighted assets. For these organizations, the only two 
risk weights that would change are those that relate to past due 
exposures and acquisition and development real estate loans.
    The final rule includes other changes to the general risk-based 
capital requirements that address the calculation of risk-weighted 
assets:
     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;
     Provides more comprehensive recognition of collateral and 
guarantees; and
     Provides a more favorable capital treatment for 
transactions cleared through qualifying central counterparties.\221\
---------------------------------------------------------------------------

    \221\ Section 939A of the Dodd-Frank Act requires federal 
agencies to remove references to credit ratings from regulations and 
replace credit ratings with appropriate alternatives. The final rule 
introduces alternative measures of creditworthiness for foreign 
debt, securitization positions, and resecuritization positions.
---------------------------------------------------------------------------

    As a result of the new requirements, some covered small banking 
organizations may have to alter their capital structure (including by 
raising new capital or increasing retention of earnings) in order to 
achieve the new minimum capital requirements and avoid restrictions on 
distributions of capital and discretionary bonus payments.
    The agencies have excluded from this analysis any burden associated 
with changes to the Consolidated Reports of Income and Condition for 
banks (FFIEC 031 and 041; OMB Nos. 7100-0036, 3064-0052, 1557-0081), 
the Financial Statements for Bank Holding Companies (FR Y-9; OMB No. 
7100-0128), and the Capital Assessments and Stress Testing information 
collection (FR Y-14A/Q/M; OMB No. 7100-0341). The agencies are 
proposing information collection changes to reflect the requirements of 
the final rule, and are 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 final rule is located in the Paperwork 
Reduction Act section, below.
    The agencies estimate that managerial/technical, senior management, 
legal counsel, and administrative/junior analyst skills will be 
necessary for the preparation of reports and records related to this 
final rule.
Board
    To estimate the cost of capital needed to comply with the final 
rule, the Board estimated common equity tier 1, tier 1, and total risk-
based capital as defined under the more stringent eligibility standards 
for capital instruments. The Board also adjusted risk-weighted assets 
for each banking organization to estimate the impact of compliance with 
the changes under final rule and then compared each banking 
organization's risk-based capital ratios to the higher minimums 
required under the final rule. If a banking organization's new measure 
of capital under the final rule would not meet the minimums required 
for ``adequately-capitalized'' under the final rule, the Board 
considered that difference to be a ``shortfall'', or the amount of 
capital that a banking organization would need to raise in order to 
comply with the rule.\222\
---------------------------------------------------------------------------

    \222\ The Board's analysis assumed that the changes included in 
the final rule were on a fully phased-in basis. In addition, for the 
purposes of this analysis, banking organizations that did not meet 
the minimum requirements (undercapitalized institutions) under the 
current rules were excluded in order to isolate the effect of the 
rule on institutions that were otherwise adequately or well-
capitalized.
---------------------------------------------------------------------------

    To estimate each small state member bank's capital risk-based 
capital ratios under the final rule, the Board used currently available 
data from the quarterly Call Reports. The Board arrived at estimates of 
the new numerators of the capital ratios by combining various 
regulatory reporting items to reflect definitional changes to common 
equity tier 1 capital, tier 1 capital, and total capital as described 
in the final rule. The capital ratio denominator, risk-weighted assets, 
will also change under the final rule. The uniqueness of each 
institution's asset portfolio will cause the direction and extent of 
the change in the denominator to vary from institution to institution. 
The Board, however, was able to arrive at a reasonable proxy for risk-
weighted assets under the standardized approach in the final rule by 
using information that is in the Call Reports. In particular, the Board 
adjusted foreign exposures, high volatility commercial real estate, 
past-due loans, and securitization exposures to account for new risk 
weights under the final rule.
    Using the estimates of the new capital levels and standardized 
risk-weighted assets under the final rule, the Board estimated the 
capital shortfall each banking organization would encounter if the rule 
was fully phased in, as discussed above. Table 27 shows the Board's 
estimates of the number of state member banks that would not meet the 
minimum capital requirements according to Call Report data as of March 
30, 2013. This table also shows the projected Basel III capital 
shortfall for those banking organizations were the final rule fully 
implemented. Because institutions must simultaneously meet all of the 
minimum capital requirements, the largest shortfall amount represents 
our estimate of the amount of capital Board-regulated banking 
organizations will need to accumulate to meet new minimum capital 
requirements under the final rule, fully implemented.
    Because SLHCs are not currently subject to regulatory capital 
reporting requirements, the Board is unable to use reporting 
information (as was done for small state member banks) to estimate 
capital and risk-weighted assets under the final rule for small SLHCs. 
Therefore, this analysis does not include an estimation of the capital 
shortfall for small SLHCs.

