[Federal Register Volume 78, Number 198 (Friday, October 11, 2013)]
[Rules and Regulations]
[Pages 62018-62291]
From the Federal Register Online via the Government Publishing 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
[[Page 62019]]
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
[[Page 62021]]
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.
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\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)).
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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\
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\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\
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\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).
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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\
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\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\
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\37\ See section 165 of the Dodd-Frank Act, 12 U.S.C. 5365.
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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\
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\38\ See 12 U.S.C. 1831n(a)(2).
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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\
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\39\ ``Calibrating regulatory capital requirements and buffers:
A top-down approach.'' Basel Committee on Banking Supervision,
October, 2010, available at www.bis.org.
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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\
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\41\ See 12 CFR 225.8.
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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\
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\42\ See 76 FR 21170 (April 14, 2011) for a comparable
definition of ``executive officer.''
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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.
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\43\ See 12 CFR part 215.
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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\
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\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).
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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.
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\45\ Calculations in this table are based on the assumption that
the countercyclical capital buffer amount is zero.
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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.
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\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
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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\
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\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).
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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\
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\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.
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\65\ See 12 CFR 6.2.
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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.
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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.
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\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).
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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.
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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.
---------------------------------------------------------------------------
\71\ 29 U.S.C. 1002, et seq.
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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.
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(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.
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\73\ See 12 CFR part 225, appendix A, section II.A.1.
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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\
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\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).
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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.
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\77\ 15 U.S.C. 80 a-1 et seq.
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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.
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\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.
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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
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\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\
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\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.
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\81\ Public Law 111-240, 124 Stat. 2504 (2010).
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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\
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\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.
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U.S. law is consistent with the Basel non-viability standard. The
resolution regime established in Title II, section 210 of the Dodd-
Frank Act provides the FDIC with the authority necessary to place
failing financial companies that pose a significant risk to the
financial stability of the United States into receivership.\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.
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\83\ See 12 U.S.C. 5384.
\84\ See 12 U.S.C. 5384.
\85\ 12 U.S.C. 1821.
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Consistent with the Basel non-viability standard, under the
proposal, additional tier 1 and tier 2 capital instruments issued by
advanced approaches banking organizations after the date on which such
organizations would have been required to comply with any 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).
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Under the proposed rule, the limitations described previously on
the inclusion of minority interest in regulatory capital would have
applied to capital instruments issued by consolidated REIT
subsidiaries. Specifically, preferred stock issued by a REIT subsidiary
that met the proposed definition of an operating entity (as defined
below) would have qualified for inclusion in the regulatory capital of
a banking organization subject to the limitations outlined in section
21 of the proposed rule only if the REIT preferred stock met the
criteria for additional tier 1 or tier 2 capital instruments outlined
in section 20 of the proposed rules. Because a REIT must distribute 90
percent of its earnings to maintain its tax-advantaged status, a
banking organization might be reluctant to cancel dividends on the REIT
preferred 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.
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\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.
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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).
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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.
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\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.
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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).
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\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).
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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.
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\97\ The deduction provided for in the agencies' existing
regulations would be removed and would exist solely in the final
rule.
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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\
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\98\ 12 U.S.C. 1464(t)(5).
\99\ See 12 CFR 167.1; 12 CFR 167.5(a)(2)(iv).
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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\
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\100\ 12 CFR 324.22.
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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\
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\101\ 825-10-25 (former Financial Accounting Standards Board
Statement No. 159).
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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.
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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\
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\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.
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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\
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\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\
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\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.
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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
[[Page 62068]]
[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).
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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).
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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.
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\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).
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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.
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\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.
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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.
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\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\
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\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).
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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.
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\144\ These warranties may cover only those loans that were
originated within 1 year of the date of transfer.
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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.
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\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.
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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\
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\149\ See section 34(a)(2) of the final rule.
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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.
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\155\ See section 2 of the final rule for the definition of a
repo-style transaction.
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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.
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\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.
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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.
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\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.
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\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.
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\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.
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\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\
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\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\
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\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.
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\170\ Such transactions are treated as derivative contracts as
provided in section 34 or section 35 of the final rule.
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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.
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\171\ 77 FR 53060 (August 30, 2012).
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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\
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\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.
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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).
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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.
---------------------------------------------------------------------------
\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.
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\183\ Interagency Statement on the Purchase and Risk Management
of Life Insurance, pp. 19-20, http://www.federalreserve.gov/boarddocs/srletters/2004/SR0419a1.pdf.
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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.
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\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.
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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.
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\185\ See 76 FR 37620 (June 28, 2011).
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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.
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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.
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\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).
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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.
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\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.
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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\
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\190\ Other public disclosure requirements would continue to
apply, such as federal securities law, and regulatory reporting
requirements for banking organizations.
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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.
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\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.
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\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;
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\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.
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\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.
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\206\ See 12 U.S.C. 1831n, note.
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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\
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\207\ See 77 FR 53060 (August 30, 2012).
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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\
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\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.
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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\
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\209\ See 15 U.S.C. 78o-7, note.
\210\ See 12 U.S.C. 5371.
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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\
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\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).
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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\
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\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).
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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.
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\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).
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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\
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\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.
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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.
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\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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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
[[Page 62156]]
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 family residential mortgages, which
would have required banking organizations to categorize residential
mortgage loans into one of two categories based on certain underwriting
standards and product features, and then risk weight each loan based on
its loan-to-value ratio. The agencies also are retaining the 120-day
safe harbor from recourse treatment for loans transferred pursuant to
an early default provision. The agencies believe that these changes
will meaningfully reduce the compliance burden of the final rule for
small banking organizations. For instance, in contrast to the proposal,
the final rule does not require banking organizations to review
existing mortgage loan files, purchase new software to track loan-to-
value ratios, train employees on the new risk-weight methodology, or
hold more capital for exposures that would have been deemed category 2
under the proposed rule, removing the proposed distinction between risk
weights for category 1 and 2 residential mortgage exposures.
---------------------------------------------------------------------------
\234\ For most non-advanced approaches banking organizations,
this will be a one-time only election. However, in certain limited
circumstances, such as a merger of organizations that have made
different elections, the primary Federal supervisory may permit the
resultant entity to make a new election.
---------------------------------------------------------------------------
Similarly, the option to elect to retain the current treatment of
AOCI will reduce the burden associated with managing the volatility in
regulatory capital resulting from changes in the value of a banking
organization's AFS debt securities portfolio due to shifting interest
rate environments. Additionally, the final rule grandfathers the
regulatory capital treatment of trust preferred securities issued by
certain small banking organizations prior to May 19, 2010, as permitted
by section 171 of the Dodd-Frank Act, to reduce the amount of capital
small banking organizations must raise to comply with the final rule.
These modifications to the proposed rule should substantially reduce
compliance burden for small banking organizations.
This Supplementary Information section includes statements of
factual, policy, and legal reasons for selecting alternatives adopted
in this final rule and why each one of the other significant
alternatives to the final rule considered by the agencies and which
affect small entities was rejected.
XVII. Paperwork Reduction Act
In accordance with the requirements of the Paperwork Reduction Act
(PRA) of 1995 (44 U.S.C. 3501-3521), the agencies may not conduct or
sponsor, and the respondent is not required to respond to, an
information collection unless it displays a currently valid Office of
Management and Budget (OMB) control number.
In conjunction with the proposed rules, the OCC and FDIC submitted
the information collection requirements contained therein to OMB for
review. In response, OMB filed comments with the OCC and FDIC in
accordance with 5 CFR 1320.11(c) withholding PRA approval and
instructing that the collection should be resubmitted to OMB at the
final rule stage. As instructed by OMB, the information collection
requirements contained in this final rule have been submitted by the
OCC and FDIC to OMB for review under the PRA, under OMB Control Nos.
1557-0234 and 3064-0153. In accordance with the PRA (44 U.S.C. 3506; 5
CFR part 1320, Appendix A.1), the Board has reviewed the final rule
under the authority delegated by OMB. The Board's OMB Control No. is
7100-0313.
The final rule contains information collection requirements subject
to the PRA. They are found in sections --.3, --.22, --.35, --.37,
--.41, --.42, --.62, --.63 (including tables), --.121 through --.124,
--.132, --.141, --.142, --.153, --.173 (including tables). The
information collection requirements contained in sections --.203
through --.212 concerning market risk are approved by OMB under Control
Nos. 1557-0247, 7100-0314, and 3064-0178.
A total of nine comments were received concerning paperwork. Seven
expressed concern regarding the increase in paperwork resulting from
the rule. They addressed the concept of paperwork generally and not
within the context of the PRA.
One comment addressed cost, competitiveness, and qualitative impact
statements, and noted the lack of cost estimates. It was unclear
whether the commenter was referring to cost estimates for regulatory
burden, which are included in the preamble to the rule, or cost
estimates regarding the PRA burden, which are included in the
submissions (information collection requests) made to OMB by the
agencies regarding the final rule. All of the agencies' submissions are
publicly available at www.reginfo.gov.
One commenter seemed to indicate that the agencies' and the FDIC's
burden estimates are overstated. The commenter stated that, for their
institution, the PRA burden will parallel that of interest rate risk
(240 hours per year). The agencies' estimates far exceed that figure,
so no change to the estimates would be necessary. The agencies'
continue to believe that their estimates are reasonable averages that
are not overstated.
The agencies have an ongoing interest in your comments. Comments
are invited on:
(a) Whether the collection of information is necessary for the
proper performance of the agencies' functions, including whether the
information has practical utility;
(b) The accuracy of the estimates of the burden of the information
collection, including the validity of the methodology and assumptions
used;
(c) Ways to enhance the quality, utility, and clarity of the
information to be collected;
(d) Ways to minimize the burden of the information collection on
respondents, including through the use of automated collection
techniques or other forms of information technology; and
(e) Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.
XVIII. Plain Language
Section 722 of the Gramm-Leach-Bliley Act requires the Federal
banking agencies to use plain language in all proposed and rules
published after January 1, 2000. The agencies have sought to present
the proposed rule in a simple and straightforward manner and did not
receive any comments on the use of plain language.
[[Page 62157]]
XIX. OCC Unfunded Mandates Reform Act of 1995 Determinations
Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) (2
U.S.C. 1532 et seq.) requires that an agency prepare a written
statement before promulgating a rule that includes a Federal mandate
that may result in the expenditure by State, local, and Tribal
governments, in the aggregate, or by the private sector of $100 million
or more (adjusted annually for inflation) in any one year. If a written
statement is required, the UMRA (2 U.S.C. 1535) also requires an agency
to identify and consider a reasonable number of regulatory alternatives
before promulgating a rule and from those alternatives, either select
the least costly, most cost-effective or least burdensome alternative
that achieves the objectives of the rule, or provide a statement with
the rule explaining why such an option was not chosen.
Under this rule, the changes to minimum capital requirements
include a new common equity tier 1 capital ratio, a higher minimum tier
1 capital ratio, a supplementary leverage ratio for advanced approaches
banks, new thresholds for prompt corrective action purposes, a new
capital conservation buffer, and a new countercyclical capital buffer
for advanced approaches banks. To estimate the impact of this rule on
bank capital needs, the OCC estimated the amount of capital banks will
need to raise to meet the new minimum standards relative to the amount
of capital they currently hold. To estimate new capital ratios and
requirements, the OCC used currently available data from banks'
quarterly Consolidated Reports of Condition and Income (Call Reports)
to approximate capital under the proposed rule. Most banks have raised
their capital levels well above the existing minimum requirements and,
after comparing existing levels with the proposed new requirements, the
OCC has determined that its proposed rule will not result in
expenditures by State, local, and Tribal governments, or by the private
sector, of $100 million or more. Accordingly, the UMRA does not require
that a written statement accompany this rule.
Text of Common Rule
Part [----]--CAPITAL ADEQUACY OF [BANK]s
Sec.
Subpart A--General Provisions
--.1 Purpose, applicability, reservations of authority, and timing.
--.2 Definitions.
--.3 Operational requirements for certain exposures.
--.4 through --.9 [RESERVED]
Subpart B--Capital Ratio Requirements and Buffers
--.10 Minimum capital requirements.
--.11 Capital conservation buffer and countercyclical capital buffer
amount.
--.12 through --.19 [RESERVED]
Subpart C--Definition of Capital
--.20 Capital components and eligibility criteria for regulatory
capital instruments.
--.21 Minority interest.
--.22 Regulatory capital adjustments and deductions.
--.23 through --.29 [RESERVED]
Subpart D--Risk-weighted Assets--Standardized Approach
--.30 Applicability.
Risk-Weighted Assets for General Credit Risk
--.31 Mechanics for calculating risk-weighted assets for general
credit risk.
--.32 General risk weights.
--.33 Off-balance sheet exposures.
--.34 OTC derivative contracts.
--.35 Cleared transactions.
--.36 Guarantees and credit derivatives: Substitution treatment.
--.37 Collateralized transactions.
Risk-Weighted Assets for Unsettled Transactions
--.38 Unsettled transactions.
--.39 through --.40 [RESERVED]
Risk-Weighted Assets for Securitization Exposures
--.41 Operational requirements for securitization exposures.
--.42 Risk-weighted assets for securitization exposures.
--.43 Simplified supervisory formula approach (SSFA) and the gross-
up approach.
--.44 Securitization exposures to which the SSFA and gross-up
approach do not apply.
--.45 Recognition of credit risk mitigants for securitization
exposures.
--.46 through --.50 [RESERVED]
Risk-Weighted Assets for Equity Exposures
--.51 Introduction and exposure measurement.
--.52 Simple risk-weight approach (SRWA).
--.53 Equity exposures to investment funds.
--.54 through --.60 [RESERVED]
Disclosures
--.61 Purpose and scope.
--.62 Disclosure requirements.
--.63 Disclosures by [BANK]s described in Sec. --.61.
--.64 through --.99 [RESERVED]
Subpart E--Risk-Weighted Assets--Internal Ratings-Based and Advanced
Measurement Approaches
--.100 Purpose, applicability, and principle of conservatism.
--.101 Definitions.
--.102 through --.120 [RESERVED]
Qualification
--.121 Qualification process.
--.122 Qualification requirements.
--.123 Ongoing qualification.
--.124 Merger and acquisition transitional arrangements.
--.125 through --.130 [RESERVED]
Risk-Weighted Assets For General Credit Risk
--.131 Mechanics for calculating total wholesale and retail risk-
weighted assets.
--.132 Counterparty credit risk of repo-style transactions, eligible
margin loans, and OTC derivative contracts.
--.133 Cleared transactions.
--.134 Guarantees and credit derivatives: PD substitution and LGD
adjustment approaches.
--.135 Guarantees and credit derivatives: Double default treatment.
--.136 Unsettled transactions.
--.137 through --.140 [RESERVED]
Risk-Weighted Assets for Securitization Exposures
--.141 Operational criteria for recognizing the transfer of risk.
--.142 Risk-weighted assets for securitization exposures.
--.143 Supervisory formula approach (SFA).
--.144 Simplified supervisory formula approach (SSFA).
--.145 Recognition of credit risk mitigants for securitization
exposures.
--.146 through --.150 [RESERVED]
Risk-Weighted Assets For Equity Exposures
--.151 Introduction and exposure measurement.
--.152 Simple risk weight approach (SRWA).
--.153 Internal models approach (IMA).
--.154 Equity exposures to investment funds.
--.155 Equity derivative contracts.
--.166 through --.160 [RESERVED]
Risk-Weighted Assets For Operational Risk
--.161 Qualification requirements for incorporation of operational
risk mitigants.
--.162 Mechanics of risk-weighted asset calculation.
--.163 through --.170 [RESERVED]
Disclosures
--.171 Purpose and scope.
--.172 Disclosure requirements.
--.173 Disclosures by certain advanced approaches [BANKS].
--.174 through --.200 [RESERVED]
Subpart F--Risk-weighted Assets--Market Risk
--.201 Purpose, applicability, and reservation of authority.
--.202 Definitions.
--.203 Requirements for application of this subpart F.
--.204 Measure for market risk.
--.205 VaR-based measure.
[[Page 62158]]
--.206 Stressed VaR-based measure.
--.207 Specific risk.
--.208 Incremental risk.
--.209 Comprehensive risk.
--.210 Standardized measurement method for specific risk.
--.211 Simplified supervisory formula approach (SSFA).
--.212 Market risk disclosures.
--.213 through --.299 [RESERVED]
Subpart G--Transition Provisions
--.300 Transitions.
Subpart A--General Provisions
Sec. --.1 Purpose, applicability, reservations of authority, and
timing.
(a) Purpose. This [PART] establishes minimum capital requirements
and overall capital adequacy standards for [BANK]s. This [PART]
includes methodologies for calculating minimum capital requirements,
public disclosure requirements related to the capital requirements, and
transition provisions for the application of this [PART].
(b) Limitation of authority. Nothing in this [PART] shall be read
to limit the authority of the [AGENCY] to take action under other
provisions of law, including action to address unsafe or unsound
practices or conditions, deficient capital levels, or violations of law
or regulation, under section 8 of the Federal Deposit Insurance Act.
(c) Applicability. Subject to the requirements in paragraphs (d)
and (f) of this section:
(1) Minimum capital requirements and overall capital adequacy
standards. Each [BANK] must calculate its minimum capital requirements
and meet the overall capital adequacy standards in subpart B of this
part.
(2) Regulatory capital. Each [BANK] must calculate its regulatory
capital in accordance with subpart C of this part.
(3) Risk-weighted assets. (i) Each [BANK] must use the
methodologies in subpart D of this part (and subpart F of this part for
a market risk [BANK]) to calculate standardized total risk-weighted
assets.
(ii) Each advanced approaches [BANK] must use the methodologies in
subpart E (and subpart F of this part for a market risk [BANK]) to
calculate advanced approaches total risk-weighted assets.
(4) Disclosures. (i) Except for an advanced approaches [BANK] that
is making public disclosures pursuant to the requirements in subpart E
of this part, each [BANK] with total consolidated assets of $50 billion
or more must make the public disclosures described in subpart D of this
part.
(ii) Each market risk [BANK] must make the public disclosures
described in subpart F of this part.
(iii) Each advanced approaches [BANK] must make the public
disclosures described in subpart E of this part.
(d) Reservation of authority. (1) Additional capital in the
aggregate. The [AGENCY] may require a [BANK] to hold an amount of
regulatory capital greater than otherwise required under this part if
the [AGENCY] determines that the [BANK]'s capital requirements under
this part are not commensurate with the [BANK]'s credit, market,
operational, or other risks.
(2) Regulatory capital elements. (i) If the [AGENCY] determines
that a particular common equity tier 1, additional tier 1, or tier 2
capital element has characteristics or terms that diminish its ability
to absorb losses, or otherwise present safety and soundness concerns,
the [AGENCY] may require the [BANK] to exclude all or a portion of such
element from common equity tier 1 capital, additional tier 1 capital,
or tier 2 capital, as appropriate.
(ii) Notwithstanding the criteria for regulatory capital
instruments set forth in subpart C of this part, the [AGENCY] may find
that a capital element may be included in a [BANK]'s common equity tier
1 capital, additional tier 1 capital, or tier 2 capital on a permanent
or temporary basis consistent with the loss absorption capacity of the
element and in accordance with Sec. --.20(e).
(3) Risk-weighted asset amounts. If the [AGENCY] determines that
the risk-weighted asset amount calculated under this part by the [BANK]
for one or more exposures is not commensurate with the risks associated
with those exposures, the [AGENCY] may require the [BANK] to assign a
different risk-weighted asset amount to the exposure(s) or to deduct
the amount of the exposure(s) from its regulatory capital.
(4) Total leverage. If the [AGENCY] determines that the leverage
exposure amount, or the amount reflected in the [BANK]'s reported
average total consolidated assets, for an on- or off-balance sheet
exposure calculated by a [BANK] under Sec. --.10 is inappropriate for
the exposure(s) or the circumstances of the [BANK], the [AGENCY] may
require the [BANK] to adjust this exposure amount in the numerator and
the denominator for purposes of the leverage ratio calculations.
(5) Consolidation of certain exposures. The [AGENCY] may determine
that the risk-based capital treatment for an exposure or the treatment
provided to an entity that is not consolidated on the [BANK]'s balance
sheet is not commensurate with the risk of the exposure and the
relationship of the [BANK] to the entity. Upon making this
determination, the [AGENCY] may require the [BANK] to treat the
exposure or entity as if it were consolidated on the balance sheet of
the [BANK] for purposes of determining the [BANK]'s risk-based capital
requirements and calculating the [BANK]'s risk-based capital ratios
accordingly. The [AGENCY] will look to the substance of, and risk
associated with, the transaction, as well as other relevant factors the
[AGENCY] deems appropriate in determining whether to require such
treatment.
(6) Other reservation of authority. With respect to any deduction
or limitation required under this part, the [AGENCY] may require a
different deduction or limitation, provided that such alternative
deduction or limitation is commensurate with the [BANK]'s risk and
consistent with safety and soundness.
(e) Notice and response procedures. In making a determination under
this section, the [AGENCY] will apply notice and response procedures in
the same manner as the notice and response procedures in [12 CFR 3.404,
(OCC); 12 CFR 263.202 (Board)].
(f) Timing. (1) Subject to the transition provisions in subpart G
of this part, an advanced approaches [BANK] that is not a savings and
loan holding company must:
(i) Except as described in paragraph (f)(1)(ii) of this section,
beginning on January 1, 2014, calculate advanced approaches total risk-
weighted assets in accordance with subpart E and, if applicable,
subpart F of this part and, beginning on January 1, 2015, calculate
standardized total risk-weighted assets in accordance with subpart D
and, if applicable, subpart F of this part;
(ii) From January 1, 2014 to December 31, 2014:
(A) Calculate risk-weighted assets in accordance with the general
risk-based capital rules under [12 CFR part 3, appendix A and, if
applicable, appendix B (national banks), or 12 CFR part 167 (Federal
savings associations) (OCC); 12 CFR parts 208 or 225, appendix A, and,
if applicable, appendix E (state member banks or bank holding
companies, respectively) (Board)] \1\ and substitute
[[Page 62159]]
such risk-weighted assets for standardized total risk-weighted assets
for purposes of Sec. --.10;
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\1\ For the purpose of calculating its general risk-based
capital ratios from January 1, 2014 to December 31, 2014, an
advanced approaches [BANK] shall adjust, as appropriate, its risk-
weighted asset measure (as that amount is calculated under [12 CFR
part 3, appendix A, Sec. 3 and, if applicable, 12 CFR part 3,
appendix B (national banks), or 12 CFR part 167 (Federal savings
associations) (OCC); 12 CFR parts 208 and 225, and, if applicable,
appendix E (state member banks or bank holding companies,
respectively) (Board)] in the general risk-based capital rules) by
excluding those assets that are deducted from its regulatory capital
under Sec. --.22.
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(B) If applicable, calculate general market risk equivalent assets
in accordance with [12 CFR part 3, appendix B, section 4(a)(3)
(national banks) (OCC); 12 CFR parts 208 or 225, appendix E, section
4(a)(3) (state member banks or bank holding companies, respectively)
(Board); and 12 CFR part 325, appendix C, section 4(a)(3) (state
nonmember banks and state savings associations)] and substitute such
general market risk equivalent assets for standardized market risk-
weighted assets for purposes of Sec. --.20(d)(3); and
(C) Substitute the corresponding provision or provisions of [12 CFR
part 3, appendix A, and, if applicable, appendix B (national banks), or
12 CFR part 167 (Federal savings associations) (OCC)); 12 CFR parts 208
or 225, appendix A, and, if applicable, appendix E (state member banks
or bank holding companies, respectively) (Board)] for any reference to
subpart D of this part in: Sec. --.121(c); Sec. --.124(a) and (b);
Sec. --.144(b); Sec. --.154(c) and (d); Sec. --.202(b) (definition
of covered position in paragraph (b)(3)(iv)); and Sec. --.211(b);\2\
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\2\ In addition, for purposes of Sec. --.201(c)(3), from
January 1, 2014 to December 31, 2014, for any circumstance in which
the [AGENCY] may require a [BANK] to calculate risk-based capital
requirements for specific positions or portfolios under subpart D of
this part, the [AGENCY] will instead require the [BANK] to make such
calculations according to [12 CFR part 3, appendix A, Sec. 3,
appendix A, section 3 and, if applicable, 12 CFR part 3, appendix B
(national banks), or 12 CFR part 167 (Federal savings associations)
(OCC); 12 CFR parts 208 and 225, appendix A and, if applicable,
appendix E (state member banks or bank holding companies,
respectively) (Board)].
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(iii) Beginning on January 1, 2014, calculate and maintain minimum
capital ratios in accordance with subparts A, B, and C of this part,
provided, however, that such [BANK] must:
(A) From January 1, 2014 to December 31, 2014, maintain a minimum
common equity tier 1 capital ratio of 4 percent, a minimum tier 1
capital ratio of 5.5 percent, a minimum total capital ratio of 8
percent, and a minimum leverage ratio of 4 percent; and
(B) From January 1, 2015 to December 31, 2017, an advanced
approaches [BANK]:
(1) Is not required to maintain a supplementary leverage ratio; and
(2) Must calculate a supplementary leverage ratio in accordance
with Sec. --.10(c), and must report the calculated supplementary
leverage ratio on any applicable regulatory reports.
(2) Subject to the transition provisions in subpart G of this part,
a [BANK] that is not an advanced approaches [BANK] or a savings and
loan holding company that is an advanced approaches [BANK] must:
(i) Beginning on January 1, 2015, calculate standardized total
risk-weighted assets in accordance with subpart D, and if applicable,
subpart F of this part; and
(ii) Beginning on January 1, 2015, calculate and maintain minimum
capital ratios in accordance with subparts A, B and C of this part,
provided, however, that from January 1, 2015 to December 31, 2017, a
savings and loan holding company that is an advanced approaches [BANK]:
(A) Is not required to maintain a supplementary leverage ratio; and
(B) Must calculate a supplementary leverage ratio in accordance
with Sec. --.10(c), and must report the calculated supplementary
leverage ratio on any applicable regulatory reports.
(3) Beginning on January 1, 2016, and subject to the transition
provisions in subpart G of this part, a [BANK] is subject to
limitations on distributions and discretionary bonus payments with
respect to its capital conservation buffer and any applicable
countercyclical capital buffer amount, in accordance with subpart B of
this part.
Sec. --.2 Definitions.
As used in this part:
Additional tier 1 capital is defined in Sec. --.20(c).
Advanced approaches [BANK] means a [BANK] that is described in
Sec. --.100(b)(1).
Advanced approaches total risk-weighted assets means:
(1) The sum of:
(i) Credit-risk-weighted assets;
(ii) Credit valuation adjustment (CVA) risk-weighted assets;
(iii) Risk-weighted assets for operational risk; and
(iv) For a market risk [BANK] only, advanced market risk-weighted
assets; minus
(2) Excess eligible credit reserves not included in the [BANK]'s
tier 2 capital.
Advanced market risk-weighted assets means the advanced measure for
market risk calculated under Sec. --.204 multiplied by 12.5.
Affiliate with respect to a company, means any company that
controls, is controlled by, or is under common control with, the
company.
Allocated transfer risk reserves means reserves that have been
established in accordance with section 905(a) of the International
Lending Supervision Act, against certain assets whose value U.S.
supervisory authorities have found to be significantly impaired by
protracted transfer risk problems.
Allowances for loan and lease losses (ALLL) means valuation
allowances that have been established through a charge against earnings
to cover estimated credit losses on loans, lease financing receivables
or other extensions of credit as determined in accordance with GAAP.
ALLL excludes ``allocated transfer risk reserves.'' For purposes of
this part, ALLL includes allowances that have been established through
a charge against earnings to cover estimated credit losses associated
with off-balance sheet credit exposures as determined in accordance
with GAAP.
Asset-backed commercial paper (ABCP) program means a program
established primarily for the purpose of issuing commercial paper that
is investment grade and backed by underlying exposures held in a
bankruptcy-remote special purpose entity (SPE).
Asset-backed commercial paper (ABCP) program sponsor means a [BANK]
that:
(1) Establishes an ABCP program;
(2) Approves the sellers permitted to participate in an ABCP
program;
(3) Approves the exposures to be purchased by an ABCP program; or
(4) Administers the ABCP program by monitoring the underlying
exposures, underwriting or otherwise arranging for the placement of
debt or other obligations issued by the program, compiling monthly
reports, or ensuring compliance with the program documents and with the
program's credit and investment policy.
Bank holding company means a bank holding company as defined in
section 2 of the Bank Holding Company Act.
Bank Holding Company Act means the Bank Holding Company Act of
1956, as amended (12 U.S.C. 1841 et seq.).
Bankruptcy remote means, with respect to an entity or asset, that
the entity or asset would be excluded from an insolvent entity's estate
in receivership, insolvency, liquidation, or similar proceeding.
Call Report means Consolidated Reports of Condition and Income.
Carrying value means, with respect to an asset, the value of the
asset on the balance sheet of the [BANK], determined in accordance with
GAAP.
Central counterparty (CCP) means a counterparty (for example, a
clearing house) that facilitates trades between counterparties in one
or more financial markets by either guaranteeing trades or novating
contracts.
CFTC means the U.S. Commodity Futures Trading Commission.
[[Page 62160]]
Clean-up call means a contractual provision that permits an
originating [BANK] or servicer to call securitization exposures before
their stated maturity or call date.
Cleared transaction means an exposure associated with an
outstanding derivative contract or repo-style transaction that a [BANK]
or clearing member has entered into with a central counterparty (that
is, a transaction that a central counterparty has accepted).
(1) The following transactions are cleared transactions:
(i) A transaction between a CCP and a [BANK] that is a clearing
member of the CCP where the [BANK] enters into the transaction with the
CCP for the [BANK]'s own account;
(ii) A transaction between a CCP and a [BANK] that is a clearing
member of the CCP where the [BANK] is acting as a financial
intermediary on behalf of a clearing member client and the transaction
offsets another transaction that satisfies the requirements set forth
in Sec. --.3(a);
(iii) A transaction between a clearing member client [BANK] and a
clearing member where the clearing member acts as a financial
intermediary on behalf of the clearing member client and enters into an
offsetting transaction with a CCP, provided that the requirements set
forth in Sec. --.3(a) are met; or
(iv) A transaction between a clearing member client [BANK] and a
CCP where a clearing member guarantees the performance of the clearing
member client [BANK] to the CCP and the transaction meets the
requirements of Sec. --.3(a)(2) and (3).
(2) The exposure of a [BANK] that is a clearing member to its
clearing member client is not a cleared transaction where the [BANK] is
either acting as a financial intermediary and enters into an offsetting
transaction with a CCP or where the [BANK] provides a guarantee to the
CCP on the performance of the client.\3\
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\3\ For the standardized approach treatment of these exposures,
see Sec. --.34(e) (OTC derivative contracts) or Sec. --.37(c)
(repo-style transactions). For the advanced approaches treatment of
these exposures, see Sec. Sec. --.132(c)(8) and (d) (OTC derivative
contracts) or Sec. Sec. --.132(b) and Sec. --.132(d) (repo-style
transactions) and for calculation of the margin period of risk, see
Sec. Sec. --.132(d)(5)(iii)(C) (OTC derivative contracts) and Sec.
--.132(d)(5)(iii)(A) (repo-style transactions).
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Clearing member means a member of, or direct participant in, a CCP
that is entitled to enter into transactions with the CCP.
Clearing member client means a party to a cleared transaction
associated with a CCP in which a clearing member acts either as a
financial intermediary with respect to the party or guarantees the
performance of the party to the CCP.
Collateral agreement means a legal contract that specifies the time
when, and circumstances under which, a counterparty is required to
pledge collateral to a [BANK] for a single financial contract or for
all financial contracts in a netting set and confers upon the [BANK] a
perfected, first-priority security interest (notwithstanding the prior
security interest of any custodial agent), or the legal equivalent
thereof, in the collateral posted by the counterparty under the
agreement. This security interest must provide the [BANK] with a right
to close out the financial positions and liquidate the collateral upon
an event of default of, or failure to perform by, the counterparty
under the collateral agreement. A contract would not satisfy this
requirement if the [BANK]'s exercise of rights under the agreement may
be stayed or avoided under applicable law in the relevant
jurisdictions, other than in receivership, conservatorship, resolution
under the Federal Deposit Insurance Act, Title II of the Dodd-Frank
Act, or under any similar insolvency law applicable to GSEs.
Commitment means any legally binding arrangement that obligates a
[BANK] to extend credit or to purchase assets.
Commodity derivative contract means a commodity-linked swap,
purchased commodity-linked option, forward commodity-linked contract,
or any other instrument linked to commodities that gives rise to
similar counterparty credit risks.
Commodity Exchange Act means the Commodity Exchange Act of 1936 (7
U.S.C. 1 et seq.)
Common equity tier 1 capital is defined in Sec. --.20(b).
Common equity tier 1 minority interest means the common equity tier
1 capital of a depository institution or foreign bank that is:
(1) A consolidated subsidiary of a [BANK]; and
(2) Not owned by the [BANK].
Company means a corporation, partnership, limited liability
company, depository institution, business trust, special purpose
entity, association, or similar organization.
Control. A person or company controls a company if it:
(1) Owns, controls, or holds with power to vote 25 percent or more
of a class of voting securities of the company; or
(2) Consolidates the company for financial reporting purposes.
Corporate exposure means an exposure to a company that is not:
(1) An exposure to a sovereign, the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, a multi-lateral development bank (MDB), a
depository institution, a foreign bank, a credit union, or a public
sector entity (PSE);
(2) An exposure to a GSE;
(3) A residential mortgage exposure;
(4) A pre-sold construction loan;
(5) A statutory multifamily mortgage;
(6) A high volatility commercial real estate (HVCRE) exposure;
(7) A cleared transaction;
(8) A default fund contribution;
(9) A securitization exposure;
(10) An equity exposure; or
(11) An unsettled transaction.
Country risk classification (CRC) with respect to a sovereign,
means the most recent consensus CRC published by the Organization for
Economic Cooperation and Development (OECD) as of December 31st of the
prior calendar year that provides a view of the likelihood that the
sovereign will service its external debt.
Covered savings and loan holding company means a top-tier savings
and loan holding company other than:
(1) A top-tier savings and loan holding company that is:
(i) A grandfathered unitary savings and loan holding company as
defined in section 10(c)(9)(A) of HOLA; and
(ii) As of June 30 of the previous calendar year, derived 50
percent or more of its total consolidated assets or 50 percent of its
total revenues on an enterprise-wide basis (as calculated under GAAP)
from activities that are not financial in nature under section 4(k) of
the Bank Holding Company Act (12 U.S.C. 1842(k));
(2) A top-tier savings and loan holding company that is an
insurance underwriting company; or
(3)(i) A top-tier savings and loan holding company that, as of June
30 of the previous calendar year, held 25 percent or more of its total
consolidated assets in subsidiaries that are insurance underwriting
companies (other than assets associated with insurance for credit
risk); and
(ii) For purposes of paragraph (3)(i) of this definition, the
company must calculate its total consolidated assets in accordance with
GAAP, or if the company does not calculate its total consolidated
assets under GAAP for any regulatory purpose (including compliance with
applicable securities laws), the company may estimate its total
consolidated assets, subject to review and adjustment by the Board.
[[Page 62161]]
Credit derivative means a financial contract executed under
standard industry credit derivative documentation that allows one party
(the protection purchaser) to transfer the credit risk of one or more
exposures (reference exposure(s)) to another party (the protection
provider) for a certain period of time.
Credit-enhancing interest-only strip (CEIO) means an on-balance
sheet asset that, in form or in substance:
(1) Represents a contractual right to receive some or all of the
interest and no more than a minimal amount of principal due on the
underlying exposures of a securitization; and
(2) Exposes the holder of the CEIO to credit risk directly or
indirectly associated with the underlying exposures that exceeds a pro
rata share of the holder's claim on the underlying exposures, whether
through subordination provisions or other credit-enhancement
techniques.
Credit-enhancing representations and warranties means
representations and warranties that are made or assumed in connection
with a transfer of underlying exposures (including loan servicing
assets) and that obligate a [BANK] to protect another party from losses
arising from the credit risk of the underlying exposures. Credit-
enhancing representations and warranties include provisions to protect
a party from losses resulting from the default or nonperformance of the
counterparties of the underlying exposures or from an insufficiency in
the value of the collateral backing the underlying exposures. Credit-
enhancing representations and warranties do not include:
(1) Early default clauses and similar warranties that permit the
return of, or premium refund clauses covering, 1-4 family residential
first mortgage loans that qualify for a 50 percent risk weight for a
period not to exceed 120 days from the date of transfer. These
warranties may cover only those loans that were originated within 1
year of the date of transfer;
(2) Premium refund clauses that cover assets guaranteed, in whole
or in part, by the U.S. Government, a U.S. Government agency or a GSE,
provided the premium refund clauses are for a period not to exceed 120
days from the date of transfer; or
(3) Warranties that permit the return of underlying exposures in
instances of misrepresentation, fraud, or incomplete documentation.
Credit risk mitigant means collateral, a credit derivative, or a
guarantee.
Credit-risk-weighted assets means 1.06 multiplied by the sum of:
(1) Total wholesale and retail risk-weighted assets as calculated
under Sec. --.131;
(2) Risk-weighted assets for securitization exposures as calculated
under Sec. --.142; and
(3) Risk-weighted assets for equity exposures as calculated under
Sec. --.151.
Credit union means an insured credit union as defined under the
Federal Credit Union Act (12 U.S.C. 1752 et seq.).
Current exposure means, with respect to a netting set, the larger
of zero or the fair value of a transaction or portfolio of transactions
within the netting set that would be lost upon default of the
counterparty, assuming no recovery on the value of the transactions.
Current exposure is also called replacement cost.
Current exposure methodology means the method of calculating the
exposure amount for over-the-counter derivative contracts in Sec.
--.34(a) and exposure at default (EAD) in Sec. --.132(c)(5) or (6), as
applicable.
Custodian means a financial institution that has legal custody of
collateral provided to a CCP.
Default fund contribution means the funds contributed or
commitments made by a clearing member to a CCP's mutualized loss
sharing arrangement.
Depository institution means a depository institution as defined in
section 3 of the Federal Deposit Insurance Act.
Depository institution holding company means a bank holding company
or savings and loan holding company.
Derivative contract means a financial contract whose value is
derived from the values of one or more underlying assets, reference
rates, or indices of asset values or reference rates. Derivative
contracts include interest rate derivative contracts, exchange rate
derivative contracts, equity derivative contracts, commodity derivative
contracts, credit derivative contracts, and any other instrument that
poses similar counterparty credit risks. Derivative contracts also
include unsettled securities, commodities, and foreign exchange
transactions with a contractual settlement or delivery lag that is
longer than the lesser of the market standard for the particular
instrument or five business days.
Discretionary bonus payment means a payment made to an executive
officer of a [BANK], where:
(1) The [BANK] retains discretion as to whether to make, and the
amount of, the payment until the payment is awarded to the executive
officer;
(2) The amount paid is determined by the [BANK] without prior
promise to, or agreement with, the executive officer; and
(3) The executive officer has no contractual right, whether express
or implied, to the bonus payment.
Distribution means:
(1) A reduction of tier 1 capital through the repurchase of a tier
1 capital instrument or by other means, except when a [BANK], within
the same quarter when the repurchase is announced, fully replaces a
tier 1 capital instrument it has repurchased by issuing another capital
instrument that meets the eligibility criteria for:
(i) A common equity tier 1 capital instrument if the instrument
being repurchased was part of the [BANK]'s common equity tier 1
capital, or
(ii) A common equity tier 1 or additional tier 1 capital instrument
if the instrument being repurchased was part of the [BANK]'s tier 1
capital;
(2) A reduction of tier 2 capital through the repurchase, or
redemption prior to maturity, of a tier 2 capital instrument or by
other means, except when a [BANK], within the same quarter when the
repurchase or redemption is announced, fully replaces a tier 2 capital
instrument it has repurchased by issuing another capital instrument
that meets the eligibility criteria for a tier 1 or tier 2 capital
instrument;
(3) A dividend declaration or payment on any tier 1 capital
instrument;
(4) A dividend declaration or interest payment on any tier 2
capital instrument if the [BANK] has full discretion to permanently or
temporarily suspend such payments without triggering an event of
default; or
(5) Any similar transaction that the [AGENCY] determines to be in
substance a distribution of capital.
Dodd-Frank Act means the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (Pub. L. 111-203, 124 Stat. 1376).
Early amortization provision means a provision in the documentation
governing a securitization that, when triggered, causes investors in
the securitization exposures to be repaid before the original stated
maturity of the securitization exposures, unless the provision:
(1) Is triggered solely by events not directly related to the
performance of the underlying exposures or the originating [BANK] (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.
[[Page 62162]]
Effective notional amount means for an eligible guarantee or
eligible credit derivative, the lesser of the contractual notional
amount of the credit risk mitigant and the exposure amount (or EAD for
purposes of subpart E of this part) of the hedged exposure, multiplied
by the percentage coverage of the credit risk mitigant.
Eligible ABCP liquidity facility means a liquidity facility
supporting ABCP, in form or in substance, that is subject to an asset
quality test at the time of draw that precludes funding against assets
that are 90 days or more past due or in default. Notwithstanding the
preceding sentence, a liquidity facility is an eligible ABCP liquidity
facility if the assets or exposures funded under the liquidity facility
that do not meet the eligibility requirements are guaranteed by a
sovereign that qualifies for a 20 percent risk weight or lower.
Eligible clean-up call means a clean-up call that:
(1) Is exercisable solely at the discretion of the originating
[BANK] or servicer;
(2) Is not structured to avoid allocating losses to securitization
exposures held by investors or otherwise structured to provide credit
enhancement to the securitization; and
(3)(i) For a traditional securitization, is only exercisable when
10 percent or less of the principal amount of the underlying exposures
or securitization exposures (determined as of the inception of the
securitization) is outstanding; or
(ii) For a synthetic securitization, is only exercisable when 10
percent or less of the principal amount of the reference portfolio of
underlying exposures (determined as of the inception of the
securitization) is outstanding.
Eligible credit derivative means a credit derivative in the form of
a credit default swap, nth-to-default swap, total return
swap, or any other form of credit derivative approved by the [AGENCY],
provided that:
(1) The contract meets the requirements of an eligible guarantee
and has been confirmed by the protection purchaser and the protection
provider;
(2) Any assignment of the contract has been confirmed by all
relevant parties;
(3) If the credit derivative is a credit default swap or
nth-to-default swap, the contract includes the following
credit events:
(i) Failure to pay any amount due under the terms of the reference
exposure, subject to any applicable minimal payment threshold that is
consistent with standard market practice and with a grace period that
is closely in line with the grace period of the reference exposure; and
(ii) Receivership, insolvency, liquidation, conservatorship or
inability of the reference exposure issuer to pay its debts, or its
failure or admission in writing of its inability generally to pay its
debts as they become due, and similar events;
(4) The terms and conditions dictating the manner in which the
contract is to be settled are incorporated into the contract;
(5) If the contract allows for cash settlement, the contract
incorporates a robust valuation process to estimate loss reliably and
specifies a reasonable period for obtaining post-credit event
valuations of the reference exposure;
(6) If the contract requires the protection purchaser to transfer
an exposure to the protection provider at settlement, the terms of at
least one of the exposures that is permitted to be transferred under
the contract provide that any required consent to transfer may not be
unreasonably withheld;
(7) If the credit derivative is a credit default swap or
nth-to-default swap, the contract clearly identifies the
parties responsible for determining whether a credit event has
occurred, specifies that this determination is not the sole
responsibility of the protection provider, and gives the protection
purchaser the right to notify the protection provider of the occurrence
of a credit event; and
(8) If the credit derivative is a total return swap and the [BANK]
records net payments received on the swap as net income, the [BANK]
records offsetting deterioration in the value of the hedged exposure
(either through reductions in fair value or by an addition to
reserves).
Eligible credit reserves means all general allowances that have
been established through a charge against earnings to cover estimated
credit losses associated with on- or off-balance sheet wholesale and
retail exposures, including the ALLL associated with such exposures,
but excluding allocated transfer risk reserves established pursuant to
12 U.S.C. 3904 and other specific reserves created against recognized
losses.
Eligible guarantee means a guarantee from an eligible guarantor
that:
(1) Is written;
(2) Is either:
(i) Unconditional, or
(ii) A contingent obligation of the U.S. government or its
agencies, the enforceability of which is dependent upon some
affirmative action on the part of the beneficiary of the guarantee or a
third party (for example, meeting servicing requirements);
(3) Covers all or a pro rata portion of all contractual payments of
the obligated party on the reference exposure;
(4) Gives the beneficiary a direct claim against the protection
provider;
(5) Is not unilaterally cancelable by the protection provider for
reasons other than the breach of the contract by the beneficiary;
(6) Except for a guarantee by a sovereign, is legally enforceable
against the protection provider in a jurisdiction where the protection
provider has sufficient assets against which a judgment may be attached
and enforced;
(7) Requires the protection provider to make payment to the
beneficiary on the occurrence of a default (as defined in the
guarantee) of the obligated party on the reference exposure in a timely
manner without the beneficiary first having to take legal actions to
pursue the obligor for payment;
(8) Does not increase the beneficiary's cost of credit protection
on the guarantee in response to deterioration in the credit quality of
the reference exposure; and
(9) Is not provided by an affiliate of the [BANK], unless the
affiliate is an insured depository institution, foreign bank,
securities broker or dealer, or insurance company that:
(i) Does not control the [BANK]; and
(ii) Is subject to consolidated supervision and regulation
comparable to that imposed on depository institutions, U.S. securities
broker-dealers, or U.S. insurance companies (as the case may be).
Eligible guarantor means:
(1) A sovereign, the Bank for International Settlements, the
International Monetary Fund, the European Central Bank, the European
Commission, a Federal Home Loan Bank, Federal Agricultural Mortgage
Corporation (Farmer Mac), a multilateral development bank (MDB), a
depository institution, a bank holding company, a savings and loan
holding company, a credit union, a foreign bank, or a qualifying
central counterparty; or
(2) An entity (other than a special purpose entity):
(i) That at the time the guarantee is issued or anytime thereafter,
has issued and outstanding an unsecured debt security without credit
enhancement that is investment grade;
(ii) Whose creditworthiness is not positively correlated with the
credit risk of the exposures for which it has provided guarantees; and
(iii) That is not an insurance company engaged predominately in the
business of providing credit protection (such as a monoline bond
insurer or re-insurer).
[[Page 62163]]
Eligible margin loan means:
(1) An extension of credit where:
(i) The extension of credit is collateralized exclusively by liquid
and readily marketable debt or equity securities, or gold;
(ii) The collateral is marked-to-fair value daily, and the
transaction is subject to daily margin maintenance requirements; and
(iii) The extension of credit is conducted under an agreement that
provides the [BANK] the right to accelerate and terminate the extension
of credit and to liquidate or set-off collateral promptly upon an event
of default, including upon an event of receivership, insolvency,
liquidation, conservatorship, or similar proceeding, of the
counterparty, provided that, in any such case, any exercise of rights
under the agreement will not be stayed or avoided under applicable law
in the relevant jurisdictions, other than in receivership,
conservatorship, resolution under the Federal Deposit Insurance Act,
Title II of the Dodd-Frank Act, or under any similar insolvency law
applicable to GSEs.\4\
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\4\ This requirement is met where all transactions under the
agreement are (i) executed under U.S. law and (ii) constitute
``securities contracts'' under section 555 of the Bankruptcy Code
(11 U.S.C. 555), qualified financial contracts under section
11(e)(8) of the Federal Deposit Insurance Act, or netting contracts
between or among financial institutions under sections 401-407 of
the Federal Deposit Insurance Corporation Improvement Act or the
Federal Reserve Board's Regulation EE (12 CFR part 231).
---------------------------------------------------------------------------
(2) In order to recognize an exposure as an eligible margin loan
for purposes of this subpart, a [BANK] must comply with the
requirements of Sec. --.3(b) with respect to that exposure.
Eligible servicer cash advance facility means a servicer cash
advance facility in which:
(1) The servicer is entitled to full reimbursement of advances,
except that a servicer may be obligated to make non-reimbursable
advances for a particular underlying exposure if any such advance is
contractually limited to an insignificant amount of the outstanding
principal balance of that exposure;
(2) The servicer's right to reimbursement is senior in right of
payment to all other claims on the cash flows from the underlying
exposures of the securitization; and
(3) The servicer has no legal obligation to, and does not make
advances to the securitization if the servicer concludes the advances
are unlikely to be repaid.
Employee stock ownership plan has the same meaning as in 29 CFR
2550.407d-6.
Equity derivative contract means an equity-linked swap, purchased
equity-linked option, forward equity-linked contract, or any other
instrument linked to equities that gives rise to similar counterparty
credit risks.