[[Page 62153]]



 Table 27--Projected Number of Small State Member Banks With Less Than $500 Million in Total Assets a Basel III
 Capital Shortfall and $ Amount of Basel III Capital Shortfall Under the Standardized Approach, Fully Phased-In
----------------------------------------------------------------------------------------------------------------
                                          Projected number of state member       Projected Basel III capital
                                            banks with Basel III capital       shortfall for state member banks
                                            shortfall (fully phased-in)               (fully phased-in)
----------------------------------------------------------------------------------------------------------------
Common Equity Tier 1 to Risk-weighted                                    0                                   $0
 Assets...............................
Tier 1 to Risk-weighted Assets........                                   0                                    0
Minimum Total Capital + Conservation                                     9                                 11.3
 Buffer...............................
----------------------------------------------------------------------------------------------------------------

    As shown in Table 27, the Board estimates that all small state 
member banks that meet the minimum requirements under the current rules 
will meet both the new common equity tier 1 minimum of 4.5 percent and 
the 6 percent minimum for tier 1 capital. The Board estimates that nine 
small state member banks will need to increase capital by a combined 
$11.3 million by January 1, 2019 in order to meet the minimum total 
capital, including conservation buffer.\223\
---------------------------------------------------------------------------

    \223\ The Board estimates that under the Small Business 
Administration's prior $175 million asset threshold, all small state 
member banks that meet the minimum requirements under the current 
rules will meet both the new common equity tier 1 minimum of 4.5 
percent and the 6 percent minimum for tier 1 capital. The Board 
estimates that two small state member banks will need to increase 
capital by a combined $1.08 million by January 1, 2019 in order to 
meet the minimum total capital, including conservation buffer.
---------------------------------------------------------------------------

    To estimate the cost to small state member banks of the new capital 
requirement, the Board examined the effect of this requirement on 
capital structure and the overall cost of capital.\224\ The cost of 
financing a bank or any firm 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 
force a bank to deleverage and--all else equal--would increase the cost 
of capital for that bank.
---------------------------------------------------------------------------

    \224\ See Merton H. Miller, (1995), ``Do the M & M propositions 
apply to banks?'' Journal of Banking & Finance, Vol. 19, pp. 483-
489.
---------------------------------------------------------------------------

    This increased cost in the most burdensome year would be tax 
benefits foregone: The capital requirement ($11.3 million), multiplied 
by the interest rate on the debt displaced and by the effective 
marginal tax rate for the banks affected by the 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. 
Using an estimated interest rate on debt of 6 percent, the Board 
estimated that the annual tax benefits foregone on $11.3 million of 
capital switching from debt to equity is approximately $6,391 per year 
($1.08 million * 0.06 (interest rate) * 0.094 (median marginal tax 
savings)).\225\ On average, the cost is approximately $710 per small 
state member bank per year.\226\
---------------------------------------------------------------------------

    \225\ 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.
    \226\ The Board estimates that under the Small Business 
Administration's prior $175 million asset threshold, that the annual 
tax benefits foregone on $1.08 million of capital switching from 
debt to equity is approximately $610 per year ($1.08 million * 0.06 
(interest rate) * 0.094 (median marginal tax savings)). On average, 
the cost is approximately $305 per small state member bank per year 
under the $175 million threshold.
---------------------------------------------------------------------------

    As shown in Table 28, the Board also estimated that the cost of 
implementing the creditworthiness in the final rule will be 
approximately $27.3 million for small state member banks. For the nine 
small state member banks that also have to raise additional capital, 
the Board estimates that the cost of the final rule will be 
approximately $43,710. For all other small state member banks, the 
Board estimated the cost of the final rule as $43,000 per 
institution.\227\
---------------------------------------------------------------------------

    \227\ The Board estimates that under the Small Business 
Administration's prior $175 million asset threshold, the cost of 
implementing the creditworthiness in the final rule will be 
approximately $15.8 million for small state member banks (369 
institutions * $42,925 cost per institution). For the two small 
state member banks that also have to raise additional capital, the 
Board estimates that the cost of the final rule will be 
approximately $43,305. For all other small state member banks, the 
Board estimated the cost of the final rule as $43,000 per 
institution.