Equity exposure means:
(1) A security or instrument (whether voting or non-voting) that
represents a direct or an indirect ownership interest in, and is a
residual claim on, the assets and income of a company, unless:
(i) The issuing company is consolidated with the [BANK] under GAAP;
(ii) The [BANK] is required to deduct the ownership interest from
tier 1 or tier 2 capital under this part;
(iii) The ownership interest incorporates a payment or other
similar obligation on the part of the issuing company (such as an
obligation to make periodic payments); or
(iv) The ownership interest is a securitization exposure;
(2) A security or instrument that is mandatorily convertible into a
security or instrument described in paragraph (1) of this definition;
(3) An option or warrant that is exercisable for a security or
instrument described in paragraph (1) of this definition; or
(4) Any other security or instrument (other than a securitization
exposure) to the extent the return on the security or instrument is
based on the performance of a security or instrument described in
paragraph (1) of this definition.
ERISA means the Employee Retirement Income and Security Act of 1974
(29 U.S.C. 1001 et seq.).
Exchange rate derivative contract means a cross-currency interest
rate swap, forward foreign-exchange contract, currency option
purchased, or any other instrument linked to exchange rates that gives
rise to similar counterparty credit risks.
Executive officer means a person who holds the title or, without
regard to title, salary, or compensation, performs the function of one
or more of the following positions: President, chief executive officer,
executive chairman, chief 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 [BANK] deems to have equivalent
responsibility.
Expected credit loss (ECL) means:
(1) For a wholesale exposure to a non-defaulted obligor or segment
of non-defaulted retail exposures that is carried at fair value with
gains and losses flowing through earnings or that is classified as
held-for-sale and is carried at the lower of cost or fair value with
losses flowing through earnings, zero.
(2) For all other wholesale exposures to non-defaulted obligors or
segments of non-defaulted retail exposures, the product of the
probability of default (PD) times the loss given default (LGD) times
the exposure at default (EAD) for the exposure or segment.
(3) For a wholesale exposure to a defaulted obligor or segment of
defaulted retail exposures, the [BANK]'s impairment estimate for
allowance purposes for the exposure or segment.
(4) Total ECL is the sum of expected credit losses for all
wholesale and retail exposures other than exposures for which the
[BANK] has applied the double default treatment in Sec. --.135.
Exposure amount means:
(1) For the on-balance sheet component of an exposure (other than
an available-for-sale or held-to-maturity security, if the [BANK] has
made an AOCI opt-out election (as defined in Sec. --.22(b)(2)); an OTC
derivative contract; a repo-style transaction or an eligible margin
loan for which the [BANK] determines the exposure amount under Sec.
--.37; a cleared transaction; a default fund contribution; or a
securitization exposure), the [BANK]'s carrying value of the exposure.
(2) For a security (that is not a securitization exposure, equity
exposure, or preferred stock classified as an equity security under
GAAP) classified as available-for-sale or held-to-maturity if the
[BANK] has made an AOCI opt-out election (as defined in Sec.
--.22(b)(2)), the [BANK]'s carrying value (including net accrued but
unpaid interest and fees) for the exposure less any net unrealized
gains on the exposure and plus any net unrealized losses on the
exposure.
(3) For available-for-sale preferred stock classified as an equity
security under GAAP if the [BANK] has made an AOCI opt-out election (as
defined in Sec. --.22(b)(2)), the [BANK]'s carrying value of the
exposure less any net unrealized gains on the exposure that are
reflected in such carrying value but excluded from the [BANK]'s
regulatory capital components.
(4) For the off-balance sheet component of an exposure (other than
an OTC derivative contract; a repo-style transaction or an eligible
margin loan for which the [BANK] calculates the exposure amount under
Sec. --.37; a cleared transaction; a default fund contribution; or a
securitization exposure), the notional amount of the off-balance sheet
component multiplied by the appropriate credit conversion factor (CCF)
in Sec. --.33.
[[Page 62164]]
(5) For an exposure that is an OTC derivative contract, the
exposure amount determined under Sec. --.34.
(6) For an exposure that is a cleared transaction, the exposure
amount determined under Sec. --.35.
(7) For an exposure that is an eligible margin loan or repo-style
transaction for which the bank calculates the exposure amount as
provided in Sec. --.37, the exposure amount determined under Sec.
--.37.
(8) For an exposure that is a securitization exposure, the exposure
amount determined under Sec. --.42.
Federal Deposit Insurance Act means the Federal Deposit Insurance
Act (12 U.S.C. 1813).
Federal Deposit Insurance Corporation Improvement Act means the
Federal Deposit Insurance Corporation Improvement Act of 1991 (12
U.S.C. 4401).
Financial collateral means collateral:
(1) In the form of:
(i) Cash on deposit with the [BANK] (including cash held for the
[BANK] by a third-party custodian or trustee);
(ii) Gold bullion;
(iii) Long-term debt securities that are not resecuritization
exposures and that are investment grade;
(iv) Short-term debt instruments that are not resecuritization
exposures and that are investment grade;
(v) Equity securities that are publicly traded;
(vi) Convertible bonds that are publicly traded; or
(vii) Money market fund shares and other mutual fund shares if a
price for the shares is publicly quoted daily; and
(2) In which the [BANK] has a perfected, first-priority security
interest or, outside of the United States, the legal equivalent thereof
(with the exception of cash on deposit and notwithstanding the prior
security interest of any custodial agent).
Financial institution means:
(1) A bank holding company; savings and loan holding company;
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 non-member bank that is not a
depository institution; insurance company; securities holding company
as defined in section 618 of the Dodd-Frank Act; broker or dealer
registered with the SEC under section 15 of the Securities Exchange
Act; futures commission merchant as defined in section 1a of the
Commodity Exchange Act; swap dealer as defined in section 1a of the
Commodity Exchange Act; or security-based swap dealer as defined in
section 3 of the Securities Exchange Act;
(2) Any designated financial market utility, as defined in section
803 of the Dodd-Frank Act;
(3) Any entity not domiciled in the United States (or a political
subdivision thereof) that is supervised and regulated in a manner
similar to entities described in paragraphs (1) or (2) of this
definition; or
(4) Any other company:
(i) Of which the [BANK] owns:
(A) An investment in GAAP equity instruments of the company with an
adjusted carrying value or exposure amount equal to or greater than $10
million; or
(B) More than 10 percent of the company's issued and outstanding
common shares (or similar equity interest), and
(ii) Which is predominantly engaged in the following activities:
(A) Lending money, securities or other financial instruments,
including servicing loans;
(B) Insuring, guaranteeing, indemnifying against loss, harm,
damage, illness, disability, or death, or issuing annuities;
(C) Underwriting, dealing in, making a market in, or investing as
principal in securities or other financial instruments; or
(D) Asset management activities (not including investment or
financial advisory activities).
(5) For the purposes of this definition, a company is
``predominantly engaged'' in an activity or activities if:
(i) 85 percent or more of the total consolidated annual gross
revenues (as determined in accordance with applicable accounting
standards) of the company is either of the two most recent calendar
years were derived, directly or indirectly, by the company on a
consolidated basis from the activities; or
(ii) 85 percent or more of the company's consolidated total assets
(as determined in accordance with applicable accounting standards) as
of the end of either of the two most recent calendar years were related
to the activities.
(6) Any other company that the [AGENCY] may determine is a
financial institution based on activities similar in scope, nature, or
operation to those of the entities included in paragraphs (1) through
(4) of this definition.
(7) For purposes of this part, ``financial institution'' does not
include the following entities:
(i) GSEs;
(ii) Small business investment companies, as defined in section 102
of the Small Business Investment Act of 1958 (15 U.S.C. 662);
(iii) Entities designated as Community Development Financial
Institutions (CDFIs) under 12 U.S.C. 4701 et seq. and 12 CFR part 1805;
(iv) Entities registered with the SEC under the Investment Company
Act of 1940 (15 U.S.C. 80a-1) or foreign equivalents thereof;
(v) Entities to the extent that the [BANK]'s investment in such
entities would qualify as a community development investment under
section 24 (Eleventh) of the National Bank Act; and
(vi) An employee benefit plan as defined in paragraphs (3) and (32)
of section 3 of ERISA, a ``governmental plan'' (as defined in 29 U.S.C.
1002(32)) that complies with the tax deferral qualification
requirements provided in the Internal Revenue Code, or any similar
employee benefit plan established under the laws of a foreign
jurisdiction.
First-lien residential mortgage exposure means a residential
mortgage exposure secured by a first lien.
Foreign bank means a foreign bank as defined in Sec. 211.2 of the
Federal Reserve Board's Regulation K (12 CFR 211.2) (other than a
depository institution).
Forward agreement means a legally binding contractual obligation to
purchase assets with certain drawdown at a specified future date, not
including commitments to make residential mortgage loans or forward
foreign exchange contracts.
GAAP means generally accepted accounting principles as used in the
United States.
Gain-on-sale means an increase in the equity capital of a [BANK]
(as reported on [Schedule RC of the Call Report or Schedule HC of the
FR Y-9C]) resulting from a traditional securitization (other than an
increase in equity capital resulting from the [BANK]'s receipt of cash
in connection with the securitization or reporting of a mortgage
servicing asset on [Schedule RC of the Call Report or Schedule HC of
the FRY-9C]).
General obligation means a bond or similar obligation that is
backed by the full faith and credit of a public sector entity (PSE).
Government-sponsored enterprise (GSE) means an entity established
or chartered by the U.S. government to serve public purposes specified
by the U.S. Congress but whose debt obligations are not explicitly
guaranteed by the full faith and credit of the U.S. government.
[[Page 62165]]
Guarantee means a financial guarantee, letter of credit, insurance,
or other similar financial instrument (other than a credit derivative)
that allows one party (beneficiary) to transfer the credit risk of one
or more specific exposures (reference exposure) to another party
(protection provider).
High volatility commercial real estate (HVCRE) exposure means a
credit facility that, prior to conversion to permanent financing,
finances or has financed the acquisition, development, or construction
(ADC) of real property, unless the facility finances:
(1) One- to four-family residential properties;
(2) Real property that:
(i) Would qualify as an investment in community development under
12 U.S.C. 338a or 12 U.S.C. 24 (Eleventh), as applicable, or as a
``qualified investment'' under [12 CFR part 25 (national bank), 12 CFR
part 195 (Federal savings association) (OCC); 12 CFR part 228 (Board)],
and
(ii) Is not an ADC loan to any entity described in [12 CFR part
25.12(g)(3) (national banks) and 12 CFR 195.12(g)(3) (Federal savings
associations) (OCC); 12 CFR 208.22(a)(3) or 228.12(g)(3) (Board)],
unless it is otherwise described in paragraph (1), (2)(i), (3) or (4)
of this definition;
(3) The purchase or development of agricultural land, which
includes all land known to be used or usable for agricultural purposes
(such as crop and livestock production), provided that the valuation of
the agricultural land is based on its value for agricultural purposes
and the valuation does not take into consideration any potential use of
the land for non-agricultural commercial development or residential
development; or
(4) Commercial real estate projects in which:
(i) The loan-to-value ratio is less than or equal to the applicable
maximum supervisory loan-to-value ratio in the [AGENCY]'s real estate
lending standards at [12 CFR part 34, subpart D (national banks) and 12
CFR part 160, subparts A and B (Federal savings associations) (OCC); 12
CFR part 208, appendix C (Board)];
(ii) The borrower has contributed capital to the project in the
form of cash or unencumbered readily marketable assets (or has paid
development expenses out-of-pocket) of at least 15 percent of the real
estate's appraised ``as completed'' value; and
(iii) The borrower contributed the amount of capital required by
paragraph (4)(ii) of this definition before the [BANK] advances funds
under the credit facility, and the capital contributed by the borrower,
or internally generated by the project, is contractually required to
remain in the project throughout the life of the project. The life of a
project concludes only when the credit facility is converted to
permanent financing or is sold or paid in full. Permanent financing may
be provided by the [BANK] that provided the ADC facility as long as the
permanent financing is subject to the [BANK]'s underwriting criteria
for long-term mortgage loans.
Home country means the country where an entity is incorporated,
chartered, or similarly established.
Indirect exposure means an exposure that arises from the [BANK]'s
investment in an investment fund which holds an investment in the
[BANK]'s own capital instrument or an investment in the capital of an
unconsolidated financial institution.
Insurance company means an insurance company as defined in section
201 of the Dodd-Frank Act (12 U.S.C. 5381).
Insurance underwriting company means an insurance company as
defined in section 201 of the Dodd-Frank Act (12 U.S.C. 5381) that
engages in insurance underwriting activities.
Insured depository institution means an insured depository
institution as defined in section 3 of the Federal Deposit Insurance
Act.
Interest rate derivative contract means a single-currency interest
rate swap, basis swap, forward rate agreement, purchased interest rate
option, when-issued securities, or any other instrument linked to
interest rates that gives rise to similar counterparty credit risks.
International Lending Supervision Act means the International
Lending Supervision Act of 1983 (12 U.S.C. 3907).
Investing bank means, with respect to a securitization, a [BANK]
that assumes the credit risk of a securitization exposure (other than
an originating [BANK] of the securitization). In the typical synthetic
securitization, the investing [BANK] sells credit protection on a pool
of underlying exposures to the originating [BANK].
Investment fund means a company:
(1) Where all or substantially all of the assets of the company are
financial assets; and
(2) That has no material liabilities.
Investment grade means that the entity to which the [BANK] 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.
Investment in the capital of an unconsolidated financial
institution means a net long position calculated in accordance with
Sec. --.22(h) in an instrument that is recognized as capital for
regulatory purposes by the primary supervisor of an unconsolidated
regulated financial institution and is an instrument that is part of
the GAAP equity of an unconsolidated unregulated financial institution,
including direct, indirect, and synthetic exposures to capital
instruments, excluding underwriting positions held by the [BANK] for
five or fewer business days.
Investment in the [BANK]'s own capital instrument means a net long
position calculated in accordance with Sec. --.22(h) in the [BANK]'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
[BANK]'s own capital instrument includes any contractual obligation to
purchase such capital instrument.
Junior-lien residential mortgage exposure means a residential
mortgage exposure that is not a first-lien residential mortgage
exposure.
Main index means the Standard & Poor's 500 Index, the FTSE All-
World Index, and any other index for which the [BANK] can demonstrate
to the satisfaction of the [AGENCY] that the equities represented in
the index have comparable liquidity, depth of market, and size of bid-
ask spreads as equities in the Standard & Poor's 500 Index and FTSE
All-World Index.
Market risk [BANK] means a [BANK] that is described in Sec.
--.201(b).
Money market fund means an investment fund that is subject to 17
CFR 270.2a-7 or any foreign equivalent thereof.
Mortgage servicing assets (MSAs) means the contractual rights owned
by a [BANK] to service for a fee mortgage loans that are owned by
others.
Multilateral development bank (MDB) means the International Bank
for Reconstruction and Development, the Multilateral Investment
Guarantee Agency, the International Finance Corporation, the Inter-
American Development Bank, the Asian Development Bank, the African
Development Bank, the European Bank for Reconstruction and Development,
the European Investment Bank, the European Investment Fund, the Nordic
Investment Bank, the Caribbean Development Bank, the Islamic
[[Page 62166]]
Development Bank, the Council of Europe Development Bank, and any other
multilateral lending institution or regional development bank in which
the U.S. government is a shareholder or contributing member or which
the [AGENCY] determines poses comparable credit risk.
National Bank Act means the National Bank Act (12 U.S.C. 24).
Netting set means a group of transactions with a single
counterparty that are subject to a qualifying master netting agreement
or a qualifying cross-product master netting agreement. For purposes of
calculating risk-based capital requirements using the internal models
methodology in subpart E of this part, this term does not cover a
transaction:
(1) That is not subject to such a master netting agreement; or
(2) Where the [BANK] has identified specific wrong-way risk.
Non-significant investment in the capital of an unconsolidated
financial institution means an investment in the capital of an
unconsolidated financial institution where the [BANK] owns 10 percent
or less of the issued and outstanding common stock of the
unconsolidated financial institution.
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.
Operating entity means a company established to conduct business
with clients with the intention of earning a profit in its own right.
Original maturity with respect to an off-balance sheet commitment
means the length of time between the date a commitment is issued and:
(1) For a commitment that is not subject to extension or renewal,
the stated expiration date of the commitment; or
(2) For a commitment that is subject to extension or renewal, the
earliest date on which the [BANK] can, at its option, unconditionally
cancel the commitment.
Originating [BANK], with respect to a securitization, means a
[BANK] that:
(1) Directly or indirectly originated or securitized the underlying
exposures included in the securitization; or
(2) Serves as an ABCP program sponsor to the securitization.
Over-the-counter (OTC) derivative contract means a derivative
contract that is not a cleared transaction. An OTC derivative includes
a transaction:
(1) Between a [BANK] that is a clearing member and a counterparty
where the [BANK] is acting as a financial intermediary and enters into
a cleared transaction with a CCP that offsets the transaction with the
counterparty; or
(2) In which a [BANK] that is a clearing member provides a CCP a
guarantee on the performance of the counterparty to the transaction.
Performance standby letter of credit (or performance bond) means an
irrevocable obligation of a [BANK] to pay a third-party beneficiary
when a customer (account party) fails to perform on any contractual
nonfinancial or commercial obligation. To the extent permitted by law
or regulation, performance standby letters of credit include
arrangements backing, among other things, subcontractors' and
suppliers' performance, labor and materials contracts, and construction
bids.
Pre-sold construction loan means any one-to-four family residential
construction loan to a builder that meets the requirements of section
618(a)(1) or (2) of the Resolution Trust Corporation Refinancing,
Restructuring, and Improvement Act of 1991 (12 U.S.C. 1831n note) and
the following criteria:
(1) The loan is made in accordance with prudent underwriting
standards, meaning that the [BANK] has obtained sufficient
documentation that the buyer of the home has a legally binding written
sales contract and has a firm written commitment for permanent
financing of the home upon completion;
(2) The purchaser is an individual(s) that intends to occupy the
residence and is not a partnership, joint venture, trust, corporation,
or any other entity (including an entity acting as a sole
proprietorship) that is purchasing one or more of the residences for
speculative purposes;
(3) The purchaser has entered into a legally binding written sales
contract for the residence;
(4) The purchaser has not terminated the contract;
(5) The purchaser has made a substantial earnest money deposit of
no less than 3 percent of the sales price, which is subject to
forfeiture if the purchaser terminates the sales contract; provided
that, the earnest money deposit shall not be subject to forfeiture by
reason of breach or termination of the sales contract on the part of
the builder;
(6) The earnest money deposit must be held in escrow by the [BANK]
or an independent party in a fiduciary capacity, and the escrow
agreement must provide that in an event of default arising from the
cancellation of the sales contract by the purchaser of the residence,
the escrow funds shall be used to defray any cost incurred by the
[BANK];
(7) The builder must incur at least the first 10 percent of the
direct costs of construction of the residence (that is, actual costs of
the land, labor, and material) before any drawdown is made under the
loan;
(8) The loan may not exceed 80 percent of the sales price of the
presold residence; and
(9) The loan is not more than 90 days past due, or on nonaccrual.
Protection amount (P) means, with respect to an exposure hedged by
an eligible guarantee or eligible credit derivative, the effective
notional amount of the guarantee or credit derivative, reduced to
reflect any currency mismatch, maturity mismatch, or lack of
restructuring coverage (as provided in Sec. Sec. --.36 or --.134, as
appropriate).
Publicly-traded means traded on:
(1) Any exchange registered with the SEC as a national securities
exchange under section 6 of the Securities Exchange Act; or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities
regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in
question.
Public sector entity (PSE) means a state, local authority, or other
governmental subdivision below the sovereign level.
Qualifying central counterparty (QCCP) means a central counterparty
that:
(1)(i) Is a designated financial market utility (FMU) under Title
VIII of the Dodd-Frank Act;
(ii) If not located in the United States, is regulated and
supervised in a manner equivalent to a designated FMU; or
(iii) Meets the following standards:
(A) The central counterparty requires all parties to contracts
cleared by the counterparty to be fully collateralized on a daily
basis;
(B) The [BANK] demonstrates to the satisfaction of the [AGENCY]
that the central counterparty:
(1) Is in sound financial condition;
(2) Is subject to supervision by the Board, the CFTC, or the
Securities Exchange Commission (SEC), or, if the central counterparty
is not located in the United States, is subject to effective oversight
by a national supervisory authority in its home country; and
(3) Meets or exceeds the risk-management standards for central
counterparties set forth in regulations established by the Board, the
CFTC, or the SEC under Title VII or Title VIII of the Dodd-Frank Act;
or if the central counterparty is not located in the United States,
meets or exceeds similar
[[Page 62167]]
risk-management standards established under the law of its home country
that are consistent with international standards for central
counterparty risk management as established by the relevant standard
setting body of the Bank of International Settlements; and
(2)(i) Provides the [BANK] with the central counterparty's
hypothetical capital requirement or the information necessary to
calculate such hypothetical capital requirement, and other information
the [BANK] is required to obtain under Sec. Sec. --.35(d)(3) and
--.133(d)(3);
(ii) Makes available to the [AGENCY] and the CCP's regulator the
information described in paragraph (2)(i) of this definition; and
(iii) Has not otherwise been determined by the [AGENCY] to not be a
QCCP due to its financial condition, risk profile, failure to meet
supervisory risk management standards, or other weaknesses or
supervisory concerns that are inconsistent with the risk weight
assigned to qualifying central counterparties under Sec. Sec. --.35
and --.133.
(3) Exception. A QCCP that fails to meet the requirements of a QCCP
in the future may still be treated as a QCCP under the conditions
specified in Sec. --.3(f).
Qualifying master netting agreement means a written, legally
enforceable agreement provided that:
(1) The agreement creates a single legal obligation for all
individual transactions covered by the agreement upon an event of
default, including upon an event of receivership, insolvency,
liquidation, or similar proceeding, of the counterparty;
(2) The agreement provides the [BANK] the right to accelerate,
terminate, and close-out on a net basis all transactions under the
agreement and to liquidate or set-off collateral promptly upon an event
of default, including upon an event of receivership, insolvency,
liquidation, or similar proceeding, of the counterparty, provided that,
in any such case, any exercise of rights under the agreement will not
be stayed or avoided under applicable law in the relevant
jurisdictions, other than in receivership, conservatorship, resolution
under the Federal Deposit Insurance Act, Title II of the Dodd-Frank
Act, or under any similar insolvency law applicable to GSEs;
(3) The agreement does not contain a walkaway clause (that is, a
provision that permits a non-defaulting counterparty to make a lower
payment than it otherwise would make under the agreement, or no payment
at all, to a defaulter or the estate of a defaulter, even if the
defaulter or the estate of the defaulter is a net creditor under the
agreement); and
(4) In order to recognize an agreement as a qualifying master
netting agreement for purposes of this subpart, a [BANK] must comply
with the requirements of Sec. --.3(d) with respect to that agreement.
Regulated financial institution means a financial institution
subject to consolidated supervision and regulation comparable to that
imposed on the following U.S. financial institutions: Depository
institutions, depository institution holding companies, nonbank
financial companies supervised by the Board, designated financial
market utilities, securities broker-dealers, credit unions, or
insurance companies.
Repo-style transaction means a repurchase or reverse repurchase
transaction, or a securities borrowing or securities lending
transaction, including a transaction in which the [BANK] acts as agent
for a customer and indemnifies the customer against loss, provided
that:
(1) The transaction is based solely on liquid and readily
marketable securities, cash, or gold;
(2) The transaction is marked-to-fair value daily and subject to
daily margin maintenance requirements;
(3)(i) The transaction is a ``securities contract'' or ``repurchase
agreement'' under section 555 or 559, respectively, of the Bankruptcy
Code (11 U.S.C. 555 or 559), a qualified financial contract under
section 11(e)(8) of the Federal Deposit Insurance Act, or a netting
contract between or among financial institutions under sections 401-407
of the Federal Deposit Insurance Corporation Improvement Act or the
Federal Reserve Board's Regulation EE (12 CFR part 231); or
(ii) If the transaction does not meet the criteria set forth in
paragraph (3)(i) of this definition, then either:
(A) The transaction is executed under an agreement that provides
the [BANK] the right to accelerate, terminate, and close-out the
transaction on a net basis and to liquidate or set-off collateral
promptly upon an event of default, including upon an event of
receivership, insolvency, liquidation, or similar proceeding, of the
counterparty, provided that, in any such case, any exercise of rights
under the agreement will not be stayed or avoided under applicable law
in the relevant jurisdictions, other than in receivership,
conservatorship, resolution under the Federal Deposit Insurance Act,
Title II of the Dodd-Frank Act, or under any similar insolvency law
applicable to GSEs; or
(B) The transaction is:
(1) Either overnight or unconditionally cancelable at any time by
the [BANK]; and
(2) Executed under an agreement that provides the [BANK] the right
to accelerate, terminate, and close-out the transaction on a net basis
and to liquidate or set-off collateral promptly upon an event of
counterparty default; and
(4) In order to recognize an exposure as a repo-style transaction
for purposes of this subpart, a [BANK] must comply with the
requirements of Sec. --.3(e) of this part with respect to that
exposure.
Resecuritization means a securitization which has more than one
underlying exposure and in which one or more of the underlying
exposures is a securitization exposure.
Resecuritization exposure means:
(1) An on- or off-balance sheet exposure to a resecuritization;
(2) An exposure that directly or indirectly references a
resecuritization exposure.
(3) An exposure to an asset-backed commercial paper program is not
a resecuritization exposure if either:
(i) The program-wide credit enhancement does not meet the
definition of a resecuritization exposure; or
(ii) 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.
Residential mortgage exposure means an exposure (other than a
securitization exposure, equity exposure, statutory multifamily
mortgage, or presold construction loan) that is:
(1) An exposure that is primarily secured by a first or subsequent
lien on one-to-four family residential property; or
(2)(i) An exposure with an original and outstanding amount of $1
million or less that is primarily secured by a first or subsequent lien
on residential property that is not one-to-four family; and
(ii) For purposes of calculating capital requirements under subpart
E of this part, is managed as part of a segment of exposures with
homogeneous risk characteristics and not on an individual-exposure
basis.
Revenue obligation means a bond or similar obligation that is an
obligation of a PSE, but which the PSE is committed to repay with
revenues from the specific project financed rather than general tax
funds.
Savings and loan holding company means a savings and loan holding
[[Page 62168]]
company as defined in section 10 of the Home Owners' Loan Act (12
U.S.C. 1467a).
Securities and Exchange Commission (SEC) means the U.S. Securities
and Exchange Commission.
Securities Exchange Act means the Securities Exchange Act of 1934
(15 U.S.C. 78).
Securitization exposure means:
(1) An on-balance sheet or off-balance sheet credit exposure
(including credit-enhancing representations and warranties) that arises
from a traditional securitization or synthetic securitization
(including a resecuritization), or
(2) An exposure that directly or indirectly references a
securitization exposure described in paragraph (1) of this definition.
Securitization special purpose entity (securitization SPE) means a
corporation, trust, or other entity organized for the specific purpose
of holding underlying exposures of a securitization, the activities of
which are limited to those appropriate to accomplish this purpose, and
the structure of which is intended to isolate the underlying exposures
held by the entity from the credit risk of the seller of the underlying
exposures to the entity.
Separate account means a legally segregated pool of assets owned
and held by an insurance company and maintained separately from the
insurance company's general account assets for the benefit of an
individual contract holder. To be a separate account:
(1) The account must be legally recognized as a separate account
under applicable law;
(2) The assets in the account must be insulated from general
liabilities of the insurance company under applicable law in the event
of the insurance company'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 gains and losses, net of contract fees and
assessments, must be passed through to the contract holder, provided
that the contract may specify conditions under which there may be a
minimum guarantee but must not include contract terms that limit the
maximum investment return available to the policyholder.
Servicer cash advance facility means a facility under which the
servicer of the underlying exposures of a securitization may advance
cash to ensure an uninterrupted flow of payments to investors in the
securitization, including advances made to cover foreclosure costs or
other expenses to facilitate the timely collection of the underlying
exposures.
Significant investment in the capital of an unconsolidated
financial institution means an investment in the capital of an
unconsolidated financial institution where the [BANK] owns more than 10
percent of the issued and outstanding common stock of the
unconsolidated financial institution.
Small Business Act means the Small Business Act (15 U.S.C. 632).
Small Business Investment Act means the Small Business Investment
Act of 1958 (15 U.S.C. 682).
Sovereign means a central government (including the U.S.
government) or an agency, department, ministry, or central bank of a
central government.
Sovereign default means 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 and interest
timely and fully, arrearages, or restructuring.
Sovereign exposure means:
(1) A direct exposure to a sovereign; or
(2) An exposure directly and unconditionally backed by the full
faith and credit of a sovereign.
Specific wrong-way risk means wrong-way risk that arises when
either:
(1) The counterparty and issuer of the collateral supporting the
transaction; or
(2) The counterparty and the reference asset of the transaction,
are affiliates or are the same entity.
Standardized market risk-weighted assets means the standardized
measure for market risk calculated under Sec. --.204 multiplied by
12.5.
Standardized total risk-weighted assets means:
(1) The sum of:
(i) Total risk-weighted assets for general credit risk as
calculated under Sec. --.31;
(ii) Total risk-weighted assets for cleared transactions and
default fund contributions as calculated under Sec. --.35;
(iii) Total risk-weighted assets for unsettled transactions as
calculated under Sec. --.38;
(iv) Total risk-weighted assets for securitization exposures as
calculated under Sec. --.42;
(v) Total risk-weighted assets for equity exposures as calculated
under Sec. Sec. --.52 and --.53; and
(vi) For a market risk [BANK] only, standardized market risk-
weighted assets; minus
(2) Any amount of the [BANK]'s allowance for loan and lease losses
that is not included in tier 2 capital and any amount of allocated
transfer risk reserves.
Statutory multifamily mortgage means a loan secured by a
multifamily residential property that meets the requirements under
section 618(b)(1) of the Resolution Trust Corporation Refinancing,
Restructuring, and Improvement Act of 1991, and that meets the
following criteria: \5\
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\5\ The types of loans that qualify as loans secured by
multifamily residential properties are listed in the instructions
for preparation of the [REGULATORY REPORT].
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(1) The loan is made in accordance with prudent underwriting
standards;
(2) The principal amount of the loan at origination does not exceed
80 percent of the value of the property (or 75 percent of the value of
the property if the loan is based on an interest rate that changes over
the term of the loan) where the value of the property is the lower of
the acquisition cost of the property or the appraised (or, if
appropriate, evaluated) value of the property;
(3) All principal and interest payments on the loan must have been
made on a timely basis in accordance with the terms of the loan for at
least one year prior to applying a 50 percent risk weight to the loan,
or in the case where an existing owner is refinancing a loan on the
property, all principal and interest payments on the loan being
refinanced must have been made on a timely basis in accordance with the
terms of the loan for at least one year prior to applying a 50 percent
risk weight to the loan;
(4) Amortization of principal and interest on the loan must occur
over a period of not more than 30 years and the minimum original
maturity for repayment of principal must not be less than 7 years;
(5) Annual net operating income (before making any payment on the
loan) generated by the property securing the loan during its most
recent fiscal year must not be less than 120 percent of the loan's
current annual debt service (or 115 percent of current annual debt
service if the loan is based on an interest rate that changes over the
term of the loan) or, in the case of a cooperative or other not-for-
profit housing project, the property must generate sufficient cash flow
to provide comparable protection to the [BANK]; and
(6) The loan is not more than 90 days past due, or on nonaccrual.
Subsidiary means, with respect to a company, a company controlled
by that company.
[[Page 62169]]
Synthetic exposure means an exposure whose value is linked to the
value of an investment in the [BANK]'s own capital instrument or to the
value of an investment in the capital of an unconsolidated financial
institution.
Synthetic securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying
exposures is retained or transferred to one or more third parties
through the use of one or more credit derivatives or guarantees (other
than a guarantee that transfers only the credit risk of an individual
retail exposure);
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends upon the
performance of the underlying exposures; and
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities).
Tier 1 capital means the sum of common equity tier 1 capital and
additional tier 1 capital.
Tier 1 minority interest means the tier 1 capital of a consolidated
subsidiary of a [BANK] that is not owned by the [BANK].
Tier 2 capital is defined in Sec. --.20(d).
Total capital means the sum of tier 1 capital and tier 2 capital.
Total capital minority interest means the total capital of a
consolidated subsidiary of a [BANK] that is not owned by the [BANK].
Total leverage exposure means the sum of the following:
(1) The balance sheet carrying value of all of the [BANK]'s on-
balance sheet assets, less amounts deducted from tier 1 capital under
Sec. --.22(a), (c), and (d);
(2) The potential future credit exposure (PFE) amount for each
derivative contract to which the [BANK] is a counterparty (or each
single-product netting set of such transactions) determined in
accordance with Sec. --.34, but without regard to Sec. --.34(b);
(3) 10 percent of the notional amount of unconditionally
cancellable commitments made by the [BANK]; and
(4) The notional amount of all other off-balance sheet exposures of
the [BANK] (excluding securities lending, securities borrowing, reverse
repurchase transactions, derivatives and unconditionally cancellable
commitments).
Traditional securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying
exposures is transferred to one or more third parties other than
through the use of credit derivatives or guarantees;
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends upon the
performance of the underlying exposures;
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities);
(5) The underlying exposures are not owned by an operating company;
(6) The underlying exposures are not owned by a small business
investment company defined in section 302 of the Small Business
Investment Act;
(7) The underlying exposures are not owned by a firm an investment
in which qualifies as a community development investment under section
24(Eleventh) of the National Bank Act;
(8) The [AGENCY] may determine that a transaction in which the
underlying exposures are owned by an investment firm that exercises
substantially unfettered control over the size and composition of its
assets, liabilities, and off-balance sheet exposures is not a
traditional securitization based on the transaction's leverage, risk
profile, or economic substance;
(9) The [AGENCY] may deem a transaction that meets the definition
of a traditional securitization, notwithstanding paragraph (5), (6), or
(7) of this definition, to be a traditional securitization based on the
transaction's leverage, risk profile, or economic substance; and
(10) The transaction is not:
(i) An investment fund;
(ii) A collective investment fund (as defined in [12 CFR 9.18
(national bank) and 12 CFR 151.40 (Federal saving association) (OCC);
12 CFR 208.34 (Board)];
(iii) An employee benefit plan (as defined in paragraphs (3) and
(32) of section 3 of ERISA), a ``governmental plan'' (as defined in 29
U.S.C. 1002(32)) that complies with the tax deferral qualification
requirements provided in the Internal Revenue Code, or any similar
employee benefit plan established under the laws of a foreign
jurisdiction;
(iv) A synthetic exposure to the capital of a financial institution
to the extent deducted from capital under Sec. --.22; or
(v) Registered with the SEC under the Investment Company Act of
1940 (15 U.S.C. 80a-1) or foreign equivalents thereof.
Tranche means all securitization exposures associated with a
securitization that have the same seniority level.
Two-way market means 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.
Unconditionally cancelable means with respect to a commitment, that
a [BANK] may, at any time, with or without cause, refuse to extend
credit under the commitment (to the extent permitted under applicable
law).
Underlying exposures means one or more exposures that have been
securitized in a securitization transaction.
Unregulated financial institution means, for purposes of Sec.
--.131, a financial institution that is not a regulated financial
institution, including any financial institution that would meet the
definition of ``financial institution'' under this section but for the
ownership interest thresholds set forth in paragraph (4)(i) of that
definition.
U.S. Government agency means an instrumentality of the U.S.
Government whose obligations are fully and explicitly guaranteed as to
the timely payment of principal and interest by the full faith and
credit of the U.S. Government.
Value-at-Risk (VaR) means the estimate of the maximum amount that
the value of one or more exposures could decline due to market price or
rate movements during a fixed holding period within a stated confidence
interval.
Wrong-way risk means the risk that arises when an exposure to a
particular counterparty is positively correlated with the probability
of default of such counterparty itself.
Sec. --.3 Operational requirements for counterparty credit risk.
For purposes of calculating risk-weighted assets under subparts D
and E of this part:
(a) Cleared transaction. In order to recognize certain exposures as
cleared transactions pursuant to paragraphs (1)(ii), (iii) or (iv) of
the definition of ``cleared transaction'' in Sec. --.2, the
[[Page 62170]]
exposures must meet the applicable requirements set forth in this
paragraph (a).
(1) The offsetting transaction must be identified by the CCP as a
transaction for the clearing member client.
(2) The collateral supporting the transaction must be held in a
manner that prevents the [BANK] from facing any loss due to an event of
default, including from a liquidation, receivership, insolvency, or
similar proceeding of either the clearing member or the clearing
member's other clients. Omnibus accounts established under 17 CFR parts
190 and 300 satisfy the requirements of this paragraph (a).
(3) The [BANK] must conduct sufficient legal review to conclude
with a well-founded basis (and maintain sufficient written
documentation of that legal review) that in the event of a legal
challenge (including one resulting from a default or receivership,
insolvency, liquidation, or similar proceeding) the relevant court and
administrative authorities would find the arrangements of paragraph
(a)(2) of this section to be legal, valid, binding and enforceable
under the law of the relevant jurisdictions.
(4) The offsetting transaction with a clearing member must be
transferable under the transaction documents and applicable laws in the
relevant jurisdiction(s) to another clearing member should the clearing
member default, become insolvent, or enter receivership, insolvency,
liquidation, or similar proceedings.
(b) Eligible margin loan. In order to recognize an exposure as an
eligible margin loan as defined in Sec. --.2, a [BANK] must conduct
sufficient legal review to conclude with a well-founded basis (and
maintain sufficient written documentation of that legal review) that
the agreement underlying the exposure:
(1) Meets the requirements of paragraph (1)(iii) of the definition
of eligible margin loan in Sec. --.2, and
(2) Is legal, valid, binding, and enforceable under applicable law
in the relevant jurisdictions.
(c) Qualifying cross-product master netting agreement. In order to
recognize an agreement as a qualifying cross-product master netting
agreement as defined in Sec. --.101, a [BANK] must obtain a written
legal opinion verifying the validity and enforceability of the
agreement under applicable law of the relevant jurisdictions if the
counterparty fails to perform upon an event of default, including upon
receivership, insolvency, liquidation, or similar proceeding.
(d) Qualifying master netting agreement. In order to recognize an
agreement as a qualifying master netting agreement as defined in Sec.
--.2, a [BANK] must:
(1) Conduct sufficient legal review to conclude with a well-founded
basis (and maintain sufficient written documentation of that legal
review) that:
(i) The agreement meets the requirements of paragraph (2) of the
definition of qualifying master netting agreement in Sec. --.2; and
(ii) In the event of a legal challenge (including one resulting
from default or from receivership, insolvency, liquidation, or similar
proceeding) the relevant court and administrative authorities would
find the agreement to be legal, valid, binding, and enforceable under
the law of the relevant jurisdictions; and
(2) Establish and maintain written procedures to monitor possible
changes in relevant law and to ensure that the agreement continues to
satisfy the requirements of the definition of qualifying master netting
agreement in Sec. --.2.
(e) Repo-style transaction. In order to recognize an exposure as a
repo-style transaction as defined in Sec. --.2, a [BANK] must conduct
sufficient legal review to conclude with a well-founded basis (and
maintain sufficient written documentation of that legal review) that
the agreement underlying the exposure:
(1) Meets the requirements of paragraph (3) of the definition of
repo-style transaction in Sec. --.2, and
(2) Is legal, valid, binding, and enforceable under applicable law
in the relevant jurisdictions.
(f) Failure of a QCCP to satisfy the rule's requirements. If a
[BANK] determines that a CCP ceases to be a QCCP due to the failure of
the CCP to satisfy one or more of the requirements set forth in
paragraphs (2)(i) through (2)(iii) of the definition of a QCCP in Sec.
--.2, the [BANK] may continue to treat the CCP as a QCCP for up to
three months following the determination. If the CCP fails to remedy
the relevant deficiency within three months after the initial
determination, or the CCP fails to satisfy the requirements set forth
in paragraphs (2)(i) through (2)(iii) of the definition of a QCCP
continuously for a three-month period after remedying the relevant
deficiency, a [BANK] may not treat the CCP as a QCCP for the purposes
of this part until after the [BANK] has determined that the CCP has
satisfied the requirements in paragraphs (2)(i) through (2)(iii) of the
definition of a QCCP for three continuous months.
Sec. Sec. --.4 through --.9 [Reserved]
Subpart B--Capital Ratio Requirements and Buffers
Sec. --.10 Minimum capital requirements.
(a) Minimum capital requirements. A [BANK] must maintain the
following minimum capital ratios:
(1) A common equity tier 1 capital ratio of 4.5 percent.
(2) A tier 1 capital ratio of 6 percent.
(3) A total capital ratio of 8 percent.
(4) A leverage ratio of 4 percent.
(5) For advanced approaches [BANK]s, a supplementary leverage ratio
of 3 percent.
(b) Standardized capital ratio calculations. Other than as provided
in paragraph (c) of this section:
(1) Common equity tier 1 capital ratio. A [BANK]'s common equity
tier 1 capital ratio is the ratio of the [BANK]'s common equity tier 1
capital to standardized total risk-weighted assets;
(2) Tier 1 capital ratio. A [BANK]'s tier 1 capital ratio is the
ratio of the [BANK]'s tier 1 capital to standardized total risk-
weighted assets;
(3) Total capital ratio. A [BANK]'s total capital ratio is the
ratio of the [BANK]'s total capital to standardized total risk-weighted
assets; and
(4) Leverage ratio. A [BANK]'s leverage ratio is the ratio of the
[BANK]'s tier 1 capital to the [BANK]'s average total consolidated
assets as reported on the [BANK]'s [REGULATORY REPORT] minus amounts
deducted from tier 1 capital under Sec. --.22(a), (c) and (d).
(c) Advanced approaches capital ratio calculations. An advanced
approaches [BANK] that has completed the parallel run process and
received notification from the [AGENCY] pursuant to Sec. --.121(d)
must determine its regulatory capital ratios as described in this
paragraph (c).
(1) Common equity tier 1 capital ratio. The [BANK]'s common equity
tier 1 capital ratio is the lower of:
(i) The ratio of the [BANK]'s common equity tier 1 capital to
standardized total risk-weighted assets; and
(ii) The ratio of the [BANK]'s common equity tier 1 capital to
advanced approaches total risk-weighted assets.
(2) Tier 1 capital ratio. The [BANK]'s tier 1 capital ratio is the
lower of:
(i) The ratio of the [BANK]'s tier 1 capital to standardized total
risk-weighted assets; and
(ii) The ratio of the [BANK]'s tier 1 capital to advanced
approaches total risk-weighted assets.
(3) Total capital ratio. The [BANK]'s total capital ratio is the
lower of:
[[Page 62171]]
(i) The ratio of the [BANK]'s total capital to standardized total
risk-weighted assets; and
(ii) The ratio of the [BANK]'s advanced-approaches-adjusted total
capital to advanced approaches total risk-weighted assets. A [BANK]'s
advanced-approaches-adjusted total capital is the [BANK]'s total
capital after being adjusted as follows:
(A) An advanced approaches [BANK] must deduct from its total
capital any allowance for loan and lease losses included in its tier 2
capital in accordance with Sec. --.20(d)(3); and
(B) An advanced approaches [BANK] must add to its total capital any
eligible credit reserves that exceed the [BANK]'s total expected credit
losses to the extent that the excess reserve amount does not exceed 0.6
percent of the [BANK]'s credit risk-weighted assets.
(4) Supplementary leverage ratio. An advanced approaches [BANK]'s
supplementary leverage ratio is the simple arithmetic mean of the ratio
of its tier 1 capital to total leverage exposure calculated as of the
last day of each month in the reporting quarter.
(d) Capital adequacy. (1) Notwithstanding the minimum requirements
in this part, a [BANK] must maintain capital commensurate with the
level and nature of all risks to which the [BANK] is exposed. The
supervisory evaluation of a [BANK]'s capital adequacy is based on an
individual assessment of numerous factors, including those listed at
[12 CFR 3.10 (national banks), 12 CFR 167.3(c) (Federal savings
associations) and 12 CFR 208.4 (state member banks)].
(2) A [BANK] must have a process for assessing its overall capital
adequacy in relation to its risk profile and a comprehensive strategy
for maintaining an appropriate level of capital.
Sec. --.11 Capital conservation buffer and countercyclical capital
buffer amount.
(a) Capital conservation buffer. (1) Composition of the capital
conservation buffer. The capital conservation buffer is composed solely
of common equity tier 1 capital.
(2) Definitions. For purposes of this section, the following
definitions apply:
(i) Eligible retained income. The eligible retained income of a
[BANK] is the [BANK]'s net income for the four calendar quarters
preceding the current calendar quarter, based on the [BANK]'s quarterly
[REGULATORY REPORT]s, net of any distributions and associated tax
effects not already reflected in net income.
(ii) Maximum payout ratio. The maximum payout ratio is the
percentage of eligible retained income that a [BANK] can pay out in the
form of distributions and discretionary bonus payments during the
current calendar quarter. The maximum payout ratio is based on the
[BANK]'s capital conservation buffer, calculated as of the last day of
the previous calendar quarter, as set forth in Table 1 to Sec. --.11.
(iii) Maximum payout amount. A [BANK]'s maximum payout amount for
the current calendar quarter is equal to the [BANK]'s eligible retained
income, multiplied by the applicable maximum payout ratio, as set forth
in Table 1 to Sec. --.11.
(iv) Private sector credit exposure. Private sector credit exposure
means an exposure to a company or an individual that is not an exposure
to a sovereign, the Bank for International Settlements, the European
Central Bank, the European Commission, the International Monetary Fund,
a MDB, a PSE, or a GSE.
(3) Calculation of capital conservation buffer. (i) A [BANK]'s
capital conservation buffer is equal to the lowest of the following
ratios, calculated as of the last day of the previous calendar quarter
based on the [BANK]'s most recent [REGULATORY REPORT]:
(A) The [BANK]'s common equity tier 1 capital ratio minus the
[BANK]'s minimum common equity tier 1 capital ratio requirement under
Sec. --.10;
(B) The [BANK]'s tier 1 capital ratio minus the [BANK]'s minimum
tier 1 capital ratio requirement under Sec. --.10; and
(C) The [BANK]'s total capital ratio minus the [BANK]'s minimum
total capital ratio requirement under Sec. --.10; or
(ii) Notwithstanding paragraphs (a)(3)(i)(A)-(C) of this section,
if the [BANK]'s common equity tier 1, tier 1 or total capital ratio is
less than or equal to the [BANK]'s minimum common equity tier 1, tier 1
or total capital ratio requirement under Sec. --.10, respectively, the
[BANK]'s capital conservation buffer is zero.
(4) Limits on distributions and discretionary bonus payments. (i) A
[BANK] shall not make distributions or discretionary bonus payments or
create an obligation to make such distributions or payments during the
current calendar quarter that, in the aggregate, exceed the maximum
payout amount.
(ii) A [BANK] with a capital conservation buffer that is greater
than 2.5 percent plus 100 percent of its applicable countercyclical
capital buffer, in accordance with paragraph (b) of this section, is
not subject to a maximum payout amount under this section.
(iii) Negative eligible retained income. Except as provided in
paragraph (a)(4)(iv) of this section, a [BANK] may not make
distributions or discretionary bonus payments during the current
calendar quarter if the [BANK]'s:
(A) Eligible retained income is negative; and
(B) Capital conservation buffer was less than 2.5 percent as of the
end of the previous calendar quarter.
(iv) Prior approval. Notwithstanding the limitations in paragraphs
(a)(4)(i) through (iii) of this section, the [AGENCY] may permit a
[BANK] to make a distribution or discretionary bonus payment upon a
request of the [BANK], if the [AGENCY] determines that the distribution
or discretionary bonus payment would not be contrary to the purposes of
this section, or to the safety and soundness of the [BANK]. In making
such a determination, the [AGENCY] will consider the nature and extent
of the request and the particular circumstances giving rise to the
request.
Table 1 to Sec. --.11--Calculation of Maximum Payout Amount
------------------------------------------------------------------------
Maximum payout ratio (as a
Capital conservation buffer percentage of eligible retained
income)
------------------------------------------------------------------------
Greater than 2.5 percent plus 100 No payout ratio limitation applies.
percent of the [BANK]'s
applicable countercyclical
capital buffer amount.
Less than or equal to 2.5 percent 60 percent.
plus 100 percent of the [BANK]'s
applicable countercyclical
capital buffer amount, and
greater than 1.875 percent plus
75 percent of the [BANK]'s
applicable countercyclical
capital buffer amount.
Less than or equal to 1.875 40 percent.
percent plus 75 percent of the
[BANK]'s applicable
countercyclical capital buffer
amount, and greater than 1.25
percent plus 50 percent of the
[BANK]'s applicable
countercyclical capital buffer
amount.
[[Page 62172]]
Less than or equal to 1.25 20 percent.
percent plus 50 percent of the
[BANK]'s applicable
countercyclical capital buffer
amount, and greater than 0.625
percent plus 25 percent of the
[BANK]'s applicable
countercyclical capital buffer
amount.
Less than or equal to 0.625 0 percent.
percent plus 25 percent of the
[BANK]'s applicable
countercyclical capital buffer
amount.
------------------------------------------------------------------------
(v) Other limitations on distributions. Additional limitations on
distributions may apply to a [BANK] under [12 CFR part 3, subparts H
and I; 12 CFR part 5.46, 12 CFR part 5, subpart E; 12 CFR part 6 (OCC);
12 CFR 225.4; 12 CFR 225.8; 12 CFR 263.202 (Board)].
(b) Countercyclical capital buffer amount. (1) General. An advanced
approaches [BANK] must calculate a countercyclical capital buffer
amount in accordance with the following paragraphs for purposes of
determining its maximum payout ratio under Table 1 to Sec. --.11.
(i) Extension of capital conservation buffer. The countercyclical
capital buffer amount is an extension of the capital conservation
buffer as described in paragraph (a) of this section.
(ii) Amount. An advanced approaches [BANK] has a countercyclical
capital buffer amount determined by calculating the weighted average of
the countercyclical capital buffer amounts established for the national
jurisdictions where the [BANK]'s private sector credit exposures are
located, as specified in paragraphs (b)(2) and (3) of this section.
(iii) Weighting. The weight assigned to a jurisdiction's
countercyclical capital buffer amount is calculated by dividing the
total risk-weighted assets for the [BANK]'s private sector credit
exposures located in the jurisdiction by the total risk-weighted assets
for all of the [BANK]'s private sector credit exposures. The
methodology a [BANK] uses for determining risk-weighted assets for
purposes of this paragraph (b) must be the methodology that determines
its risk-based capital ratios under Sec. --.10. Notwithstanding the
previous sentence, the risk-weighted asset amount for a private sector
credit exposure that is a covered position under subpart F of this part
is its specific risk add-on as determined under Sec. --.210 multiplied
by 12.5.
(iv) Location. (A) Except as provided in paragraphs (b)(1)(iv)(B)
and (b)(1)(iv)(C) of this section, the location of a private sector
credit exposure is the national jurisdiction where the borrower is
located (that is, where it is incorporated, chartered, or similarly
established or, if the borrower is an individual, where the borrower
resides).
(B) If, in accordance with subparts D or E of this part, the [BANK]
has assigned to a private sector credit exposure a risk weight
associated with a protection provider on a guarantee or credit
derivative, the location of the exposure is the national jurisdiction
where the protection provider is located.
(C) The location of a securitization exposure is the location of
the underlying exposures, or, if the underlying exposures are located
in more than one national jurisdiction, the national jurisdiction where
the underlying exposures with the largest aggregate unpaid principal
balance are located. For purposes of this paragraph (b), the location
of an underlying exposure shall be the location of the borrower,
determined consistent with paragraph (b)(1)(iv)(A) of this section.
(2) Countercyclical capital buffer amount for credit exposures in
the United States--(i) Initial countercyclical capital buffer amount
with respect to credit exposures in the United States. The initial
countercyclical capital buffer amount in the United States is zero.
(ii) Adjustment of the countercyclical capital buffer amount. The
[AGENCY] will adjust the countercyclical capital buffer amount for
credit exposures in the United States in accordance with applicable
law.\6\
---------------------------------------------------------------------------
\6\ The [AGENCY] expects that any adjustment will be based on a
determination made jointly by the Board, OCC, and FDIC.
---------------------------------------------------------------------------
(iii) Range of countercyclical capital buffer amount. The [AGENCY]
will adjust the countercyclical capital buffer amount for credit
exposures in the United States between zero percent and 2.5 percent of
risk-weighted assets.
(iv) Adjustment determination. The [AGENCY] will base its decision
to adjust the countercyclical capital buffer amount under this section
on a range of macroeconomic, financial, and supervisory information
indicating an increase in systemic risk including, but not limited to,
the ratio of credit to gross domestic product, a variety of asset
prices, other factors indicative of relative credit and liquidity
expansion or contraction, funding spreads, credit condition surveys,
indices based on credit default swap spreads, options implied
volatility, and measures of systemic risk.
(v) Effective date of adjusted countercyclical capital buffer
amount. (A) Increase adjustment. A determination by the [AGENCY] under
paragraph (b)(2)(ii) of this section to increase the countercyclical
capital buffer amount will be effective 12 months from the date of
announcement, unless the [AGENCY] establishes an earlier effective date
and includes a statement articulating the reasons for the earlier
effective date.
(B) Decrease adjustment. A determination by the [AGENCY] to
decrease the established countercyclical capital buffer amount under
paragraph (b)(2)(ii) of this section 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.
(vi) Twelve month sunset. The countercyclical capital buffer amount
will return to zero percent 12 months after the effective date that the
adjusted countercyclical capital buffer amount is announced, unless the
[AGENCY] announces a decision to maintain the adjusted countercyclical
capital buffer amount or adjust it again before the expiration of the
12-month period.
(3) Countercyclical capital buffer amount for foreign
jurisdictions. The [AGENCY] will adjust the countercyclical capital
buffer amount for private sector credit exposures to reflect decisions
made by foreign jurisdictions consistent with due process requirements
described in paragraph (b)(2) of this section.
Sec. Sec. --.12 through --.19 [Reserved]
Subpart C--Definition of Capital
Sec. --.20 Capital components and eligibility criteria for regulatory
capital instruments.
(a) Regulatory capital components. A [BANK]'s regulatory capital
components are:
(1) Common equity tier 1 capital;
[[Page 62173]]
(2) Additional tier 1 capital; and
(3) Tier 2 capital.
(b) Common equity tier 1 capital. Common equity tier 1 capital is
the sum of the common equity tier 1 capital elements in this paragraph
(b), minus regulatory adjustments and deductions in Sec. --.22. The
common equity tier 1 capital elements are:
(1) Any common stock instruments (plus any related surplus) issued
by the [BANK], net of treasury stock, and any capital instruments
issued by mutual banking organizations, that meet all the following
criteria:
(i) The instrument is paid-in, issued directly by the [BANK], and
represents the most subordinated claim in a receivership, insolvency,
liquidation, or similar proceeding of the [BANK];
(ii) The holder of the instrument is entitled to a claim on the
residual assets of the [BANK] that is proportional with the holder's
share of the [BANK]'s issued capital after all senior claims have been
satisfied in a receivership, insolvency, liquidation, or similar
proceeding;
(iii) The instrument has no maturity date, can only be redeemed via
discretionary repurchases with the prior approval of the [AGENCY], and
does not contain any term or feature that creates an incentive to
redeem;
(iv) The [BANK] 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;
(v) Any cash dividend payments on the instrument are paid out of
the [BANK]'s net income, retained earnings, or surplus related to
common stock, and are not subject to a limit imposed by the contractual
terms governing the instrument;
(vi) The [BANK] has full discretion at all times to refrain from
paying any dividends and making any other 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 [BANK];
(vii) Dividend payments and any other distributions on the
instrument may be paid only after all legal and contractual obligations
of the [BANK] have been satisfied, including payments due on more
senior claims;
(viii) 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 [BANK] with greater priority in a receivership,
insolvency, liquidation, or similar proceeding;
(ix) The paid-in amount is classified as equity under GAAP;
(x) The [BANK], or an entity that the [BANK] controls, did not
purchase or directly or indirectly fund the purchase of the instrument;
(xi) The instrument is not secured, not covered by a guarantee of
the [BANK] or of an affiliate of the [BANK], and is not subject to any
other arrangement that legally or economically enhances the seniority
of the instrument;
(xii) The instrument has been issued in accordance with applicable
laws and regulations; and
(xiii) The instrument is reported on the [BANK]'s regulatory
financial statements separately from other capital instruments.
(2) Retained earnings.
(3) Accumulated other comprehensive income (AOCI) as reported under
GAAP.\7\
---------------------------------------------------------------------------
\7\ See Sec. --.22 for specific adjustments related to AOCI.
---------------------------------------------------------------------------
(4) Any common equity tier 1 minority interest, subject to the
limitations in Sec. --.21(c).
(5) Notwithstanding the criteria for common stock instruments
referenced above, a [BANK]'s common stock issued and held in trust for
the benefit of its employees as part of an employee stock ownership
plan does not violate any of the criteria in paragraph (b)(1)(iii),
paragraph (b)(1)(iv) or paragraph (b)(1)(xi) of this section, provided
that any repurchase of the stock is required solely by virtue of ERISA
for an instrument of a [BANK] that is not publicly-traded. In addition,
an instrument issued by a [BANK] to its employee stock ownership plan
does not violate the criterion in paragraph (b)(1)(x) of this section.
(c) Additional tier 1 capital. Additional tier 1 capital is the sum
of additional tier 1 capital elements and any related surplus, minus
the regulatory adjustments and deductions in Sec. --.22. Additional
tier 1 capital elements are:
(1) Instruments (plus any related surplus) that meet the following
criteria:
(i) The instrument is issued and paid-in;
(ii) The instrument is subordinated to depositors, general
creditors, and subordinated debt holders of the [BANK] in a
receivership, insolvency, liquidation, or similar proceeding;
(iii) The instrument is not secured, not covered by a guarantee of
the [BANK] or of an affiliate of the [BANK], and not subject to any
other arrangement that legally or economically enhances the seniority
of the instrument;
(iv) 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; and
(v) If callable by its terms, the instrument may be called by the
[BANK] 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 that precludes the
instrument from being included in additional tier 1 capital, a tax
event, or if the issuing entity is required to register as an
investment company pursuant to the Investment Company Act of 1940 (15
U.S.C. 80a-1 et seq.). In addition:
(A) The [BANK] must receive prior approval from the [AGENCY] to
exercise a call option on the instrument.
(B) The [BANK] does not create at issuance of the instrument,
through any action or communication, an expectation that the call
option will be exercised.
(C) Prior to exercising the call option, or immediately thereafter,
the [BANK] must either: Replace the instrument to be called with an
equal amount of instruments that meet the criteria under paragraph (b)
of this section or this paragraph (c); \8\ or demonstrate to the
satisfaction of the [AGENCY] that following redemption, the [BANK] will
continue to hold capital commensurate with its risk.
---------------------------------------------------------------------------
\8\ Replacement can be concurrent with redemption of existing
additional tier 1 capital instruments.
---------------------------------------------------------------------------
(vi) Redemption or repurchase of the instrument requires prior
approval from the [AGENCY].
(vii) The [BANK] has full discretion at all times to cancel
dividends or other 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 [BANK] except in relation to
any distributions to holders of common stock or instruments that are
pari passu with the instrument.
(viii) Any distributions on the instrument are paid out of the
[BANK]'s net income, retained earnings, or surplus related to other
additional tier 1 capital instruments.
(ix) 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 [BANK]'s credit quality, but may have a dividend rate that is
adjusted periodically independent of the [BANK]'s credit quality, in
relation to
[[Page 62174]]
general market interest rates or similar adjustments.
(x) The paid-in amount is classified as equity under GAAP.
(xi) The [BANK], or an entity that the [BANK] controls, did not
purchase or directly or indirectly fund the purchase of the instrument.
(xii) The instrument does not have any features that would limit or
discourage additional issuance of capital by the [BANK], such as
provisions that require the [BANK] to compensate holders of the
instrument if a new instrument is issued at a lower price during a
specified time frame.
(xiii) If the instrument is not issued directly by the [BANK] or by
a subsidiary of the [BANK] that is an operating entity, the only asset
of the issuing entity is its investment in the capital of the [BANK],
and proceeds must be immediately available without limitation to the
[BANK] or to the [BANK]'s top-tier holding company in a form which
meets or exceeds all of the other criteria for additional tier 1
capital instruments.\9\
---------------------------------------------------------------------------
\9\ De minimis assets related to the operation of the issuing
entity can be disregarded for purposes of this criterion.
---------------------------------------------------------------------------
(xiv) For an advanced approaches [BANK], the governing agreement,
offering circular, or prospectus of an instrument issued after the date
upon which the [BANK] becomes subject to this part as set forth in
Sec. --.1(f) 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 [BANK] enters into a receivership, insolvency,
liquidation, or similar proceeding.
(2) Tier 1 minority interest, subject to the limitations in Sec.
--.21(d), that is not included in the [BANK]'s common equity tier 1
capital.
(3) Any and all instruments that qualified as tier 1 capital under
the [AGENCY]'s general risk-based capital rules under [12 CFR part 3,
appendix A (national banks), 12 CFR 167 (Federal savings associations)
(OCC); 12 CFR part 208, appendix A, 12 CFR part 225, appendix A
(Board)] as then in effect, that were issued under the Small Business
Jobs Act of 2010 \10\ or prior to October 4, 2010, under the Emergency
Economic Stabilization Act of 2008.\11\
---------------------------------------------------------------------------
\10\ Public Law 111-240; 124 Stat. 2504 (2010).
\11\ Public Law 110-343, 122 Stat. 3765 (2008).
---------------------------------------------------------------------------
(4) Notwithstanding the criteria for additional tier 1 capital
instruments referenced above:
(i) An instrument issued by a [BANK] and held in trust for the
benefit of its employees as part of an employee stock ownership plan
does not violate any of the criteria in paragraph (c)(1)(iii) of this
section, provided that any repurchase is required solely by virtue of
ERISA for an instrument of a [BANK] that is not publicly-traded. In
addition, an instrument issued by a [BANK] to its employee stock
ownership plan does not violate the criteria in paragraph (c)(1)(v) or
paragraph (c)(1)(xi) of this section; and
(ii) An instrument with terms that provide that the instrument may
be called earlier than five years upon the occurrence of a rating
agency event does not violate the criterion in paragraph (c)(1)(v) of
this section provided that the instrument was issued and included in a
[BANK]'s tier 1 capital prior to January 1, 2014, and that such
instrument satisfies all other criteria under this Sec. --.20(c).
(d) Tier 2 Capital. Tier 2 capital is the sum of tier 2 capital
elements and any related surplus, minus regulatory adjustments and
deductions in Sec. --.22. Tier 2 capital elements are:
(1) Instruments (plus related surplus) that meet the following
criteria:
(i) The instrument is issued and paid-in;
(ii) The instrument is subordinated to depositors and general
creditors of the [BANK];
(iii) The instrument is not secured, not covered by a guarantee of
the [BANK] or of an affiliate of the [BANK], and not subject to any
other arrangement that legally or economically enhances the seniority
of the instrument in relation to more senior claims;
(iv) 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 the 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 [BANK] to redeem the instrument prior
to maturity; \12\ and
---------------------------------------------------------------------------
\12\ An instrument that by its terms automatically converts into
a tier 1 capital instrument prior to five years after issuance
complies with the five-year maturity requirement of this criterion.
---------------------------------------------------------------------------
(v) The instrument, by its terms, may be called by the [BANK] 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, a tax event, or if the issuing entity is required to
register as an investment company pursuant to the Investment Company
Act of 1940 (15 U.S.C. 80a-1 et seq.). In addition:
(A) The [BANK] must receive the prior approval of the [AGENCY] to
exercise a call option on the instrument.
(B) The [BANK] does not create at issuance, through action or
communication, an expectation the call option will be exercised.
(C) Prior to exercising the call option, or immediately thereafter,
the [BANK] must either: Replace any amount called with an equivalent
amount of an instrument that meets the criteria for regulatory capital
under this section; \13\ or demonstrate to the satisfaction of the
[AGENCY] that following redemption, the [BANK] would continue to hold
an amount of capital that is commensurate with its risk.
---------------------------------------------------------------------------
\13\ A [BANK] may replace tier 2 capital instruments concurrent
with the redemption of existing tier 2 capital instruments.
---------------------------------------------------------------------------
(vi) 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 [BANK].
(vii) 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 [BANK]'s credit standing, but may have a dividend rate
that is adjusted periodically independent of the [BANK]'s credit
standing, in relation to general market interest rates or similar
adjustments.
(viii) The [BANK], or an entity that the [BANK] controls, has not
purchased and has not directly or indirectly funded the purchase of the
instrument.
(ix) If the instrument is not issued directly by the [BANK] or by a
subsidiary of the [BANK] that is an operating entity, the only asset of
the issuing entity is its investment in the capital of the [BANK], and
proceeds must be immediately available without limitation to the [BANK]
or the [BANK]'s top-tier holding company in a form that meets or
exceeds all the other criteria for tier 2 capital instruments under
this section.\14\
---------------------------------------------------------------------------
\14\ A [BANK] may disregard de minimis assets related to the
operation of the issuing entity for purposes of this criterion.
---------------------------------------------------------------------------
(x) Redemption of the instrument prior to maturity or repurchase
requires the prior approval of the [AGENCY].
(xi) For an advanced approaches [BANK], the governing agreement,
offering circular, or prospectus of an instrument issued after the date
on which the advanced approaches [BANK]
[[Page 62175]]
becomes subject to this part under Sec. --.1(f) 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 [BANK] enters into a
receivership, insolvency, liquidation, or similar proceeding.
(2) Total capital minority interest, subject to the limitations set
forth in Sec. --.21(e), that is not included in the [BANK]'s tier 1
capital.
(3) ALLL up to 1.25 percent of the [BANK]'s standardized total
risk-weighted assets not including any amount of the ALLL (and
excluding in the case of a market risk [BANK], its standardized market
risk-weighted assets).
(4) Any instrument that qualified as tier 2 capital under the
[AGENCY]'s general risk-based capital rules under [12 CFR part 3,
appendix A, 12 CFR 167 (OCC); 12 CFR part 208, appendix A, 12 CFR part
225, appendix A (Board)] as then in effect, that were issued under the
Small Business Jobs Act of 2010,\15\ or prior to October 4, 2010, under
the Emergency Economic Stabilization Act of 2008.\16\
---------------------------------------------------------------------------
\15\ Public Law 111-240; 124 Stat. 2504 (2010).
\16\ Public Law 110-343, 122 Stat. 3765 (2008).
---------------------------------------------------------------------------
(5) For a [BANK] that makes an AOCI opt-out election (as defined in
paragraph (b)(2) of this section), 45 percent of pretax net unrealized
gains on available-for-sale preferred stock classified as an equity
security under GAAP and available-for-sale equity exposures.
(6) Notwithstanding the criteria for tier 2 capital instruments
referenced above, an instrument with terms that provide that the
instrument may be called earlier than five years upon the occurrence of
a rating agency event does not violate the criterion in paragraph
(d)(1)(v) of this section provided that the instrument was issued and
included in a [BANK]'s tier 1 or tier 2 capital prior to January 1,
2014, and that such instrument satisfies all other criteria under this
paragraph (d).
(e) [AGENCY] approval of a capital element. (1) A [BANK] must
receive [AGENCY] prior approval to include a capital element (as listed
in this section) in its common equity tier 1 capital, additional tier 1
capital, or tier 2 capital unless the element:
(i) Was included in a [BANK]'s tier 1 capital or tier 2 capital
prior to May 19, 2010 in accordance with the [AGENCY]'s risk-based
capital rules that were effective as of that date and the underlying
instrument may continue to be included under the criteria set forth in
this section; or
(ii) Is equivalent, in terms of capital quality and ability to
absorb losses with respect to all material terms, to a regulatory
capital element the [AGENCY] determined may be included in regulatory
capital pursuant to paragraph (e)(3) of this section.
(2) When considering whether a [BANK] may include a regulatory
capital element in its common equity tier 1 capital, additional tier 1
capital, or tier 2 capital, the [AGENCY] will consult with the [other
Federal banking agencies].
(3) After determining that a regulatory capital element may be
included in a [BANK]'s common equity tier 1 capital, additional tier 1
capital, or tier 2 capital, the [AGENCY] will make its decision
publicly available, including a brief description of the material terms
of the regulatory capital element and the rationale for the
determination.
Sec. --.21 Minority interest.
(a) Applicability. For purposes of Sec. --.20, a [BANK] is subject
to the minority interest limitations in this section if:
(1) A consolidated subsidiary of the [BANK] has issued regulatory
capital that is not owned by the [BANK]; and
(2) For each relevant regulatory capital ratio of the consolidated
subsidiary, the ratio exceeds the sum of the subsidiary's minimum
regulatory capital requirements plus its capital conservation buffer.
(b) Difference in capital adequacy standards at the subsidiary
level. For purposes of the minority interest calculations in this
section, if the consolidated subsidiary issuing the capital is not
subject to capital adequacy standards similar to those of the [BANK],
the [BANK] must assume that the capital adequacy standards of the
[BANK] apply to the subsidiary.
(c) Common equity tier 1 minority interest includable in the common
equity tier 1 capital of the [BANK]. For each consolidated subsidiary
of a [BANK], the amount of common equity tier 1 minority interest the
[BANK] may include in common equity tier 1 capital is equal to:
(1) The common equity tier 1 minority interest of the subsidiary;
minus
(2) The percentage of the subsidiary's common equity tier 1 capital
that is not owned by the [BANK], multiplied by the difference between
the common equity tier 1 capital of the subsidiary and the lower of:
(i) The amount of common equity tier 1 capital the subsidiary must
hold, or would be required to hold pursuant to paragraph (b) of this
section, to avoid restrictions on distributions and discretionary bonus
payments under Sec. --.11 or equivalent standards established by the
subsidiary's home country supervisor; or
(ii)(A) The standardized total risk-weighted assets of the [BANK]
that relate to the subsidiary multiplied by
(B) The common equity tier 1 capital ratio the subsidiary must
maintain to avoid restrictions on distributions and discretionary bonus
payments under Sec. --.11 or equivalent standards established by the
subsidiary's home country supervisor.
(d) Tier 1 minority interest includable in the tier 1 capital of
the [BANK]. For each consolidated subsidiary of the [BANK], the amount
of tier 1 minority interest the [BANK] may include in tier 1 capital is
equal to:
(1) The tier 1 minority interest of the subsidiary; minus
(2) The percentage of the subsidiary's tier 1 capital that is not
owned by the [BANK] multiplied by the difference between the tier 1
capital of the subsidiary and the lower of:
(i) The amount of tier 1 capital the subsidiary must hold, or would
be required to hold pursuant to paragraph (b) of this section, to avoid
restrictions on distributions and discretionary bonus payments under
Sec. --.11 or equivalent standards established by the subsidiary's
home country supervisor, or
(ii)(A) The standardized total risk-weighted assets of the [BANK]
that relate to the subsidiary multiplied by
(B) The tier 1 capital ratio the subsidiary must maintain to avoid
restrictions on distributions and discretionary bonus payments under
Sec. --.11 or equivalent standards established by the subsidiary's
home country supervisor.
(e) Total capital minority interest includable in the total capital
of the [BANK]. For each consolidated subsidiary of the [BANK], the
amount of total capital minority interest the [BANK] may include in
total capital is equal to:
(1) The total capital minority interest of the subsidiary; minus
(2) The percentage of the subsidiary's total capital that is not
owned by the [BANK] multiplied by the difference between the total
capital of the subsidiary and the lower of:
(i) The amount of total capital the subsidiary must hold, or would
be required to hold pursuant to paragraph (b) of this section, to avoid
restrictions on distributions and discretionary bonus payments under
Sec. --.11 or equivalent standards established by the subsidiary's
home country supervisor, or
[[Page 62176]]
(ii)(A) The standardized total risk-weighted assets of the [BANK]
that relate to the subsidiary multiplied by
(B) The total capital ratio the subsidiary must maintain to avoid
restrictions on distributions and discretionary bonus payments under
Sec. --.11 or equivalent standards established by the subsidiary's
home country supervisor.
Sec. --.22 Regulatory capital adjustments and deductions.
(a) Regulatory capital deductions from common equity tier 1
capital. A [BANK] must deduct from the sum of its common equity tier 1
capital elements the items set forth in this paragraph (a):
(1) Goodwill, net of associated deferred tax liabilities (DTLs) in
accordance with paragraph (e) of this section, including 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
(and that is reflected in the consolidated financial statements of the
[BANK]), in accordance with paragraph (d) of this section;
(2) Intangible assets, other than MSAs, net of associated DTLs in
accordance with paragraph (e) of this section;
(3) Deferred tax assets (DTAs) that arise from net operating loss
and tax credit carryforwards net of any related valuation allowances
and net of DTLs in accordance with paragraph (e) of this section;
(4) Any gain-on-sale in connection with a securitization exposure;
(5)(i) Any defined benefit pension fund net asset, net of any
associated DTL in accordance with paragraph (e) of this section, held
by a depository institution holding company. With the prior approval of
the [AGENCY], this deduction is not required for any defined benefit
pension fund net asset to the extent the depository institution holding
company has unrestricted and unfettered access to the assets in that
fund.
(ii) For an insured depository institution, no deduction is
required.
(iii) A [BANK] must risk weight any portion of the defined benefit
pension fund asset that is not deducted under paragraphs (a)(5)(i) or
(a)(5)(ii) of this section as if the [BANK] directly holds a
proportional ownership share of each exposure in the defined benefit
pension fund.
(6) For an advanced approaches [BANK] that has completed the
parallel run process and that has received notification from the
[AGENCY] pursuant to Sec. --.121(d), the amount of expected credit
loss that exceeds its eligible credit reserves; and
(7) With respect to a financial subsidiary, the aggregate amount of
the [BANK]'s outstanding equity investment, including retained
earnings, in its financial subsidiaries (as defined in [12 CFR 5.39
(OCC); 12 CFR 208.77 (Board))]. A [BANK] must not consolidate the
assets and liabilities of a financial subsidiary with those of the
parent bank, and no other deduction is required under paragraph (c) of
this section for investments in the capital instruments of financial
subsidiaries.
(b) Regulatory adjustments to common equity tier 1 capital. (1) A
[BANK] must adjust the sum of common equity tier 1 capital elements
pursuant to the requirements set forth in this paragraph (b). Such
adjustments to common equity tier 1 capital must be made net of the
associated deferred tax effects.
(i) A [BANK] that makes an AOCI opt-out election (as defined in
paragraph (b)(2) of this section), must make the adjustments required
under Sec. --.22(b)(2)(i).
(ii) A [BANK] that is an advanced approaches [BANK], and a [BANK]
that has not made an AOCI opt-out election (as defined in paragraph
(b)(2) of this section), must deduct any accumulated net gains and 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.
(iii) A [BANK] must deduct any net gain and add any net loss
related to changes in the fair value of liabilities that are due to
changes in the [BANK]'s own credit risk. An advanced approaches [BANK]
also must deduct the credit spread premium over the risk free rate for
derivatives that are liabilities.
(2) AOCI opt-out election. (i) A [BANK] that is not an advanced
approaches [BANK] may make a one-time election to opt out of the
requirement to include all components of AOCI (with the exception of
accumulated net gains and losses on cash flow hedges related to items
that are not fair-valued on the balance sheet) in common equity tier 1
capital (AOCI opt-out election). A [BANK] that makes an AOCI opt-out
election in accordance with this paragraph (b)(2) must adjust common
equity tier 1 capital as follows:
(A) Subtract any net unrealized gains and add any net unrealized
losses on available-for-sale securities;
(B) Subtract any net unrealized losses on available-for-sale
preferred stock classified as an equity security under GAAP and
available-for-sale equity exposures;
(C) Subtract any accumulated net gains and add any accumulated net
losses on cash flow hedges;
(D) Subtract 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 [BANK]'s option, the portion relating to pension
assets deducted under paragraph (a)(5) of this section); and
(E) Subtract any net unrealized gains and add any net unrealized
losses on held-to-maturity securities that are included in AOCI.
(ii) A [BANK] that is not an advanced approaches [BANK] must make
its AOCI opt-out election in its [REGULATORY REPORT] filed for the
first regulatory reporting period after the date required for such
[BANK] to comply with subpart A of this part as set forth in Sec.
--.1(f).
(iii) With respect to a [BANK] that is not an advanced approaches
[BANK], each of its subsidiary banking organizations that is subject to
regulatory capital requirements issued by the Board of Governors of the
Federal Reserve, the Federal Deposit Insurance Corporation, or the
Office of the Comptroller of the Currency \17\ must elect the same
option as the [BANK] pursuant to this paragraph (b)(2).
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\17\ These rules include the regulatory capital requirements set
forth at 12 CFR part 3 (OCC); 12 CFR part 225 (Board); 12 CFR part
325, and 12 CFR part 390 (FDIC).
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(iv) With prior notice to the [AGENCY], a [BANK] resulting from a
merger, acquisition, or purchase transaction and that is not an
advanced approaches [BANK] may change its AOCI opt-out election in its
[REGULATORY REPORT] filed for the first reporting period after the date
required for such [BANK] to comply with subpart A of this part as set
forth in Sec. --.1(f) if:
(A) Other than as set forth in paragraph (b)(2)(iv)(C) of this
section, the merger, acquisition, or purchase transaction involved the
acquisition or purchase of all or substantially all of either the
assets or voting stock of another banking organization that is subject
to regulatory capital requirements issued by the Board of Governors of
the Federal Reserve, the Federal Deposit Insurance Corporation, or the
Office of the Comptroller of the Currency; \18\
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\18\ These rules include the regulatory capital requirements set
forth at 12 CFR part 3 (OCC); 12 CFR part 225 (Board); 12 CFR part
325, and 12 CFR part 390 (FDIC).
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[[Page 62177]]
(B) Prior to the merger, acquisition, or purchase transaction, only
one of the banking organizations involved in the transaction made an
AOCI opt-out election under this section; and
(C) A [BANK] may, with the prior approval of the [AGENCY], change
its AOCI opt-out election under this paragraph (b) in the case of a
merger, acquisition, or purchase transaction that meets the
requirements set forth at paragraph (b)(2)(iv)(B) of this section, but
does not meet the requirements of paragraph (b)(2)(iv)(A). In making
such a determination, the [AGENCY] 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 [BANK] resulting from the merger, acquisition, or purchase
transaction.
(c) Deductions from regulatory capital related to investments in
capital instruments \19\--(1) Investment in the [BANK]'s own capital
instruments. A [BANK] must deduct an investment in the [BANK]'s own
capital instruments as follows:
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\19\ The [BANK] must calculate amounts deducted under paragraphs
(c) through (f) of this section after it calculates the amount of
ALLL includable in tier 2 capital under Sec. --.20(d)(3).
---------------------------------------------------------------------------
(i) A [BANK] must deduct an investment in the [BANK]'s own common
stock instruments from its common equity tier 1 capital elements to the
extent such instruments are not excluded from regulatory capital under
Sec. --.20(b)(1);
(ii) A [BANK] must deduct an investment in the [BANK]'s own
additional tier 1 capital instruments from its additional tier 1
capital elements; and
(iii) A [BANK] must deduct an investment in the [BANK]'s own tier 2
capital instruments from its tier 2 capital elements.
(2) Corresponding deduction approach. For purposes of subpart C of
this part, the corresponding deduction approach is the methodology used
for the deductions from regulatory capital related to reciprocal cross
holdings (as described in paragraph (c)(3) of this section), non-
significant investments in the capital of unconsolidated financial
institutions (as described in paragraph (c)(4) of this section), and
non-common stock significant investments in the capital of
unconsolidated financial institutions (as described in paragraph (c)(5)
of this section). Under the corresponding deduction approach, a [BANK]
must make deductions from the component of capital for which the
underlying instrument would qualify if it were issued by the [BANK]
itself, as described in paragraphs (c)(2)(i)-(iii) of this section. If
the [BANK] does not have a sufficient amount of a specific component of
capital to effect the required deduction, the shortfall must be
deducted according to paragraph (f) of this section.
(i) If an investment is in the form of an instrument issued by a
financial institution that is not a regulated financial institution,
the [BANK] must treat the instrument as:
(A) A common equity tier 1 capital instrument if it is common stock
or represents the most subordinated claim in liquidation of the
financial institution; and
(B) An additional tier 1 capital instrument if it is subordinated
to all creditors of the financial institution and is senior in
liquidation only to common shareholders.
(ii) If an investment is in the form of an instrument issued by a
regulated financial institution and the instrument does not meet the
criteria for common equity tier 1, additional tier 1 or tier 2 capital
instruments under Sec. --.20, the [BANK] must treat the instrument as:
(A) A common equity tier 1 capital instrument if it is common stock
included in GAAP equity or represents the most subordinated claim in
liquidation of the financial institution;
(B) An additional tier 1 capital instrument if it is included in
GAAP equity, subordinated to all creditors of the financial
institution, and senior in a receivership, insolvency, liquidation, or
similar proceeding only to common shareholders; and
(C) A tier 2 capital instrument if it is not included in GAAP
equity but considered regulatory capital by the primary supervisor of
the financial institution.
(iii) If an investment is in the form of a non-qualifying capital
instrument (as defined in Sec. --.300(c)), the [BANK] must treat the
instrument as:
(A) An additional tier 1 capital instrument if such instrument was
included in the issuer's tier 1 capital prior to May 19, 2010; or
(B) A tier 2 capital instrument if such instrument was included in
the issuer's tier 2 capital (but not includable in tier 1 capital)
prior to May 19, 2010.
(3) Reciprocal cross holdings in the capital of financial
institutions. A [BANK] must deduct investments in the capital of other
financial institutions it holds reciprocally, where such reciprocal
cross holdings result from a formal or informal arrangement to swap,
exchange, or otherwise intend to hold each other's capital instruments,
by applying the corresponding deduction approach.
(4) Non-significant investments in the capital of unconsolidated
financial institutions. (i) A [BANK] must deduct its non-significant
investments in the capital of unconsolidated financial institutions (as
defined in Sec. --.2) that, in the aggregate, exceed 10 percent of the
sum of the [BANK]'s common equity tier 1 capital elements minus all
deductions from and adjustments to common equity tier 1 capital
elements required under paragraphs (a) through (c)(3) of this section
(the 10 percent threshold for non-significant investments) by applying
the corresponding deduction approach.\20\ The deductions described in
this section are net of associated DTLs in accordance with paragraph
(e) of this section. In addition, a [BANK] that underwrites a failed
underwriting, with the prior written approval of the [AGENCY], for the
period of time stipulated by the [AGENCY], is not required to deduct a
non-significant investment in the capital of an unconsolidated
financial institution pursuant to this paragraph (c) to the extent the
investment is related to the failed underwriting.\21\
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\20\ With the prior written approval of the [AGENCY], for the
period of time stipulated by the [AGENCY], a [BANK] is not required
to deduct a non-significant investment in the capital instrument of
an unconsolidated financial institution pursuant to this paragraph
if the financial institution is in distress and if such investment
is made for the purpose of providing financial support to the
financial institution, as determined by the [AGENCY].
\21\ Any non-significant investments in the capital of
unconsolidated financial institutions that do not exceed the 10
percent threshold for non-significant investments under this section
must be assigned the appropriate risk weight under subparts D, E, or
F of this part, as applicable.
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(ii) The amount to be deducted under this section from a specific
capital component is equal to:
(A) The [BANK]'s non-significant investments in the capital of
unconsolidated financial institutions exceeding the 10 percent
threshold for non-significant investments, multiplied by
(B) The ratio of the [BANK]'s non-significant investments in the
capital of unconsolidated financial institutions in the form of such
capital component to the [BANK]'s total non-significant investments in
unconsolidated financial institutions.
(5) Significant investments in the capital of unconsolidated
financial institutions that are not in the form of common stock. A
[BANK] must deduct its significant investments in the capital of
unconsolidated financial institutions that are not in the form of
common stock by applying the corresponding
[[Page 62178]]
deduction approach.\22\ The deductions described in this section are
net of associated DTLs in accordance with paragraph (e) of this
section. In addition, with the prior written approval of the [AGENCY],
for the period of time stipulated by the [AGENCY], a [BANK] that
underwrites a failed underwriting is not required to deduct a
significant investment in the capital of an unconsolidated financial
institution pursuant to this paragraph (c) if such investment is
related to such failed underwriting.
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\22\ With prior written approval of the [AGENCY], for the period
of time stipulated by the [AGENCY], a [BANK] is not required to
deduct a significant investment in the capital instrument of an
unconsolidated financial institution in distress which is not in the
form of common stock pursuant to this section if such investment is
made for the purpose of providing financial support to the financial
institution as determined by the [AGENCY].
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(d) Items subject to the 10 and 15 percent common equity tier 1
capital deduction thresholds. (1) A [BANK] must deduct from common
equity tier 1 capital elements the amount of each of the items set
forth in this paragraph (d) that, individually, exceeds 10 percent of
the sum of the [BANK]'s common equity tier 1 capital elements, less
adjustments to and deductions from common equity tier 1 capital
required under paragraphs (a) through (c) of this section (the 10
percent common equity tier 1 capital deduction threshold).
(i) DTAs arising from temporary differences that the [BANK] could
not realize through net operating loss carrybacks, net of any related
valuation allowances and net of DTLs, in accordance with paragraph (e)
of this section. A [BANK] is not required to deduct from the sum of its
common equity tier 1 capital elements DTAs (net of any related
valuation allowances and net of DTLs, in accordance with Sec.
--.22(e)) arising from timing differences that the [BANK] could realize
through net operating loss carrybacks. The [BANK] must risk weight
these assets at 100 percent. For a [BANK] that is a member of a
consolidated group for tax purposes, the amount of DTAs that could be
realized through net operating loss carrybacks may not exceed the
amount that the [BANK] could reasonably expect to have refunded by its
parent holding company.
(ii) MSAs net of associated DTLs, in accordance with paragraph (e)
of this section.
(iii) Significant investments in the capital of unconsolidated
financial institutions in the form of common stock, net of associated
DTLs in accordance with paragraph (e) of this section.\23\ Significant
investments in the capital of unconsolidated financial institutions in
the form of common stock subject to the 10 percent common equity tier 1
capital deduction threshold may be reduced by any goodwill embedded in
the valuation of such investments deducted by the [BANK] pursuant to
paragraph (a)(1) of this section. In addition, with the prior written
approval of the [AGENCY], for the period of time stipulated by the
[AGENCY], a [BANK] that underwrites a failed underwriting is not
required to deduct a significant investment in the capital of an
unconsolidated financial institution in the form of common stock
pursuant to this paragraph (d) if such investment is related to such
failed underwriting.
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\23\ With the prior written approval of the [AGENCY], for the
period of time stipulated by the [AGENCY], a [BANK] is not required
to deduct a significant investment in the capital instrument of an
unconsolidated financial institution in distress in the form of
common stock pursuant to this section if such investment is made for
the purpose of providing financial support to the financial
institution as determined by the [AGENCY].
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(2) A [BANK] must deduct from common equity tier 1 capital elements
the items listed in paragraph (d)(1) of this section that are not
deducted as a result of the application of the 10 percent common equity
tier 1 capital deduction threshold, and that, in aggregate, exceed
17.65 percent of the sum of the [BANK]'s common equity tier 1 capital
elements, minus adjustments to and deductions from common equity tier 1
capital required under paragraphs (a) through (c) of this section,
minus the items listed in paragraph (d)(1) of this section (the 15
percent common equity tier 1 capital deduction threshold). Any goodwill
that has been deducted under paragraph (a)(1) of this section can be
excluded from the significant investments in the capital of
unconsolidated financial institutions in the form of common stock.\24\
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\24\ The amount of the items in paragraph (d) of this section
that is not deducted from common equity tier 1 capital pursuant to
this section must be included in the risk-weighted assets of the
[BANK] and assigned a 250 percent risk weight.
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(3) For purposes of calculating the amount of DTAs subject to the
10 and 15 percent common equity tier 1 capital deduction thresholds, a
[BANK] may exclude DTAs and DTLs relating to adjustments made to common
equity tier 1 capital under paragraph (b) of this section. A [BANK]
that elects to exclude DTAs relating to adjustments under paragraph (b)
of this section also must exclude DTLs and must do so consistently in
all future calculations. A [BANK] may change its exclusion preference
only after obtaining the prior approval of the [AGENCY].
(e) Netting of DTLs against assets subject to deduction. (1) Except
as described in paragraph (e)(3) of this section, netting of DTLs
against assets that are subject to deduction under this section is
permitted, but not required, if the following conditions are met:
(i) The DTL is associated with the asset; and
(ii) The DTL would be extinguished if the associated asset becomes
impaired or is derecognized under GAAP.
(2) A DTL may only be netted against a single asset.
(3) For purposes of calculating the amount of DTAs subject to the
threshold deduction in paragraph (d) of this section, the amount of
DTAs that arise from net operating loss and tax credit carryforwards,
net of any related valuation allowances, and of DTAs arising from
temporary differences that the [BANK] could not realize through net
operating loss carrybacks, net of any related valuation allowances, may
be offset by DTLs (that have not been netted against assets subject to
deduction pursuant to paragraph (e)(1) of this section) subject to the
conditions set forth in this paragraph (e).
(i) Only the DTAs and DTLs that relate to taxes levied by the same
taxation authority and that are eligible for offsetting by that
authority may be offset for purposes of this deduction.
(ii) The amount of DTLs that the [BANK] nets against DTAs that
arise from net operating loss and tax credit carryforwards, net of any
related valuation allowances, and against DTAs arising from temporary
differences that the [BANK] could not realize through net operating
loss carrybacks, net of any related valuation allowances, must be
allocated in proportion to the amount of DTAs that arise from net
operating loss and tax credit carryforwards (net of any related
valuation allowances, but before any offsetting of DTLs) and of DTAs
arising from temporary differences that the [BANK] could not realize
through net operating loss carrybacks (net of any related valuation
allowances, but before any offsetting of DTLs), respectively.
(4) A [BANK] may offset DTLs embedded in the carrying value of a
leveraged lease portfolio acquired in a business combination that are
not recognized under GAAP against DTAs that are subject to paragraph
(d) of this section in accordance with this paragraph (e).
(5) A [BANK] must net DTLs against assets subject to deduction
under this section in a consistent manner from reporting period to
reporting period. A [BANK] may change its preference
[[Page 62179]]
regarding the manner in which it nets DTLs against specific assets
subject to deduction under this section only after obtaining the prior
approval of the [AGENCY].
(f) Insufficient amounts of a specific regulatory capital component
to effect deductions. Under the corresponding deduction approach, if a
[BANK] does not have a sufficient amount of a specific component of
capital to effect the required deduction after completing the
deductions required under paragraph (d) of this section, the [BANK]
must deduct the shortfall from the next higher (that is, more
subordinated) component of regulatory capital.
(g) Treatment of assets that are deducted. A [BANK] must exclude
from standardized total risk-weighted assets and, as applicable,
advanced approaches total risk-weighted assets any item deducted from
regulatory capital under paragraphs (a), (c), and (d) of this section.
(h) Net long position. (1) For purposes of calculating an
investment in the [BANK]'s own capital instrument and an investment in
the capital of an unconsolidated financial institution under this
section, the net long position is the gross long position in the
underlying instrument determined in accordance with paragraph (h)(2) of
this section, as adjusted to recognize a short position in the same
instrument calculated in accordance with paragraph (h)(3) of this
section.
(2) Gross long position. The gross long position is determined as
follows:
(i) For an equity exposure that is held directly, the adjusted
carrying value as that term is defined in Sec. --.51(b);
(ii) For an exposure that is held directly and is not an equity
exposure or a securitization exposure, the exposure amount as that term
is defined in Sec. --.2;
(iii) For an indirect exposure, the [BANK]'s carrying value of the
investment in the investment fund, provided that, alternatively:
(A) A [BANK] may, with the prior approval of the [AGENCY], use a
conservative estimate of the amount of its investment in its own
capital instruments or the capital of an unconsolidated financial
institution held through a position in an index; or
(B) A [BANK] may calculate the gross long position for the [BANK]'s
own capital instruments or the capital of an unconsolidated financial
institution by multiplying the [BANK]'s carrying value of its
investment in the investment fund by either:
(1) The highest stated investment limit (in percent) for
investments in the [BANK]'s own capital instruments or the capital of
unconsolidated financial institutions as stated in the prospectus,
partnership agreement, or similar contract defining permissible
investments of the investment fund; or
(2) The investment fund's actual holdings of own capital
instruments or the capital of unconsolidated financial institutions.
(iv) For a synthetic exposure, the amount of the [BANK]'s loss on
the exposure if the reference capital instrument were to have a value
of zero.
(3) Adjustments to reflect a short position. In order to adjust the
gross long position to recognize a short position in the same
instrument, the following criteria must be met:
(i) The maturity of the short position must match the maturity of
the long position, or the short position has a residual maturity of at
least one year (maturity requirement); or
(ii) For a position that is a trading asset or trading liability
(whether on- or off-balance sheet) as reported on the [BANK]'s
[REGULATORY REPORT], if the [BANK] has a contractual right or
obligation to sell the long position at a specific point in time and
the counterparty to the contract has an obligation to purchase the long
position if the [BANK] exercises its right to sell, this point in time
may be treated as the maturity of the long position such that the
maturity of the long position and short position are deemed to match
for purposes of the maturity requirement, even if the maturity of the
short position is less than one year; and
(iii) For an investment in the [BANK]'s own capital instrument
under paragraph (c)(1) of this section or an investment in a capital of
an unconsolidated financial institution under paragraphs (c)(4),
(c)(5), and (d)(1)(iii) of this section.
(A) A [BANK] may only net a short position against a long position
in the [BANK]'s own capital instrument under paragraph (c)(1) of this
section if the short position involves no counterparty credit risk.
(B) A gross long position in a [BANK]'s own capital instrument or
in a capital instrument of an unconsolidated financial institution
resulting from a position in an index may be netted against a short
position in the same index. Long and short positions in the same index
without maturity dates are considered to have matching maturities.
(C) A short position in an index that is hedging a long cash or
synthetic position in a [BANK]'s own capital instrument or in a capital
instrument of an unconsolidated financial institution can be decomposed
to provide recognition of the hedge. More specifically, the portion of
the index that is composed of the same underlying instrument that is
being hedged may be used to offset the long position if both the long
position being hedged and the short position in the index are reported
as a trading asset or trading liability (whether on- or off-balance
sheet) on the [BANK]'s [REGULATORY REPORT], and the hedge is deemed
effective by the [BANK]'s internal control processes, which have not
been found to be inadequate by the [AGENCY].
Sec. Sec. --.23 through --.29 [Reserved]
Subpart D--Risk-Weighted Assets--Standardized Approach
Sec. --.30 Applicability.
(a) This subpart sets forth methodologies for determining risk-
weighted assets for purposes of the generally applicable risk-based
capital requirements for all [BANK]s.
(b) Notwithstanding paragraph (a) of this section, a market risk
[BANK] must exclude from its calculation of risk-weighted assets under
this subpart the risk-weighted asset amounts of all covered positions,
as defined in subpart F of this part (except foreign exchange positions
that are not trading positions, OTC derivative positions, cleared
transactions, and unsettled transactions).
Risk-Weighted Assets For General Credit Risk
Sec. --.31 Mechanics for calculating risk-weighted assets for general
credit risk.
(a) General risk-weighting requirements. A [BANK] must apply risk
weights to its exposures as follows:
(1) A [BANK] must determine the exposure amount of each on-balance
sheet exposure, each OTC derivative contract, and each off-balance
sheet commitment, trade and transaction-related contingency, guarantee,
repo-style transaction, financial standby letter of credit, forward
agreement, or other similar transaction that is not:
(i) An unsettled transaction subject to Sec. --.38;
(ii) A cleared transaction subject to Sec. --.35;
(iii) A default fund contribution subject to Sec. --.35;
(iv) A securitization exposure subject to Sec. Sec. --.41 through
--.45; or
(v) An equity exposure (other than an equity OTC derivative
contract) subject to Sec. Sec. --.51 through --.53.
(2) The [BANK] must multiply each exposure amount by the risk
weight appropriate to the exposure based on
[[Page 62180]]
the exposure type or counterparty, eligible guarantor, or financial
collateral to determine the risk-weighted asset amount for each
exposure.
(b) Total risk-weighted assets for general credit risk equals the
sum of the risk-weighted asset amounts calculated under this section.
Sec. --.32 General risk weights.
(a) Sovereign exposures--(1) Exposures to the U.S. government. (i)
Notwithstanding any other requirement in this subpart, a [BANK] must
assign a zero percent risk weight to:
(A) An exposure to the U.S. government, its central bank, or a U.S.
government agency; and
(B) The portion of an exposure that is directly and unconditionally
guaranteed by the U.S. government, its central bank, or a U.S.
government agency. This includes a deposit or other exposure, or the
portion of a deposit or other exposure, that is insured or otherwise
unconditionally guaranteed by the FDIC or National Credit Union
Administration.
(ii) A [BANK] must assign a 20 percent risk weight to the portion
of an exposure that is conditionally guaranteed by the U.S. government,
its central bank, or a U.S. government agency. This includes an
exposure, or the portion of an exposure, that is conditionally
guaranteed by the FDIC or National Credit Union Administration.
(2) Other sovereign exposures. In accordance with Table 1 to Sec.
--.32, a [BANK] must assign a risk weight to a sovereign exposure based
on the CRC applicable to the sovereign or the sovereign's OECD
membership status if there is no CRC applicable to the sovereign.