 Table 28--Estimated Costs of Creditworthiness Measurement Activities for State Member Banks With Less Than $500
                                             Million in Total Assets
----------------------------------------------------------------------------------------------------------------
                                       Number of        Estimated hours   Estimated cost per
           Institution               institutions       per institution       institution       Estimated cost
----------------------------------------------------------------------------------------------------------------
Small state member banks (assets                636                 505             $42,925         $27,300,300
 < $500 million)................
----------------------------------------------------------------------------------------------------------------

    Because the Board has followed phased-in approach to reporting 
requirements for savings and loan holding companies, the Board does not 
possess the same detailed financial information on small savings and 
loan holding companies as it possesses regarding other small banking 
organizations. The Board, however, sought comment on the potential 
impact of the proposed requirements on small savings and loan holding 
companies. Several commenters expressed concern that the Federal 
Reserve's Small Bank Holding Company Policy Statement does not apply to 
savings and loan holding companies with total consolidated assets less 
than $500 million. These commenters noted that small savings and loan 
holding companies presently do not have capital structures that would 
allow them to comply with the requirements of the Basel III proposal 
and requested that the Small Bank Holding Company Policy exemption be 
extended to small savings and loan holding companies.

[[Page 62154]]

    For small savings and loan holding companies, the compliance 
burdens described above may be greater than for those of other covered 
small banking organizations. Small savings and loan holding companies 
previously have not been subject to regulatory capital requirements and 
reporting requirements tied regulatory capital requirements. Small 
savings and loan holding companies may therefore need to invest 
additional resources in establishing internal systems (including 
purchasing software or hiring new personnel or training existing 
personnel) or raising capital to achieve compliance with the new 
minimum capital requirements and avoid restrictions on distributions of 
capital and discretionary bonus payments the requirements of the final 
rule.
    Covered small banking organizations that would have to raise 
additional capital to comply with the requirements of the proposals may 
incur certain costs, including costs associated with issuance of 
regulatory capital instruments. The agencies have sought to minimize 
the burden of raising additional capital by providing for transitional 
arrangements that phase-in the new capital requirements over several 
years, allowing banking organizations time to accumulate additional 
capital through retained earnings as well as raising capital in the 
market. While the final rule establishes a narrower definition of 
regulatory capital--in the form of a minimum common equity tier 1 
capital ratio, a higher minimum tier 1 capital ratio, and more 
stringent limitations on and deductions from capital--the vast majority 
of capital instruments currently held by small covered banking 
organizations, such as common stock and noncumulative perpetual 
preferred stock, would remain eligible as regulatory capital 
instruments under the proposed requirements.
OCC
    To estimate the cost of capital needed to comply with the final 
rule, the OCC estimated common equity tier 1, tier 1, and total risk-
based capital as defined under the more stringent eligibility standards 
for capital instruments. The OCC also adjusted risk-weighted assets for 
each banking organization to estimate the impact of compliance with the 
changes under final rule and then compared each banking organization's 
risk-based capital ratios to the higher minimums required under the 
final rule. If a banking organization's new measure of capital under 
the final rule would not meet the minimums required for ``adequately-
capitalized'' under the final rule, the OCC considered that difference 
to be a ``shortfall'', or the amount of capital that a banking 
organization would need to raise in order to comply with the rule.\228\
---------------------------------------------------------------------------

    \228\ The OCC's analysis assumed that the changes included in 
the final rule were on a fully phased-in basis. In addition, for the 
purposes of this analysis, the amount of additional capital 
necessary for a banking organization that is currently 
undercapitalized to meet the current requirements was excluded in 
order to isolate the effect of the final rule from the requirements 
of the current rules.
---------------------------------------------------------------------------