Table 1 to Sec. --.32--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
------------------------------------------------------------------------
(3) Certain sovereign exposures. Notwithstanding paragraph (a)(2)
of this section, a [BANK] may assign to a sovereign exposure a risk
weight that is lower than the applicable risk weight in Table 1 to
Sec. --.32 if:
(i) The exposure is denominated in the sovereign's currency;
(ii) The [BANK] has at least an equivalent amount of liabilities in
that currency; and
(iii) The risk weight is not lower than the risk weight that the
home country supervisor allows [BANK]s under its jurisdiction to assign
to the same exposures to the sovereign.
(4) Exposures to a non-OECD member sovereign with no CRC. Except as
provided in paragraphs (a)(3), (a)(5) and (a)(6) of this section, a
[BANK] must assign a 100 percent risk weight to an exposure to a
sovereign if the sovereign does not have a CRC.
(5) Exposures to an OECD member sovereign with no CRC. Except as
provided in paragraph (a)(6) of this section, a [BANK] must assign a 0
percent risk weight to an exposure to a sovereign that is a member of
the OECD if the sovereign does not have a CRC.
(6) Sovereign default. A [BANK] must assign a 150 percent risk
weight to a sovereign exposure 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.
(b) Certain supranational entities and multilateral development
banks (MDBs). A [BANK] must assign a zero percent risk weight to an
exposure to the Bank for International Settlements, the European
Central Bank, the European Commission, the International Monetary Fund,
or an MDB.
(c) Exposures to GSEs. (1) A [BANK] must assign a 20 percent risk
weight to an exposure to a GSE other than an equity exposure or
preferred stock.
(2) A [BANK] must assign a 100 percent risk weight to preferred
stock issued by a GSE.
(d) Exposures to depository institutions, foreign banks, and credit
unions--(1) Exposures to U.S. depository institutions and credit
unions. A [BANK] must assign a 20 percent risk weight to an exposure to
a depository institution or credit union that is organized under the
laws of the United States or any state thereof, except as otherwise
provided under paragraph (d)(3) of this section.
(2) Exposures to foreign banks. (i) Except as otherwise provided
under paragraphs (d)(2)(iv) and (d)(3) of this section, a [BANK] must
assign a risk weight to an exposure to a foreign bank, in accordance
with Table 2 to Sec. --.32, based on the CRC that corresponds to the
foreign bank's home country or the OECD membership status of the
foreign bank's home country if there is no CRC applicable to the
foreign bank's home country.
Table 2 to Sec. --.32--Risk Weights for Exposures to Foreign Banks
------------------------------------------------------------------------
Risk weight
(in percent)
------------------------------------------------------------------------
CRC:
0-1................................................... 20
2..................................................... 50
3..................................................... 100
4-7................................................... 150
OECD Member with No CRC................................. 20
Non-OECD Member with No CRC............................. 100
Sovereign Default....................................... 150
------------------------------------------------------------------------
(ii) A [BANK] must assign a 20 percent risk weight to an exposure
to a foreign bank whose home country is a member of the OECD and does
not have a CRC.
(iii) A [BANK] must assign a 100 percent risk weight to an exposure
to a foreign bank whose home country is not a member of the OECD and
does not have a CRC, with the exception of self-liquidating, trade-
related contingent items that arise from the movement of goods, and
that have a maturity of three months or less, which may be assigned a
20 percent risk weight.
(iv) A [BANK] must 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 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.
(3) A [BANK] must assign a 100 percent risk weight to an exposure
to a financial institution if the exposure may be included in that
financial institution's capital unless the exposure is:
(i) An equity exposure;
(ii) A significant investment in the capital of an unconsolidated
financial institution in the form of common stock pursuant to Sec.
--.22(d)(iii);
(iii) Deducted from regulatory capital under Sec. --.22; or
(iv) Subject to a 150 percent risk weight under paragraph
(d)(2)(iv) or Table 2 of paragraph (d)(2) of this section.
(e) Exposures to public sector entities (PSEs)--(1) Exposures to
U.S. PSEs. (i) A [BANK] must 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.
(ii) A [BANK] must assign a 50 percent risk weight to a revenue
obligation exposure to a PSE that is organized under the laws of the
United States or any state or political subdivision thereof.
[[Page 62181]]
(2) Exposures to foreign PSEs. (i) Except as provided in paragraphs
(e)(1) and (e)(3) of this section, a [BANK] must assign a risk weight
to a general obligation exposure to a PSE, in accordance with Table 3
to Sec. --.32, based on the CRC that corresponds to the PSE's home
country or the OECD membership status of the PSE's home country if
there is no CRC applicable to the PSE's home country.
(ii) Except as provided in paragraphs (e)(1) and (e)(3) of this
section, a [BANK] must assign a risk weight to a revenue obligation
exposure to a PSE, in accordance with Table 4 to Sec. --.32, based on
the CRC that corresponds to the PSE's home country; or the OECD
membership status of the PSE's home country if there is no CRC
applicable to the PSE's home country.
(3) A [BANK] may assign a lower risk weight than would otherwise
apply under Tables 3 or 4 to Sec. --.32 to an exposure to a foreign
PSE if:
(i) The PSE's home country supervisor allows banks under its
jurisdiction to assign a lower risk weight to such exposures; and
(ii) The risk weight is not lower than the risk weight that
corresponds to the PSE's home country in accordance with Table 1 to
Sec. --.32.
Table 3 to Sec. --.32--Risk Weights for Non-U.S. PSE General
Obligations
------------------------------------------------------------------------
Risk weight
(in percent)
------------------------------------------------------------------------
CRC:
0-1................................................... 20
2..................................................... 50
3..................................................... 100
4-7................................................... 150
OECD Member with No CRC................................. 20
Non-OECD Member with No CRC............................. 100
Sovereign Default....................................... 150
------------------------------------------------------------------------
Table 4 to Sec. --.32--Risk Weights for Non-U.S. PSE Revenue
Obligations
------------------------------------------------------------------------
Risk weight
(in percent)
------------------------------------------------------------------------
CRC:
0-1................................................... 50
2-3................................................... 100
4-7................................................... 150
OECD Member with No CRC................................. 50
Non-OECD Member with No CRC............................. 100
Sovereign Default....................................... 150
------------------------------------------------------------------------
(4) Exposures to PSEs from an OECD member sovereign with no CRC.
(i) A [BANK] must assign a 20 percent risk weight to a general
obligation exposure to a PSE whose home country is an OECD member
sovereign with no CRC.
(ii) A [BANK] must assign a 50 percent risk weight to a revenue
obligation exposure to a PSE whose home country is an OECD member
sovereign with no CRC.
(5) Exposures to PSEs whose home country is not an OECD member
sovereign with no CRC. A [BANK] must assign a 100 percent risk weight
to an exposure to a PSE whose home country is not a member of the OECD
and does not have a CRC.
(6) A [BANK] must assign a 150 percent risk weight to a PSE
exposure immediately upon determining that an event of sovereign
default has occurred in a PSE's home country or if an event of
sovereign default has occurred in the PSE's home country during the
previous five years.
(f) Corporate exposures. A [BANK] must assign a 100 percent risk
weight to all its corporate exposures.
(g) Residential mortgage exposures. (1) A [BANK] must assign a 50
percent risk weight to a first-lien residential mortgage exposure that:
(i) Is secured by a property that is either owner-occupied or
rented;
(ii) Is made in accordance with prudent underwriting standards,
including standards relating to the loan amount as a percent of the
appraised value of the property;
(iii) Is not 90 days or more past due or carried in nonaccrual
status; and
(iv) Is not restructured or modified.
(2) A [BANK] must assign a 100 percent risk weight to a first-lien
residential mortgage exposure that does not meet the criteria in
paragraph (g)(1) of this section, and to junior-lien residential
mortgage exposures.
(3) For the purpose of this paragraph (g), if a [BANK] holds the
first-lien and junior-lien(s) residential mortgage exposures, and no
other party holds an intervening lien, the [BANK] must combine the
exposures and treat them as a single first-lien residential mortgage
exposure.
(4) A loan modified or restructured solely pursuant to the U.S.
Treasury's Home Affordable Mortgage Program is not modified or
restructured for purposes of this section.
(h) Pre-sold construction loans. A [BANK] must assign a 50 percent
risk weight to a pre-sold construction loan unless the purchase
contract is cancelled, in which case a [BANK] must assign a 100 percent
risk weight.
(i) Statutory multifamily mortgages. A [BANK] must assign a 50
percent risk weight to a statutory multifamily mortgage.
(j) High-volatility commercial real estate (HVCRE) exposures. A
[BANK] must assign a 150 percent risk weight to an HVCRE exposure.
(k) Past due exposures. Except for a sovereign exposure or a
residential mortgage exposure, a [BANK] must determine a risk weight
for an exposure that is 90 days or more past due or on nonaccrual
according to the requirements set forth in this paragraph (k).
(1) A [BANK] must assign a 150 percent risk weight to the portion
of the exposure that is not guaranteed or that is unsecured.
(2) A [BANK] may assign a risk weight to the guaranteed portion of
a past due exposure based on the risk weight that applies under Sec.
--.36 if the guarantee or credit derivative meets the requirements of
that section.
(3) A [BANK] may assign a risk weight to the collateralized portion
of a past due exposure based on the risk weight that applies under
Sec. --.37 if the collateral meets the requirements of that section.
(l) Other assets. (1) A [BANK] must assign a zero percent risk
weight to cash owned and held in all offices of the [BANK] or in
transit; to gold bullion held in the [BANK]'s own vaults or held in
another depository institution's vaults on an allocated basis, to the
extent the gold bullion assets are offset by gold bullion liabilities;
and to exposures that arise from the settlement of cash transactions
(such as equities, fixed income, spot foreign exchange and spot
commodities) with a central counterparty where there is no assumption
of ongoing counterparty credit risk by the central counterparty after
settlement of the trade and associated default fund contributions.
(2) A [BANK] must assign a 20 percent risk weight to cash items in
the process of collection.
(3) A [BANK] must assign a 100 percent risk weight to DTAs arising
from temporary differences that the [BANK] could realize through net
operating loss carrybacks.
(4) A [BANK] must assign a 250 percent risk weight to the portion
of each of the following items that is not deducted from common equity
tier 1 capital pursuant to Sec. --.22(d):
(i) MSAs; and
(ii) DTAs arising from temporary differences that the [BANK] could
not realize through net operating loss carrybacks.
(5) A [BANK] must assign a 100 percent risk weight to all assets
not specifically assigned a different risk weight under this subpart
and that are
[[Page 62182]]
not deducted from tier 1 or tier 2 capital pursuant to Sec. --.22.
(6) Notwithstanding the requirements of this section, a [BANK] may
assign an asset that is not included in one of the categories provided
in this section to the risk weight category applicable under the
capital rules applicable to bank holding companies and savings and loan
holding companies at 12 CFR part 217, provided that all of the
following conditions apply:
(i) The [BANK] is not authorized to hold the asset under applicable
law other than debt previously contracted or similar authority; and
(ii) 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 this subpart.
Sec. --.33 Off-balance sheet exposures.
(a) General. (1) A [BANK] must calculate the exposure amount of an
off-balance sheet exposure using the credit conversion factors (CCFs)
in paragraph (b) of this section.
(2) Where a [BANK] commits to provide a commitment, the [BANK] may
apply the lower of the two applicable CCFs.
(3) Where a [BANK] provides a commitment structured as a
syndication or participation, the [BANK] is only required to calculate
the exposure amount for its pro rata share of the commitment.
(4) Where a [BANK] provides a commitment, enters into a repurchase
agreement, or provides a credit-enhancing representation and warranty,
and such commitment, repurchase agreement, or credit-enhancing
representation and warranty is not a securitization exposure, the
exposure amount shall be no greater than the maximum contractual amount
of the commitment, repurchase agreement, or credit-enhancing
representation and warranty, as applicable.
(b) Credit conversion factors--(1) Zero percent CCF. A [BANK] must
apply a zero percent CCF to the unused portion of a commitment that is
unconditionally cancelable by the [BANK].
(2) 20 percent CCF. A [BANK] must apply a 20 percent CCF to the
amount of:
(i) Commitments with an original maturity of one year or less that
are not unconditionally cancelable by the [BANK]; and
(ii) Self-liquidating, trade-related contingent items that arise
from the movement of goods, with an original maturity of one year or
less.
(3) 50 percent CCF. A [BANK] must apply a 50 percent CCF to the
amount of:
(i) Commitments with an original maturity of more than one year
that are not unconditionally cancelable by the [BANK]; and
(ii) Transaction-related contingent items, including performance
bonds, bid bonds, warranties, and performance standby letters of
credit.
(4) 100 percent CCF. A [BANK] must apply a 100 percent CCF to the
amount of the following off-balance-sheet items and other similar
transactions:
(i) Guarantees;
(ii) Repurchase agreements (the off-balance sheet component of
which equals the sum of the current fair values of all positions the
[BANK] has sold subject to repurchase);
(iii) Credit-enhancing representations and warranties that are not
securitization exposures;
(iv) Off-balance sheet securities lending transactions (the off-
balance sheet component of which equals the sum of the current fair
values of all positions the [BANK] has lent under the transaction);
(v) Off-balance sheet securities borrowing transactions (the off-
balance sheet component of which equals the sum of the current fair
values of all non-cash positions the [BANK] has posted as collateral
under the transaction);
(vi) Financial standby letters of credit; and
(vii) Forward agreements.
Sec. --.34 OTC derivative contracts.
(a) Exposure amount--(1) Single OTC derivative contract. Except as
modified by paragraph (b) of this section, the exposure amount for a
single OTC derivative contract that is not subject to a qualifying
master netting agreement is equal to the sum of the [BANK]'s current
credit exposure and potential future credit exposure (PFE) on the OTC
derivative contract.
(i) Current credit exposure. The current credit exposure for a
single OTC derivative contract is the greater of the mark-to-fair value
of the OTC derivative contract or zero.
(ii) PFE. (A) The PFE for a single OTC derivative contract,
including an OTC derivative contract with a negative mark-to-fair
value, is calculated by multiplying the notional principal amount of
the OTC derivative contract by the appropriate conversion factor in
Table 1 to Sec. --.34.
(B) For purposes of calculating either the PFE under this paragraph
(a) or the gross PFE under paragraph (a)(2) of this section for
exchange rate contracts and other similar contracts in which the
notional principal amount is equivalent to the cash flows, notional
principal amount is the net receipts to each party falling due on each
value date in each currency.
(C) For an OTC derivative contract that does not fall within one of
the specified categories in Table 1 to Sec. --.34, the PFE must be
calculated using the appropriate ``other'' conversion factor.
(D) A [BANK] must use an OTC derivative contract's effective
notional principal amount (that is, the apparent or stated notional
principal amount multiplied by any multiplier in the OTC derivative
contract) rather than the apparent or stated notional principal amount
in calculating PFE.
(E) The PFE of the protection provider of a credit derivative is
capped at the net present value of the amount of unpaid premiums.
[[Page 62183]]
Table 1 to Sec. --.34--Conversion Factor Matrix for Derivative Contracts\1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Credit
Foreign Credit (non- Precious
Interest exchange (investment investment- metals
Remaining maturity \2\ rate rate and grade grade Equity (except Other
gold reference reference gold)
asset) \3\ 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 equal to five years... 0.005 0.05 0.05 0.10 0.08 0.07 0.12
Greater than five years...................................... 0.015 0.075 0.05 0.10 0.10 0.08 0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the
derivative contract.
\2\ For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that
the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract
with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005.
\3\ A [BANK] must use the column labeled ``Credit (investment-grade reference asset)'' for a credit derivative whose reference asset is an outstanding
unsecured long-term debt security without credit enhancement that is investment grade. A [BANK] must use the column labeled ``Credit (non-investment-
grade reference asset)'' for all other credit derivatives.
(2) Multiple OTC derivative contracts subject to a qualifying
master netting agreement. Except as modified by paragraph (b) of this
section, the exposure amount for multiple OTC derivative contracts
subject to a qualifying master netting agreement is equal to the sum of
the net current credit exposure and the adjusted sum of the PFE amounts
for all OTC derivative contracts subject to the qualifying master
netting agreement.
(i) Net current credit exposure. The net current credit exposure is
the greater of the net sum of all positive and negative mark-to-fair
values of the individual OTC derivative contracts subject to the
qualifying master netting agreement or zero.
(ii) Adjusted sum of the PFE amounts. The adjusted sum of the PFE
amounts, Anet, is calculated as Anet = (0.4 x Agross) + (0.6 x NGR x
Agross),
where:
(A) Agross = the gross PFE (that is, the sum of the PFE amounts as
determined under paragraph (a)(1)(ii) of this section for each
individual derivative contract subject to the qualifying master
netting agreement); and
(B) Net-to-gross Ratio (NGR) = the ratio of the net current credit
exposure to the gross current credit exposure. In calculating the
NGR, the gross current credit exposure equals the sum of the
positive current credit exposures (as determined under paragraph
(a)(1)(i) of this section) of all individual derivative contracts
subject to the qualifying master netting agreement.
(b) Recognition of credit risk mitigation of collateralized OTC
derivative contracts: (1) A [BANK] may recognize the credit risk
mitigation benefits of financial collateral that secures an OTC
derivative contract or multiple OTC derivative contracts subject to a
qualifying master netting agreement (netting set) by using the simple
approach in Sec. --.37(b).
(2) As an alternative to the simple approach, a [BANK] may
recognize the credit risk mitigation benefits of financial collateral
that secures such a contract or netting set if the financial collateral
is marked-to-fair value on a daily basis and subject to a daily margin
maintenance requirement by applying a risk weight to the exposure as if
it were uncollateralized and adjusting the exposure amount calculated
under paragraph (a)(1) or (2) of this section using the collateral
haircut approach in Sec. --.37(c). The [BANK] must substitute the
exposure amount calculated under paragraph (a)(1) or (2) of this
section for [Sigma]E in the equation in Sec. --.37(c)(2).
(c) Counterparty credit risk for OTC credit derivatives. (1)
Protection purchasers. A [BANK] that purchases an OTC credit derivative
that is recognized under Sec. --.36 as a credit risk mitigant for an
exposure that is not a covered position under subpart F is not required
to compute a separate counterparty credit risk capital requirement
under Sec. --.32 provided that the [BANK] does so consistently for all
such credit derivatives. The [BANK] 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.
(2) Protection providers. (i) A [BANK] that is the protection
provider under an OTC credit derivative must treat the OTC credit
derivative as an exposure to the underlying reference asset. The [BANK]
is not required to compute a counterparty credit risk capital
requirement for the OTC credit derivative under Sec. --.32, provided
that this treatment is applied consistently for all such OTC credit
derivatives. The [BANK] must either include all or exclude all such OTC
credit derivatives that are subject to a qualifying master netting
agreement from any measure used to determine counterparty credit risk
exposure.
(ii) The provisions of this paragraph (c)(2) apply to all relevant
counterparties for risk-based capital purposes unless the [BANK] is
treating the OTC credit derivative as a covered position under subpart
F, in which case the [BANK] must compute a supplemental counterparty
credit risk capital requirement under this section.
(d) Counterparty credit risk for OTC equity derivatives. (1) A
[BANK] must treat an OTC equity derivative contract as an equity
exposure and compute a risk-weighted asset amount for the OTC equity
derivative contract under Sec. Sec. --.51 through --.53 (unless the
[BANK] is treating the contract as a covered position under subpart F
of this part).
(2) In addition, the [BANK] must also calculate a risk-based
capital requirement for the counterparty credit risk of an OTC equity
derivative contract under this section if the [BANK] is treating the
contract as a covered position under subpart F of this part.
(3) If the [BANK] risk weights the contract under the Simple Risk-
Weight Approach (SRWA) in Sec. --.52, the [BANK] may choose not to
hold risk-based capital against the counterparty credit risk of the OTC
equity derivative contract, as long as it does so for all such
contracts. Where the OTC equity derivative contracts are subject to a
qualified master netting agreement, a [BANK] using the SRWA must either
include all or exclude all of the contracts from any measure used to
determine counterparty credit risk exposure.
(e) Clearing member [BANK]'s exposure amount. A clearing member
[BANK]'s exposure amount for an OTC
[[Page 62184]]
derivative contract or netting set of OTC derivative contracts where
the [BANK] is either acting as a financial intermediary and enters into
an offsetting transaction with a QCCP or where the [BANK] provides a
guarantee to the QCCP on the performance of the client equals the
exposure amount calculated according to paragraph (a)(1) or (2) of this
section multiplied by the scaling factor 0.71. If the [BANK] determines
that a longer period is appropriate, the [BANK] must use a larger
scaling factor to adjust for a longer holding period as follows:
[GRAPHIC] [TIFF OMITTED] TR11OC13.015
where
H = the holding period greater than five days. Additionally, the
[AGENCY] may require the [BANK] to set a longer holding period if
the [AGENCY] determines that a longer period is appropriate due to
the nature, structure, or characteristics of the transaction or is
commensurate with the risks associated with the transaction.
Sec. --.35 Cleared transactions.
(a) General requirements--(1) Clearing member clients. A [BANK]
that is a clearing member client must use the methodologies described
in paragraph (b) of this section to calculate risk-weighted assets for
a cleared transaction.
(2) Clearing members. A [BANK] that is a clearing member must use
the methodologies described in paragraph (c) of this section to
calculate its risk-weighted assets for a cleared transaction and
paragraph (d) of this section to calculate its risk-weighted assets for
its default fund contribution to a CCP.
(b) Clearing member client [BANK]s--(1) Risk-weighted assets for
cleared transactions. (i) To determine the risk-weighted asset amount
for a cleared transaction, a [BANK] that is a clearing member client
must multiply the trade exposure amount for the cleared transaction,
calculated in accordance with paragraph (b)(2) of this section, by the
risk weight appropriate for the cleared transaction, determined in
accordance with paragraph (b)(3) of this section.
(ii) A clearing member client [BANK]'s total risk-weighted assets
for cleared transactions is the sum of the risk-weighted asset amounts
for all its cleared transactions.
(2) Trade exposure amount. (i) For a cleared transaction that is
either a derivative contract or a netting set of derivative contracts,
the trade exposure amount equals:
(A) The exposure amount for the derivative contract or netting set
of derivative contracts, calculated using the methodology used to
calculate exposure amount for OTC derivative contracts under Sec.
--.34; plus
(B) The fair value of the collateral posted by the clearing member
client [BANK] and held by the CCP, clearing member, or custodian in a
manner that is not bankruptcy remote.
(ii) For a cleared transaction that is a repo-style transaction or
netting set of repo-style transactions, the trade exposure amount
equals:
(A) The exposure amount for the repo-style transaction calculated
using the methodologies under Sec. --.37(c); plus
(B) The fair value of the collateral posted by the clearing member
client [BANK] and held by the CCP, clearing member, or custodian in a
manner that is not bankruptcy remote.
(3) Cleared transaction risk weights. (i) For a cleared transaction
with a QCCP, a clearing member client [BANK] must apply a risk weight
of:
(A) 2 percent if the collateral posted by the [BANK] to the QCCP or
clearing member is subject to an arrangement that prevents any losses
to the clearing member client [BANK] 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 the clearing member client [BANK] 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 an event of
default or from liquidation, insolvency, or receivership proceedings)
the relevant court and administrative authorities would find the
arrangements to be legal, valid, binding and enforceable under the law
of the relevant jurisdictions; or
(B) 4 percent if the requirements of Sec. --.35(b)(3)(A) are not
met.
(ii) For a cleared transaction with a CCP that is not a QCCP, a
clearing member client [BANK] must apply the risk weight appropriate
for the CCP according to Sec. --.32.
(4) Collateral. (i) Notwithstanding any other requirements in this
section, collateral posted by a clearing member client [BANK] that is
held by a custodian (in its capacity as custodian) in a manner that is
bankruptcy remote from the CCP, the custodian, clearing member and
other clearing member clients of the clearing member, is not subject to
a capital requirement under this section.
(ii) A clearing member client [BANK] must calculate a risk-weighted
asset amount for any collateral provided to a CCP, clearing member, or
custodian in connection with a cleared transaction in accordance with
the requirements under Sec. --.32.
(c) Clearing member [BANK]s--(1) Risk-weighted assets for cleared
transactions.
(i) To determine the risk-weighted asset amount for a cleared
transaction, a clearing member [BANK] must multiply the trade exposure
amount for the cleared transaction, calculated in accordance with
paragraph (c)(2) of this section, by the risk weight appropriate for
the cleared transaction, determined in accordance with paragraph (c)(3)
of this section.
(ii) A clearing member [BANK]'s total risk-weighted assets for
cleared transactions is the sum of the risk-weighted asset amounts for
all of its cleared transactions.
(2) Trade exposure amount. A clearing member [BANK] must calculate
its trade exposure amount for a cleared transaction as follows:
(i) For a cleared transaction that is either a derivative contract
or a netting set of derivative contracts, the trade exposure amount
equals:
(A) The exposure amount for the derivative contract, calculated
using the methodology to calculate exposure amount for OTC derivative
contracts under Sec. --.34; plus
(B) The fair value of the collateral posted by the clearing member
[BANK] and held by the CCP in a manner that is not bankruptcy remote.
(ii) For a cleared transaction that is a repo-style transaction or
netting set of repo-style transactions, trade exposure amount equals:
(A) The exposure amount for repo-style transactions calculated
using methodologies under Sec. --.37(c); plus
(B) The fair value of the collateral posted by the clearing member
[BANK] and held by the CCP in a manner that is not bankruptcy remote.
(3) Cleared transaction risk weight. (i) A clearing member [BANK]
must apply a risk weight of 2 percent to the trade exposure amount for
a cleared transaction with a QCCP.
(ii) For a cleared transaction with a CCP that is not a QCCP, a
clearing member [BANK] must apply the risk weight appropriate for the
CCP according to Sec. --.32.
(4) Collateral. (i) Notwithstanding any other requirement in this
section, collateral posted by a clearing member [BANK] that is held by
a custodian in a manner that is bankruptcy remote
[[Page 62185]]
from the CCP is not subject to a capital requirement under this
section.
(ii) A clearing member [BANK] must calculate a risk-weighted asset
amount for any collateral provided to a CCP, clearing member, or a
custodian in connection with a cleared transaction in accordance with
requirements under Sec. --.32.
(d) Default fund contributions. (1) General requirement. A clearing
member [BANK] must determine the risk-weighted asset amount for a
default fund contribution to a CCP at least quarterly, or more
frequently if, in the opinion of the [BANK] or the [AGENCY], there is a
material change in the financial condition of the CCP.
(2) Risk-weighted asset amount for default fund contributions to
non-qualifying CCPs. A clearing member [BANK]'s risk-weighted asset
amount for default fund contributions to CCPs that are not QCCPs equals
the sum of such default fund contributions multiplied by 1,250 percent,
or an amount determined by the [AGENCY], based on factors such as size,
structure and membership characteristics of the CCP and riskiness of
its transactions, in cases where such default fund contributions may be
unlimited.
(3) Risk-weighted asset amount for default fund contributions to
QCCPs. A clearing member [BANK]'s risk-weighted asset amount for
default fund contributions to QCCPs equals the sum of its capital
requirement, KCM for each QCCP, as calculated under the
methodology set forth in paragraphs (d)(3)(i) through (iii) of this
section (Method 1), multiplied by 1,250 percent or in paragraphs
(d)(3)(iv) of this section (Method 2).
(i) Method 1. The hypothetical capital requirement of a QCCP
(KCCP) equals:
[GRAPHIC] [TIFF OMITTED] TR11OC13.058
Where:
(A) EBRMi = the exposure amount for each transaction
cleared through the QCCP by clearing member i, calculated in
accordance with Sec. --.34 for OTC derivative contracts and Sec.
--.37(c)(2) for repo-style transactions, provided that:
(1) For purposes of this section, in calculating the exposure
amount the [BANK] may replace the formula provided in Sec.
--.34(a)(2)(ii) with the following: Anet = (0.15 x Agross) + (0.85 x
NGR x Agross); and
(2) For option derivative contracts that are cleared
transactions, the PFE described in Sec. --.34(a)(1)(ii) must be
adjusted by multiplying the notional principal amount of the
derivative contract by the appropriate conversion factor in Table 1
to Sec. --.34 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.
(3) For repo-style transactions, when applying Sec.
--.37(c)(2), the [BANK] must use the methodology in Sec.
--.37(c)(3);
(B) VMi = any collateral posted by clearing member i
to the QCCP that it is entitled to receive from the QCCP, but has
not yet received, and any collateral that the QCCP has actually
received from clearing member i;
(C) IMi = the collateral posted as initial margin by
clearing member i to the QCCP;
(D) DFi = the funded portion of clearing member i's
default fund contribution that will be applied to reduce the QCCP's
loss upon a default by clearing member i;
(E) RW = 20 percent, except when the [AGENCY] has determined
that a higher risk weight is more appropriate based on the specific
characteristics of the QCCP and its clearing members; and
(F) Where a QCCP has provided its KCCP, a [BANK] must
rely on such disclosed figure instead of calculating KCCP
under this paragraph (d), unless the [BANK] determines that a more
conservative figure is appropriate based on the nature, structure,
or characteristics of the QCCP.
(ii) For a [BANK] that is a clearing member of a QCCP with a
default fund supported by funded commitments, KCM equals:
[GRAPHIC] [TIFF OMITTED] TR11OC13.016
Subscripts 1 and 2 denote the clearing members with the two largest
ANet values. For purposes of this paragraph (d), for
derivatives ANet is defined in Sec. --.34(a)(2)(ii) and for
repo-style transactions, ANet means the exposure amount as
defined in Sec. --.37(c)(2) using the methodology in Sec.
--.37(c)(3);
(B) N = the number of clearing members in the QCCP;
(C) DFCCP = the QCCP's own funds and other financial
resources that would be used to cover its losses before clearing
members' default fund contributions are used to cover losses;
(D) DFCM = funded default fund contributions from all
clearing members and any other clearing member
[[Page 62186]]
contributed financial resources that are available to absorb mutualized
QCCP losses;
(E) DF = DFCCP + DFCM (that is, the total
funded default fund contribution);
[GRAPHIC] [TIFF OMITTED] TR11OC13.017
Where:
(1) DFi = the [BANK]'s unfunded commitment to the default
fund;
(2) DFCM = the total of all clearing members' unfunded
commitment to the default fund; and
(3) K*CM as defined in paragraph (d)(3)(ii) of this section.
(B) For a [BANK] that is a clearing member of a QCCP with a
default fund supported by unfunded commitments and is unable to
calculate KCM using the methodology described in
paragraph (d)(3)(iii) of this section, KCM equals:
[[Page 62187]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.018
Where:
(1) IMi = the [BANK]'s initial margin posted to the QCCP;
(2) IMCM = the total of initial margin posted to the
QCCP; and
(3)K*CM as defined in paragraph (d)(3)(ii) of this section.
(iv) Method 2. A clearing member [BANK]'s risk-weighted asset
amount for its default fund contribution to a QCCP, RWADF,
equals:
RWADF = Min {12.5 * DF; 0.18 * TE{time}
Where:
(A) TE = the [BANK]'s trade exposure amount to the QCCP, calculated
according to section 35(c)(2);
(B) DF = the funded portion of the [BANK]'s default fund
contribution to the QCCP.
(4) Total risk-weighted assets for default fund contributions.
Total risk-weighted assets for default fund contributions is the sum of
a clearing member [BANK]'s risk-weighted assets for all of its default
fund contributions to all CCPs of which the [BANK] is a clearing
member.
Sec. --.36 Guarantees and credit derivatives: substitution treatment.
(a) Scope--(1) General. A [BANK] may recognize the credit risk
mitigation benefits of an eligible guarantee or eligible credit
derivative by substituting the risk weight associated with the
protection provider for the risk weight assigned to an exposure, as
provided under this section.
(2) This section applies to exposures for which:
(i) Credit risk is fully covered by an eligible guarantee or
eligible credit derivative; or
(ii) Credit risk is covered on a pro rata basis (that is, on a
basis in which the [BANK] and the protection provider share losses
proportionately) by an eligible guarantee or eligible credit
derivative.
(3) Exposures on which there is a tranching of credit risk
(reflecting at least two different levels of seniority) generally are
securitization exposures subject to Sec. Sec. --.41 through --.45.
(4) If multiple eligible guarantees or eligible credit derivatives
cover a single exposure described in this section, a [BANK] may treat
the hedged exposure as multiple separate exposures each covered by a
single eligible guarantee or eligible credit derivative and may
calculate a separate risk-weighted asset amount for each separate
exposure as described in paragraph (c) of this section.
(5) If a single eligible guarantee or eligible credit derivative
covers multiple hedged exposures described in paragraph (a)(2) of this
section, a [BANK] must treat each hedged exposure as covered by a
separate eligible guarantee or eligible credit derivative and must
calculate a separate risk-weighted asset amount for each exposure as
described in paragraph (c) of this section.
(b) Rules of recognition. (1) A [BANK] may only recognize the
credit risk mitigation benefits of eligible guarantees and eligible
credit derivatives.
(2) A [BANK] may only recognize the credit risk mitigation benefits
of an eligible credit derivative to hedge an exposure that is different
from the credit derivative's reference exposure used for determining
the derivative's cash settlement value, deliverable obligation, or
occurrence of a credit event if:
(i) The reference exposure ranks pari passu with, or is
subordinated to, the hedged exposure; and
(ii) The reference exposure and the hedged exposure are to the same
legal entity, and legally enforceable cross-default or cross-
acceleration clauses are in place to ensure payments under the credit
derivative are triggered when the obligated party of the hedged
exposure fails to pay under the terms of the hedged exposure.
(c) Substitution approach--(1) Full coverage. If an eligible
guarantee or eligible credit derivative meets the conditions in
paragraphs (a) and (b) of this section and the protection amount (P) of
the guarantee or credit derivative is greater than or equal to the
exposure amount of the hedged exposure, a [BANK] may recognize the
guarantee or credit derivative in determining the risk-weighted asset
amount for the hedged exposure by substituting the risk weight
applicable to the guarantor or credit derivative protection provider
under Sec. --.32 for the risk weight assigned to the exposure.
(2) Partial coverage. If an eligible guarantee or eligible credit
derivative meets the conditions in Sec. Sec. --.36(a) and --.37(b) and
the protection amount (P) of the guarantee or credit derivative is less
than the exposure amount of the hedged exposure, the [BANK] must treat
the hedged exposure as two separate exposures (protected and
unprotected) in order to recognize the credit risk mitigation benefit
of the guarantee or credit derivative.
(i) The [BANK] may calculate the risk-weighted asset amount for the
protected exposure under Sec. --.32, where the applicable risk weight
is the risk weight applicable to the guarantor or credit derivative
protection provider.
(ii) The [BANK] must calculate the risk-weighted asset amount for
the unprotected exposure under Sec. --.32, where the applicable risk
weight is that of the unprotected portion of the hedged exposure.
(iii) The treatment provided in this section is applicable when the
credit risk of an exposure is covered on a partial pro rata basis and
may be applicable when an adjustment is made to the effective notional
amount of the guarantee or credit derivative under paragraphs (d), (e),
or (f) of this section.
(d) Maturity mismatch adjustment. (1) A [BANK] that recognizes an
eligible guarantee or eligible credit derivative in determining the
risk-weighted asset amount for a hedged exposure must adjust the
effective notional amount of the credit risk mitigant to reflect any
maturity mismatch between the hedged exposure and the credit risk
mitigant.
(2) A maturity mismatch occurs when the residual maturity of a
credit risk mitigant is less than that of the hedged exposure(s).
(3) The residual maturity of a hedged exposure is the longest
possible remaining time before the obligated party of the hedged
exposure is scheduled to fulfil its obligation on the hedged exposure.
If a credit risk mitigant has embedded options that may reduce its
term, the [BANK] (protection purchaser) must use the shortest possible
residual maturity for the credit risk mitigant. If a call is at the
discretion of the protection provider, the residual maturity of the
credit risk mitigant is at the first call date. If the call is at the
discretion of the [BANK] (protection purchaser), but the terms of the
arrangement at origination of the credit risk mitigant contain a
positive incentive for the [BANK] to call the transaction before
contractual maturity, the remaining time to the first call date is the
residual maturity of the credit risk mitigant.
(4) A credit risk mitigant with a maturity mismatch may be
recognized only if its original maturity is greater than or equal to
one year and its residual maturity is greater than three months.
(5) When a maturity mismatch exists, the [BANK] must apply the
following adjustment to reduce the effective notional amount of the
credit risk mitigant: Pm = E x (t-0.25)/(T-0.25), where:
(i) Pm = effective notional amount of the credit risk mitigant,
adjusted for maturity mismatch;
(ii) E = effective notional amount of the credit risk mitigant;
(iii) t = the lesser of T or the residual maturity of the credit
risk mitigant, expressed in years; and
[[Page 62188]]
(iv) T = the lesser of five or the residual maturity of the hedged
exposure, expressed in years.
(e) Adjustment for credit derivatives without restructuring as a
credit event. If a [BANK] recognizes an eligible credit derivative that
does not include as a credit event a restructuring of the hedged
exposure involving forgiveness or postponement of principal, interest,
or fees that results in a credit loss event (that is, a charge-off,
specific provision, or other similar debit to the profit and loss
account), the [BANK] must apply the following adjustment to reduce the
effective notional amount of the credit derivative: Pr = Pm x 0.60,
where:
(1) Pr = effective notional amount of the credit risk mitigant,
adjusted for lack of restructuring event (and maturity mismatch, if
applicable); and
(2) Pm = effective notional amount of the credit risk mitigant
(adjusted for maturity mismatch, if applicable).
(f) Currency mismatch adjustment. (1) If a [BANK] recognizes an
eligible guarantee or eligible credit derivative that is denominated in
a currency different from that in which the hedged exposure is
denominated, the [BANK] must apply the following formula to the
effective notional amount of the guarantee or credit derivative: Pc =
Pr x (1-HFX), where:
(i) Pc = effective notional amount of the credit risk mitigant,
adjusted for currency mismatch (and maturity mismatch and lack of
restructuring event, if applicable);
(ii) Pr = effective notional amount of the credit risk mitigant
(adjusted for maturity mismatch and lack of restructuring event, if
applicable); and
(iii) HFX = haircut appropriate for the currency mismatch
between the credit risk mitigant and the hedged exposure.
(2) A [BANK] must set HFX equal to eight percent unless
it qualifies for the use of and uses its own internal estimates of
foreign exchange volatility based on a ten-business-day holding period.
A [BANK] qualifies for the use of its own internal estimates of foreign
exchange volatility if it qualifies for the use of its own-estimates
haircuts in Sec. --.37(c)(4).
(3) A [BANK] must adjust HFX calculated in paragraph
(f)(2) of this section upward if the [BANK] revalues the guarantee or
credit derivative less frequently than once every 10 business days
using the following square root of time formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.021
Sec. --.37 Collateralized transactions.
(a) General. (1) To recognize the risk-mitigating effects of
financial collateral, a [BANK] may use:
(i) The simple approach in paragraph (b) of this section for any
exposure; or
(ii) The collateral haircut approach in paragraph (c) of this
section for repo-style transactions, eligible margin loans,
collateralized derivative contracts, and single-product netting sets of
such transactions.
(2) A [BANK] may use any approach described in this section that is
valid for a particular type of exposure or transaction; however, it
must use the same approach for similar exposures or transactions.
(b) The simple approach--(1) General requirements. (i) A [BANK] may
recognize the credit risk mitigation benefits of financial collateral
that secures any exposure.
(ii) To qualify for the simple approach, the financial collateral
must meet the following requirements:
(A) The collateral must be subject to a collateral agreement for at
least the life of the exposure;
(B) The collateral must be revalued at least every six months; and
(C) The collateral (other than gold) and the exposure must be
denominated in the same currency.
(2) Risk weight substitution. (i) A [BANK] may apply a risk weight
to the portion of an exposure that is secured by the fair value of
financial collateral (that meets the requirements of paragraph (b)(1)
of this section) based on the risk weight assigned to the collateral
under Sec. --.32. For repurchase agreements, reverse repurchase
agreements, and securities lending and borrowing transactions, the
collateral is the instruments, gold, and cash the [BANK] has borrowed,
purchased subject to resale, or taken as collateral from the
counterparty under the transaction. Except as provided in paragraph
(b)(3) of this section, the risk weight assigned to the collateralized
portion of the exposure may not be less than 20 percent.
(ii) A [BANK] must apply a risk weight to the unsecured portion of
the exposure based on the risk weight applicable to the exposure under
this subpart.
(3) Exceptions to the 20 percent risk-weight floor and other
requirements. Notwithstanding paragraph (b)(2)(i) of this section:
(i) A [BANK] may assign a zero percent risk weight to an exposure
to an OTC derivative contract that is marked-to-market on a daily basis
and subject to a daily margin maintenance requirement, to the extent
the contract is collateralized by cash on deposit.
(ii) A [BANK] may assign a 10 percent risk weight to an exposure to
an OTC derivative contract that is marked-to-market daily and subject
to a daily margin maintenance requirement, to the extent that the
contract is collateralized by an exposure to a sovereign that qualifies
for a zero percent risk weight under Sec. --.32.
(iii) A [BANK] may assign a zero percent risk weight to the
collateralized portion of an exposure where:
(A) The financial collateral is cash on deposit; or
(B) The financial collateral is an exposure to a sovereign that
qualifies for a zero percent risk weight under Sec. --.32, and the
[BANK] has discounted the fair value of the collateral by 20 percent.
(c) Collateral haircut approach--(1) General. A [BANK] may
recognize the credit risk mitigation benefits of financial collateral
that secures an eligible margin loan, repo-style transaction,
collateralized derivative contract, or single-product netting set of
such transactions, and of any collateral that secures a repo-style
transaction that is included in the [BANK]'s VaR-based measure under
subpart F of this part by using the collateral haircut approach in this
section. A [BANK] may use the standard supervisory haircuts in
paragraph (c)(3) of this section or, with prior written approval of the
[AGENCY], its own estimates of haircuts according to paragraph (c)(4)
of this section.
(2) Exposure amount equation. A [BANK] must determine the exposure
amount for an eligible margin loan, repo-style transaction,
collateralized derivative contract, or a single-product netting set of
such transactions by setting the exposure amount equal to
[[Page 62189]]
max {0, [([Sigma]E - [Sigma]C) + [Sigma](Es x Hs) + [Sigma](Efx x
Hfx)]{time} , where:
(i)(A) For eligible margin loans and repo-style transactions and
netting sets thereof, [Sigma]E equals the value of the exposure (the
sum of the current fair values of all instruments, gold, and cash
the [BANK] has lent, sold subject to repurchase, or posted as
collateral to the counterparty under the transaction (or netting
set)); and
(B) For collateralized derivative contracts and netting sets
thereof, [Sigma]E equals the exposure amount of the OTC derivative
contract (or netting set) calculated under Sec. --.34 (a)(1) or
(2).
(ii) [Sigma]C equals the value of the collateral (the sum of the
current fair values of all instruments, gold and cash the [BANK] has
borrowed, purchased subject to resale, or taken as collateral from
the counterparty under the transaction (or netting set));
(iii) Es equals the absolute value of the net position in a
given instrument or in gold (where the net position in the
instrument or gold equals the sum of the current fair values of the
instrument or gold the [BANK] has lent, sold subject to repurchase,
or posted as collateral to the counterparty minus the sum of the
current fair values of that same instrument or gold the [BANK] has
borrowed, purchased subject to resale, or taken as collateral from
the counterparty);
(iv) Hs equals the market price volatility haircut appropriate
to the instrument or gold referenced in Es;
(v) Efx equals the absolute value of the net position of
instruments and cash in a currency that is different from the
settlement currency (where the net position in a given currency
equals the sum of the current fair values of any instruments or cash
in the currency the [BANK] has lent, sold subject to repurchase, or
posted as collateral to the counterparty minus the sum of the
current fair values of any instruments or cash in the currency the
[BANK] has borrowed, purchased subject to resale, or taken as
collateral from the counterparty); and
(vi) Hfx equals the haircut appropriate to the mismatch between
the currency referenced in Efx and the settlement currency.
(3) Standard supervisory haircuts. (i) A [BANK] must use the
haircuts for market price volatility (Hs) provided in Table 1 to Sec.
--.37, as adjusted in certain circumstances in accordance with the
requirements of paragraphs (c)(3)(iii) and (iv) of this section.
Table 1 to Sec. --.37--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 (in percent) under Sec. --.32 (in percent) exposures (in
-----------------\2\---------------------------------------------------- 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 1 to Sec. --.37 are based on a 10 business-day holding period.
\2\ Includes a foreign PSE that receives a zero percent risk weight.
(ii) For currency mismatches, a [BANK] must use a haircut for
foreign exchange rate volatility (Hfx) of 8.0 percent, as adjusted in
certain circumstances under paragraphs (c)(3)(iii) and (iv) of this
section.
(iii) For repo-style transactions, a [BANK] may multiply the
standard supervisory haircuts provided in paragraphs (c)(3)(i) and (ii)
of this section by the square root of \1/2\ (which equals 0.707107).
(iv) If the number of trades in a netting set exceeds 5,000 at any
time during a quarter, a [BANK] must adjust the supervisory haircuts
provided in paragraphs (c)(3)(i) and (ii) of this section upward on the
basis of a holding period of twenty business days for the following
quarter except in the calculation of the exposure amount for purposes
of Sec. --.35. If a netting set contains one or more trades involving
illiquid collateral or an OTC derivative that cannot be easily
replaced, a [BANK] must adjust the supervisory haircuts upward on the
basis of a holding period of twenty business days. If over the two
previous quarters more than two margin disputes on a netting set have
occurred that lasted more than the holding period, then the [BANK] must
adjust the supervisory haircuts upward for that netting set on the
basis of a holding period that is at least two times the minimum
holding period for that netting set. A [BANK] must adjust the standard
supervisory haircuts upward using the following formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.022
(A) TM equals a holding period of longer than 10
business days for eligible margin loans and derivative contracts or
longer than 5 business days for repo-style transactions;
(B) HS equals the standard supervisory haircut; and
(C) TS equals 10 business days for eligible margin
loans and derivative contracts or 5 business days for repo-style
transactions.
(v) If the instrument a [BANK] has lent, sold subject to
repurchase, or posted as collateral does not meet the definition of
financial collateral, the [BANK] must use a 25.0 percent haircut for
market price volatility (Hs).
(4) Own internal estimates for haircuts. With the prior written
approval of the [AGENCY], a [BANK] may calculate haircuts (Hs and Hfx)
using its own internal estimates of the volatilities of market prices
and foreign exchange rates:
(i) To receive [AGENCY] approval to use its own internal estimates,
a [BANK]
[[Page 62190]]
must satisfy the following minimum standards:
(A) A [BANK] must use a 99th percentile one-tailed confidence
interval.
(B) The minimum holding period for a repo-style transaction is five
business days and for an eligible margin loan is ten business days
except for transactions or netting sets for which paragraph
(c)(4)(i)(C) of this section applies. When a [BANK] calculates an own-
estimates haircut on a TN-day holding period, which is
different from the minimum holding period for the transaction type, the
applicable haircut (HM) is calculated using the following
square root of time formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.023
(1) TM equals 5 for repo-style transactions and 10
for eligible margin loans;
(2) TN equals the holding period used by the [BANK]
to derive HN; and
(3) HN equals the haircut based on the holding period
TN.
(C) If the number of trades in a netting set exceeds 5,000 at any
time during a quarter, a [BANK] must calculate the haircut using a
minimum holding period of twenty business days for the following
quarter except in the calculation of the exposure amount for purposes
of Sec. --.35. If a netting set contains one or more trades involving
illiquid collateral or an OTC derivative that cannot be easily
replaced, a [BANK] must calculate the haircut using a minimum holding
period of twenty business days. If over the two previous quarters more
than two margin disputes on a netting set have occurred that lasted
more than the holding period, then the [BANK] must calculate the
haircut for transactions in that netting set on the basis of a holding
period that is at least two times the minimum holding period for that
netting set.
(D) A [BANK] is required to calculate its own internal estimates
with inputs calibrated to historical data from a continuous 12-month
period that reflects a period of significant financial stress
appropriate to the security or category of securities.
(E) A [BANK] must have policies and procedures that describe how it
determines the period of significant financial stress used to calculate
the [BANK]'s own internal estimates for haircuts under this section and
must be able to provide empirical support for the period used. The
[BANK] must obtain the prior approval of the [AGENCY] for, and notify
the [AGENCY] if the [BANK] makes any material changes to, these
policies and procedures.
(F) Nothing in this section prevents the [AGENCY] from requiring a
[BANK] to use a different period of significant financial stress in the
calculation of own internal estimates for haircuts.
(G) A [BANK] must update its data sets and calculate haircuts no
less frequently than quarterly and must also reassess data sets and
haircuts whenever market prices change materially.
(ii) With respect to debt securities that are investment grade, a
[BANK] may calculate haircuts for categories of securities. For a
category of securities, the [BANK] must calculate the haircut on the
basis of internal volatility estimates for securities in that category
that are representative of the securities in that category that the
[BANK] has lent, sold subject to repurchase, posted as collateral,
borrowed, purchased subject to resale, or taken as collateral. In
determining relevant categories, the [BANK] must at a minimum take into
account:
(A) The type of issuer of the security;
(B) The credit quality of the security;
(C) The maturity of the security; and
(D) The interest rate sensitivity of the security.
(iii) With respect to debt securities that are not investment grade
and equity securities, a [BANK] must calculate a separate haircut for
each individual security.
(iv) Where an exposure or collateral (whether in the form of cash
or securities) is denominated in a currency that differs from the
settlement currency, the [BANK] must calculate a separate currency
mismatch haircut for its net position in each mismatched currency based
on estimated volatilities of foreign exchange rates between the
mismatched currency and the settlement currency.
(v) A [BANK]'s own estimates of market price and foreign exchange
rate volatilities may not take into account the correlations among
securities and foreign exchange rates on either the exposure or
collateral side of a transaction (or netting set) or the correlations
among securities and foreign exchange rates between the exposure and
collateral sides of the transaction (or netting set).
Risk-Weighted Assets for Unsettled Transactions
Sec. --.38 Unsettled transactions.
(a) Definitions. For purposes of this section:
(1) Delivery-versus-payment (DvP) transaction means a securities or
commodities transaction in which the buyer is obligated to make payment
only if the seller has made delivery of the securities or commodities
and the seller is obligated to deliver the securities or commodities
only if the buyer has made payment.
(2) Payment-versus-payment (PvP) transaction means a foreign
exchange transaction in which each counterparty is obligated to make a
final transfer of one or more currencies only if the other counterparty
has made a final transfer of one or more currencies.
(3) A transaction has a normal settlement period if the contractual
settlement period for the transaction is equal to or less than the
market standard for the instrument underlying the transaction and equal
to or less than five business days.
(4) Positive current exposure of a [BANK] for a transaction is the
difference between the transaction value at the agreed settlement price
and the current market price of the transaction, if the difference
results in a credit exposure of the [BANK] to the counterparty.
(b) Scope. This section applies to all transactions involving
securities, foreign exchange instruments, and commodities that have a
risk of delayed settlement or delivery. This section does not apply to:
(1) Cleared transactions that are marked-to-market daily and
subject to daily receipt and payment of variation margin;
(2) Repo-style transactions, including unsettled repo-style
transactions;
(3) One-way cash payments on OTC derivative contracts; or
(4) Transactions with a contractual settlement period that is
longer than the normal settlement period (which are treated as OTC
derivative contracts as provided in Sec. --.34).
(c) System-wide failures. In the case of a system-wide failure of a
settlement, clearing system or central counterparty, the [AGENCY] may
waive risk-based capital requirements for unsettled and failed
transactions until the situation is rectified.
(d) Delivery-versus-payment (DvP) and payment-versus-payment (PvP)
transactions. A [BANK] must hold risk-based capital against any DvP or
PvP transaction with a normal settlement period if the [BANK]'s
counterparty has not made delivery or payment within five business days
after the settlement date. The [BANK] must determine its risk-weighted
asset amount for such a transaction by multiplying the positive current
exposure of the transaction for the [BANK] by the appropriate risk
weight in Table 1 to Sec. --.38.
[[Page 62191]]
Table 1 to Sec. --.38--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
------------------------------------------------------------------------
(e) Non-DvP/non-PvP (non-delivery-versus-payment/non-payment-
versus-payment) transactions. (1) A [BANK] must hold risk-based capital
against any non-DvP/non-PvP transaction with a normal settlement period
if the [BANK] has delivered cash, securities, commodities, or
currencies to its counterparty but has not received its corresponding
deliverables by the end of the same business day. The [BANK] must
continue to hold risk-based capital against the transaction until the
[BANK] has received its corresponding deliverables.
(2) From the business day after the [BANK] has made its delivery
until five business days after the counterparty delivery is due, the
[BANK] must calculate the risk-weighted asset amount for the
transaction by treating the current fair value of the deliverables owed
to the [BANK] as an exposure to the counterparty and using the
applicable counterparty risk weight under Sec. --.32.
(3) If the [BANK] has not received its deliverables by the fifth
business day after counterparty delivery was due, the [BANK] must
assign a 1,250 percent risk weight to the current fair value of the
deliverables owed to the [BANK].
(f) Total risk-weighted assets for unsettled transactions. Total
risk-weighted assets for unsettled transactions is the sum of the risk-
weighted asset amounts of all DvP, PvP, and non-DvP/non-PvP
transactions.
Sec. Sec. --.39 through --.40 [Reserved]
Risk-Weighted Assets for Securitization Exposures
Sec. --.41 Operational requirements for securitization exposures.
(a) Operational criteria for traditional securitizations. A [BANK]
that transfers exposures it has originated or purchased to a
securitization SPE or other third party in connection with a
traditional securitization may exclude the exposures from the
calculation of its risk-weighted assets only if each condition in this
section is satisfied. A [BANK] that meets these conditions must hold
risk-based capital against any credit risk it retains in connection
with the securitization. A [BANK] that fails to meet these conditions
must 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. The
conditions are:
(1) The exposures are not reported on the [BANK]'s consolidated
balance sheet under GAAP;
(2) The [BANK] has transferred to one or more third parties credit
risk associated with the underlying exposures;
(3) Any clean-up calls relating to the securitization are eligible
clean-up calls; and
(4) The securitization does not:
(i) Include one or more underlying exposures in which the borrower
is permitted to vary the drawn amount within an agreed limit under a
line of credit; and
(ii) Contain an early amortization provision.
(b) Operational criteria for synthetic securitizations. For
synthetic securitizations, a [BANK] may recognize for risk-based
capital purposes the use of a credit risk mitigant to hedge underlying
exposures only if each condition in this paragraph (b) is satisfied. A
[BANK] that meets these conditions must hold risk-based capital against
any credit risk of the exposures it retains in connection with the
synthetic securitization. A [BANK] that fails to meet these conditions
or chooses not to recognize the credit risk mitigant for purposes of
this section must instead hold risk-based capital against the
underlying exposures as if they had not been synthetically securitized.
The conditions are:
(1) The credit risk mitigant is:
(i) Financial collateral;
(ii) A guarantee that meets all criteria as set forth in the
definition of ``eligible guarantee'' in Sec. --.2, except for the
criteria in paragraph (3) of that definition; or
(iii) A credit derivative that meets all criteria as set forth in
the definition of ``eligible credit derivative'' in Sec. --.2, except
for the criteria in paragraph (3) of the definition of ``eligible
guarantee'' in Sec. --.2.
(2) The [BANK] transfers credit risk associated with the underlying
exposures to one or more third parties, and the terms and conditions in
the credit risk mitigants employed do not include provisions that:
(i) Allow for the termination of the credit protection due to
deterioration in the credit quality of the underlying exposures;
(ii) Require the [BANK] to alter or replace the underlying
exposures to improve the credit quality of the underlying exposures;
(iii) Increase the [BANK]'s cost of credit protection in response
to deterioration in the credit quality of the underlying exposures;
(iv) Increase the yield payable to parties other than the [BANK] in
response to a deterioration in the credit quality of the underlying
exposures; or
(v) Provide for increases in a retained first loss position or
credit enhancement provided by the [BANK] after the inception of the
securitization;
(3) The [BANK] obtains a well-reasoned opinion from legal counsel
that confirms the enforceability of the credit risk mitigant in all
relevant jurisdictions; and
(4) Any clean-up calls relating to the securitization are eligible
clean-up calls.
(c) Due diligence requirements for securitization exposures. (1)
Except for exposures that are deducted from common equity tier 1
capital and exposures subject to Sec. --.42(h), if a [BANK] is unable
to demonstrate to the satisfaction of the [AGENCY] a comprehensive
understanding of the features of a securitization exposure that would
materially affect the performance of the exposure, the [BANK] must
assign the securitization exposure a risk weight of 1,250 percent. The
[BANK]'s analysis must be commensurate with the complexity of the
securitization exposure and the materiality of the exposure in relation
to its capital.
(2) A [BANK] must demonstrate its comprehensive understanding of a
securitization exposure under paragraph (c)(1) of this section, for
each securitization exposure by:
(i) Conducting an analysis of the risk characteristics of a
securitization exposure prior to acquiring the exposure, and
documenting such analysis within three business days after acquiring
the exposure, considering:
(A) Structural features of the securitization that would materially
impact the performance of the exposure, for example, the contractual
cash flow waterfall, waterfall-related triggers, credit enhancements,
liquidity enhancements, fair value triggers, the performance of
organizations that service the exposure, and deal-specific definitions
of default;
(B) 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;
[[Page 62192]]
average credit score or other measures of creditworthiness; average LTV
ratio; and industry and geographic diversification data on the
underlying exposure(s);
(C) Relevant market data of the securitization, for example, bid-
ask spread, most recent sales price and historic price volatility,
trading volume, implied market rating, and size, depth and
concentration level of the market for the securitization; and
(D) 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; and
(ii) On an on-going basis (no less frequently than quarterly),
evaluating, reviewing, and updating as appropriate the analysis
required under paragraph (c)(1) of this section for each securitization
exposure.
Sec. --.42 Risk-weighted assets for securitization exposures.
(a) Securitization risk weight approaches. Except as provided
elsewhere in this section or in Sec. --.41:
(1) A [BANK] must 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 under
paragraph (a)(1) of this section, a [BANK] may assign a risk weight to
the securitization exposure using the simplified supervisory formula
approach (SSFA) in accordance with Sec. Sec. --.43(a) through --.43(d)
and subject to the limitation under paragraph (e) of this section.
Alternatively, a [BANK] that is not subject to subpart F of this part
may assign a risk weight to the securitization exposure using the
gross-up approach in accordance with Sec. --.43(e), provided, however,
that such [BANK] must apply either the SSFA or the gross-up approach
consistently across all of its securitization exposures, except as
provided in paragraphs (a)(1), (a)(3), and (a)(4) of this section.
(3) If a securitization exposure does not require deduction under
paragraph (a)(1) of this section and the [BANK] cannot, or chooses not
to apply the SSFA or the gross-up approach to the exposure, the [BANK]
must assign a risk weight to the exposure as described in Sec. --.44.
(4) If a securitization exposure is a derivative contract (other
than protection provided by a [BANK] in the form of 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 [BANK] may choose to set the risk-weighted asset amount of the
exposure equal to the amount of the exposure as determined in paragraph
(c) of this section.
(b) Total risk-weighted assets for securitization exposures. A
[BANK]'s total risk-weighted assets for securitization exposures equals
the sum of the risk-weighted asset amount for securitization exposures
that the [BANK] risk weights under Sec. Sec. --.41(c), --.42(a)(1),
and --.43, --.44, or --.45, and paragraphs (e) through (j) of this
section, as applicable.
(c) Exposure amount of a securitization exposure--(1) On-balance
sheet securitization exposures. The exposure amount of an on-balance
sheet securitization exposure (excluding an available-for-sale or held-
to-maturity security where the [BANK] has made an AOCI opt-out election
under Sec. --.22(b)(2), a repo-style transaction, eligible margin
loan, OTC derivative contract, or cleared transaction) is equal to the
carrying value of the exposure.
(2) On-balance sheet securitization exposures held by a [BANK] that
has made an AOCI opt-out election. The exposure amount of an on-balance
sheet securitization exposure that is an available-for-sale or held-to-
maturity security held by a [BANK] that has made an AOCI opt-out
election under Sec. --.22(b)(2) is the [BANK]'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.
(3) Off-balance sheet securitization exposures. (i) Except as
provided in paragraph (j) of this section, the exposure amount of an
off-balance sheet securitization exposure that is not a repo-style
transaction, eligible margin loan, cleared transaction (other than a
credit derivative), or an OTC derivative contract (other than a credit
derivative) is the notional amount of the exposure. For an off-balance
sheet securitization exposure to an ABCP program, such as an eligible
ABCP liquidity facility, the notional amount may be reduced to the
maximum potential amount that the [BANK] could be required to fund
given the ABCP program's current underlying assets (calculated without
regard to the current credit quality of those assets).
(ii) A [BANK] must determine the exposure amount of an eligible
ABCP liquidity facility for which the SSFA does not apply by
multiplying the notional amount of the exposure by a CCF of 50 percent.
(iii) A [BANK] must determine the exposure amount of an eligible
ABCP liquidity facility for which the SSFA applies by multiplying the
notional amount of the exposure by a CCF of 100 percent.
(4) Repo-style transactions, eligible margin loans, and derivative
contracts. The exposure amount of a securitization exposure that is a
repo-style transaction, eligible margin loan, or derivative contract
(other than a credit derivative) is the exposure amount of the
transaction as calculated under Sec. --.34 or Sec. --.37, as
applicable.
(d) Overlapping exposures. If a [BANK] has multiple securitization
exposures that provide duplicative coverage to the underlying exposures
of a securitization (such as when a [BANK] provides a program-wide
credit enhancement and multiple pool-specific liquidity facilities to
an ABCP program), the [BANK] is not required to hold duplicative risk-
based capital against the overlapping position. Instead, the [BANK] may
apply to the overlapping position the applicable risk-based capital
treatment that results in the highest risk-based capital requirement.
(e) Implicit support. If a [BANK] provides support to a
securitization in excess of the [BANK]'s contractual obligation to
provide credit support to the securitization (implicit support):
(1) The [BANK] must include in risk-weighted assets all of the
underlying exposures associated with the securitization as if the
exposures had not been securitized and must deduct from common equity
tier 1 capital any after-tax gain-on-sale resulting from the
securitization; and
(2) The [BANK] must disclose publicly:
(i) That it has provided implicit support to the securitization;
and
(ii) The risk-based capital impact to the [BANK] of providing such
implicit support.
(f) Undrawn portion of a servicer cash advance facility. (1)
Notwithstanding any other provision of this subpart, a [BANK] that is a
servicer under an eligible servicer cash advance facility is not
required to hold risk-based capital against potential future cash
advance payments that it may be required to provide under the contract
governing the facility.
(2) For a [BANK] that acts as a servicer, the exposure amount for a
servicer cash advance facility that is not an eligible servicer cash
advance facility is equal to the amount of all potential future cash
advance payments that the
[[Page 62193]]
[BANK] may be contractually required to provide during the subsequent
12 month period under the contract governing the facility.
(g) Interest-only mortgage-backed securities. Regardless of any
other provisions in this subpart, the risk weight for a non-credit-
enhancing interest-only mortgage-backed security may not be less than
100 percent.
(h) Small-business loans and leases on personal property
transferred with retained contractual exposure. (1) Regardless of any
other provision of this subpart, a [BANK] that has transferred small-
business loans and leases on personal property (small-business
obligations) with recourse must include in risk-weighted assets only
its contractual exposure to the small-business obligations if all the
following conditions are met:
(i) The transaction must be treated as a sale under GAAP.
(ii) The [BANK] establishes and maintains, pursuant to GAAP, a non-
capital reserve sufficient to meet the [BANK]'s reasonably estimated
liability under the contractual obligation.
(iii) The small-business obligations are to businesses that meet
the criteria for a small-business concern established by the Small
Business Administration under section 3(a) of the Small Business Act
(15 U.S.C. 632 et seq.).
(iv) The [BANK] is well capitalized, as defined in [12 CFR 6.4
(OCC); 12 CFR 208.43 (Board)]. For purposes of determining whether a
[BANK] is well capitalized for purposes of this paragraph (h), the
[BANK]'s capital ratios must be calculated without regard to the
capital treatment for transfers of small-business obligations under
this paragraph (h).
(2) The total outstanding amount of contractual exposure retained
by a [BANK] on transfers of small-business obligations receiving the
capital treatment specified in paragraph (h)(1) of this section cannot
exceed 15 percent of the [BANK]'s total capital.
(3) If a [BANK] ceases to be well capitalized under [12 CFR 6.4
(OCC); 12 CFR 208.43 (Board)] or exceeds the 15 percent capital
limitation provided in paragraph (h)(2) of this section, the capital
treatment under paragraph (h)(1) of this section will continue to apply
to any transfers of small-business obligations with retained
contractual exposure that occurred during the time that the [BANK] was
well capitalized and did not exceed the capital limit.
(4) The risk-based capital ratios of the [BANK] must be calculated
without regard to the capital treatment for transfers of small-business
obligations specified in paragraph (h)(1) of this section for purposes
of:
(i) Determining whether a [BANK] is adequately capitalized,
undercapitalized, significantly undercapitalized, or critically
undercapitalized under the [AGENCY]'s prompt corrective action
regulations; and
(ii) Reclassifying a well-capitalized [BANK] to adequately
capitalized and requiring an adequately capitalized [BANK] to comply
with certain mandatory or discretionary supervisory actions as if the
[BANK] were in the next lower prompt-corrective-action category.
(i) Nth-to-default credit derivatives--(1) Protection provider. A
[BANK] may assign a risk weight using the SSFA in Sec. --.43 to an
nth-to-default credit derivative in accordance with this
paragraph (i). A [BANK] must determine its exposure in the
nth-to-default credit derivative as the largest notional
amount of all the underlying exposures.
(2) For purposes of determining the risk weight for an
nth-to-default credit derivative using the SSFA, the [BANK]
must calculate the attachment point and detachment point of its
exposure as follows:
(i) The attachment point (parameter A) is the ratio of the sum of
the notional amounts of all underlying exposures that are subordinated
to the [BANK]'s exposure to the total notional amount of all underlying
exposures. The ratio is expressed as a decimal value between zero and
one. In the case of a first-to-default credit derivative, there are no
underlying exposures that are subordinated to the [BANK]'s exposure. In
the case of a second-or-subsequent-to-default credit derivative, the
smallest (n-1) notional amounts of the underlying exposure(s) are
subordinated to the [BANK]'s exposure.
(ii) The detachment point (parameter D) equals the sum of parameter
A plus the ratio of the notional amount of the [BANK]'s exposure in the
nth-to-default credit derivative to the total notional
amount of all underlying exposures. The ratio is expressed as a decimal
value between zero and one.
(3) A [BANK] that does not use the SSFA to determine a risk weight
for its nth-to-default credit derivative must assign a risk
weight of 1,250 percent to the exposure.
(4) Protection purchaser--(i) First-to-default credit derivatives.
A [BANK] that obtains credit protection on a group of underlying
exposures through a first-to-default credit derivative that meets the
rules of recognition of Sec. --.36(b) must determine its risk-based
capital requirement for the underlying exposures as if the [BANK]
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 [BANK] must calculate a risk-based
capital requirement for counterparty credit risk according to Sec.
--.34 for a first-to-default credit derivative that does not meet the
rules of recognition of Sec. --.36(b).
(ii) Second-or-subsequent-to-default credit derivatives. (A) A
[BANK] that obtains credit protection on a group of underlying
exposures through a nth-to-default credit derivative that
meets the rules of recognition of Sec. --.36(b) (other than a first-
to-default credit derivative) may recognize the credit risk mitigation
benefits of the derivative only if:
(1) The [BANK] also has obtained credit protection on the same
underlying exposures in the form of first-through-(n-1)-to-default
credit derivatives; or
(2) If n-1 of the underlying exposures have already defaulted.
(B) If a [BANK] satisfies the requirements of paragraph
(i)(4)(ii)(A) of this section, the [BANK] must determine its risk-based
capital requirement for the underlying exposures as if the [BANK] had
only synthetically securitized the underlying exposure with the
nth smallest risk-weighted asset amount and had obtained no
credit risk mitigant on the other underlying exposures.
(C) A [BANK] must calculate a risk-based capital requirement for
counterparty credit risk according to Sec. --.34 for a nth-
to-default credit derivative that does not meet the rules of
recognition of Sec. --.36(b).
(j) Guarantees and credit derivatives other than nth-to-default
credit derivatives--(1) Protection provider. For a guarantee or credit
derivative (other than an nth-to-default credit derivative)
provided by a [BANK] that covers the full amount or a pro rata share of
a securitization exposure's principal and interest, the [BANK] 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.
(2) Protection purchaser. (i) A [BANK] that purchases a guarantee
or OTC credit derivative (other than an nth-to-default
credit derivative) that is recognized under Sec. --.45 as a credit
risk mitigant (including via collateral recognized under Sec. --.37)
is not required to compute a separate counterparty credit risk capital
requirement under Sec. --.31, in accordance with 34(c).
(ii) If a [BANK] cannot, or chooses not to, recognize a purchased
credit
[[Page 62194]]
derivative as a credit risk mitigant under Sec. --.45, the [BANK] must
determine the exposure amount of the credit derivative under Sec.
--.34.
(A) If the [BANK] purchases credit protection from a counterparty
that is not a securitization SPE, the [BANK] must determine the risk
weight for the exposure according to general risk weights under Sec.
--.32.
(B) If the [BANK] purchases the credit protection from a
counterparty that is a securitization SPE, the [BANK] must determine
the risk weight for the exposure according to section Sec. --.42,
including Sec. --.42(a)(4) for a credit derivative that has a first
priority claim on the cash flows from the underlying exposures of the
securitization SPE (notwithstanding amounts due under interest rate or
currency derivative contracts, fees due, or other similar payments).
Sec. --.43 Simplified supervisory formula approach (SSFA) and the
gross-up approach.
(a) General requirements for the SSFA. To use the SSFA to determine
the risk weight for a securitization exposure, a [BANK] must have data
that enables it to assign accurately the parameters described in
paragraph (b) of this section. Data used to assign the parameters
described in paragraph (b) of this section must be the most currently
available data; if the contracts governing the underlying exposures of
the securitization require payments on a monthly or quarterly basis,
the data used to assign the parameters described in paragraph (b) of
this section must be no more than 91 calendar days old. A [BANK] that
does not have the appropriate data to assign the parameters described
in paragraph (b) of this section must assign a risk weight of 1,250
percent to the exposure.
(b) SSFA parameters. To calculate the risk weight for a
securitization exposure using the SSFA, a [BANK] must have accurate
information on the following five inputs to the SSFA calculation:
(1) KG is the weighted-average (with unpaid principal
used as the weight for each exposure) total capital requirement of the
underlying exposures calculated using this subpart. KG is
expressed as a decimal value between zero and one (that is, an average
risk weight of 100 percent represents a value of KG equal to
0.08).
(2) Parameter W is expressed as a decimal value between zero and
one. Parameter W is the ratio of the sum of the dollar amounts of any
underlying exposures of the securitization that meet any of the
criteria as set forth in paragraphs (b)(2)(i) through (vi) of this
section to the balance, measured in dollars, of underlying exposures:
(i) Ninety days or more past due;
(ii) Subject to a bankruptcy or insolvency proceeding;
(iii) In the process of foreclosure;
(iv) Held as real estate owned;
(v) Has contractually deferred payments for 90 days or more, other
than principal or interest payments deferred on:
(A) Federally-guaranteed student loans, in accordance with the
terms of those guarantee programs; or
(B) 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; or
(vi) Is in default.
(3) Parameter A is the attachment point for the exposure, which
represents the threshold at which credit losses will first be allocated
to the exposure. Except as provided in Sec. --.42(i) for
nth-to-default credit derivatives, parameter A equals the
ratio of the current dollar amount of underlying exposures that are
subordinated to the exposure of the [BANK] to the current dollar amount
of underlying exposures. Any reserve account funded by the accumulated
cash flows from the underlying exposures that is subordinated to the
[BANK]'s securitization exposure may be included in the calculation of
parameter A to the extent that cash is present in the account.
Parameter A is expressed as a decimal value between zero and one.
(4) Parameter D is the detachment point for the exposure, which
represents the threshold at which credit losses of principal allocated
to the exposure would result in a total loss of principal. Except as
provided in section 42(i) for nth-to-default credit
derivatives, parameter D equals parameter A plus the ratio of the
current dollar amount of the securitization exposures that are pari
passu with the exposure (that is, have equal seniority with respect to
credit risk) to the current dollar amount of the underlying exposures.
Parameter D is expressed as a decimal value between zero and one.
(5) A supervisory calibration parameter, p, is equal to 0.5 for
securitization exposures that are not resecuritization exposures and
equal to 1.5 for resecuritization exposures.
(c) Mechanics of the SSFA. KG and W are used to
calculate KA, the augmented value of KG, which
reflects the observed credit quality of the underlying exposures.
KA is defined in paragraph (d) of this section. The values
of parameters A and D, relative to KA determine the risk
weight assigned to a securitization exposure as described in paragraph
(d) of this section. The risk weight assigned to a securitization
exposure, or portion of a securitization exposure, as appropriate, is
the larger of the risk weight determined in accordance with this
paragraph (c) or paragraph (d) of this section and a risk weight of 20
percent.
(1) When the detachment point, 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.
(2) When the attachment point, parameter A, for a securitization
exposure is greater than or equal to KA, the [BANK] must
calculate the risk weight in accordance with paragraph (d) of this
section.
(3) When A is less than KA and D is greater than
KA, the risk weight is a weighted-average of 1,250 percent
and 1,250 percent times KSSFA calculated in accordance with
paragraph (d) of this section. For the purpose of this weighted-average
calculation:
[[Page 62195]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.024
(e) Gross-up approach--(1) Applicability. A [BANK] that is not
subject to subpart F of this part may apply the gross-up approach set
forth in this section instead of the SSFA to determine the risk weight
of its securitization exposures, provided that it applies the gross-up
approach to all of its securitization exposures, except as otherwise
provided for certain securitization exposures in Sec. Sec. --.44 and
--.45.
(2) To use the gross-up approach, a [BANK] must calculate the
following four inputs:
(i) Pro rata share, which is the par value of the [BANK]'s
securitization exposure as a percent of the par value of the tranche in
which the securitization exposure resides;
(ii) Enhanced amount, which is the par value of tranches that are
more senior to the tranche in which the [BANK]'s securitization
resides;
(iii) Exposure amount of the [BANK]'s securitization exposure
calculated under Sec. --.42(c); and
(iv) Risk weight, which is the weighted-average risk weight of
underlying exposures of the securitization as calculated under this
subpart.
(3) Credit equivalent amount. The credit equivalent amount of a
securitization exposure under this section equals the sum of:
(i) The exposure amount of the [BANK]'s securitization exposure;
and
(ii) The pro rata share multiplied by the enhanced amount, each
calculated in accordance with paragraph (e)(2) of this section.
(4) Risk-weighted assets. To calculate risk-weighted assets for a
securitization exposure under the gross-up approach, a [BANK] must
apply the risk weight
[[Page 62196]]
required under paragraph (e)(2) of this section to the credit
equivalent amount calculated in paragraph (e)(3) of this section.
(f) Limitations. Notwithstanding any other provision of this
section, a [BANK] must assign a risk weight of not less than 20 percent
to a securitization exposure.
Sec. --.44 Securitization exposures to which the SSFA and gross-up
approach do not apply.
(a) General requirement. A [BANK] must assign a 1,250 percent risk
weight to all securitization exposures to which the [BANK] does not
apply the SSFA or the gross-up approach under Sec. --.43, except as
set forth in this section.
(b) Eligible ABCP liquidity facilities. A [BANK] may determine the
risk-weighted asset amount of an eligible ABCP liquidity facility by
multiplying the exposure amount by the highest risk weight applicable
to any of the individual underlying exposures covered by the facility.
(c) A securitization exposure in a second loss position or better
to an ABCP program--(1) Risk weighting. A [BANK] may determine the
risk-weighted asset amount of a securitization exposure that is in a
second loss position or better to an ABCP program that meets the
requirements of paragraph (c)(2) of this section by multiplying the
exposure amount by the higher of the following risk weights:
(i) 100 percent; and
(ii) The highest risk weight applicable to any of the individual
underlying exposures of the ABCP program.
(2) Requirements. (i) The exposure is not an eligible ABCP
liquidity facility;
(ii) The exposure must be economically in a second loss position or
better, and the first loss position must provide significant credit
protection to the second loss position;
(iii) The exposure qualifies as investment grade; and
(iv) The [BANK] holding the exposure must not retain or provide
protection to the first loss position.
Sec. --.45 Recognition of credit risk mitigants for securitization
exposures.
(a) General. (1) An originating [BANK] that has obtained a credit
risk mitigant to hedge its exposure to a synthetic or traditional
securitization that satisfies the operational criteria provided in
Sec. --.41 may recognize the credit risk mitigant under Sec. Sec.
--.36 or --.37, but only as provided in this section.
(2) An investing [BANK] that has obtained a credit risk mitigant to
hedge a securitization exposure may recognize the credit risk mitigant
under Sec. Sec. --.36 or--.37, but only as provided in this section.
(b) Mismatches. A [BANK] must make any applicable adjustment to the
protection amount of an eligible guarantee or credit derivative as
required in Sec. --.36(d), (e), and (f) for any hedged securitization
exposure. In the context of a synthetic securitization, when an
eligible guarantee or eligible credit derivative covers multiple hedged
exposures that have different residual maturities, the [BANK] must use
the longest residual maturity of any of the hedged exposures as the
residual maturity of all hedged exposures.
Sec. Sec. --.46 through --.50 [Reserved]
Risk-Weighted Assets for Equity Exposures
Sec. --.51 Introduction and exposure measurement.
(a) General. (1) To calculate its risk-weighted asset amounts for
equity exposures that are not equity exposures to an investment fund, a
[BANK] must use the Simple Risk-Weight Approach (SRWA) provided in
--.52. A [BANK] must use the look-through approaches provided in Sec.
--.53 to calculate its risk-weighted asset amounts for equity exposures
to investment funds.
(2) A [BANK] must treat an investment in a separate account (as
defined in Sec. --.2) as if it were an equity exposure to an
investment fund as provided in Sec. --.53.
(3) Stable value protection. (i) Stable value protection means a
contract where the provider of the contract is obligated to pay:
(A) The policy owner of a 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; or
(B) The beneficiary of the contract an amount equal to the
shortfall between the fair value and book value of a specified
portfolio of assets.
(ii) A [BANK] 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 of the carrying value of its
separate account as an equity exposure to an investment fund.
(iii) A [BANK] that provides stable value protection must treat the
exposure as an equity derivative with an adjusted carrying value
determined as the sum of paragraphs (b)(1) and (3) of this section.
(b) Adjusted carrying value. For purposes of Sec. Sec. --.51
through --.53, the adjusted carrying value of an equity exposure is:
(1) For the on-balance sheet component of an equity exposure (other
than an equity exposure that is classified as available-for-sale where
the [BANK] has made an AOCI opt-out election under Sec. --.22(b)(2)),
the [BANK]'s carrying value of the exposure;
(2) For the on-balance sheet component of an equity exposure that
is classified as available-for-sale where the [BANK] has made an AOCI
opt-out election under Sec. --.22(b)(2), the [BANK]'s carrying value
of the exposure less any net unrealized gains on the exposure that are
reflected in such carrying value but excluded from the [BANK]'s
regulatory capital components;
(3) For the off-balance sheet component of an equity exposure that
is not an equity commitment, the effective notional principal amount of
the exposure, the size of which is equivalent to a hypothetical on-
balance sheet position in the underlying equity instrument that would
evidence the same change in fair value (measured in dollars) given a
small change in the price of the underlying equity instrument, minus
the adjusted carrying value of the on-balance sheet component of the
exposure as calculated in paragraph (b)(1) of this section; and
(4) For a commitment to acquire an equity exposure (an equity
commitment), the effective notional principal amount of the exposure is
multiplied by the following conversion factors (CFs):
(i) Conditional equity commitments with an original maturity of one
year or less receive a CF of 20 percent.
(ii) Conditional equity commitments with an original maturity of
over one year receive a CF of 50 percent.
(iii) Unconditional equity commitments receive a CF of 100 percent.
Sec. --.52 Simple risk-weight approach (SRWA).
(a) General. Under the SRWA, a [BANK]'s total risk-weighted assets
for equity exposures equals the sum of the risk-weighted asset amounts
for each of the [BANK]'s individual equity exposures (other than equity
exposures to an investment fund) as determined under this section and
the risk-weighted asset amounts for each of the [BANK]'s individual
equity exposures to an investment fund as determined under Sec. --.53.
[[Page 62197]]
(b) SRWA computation for individual equity exposures. A [BANK] must
determine the risk-weighted asset amount for an individual equity
exposure (other than an equity exposure to an investment fund) by
multiplying the adjusted carrying value of the equity exposure or the
effective portion and ineffective portion of a hedge pair (as defined
in paragraph (c) of this section) by the lowest applicable risk weight
in this paragraph (b).
(1) Zero percent risk weight equity exposures. An equity exposure
to a sovereign, 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 Sec. --.32 may be assigned a zero percent
risk weight.
(2) 20 percent risk weight equity exposures. An equity exposure to
a PSE, Federal Home Loan Bank or the Federal Agricultural Mortgage
Corporation (Farmer Mac) must be assigned a 20 percent risk weight.
(3) 100 percent risk weight equity exposures. The equity exposures
set forth in this paragraph (b)(3) must be assigned a 100 percent risk
weight.
(i) Community development equity exposures. An equity exposure that
qualifies as a community development investment under section 24
(Eleventh) of the National Bank Act, 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.
(ii) Effective portion of hedge pairs. The effective portion of a
hedge pair.
(iii) Non-significant equity exposures. Equity exposures, excluding
significant investments in the capital of an unconsolidated financial
institution in the form of common stock and exposures to an investment
firm that would meet the definition of a traditional securitization
were it not for the application of paragraph (8) of that definition in
Sec. --.2 and has greater than immaterial leverage, to the extent that
the aggregate adjusted carrying value of the exposures does not exceed
10 percent of the [BANK]'s total capital.
(A) To compute the aggregate adjusted carrying value of a [BANK]'s
equity exposures for purposes of this section, the [BANK] may exclude
equity exposures described in paragraphs (b)(1), (b)(2), (b)(3)(i), and
(b)(3)(ii) of this section, the equity exposure in a hedge pair with
the smaller adjusted carrying value, and a proportion of each equity
exposure to an investment fund equal to the proportion of the assets of
the investment fund that are not equity exposures or that meet the
criterion of paragraph (b)(3)(i) of this section. If a [BANK] does not
know the actual holdings of the investment fund, the [BANK] may
calculate the proportion of the assets of the fund that are not equity
exposures based on the terms of the prospectus, partnership agreement,
or similar contract that defines the fund's permissible investments. If
the sum of the investment limits for all exposure classes within the
fund exceeds 100 percent, the [BANK] must assume for purposes of this
section that the investment fund invests to the maximum extent possible
in equity exposures.
(B) When determining which of a [BANK]'s equity exposures qualify
for a 100 percent risk weight under this paragraph (b), a [BANK] first
must include equity exposures to unconsolidated small business
investment companies or held through consolidated small business
investment companies described in section 302 of the Small Business
Investment Act, then must include publicly traded equity exposures
(including those held indirectly through investment funds), and then
must include non-publicly traded equity exposures (including those held
indirectly through investment funds).
(4) 250 percent risk weight equity exposures. Significant
investments in the capital of unconsolidated financial institutions in
the form of common stock that are not deducted from capital pursuant to
Sec. --.22(d) are assigned a 250 percent risk weight.
(5) 300 percent risk weight equity exposures. A publicly traded
equity exposure (other than an equity exposure described in paragraph
(b)(7) of this section and including the ineffective portion of a hedge
pair) must be assigned a 300 percent risk weight.
(6) 400 percent risk weight equity exposures. An equity exposure
(other than an equity exposure described in paragraph (b)(7)) of this
section that is not publicly traded must be assigned a 400 percent risk
weight.
(7) 600 percent risk weight equity exposures. An equity exposure to
an investment firm must be assigned a 600 percent risk weight, provided
that the investment firm:
(i) Would meet the definition of a traditional securitization were
it not for the application of paragraph (8) of that definition; and
(ii) Has greater than immaterial leverage.
(c) Hedge transactions--(1) Hedge pair. A hedge pair is two equity
exposures that form an effective hedge so long as each equity exposure
is publicly traded or has a return that is primarily based on a
publicly traded equity exposure.
(2) Effective hedge. Two equity exposures form an effective hedge
if the exposures either have the same remaining maturity or each has a
remaining maturity of at least three months; the hedge relationship is
formally documented in a prospective manner (that is, before the [BANK]
acquires at least one of the equity exposures); the documentation
specifies the measure of effectiveness (E) the [BANK] will use for the
hedge relationship throughout the life of the transaction; and the
hedge relationship has an E greater than or equal to 0.8. A [BANK] must
measure E at least quarterly and must use one of three alternative
measures of E as set forth in this paragraph (c).
(i) Under the dollar-offset method of measuring effectiveness, the
[BANK] must determine the ratio of value change (RVC). The RVC is the
ratio of the cumulative sum of the changes in value of one equity
exposure to the cumulative sum of the changes in the value of the other
equity exposure. If RVC is positive, the hedge is not effective and E
equals 0. If RVC is negative and greater than or equal to -1 (that is,
between zero and -1), then E equals the absolute value of RVC. If RVC
is negative and less than -1, then E equals 2 plus RVC.
(ii) Under the variability-reduction method of measuring
effectiveness:
[[Page 62198]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.027
(iii) Under the regression method of measuring effectiveness, E
equals the coefficient of determination of a regression in which the
change in value of one exposure in a hedge pair is the dependent
variable and the change in value of the other exposure in a hedge pair
is the independent variable. However, if the estimated regression
coefficient is positive, then E equals zero.
(3) The effective portion of a hedge pair is E multiplied by the
greater of the adjusted carrying values of the equity exposures forming
a hedge pair.
(4) The ineffective portion of a hedge pair is (1-E) multiplied by
the greater of the adjusted carrying values of the equity exposures
forming a hedge pair.
Sec. --.53 Equity exposures to investment funds.
(a) Available approaches. (1) Unless the exposure meets the
requirements for a community development equity exposure under Sec.
--.52(b)(3)(i), a [BANK] must determine the risk-weighted asset amount
of an equity exposure to an investment fund under the full look-through
approach described in paragraph (b) of this section, the simple
modified look-through approach described in paragraph (c) of this
section, or the alterative modified look-through approach described
paragraph (d) of this section, provided, however, that the minimum risk
weight that may be assigned to an equity exposure under this section is
20 percent.
(2) The risk-weighted asset amount of an equity exposure to an
investment fund that meets the requirements for a community development
equity exposure in Sec. --.52(b)(3)(i) is its adjusted carrying value.
(3) If an equity exposure to an investment fund is part of a hedge
pair and the [BANK] does not use the full look-through approach, the
[BANK] must use the ineffective portion of the hedge pair as determined
under Sec. --.52(c) as the adjusted carrying value for the equity
exposure to the investment fund. The risk-weighted asset amount of the
effective portion of the hedge pair is equal to its adjusted carrying
value.
(b) Full look-through approach. A [BANK] that is able to calculate
a risk-weighted asset amount for its proportional ownership share of
each exposure held by the investment fund (as calculated under this
subpart as if the proportional ownership share of the adjusted carrying
value of each exposure were held directly by the [BANK]) may set the
risk-weighted asset amount of the [BANK]'s exposure to the fund equal
to the product of:
(1) The aggregate risk-weighted asset amounts of the exposures held
by the fund as if they were held directly by the [BANK]; and
(2) The [BANK]'s proportional ownership share of the fund.
(c) Simple modified look-through approach. Under the simple
modified look-through approach, the risk-weighted asset amount for a
[BANK]'s equity exposure to an investment fund equals the adjusted
carrying value of the equity exposure multiplied by the highest risk
weight that applies to any exposure the fund is permitted to hold under
the prospectus, partnership agreement, or similar agreement that
defines the fund's permissible investments (excluding derivative
contracts that are used for hedging rather than speculative purposes
and that do not constitute a material portion of the fund's exposures).
(d) Alternative modified look-through approach. Under the
alternative modified look-through approach, a [BANK] may assign the
adjusted carrying value of an equity exposure to an investment fund on
a pro rata basis to different risk weight categories under this subpart
based on the investment limits in the fund's prospectus, partnership
agreement, or similar contract that defines the fund's permissible
investments. The risk-weighted asset amount for the [BANK]'s equity
exposure to the investment fund equals the sum of each portion of the
adjusted carrying value assigned to an exposure type multiplied by the
applicable risk weight under this subpart. If the sum of the investment
limits for all exposure types within the fund exceeds 100 percent, the
[BANK] must assume that the fund invests to the maximum extent
permitted under its investment limits in the exposure type with the
highest applicable risk weight under this subpart and continues to make
investments in order of the exposure type with the next highest
applicable risk weight under this subpart until the maximum total
investment level is reached. If more than one exposure type applies to
an exposure, the [BANK] must use the highest applicable risk weight. A
[BANK] may exclude derivative contracts held by the fund that are used
for hedging rather than for speculative purposes and do not constitute
a material portion of the fund's exposures.
Sec. Sec. --.54 through --.60 [Reserved]
Disclosures
Sec. --.61 Purpose and scope.
Sections --.61---.63 of this subpart establish public disclosure
requirements related to the capital requirements described in subpart B
of this part for a [BANK] with total consolidated assets of $50 billion
or more as reported on the [BANK]'s most recent year-end [REGULATORY
REPORT] that is not an advanced approaches [BANK] making public
disclosures pursuant to Sec. --.172. An advanced approaches [BANK]
that has not received approval from the [AGENCY] to exit parallel run
pursuant to Sec. --.121(d) is subject to the disclosure requirements
described in Sec. Sec. --.62 and --.63. Such a [BANK] must comply with
[[Page 62199]]
Sec. --.62 unless it is a consolidated subsidiary of a bank holding
company, savings and loan holding company, 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. For purposes of this
section, total consolidated assets are determined based on the average
of the [BANK]'s total consolidated assets in the four most recent
quarters as reported on the [REGULATORY REPORT]; or the average of the
[BANK]'s total consolidated assets in the most recent consecutive
quarters as reported quarterly on the [BANK]'s [REGULATORY REPORT] if
the [BANK] has not filed such a report for each of the most recent four
quarters.
Sec. --.62 Disclosure requirements.
(a) A [BANK] described in Sec. --.61 must provide timely public
disclosures each calendar quarter of the information in the applicable
tables in Sec. --.63. If a significant change occurs, such that the
most recent reported amounts are no longer reflective of the [BANK]'s
capital adequacy and risk profile, then a brief discussion of this
change and its likely impact must be disclosed as soon as practicable
thereafter. Qualitative disclosures that typically do not change each
quarter (for example, a general summary of the [BANK]'s risk management
objectives and policies, reporting system, and definitions) may be
disclosed annually after the end of the fourth calendar quarter,
provided that any significant changes are disclosed in the interim. The
[BANK]'s management may provide all of the disclosures required by
Sec. Sec. --.61 through --.63 in one place on the [BANK]'s public Web
site or may provide the disclosures in more than one public financial
report or other regulatory reports, provided that the [BANK] publicly
provides a summary table specifically indicating the location(s) of all
such disclosures.
(b) A [BANK] described in Sec. --.61 must have a formal disclosure
policy approved by the board of directors that addresses its approach
for determining the disclosures it makes. The policy must address the
associated internal controls and disclosure controls and procedures.
The board of directors and senior management are responsible for
establishing and maintaining an effective internal control structure
over financial reporting, including the disclosures required by this
subpart, and must ensure that appropriate review of the disclosures
takes place. One or more senior officers of the [BANK] must attest that
the disclosures meet the requirements of this subpart.
(c) If a [BANK] described in Sec. --.61 concludes that specific
commercial or financial information that it would otherwise be required
to disclose under this section would be exempt from disclosure by the
[AGENCY] under the Freedom of Information Act (5 U.S.C. 552), then the
[BANK] is not required to disclose that specific information pursuant
to this section, but must disclose more general information about the
subject matter of the requirement, together with the fact that, and the
reason why, the specific items of information have not been disclosed.
Sec. --.63 Disclosures by [BANK]s described in Sec. --.61.
(a) Except as provided in Sec. --.62, a [BANK] described in Sec.
--.61 must make the disclosures described in Tables 1 through 10 of
this section. The [BANK] must make these disclosures publicly available
for each of the last three years (that is, twelve quarters) or such
shorter period beginning on January 1, 2015.
(b) A [BANK] must publicly disclose each quarter the following:
(1) Common equity tier 1 capital, additional tier 1 capital, tier 2
capital, tier 1 and total capital ratios, including the regulatory
capital elements and all the regulatory adjustments and deductions
needed to calculate the numerator of such ratios;
(2) Total risk-weighted assets, including the different regulatory
adjustments and deductions needed to calculate total risk-weighted
assets;
(3) Regulatory capital ratios during any transition periods,
including a description of all the regulatory capital elements and all
regulatory adjustments and deductions needed to calculate the numerator
and denominator of each capital ratio during any transition period; and
(4) A reconciliation of regulatory capital elements as they relate
to its balance sheet in any audited consolidated financial statements.
Table 1 to Sec. --.63--Scope of Application
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures....... (a).............. The name of the top
corporate entity in
the group to which
subpart D of this
part applies.
(b).............. A brief description
of the differences
in the basis for
consolidating
entities \1\ for
accounting and
regulatory purposes,
with a description
of those entities:
(1) That are fully
consolidated;
(2) That are
deconsolidated and
deducted from total
capital;
(3) For which the
total capital
requirement is
deducted; and
(4) That are neither
consolidated nor
deducted (for
example, where the
investment in the
entity is assigned a
risk weight in
accordance with this
subpart).
(c).............. Any restrictions, or
other major
impediments, on
transfer of funds or
total capital within
the group.
(d).............. The aggregate amount
of surplus capital
of insurance
subsidiaries
included in the
total capital of the
consolidated group.
(e).............. The aggregate amount
by which actual
total capital is
less than the
minimum total
capital requirement
in all subsidiaries,
with total capital
requirements and the
name(s) of the
subsidiaries with
such deficiencies.
------------------------------------------------------------------------
\1\ Entities include securities, insurance and other financial
subsidiaries, commercial subsidiaries (where permitted), and
significant minority equity investments in insurance, financial and
commercial entities.
Table 2 to Sec. --.63--Capital Structure
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures....... (a).............. Summary information
on the terms and
conditions of the
main features of all
regulatory capital
instruments.
Quantitative Disclosures...... (b).............. The amount of common
equity tier 1
capital, with
separate disclosure
of:
(1) Common stock and
related surplus;
[[Page 62200]]
(2) Retained
earnings;
(3) Common equity
minority interest;
(4) AOCI; and
(5) Regulatory
adjustments and
deductions made to
common equity tier 1
capital.
(c).............. The amount of tier 1
capital, with
separate disclosure
of:
(1) Additional tier 1
capital elements,
including additional
tier 1 capital
instruments and tier
1 minority interest
not included in
common equity tier 1
capital; and
(2) Regulatory
adjustments and
deductions made to
tier 1 capital.
(d).............. The amount of total
capital, with
separate disclosure
of:
(1) Tier 2 capital
elements, including
tier 2 capital
instruments and
total capital
minority interest
not included in tier
1 capital; and
(2) Regulatory
adjustments and
deductions made to
total capital.
------------------------------------------------------------------------
Table 3 to Sec. --.63--Capital Adequacy
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. A summary discussion
of the [BANK]'s
approach to
assessing the
adequacy of its
capital to support
current and future
activities.
Quantitative disclosures...... (b).............. Risk-weighted assets
for:
(1) Exposures to
sovereign entities;
(2) Exposures to
certain
supranational
entities and MDBs;
(3) Exposures to
depository
institutions,
foreign banks, and
credit unions;
(4) Exposures to
PSEs;
(5) Corporate
exposures;
(6) Residential
mortgage exposures;
(7) Statutory
multifamily
mortgages and pre-
sold construction
loans;
(8) HVCRE loans;
(9) Past due loans;
(10) Other assets;
(11) Cleared
transactions;
(12) Default fund
contributions;
(13) Unsettled
transactions;
(14) Securitization
exposures; and
(15) Equity
exposures.
(c).............. Standardized market
risk-weighted assets
as calculated under
subpart F of this
part.
(d).............. Common equity tier 1,
tier 1 and total
risk-based capital
ratios:
(1) For the top
consolidated group;
and
(2) For each
depository
institution
subsidiary.
(e).............. Total standardized
risk-weighted
assets.
------------------------------------------------------------------------
Table 4 to Sec. --.63--Capital Conservation Buffer
------------------------------------------------------------------------
------------------------------------------------------------------------
Quantitative Disclosures...... (a).............. At least quarterly,
the [BANK] must
calculate and
publicly disclose
the capital
conservation buffer
as described under
Sec. --.11.
(b).............. At least quarterly,
the [BANK] must
calculate and
publicly disclose
the eligible
retained income of
the [BANK], as
described under Sec.
--.11.
(c).............. At least quarterly,
the [BANK] must
calculate and
publicly disclose
any limitations it
has on distributions
and discretionary
bonus payments
resulting from the
capital conservation
buffer framework
described under Sec.
--.11, including
the maximum payout
amount for the
quarter.
------------------------------------------------------------------------
(c) General qualitative disclosure requirement. For each separate
risk area described in Tables 5 through 10, the [BANK] must describe
its risk management objectives and policies, including: Strategies and
processes; the structure and organization of the relevant risk
management function; the scope and nature of risk reporting and/or
measurement systems; policies for hedging and/or mitigating risk and
strategies and processes for monitoring the continuing effectiveness of
hedges/mitigants.