    To estimate each national bank or federal savings association's 
capital risk-based capital ratios under the final rule, the OCC used 
currently available data from the quarterly Call Reports. The OCC 
arrived at estimates of the new numerators of the capital ratios by 
combining various regulatory reporting items to reflect definitional 
changes to common equity tier 1 capital, tier 1 capital, and total 
capital as described in the final rule. The capital ratio denominator, 
risk-weighted assets, will also change under the final rule. The 
uniqueness of each institution's asset portfolio will cause the 
direction and extent of the change in the denominator to vary from 
institution to institution. The OCC, however, was able to arrive at a 
reasonable proxy for risk-weighted assets under the standardized 
approach in the final rule by using information that is in the Call 
Reports. In particular, the OCC adjusted foreign exposures, high 
volatility commercial real estate, past-due loans, and securitization 
exposures to account for new risk weights under the final rule.
    Using the estimates of the new capital levels and standardized 
risk-weighted assets under the final rule, the OCC estimated the 
capital shortfall each banking organization would encounter if the rule 
was fully phased in, as discussed above.
    Table 29 shows the OCC's estimates of the number of small national 
banks and federal savings associations that would not meet the minimum 
capital requirements according to Call Report data as of March 31, 
2013. Table 30, which also uses Call Report Data as of March 31, 2013, 
shows the projected Basel III capital shortfalls for those banking 
organizations during the final rule phase-in periods. Because 
institutions must simultaneously meet all of the minimum capital 
requirements, the largest shortfall amount represents our estimate of 
the amount of capital small OCC-regulated banking organizations will 
need to accumulate to meet new minimum capital requirements under the 
final rule, fully implemented.

   Table 29--Projected Cumulative Number of Institutions Short of Basel III Capital Transition Schedule, OCC-Regulated Institutions With Consolidated
                                                 Banking Assets of $500 Million or less, March 31, 2013
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                           Jan. 1, 2016
                                         Mar. 31, 2013     Jan. 1, 2014    Jan. 1, 2015        (PCA)       Jan. 1, 2017    Jan. 1, 2018    Jan. 1, 2019
--------------------------------------------------------------------------------------------------------------------------------------------------------
Common Equity to Risk-Weighted Assets                  3               8              13              22              22              22              22
Tier 1 to Risk-Weighted Assets.......                  7              14              17              31              31              31              31
Minimum Total Capital + Conservation                  23  ..............  ..............              25              28              33              41
 Buffer..............................
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 62155]]


 Table 30--Projected Cumulative Basel III Capital Shortfall, OCC-Regulated Institutions With Consolidated Banking Assets of $500 Million or Less, ($ in
                                                                Millions) March 31, 2013
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                           Jan. 1, 2016
                                         Mar. 31, 2013     Jan. 1, 2014    Jan. 1, 2015        (PCA)       Jan. 1, 2017    Jan. 1, 2018    Jan. 1, 2019
--------------------------------------------------------------------------------------------------------------------------------------------------------
Common Equity to Risk-Weighted Assets              $13.0           $33.1           $40.0           $84.9           $84.9           $84.9           $84.9
Tier 1 to Risk-Weighted Assets.......               20.9            45.5            56.5           114.9           114.9           114.9           114.9
Minimum Total Capital + Conservation                67.3  ..............  ..............            86.7           102.9           134.0           163.6
 Buffer..............................
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The OCC estimates that 41 small national banks and federal savings 
associations will need to increase capital by a combined $163.6 million 
by January 1, 2019 in order to meet the minimum total capital, 
including conservation buffer.\229\
---------------------------------------------------------------------------

    \229\ The OCC estimates that under the Small Business 
Administration's prior $175 million asset threshold, 21 small OCC-
regulated institutions will need to increase capital by a combined 
$54.1 million by January 1, 2019, in order to meet the minimum total 
capital, including conservation buffer.
---------------------------------------------------------------------------

    To estimate the cost to small national banks and federal savings 
associations of the new capital requirement, the OCC examined the 
effect of this requirement on capital structure and the overall cost of 
capital.\230\ The cost of financing a bank or any firm 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 force a bank to deleverage and--all else 
equal--would increase the cost of capital for that bank.
---------------------------------------------------------------------------

    \230\ See Merton H. Miller, (1995), ``Do the M & M propositions 
apply to banks?'' Journal of Banking & Finance, Vol. 19, pp. 483-
489.
---------------------------------------------------------------------------