Table 5 to Sec. --.63 \1\--Credit Risk: General Disclosures
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures....... (a).............. The general
qualitative
disclosure
requirement with
respect to credit
risk (excluding
counterparty credit
risk disclosed in
accordance with
Table 6), including
the:
(1) Policy for
determining past due
or delinquency
status;
(2) Policy for
placing loans on
nonaccrual;
(3) Policy for
returning loans to
accrual status;
(4) Definition of and
policy for
identifying impaired
loans (for financial
accounting
purposes);
[[Page 62201]]
(5) Description of
the methodology that
the [BANK] uses to
estimate its
allowance for loan
and lease losses,
including
statistical methods
used where
applicable;
(6) Policy for
charging-off
uncollectible
amounts; and
(7) Discussion of the
[BANK]'s credit risk
management policy.
Quantitative Disclosures...... (b).............. Total credit risk
exposures and
average credit risk
exposures, after
accounting offsets
in accordance with
GAAP, without taking
into account the
effects of credit
risk mitigation
techniques (for
example, collateral
and netting not
permitted under
GAAP), over the
period categorized
by major types of
credit exposure. For
example, [BANK]s
could use categories
similar to that used
for financial
statement purposes.
Such categories
might include, for
instance
(1) Loans, off-
balance sheet
commitments, and
other non-derivative
off-balance sheet
exposures;
(2) Debt securities;
and
(3) OTC
derivatives.\2\
(c).............. Geographic
distribution of
exposures,
categorized in
significant areas by
major types of
credit exposure.\3\
(d).............. Industry or
counterparty type
distribution of
exposures,
categorized by major
types of credit
exposure.
(e).............. By major industry or
counterparty type:
(1) Amount of
impaired loans for
which there was a
related allowance
under GAAP;
(2) Amount of
impaired loans for
which there was no
related allowance
under GAAP;
(3) Amount of loans
past due 90 days and
on nonaccrual;
(4) Amount of loans
past due 90 days and
still accruing; \4\
(5) The balance in
the allowance for
loan and lease
losses at the end of
each period,
disaggregated on the
basis of the
[BANK]'s impairment
method. To
disaggregate the
information required
on the basis of
impairment
methodology, an
entity shall
separately disclose
the amounts based on
the requirements in
GAAP; and
(6) Charge-offs
during the period.
(f).............. Amount of impaired
loans and, if
available, the
amount of past due
loans categorized by
significant
geographic areas
including, if
practical, the
amounts of
allowances related
to each geographical
area,\5\ further
categorized as
required by GAAP.
(g).............. Reconciliation of
changes in ALLL.\6\
(h).............. Remaining contractual
maturity delineation
(for example, one
year or less) of the
whole portfolio,
categorized by
credit exposure.
------------------------------------------------------------------------
\1\ Table 5 does not cover equity exposures, which should be reported in
Table 9.
\2\ See, for example, ASC Topic 815-10 and 210, as they may be amended
from time to time.
\3\ Geographical areas may consist of individual countries, groups of
countries, or regions within countries. A [BANK] might choose to
define the geographical areas based on the way the [BANK]'s portfolio
is geographically managed. The criteria used to allocate the loans to
geographical areas must be specified.
\4\ A [BANK] is encouraged also to provide an analysis of the aging of
past-due loans.
\5\ The portion of the general allowance that is not allocated to a
geographical area should be disclosed separately.
\6\ The reconciliation should include the following: A description of
the allowance; the opening balance of the allowance; charge-offs taken
against the allowance during the period; amounts provided (or
reversed) for estimated probable loan losses during the period; any
other adjustments (for example, exchange rate differences, business
combinations, acquisitions and disposals of subsidiaries), including
transfers between allowances; and the closing balance of the
allowance. Charge-offs and recoveries that have been recorded directly
to the income statement should be disclosed separately.
Table 6 to Sec. --.63--General Disclosure for Counterparty Credit Risk-
Related Exposures
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures....... (a).............. The general
qualitative
disclosure
requirement with
respect to OTC
derivatives,
eligible margin
loans, and repo-
style transactions,
including a
discussion of:
(1) The methodology
used to assign
credit limits for
counterparty credit
exposures;
(2) Policies for
securing collateral,
valuing and managing
collateral, and
establishing credit
reserves;
(3) The primary types
of collateral taken;
and
(4) The impact of the
amount of collateral
the [BANK] would
have to provide
given a
deterioration in the
[BANK]'s own
creditworthiness.
Quantitative Disclosures...... (b).............. Gross positive fair
value of contracts,
collateral held
(including type, for
example, cash,
government
securities), and net
unsecured credit
exposure.\1\ A
[BANK] also must
disclose the
notional value of
credit derivative
hedges purchased for
counterparty credit
risk protection and
the distribution of
current credit
exposure by exposure
type.\2\
[[Page 62202]]
(c).............. Notional amount of
purchased and sold
credit derivatives,
segregated between
use for the [BANK]'s
own credit portfolio
and in its
intermediation
activities,
including the
distribution of the
credit derivative
products used,
categorized further
by protection bought
and sold within each
product group.
------------------------------------------------------------------------
\1\ Net unsecured credit exposure is the credit exposure after
considering both the benefits from legally enforceable netting
agreements and collateral arrangements without taking into account
haircuts for price volatility, liquidity, etc.
\2\ This may include interest rate derivative contracts, foreign
exchange derivative contracts, equity derivative contracts, credit
derivatives, commodity or other derivative contracts, repo-style
transactions, and eligible margin loans.
Table 7 to Sec. --.63--Credit Risk Mitigation 1 2
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures....... (a).............. The general
qualitative
disclosure
requirement with
respect to credit
risk mitigation,
including:
(1) Policies and
processes for
collateral valuation
and management;
(2) A description of
the main types of
collateral taken by
the [BANK];
(3) The main types of
guarantors/credit
derivative
counterparties and
their
creditworthiness;
and
(4) Information about
(market or credit)
risk concentrations
with respect to
credit risk
mitigation.
Quantitative Disclosures...... (b).............. For each separately
disclosed credit
risk portfolio, the
total exposure that
is covered by
eligible financial
collateral, and
after the
application of
haircuts.
(c).............. For each separately
disclosed portfolio,
the total exposure
that is covered by
guarantees/credit
derivatives and the
risk-weighted asset
amount associated
with that exposure.
------------------------------------------------------------------------
\1\ At a minimum, a [BANK] must provide the disclosures in Table 7 in
relation to credit risk mitigation that has been recognized for the
purposes of reducing capital requirements under this subpart. Where
relevant, [BANK]s are encouraged to give further information about
mitigants that have not been recognized for that purpose.
\2\ Credit derivatives that are treated, for the purposes of this
subpart, as synthetic securitization exposures should be excluded from
the credit risk mitigation disclosures and included within those
relating to securitization (Table 8).
Table 8 to Sec. --.63--Securitization
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures....... (a).............. The general
qualitative
disclosure
requirement with
respect to a
securitization
(including synthetic
securitizations),
including a
discussion of:
(1) The [BANK]'s
objectives for
securitizing assets,
including the extent
to which these
activities transfer
credit risk of the
underlying exposures
away from the [BANK]
to other entities
and including the
type of risks
assumed and retained
with
resecuritization
activity; \1\
(2) The nature of the
risks (e.g.
liquidity risk)
inherent in the
securitized assets;
(3) The roles played
by the [BANK] in the
securitization
process \2\ and an
indication of the
extent of the
[BANK]'s involvement
in each of them;
(4) The processes in
place to monitor
changes in the
credit and market
risk of
securitization
exposures including
how those processes
differ for
resecuritization
exposures;
(5) The [BANK]'s
policy for
mitigating the
credit risk retained
through
securitization and
resecuritization
exposures; and
(6) The risk-based
capital approaches
that the [BANK]
follows for its
securitization
exposures including
the type of
securitization
exposure to which
each approach
applies.
(b).............. A list of:
(1) The type of
securitization SPEs
that the [BANK], as
sponsor, uses to
securitize third-
party exposures. The
[BANK] must indicate
whether it has
exposure to these
SPEs, either on- or
off-balance sheet;
and
(2) Affiliated
entities:
(i) That the [BANK]
manages or advises;
and
(ii) That invest
either in the
securitization
exposures that the
[BANK] has
securitized or in
securitization SPEs
that the [BANK]
sponsors.\3\
(c).............. Summary of the
[BANK]'s accounting
policies for
securitization
activities,
including:
(1) Whether the
transactions are
treated as sales or
financings;
(2) Recognition of
gain-on-sale;
(3) Methods and key
assumptions applied
in valuing retained
or purchased
interests;
(4) Changes in
methods and key
assumptions from the
previous period for
valuing retained
interests and impact
of the changes;
(5) Treatment of
synthetic
securitizations;
(6) How exposures
intended to be
securitized are
valued and whether
they are recorded
under subpart D of
this part; and
(7) Policies for
recognizing
liabilities on the
balance sheet for
arrangements that
could require the
[BANK] to provide
financial support
for securitized
assets.
[[Page 62203]]
(d).............. An explanation of
significant changes
to any quantitative
information since
the last reporting
period.
Quantitative Disclosures...... (e).............. The total outstanding
exposures
securitized by the
[BANK] in
securitizations that
meet the operational
criteria provided in
Sec. --.41
(categorized into
traditional and
synthetic
securitizations), by
exposure type,
separately for
securitizations of
third-party
exposures for which
the bank acts only
as sponsor.\4\
(f).............. For exposures
securitized by the
[BANK] in
securitizations that
meet the operational
criteria in Sec. --
.41:
(1) Amount of
securitized assets
that are impaired/
past due categorized
by exposure type;
\5\ and
(2) Losses recognized
by the [BANK] during
the current period
categorized by
exposure type.\6\
(g).............. The total amount of
outstanding
exposures intended
to be securitized
categorized by
exposure type.
(h).............. Aggregate amount of:
(1) On-balance sheet
securitization
exposures retained
or purchased
categorized by
exposure type; and
(2) Off-balance sheet
securitization
exposures
categorized by
exposure type.
(i).............. (1) Aggregate amount
of securitization
exposures retained
or purchased and the
associated capital
requirements for
these exposures,
categorized between
securitization and
resecuritization
exposures, further
categorized into a
meaningful number of
risk weight bands
and by risk-based
capital approach
(e.g., SSFA); and
(2) Exposures that
have been deducted
entirely from tier 1
capital, CEIOs
deducted from total
capital (as
described in Sec.
--.42(a)(1), and
other exposures
deducted from total
capital should be
disclosed separately
by exposure type.
(j).............. Summary of current
year's
securitization
activity, including
the amount of
exposures
securitized (by
exposure type), and
recognized gain or
loss on sale by
exposure type.
(k).............. Aggregate amount of
resecuritization
exposures retained
or purchased
categorized
according to:
(1) Exposures to
which credit risk
mitigation is
applied and those
not applied; and
(2) Exposures to
guarantors
categorized
according to
guarantor
creditworthiness
categories or
guarantor name.
------------------------------------------------------------------------
\1\ The [BANK] should describe the structure of resecuritizations in
which it participates; this description should be provided for the
main categories of resecuritization products in which the [BANK] is
active.
\2\ For example, these roles may include originator, investor, servicer,
provider of credit enhancement, sponsor, liquidity provider, or swap
provider.
\3\ Such affiliated entities may include, for example, money market
funds, to be listed individually, and personal and private trusts, to
be noted collectively.
\4\ ``Exposures securitized'' include underlying exposures originated by
the bank, whether generated by them or purchased, and recognized in
the balance sheet, from third parties, and third-party exposures
included in sponsored transactions. Securitization transactions
(including underlying exposures originally on the bank's balance sheet
and underlying exposures acquired by the bank from third-party
entities) in which the originating bank does not retain any
securitization exposure should be shown separately but need only be
reported for the year of inception. Banks are required to disclose
exposures regardless of whether there is a capital charge under this
part.
\5\ Include credit-related other than temporary impairment (OTTI).
\6\ For example, charge-offs/allowances (if the assets remain on the
bank's balance sheet) or credit-related OTTI of interest-only strips
and other retained residual interests, as well as recognition of
liabilities for probable future financial support required of the bank
with respect to securitized assets.
Table 9 to Sec. --.63--Equities Not Subject to Subpart F of This Part
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures....... (a).............. The general
qualitative
disclosure
requirement with
respect to equity
risk for equities
not subject to
subpart F of this
part, including:
(1) Differentiation
between holdings on
which capital gains
are expected and
those taken under
other objectives
including for
relationship and
strategic reasons;
and
(2) Discussion of
important policies
covering the
valuation of and
accounting for
equity holdings not
subject to subpart F
of this part. This
includes the
accounting
techniques and
valuation
methodologies used,
including key
assumptions and
practices affecting
valuation as well as
significant changes
in these practices.
Quantitative Disclosures...... (b).............. Value disclosed on
the balance sheet of
investments, as well
as the fair value of
those investments;
for securities that
are publicly traded,
a comparison to
publicly-quoted
share values where
the share price is
materially different
from fair value.
(c).............. The types and nature
of investments,
including the amount
that is: (1)
Publicly traded; and
(2) Non publicly
traded.
(d).............. The cumulative
realized gains
(losses) arising
from sales and
liquidations in the
reporting period.
[[Page 62204]]
(e).............. (1) Total unrealized
gains (losses).\1\
(2) Total latent
revaluation gains
(losses).\2\
(3) Any amounts of
the above included
in tier 1 or tier 2
capital.
(f).............. Capital requirements
categorized by
appropriate equity
groupings,
consistent with the
[BANK]'s
methodology, as well
as the aggregate
amounts and the type
of equity
investments subject
to any supervisory
transition regarding
regulatory capital
requirements.
------------------------------------------------------------------------
\1\ Unrealized gains (losses) recognized on the balance sheet but not
through earnings.
\2\ Unrealized gains (losses) not recognized either on the balance sheet
or through earnings.
Table 10 to Sec. --.63--Interest Rate Risk for Non-Trading Activities
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. The general
qualitative
disclosure
requirement,
including the nature
of interest rate
risk for non-trading
activities and key
assumptions,
including
assumptions
regarding loan
prepayments and
behavior of non-
maturity deposits,
and frequency of
measurement of
interest rate risk
for non-trading
activities.
Quantitative disclosures...... (b).............. The increase
(decline) in
earnings or economic
value (or relevant
measure used by
management) for
upward and downward
rate shocks
according to
management's method
for measuring
interest rate risk
for non-trading
activities,
categorized by
currency (as
appropriate).
------------------------------------------------------------------------
Sec. Sec. --.64 through --.99 [Reserved]
Subpart E--Risk-Weighted Assets--Internal Ratings-Based and
Advanced Measurement Approaches
Sec. --.100 Purpose, applicability, and principle of conservatism.
(a) Purpose. This subpart E establishes:
(1) Minimum qualifying criteria for [BANK]s using institution-
specific internal risk measurement and management processes for
calculating risk-based capital requirements; and
(2) Methodologies for such [BANK]s to calculate their total risk-
weighted assets.
(b) Applicability. (1) This subpart applies to a [BANK] that:
(i) Has consolidated total assets, as reported on its most recent
year-end [REGULATORY REPORT] equal to $250 billion or more;
(ii) Has consolidated total on-balance sheet foreign exposure on
its most recent year-end [REGULATORY REPORT] equal to $10 billion or
more (where total on-balance sheet foreign exposure equals total cross-
border claims less claims with a head office or guarantor located in
another country plus redistributed guaranteed amounts to the country of
head office or guarantor plus local country claims on local residents
plus revaluation gains on foreign exchange and derivative products,
calculated in accordance with the Federal Financial Institutions
Examination Council (FFIEC) 009 Country Exposure Report);
(iii) Is a subsidiary of a depository institution that uses the
advanced approaches pursuant to subpart E of 12 CFR part 3 (OCC), 12
CFR part 217 (Board), or 12 CFR part 325 (FDIC) to calculate its total
risk-weighted assets;
(iv) Is a subsidiary of a bank holding company or savings and loan
holding company that uses the advanced approaches pursuant to 12 CFR
part 217 to calculate its total risk-weighted assets; or
(v) Elects to use this subpart to calculate its total risk-weighted
assets.
(2) A [BANK] that is subject to this subpart shall remain subject
to this subpart unless the [AGENCY] determines in writing that
application of this subpart is not appropriate in light of the [BANK]'s
asset size, level of complexity, risk profile, or scope of operations.
In making a determination under this paragraph (b), the [AGENCY] will
apply notice and response procedures in the same manner and to the same
extent as the notice and response procedures in [12 CFR 3.404 (OCC), 12
CFR 263.202 (Board), and 12 CFR 324.5 (FDIC)].
(3) A market risk [BANK] must exclude from its calculation of risk-
weighted assets under this subpart the risk-weighted asset amounts of
all covered positions, as defined in subpart F of this part (except
foreign exchange positions that are not trading positions, over-the-
counter derivative positions, cleared transactions, and unsettled
transactions).
(c) Principle of conservatism. Notwithstanding the requirements of
this subpart, a [BANK] may choose not to apply a provision of this
subpart to one or more exposures provided that:
(1) The [BANK] can demonstrate on an ongoing basis to the
satisfaction of the [AGENCY] that not applying the provision would, in
all circumstances, unambiguously generate a risk-based capital
requirement for each such exposure greater than that which would
otherwise be required under this subpart;
(2) The [BANK] appropriately manages the risk of each such
exposure;
(3) The [BANK] notifies the [AGENCY] in writing prior to applying
this principle to each such exposure; and
(4) The exposures to which the [BANK] applies this principle are
not, in the aggregate, material to the [BANK].
Sec. --.101 Definitions.
(a) Terms that are set forth in Sec. --.2 and used in this subpart
have the definitions assigned thereto in Sec. --.2.
(b) For the purposes of this subpart, the following terms are
defined as follows:
Advanced internal ratings-based (IRB) systems means an advanced
approaches [BANK]'s internal risk rating and segmentation system; risk
parameter quantification system; data management and maintenance
system; and control, oversight, and validation system for credit risk
of wholesale and retail exposures.
Advanced systems means an advanced approaches [BANK]'s advanced IRB
systems, operational risk management processes, operational risk data
and assessment systems, operational risk quantification systems, and,
to the extent used by the [BANK], the internal models methodology,
advanced CVA approach, double default excessive correlation detection
process, and internal models approach (IMA) for equity exposures.
Backtesting means the comparison of a [BANK]'s internal estimates
with actual outcomes during a sample period
[[Page 62205]]
not used in model development. In this context, backtesting is one form
of out-of-sample testing.
Benchmarking means the comparison of a [BANK]'s internal estimates
with relevant internal and external data or with estimates based on
other estimation techniques.
Bond option contract means a bond option, bond future, or any other
instrument linked to a bond that gives rise to similar counterparty
credit risk.
Business environment and internal control factors means the
indicators of a [BANK]'s operational risk profile that reflect a
current and forward-looking assessment of the [BANK]'s underlying
business risk factors and internal control environment.
Credit default swap (CDS) means a financial contract executed under
standard industry documentation that allows one party (the protection
purchaser) to transfer the credit risk of one or more exposures
(reference exposure(s)) to another party (the protection provider) for
a certain period of time.
Credit valuation adjustment (CVA) means the fair value adjustment
to reflect counterparty credit risk in valuation of OTC derivative
contracts.
Default--For the purposes of calculating capital requirements under
this subpart:
(1) Retail. (i) A retail exposure of a [BANK] is in default if:
(A) The exposure is 180 days past due, in the case of a residential
mortgage exposure or revolving exposure;
(B) The exposure is 120 days past due, in the case of retail
exposures that are not residential mortgage exposures or revolving
exposures; or
(C) The [BANK] has taken a full or partial charge-off, write-down
of principal, or material negative fair value adjustment of principal
on the exposure for credit-related reasons.
(ii) Notwithstanding paragraph (1)(i) of this definition, for a
retail exposure held by a non-U.S. subsidiary of the [BANK] that is
subject to an internal ratings-based approach to capital adequacy
consistent with the Basel Committee on Banking Supervision's
``International Convergence of Capital Measurement and Capital
Standards: A Revised Framework'' in a non-U.S. jurisdiction, the [BANK]
may elect to use the definition of default that is used in that
jurisdiction, provided that the [BANK] has obtained prior approval from
the [AGENCY] to use the definition of default in that jurisdiction.
(iii) A retail exposure in default remains in default until the
[BANK] has reasonable assurance of repayment and performance for all
contractual principal and interest payments on the exposure.
(2) Wholesale. (i) A [BANK]'s wholesale obligor is in default if:
(A) The [BANK] determines that the obligor is unlikely to pay its
credit obligations to the [BANK] in full, without recourse by the
[BANK] to actions such as realizing collateral (if held); or
(B) The obligor is past due more than 90 days on any material
credit obligation(s) to the [BANK].\25\
---------------------------------------------------------------------------
\25\ Overdrafts are past due once the obligor has breached an
advised limit or been advised of a limit smaller than the current
outstanding balance.
---------------------------------------------------------------------------
(ii) An obligor in default remains in default until the [BANK] has
reasonable assurance of repayment and performance for all contractual
principal and interest payments on all exposures of the [BANK] to the
obligor (other than exposures that have been fully written-down or
charged-off).
Dependence means a measure of the association among operational
losses across and within units of measure.
Economic downturn conditions means, with respect to an exposure
held by the [BANK], those conditions in which the aggregate default
rates for that exposure's wholesale or retail exposure subcategory (or
subdivision of such subcategory selected by the [BANK]) in the
exposure's national jurisdiction (or subdivision of such jurisdiction
selected by the [BANK]) are significantly higher than average.
Effective maturity (M) of a wholesale exposure means:
(1) For wholesale exposures other than repo-style transactions,
eligible margin loans, and OTC derivative contracts described in
paragraph (2) or (3) of this definition:
(i) The weighted-average remaining maturity (measured in years,
whole or fractional) of the expected contractual cash flows from the
exposure, using the undiscounted amounts of the cash flows as weights;
or
(ii) The nominal remaining maturity (measured in years, whole or
fractional) of the exposure.
(2) For repo-style transactions, eligible margin loans, and OTC
derivative contracts subject to a qualifying master netting agreement
for which the [BANK] does not apply the internal models approach in
section 132(d), the weighted-average remaining maturity (measured in
years, whole or fractional) of the individual transactions subject to
the qualifying master netting agreement, with the weight of each
individual transaction set equal to the notional amount of the
transaction.
(3) For repo-style transactions, eligible margin loans, and OTC
derivative contracts for which the [BANK] applies the internal models
approach in Sec. --.132(d), the value determined in Sec.
--.132(d)(4).
Eligible double default guarantor, with respect to a guarantee or
credit derivative obtained by a [BANK], means:
(1) U.S.-based entities. A depository institution, a bank holding
company, a savings and loan holding company, or a securities broker or
dealer registered with the SEC under the Securities Exchange Act, if at
the time the guarantee is issued or anytime thereafter, has issued and
outstanding an unsecured debt security without credit enhancement that
is investment grade.
(2) Non-U.S.-based entities. A foreign bank, or a non-U.S.-based
securities firm if the [BANK] demonstrates that the guarantor is
subject to consolidated supervision and regulation comparable to that
imposed on U.S. depository institutions, or securities broker-dealers)
if at the time the guarantee is issued or anytime thereafter, has
issued and outstanding an unsecured debt security without credit
enhancement that is investment grade.
Eligible operational risk offsets means amounts, not to exceed
expected operational loss, that:
(1) Are generated by internal business practices to absorb highly
predictable and reasonably stable operational losses, including
reserves calculated consistent with GAAP; and
(2) Are available to cover expected operational losses with a high
degree of certainty over a one-year horizon.
Eligible purchased wholesale exposure means a purchased wholesale
exposure that:
(1) The [BANK] or securitization SPE purchased from an unaffiliated
seller and did not directly or indirectly originate;
(2) Was generated on an arm's-length basis between the seller and
the obligor (intercompany accounts receivable and receivables subject
to contra-accounts between firms that buy and sell to each other do not
satisfy this criterion);
(3) Provides the [BANK] or securitization SPE with a claim on all
proceeds from the exposure or a pro rata interest in the proceeds from
the exposure;
(4) Has an M of less than one year; and
(5) When consolidated by obligor, does not represent a concentrated
exposure relative to the portfolio of purchased wholesale exposures.
[[Page 62206]]
Expected exposure (EE) means the expected value of the probability
distribution of non-negative credit risk exposures to a counterparty at
any specified future date before the maturity date of the longest term
transaction in the netting set. Any negative fair values in the
probability distribution of fair values to a counterparty at a
specified future date are set to zero to convert the probability
distribution of fair values to the probability distribution of credit
risk exposures.
Expected operational loss (EOL) means the expected value of the
distribution of potential aggregate operational losses, as generated by
the [BANK]'s operational risk quantification system using a one-year
horizon.
Expected positive exposure (EPE) means the weighted average over
time of expected (non-negative) exposures to a counterparty where the
weights are the proportion of the time interval that an individual
expected exposure represents. When calculating risk-based capital
requirements, the average is taken over a one-year horizon.
Exposure at default (EAD) means:
(1) For the on-balance sheet component of a wholesale exposure or
segment of retail exposures (other than an OTC derivative contract, a
repo-style transaction or eligible margin loan for which the [BANK]
determines EAD under Sec. --.132, a cleared transaction, or default
fund contribution), EAD means the [BANK]'s carrying value (including
net accrued but unpaid interest and fees) for the exposure or segment
less any allocated transfer risk reserve for the exposure or segment.
(2) For the off-balance sheet component of a wholesale exposure or
segment of retail exposures (other than an OTC derivative contract, a
repo-style transaction or eligible margin loan for which the [BANK]
determines EAD under Sec. --.132, cleared transaction, or default fund
contribution) in the form of a loan commitment, line of credit, trade-
related letter of credit, or transaction-related contingency, EAD means
the [BANK]'s best estimate of net additions to the outstanding amount
owed the [BANK], including estimated future additional draws of
principal and accrued but unpaid interest and fees, that are likely to
occur over a one-year horizon assuming the wholesale exposure or the
retail exposures in the segment were to go into default. This estimate
of net additions must reflect what would be expected during economic
downturn conditions. For the purposes of this definition:
(i) Trade-related letters of credit are short-term, self-
liquidating instruments that are used to finance the movement of goods
and are collateralized by the underlying goods.
(ii) Transaction-related contingencies relate to a particular
transaction and include, among other things, performance bonds and
performance-based letters of credit.
(3) For the off-balance sheet component of a wholesale exposure or
segment of retail exposures (other than an OTC derivative contract, a
repo-style transaction, or eligible margin loan for which the [BANK]
determines EAD under Sec. --.132, cleared transaction, or default fund
contribution) in the form of anything other than a loan commitment,
line of credit, trade-related letter of credit, or transaction-related
contingency, EAD means the notional amount of the exposure or segment.
(4) EAD for OTC derivative contracts is calculated as described in
Sec. --.132. A [BANK] also may determine EAD for repo-style
transactions and eligible margin loans as described in Sec. --.132.
Exposure category means any of the wholesale, retail,
securitization, or equity exposure categories.
External operational loss event data means, with respect to a
[BANK], gross operational loss amounts, dates, recoveries, and relevant
causal information for operational loss events occurring at
organizations other than the [BANK].
IMM exposure means a repo-style transaction, eligible margin loan,
or OTC derivative for which a [BANK] calculates its EAD using the
internal models methodology of Sec. --.132(d).
Internal operational loss event data means, with respect to a
[BANK], gross operational loss amounts, dates, recoveries, and relevant
causal information for operational loss events occurring at the [BANK].
Loss given default (LGD) means:
(1) For a wholesale exposure, the greatest of:
(i) Zero;
(ii) The [BANK]'s empirically based best estimate of the long-run
default-weighted average economic loss, per dollar of EAD, the [BANK]
would expect to incur if the obligor (or a typical obligor in the loss
severity grade assigned by the [BANK] to the exposure) were to default
within a one-year horizon over a mix of economic conditions, including
economic downturn conditions; or
(iii) The [BANK]'s empirically based best estimate of the economic
loss, per dollar of EAD, the [BANK] would expect to incur if the
obligor (or a typical obligor in the loss severity grade assigned by
the [BANK] to the exposure) were to default within a one-year horizon
during economic downturn conditions.
(2) For a segment of retail exposures, the greatest of:
(i) Zero;
(ii) The [BANK]'s empirically based best estimate of the long-run
default-weighted average economic loss, per dollar of EAD, the [BANK]
would expect to incur if the exposures in the segment were to default
within a one-year horizon over a mix of economic conditions, including
economic downturn conditions; or
(iii) The [BANK]'s empirically based best estimate of the economic
loss, per dollar of EAD, the [BANK] would expect to incur if the
exposures in the segment were to default within a one-year horizon
during economic downturn conditions.
(3) The economic loss on an exposure in the event of default is all
material credit-related losses on the exposure (including accrued but
unpaid interest or fees, losses on the sale of collateral, direct
workout costs, and an appropriate allocation of indirect workout
costs). Where positive or negative cash flows on a wholesale exposure
to a defaulted obligor or a defaulted retail exposure (including
proceeds from the sale of collateral, workout costs, additional
extensions of credit to facilitate repayment of the exposure, and draw-
downs of unused credit lines) occur after the date of default, the
economic loss must reflect the net present value of cash flows as of
the default date using a discount rate appropriate to the risk of the
defaulted exposure.
Obligor means the legal entity or natural person contractually
obligated on a wholesale exposure, except that a [BANK] may treat the
following exposures as having separate obligors:
(1) Exposures to the same legal entity or natural person
denominated in different currencies;
(2)(i) An income-producing real estate exposure for which all or
substantially all of the repayment of the exposure is reliant on the
cash flows of the real estate serving as collateral for the exposure;
the [BANK], in economic substance, does not have recourse to the
borrower beyond the real estate collateral; and no cross-default or
cross-acceleration clauses are in place other than clauses obtained
solely out of an abundance of caution; and
(ii) Other credit exposures to the same legal entity or natural
person; and
(3)(i) A wholesale exposure authorized under section 364 of the
U.S. Bankruptcy Code (11 U.S.C. 364) to a legal entity or natural
person who is a debtor-in-possession for purposes of Chapter 11 of the
Bankruptcy Code; and
[[Page 62207]]
(ii) Other credit exposures to the same legal entity or natural
person.
Operational loss means a loss (excluding insurance or tax effects)
resulting from an operational loss event. Operational loss includes all
expenses associated with an operational loss event except for
opportunity costs, forgone revenue, and costs related to risk
management and control enhancements implemented to prevent future
operational losses.
Operational loss event means an event that results in loss and is
associated with any of the following seven operational loss event type
categories:
(1) Internal fraud, which means the operational loss event type
category that comprises operational losses resulting from an act
involving at least one internal party of a type intended to defraud,
misappropriate property, or circumvent regulations, the law, or company
policy excluding diversity- and discrimination-type events.
(2) External fraud, which means the operational loss event type
category that comprises operational losses resulting from an act by a
third party of a type intended to defraud, misappropriate property, or
circumvent the law. Retail credit card losses arising from non-
contractual, third-party-initiated fraud (for example, identity theft)
are external fraud operational losses. All other third-party-initiated
credit losses are to be treated as credit risk losses.
(3) Employment practices and workplace safety, which means the
operational loss event type category that comprises operational losses
resulting from an act inconsistent with employment, health, or safety
laws or agreements, payment of personal injury claims, or payment
arising from diversity- and discrimination-type events.
(4) Clients, products, and business practices, which means the
operational loss event type category that comprises operational losses
resulting from the nature or design of a product or from an
unintentional or negligent failure to meet a professional obligation to
specific clients (including fiduciary and suitability requirements).
(5) Damage to physical assets, which means the operational loss
event type category that comprises operational losses resulting from
the loss of or damage to physical assets from natural disaster or other
events.
(6) Business disruption and system failures, which means the
operational loss event type category that comprises operational losses
resulting from disruption of business or system failures.
(7) Execution, delivery, and process management, which means the
operational loss event type category that comprises operational losses
resulting from failed transaction processing or process management or
losses arising from relations with trade counterparties and vendors.
Operational risk means the risk of loss resulting from inadequate
or failed internal processes, people, and systems or from external
events (including legal risk but excluding strategic and reputational
risk).
Operational risk exposure means the 99.9th percentile of the
distribution of potential aggregate operational losses, as generated by
the [BANK]'s operational risk quantification system over a one-year
horizon (and not incorporating eligible operational risk offsets or
qualifying operational risk mitigants).
Other retail exposure means an exposure (other than a
securitization exposure, an equity exposure, a residential mortgage
exposure, a pre-sold construction loan, a qualifying revolving
exposure, or the residual value portion of a lease exposure) that is
managed as part of a segment of exposures with homogeneous risk
characteristics, not on an individual-exposure basis, and is either:
(1) An exposure to an individual for non-business purposes; or
(2) An exposure to an individual or company for business purposes
if the [BANK]'s consolidated business credit exposure to the individual
or company is $1 million or less.
Probability of default (PD) means:
(1) For a wholesale exposure to a non-defaulted obligor, the
[BANK]'s empirically based best estimate of the long-run average one-
year default rate for the rating grade assigned by the [BANK] to the
obligor, capturing the average default experience for obligors in the
rating grade over a mix of economic conditions (including economic
downturn conditions) sufficient to provide a reasonable estimate of the
average one-year default rate over the economic cycle for the rating
grade.
(2) For a segment of non-defaulted retail exposures, the [BANK]'s
empirically based best estimate of the long-run average one-year
default rate for the exposures in the segment, capturing the average
default experience for exposures in the segment over a mix of economic
conditions (including economic downturn conditions) sufficient to
provide a reasonable estimate of the average one-year default rate over
the economic cycle for the segment.
(3) For a wholesale exposure to a defaulted obligor or segment of
defaulted retail exposures, 100 percent.
Qualifying cross-product master netting agreement means a
qualifying master netting agreement that provides for termination and
close-out netting across multiple types of financial transactions or
qualifying master netting agreements in the event of a counterparty's
default, provided that the underlying financial transactions are OTC
derivative contracts, eligible margin loans, or repo-style
transactions. In order to treat an agreement as a qualifying cross-
product master netting agreement for purposes of this subpart, a [BANK]
must comply with the requirements of Sec. --.3(c) of this part with
respect to that agreement.
Qualifying revolving exposure (QRE) means an exposure (other than a
securitization exposure or equity exposure) to an individual that is
managed as part of a segment of exposures with homogeneous risk
characteristics, not on an individual-exposure basis, and:
(1) Is revolving (that is, the amount outstanding fluctuates,
determined largely by a borrower's decision to borrow and repay up to a
pre-established maximum amount, except for an outstanding amount that
the borrower is required to pay in full every month);
(2) Is unsecured and unconditionally cancelable by the [BANK] to
the fullest extent permitted by Federal law; and
(3)(i) Has a maximum contractual exposure amount (drawn plus
undrawn) of up to $100,000; or
(ii) With respect to a product with an outstanding amount that the
borrower is required to pay in full every month, the total outstanding
amount does not in practice exceed $100,000.
(4) A segment of exposures that contains one or more exposures that
fails to meet paragraph (3)(ii) of this definition must be treated as a
segment of other retail exposures for the 24 month period following the
month in which the total outstanding amount of one or more exposures
individually exceeds $100,000.
Retail exposure means a residential mortgage exposure, a qualifying
revolving exposure, or an other retail exposure.
Retail exposure subcategory means the residential mortgage
exposure, qualifying revolving exposure, or other retail exposure
subcategory.
Risk parameter means a variable used in determining risk-based
capital requirements for wholesale and retail exposures, specifically
probability of default (PD), loss given default (LGD),
[[Page 62208]]
exposure at default (EAD), or effective maturity (M).
Scenario analysis means a systematic process of obtaining expert
opinions from business managers and risk management experts to derive
reasoned assessments of the likelihood and loss impact of plausible
high-severity operational losses. Scenario analysis may include the
well-reasoned evaluation and use of external operational loss event
data, adjusted as appropriate to ensure relevance to a [BANK]'s
operational risk profile and control structure.
Total wholesale and retail risk-weighted assets means the sum of:
(1) Risk-weighted assets for wholesale exposures that are not IMM
exposures, cleared transactions, or default fund contributions to non-
defaulted obligors and segments of non-defaulted retail exposures;
(2) Risk-weighted assets for wholesale exposures to defaulted
obligors and segments of defaulted retail exposures;
(3) Risk-weighted assets for assets not defined by an exposure
category;
(4) Risk-weighted assets for non-material portfolios of exposures;
(5) Risk-weighted assets for IMM exposures (as determined in Sec.
--.132(d));
(6) Risk-weighted assets for cleared transactions and risk-weighted
assets for default fund contributions (as determined in Sec. --.133);
and
(7) Risk-weighted assets for unsettled transactions (as determined
in Sec. --.136).
Unexpected operational loss (UOL) means the difference between the
[BANK]'s operational risk exposure and the [BANK]'s expected
operational loss.
Unit of measure means the level (for example, organizational unit
or operational loss event type) at which the [BANK]'s operational risk
quantification system generates a separate distribution of potential
operational losses.
Wholesale exposure means a credit exposure to a company, natural
person, sovereign, or governmental entity (other than a securitization
exposure, retail exposure, pre-sold construction loan, or equity
exposure).
Wholesale exposure subcategory means the HVCRE or non-HVCRE
wholesale exposure subcategory.
Qualification
Sec. --.121 Qualification process.
(a) Timing. (1) A [BANK] that is described in Sec. --.100(b)(1)(i)
through (iv) must adopt a written implementation plan no later than six
months after the date the [BANK] meets a criterion in that section. The
implementation plan must incorporate an explicit start date no later
than 36 months after the date the [BANK] meets at least one criterion
under Sec. --.100(b)(1)(i) through (iv). The [AGENCY] may extend the
start date.
(2) A [BANK] that elects to be subject to this appendix under Sec.
--.100(b)(1)(v) must adopt a written implementation plan.
(b) Implementation plan. (1) The [BANK]'s implementation plan must
address in detail how the [BANK] complies, or plans to comply, with the
qualification requirements in Sec. --.122. The [BANK] also must
maintain a comprehensive and sound planning and governance process to
oversee the implementation efforts described in the plan. At a minimum,
the plan must:
(i) Comprehensively address the qualification requirements in Sec.
--.122 for the [BANK] and each consolidated subsidiary (U.S. and
foreign-based) of the [BANK] with respect to all portfolios and
exposures of the [BANK] and each of its consolidated subsidiaries;
(ii) Justify and support any proposed temporary or permanent
exclusion of business lines, portfolios, or exposures from the
application of the advanced approaches in this subpart (which business
lines, portfolios, and exposures must be, in the aggregate, immaterial
to the [BANK]);
(iii) Include the [BANK]'s self-assessment of:
(A) The [BANK]'s current status in meeting the qualification
requirements in Sec. --.122; and
(B) The consistency of the [BANK]'s current practices with the
[AGENCY]'s supervisory guidance on the qualification requirements;
(iv) Based on the [BANK]'s self-assessment, identify and describe
the areas in which the [BANK] proposes to undertake additional work to
comply with the qualification requirements in Sec. --.122 or to
improve the consistency of the [BANK]'s current practices with the
[AGENCY]'s supervisory guidance on the qualification requirements (gap
analysis);
(v) Describe what specific actions the [BANK] will take to address
the areas identified in the gap analysis required by paragraph
(b)(1)(iv) of this section;
(vi) Identify objective, measurable milestones, including delivery
dates and a date when the [BANK]'s implementation of the methodologies
described in this subpart will be fully operational;
(vii) Describe resources that have been budgeted and are available
to implement the plan; and
(viii) Receive approval of the [BANK]'s board of directors.
(2) The [BANK] must submit the implementation plan, together with a
copy of the minutes of the board of directors' approval, to the
[AGENCY] at least 60 days before the [BANK] proposes to begin its
parallel run, unless the [AGENCY] waives prior notice.
(c) Parallel run. Before determining its risk-weighted assets under
this subpart and following adoption of the implementation plan, the
[BANK] must conduct a satisfactory parallel run. A satisfactory
parallel run is a period of no less than four consecutive calendar
quarters during which the [BANK] complies with the qualification
requirements in Sec. --.122 to the satisfaction of the [AGENCY].
During the parallel run, the [BANK] must report to the [AGENCY] on a
calendar quarterly basis its risk-based capital ratios determined in
accordance with Sec. --.10(b)(1) through (3) and Sec. --10.(c)(1)
through (3). During this period, the [BANK]'s minimum risk-based
capital ratios are determined as set forth in subpart D of this part.
(d) Approval to calculate risk-based capital requirements under
this subpart. The [AGENCY] will notify the [BANK] of the date that the
[BANK] must begin to use this subpart for purposes of Sec. --.10 if
the [AGENCY] determines that:
(1) The [BANK] fully complies with all the qualification
requirements in Sec. --.122;
(2) The [BANK] has conducted a satisfactory parallel run under
paragraph (c) of this section; and
(3) The [BANK] has an adequate process to ensure ongoing compliance
with the qualification requirements in Sec. --.122.
Sec. --.122 Qualification requirements.
(a) Process and systems requirements. (1) A [BANK] must have a
rigorous process for assessing its overall capital adequacy in relation
to its risk profile and a comprehensive strategy for maintaining an
appropriate level of capital.
(2) The systems and processes used by a [BANK] for risk-based
capital purposes under this subpart must be consistent with the
[BANK]'s internal risk management processes and management information
reporting systems.
(3) Each [BANK] must have an appropriate infrastructure with risk
measurement and management processes that meet the qualification
requirements of this section and are appropriate given the [BANK]'s
size and level of complexity. Regardless of whether the systems and
models that generate the risk parameters necessary
[[Page 62209]]
for calculating a [BANK]'s risk-based capital requirements are located
at any affiliate of the [BANK], the [BANK] itself must ensure that the
risk parameters and reference data used to determine its risk-based
capital requirements are representative of its own credit risk and
operational risk exposures.
(b) Risk rating and segmentation systems for wholesale and retail
exposures. (1) A [BANK] must have an internal risk rating and
segmentation system that accurately and reliably differentiates among
degrees of credit risk for the [BANK]'s wholesale and retail exposures.
(2) For wholesale exposures:
(i) A [BANK] must have an internal risk rating system that
accurately and reliably assigns each obligor to a single rating grade
(reflecting the obligor's likelihood of default). A [BANK] may elect,
however, not to assign to a rating grade an obligor to whom the [BANK]
extends credit based solely on the financial strength of a guarantor,
provided that all of the [BANK]'s exposures to the obligor are fully
covered by eligible guarantees, the [BANK] applies the PD substitution
approach in Sec. --.134(c)(1) to all exposures to that obligor, and
the [BANK] immediately assigns the obligor to a rating grade if a
guarantee can no longer be recognized under this part. The [BANK]'s
wholesale obligor rating system must have at least seven discrete
rating grades for non-defaulted obligors and at least one rating grade
for defaulted obligors.
(ii) Unless the [BANK] has chosen to directly assign LGD estimates
to each wholesale exposure, the [BANK] must have an internal risk
rating system that accurately and reliably assigns each wholesale
exposure to a loss severity rating grade (reflecting the [BANK]'s
estimate of the LGD of the exposure). A [BANK] employing loss severity
rating grades must have a sufficiently granular loss severity grading
system to avoid grouping together exposures with widely ranging LGDs.
(3) For retail exposures, a [BANK] must have an internal system
that groups retail exposures into the appropriate retail exposure
subcategory, groups the retail exposures in each retail exposure
subcategory into separate segments with homogeneous risk
characteristics, and assigns accurate and reliable PD and LGD estimates
for each segment on a consistent basis. The [BANK]'s system must
identify and group in separate segments by subcategories exposures
identified in Sec. --.131(c)(2)(ii) and (iii).
(4) The [BANK]'s internal risk rating policy for wholesale
exposures must describe the [BANK]'s rating philosophy (that is, must
describe how wholesale obligor rating assignments are affected by the
[BANK]'s choice of the range of economic, business, and industry
conditions that are considered in the obligor rating process).
(5) The [BANK]'s internal risk rating system for wholesale
exposures must provide for the review and update (as appropriate) of
each obligor rating and (if applicable) each loss severity rating
whenever the [BANK] receives new material information, but no less
frequently than annually. The [BANK]'s retail exposure segmentation
system must provide for the review and update (as appropriate) of
assignments of retail exposures to segments whenever the [BANK]
receives new material information, but generally no less frequently
than quarterly.
(c) Quantification of risk parameters for wholesale and retail
exposures. (1) The [BANK] must have a comprehensive risk parameter
quantification process that produces accurate, timely, and reliable
estimates of the risk parameters for the [BANK]'s wholesale and retail
exposures.
(2) Data used to estimate the risk parameters must be relevant to
the [BANK]'s actual wholesale and retail exposures, and of sufficient
quality to support the determination of risk-based capital requirements
for the exposures.
(3) The [BANK]'s risk parameter quantification process must produce
appropriately conservative risk parameter estimates where the [BANK]
has limited relevant data, and any adjustments that are part of the
quantification process must not result in a pattern of bias toward
lower risk parameter estimates.
(4) The [BANK]'s risk parameter estimation process should not rely
on the possibility of U.S. government financial assistance, except for
the financial assistance that the U.S. government has a legally binding
commitment to provide.
(5) Where the [BANK]'s quantifications of LGD directly or
indirectly incorporate estimates of the effectiveness of its credit
risk management practices in reducing its exposure to troubled obligors
prior to default, the [BANK] must support such estimates with empirical
analysis showing that the estimates are consistent with its historical
experience in dealing with such exposures during economic downturn
conditions.
(6) PD estimates for wholesale obligors and retail segments must be
based on at least five years of default data. LGD estimates for
wholesale exposures must be based on at least seven years of loss
severity data, and LGD estimates for retail segments must be based on
at least five years of loss severity data. EAD estimates for wholesale
exposures must be based on at least seven years of exposure amount
data, and EAD estimates for retail segments must be based on at least
five years of exposure amount data.
(7) Default, loss severity, and exposure amount data must include
periods of economic downturn conditions, or the [BANK] must adjust its
estimates of risk parameters to compensate for the lack of data from
periods of economic downturn conditions.
(8) The [BANK]'s PD, LGD, and EAD estimates must be based on the
definition of default in Sec. --.101.
(9) The [BANK] must review and update (as appropriate) its risk
parameters and its risk parameter quantification process at least
annually.
(10) The [BANK] must, at least annually, conduct a comprehensive
review and analysis of reference data to determine relevance of
reference data to the [BANK]'s exposures, quality of reference data to
support PD, LGD, and EAD estimates, and consistency of reference data
to the definition of default in Sec. --.101.
(d) Counterparty credit risk model. A [BANK] must obtain the prior
written approval of the [AGENCY] under Sec. --.132 to use the internal
models methodology for counterparty credit risk and the advanced CVA
approach for the CVA capital requirement.
(e) Double default treatment. A [BANK] must obtain the prior
written approval of the [AGENCY] under Sec. --.135 to use the double
default treatment.
(f) Equity exposures model. A [BANK] must obtain the prior written
approval of the [AGENCY] under Sec. --.153 to use the internal models
approach for equity exposures.
(g) Operational risk. (1) Operational risk management processes. A
[BANK] must:
(i) Have an operational risk management function that:
(A) Is independent of business line management; and
(B) Is responsible for designing, implementing, and overseeing the
[BANK]'s operational risk data and assessment systems, operational risk
quantification systems, and related processes;
(ii) Have and document a process (which must capture business
environment and internal control factors affecting the [BANK]'s
operational risk
[[Page 62210]]
profile) to identify, measure, monitor, and control operational risk in
the [BANK]'s products, activities, processes, and systems; andk
(iii) Report operational risk exposures, operational loss events,
and other relevant operational risk information to business unit
management, senior management, and the board of directors (or a
designated committee of the board).
(2) Operational risk data and assessment systems. A [BANK] must
have operational risk data and assessment systems that capture
operational risks to which the [BANK] is exposed. The [BANK]'s
operational risk data and assessment systems must:
(i) Be structured in a manner consistent with the [BANK]'s current
business activities, risk profile, technological processes, and risk
management processes; and
(ii) Include credible, transparent, systematic, and verifiable
processes that incorporate the following elements on an ongoing basis:
(A) Internal operational loss event data. The [BANK] must have a
systematic process for capturing and using internal operational loss
event data in its operational risk data and assessment systems.
(1) The [BANK]'s operational risk data and assessment systems must
include a historical observation period of at least five years for
internal operational loss event data (or such shorter period approved
by the [AGENCY] to address transitional situations, such as integrating
a new business line).
(2) The [BANK] must be able to map its internal operational loss
event data into the seven operational loss event type categories.
(3) The [BANK] may refrain from collecting internal operational
loss event data for individual operational losses below established
dollar threshold amounts if the [BANK] can demonstrate to the
satisfaction of the [AGENCY] that the thresholds are reasonable, do not
exclude important internal operational loss event data, and permit the
[BANK] to capture substantially all the dollar value of the [BANK]'s
operational losses.
(B) External operational loss event data. The [BANK] must have a
systematic process for determining its methodologies for incorporating
external operational loss event data into its operational risk data and
assessment systems.
(C) Scenario analysis. The [BANK] must have a systematic process
for determining its methodologies for incorporating scenario analysis
into its operational risk data and assessment systems.
(D) Business environment and internal control factors. The [BANK]
must incorporate business environment and internal control factors into
its operational risk data and assessment systems. The [BANK] must also
periodically compare the results of its prior business environment and
internal control factor assessments against its actual operational
losses incurred in the intervening period.
(3) Operational risk quantification systems. (i) The [BANK]'s
operational risk quantification systems:
(A) Must generate estimates of the [BANK]'s operational risk
exposure using its operational risk data and assessment systems;
(B) Must employ a unit of measure that is appropriate for the
[BANK]'s range of business activities and the variety of operational
loss events to which it is exposed, and that does not combine business
activities or operational loss events with demonstrably different risk
profiles within the same loss distribution;
(C) Must include a credible, transparent, systematic, and
verifiable approach for weighting each of the four elements, described
in paragraph (g)(2)(ii) of this section, that a [BANK] is required to
incorporate into its operational risk data and assessment systems;
(D) May use internal estimates of dependence among operational
losses across and within units of measure if the [BANK] can demonstrate
to the satisfaction of the [AGENCY] that its process for estimating
dependence is sound, robust to a variety of scenarios, and implemented
with integrity, and allows for uncertainty surrounding the estimates.
If the [BANK] has not made such a demonstration, it must sum
operational risk exposure estimates across units of measure to
calculate its total operational risk exposure; and
(E) Must be reviewed and updated (as appropriate) whenever the
[BANK] becomes aware of information that may have a material effect on
the [BANK]'s estimate of operational risk exposure, but the review and
update must occur no less frequently than annually.
(ii) With the prior written approval of the [AGENCY], a [BANK] may
generate an estimate of its operational risk exposure using an
alternative approach to that specified in paragraph (g)(3)(i) of this
section. A [BANK] proposing to use such an alternative operational risk
quantification system must submit a proposal to the [AGENCY]. In
determining whether to approve a [BANK]'s proposal to use an
alternative operational risk quantification system, the [AGENCY] will
consider the following principles:
(A) Use of the alternative operational risk quantification system
will be allowed only on an exception basis, considering the size,
complexity, and risk profile of the [BANK];
(B) The [BANK] must demonstrate that its estimate of its
operational risk exposure generated under the alternative operational
risk quantification system is appropriate and can be supported
empirically; and
(C) A [BANK] must not use an allocation of operational risk capital
requirements that includes entities other than depository institutions
or the benefits of diversification across entities.
(h) Data management and maintenance. (1) A [BANK] must have data
management and maintenance systems that adequately support all aspects
of its advanced systems and the timely and accurate reporting of risk-
based capital requirements.
(2) A [BANK] must retain data using an electronic format that
allows timely retrieval of data for analysis, validation, reporting,
and disclosure purposes.
(3) A [BANK] must retain sufficient data elements related to key
risk drivers to permit adequate monitoring, validation, and refinement
of its advanced systems.
(i) Control, oversight, and validation mechanisms. (1) The [BANK]'s
senior management must ensure that all components of the [BANK]'s
advanced systems function effectively and comply with the qualification
requirements in this section.
(2) The [BANK]'s board of directors (or a designated committee of
the board) must at least annually review the effectiveness of, and
approve, the [BANK]'s advanced systems.
(3) A [BANK] must have an effective system of controls and
oversight that:
(i) Ensures ongoing compliance with the qualification requirements
in this section;
(ii) Maintains the integrity, reliability, and accuracy of the
[BANK]'s advanced systems; and
(iii) Includes adequate governance and project management
processes.
(4) The [BANK] must validate, on an ongoing basis, its advanced
systems. The [BANK]'s validation process must be independent of the
advanced systems' development, implementation, and operation, or the
validation process must be subjected to an independent review of its
adequacy and effectiveness. Validation must include:
(i) An evaluation of the conceptual soundness of (including
developmental
[[Page 62211]]
evidence supporting) the advanced systems;
(ii) An ongoing monitoring process that includes verification of
processes and benchmarking; and
(iii) An outcomes analysis process that includes backtesting.
(5) The [BANK] must have an internal audit function independent of
business-line management that at least annually assesses the
effectiveness of the controls supporting the [BANK]'s advanced systems
and reports its findings to the [BANK]'s board of directors (or a
committee thereof).
(6) The [BANK] must periodically stress test its advanced systems.
The stress testing must include a consideration of how economic cycles,
especially downturns, affect risk-based capital requirements (including
migration across rating grades and segments and the credit risk
mitigation benefits of double default treatment).
(j) Documentation. The [BANK] must adequately document all material
aspects of its advanced systems.
Sec. --.123 Ongoing qualification.
(a) Changes to advanced systems. A [BANK] must meet all the
qualification requirements in Sec. --.122 on an ongoing basis. A
[BANK] must notify the [AGENCY] when the [BANK] makes any change to an
advanced system that would result in a material change in the [BANK]'s
advanced approaches total risk-weighted asset amount for an exposure
type or when the [BANK] makes any significant change to its modeling
assumptions.
(b) Failure to comply with qualification requirements. (1) If the
[AGENCY] determines that a [BANK] that uses this subpart and that has
conducted a satisfactory parallel run fails to comply with the
qualification requirements in Sec. --.122, the [AGENCY] will notify
the [BANK] in writing of the [BANK]'s failure to comply.
(2) The [BANK] must establish and submit a plan satisfactory to the
[AGENCY] to return to compliance with the qualification requirements.
(3) In addition, if the [AGENCY] determines that the [BANK]'s
advanced approaches total risk-weighted assets are not commensurate
with the [BANK]'s credit, market, operational, or other risks, the
[AGENCY] may require such a [BANK] to calculate its advanced approaches
total risk-weighted assets with any modifications provided by the
[AGENCY].
Sec. --.124 Merger and acquisition transitional arrangements.
(a) Mergers and acquisitions of companies without advanced systems.
If a [BANK] merges with or acquires a company that does not calculate
its risk-based capital requirements using advanced systems, the [BANK]
may use subpart D of this part to determine the risk-weighted asset
amounts for the merged or acquired company's exposures for up to 24
months after the calendar quarter during which the merger or
acquisition consummates. The [AGENCY] may extend this transition period
for up to an additional 12 months. Within 90 days of consummating the
merger or acquisition, the [BANK] must submit to the [AGENCY] an
implementation plan for using its advanced systems for the acquired
company. During the period in which subpart D of this part applies to
the merged or acquired company, any ALLL, net of allocated transfer
risk reserves established pursuant to 12 U.S.C. 3904, associated with
the merged or acquired company's exposures may be included in the
acquiring [BANK]'s tier 2 capital up to 1.25 percent of the acquired
company's risk-weighted assets. All general allowances of the merged or
acquired company must be excluded from the [BANK]'s eligible credit
reserves. In addition, the risk-weighted assets of the merged or
acquired company are not included in the [BANK]'s credit-risk-weighted
assets but are included in total risk-weighted assets. If a [BANK]
relies on this paragraph (a), the [BANK] must disclose publicly the
amounts of risk-weighted assets and qualifying capital calculated under
this subpart for the acquiring [BANK] and under subpart D of this part
for the acquired company.
(b) Mergers and acquisitions of companies with advanced systems.
(1) If a [BANK] merges with or acquires a company that calculates its
risk-based capital requirements using advanced systems, the [BANK] may
use the acquired company's advanced systems to determine total risk-
weighted assets for the merged or acquired company's exposures for up
to 24 months after the calendar quarter during which the acquisition or
merger consummates. The [AGENCY] may extend this transition period for
up to an additional 12 months. Within 90 days of consummating the
merger or acquisition, the [BANK] must submit to the [AGENCY] an
implementation plan for using its advanced systems for the merged or
acquired company.
(2) If the acquiring [BANK] is not subject to the advanced
approaches in this subpart at the time of acquisition or merger, during
the period when subpart D of this part applies to the acquiring [BANK],
the ALLL associated with the exposures of the merged or acquired
company may not be directly included in tier 2 capital. Rather, any
excess eligible credit reserves associated with the merged or acquired
company's exposures may be included in the [BANK]'s tier 2 capital up
to 0.6 percent of the credit-risk-weighted assets associated with those
exposures.
Sec. Sec. --.125 through --.130 [Reserved]
Risk-Weighted Assets for General Credit Risk
Sec. --.131 Mechanics for calculating total wholesale and retail
risk-weighted assets.
(a) Overview. A [BANK] must calculate its total wholesale and
retail risk-weighted asset amount in four distinct phases:
(1) Phase 1--categorization of exposures;
(2) Phase 2--assignment of wholesale obligors and exposures to
rating grades and segmentation of retail exposures;
(3) Phase 3--assignment of risk parameters to wholesale exposures
and segments of retail exposures; and
(4) Phase 4--calculation of risk-weighted asset amounts.
(b) Phase 1--Categorization. The [BANK] must determine which of its
exposures are wholesale exposures, retail exposures, securitization
exposures, or equity exposures. The [BANK] must categorize each retail
exposure as a residential mortgage exposure, a QRE, or an other retail
exposure. The [BANK] must identify which wholesale exposures are HVCRE
exposures, sovereign exposures, OTC derivative contracts, repo-style
transactions, eligible margin loans, eligible purchased wholesale
exposures, cleared transactions, default fund contributions, unsettled
transactions to which Sec. --.136 applies, and eligible guarantees or
eligible credit derivatives that are used as credit risk mitigants. The
[BANK] must identify any on-balance sheet asset that does not meet the
definition of a wholesale, retail, equity, or securitization exposure,
as well as any non-material portfolio of exposures described in
paragraph (e)(4) of this section.
(c) Phase 2--Assignment of wholesale obligors and exposures to
rating grades and retail exposures to segments--(1) Assignment of
wholesale obligors and exposures to rating grades.
(i) The [BANK] must assign each obligor of a wholesale exposure to
a single obligor rating grade and must assign each wholesale exposure
to which it does not directly assign an LGD estimate to a loss severity
rating grade.
(ii) The [BANK] must identify which of its wholesale obligors are
in default.
[[Page 62212]]
(2) Segmentation of retail exposures. (i) The [BANK] must group the
retail exposures in each retail subcategory into segments that have
homogeneous risk characteristics.
(ii) The [BANK] must identify which of its retail exposures are in
default. The [BANK] must segment defaulted retail exposures separately
from non-defaulted retail exposures.
(iii) If the [BANK] determines the EAD for eligible margin loans
using the approach in Sec. --.132(b), the [BANK] must identify which
of its retail exposures are eligible margin loans for which the [BANK]
uses this EAD approach and must segment such eligible margin loans
separately from other retail exposures.
(3) Eligible purchased wholesale exposures. A [BANK] may group its
eligible purchased wholesale exposures into segments that have
homogeneous risk characteristics. A [BANK] must use the wholesale
exposure formula in Table 1 of this section to determine the risk-based
capital requirement for each segment of eligible purchased wholesale
exposures.
(d) Phase 3--Assignment of risk parameters to wholesale exposures
and segments of retail exposures. (1) Quantification process. Subject
to the limitations in this paragraph (d), the [BANK] must:
(i) Associate a PD with each wholesale obligor rating grade;
(ii) Associate an LGD with each wholesale loss severity rating
grade or assign an LGD to each wholesale exposure;
(iii) Assign an EAD and M to each wholesale exposure; and
(iv) Assign a PD, LGD, and EAD to each segment of retail exposures.
(2) Floor on PD assignment. The PD for each wholesale obligor or
retail segment may not be less than 0.03 percent, except for exposures
to or directly and unconditionally guaranteed by a sovereign entity,
the Bank for International Settlements, the International Monetary
Fund, the European Commission, the European Central Bank, or a
multilateral development bank, to which the [BANK] assigns a rating
grade associated with a PD of less than 0.03 percent.
(3) Floor on LGD estimation. The LGD for each segment of
residential mortgage exposures may not be less than 10 percent, except
for segments of residential mortgage exposures for which all or
substantially all of the principal of each exposure is either:
(i) Directly and unconditionally guaranteed by the full faith and
credit of a sovereign entity; or
(ii) Guaranteed by a contingent obligation of the U.S. government
or its agencies, the enforceability of which is dependent upon some
affirmative action on the part of the beneficiary of the guarantee or a
third party (for example, meeting servicing requirements).
(4) Eligible purchased wholesale exposures. A [BANK] must assign a
PD, LGD, EAD, and M to each segment of eligible purchased wholesale
exposures. If the [BANK] can estimate ECL (but not PD or LGD) for a
segment of eligible purchased wholesale exposures, the [BANK] must
assume that the LGD of the segment equals 100 percent and that the PD
of the segment equals ECL divided by EAD. The estimated ECL must be
calculated for the exposures without regard to any assumption of
recourse or guarantees from the seller or other parties.
(5) Credit risk mitigation: credit derivatives, guarantees, and
collateral. (i) A [BANK] may take into account the risk reducing
effects of eligible guarantees and eligible credit derivatives in
support of a wholesale exposure by applying the PD substitution or LGD
adjustment treatment to the exposure as provided in Sec. --.134 or, if
applicable, applying double default treatment to the exposure as
provided in Sec. --.135. A [BANK] may decide separately for each
wholesale exposure that qualifies for the double default treatment
under Sec. --.135 whether to apply the double default treatment or to
use the PD substitution or LGD adjustment treatment without recognizing
double default effects.
(ii) A [BANK] may take into account the risk reducing effects of
guarantees and credit derivatives in support of retail exposures in a
segment when quantifying the PD and LGD of the segment.
(iii) Except as provided in paragraph (d)(6) of this section, a
[BANK] may take into account the risk reducing effects of collateral in
support of a wholesale exposure when quantifying the LGD of the
exposure, and may take into account the risk reducing effects of
collateral in support of retail exposures when quantifying the PD and
LGD of the segment.
(6) EAD for OTC derivative contracts, repo-style transactions, and
eligible margin loans. A [BANK] must calculate its EAD for an OTC
derivative contract as provided in Sec. --.132 (c) and (d). A [BANK]
may take into account the risk-reducing effects of financial collateral
in support of a repo-style transaction or eligible margin loan and of
any collateral in support of a repo-style transaction that is included
in the [BANK]'s VaR-based measure under subpart F of this part through
an adjustment to EAD as provided in Sec. --.132(b) and (d). A [BANK]
that takes collateral into account through such an adjustment to EAD
under Sec. --.132 may not reflect such collateral in LGD.
(7) Effective maturity. An exposure's M must be no greater than
five years and no less than one year, except that an exposure's M 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 [BANK]'s ongoing financing of the obligor. An
exposure is not part of a [BANK]'s ongoing financing of the obligor if
the [BANK]:
(i) Has a legal and practical ability not to renew or roll over the
exposure in the event of credit deterioration of the obligor;
(ii) Makes an independent credit decision at the inception of the
exposure and at every renewal or roll over; and
(iii) Has no substantial commercial incentive to continue its
credit relationship with the obligor in the event of credit
deterioration of the obligor.
(8) EAD for exposures to certain central counterparties. A [BANK]
may attribute an EAD of zero to exposures that arise from the
settlement of cash transactions (such as equities, fixed income, spot
foreign exchange, and spot commodities) with a central counterparty
where there is no assumption of ongoing counterparty credit risk by the
central counterparty after settlement of the trade and associated
default fund contributions.
(e) Phase 4--Calculation of risk-weighted assets--(1) Non-defaulted
exposures. (i) A [BANK] must calculate the dollar risk-based capital
requirement for each of its wholesale exposures to a non-defaulted
obligor (except for eligible guarantees and eligible credit derivatives
that hedge another wholesale exposure, IMM exposures, cleared
transactions, default fund contributions, unsettled transactions, and
exposures to which the [BANK] applies the double default treatment in
Sec. --.135) and segments of non-defaulted retail exposures by
inserting the assigned risk parameters for the wholesale obligor and
exposure or retail segment into the appropriate risk-based capital
formula specified in Table 1 and multiplying the output of the formula
(K) by the EAD of the exposure or segment. Alternatively, a [BANK] may
apply a 300 percent risk weight to the EAD of an eligible margin loan
if the [BANK] is not able to meet the [AGENCY]'s requirements for
estimation of PD and LGD for the margin loan.
[[Page 62213]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.028
[[Page 62214]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.029
(ii) The sum of all the dollar risk-based capital requirements for
each wholesale exposure to a non-defaulted obligor and segment of non-
defaulted retail exposures calculated in paragraph (e)(1)(i) of this
section and in Sec. --.135(e) equals the total dollar risk-based
capital requirement for those exposures and segments.
(iii) The aggregate risk-weighted asset amount for wholesale
exposures to non-defaulted obligors and segments of non-defaulted
retail exposures equals the total dollar risk-based capital requirement
in paragraph (e)(1)(ii) of this section multiplied by 12.5.
(2) Wholesale exposures to defaulted obligors and segments of
defaulted retail exposures--(i) Not covered by an eligible U.S.
government guarantee: The dollar risk-based capital requirement for
each wholesale exposure not covered by an eligible guarantee from the
U.S. government to a defaulted obligor and each segment of defaulted
retail exposures not covered by an eligible guarantee from the U.S.
government equals 0.08 multiplied by the EAD of the exposure or
segment.
(ii) Covered by an eligible U.S. government guarantee: The dollar
risk-based capital requirement for each wholesale exposure to a
defaulted obligor covered by an eligible guarantee from the U.S.
government and each segment of defaulted retail exposures covered by an
eligible guarantee from the U.S. government equals the sum of:
(A) The sum of the EAD of the portion of each wholesale exposure to
a defaulted obligor covered by an eligible guarantee from the U.S.
government plus the EAD of the portion of each segment of defaulted
retail exposures that is covered by an eligible guarantee from the U.S.
government and the resulting sum is multiplied by 0.016, and
(B) The sum of the EAD of the portion of each wholesale exposure to
a defaulted obligor not covered by an eligible guarantee from the U.S.
government plus the EAD of the portion of each segment of defaulted
retail exposures that is not covered by an eligible guarantee from the
U.S. government and the resulting sum is multiplied by 0.08.
(iii) The sum of all the dollar risk-based capital requirements for
each wholesale exposure to a defaulted obligor and each segment of
defaulted retail exposures calculated in paragraph
[[Page 62215]]
(e)(2)(i) of this section plus the dollar risk-based capital
requirements each wholesale exposure to a defaulted obligor and for
each segment of defaulted retail exposures calculated in paragraph
(e)(2)(ii) of this section equals the total dollar risk-based capital
requirement for those exposures and segments.
(iv) The aggregate risk-weighted asset amount for wholesale
exposures to defaulted obligors and segments of defaulted retail
exposures equals the total dollar risk-based capital requirement
calculated in paragraph (e)(2)(iii) of this section multiplied by 12.5.
(3) Assets not included in a defined exposure category. (i) A
[BANK] may assign a risk-weighted asset amount of zero to cash owned
and held in all offices of the [BANK] or in transit and for gold
bullion held in the [BANK]'s own vaults, or held in another [BANK]'s
vaults on an allocated basis, to the extent the gold bullion assets are
offset by gold bullion liabilities.
(ii) A [BANK] must assign a risk-weighted asset amount equal to 20
percent of the carrying value of cash items in the process of
collection.
(iii) A [BANK] must assign a risk-weighted asset amount equal to 50
percent of the carrying value to a pre-sold construction loan unless
the purchase contract is cancelled, in which case a [BANK] must assign
a risk-weighted asset amount equal to a 100 percent of the carrying
value of the pre-sold construction loan.
(iv) The risk-weighted asset amount for the residual value of a
retail lease exposure equals such residual value.
(v) The risk-weighted asset amount for DTAs arising from temporary
differences that the [BANK] could realize through net operating loss
carrybacks equals the carrying value, netted in accordance with Sec.
--.22.
(vi) The risk-weighted asset amount for MSAs, DTAs arising from
temporary timing differences that the [BANK] could not realize through
net operating loss carrybacks, and significant investments in the
capital of unconsolidated financial institutions in the form of common
stock that are not deducted pursuant to Sec. --.22(a)(7) equals the
amount not subject to deduction multiplied by 250 percent.
(vii) The risk-weighted asset amount for any other on-balance-sheet
asset that does not meet the definition of a wholesale, retail,
securitization, IMM, or equity exposure, cleared transaction, or
default fund contribution and is not subject to deduction under Sec.
--.22(a), (c), or (d) equals the carrying value of the asset.
(4) Non-material portfolios of exposures. The risk-weighted asset
amount of a portfolio of exposures for which the [BANK] has
demonstrated to the [AGENCY]'s satisfaction that the portfolio (when
combined with all other portfolios of exposures that the [BANK] seeks
to treat under this paragraph (e)) is not material to the [BANK] is the
sum of the carrying values of on-balance sheet exposures plus the
notional amounts of off-balance sheet exposures in the portfolio. For
purposes of this paragraph (e)(4), the notional amount of an OTC
derivative contract that is not a credit derivative is the EAD of the
derivative as calculated in Sec. --.132.
Sec. --.132 Counterparty credit risk of repo-style transactions,
eligible margin loans, and OTC derivative contracts.
(a) Methodologies for collateral recognition. (1) Instead of an LGD
estimation methodology, a [BANK] may use the following methodologies to
recognize the benefits of financial collateral in mitigating the
counterparty credit risk of repo-style transactions, eligible margin
loans, collateralized OTC derivative contracts and single product
netting sets of such transactions, and to recognize the benefits of any
collateral in mitigating the counterparty credit risk of repo-style
transactions that are included in a [BANK]'s VaR-based measure under
subpart F of this part:
(i) The collateral haircut approach set forth in paragraph (b)(2)
of this section;
(ii) The internal models methodology set forth in paragraph (d) of
this section; and
(iii) For single product netting sets of repo-style transactions
and eligible margin loans, the simple VaR methodology set forth in
paragraph (b)(3) of this section.
(2) A [BANK] may use any combination of the three methodologies for
collateral recognition; however, it must use the same methodology for
transactions in the same category.
(3) A [BANK] must use the methodology in paragraph (c) of this
section, or with prior written approval of the [AGENCY], the internal
model methodology in paragraph (d) of this section, to calculate EAD
for an OTC derivative contract or a set of OTC derivative contracts
subject to a qualifying master netting agreement. To estimate EAD for
qualifying cross-product master netting agreements, a [BANK] may only
use the internal models methodology in paragraph (d) of this section.
(4) A [BANK] must also use the methodology in paragraph (e) of this
section to calculate the risk-weighted asset amounts for CVA for OTC
derivatives.
(b) EAD for eligible margin loans and repo-style transactions--(1)
General. A [BANK] may recognize the credit risk mitigation benefits of
financial collateral that secures an eligible margin loan, repo-style
transaction, or single-product netting set of such transactions by
factoring the collateral into its LGD estimates for the exposure.
Alternatively, a [BANK] may estimate an unsecured LGD for the exposure,
as well as for any repo-style transaction that is included in the
[BANK]'s VaR-based measure under subpart F of this part, and determine
the EAD of the exposure using:
(i) The collateral haircut approach described in paragraph (b)(2)
of this section;
(ii) For netting sets only, the simple VaR methodology described in
paragraph (b)(3) of this section; or
(iii) The internal models methodology described in paragraph (d) of
this section.
(2) Collateral haircut approach--(i) EAD equation. A [BANK] may
determine EAD for an eligible margin loan, repo-style transaction, or
netting set by setting EAD equal to max
{0, [([Sigma]E - [Sigma]C) + [Sigma](Es x Hs) +
[Sigma](Efx x Hfx)]{time} ,
where:
(A) [Sigma]E equals the value of the exposure (the sum of the
current fair values of all instruments, gold, and cash the [BANK]
has lent, sold subject to repurchase, or posted as collateral to the
counterparty under the transaction (or netting set));
(B) [Sigma]C equals the value of the collateral (the sum of the
current fair values of all instruments, gold, and cash the [BANK]
has borrowed, purchased subject to resale, or taken as collateral
from the counterparty under the transaction (or netting set));
(C) Es equals the absolute value of the net position in a
given instrument or in gold (where the net position in a given
instrument or in gold equals the sum of the current fair values of
the instrument or gold the [BANK] has lent, sold subject to
repurchase, or posted as collateral to the counterparty minus the
sum of the current fair values of that same instrument or gold the
[BANK] has borrowed, purchased subject to resale, or taken as
collateral from the counterparty);
(D) Hs equals the market price volatility haircut
appropriate to the instrument or gold referenced in Es;
(E) Efx equals the absolute value of the net position of
instruments and cash in a currency that is different from the
settlement currency (where the net position in a given currency
equals the sum of the current fair values of any instruments or cash
in the currency the [BANK] has lent, sold subject to
[[Page 62216]]
repurchase, or posted as collateral to the counterparty minus the
sum of the current fair values of any instruments or cash in the
currency the [BANK] has borrowed, purchased subject to resale, or
taken as collateral from the counterparty); and
(F) Hfx equals the haircut appropriate to the mismatch
between the currency referenced in Efx and the settlement
currency.
(ii) Standard supervisory haircuts. (A) Under the standard
supervisory haircuts approach:
(1) A [BANK] must use the haircuts for market price volatility
(Hs) in Table 1 to Sec. --.132, as adjusted in certain
circumstances as provided in paragraphs (b)(2)(ii)(A)(3) and (4) of
this section;
Table 1 to Sec. --.132-- Standard Supervisory Market Price Volatility Haircuts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Haircut (in percent) assigned based on:
------------------------------------------------------------------------------ Investment
Sovereign issuers risk weight under Non-sovereign issuers risk weight grade
Residual maturity this section \2\ (in percent) under this section (in percent) securitization
------------------------------------------------------------------------------ exposures (in
Zero 20 or 50 100 20 50 100 percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than or equal to 1 year.............................. 0.5 1.0 15.0 1.0 2.0 4.0 4.0
Greater than 1 year and less than or equal to 5 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 1 to Sec. --.132 are based on a 10 business-day holding period.
\2\ Includes a foreign PSE that receives a zero percent risk weight.
(2) For currency mismatches, a [BANK] must use a haircut for
foreign exchange rate volatility (Hfx) of 8 percent, as
adjusted in certain circumstances as provided in paragraphs
(b)(2)(ii)(A)(3) and (4) of this section.
(3) For repo-style transactions, a [BANK] may multiply the
supervisory haircuts provided in paragraphs (b)(2)(ii)(A)(1) and (2) of
this section by the square root of \1/2\ (which equals 0.707107).
(4) A [BANK] must adjust the supervisory haircuts upward on the
basis of a holding period longer than ten business days (for eligible
margin loans) or five business days (for repo-style transactions) where
the following conditions apply. If the number of trades in a netting
set exceeds 5,000 at any time during a quarter, a [BANK] must adjust
the supervisory haircuts upward on the basis of a holding period of
twenty business days for the following quarter (except when a [BANK] is
calculating EAD for a cleared transaction under Sec. --.133). If a
netting set contains one or more trades involving illiquid collateral
or an OTC derivative that cannot be easily replaced, a [BANK] must
adjust the supervisory haircuts upward on the basis of a holding period
of twenty business days. If over the two previous quarters more than
two margin disputes on a netting set have occurred that lasted more
than the holding period, then the [BANK] must adjust the supervisory
haircuts upward for that netting set on the basis of a holding period
that is at least two times the minimum holding period for that netting
set. A [BANK] must adjust the standard supervisory haircuts upward
using the following formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.030
(i) TM equals a holding period of longer than 10 business
days for eligible margin loans and derivative contracts or longer
than 5 business days for repo-style transactions;
(ii) Hs equals the standard supervisory haircut; and
(iii) Ts equals 10 business days for eligible margin
loans and derivative contracts or 5 business days for repo-style
transactions.
(5) If the instrument a [BANK] has lent, sold subject to
repurchase, or posted as collateral does not meet the definition of
financial collateral, the [BANK] must use a 25.0 percent haircut for
market price volatility (Hs).
(iii) Own internal estimates for haircuts. With the prior written
approval of the [AGENCY], a [BANK] may calculate haircuts
(Hs and Hfx) using its own internal estimates of
the volatilities of market prices and foreign exchange rates.
(A) To receive [AGENCY] approval to use its own internal estimates,
a [BANK] must satisfy the following minimum quantitative standards:
(1) A [BANK] must use a 99th percentile one-tailed confidence
interval.
(2) The minimum holding period for a repo-style transaction is five
business days and for an eligible margin loan is ten business days
except for transactions or netting sets for which paragraph
(b)(2)(iii)(A)(3) of this section applies. When a [BANK] calculates an
own-estimates haircut on a TN-day holding period, which is
different from the minimum holding period for the transaction type, the
applicable haircut (HM) is calculated using the following
square root of time formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.031
(i) TM equals 5 for repo-style transactions and 10 for
eligible margin loans;
(ii) TN equals the holding period used by the [BANK] to
derive HN; and
(iii) HN equals the haircut based on the holding period
TN
[[Page 62217]]
(3) If the number of trades in a netting set exceeds 5,000 at any
time during a quarter, a [BANK] must calculate the haircut using a
minimum holding period of twenty business days for the following
quarter (except when a [BANK] is calculating EAD for a cleared
transaction under Sec. --.133). If a netting set contains one or more
trades involving illiquid collateral or an OTC derivative that cannot
be easily replaced, a [BANK] must calculate the haircut using a minimum
holding period of twenty business days. If over the two previous
quarters more than two margin disputes on a netting set have occurred
that lasted more than the holding period, then the [BANK] must
calculate the haircut for transactions in that netting set on the basis
of a holding period that is at least two times the minimum holding
period for that netting set.
(4) A [BANK] is required to calculate its own internal estimates
with inputs calibrated to historical data from a continuous 12-month
period that reflects a period of significant financial stress
appropriate to the security or category of securities.
(5) A [BANK] must have policies and procedures that describe how it
determines the period of significant financial stress used to calculate
the [BANK]'s own internal estimates for haircuts under this section and
must be able to provide empirical support for the period used. The
[BANK] must obtain the prior approval of the [AGENCY] for, and notify
the [AGENCY] if the [BANK] makes any material changes to, these
policies and procedures.
(6) Nothing in this section prevents the [AGENCY] from requiring a
[BANK] to use a different period of significant financial stress in the
calculation of own internal estimates for haircuts.
(7) A [BANK] must update its data sets and calculate haircuts no
less frequently than quarterly and must also reassess data sets and
haircuts whenever market prices change materially.
(B) With respect to debt securities that are investment grade, a
[BANK] may calculate haircuts for categories of securities. For a
category of securities, the [BANK] must calculate the haircut on the
basis of internal volatility estimates for securities in that category
that are representative of the securities in that category that the
[BANK] has lent, sold subject to repurchase, posted as collateral,
borrowed, purchased subject to resale, or taken as collateral. In
determining relevant categories, the [BANK] must at a minimum take into
account:
(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.
(C) With respect to debt securities that are not investment grade
and equity securities, a [BANK] must calculate a separate haircut for
each individual security.
(D) Where an exposure or collateral (whether in the form of cash or
securities) is denominated in a currency that differs from the
settlement currency, the [BANK] must calculate a separate currency
mismatch haircut for its net position in each mismatched currency based
on estimated volatilities of foreign exchange rates between the
mismatched currency and the settlement currency.
(E) A [BANK]'s own estimates of market price and foreign exchange
rate volatilities may not take into account the correlations among
securities and foreign exchange rates on either the exposure or
collateral side of a transaction (or netting set) or the correlations
among securities and foreign exchange rates between the exposure and
collateral sides of the transaction (or netting set).
(3) Simple VaR methodology. With the prior written approval of the
[AGENCY], a [BANK] may estimate EAD for a netting set using a VaR model
that meets the requirements in paragraph (b)(3)(iii) of this section.
In such event, the [BANK] must set EAD equal to max {0, [([Sigma]E -
[Sigma]C) + PFE]{time} , where:
(i) [Sigma]E equals the value of the exposure (the sum of the
current fair values of all instruments, gold, and cash the [BANK] has
lent, sold subject to repurchase, or posted as collateral to the
counterparty under the netting set);
(ii) [Sigma]C equals the value of the collateral (the sum of the
current fair values of all instruments, gold, and cash the [BANK] has
borrowed, purchased subject to resale, or taken as collateral from the
counterparty under the netting set); and
(iii) PFE (potential future exposure) equals the [BANK]'s
empirically based best estimate of the 99th percentile, one-tailed
confidence interval for an increase in the value of ([Sigma]E -
[Sigma]C) over a five-business-day holding period for repo-style
transactions, or over a ten-business-day holding period for eligible
margin loans except for netting sets for which paragraph (b)(3)(iv) of
this section applies using a minimum one-year historical observation
period of price data representing the instruments that the [BANK] has
lent, sold subject to repurchase, posted as collateral, borrowed,
purchased subject to resale, or taken as collateral. The [BANK] must
validate its VaR model by establishing and maintaining a rigorous and
regular backtesting regime.
(iv) If the number of trades in a netting set exceeds 5,000 at any
time during a quarter, a [BANK] must use a twenty-business-day holding
period for the following quarter (except when a [BANK] is calculating
EAD for a cleared transaction under Sec. --.133). If a netting set
contains one or more trades involving illiquid collateral, a [BANK]
must use a twenty-business-day holding period. If over the two previous
quarters more than two margin disputes on a netting set have occurred
that lasted more than the holding period, then the [BANK] must set its
PFE for that netting set equal to an estimate over a holding period
that is at least two times the minimum holding period for that netting
set.
(c) EAD for OTC derivative contracts--(1) OTC derivative contracts
not subject to a qualifying master netting agreement. A [BANK] must
determine the EAD for an OTC derivative contract that is not subject to
a qualifying master netting agreement using the current exposure
methodology in paragraph (c)(5) of this section or using the internal
models methodology described in paragraph (d) of this section.
(2) OTC derivative contracts subject to a qualifying master netting
agreement. A [BANK] must determine the EAD for multiple OTC derivative
contracts that are subject to a qualifying master netting agreement
using the current exposure methodology in paragraph (c)(6) of this
section or using the internal models methodology described in paragraph
(d) of this section.
(3) Credit derivatives. Notwithstanding paragraphs (c)(1) and
(c)(2) of this section:
(i) A [BANK] that purchases a credit derivative that is recognized
under Sec. --.134 or Sec. --.135 as a credit risk mitigant for an
exposure that is not a covered position under subpart F of this part is
not required to calculate a separate counterparty credit risk capital
requirement under this section so long as the [BANK] does so
consistently for all such credit derivatives and either includes or
excludes all such credit derivatives that are subject to a master
netting agreement from any measure used to determine counterparty
credit risk exposure to all relevant counterparties for risk-based
capital purposes.
(ii) A [BANK] that is the protection provider in a credit
derivative must treat the credit derivative as a wholesale exposure to
the reference obligor and is not required to calculate a counterparty
credit risk capital requirement for the
[[Page 62218]]
credit derivative under this section, so long as it does so
consistently for all such credit derivatives and either includes all or
excludes all such credit derivatives that are subject to a master
netting agreement from any measure used to determine counterparty
credit risk exposure to all relevant counterparties for risk-based
capital purposes (unless the [BANK] is treating the credit derivative
as a covered position under subpart F of this part, in which case the
[BANK] must calculate a supplemental counterparty credit risk capital
requirement under this section).
(4) Equity derivatives. A [BANK] must treat an equity derivative
contract as an equity exposure and compute a risk-weighted asset amount
for the equity derivative contract under Sec. Sec. --.151---.155
(unless the [BANK] is treating the contract as a covered position under
subpart F of this part). In addition, if the [BANK] is treating the
contract as a covered position under subpart F of this part, and under
certain other circumstances described in Sec. --.155, the [BANK] must
also calculate a risk-based capital requirement for the counterparty
credit risk of an equity derivative contract under this section.
(5) Single OTC derivative contract. Except as modified by paragraph
(c)(7) of this section, the EAD for a single OTC derivative contract
that is not subject to a qualifying master netting agreement is equal
to the sum of the [BANK]'s current credit exposure and potential future
credit exposure (PFE) on the derivative contract.
(i) Current credit exposure. The current credit exposure for a
single OTC derivative contract is the greater of the mark-to-fair value
of the derivative contract or zero; and
(ii) PFE. The PFE for a single OTC derivative contract, including
an OTC derivative contract with a negative mark-to-fair value, is
calculated by multiplying the notional principal amount of the
derivative contract by the appropriate conversion factor in Table 2 to
Sec. --.132. For purposes of calculating either the PFE under
paragraph (c)(5) of this section or the gross PFE under paragraph
(c)(6) of this section for exchange rate contracts and other similar
contracts in which the notional principal amount is equivalent to the
cash flows, the notional principal amount is the net receipts to each
party falling due on each value date in each currency. For any OTC
derivative contract that does not fall within one of the specified
categories in Table 2 to Sec. --.132, the PFE must be calculated using
the ``other'' conversion factors. A [BANK] must use an OTC derivative
contract's effective notional principal amount (that is, its apparent
or stated notional principal amount multiplied by any multiplier in the
OTC derivative contract) rather than its apparent or stated notional
principal amount in calculating PFE. PFE of the protection provider of
a credit derivative is capped at the net present value of the amount of
unpaid premiums.
Table 2 to Sec. --.132--Conversion Factor Matrix for OTC Derivative Contracts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Credit Credit (non-
Foreign (investment- investment- Precious
Remaining maturity \2\ Interest rate exchange rate grade grade Equity metals Other
and gold reference reference (except gold)
asset) \3\ asset)
--------------------------------------------------------------------------------------------------------------------------------------------------------
One year or less........................ 0.00 0.01 0.05 0.10 0.06 0.07 0.10
Over one to five years.................. 0.005 0.05 0.05 0.10 0.08 0.07 0.12
Over five years......................... 0.015 0.075 0.05 0.10 0.10 0.08 0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ For an OTC derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the
derivative contract.
\2\ For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that
the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract
with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005.
\3\ A [BANK] must use the column labeled ``Credit (investment-grade reference asset)'' for a credit derivative whose reference asset is an outstanding
unsecured long-term debt security without credit enhancement that is investment grade. A [BANK] must use the column labeled ``Credit (non-investment-
grade reference asset)'' for all other credit derivatives.
(6) Multiple OTC derivative contracts subject to a qualifying
master netting agreement. Except as modified by paragraph (c)(7) of
this section, the EAD for multiple OTC derivative contracts subject to
a qualifying master netting agreement is equal to the sum of the net
current credit exposure and the adjusted sum of the PFE exposure for
all OTC derivative contracts subject to the qualifying master netting
agreement.
(i) Net current credit exposure. The net current credit exposure is
the greater of:
(A) The net sum of all positive and negative fair values of the
individual OTC derivative contracts subject to the qualifying master
netting agreement; or
(B) Zero; and
(ii) Adjusted sum of the PFE. The adjusted sum of the PFE,
Anet, is calculated as
Anet = (0.4 x Agross) + (0.6 x NGR x
Agross),
where:
(A) Agross = the gross PFE (that is, the sum of the PFE
amounts (as determined under paragraph (c)(5)(ii) of this section)
for each individual derivative contract subject to the qualifying
master netting agreement); and
(B) NGR = the net to gross ratio (that is, the ratio of the net
current credit exposure to the gross current credit exposure). In
calculating the NGR, the gross current credit exposure equals the
sum of the positive current credit exposures (as determined under
paragraph (c)(6)(i) of this section) of all individual derivative
contracts subject to the qualifying master netting agreement.
(7) Collateralized OTC derivative contracts. A [BANK] may recognize
the credit risk mitigation benefits of financial collateral that
secures an OTC derivative contract or single-product netting set of OTC
derivatives by factoring the collateral into its LGD estimates for the
contract or netting set. Alternatively, a [BANK] may recognize the
credit risk mitigation benefits of financial collateral that secures
such a contract or netting set that is marked-to-market on a daily
basis and subject to a daily margin maintenance requirement by
estimating an unsecured LGD for the contract or netting set and
adjusting the EAD calculated under paragraph (c)(5) or (c)(6) of this
section using the collateral haircut approach in paragraph (b)(2) of
this section. The [BANK] must substitute the EAD calculated under
paragraph (c)(5) or (c)(6) of this section for [sum]E in the equation
in paragraph (b)(2)(i) of this section and must use a ten-business day
minimum holding period (TM = 10) unless a longer holding
period is required by paragraph (b)(2)(iii)(A)(3) of this section.
[[Page 62219]]
(8) Clearing member [BANK]'s EAD. A clearing member [BANK]'s EAD
for an OTC derivative contract or netting set of OTC derivative
contracts where the [BANK] is either acting as a financial intermediary
and enters into an offsetting transaction with a QCCP or where the
[BANK] provides a guarantee to the QCCP on the performance of the
client equals the exposure amount calculated according to paragraph
(c)(5) or (6) of this section multiplied by the scaling factor 0.71. If
the [BANK] determines that a longer period is appropriate, it must use
a larger scaling factor to adjust for a longer holding period as
follows:
[GRAPHIC] [TIFF OMITTED] TR11OC13.032
where
H = the holding period greater than five days. Additionally, the
[AGENCY] may require the [BANK] to set a longer holding period if
the [AGENCY] determines that a longer period is appropriate due to
the nature, structure, or characteristics of the transaction or is
commensurate with the risks associated with the transaction.
(d) Internal models methodology. (1)(i) With prior written approval
from the [AGENCY], a [BANK] may use the internal models methodology in
this paragraph (d) to determine EAD for counterparty credit risk for
derivative contracts (collateralized or uncollateralized) and single-
product netting sets thereof, for eligible margin loans and single-
product netting sets thereof, and for repo-style transactions and
single-product netting sets thereof.
(ii) A [BANK] that uses the internal models methodology for a
particular transaction type (derivative contracts, eligible margin
loans, or repo-style transactions) must use the internal models
methodology for all transactions of that transaction type. A [BANK] may
choose to use the internal models methodology for one or two of these
three types of exposures and not the other types.
(iii) A [BANK] may also use the internal models methodology for
derivative contracts, eligible margin loans, and repo-style
transactions subject to a qualifying cross-product netting agreement
if:
(A) The [BANK] effectively integrates the risk mitigating effects
of cross-product netting into its risk management and other information
technology systems; and
(B) The [BANK] obtains the prior written approval of the [AGENCY].
(iv) A [BANK] that uses the internal models methodology for a
transaction type must receive approval from the [AGENCY] to cease using
the methodology for that transaction type or to make a material change
to its internal model.
(2) Risk-weighted assets using IMM. Under the IMM, a [BANK] uses an
internal model to estimate the expected exposure (EE) for a netting set
and then calculates EAD based on that EE. A [BANK] must calculate two
EEs and two EADs (one stressed and one unstressed) for each netting set
as follows:
(i) EADunstressed is calculated using an EE estimate
based on the most recent data meeting the requirements of paragraph
(d)(3)(vii) of this section;
(ii) EADstressed is calculated using an EE estimate
based on a historical period that includes a period of stress to the
credit default spreads of the [BANK]'s counterparties according to
paragraph (d)(3)(viii) of this section;
(iii) The [BANK] must use its internal model's probability
distribution for changes in the fair value of a netting set that are
attributable to changes in market variables to determine EE; and
(iv) Under the internal models methodology, EAD = Max (0, [alpha] x
effective EPE - CVA), or, subject to the prior written approval of
[AGENCY] as provided in paragraph (d)(10) of this section, a more
conservative measure of EAD.
(A) CVA equals the credit valuation adjustment that the [BANK] has
recognized in its balance sheet valuation of any OTC derivative
contracts in the netting set. For purposes of this paragraph (d), CVA
does not include any adjustments to common equity tier 1 capital
attributable to changes in the fair value of the [BANK]'s liabilities
that are due to changes in its own credit risk since the inception of
the transaction with the counterparty.
[GRAPHIC] [TIFF OMITTED] TR11OC13.033
(C) [alpha] = 1.4 except as provided in paragraph (d)(5) of this
section, or when the [AGENCY] has determined that the [BANK] must set
[alpha] higher based on the [BANK]'s specific characteristics of
[[Page 62220]]
counterparty credit risk or model performance.
(v) A [BANK] may include financial collateral currently posted by
the counterparty as collateral (but may not include other forms of
collateral) when calculating EE.
(vi) If a [BANK] hedges some or all of the counterparty credit risk
associated with a netting set using an eligible credit derivative, the
[BANK] may take the reduction in exposure to the counterparty into
account when estimating EE. If the [BANK] recognizes this reduction in
exposure to the counterparty in its estimate of EE, it must also use
its internal model to estimate a separate EAD for the [BANK]'s exposure
to the protection provider of the credit derivative.
(3) Prior approval relating to EAD calculation. To obtain [AGENCY]
approval to calculate the distributions of exposures upon which the EAD
calculation is based, the [BANK] must demonstrate to the satisfaction
of the [AGENCY] that it has been using for at least one year an
internal model that broadly meets the following minimum standards, with
which the [BANK] must maintain compliance:
(i) The model must have the systems capability to estimate the
expected exposure to the counterparty on a daily basis (but is not
expected to estimate or report expected exposure on a daily basis);
(ii) The model must estimate expected exposure at enough future
dates to reflect accurately all the future cash flows of contracts in
the netting set;
(iii) The model must account for the possible non-normality of the
exposure distribution, where appropriate;
(iv) The [BANK] must measure, monitor, and control current
counterparty exposure and the exposure to the counterparty over the
whole life of all contracts in the netting set;
(v) The [BANK] must be able to measure and manage current exposures
gross and net of collateral held, where appropriate. The [BANK] must
estimate expected exposures for OTC derivative contracts both with and
without the effect of collateral agreements;
(vi) The [BANK] must have procedures to identify, monitor, and
control wrong-way risk throughout the life of an exposure. The
procedures must include stress testing and scenario analysis;
(vii) The model must use current market data to compute current
exposures. The [BANK] must estimate model parameters using historical
data from the most recent three-year period and update the data
quarterly or more frequently if market conditions warrant. The [BANK]
should consider using model parameters based on forward-looking
measures, where appropriate;
(viii) When estimating model parameters based on a stress period,
the [BANK] must use at least three years of historical data that
include a period of stress to the credit default spreads of the
[BANK]'s counterparties. The [BANK] must review the data set and update
the data as necessary, particularly for any material changes in its
counterparties. The [BANK] must demonstrate, at least quarterly, and
maintain documentation of such demonstration, that the stress period
coincides with increased CDS or other credit spreads of the [BANK]'s
counterparties. The [BANK] must have procedures to evaluate the
effectiveness of its stress calibration that include a process for
using benchmark portfolios that are vulnerable to the same risk factors
as the [BANK]'s portfolio. The [AGENCY] may require the [BANK] to
modify its stress calibration to better reflect actual historic losses
of the portfolio;
(ix) A [BANK] must subject its internal model to an initial
validation and annual model review process. The model review should
consider whether the inputs and risk factors, as well as the model
outputs, are appropriate. As part of the model review process, the
[BANK] must have a backtesting program for its model that includes a
process by which unacceptable model performance will be determined and
remedied;
(x) A [BANK] must have policies for the measurement, management and
control of collateral and margin amounts; and
(xi) A [BANK] must have a comprehensive stress testing program that
captures all credit exposures to counterparties, and incorporates
stress testing of principal market risk factors and creditworthiness of
counterparties.
(4) Calculating the maturity of exposures. (i) If the remaining
maturity of the exposure or the longest-dated contract in the netting
set is greater than one year, the [BANK] must set M for the exposure or
netting set equal to the lower of five years or M(EPE), where:
[GRAPHIC] [TIFF OMITTED] TR11OC13.034
(ii) If the remaining maturity of the exposure or the longest-dated
contract in the netting set is one year or less, the [BANK] must set M
for the exposure or netting set equal to one year, except as provided
in Sec. --.131(d)(7).
(iii) Alternatively, a [BANK] that uses an internal model to
calculate a one-sided credit valuation adjustment may use the effective
credit duration estimated by the model as M(EPE) in place of the
formula in paragraph (d)(4)(i) of this section.
(5) Effects of collateral agreements on EAD. A [BANK] may capture
the effect on EAD of a collateral agreement that requires receipt of
collateral when exposure to the counterparty increases, but may not
capture the effect on EAD of a collateral agreement that requires
receipt of collateral when counterparty credit quality deteriorates.