    This increased cost in the most burdensome year would be tax 
benefits foregone: The capital requirement ($163.6 million), multiplied 
by the interest rate on the debt displaced and by the effective 
marginal tax rate for the banks affected by the 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. 
Using an estimated interest rate on debt of 6 percent, the OCC 
estimated that the annual tax benefits foregone on $163.6 million of 
capital switching from debt to equity is approximately $0.9 million per 
year ($163.6 million * 0.06 (interest rate) * 0.094 (median marginal 
tax savings)).\231\ On average, the cost is approximately $22,500 per 
small national bank and federal savings association per year.\232\
---------------------------------------------------------------------------

    \231\ 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.
    \232\ The OCC estimates that under the Small Business 
Administration's prior $175 million asset threshold, 21 small OCC-
regulated institutions will need to increase capital by a combined 
$54.1 million by January 1, 2019. The OCC estimates that the cost of 
lost tax benefits associated with increasing total capital by $54.1 
million will be approximately $0.3 million per year ($54.1 million * 
0.06 (interest rate) * 0.094 (median marginal tax savings)). On 
average, the cost is approximately $14,500 per institution per year 
under the $175 million threshold.
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    As shown in Table 31, the OCC also estimated that the cost of 
implementing the creditworthiness in the final rule will be 
approximately $55.4 million for small national banks and federal 
savings associations ($43,00 per small OCC-regulated institution). For 
the 41 small state national banks and federal savings associations that 
also have to raise additional capital, the OCC estimates that the cost 
of the final rule will be approximately $65,500. For all other small 
national banks and federal savings associations, the OCC estimated the 
cost of the final rule as $43,000 per institution.\233\
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    \233\ The OCC estimates that under the Small Business 
Administration's prior $175 million asset threshold, the cost of 
implementing the creditworthiness in the final rule will be 
approximately $31.6 million for small national banks and federal 
savings associations (737 institutions * $42,925 cost per 
institution). For the 41 small national banks and federal savings 
associations that also have to raise additional capital, the OCC 
estimates that the cost of the final rule will be approximately 
$57,500. For all other small national banks and federal savings 
associations, the OCC estimated the cost of the final rule as 
$43,000 per institution.

      Table 31--Estimated Costs of Creditworthiness Measurement Activities, OCC-Regulated Institutions With
                       Consolidated Banking Assets of $500 Million or Less, March 31, 2013
----------------------------------------------------------------------------------------------------------------
                                    Number of OCC-
           Institution                 regulated        Estimated hours   Estimated cost per    Estimated cost
                                     institutions       per institution       institution
----------------------------------------------------------------------------------------------------------------
Small national banks and federal              1,291                 505             $42,925         $55,416,175
 savings associations...........
----------------------------------------------------------------------------------------------------------------

To determine if the final rule has a significant economic impact on 
small entities the OCC compared the estimated annual cost with annual 
noninterest expense and annual salaries and employee benefits for each 
OCC-regulated small entity. If the estimated annual cost is greater 
than or equal to 2.5 percent of total noninterest expense or 5 percent 
of annual salaries and employee benefits, the OCC classifies the impact 
as significant. The OCC estimates that the final rule will have a 
significant economic impact on 240 small OCC-regulated entities using 
the $500 million threshold. Following the same procedure, the final 
rule will have a significant economic impact on 219

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small OCC-regulated entities using the $175 million threshold. 
Accordingly, using five percent as the threshold for a substantial 
number of small entities, the OCC finds that under either SBA size 
threshold, the final rule will have a significant economic impact on a 
substantial number of small entities.

F. Steps Taken To Minimize the Economic Impact on Small Entities; 
Significant Alternatives

    In response to commenters' concerns about the potential 
implementation burden on small banking organizations, the agencies have 
made several significant revisions to the proposals for purposes of the 
final rule, as discussed above. Under the final rule, non-advanced 
approaches banking organizations will be permitted to elect to exclude 
amounts reported as AOCI when calculating regulatory capital, to the 
same extent currently permitted under the general risk-based capital 
rules.\234\ In addition, for purposes of calculating risk-weighted 
assets under the standardized approach, the agencies are not adopting 
the proposed treatment for 1-4 fami