Two methods are available to capture the effect of a collateral
agreement, as set forth in paragraphs (d)(5)(i) and (ii) of this
section:
(i) With prior written approval from the [AGENCY], a [BANK] may
include the effect of a collateral agreement within its internal model
used to
[[Page 62221]]
calculate EAD. The [BANK] may set EAD equal to the expected exposure at
the end of the margin period of risk. 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. The minimum margin period of risk is set according to
paragraph (d)(5)(iii) of this section; or
(ii) As an alternative to paragraph (d)(5)(i) of this section, a
[BANK] that can model EPE without collateral agreements but cannot
achieve the higher level of modeling sophistication to model EPE with
collateral agreements can set effective EPE for a collateralized
netting set equal to the lesser of:
(A) An add-on that reflects the potential increase in exposure of
the netting set over the margin period of risk, plus the larger of:
(1) The current exposure of the netting set reflecting all
collateral held or posted by the [BANK] excluding any collateral called
or in dispute; or
(2) The largest net exposure including all collateral held or
posted under the margin agreement that would not trigger a collateral
call. For purposes of this section, the add-on is computed as the
expected increase in the netting set's exposure over the margin period
of risk (set in accordance with paragraph (d)(5)(iii) of this section);
or
(B) Effective EPE without a collateral agreement plus any
collateral the [BANK] posts to the counterparty that exceeds the
required margin amount.
(iii) For purposes of this part, including paragraphs (d)(5)(i) and
(ii) of this section, the margin period of risk for a netting set
subject to a collateral agreement is:
(A) Five business days for repo-style transactions subject to daily
remargining and daily marking-to-market, and ten business days for
other transactions when liquid financial collateral is posted under a
daily margin maintenance requirement, or
(B) Twenty business days if the number of trades in a netting set
exceeds 5,000 at any time during the previous quarter or contains one
or more trades involving illiquid collateral or any derivative contract
that cannot be easily replaced (except if the [BANK] is calculating EAD
for a cleared transaction under Sec. --.133). If over the two previous
quarters more than two margin disputes on a netting set have occurred
that lasted more than the margin period of risk, then the [BANK] must
use a margin period of risk for that netting set that is at least two
times the minimum margin period of risk for that netting set. If the
periodicity of the receipt of collateral is N-days, the minimum margin
period of risk is the minimum margin period of risk under this
paragraph (d) plus N minus 1. This period should be extended to cover
any impediments to prompt re-hedging of any market risk.
(C) Five business days for an OTC derivative contract or netting
set of OTC derivative contracts where the [BANK] is either acting as a
financial intermediary and enters into an offsetting transaction with a
CCP or where the [BANK] provides a guarantee to the CCP on the
performance of the client. A [BANK] must use a longer holding period if
the [BANK] determines that a longer period is appropriate.
Additionally, the [AGENCY] may require the [BANK] to set a longer
holding period if the [AGENCY] determines that a longer period is
appropriate due to the nature, structure, or characteristics of the
transaction or is commensurate with the risks associated with the
transaction.
(6) Own estimate of alpha. With prior written approval of the
[AGENCY], a [BANK] may calculate alpha as the ratio of economic capital
from a full simulation of counterparty exposure across counterparties
that incorporates a joint simulation of market and credit risk factors
(numerator) and economic capital based on EPE (denominator), subject to
a floor of 1.2. For purposes of this calculation, economic capital is
the unexpected losses for all counterparty credit risks measured at a
99.9 percent confidence level over a one-year horizon. To receive
approval, the [BANK] must meet the following minimum standards to the
satisfaction of the [AGENCY]:
(i) The [BANK]'s own estimate of alpha must capture in the
numerator the effects of:
(A) The material sources of stochastic dependency of distributions
of fair values of transactions or portfolios of transactions across
counterparties;
(B) Volatilities and correlations of market risk factors used in
the joint simulation, which must be related to the credit risk factor
used in the simulation to reflect potential increases in volatility or
correlation in an economic downturn, where appropriate; and
(C) The granularity of exposures (that is, the effect of a
concentration in the proportion of each counterparty's exposure that is
driven by a particular risk factor).
(ii) The [BANK] must assess the potential model uncertainty in its
estimates of alpha.
(iii) The [BANK] must calculate the numerator and denominator of
alpha in a consistent fashion with respect to modeling methodology,
parameter specifications, and portfolio composition.
(iv) The [BANK] must review and adjust as appropriate its estimates
of the numerator and denominator of alpha on at least a quarterly basis
and more frequently when the composition of the portfolio varies over
time.
(7) Risk-based capital requirements for transactions with specific
wrong-way risk. A [BANK] must determine if a repo-style transaction,
eligible margin loan, bond option, or equity derivative contract or
purchased credit derivative to which the [BANK] applies the internal
models methodology under this paragraph (d) has specific wrong-way
risk. If a transaction has specific wrong-way risk, the [BANK] must
treat the transaction as its own netting set and exclude it from the
model described in Sec. --.132(d)(2) and instead calculate the risk-
based capital requirement for the transaction as follows:
(i) For an equity derivative contract, by multiplying:
(A) K, calculated using the appropriate risk-based capital formula
specified in Table 1 of Sec. --.131 using the PD of the counterparty
and LGD equal to 100 percent, by
(B) The maximum amount the [BANK] could lose on the equity
derivative.
(ii) For a purchased credit derivative by multiplying:
(A) K, calculated using the appropriate risk-based capital formula
specified in Table 1 of Sec. --.131 using the PD of the counterparty
and LGD equal to 100 percent, by
(B) The fair value of the reference asset of the credit derivative.
(iii) For a bond option, by multiplying:
(A) K, calculated using the appropriate risk-based capital formula
specified in Table 1 of Sec. --.131 using the PD of the counterparty
and LGD equal to 100 percent, by
(B) The smaller of the notional amount of the underlying reference
asset and the maximum potential loss under the bond option contract.
(iv) For a repo-style transaction or eligible margin loan by
multiplying:
(A) K, calculated using the appropriate risk-based capital formula
specified in Table 1 of Sec. --.131 using the
[[Page 62222]]
PD of the counterparty and LGD equal to 100 percent, by
(B) The EAD of the transaction determined according to the EAD
equation in Sec. --.131(b)(2), substituting the estimated value of the
collateral assuming a default of the counterparty for the value of the
collateral in [Sigma]c of the equation.
(8) Risk-weighted asset amount for IMM exposures with specific
wrong-way risk. The aggregate risk-weighted asset amount for IMM
exposures with specific wrong-way risk is the sum of a [BANK]'s risk-
based capital requirement for purchased credit derivatives that are not
bond options with specific wrong-way risk as calculated under paragraph
(d)(7)(ii) of this section, a [BANK]'s risk-based capital requirement
for equity derivatives with specific wrong-way risk as calculated under
paragraph (d)(7)(i) of this section, a [BANK]'s risk-based capital
requirement for bond options with specific wrong-way risk as calculated
under paragraph (d)(7)(iii) of this section, and a [BANK]'s risk-based
capital requirement for repo-style transactions and eligible margin
loans with specific wrong-way risk as calculated under paragraph
(d)(7)(iv) of this section, multiplied by 12.5.
(9) Risk-weighted assets for IMM exposures. (i) The [BANK] must
insert the assigned risk parameters for each counterparty and netting
set into the appropriate formula specified in Table 1 of Sec. --.131
and multiply the output of the formula by the EADunstressed
of the netting set to obtain the unstressed capital requirement for
each netting set. A [BANK] that uses an advanced CVA approach that
captures migrations in credit spreads under paragraph (e)(3) of this
section must set the maturity adjustment (b) in the formula equal to
zero. The sum of the unstressed capital requirement calculated for each
netting set equals Kunstressed.
(ii) The [BANK] must insert the assigned risk parameters for each
wholesale obligor and netting set into the appropriate formula
specified in Table 1 of Sec. --.131 and multiply the output of the
formula by the EADstressed of the netting set to obtain the
stressed capital requirement for each netting set. A [BANK] that uses
an advanced CVA approach that captures migrations in credit spreads
under paragraph (e)(3) of this section must set the maturity adjustment
(b) in the formula equal to zero. The sum of the stressed capital
requirement calculated for each netting set equals
Kstressed.
(iii) The [BANK]'s dollar risk-based capital requirement under the
internal models methodology equals the larger of Kunstressed
and Kstressed. A [BANK]'s risk-weighted assets amount for
IMM exposures is equal to the capital requirement multiplied by 12.5,
plus risk-weighted assets for IMM exposures with specific wrong-way
risk in paragraph (d)(8) of this section and those in paragraph (d)(10)
of this section.
(10) Other measures of counterparty exposure. (i) With prior
written approval of the [AGENCY], a [BANK] may set EAD equal to a
measure of counterparty credit risk exposure, such as peak EAD, that is
more conservative than an alpha of 1.4 (or higher under the terms of
paragraph (d)(7)(iv)(C) of this section) times the larger of
EPEunstressed and EPEstressed for every
counterparty whose EAD will be measured under the alternative measure
of counterparty exposure. The [BANK] must demonstrate the conservatism
of the measure of counterparty credit risk exposure used for EAD. With
respect to paragraph (d)(10)(i) of this section:
(A) For material portfolios of new OTC derivative products, the
[BANK] may assume that the current exposure methodology in paragraphs
(c)(5) and (c)(6) of this section meets the conservatism requirement of
this section for a period not to exceed 180 days.
(B) For immaterial portfolios of OTC derivative contracts, the
[BANK] generally may assume that the current exposure methodology in
paragraphs (c)(5) and (c)(6) of this section meets the conservatism
requirement of this section.
(ii) To calculate risk-weighted assets for purposes of the approach
in paragraph (d)(10)(i) of this section, the [BANK] must insert the
assigned risk parameters for each counterparty and netting set into the
appropriate formula specified in Table 1 of Sec. --.131, multiply the
output of the formula by the EAD for the exposure as specified above,
and multiply by 12.5.
(e) Credit valuation adjustment (CVA) risk-weighted assets--(1) In
general. With respect to its OTC derivative contracts, a [BANK] must
calculate a CVA risk-weighted asset amount for its portfolio of OTC
derivative transactions that are subject to the CVA capital requirement
using the simple CVA approach described in paragraph (e)(5) of this
section or, with prior written approval of the [AGENCY], the advanced
CVA approach described in paragraph (e)(6) of this section. A [BANK]
that receives prior [AGENCY] approval to calculate its CVA risk-
weighted asset amounts for a class of counterparties using the advanced
CVA approach must continue to use that approach for that class of
counterparties until it notifies the [AGENCY] in writing that the
[BANK] expects to begin calculating its CVA risk-weighted asset amount
using the simple CVA approach. Such notice must include an explanation
of the [BANK]'s rationale and the date upon which the [BANK] will begin
to calculate its CVA risk-weighted asset amount using the simple CVA
approach.
(2) Market risk [BANK]s. Notwithstanding the prior approval
requirement in paragraph (e)(1) of this section, a market risk [BANK]
may calculate its CVA risk-weighted asset amount using the advanced CVA
approach if the [BANK] has [AGENCY] approval to:
(i) Determine EAD for OTC derivative contracts using the internal
models methodology described in paragraph (d) of this section; and
(ii) Determine its specific risk add-on for debt positions issued
by the counterparty using a specific risk model described in Sec.
--.207(b).
(3) Recognition of hedges. (i) A [BANK] may recognize a single name
CDS, single name contingent CDS, any other equivalent hedging
instrument that references the counterparty directly, and index credit
default swaps (CDSind) as a CVA hedge under paragraph
(e)(5)(ii) of this section or paragraph (e)(6) of this section,
provided that the position is managed as a CVA hedge in accordance with
the [BANK]'s hedging policies.
(ii) A [BANK] shall not recognize as a CVA hedge any tranched or
nth-to-default credit derivative.
(4) Total CVA risk-weighted assets. Total CVA risk-weighted assets
is the CVA capital requirement, KCVA, calculated for a
[BANK]'s entire portfolio of OTC derivative counterparties that are
subject to the CVA capital requirement, multiplied by 12.5.
(5) Simple CVA approach. (i) Under the simple CVA approach, the CVA
capital requirement, KCVA, is calculated according to the
following formula:
[[Page 62223]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.035
(A) wi = the weight applicable to counterparty i under Table 3 to
Sec. --.132;
(B) Mi = the EAD-weighted average of the effective maturity of each
netting set with counterparty i (where each netting set's effective
maturity can be no less than one year.)
(C) EADitotal = the sum of the EAD for all netting sets of OTC
derivative contracts with counterparty i calculated using the
current exposure methodology described in paragraph (c) of this
section or the internal models methodology described in paragraph
(d) of this section. When the [BANK] calculates EAD under paragraph
(c) of this section, such EAD may be adjusted for purposes of
calculating EADitotal by multiplying EAD by (1-exp(-0.05 x Mi))/
(0.05 x Mi), where ``exp'' is the exponential function. When the
[BANK] calculates EAD under paragraph (d) of this section, EADitotal
equals EADunstressed.
(D) Mihedge = the notional weighted average maturity of the hedge
instrument.
(E) Bi = 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 Mihedge))/(0.05 x
Mihedge).
(F) Mind = the maturity of the CDSind or the
notional weighted average maturity of any CDSind
purchased to hedge CVA risk of counterparty i.
(G) Bind = the notional amount of one or more CDSind
purchased to hedge CVA risk for counterparty i multiplied by (1-
exp(-0.05 x Mind))/(0.05 x Mind)
(H) wind = the weight applicable to the CDSind based on
the average weight of the underlying reference names that comprise
the index under Table 3 to Sec. --.132.
(ii) The [BANK] may treat the notional amount of the index
attributable to a 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. A
[BANK] must treat the CDSind hedge with the notional amount
reduced by Bi as a CVA hedge.
Table 3 to Sec. --.132--Assignment of Counterparty Weight
------------------------------------------------------------------------
Weight wi (in
Internal PD (in percent) percent)
------------------------------------------------------------------------
0.00-0.07............................................... 0.70
>0.070-0.15............................................. 0.80
>0.15-0.40.............................................. 1.00
>0.40-2.00.............................................. 2.00
>2.00-6.00.............................................. 3.00
>6.00................................................... 10.00
------------------------------------------------------------------------
(6) Advanced CVA approach. (i) A [BANK] may use the VaR model that
it uses to determine specific risk under Sec. --.207(b) or another VaR
model that meets the quantitative requirements of Sec. --.205(b) and
Sec. --.207(b)(1) to calculate its CVA capital requirement for a
counterparty by modeling the impact of changes in the counterparties'
credit spreads, together with any recognized CVA hedges, on the CVA for
the counterparties, subject to the following requirements:
(A) The VaR model must incorporate only changes in the
counterparties' credit spreads, not changes in other risk factors. The
VaR model does not need to capture jump-to-default risk;
(B) A [BANK] that qualifies to use the advanced CVA approach must
include in that approach any immaterial OTC derivative portfolios for
which it uses the current exposure methodology in paragraph (c) of this
section according to paragraph (e)(6)(viii) of this section; and
(C) A [BANK] must have the systems capability to calculate the CVA
capital requirement for a counterparty on a daily basis (but is not
required to calculate the CVA capital requirement on a daily basis).
(ii) Under the advanced CVA approach, the CVA capital requirement,
KCVA, is calculated according to the following formulas:
[[Page 62224]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.037
Where
(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 [BANK] 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. Where no market information and no reliable proxy
based on the credit quality, industry, and region of the
counterparty are available to determine LGDMKT, a [BANK]
may use a conservative estimate when determining LGDMKT,
subject to approval by the [AGENCY].
(E) EEi = the sum of the expected exposures for all netting sets
with the counterparty at revaluation time ti, calculated according
to paragraphs (e)(6)(iv)(A) and (e)(6)(v)(A) of this section.
(F) Di = the risk-free discount factor at time ti, where D0 = 1.
(G) Exp is the exponential function.
(H) The subscript j refers either to a stressed or an unstressed
calibration as described in paragraphs (e)(6)(iv) and (v) of this
section.
(iii) Notwithstanding paragraphs (e)(6)(i) and (e)(6)(ii) of this
section, a [BANK] must use the formulas in paragraphs (e)(6)(iii)(A) or
(e)(6)(iii)(B) of this section to calculate credit spread sensitivities
if its VaR model is not based on full repricing.
(A) If the VaR model is based on credit spread sensitivities for
specific tenors, the [BANK] must calculate each credit spread
sensitivity according to the following formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.039
[[Page 62225]]
(iv) To calculate the CVAUnstressed measure for purposes
of paragraph (e)(6)(ii) of this section, the [BANK] must:
(A) Use the EEi calculated using the calibration of
paragraph (d)(3)(vii) of this section, except as provided in Sec.
--.132(e)(6)(vi), and
(B) Use the historical observation period required under Sec.
--.205(b)(2).
(v) To calculate the CVAStressed measure for purposes of
paragraph (e)(6)(ii) of this section, the [BANK] must:
(A) Use the EEi calculated using the stress calibration
in paragraph (d)(3)(viii) of this section except as provided in
paragraph (e)(6)(vi) of this section.
(B) Calibrate VaR model inputs to historical data from the most
severe twelve-month stress period contained within the three-year
stress period used to calculate EEi. The [AGENCY] may
require a [BANK] to use a different period of significant financial
stress in the calculation of the CVAStressed measure.
(vi) If a [BANK] captures the effect of a collateral agreement on
EAD using the method described in paragraph (d)(5)(ii) of this section,
for purposes of paragraph (e)(6)(ii) of this section, the [BANK] must
calculate EEi using the method in paragraph (d)(5)(ii) of
this section and keep that EE constant with the maturity equal to the
maximum of:
(A) Half of the longest maturity of a transaction in the netting
set, and
(B) The notional weighted average maturity of all transactions in
the netting set.
(vii) For purposes of paragraph (e)(6) of this section, the
[BANK]'s VaR model must capture the basis between the spreads of any
CDSind 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 [BANK] must reflect only 50 percent of the notional amount of the
CDSind hedge in the VaR model.
(viii) If a [BANK] uses the current exposure methodology described
in paragraphs (c)(5) and (c)(6) of this section to calculate the EAD
for any immaterial portfolios of OTC derivative contracts, the [BANK]
must use that EAD as a constant EE in the formula for the calculation
of CVA with the maturity equal to the maximum of:
(A) Half of the longest maturity of a transaction in the netting
set, and
(B) The notional weighted average maturity of all transactions in
the netting set.
Sec. --.133 Cleared transactions.
(a) General requirements. (1) A [BANK] that is a clearing member
client must use the methodologies described in paragraph (b) of this
section to calculate risk-weighted assets for a cleared transaction.
(2) A [BANK] that is a clearing member must use the methodologies
described in paragraph (c) of this section to calculate its risk-
weighted assets for cleared transactions and paragraph (d) of this
section to calculate its risk-weighted assets for its default fund
contribution to a CCP.
(b) Clearing member client [BANK]s--(1) Risk-weighted assets for
cleared transactions. (i) To determine the risk-weighted asset amount
for a cleared transaction, a [BANK] that is a clearing member client
must multiply the trade exposure amount for the cleared transaction,
calculated in accordance with paragraph (b)(2) of this section, by the
risk weight appropriate for the cleared transaction, determined in
accordance with paragraph (b)(3) of this section.
(ii) A clearing member client [BANK]'s total risk-weighted assets
for cleared transactions is the sum of the risk-weighted asset amounts
for all of its cleared transactions.
(2) Trade exposure amount. (i) For a cleared transaction that is a
derivative contract or a netting set of derivative contracts, trade
exposure amount equals the EAD for the derivative contract or netting
set of derivative contracts calculated using the methodology used to
calculate EAD for OTC derivative contracts set forth in Sec. --.132(c)
or (d), plus the fair value of the collateral posted by the clearing
member client [BANK] and held by the CCP or a clearing member in a
manner that is not bankruptcy remote. When the [BANK] calculates EAD
for the cleared transaction using the methodology in Sec. --.132(d),
EAD equals EADunstressed.
(ii) For a cleared transaction that is a repo-style transaction or
netting set of repo-style transactions, trade exposure amount equals
the EAD for the repo-style transaction calculated using the methodology
set forth in Sec. --.132(b)(2), (b)(3), or (d), plus the fair value of
the collateral posted by the clearing member client [BANK] and held by
the CCP or a clearing member in a manner that is not bankruptcy remote.
When the [BANK] calculates EAD for the cleared transaction under Sec.
--.132(d), EAD equals EADunstressed.
(3) Cleared transaction risk weights. (i) For a cleared transaction
with a QCCP, a clearing member client [BANK] must apply a risk weight
of:
(A) 2 percent if the collateral posted by the [BANK] to the QCCP or
clearing member is subject to an arrangement that prevents any loss to
the clearing member client [BANK] 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 the clearing member client [BANK] 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 an event of
default or from liquidation, insolvency or receivership proceedings)
the relevant court and administrative authorities would find the
arrangements to be legal, valid, binding and enforceable under the law
of the relevant jurisdictions.
(B) 4 percent, if the requirements of Sec. --.132(b)(3)(i)(A) are
not met.
(ii) For a cleared transaction with a CCP that is not a QCCP, a
clearing member client [BANK] must apply the risk weight applicable to
the CCP under Sec. --.32.
(4) Collateral. (i) Notwithstanding any other requirement of this
section, collateral posted by a clearing member client [BANK] that is
held by a custodian (in its capacity as custodian) in a manner that is
bankruptcy remote from the CCP, the custodian, clearing member, and
other clearing member clients of the clearing member, is not subject to
a capital requirement under this section.
(ii) A clearing member client [BANK] must calculate a risk-weighted
asset amount for any collateral provided to a CCP, clearing member or a
custodian in connection with a cleared transaction in accordance with
requirements under Sec. --.131.
(c) Clearing member [BANK]--(1) Risk-weighted assets for cleared
transactions. (i) To determine the risk-weighted asset amount for a
cleared transaction, a clearing member [BANK] must multiply the trade
exposure amount for the cleared transaction, calculated in accordance
with paragraph (c)(2) of this section by the risk weight appropriate
for the cleared transaction, determined in accordance with paragraph
(c)(3) of this section.
(ii) A clearing member [BANK]'s total risk-weighted assets for
cleared transactions is the sum of the risk-weighted asset amounts for
all of its cleared transactions.
(2) Trade exposure amount. A clearing member [BANK] must calculate
its trade exposure amount for a cleared transaction as follows:
[[Page 62226]]
(i) For a cleared transaction that is a derivative contract or a
netting set of derivative contracts, trade exposure amount equals the
EAD calculated using the methodology used to calculate EAD for OTC
derivative contracts set forth in Sec. --.132(c) or Sec. --.132(d),
plus the fair value of the collateral posted by the clearing member
[BANK] and held by the CCP in a manner that is not bankruptcy remote.
When the clearing member [BANK] calculates EAD for the cleared
transaction using the methodology in Sec. --.132(d), EAD equals
EADunstressed.
(ii) For a cleared transaction that is a repo-style transaction or
netting set of repo-style transactions, trade exposure amount equals
the EAD calculated under Sec. Sec. --.132(b)(2), (b)(3), or (d), plus
the fair value of the collateral posted by the clearing member [BANK]
and held by the CCP in a manner that is not bankruptcy remote. When the
clearing member [BANK] calculates EAD for the cleared transaction under
Sec. --.132(d), EAD equals EADunstressed.
(3) Cleared transaction risk weights. (i) A clearing member [BANK]
must apply a risk weight of 2 percent to the trade exposure amount for
a cleared transaction with a QCCP.
(ii) For a cleared transaction with a CCP that is not a QCCP, a
clearing member [BANK] must apply the risk weight applicable to the CCP
according to Sec. --.32.
(4) Collateral. (i) Notwithstanding any other requirement of this
section, collateral posted by a clearing member [BANK] that is held by
a custodian in a manner that is bankruptcy remote from the CCP is not
subject to a capital requirement under this section.
(ii) A clearing member [BANK] must calculate a risk-weighted asset
amount for any collateral provided to a CCP, clearing member or a
custodian in connection with a cleared transaction in accordance with
requirements under Sec. --.131
(d) Default fund contributions--(1) General requirement. A clearing
member [BANK] must determine the risk-weighted asset amount for a
default fund contribution to a CCP at least quarterly, or more
frequently if, in the opinion of the [BANK] or the [AGENCY], there is a
material change in the financial condition of the CCP.
(2) Risk-weighted asset amount for default fund contributions to
non-qualifying CCPs. A clearing member [BANK]'s risk-weighted asset
amount for default fund contributions to CCPs that are not QCCPs equals
the sum of such default fund contributions multiplied by 1,250 percent
or an amount determined by the [AGENCY], based on factors such as size,
structure and membership characteristics of the CCP and riskiness of
its transactions, in cases where such default fund contributions may be
unlimited.
(3) Risk-weighted asset amount for default fund contributions to
QCCPs. A clearing member [BANK]'s risk-weighted asset amount for
default fund contributions to QCCPs equals the sum of its capital
requirement, KCM for each QCCP, as calculated under the
methodology set forth in paragraph (d)(3)(i) of this section (Method
1), multiplied by 1,250 percent or paragraph (d)(3)(iv) of this section
(Method 2).
(i) Method 1. The hypothetical capital requirement of a QCCP
(KCCP) equals:
[GRAPHIC] [TIFF OMITTED] TR11OC13.042
Where
(A) EBRMi = the EAD for each transaction cleared through
the QCCP by clearing member i, calculated using the methodology used to
calculate EAD for OTC derivative contracts set forth in Sec.
--.132(c)(5) and Sec. --.132.(c)(6) or the methodology used to
calculate EAD for repo-style transactions set forth in Sec.
--.132(b)(2) for repo-style transactions, provided that:
(1) For purposes of this section, when calculating the EAD, the
[BANK] may replace the formula provided in Sec. --.132(c)(6)(ii) with
the following formula:
Anet = (0.15 x Agross) + (0.85 x NGR x
Agross); and
(2) For option derivative contracts that are cleared transactions,
the PFE described in Sec. --.132(c)(5) must be adjusted by multiplying
the notional principal amount of the derivative contract by the
appropriate conversion factor in Table 2 to Sec. --.132 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.
(3) For repo-style transactions, when applying Sec. --.132(b)(2),
the [BANK] must use the methodology in Sec. --.132(b)(2)(ii).
(B) VMi = any collateral posted by clearing member i to
the QCCP that it is entitled to receive from the QCCP but has not yet
received, and any collateral that the QCCP has actually received from
clearing member i;
(C) IMi = the collateral posted as initial margin by
clearing member i to the QCCP;
(D) DFi = the funded portion of clearing member i's
default fund contribution that will be applied to reduce the QCCP's
loss upon a default by clearing member i; and
(E) RW = 20 percent, except when the [AGENCY] has determined that a
higher risk weight is more appropriate based on the specific
characteristics of the QCCP and its clearing members; and
(F) Where a QCCP has provided its KCCP, a [BANK] must
rely on such disclosed figure instead of calculating KCCP
under this paragraph (d), unless the [BANK] determines that a more
conservative figure is appropriate based on the nature, structure, or
characteristics of the QCCP.
(ii) For a [BANK] that is a clearing member of a QCCP with a
default fund supported by funded commitments, KCM equals:
[[Page 62227]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.043
[[Page 62228]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.044
Where:
(A) DFi = the [BANK]'s unfunded commitment to the default
fund;
(B) DFCM = the total of all clearing members' unfunded
commitments to the default fund; and
(C) K*CM as defined in paragraph (d)(3)(ii) of this section.
(D) For a [BANK] that is a clearing member of a QCCP with a default
fund supported by unfunded commitments and that is unable to
calculate KCM using the methodology described above in
this paragraph (d)(3)(iii), KCM equals:
[GRAPHIC] [TIFF OMITTED] TR11OC13.046
Where:
(1) IMi = the [BANK]'s initial margin posted to the QCCP;
(2) IMCM = the total of initial margin posted to the
QCCP; and
(3) K*CM as defined above in this paragraph (d)(3)(iii).
(iv) Method 2. A clearing member [BANK]'s risk-weighted asset
amount for its default fund contribution to a QCCP, RWADF,
equals:
RWADF = Min {12.5 * DF; 0.18 * TE{time}
Where:
(A) TE = the [BANK]'s trade exposure amount to the QCCP calculated
according to section 133(c)(2);
(B) DF = the funded portion of the [BANK]'s default fund
contribution to the QCCP.
(v) Total risk-weighted assets for default fund contributions.
Total risk-weighted assets for default fund contributions is the sum of
a clearing member [BANK]'s risk-weighted assets for all of its default
fund contributions to all CCPs of which the [BANK] is a clearing
member.
[[Page 62229]]
Sec. --.134 Guarantees and credit derivatives: PD substitution and
LGD adjustment approaches.
(a) Scope. (1) This section applies to wholesale exposures for
which:
(i) Credit risk is fully covered by an eligible guarantee or
eligible credit derivative; or
(ii) Credit risk is covered on a pro rata basis (that is, on a
basis in which the [BANK] and the protection provider share losses
proportionately) by an eligible guarantee or eligible credit
derivative.
(2) Wholesale exposures on which there is a tranching of credit
risk (reflecting at least two different levels of seniority) are
securitization exposures subject to Sec. --.141 through Sec. --.145.
(3) A [BANK] may elect to recognize the credit risk mitigation
benefits of an eligible guarantee or eligible credit derivative
covering an exposure described in paragraph (a)(1) of this section by
using the PD substitution approach or the LGD adjustment approach in
paragraph (c) of this section or, if the transaction qualifies, using
the double default treatment in Sec. --.135. A [BANK]'s PD and LGD for
the hedged exposure may not be lower than the PD and LGD floors
described in Sec. --.131(d)(2) and (d)(3).
(4) If multiple eligible guarantees or eligible credit derivatives
cover a single exposure described in paragraph (a)(1) of this section,
a [BANK] may treat the hedged exposure as multiple separate exposures
each covered by a single eligible guarantee or eligible credit
derivative and may calculate a separate risk-based capital requirement
for each separate exposure as described in paragraph (a)(3) of this
section.
(5) If a single eligible guarantee or eligible credit derivative
covers multiple hedged wholesale exposures described in paragraph
(a)(1) of this section, a [BANK] must treat each hedged exposure as
covered by a separate eligible guarantee or eligible credit derivative
and must calculate a separate risk-based capital requirement for each
exposure as described in paragraph (a)(3) of this section.
(6) A [BANK] must use the same risk parameters for calculating ECL
as it uses for calculating the risk-based capital requirement for the
exposure.
(b) Rules of recognition. (1) A [BANK] may only recognize the
credit risk mitigation benefits of eligible guarantees and eligible
credit derivatives.
(2) A [BANK] may only recognize the credit risk mitigation benefits
of an eligible credit derivative to hedge an exposure that is different
from the credit derivative's reference exposure used for determining
the derivative's cash settlement value, deliverable obligation, or
occurrence of a credit event if:
(i) The reference exposure ranks pari passu (that is, equally) with
or is junior to the hedged exposure; and
(ii) The reference exposure and the hedged exposure are exposures
to the same legal entity, and legally enforceable cross-default or
cross-acceleration clauses are in place to assure payments under the
credit derivative are triggered when the obligor fails to pay under the
terms of the hedged exposure.
(c) Risk parameters for hedged exposures--(1) PD substitution
approach--(i) Full coverage. If an eligible guarantee or eligible
credit derivative meets the conditions in paragraphs (a) and (b) of
this section and the protection amount (P) of the guarantee or credit
derivative is greater than or equal to the EAD of the hedged exposure,
a [BANK] may recognize the guarantee or credit derivative in
determining the [BANK]'s risk-based capital requirement for the hedged
exposure by substituting the PD associated with the rating grade of the
protection provider for the PD associated with the rating grade of the
obligor in the risk-based capital formula applicable to the guarantee
or credit derivative in Table 1 of Sec. --.131 and using the
appropriate LGD as described in paragraph (c)(1)(iii) of this section.
If the [BANK] determines that full substitution of the protection
provider's PD leads to an inappropriate degree of risk mitigation, the
[BANK] may substitute a higher PD than that of the protection provider.
(ii) Partial coverage. If an eligible guarantee or eligible credit
derivative meets the conditions in paragraphs (a) and (b) of this
section and P of the guarantee or credit derivative is less than the
EAD of the hedged exposure, the [BANK] must treat the hedged exposure
as two separate exposures (protected and unprotected) in order to
recognize the credit risk mitigation benefit of the guarantee or credit
derivative.
(A) The [BANK] must calculate its risk-based capital requirement
for the protected exposure under Sec. --.131, where PD is the
protection provider's PD, LGD is determined under paragraph (c)(1)(iii)
of this section, and EAD is P. If the [BANK] determines that full
substitution leads to an inappropriate degree of risk mitigation, the
[BANK] may use a higher PD than that of the protection provider.
(B) The [BANK] must calculate its risk-based capital requirement
for the unprotected exposure under Sec. --.131, where PD is the
obligor's PD, LGD is the hedged exposure's LGD (not adjusted to reflect
the guarantee or credit derivative), and EAD is the EAD of the original
hedged exposure minus P.
(C) The treatment in paragraph (c)(1)(ii) of this section is
applicable when the credit risk of a wholesale exposure is covered on a
partial pro rata basis or when an adjustment is made to the effective
notional amount of the guarantee or credit derivative under paragraphs
(d), (e), or (f) of this section.
(iii) LGD of hedged exposures. The LGD of a hedged exposure under
the PD substitution approach is equal to:
(A) The lower of the LGD of the hedged exposure (not adjusted to
reflect the guarantee or credit derivative) and the LGD of the
guarantee or credit derivative, if the guarantee or credit derivative
provides the [BANK] with the option to receive immediate payout upon
triggering the protection; or
(B) The LGD of the guarantee or credit derivative, if the guarantee
or credit derivative does not provide the [BANK] with the option to
receive immediate payout upon triggering the protection.
(2) LGD adjustment approach. (i) Full coverage. If an eligible
guarantee or eligible credit derivative meets the conditions in
paragraphs (a) and (b) of this section and the protection amount (P) of
the guarantee or credit derivative is greater than or equal to the EAD
of the hedged exposure, the [BANK]'s risk-based capital requirement for
the hedged exposure is the greater of:
(A) The risk-based capital requirement for the exposure as
calculated under Sec. --.131, with the LGD of the exposure adjusted to
reflect the guarantee or credit derivative; or
(B) The risk-based capital requirement for a direct exposure to the
protection provider as calculated under Sec. --.131, using the PD for
the protection provider, the LGD for the guarantee or credit
derivative, and an EAD equal to the EAD of the hedged exposure.
(ii) Partial coverage. If an eligible guarantee or eligible credit
derivative meets the conditions in paragraphs (a) and (b) of this
section and the protection amount (P) of the guarantee or credit
derivative is less than the EAD of the hedged exposure, the [BANK] must
treat the hedged exposure as two separate exposures (protected and
unprotected) in order to recognize the credit risk mitigation benefit
of the guarantee or credit derivative.
(A) The [BANK]'s risk-based capital requirement for the protected
exposure would be the greater of:
(1) The risk-based capital requirement for the protected exposure
as calculated under Sec. --.131, with the LGD of the exposure adjusted
to reflect the
[[Page 62230]]
guarantee or credit derivative and EAD set equal to P; or
(2) The risk-based capital requirement for a direct exposure to the
guarantor as calculated under Sec. --.131, using the PD for the
protection provider, the LGD for the guarantee or credit derivative,
and an EAD set equal to P.
(B) The [BANK] must calculate its risk-based capital requirement
for the unprotected exposure under Sec. --.131, where PD is the
obligor's PD, LGD is the hedged exposure's LGD (not adjusted to reflect
the guarantee or credit derivative), and EAD is the EAD of the original
hedged exposure minus P.
(3) M of hedged exposures. For purposes of this paragraph (c), the
M of the hedged exposure is the same as the M of the exposure if it
were unhedged.
(d) Maturity mismatch. (1) A [BANK] that recognizes an eligible
guarantee or eligible credit derivative in determining its risk-based
capital requirement for a hedged exposure must adjust the effective
notional amount of the credit risk mitigant to reflect any maturity
mismatch between the hedged exposure and the credit risk mitigant.
(2) A maturity mismatch occurs when the residual maturity of a
credit risk mitigant is less than that of the hedged exposure(s).
(3) The residual maturity of a hedged exposure is the longest
possible remaining time before the obligor is scheduled to fulfil its
obligation on the exposure. If a credit risk mitigant has embedded
options that may reduce its term, the [BANK] (protection purchaser)
must use the shortest possible residual maturity for the credit risk
mitigant. If a call is at the discretion of the protection provider,
the residual maturity of the credit risk mitigant is at the first call
date. If the call is at the discretion of the [BANK] (protection
purchaser), but the terms of the arrangement at origination of the
credit risk mitigant contain a positive incentive for the [BANK] to
call the transaction before contractual maturity, the remaining time to
the first call date is the residual maturity of the credit risk
mitigant.\26\
---------------------------------------------------------------------------
\26\ For example, where there is a step-up in cost in
conjunction with a call feature or where the effective cost of
protection increases over time even if credit quality remains the
same or improves, the residual maturity of the credit risk mitigant
will be the remaining time to the first call.
---------------------------------------------------------------------------
(4) A credit risk mitigant with a maturity mismatch may be
recognized only if its original maturity is greater than or equal to
one year and its residual maturity is greater than three months.
(5) When a maturity mismatch exists, the [BANK] must apply the
following adjustment to the effective notional amount of the credit
risk mitigant:
Pm = E x (t - 0.25)/(T - 0.25),
where:
(i) Pm = effective notional amount of the credit risk
mitigant, adjusted for maturity mismatch;
(ii) E = effective notional amount of the credit risk mitigant;
(iii) t = the lesser of T or the residual maturity of the credit
risk mitigant, expressed in years; and
(iv) T = the lesser of five or the residual maturity of the hedged
exposure, expressed in years.
(e) Credit derivatives without restructuring as a credit event. If
a [BANK] recognizes an eligible credit derivative that does not include
as a credit event a restructuring of the hedged exposure involving
forgiveness or postponement of principal, interest, or fees that
results in a credit loss event (that is, a charge-off, specific
provision, or other similar debit to the profit and loss account), the
[BANK] must apply the following adjustment to the effective notional
amount of the credit derivative:
Pr = Pm x 0.60,
where:
(1) Pr = effective notional amount of the credit risk
mitigant, adjusted for lack of restructuring event (and maturity
mismatch, if applicable); and
(2) Pm = effective notional amount of the credit risk
mitigant adjusted for maturity mismatch (if applicable).
(f) Currency mismatch. (1) If a [BANK] recognizes an eligible
guarantee or eligible credit derivative that is denominated in a
currency different from that in which the hedged exposure is
denominated, the [BANK] must apply the following formula to the
effective notional amount of the guarantee or credit derivative:
Pc = Pr x (1 - HFX),
where:
(i) Pc = effective notional amount of the credit risk
mitigant, adjusted for currency mismatch (and maturity mismatch and
lack of restructuring event, if applicable);
(ii) Pr = effective notional amount of the credit risk
mitigant (adjusted for maturity mismatch and lack of restructuring
event, if applicable); and
(iii) HFX = haircut appropriate for the currency mismatch
between the credit risk mitigant and the hedged exposure.
(2) A [BANK] must set HFX equal to 8 percent unless it
qualifies for the use of and uses its own internal estimates of foreign
exchange volatility based on a ten-business-day holding period and
daily marking-to-market and remargining. A [BANK] qualifies for the use
of its own internal estimates of foreign exchange volatility if it
qualifies for:
(i) The own-estimates haircuts in Sec. --.132(b)(2)(iii);
(ii) The simple VaR methodology in Sec. --.132(b)(3); or
(iii) The internal models methodology in Sec. --.132(d).
(3) A [BANK] must adjust HFX calculated in paragraph
(f)(2) of this section upward if the [BANK] revalues the guarantee or
credit derivative less frequently than once every ten business days
using the square root of time formula provided in Sec.
--.132(b)(2)(iii)(A)(2).
Sec. --.135 Guarantees and credit derivatives: double default
treatment.
(a) Eligibility and operational criteria for double default
treatment. A [BANK] may recognize the credit risk mitigation benefits
of a guarantee or credit derivative covering an exposure described in
Sec. --.134(a)(1) by applying the double default treatment in this
section if all the following criteria are satisfied:
(1) The hedged exposure is fully covered or covered on a pro rata
basis by:
(i) An eligible guarantee issued by an eligible double default
guarantor; or
(ii) An eligible credit derivative that meets the requirements of
Sec. --.134(b)(2) and that is issued by an eligible double default
guarantor.
(2) The guarantee or credit derivative is:
(i) An uncollateralized guarantee or uncollateralized credit
derivative (for example, a credit default swap) that provides
protection with respect to a single reference obligor; or
(ii) An nth-to-default credit derivative (subject to the
requirements of Sec. --.142(m).
(3) The hedged exposure is a wholesale exposure (other than a
sovereign exposure).
(4) The obligor of the hedged exposure is not:
(i) An eligible double default guarantor or an affiliate of an
eligible double default guarantor; or
(ii) An affiliate of the guarantor.
(5) The [BANK] does not recognize any credit risk mitigation
benefits of the guarantee or credit derivative for the hedged exposure
other than through application of the double default treatment as
provided in this section.
(6) The [BANK] has implemented a process (which has received the
prior, written approval of the [AGENCY]) to detect excessive
correlation between the creditworthiness of the obligor of the hedged
exposure and the protection provider. If excessive correlation is
present, the [BANK] may not use the double default treatment for the
hedged exposure.
[[Page 62231]]
(b) Full coverage. If a transaction meets the criteria in paragraph
(a) of this section and the protection amount (P) of the guarantee or
credit derivative is at least equal to the EAD of the hedged exposure,
the [BANK] may determine its risk-weighted asset amount for the hedged
exposure under paragraph (e) of this section.
(c) Partial coverage. If a transaction meets the criteria in
paragraph (a) of this section and the protection amount (P) of the
guarantee or credit derivative is less than the EAD of the hedged
exposure, the [BANK] must treat the hedged exposure as two separate
exposures (protected and unprotected) in order to recognize double
default treatment on the protected portion of the exposure:
(1) For the protected exposure, the [BANK] must set EAD equal to P
and calculate its risk-weighted asset amount as provided in paragraph
(e) of this section; and
(2) For the unprotected exposure, the [BANK] must set EAD equal to
the EAD of the original exposure minus P and then calculate its risk-
weighted asset amount as provided in Sec. --.131.
(d) Mismatches. For any hedged exposure to which a [BANK] applies
double default treatment under this part, the [BANK] must make
applicable adjustments to the protection amount as required in Sec.
--.134(d), (e), and (f).
(e) The double default dollar risk-based capital requirement. The
dollar risk-based capital requirement for a hedged exposure to which a
[BANK] has applied double default treatment is KDD
multiplied by the EAD of the exposure. KDD is calculated
according to the following formula:
KDD = Ko x (0.15 + 160 x PDg),
Where:
(1)
[GRAPHIC] [TIFF OMITTED] TR11OC13.048
(2) PDg = PD of the protection provider.
(3) PDo = PD of the obligor of the hedged exposure.
(4) LGDg =
(i) The lower of the LGD of the hedged exposure (not adjusted to
reflect the guarantee or credit derivative) and the LGD of the
guarantee or credit derivative, if the guarantee or credit
derivative provides the [BANK] with the option to receive immediate
payout on triggering the protection; or
(ii) The LGD of the guarantee or credit derivative, if the guarantee
or credit derivative does not provide the [BANK] with the option to
receive immediate payout on triggering the protection; and
(5) [rho]os (asset value correlation of the obligor) is
calculated according to the appropriate formula for (R) provided in
Table 1 in Sec. --.131, with PD equal to PDo.
(6) b (maturity adjustment coefficient) is calculated according to
the formula for b provided in Table 1 in Sec. --.131, with PD equal
to the lesser of PDo and PDg; and
(7) M (maturity) is the effective maturity of the guarantee or
credit derivative, which may not be less than one year or greater
than five years.
Sec. --.136 Unsettled transactions.
(a) Definitions. For purposes of this section:
(1) Delivery-versus-payment (DvP) transaction means a securities or
commodities transaction in which the buyer is obligated to make payment
only if the seller has made delivery of the securities or commodities
and the seller is obligated to deliver the securities or commodities
only if the buyer has made payment.
(2) Payment-versus-payment (PvP) transaction means a foreign
exchange transaction in which each counterparty is obligated to make a
final transfer of one or more currencies only if the other counterparty
has made a final transfer of one or more currencies.
(3) A transaction has a normal settlement period if the contractual
settlement period for the transaction is equal to or less than the
market standard for the instrument underlying the transaction and equal
to or less than five business days.
(4) The positive current exposure of a [BANK] for a transaction is
the difference between the transaction value at the agreed settlement
price and the current market price of the transaction, if the
difference results in a credit exposure of the [BANK] to the
counterparty.
(b) Scope. This section applies to all transactions involving
securities, foreign exchange instruments, and commodities that have a
risk of delayed settlement or delivery. This section does not apply to:
(1) Cleared transactions that are subject to daily marking-to-
market and daily receipt and payment of variation margin;
(2) Repo-style transactions, including unsettled repo-style
transactions (which are addressed in Sec. Sec. --.131 and 132);
(3) One-way cash payments on OTC derivative contracts (which are
addressed in Sec. Sec. --. 131 and 132); or
(4) Transactions with a contractual settlement period that is
longer than the normal settlement period (which are treated as OTC
derivative contracts and addressed in Sec. Sec. --.131 and 132).
(c) System-wide failures. In the case of a system-wide failure of a
settlement or clearing system, or a central counterparty, the [AGENCY]
may waive risk-based capital requirements for unsettled and failed
transactions until the situation is rectified.
(d) Delivery-versus-payment (DvP) and payment-versus-payment (PvP)
transactions. A [BANK] must hold risk-based capital against any DvP or
PvP transaction with a normal settlement period if the [BANK]'s
counterparty has not made delivery or payment within five business days
after the settlement date. The [BANK] must determine its risk-weighted
asset amount for such a transaction by multiplying the positive current
exposure of the transaction for the [BANK] by the appropriate risk
weight in Table 1 to Sec. --.136.
Table 1 to Sec. --.136--Risk Weights for Unsettled DvP and PvP
Transactions
------------------------------------------------------------------------
Risk weight to
be applied to
Number of business days after contractual settlement positive
date current
exposure (in
percent)
------------------------------------------------------------------------
From 5 to 15............................................ 100
From 16 to 30........................................... 625
From 31 to 45........................................... 937.5
46 or more.............................................. 1,250
------------------------------------------------------------------------
(e) Non-DvP/non-PvP (non-delivery-versus-payment/non-payment-
versus-payment) transactions. (1) A [BANK] must hold risk-based capital
against any non-DvP/non-PvP transaction with a normal settlement period
if the [BANK] has delivered cash, securities, commodities, or
currencies to its counterparty but has not received its corresponding
deliverables by the end of the same business day. The [BANK] must
continue to hold risk-based capital against the transaction until the
[BANK] has received its corresponding deliverables.
[[Page 62232]]
(2) From the business day after the [BANK] has made its delivery
until five business days after the counterparty delivery is due, the
[BANK] must calculate its risk-based capital requirement for the
transaction by treating the current fair value of the deliverables owed
to the [BANK] as a wholesale exposure.
(i) A [BANK] may use a 45 percent LGD for the transaction rather
than estimating LGD for the transaction provided the [BANK] uses the 45
percent LGD for all transactions described in Sec. --.135(e)(1) and
(e)(2).
(ii) A [BANK] may use a 100 percent risk weight for the transaction
provided the [BANK] uses this risk weight for all transactions
described in Sec. Sec. --.135(e)(1) and (e)(2).
(3) If the [BANK] has not received its deliverables by the fifth
business day after the counterparty delivery was due, the [BANK] must
apply a 1,250 percent risk weight to the current fair value of the
deliverables owed to the [BANK].
(f) Total risk-weighted assets for unsettled transactions. Total
risk-weighted assets for unsettled transactions is the sum of the risk-
weighted asset amounts of all DvP, PvP, and non-DvP/non-PvP
transactions.
Sec. Sec. --.137 through --.140 [Reserved]
Risk-Weighted Assets for Securitization Exposures
Sec. --.141 Operational criteria for recognizing the transfer of
risk.
(a) Operational criteria for traditional securitizations. A [BANK]
that transfers exposures it has originated or purchased to a
securitization SPE or other third party in connection with a
traditional securitization may exclude the exposures from the
calculation of its risk-weighted assets only if each of the conditions
in this paragraph (a) is satisfied. A [BANK] that meets these
conditions must hold risk-based capital against any securitization
exposures it retains in connection with the securitization. A [BANK]
that fails to meet these conditions must 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. The conditions are:
(1) The exposures are not reported on the [BANK]'s consolidated
balance sheet under GAAP;
(2) The [BANK] has transferred to one or more third parties credit
risk associated with the underlying exposures;
(3) Any clean-up calls relating to the securitization are eligible
clean-up calls; and
(4) The securitization does not:
(i) Include one or more underlying exposures in which the borrower
is permitted to vary the drawn amount within an agreed limit under a
line of credit; and
(ii) Contain an early amortization provision.
(b) Operational criteria for synthetic securitizations. For
synthetic securitizations, a [BANK] may recognize for risk-based
capital purposes under this subpart the use of a credit risk mitigant
to hedge underlying exposures only if each of the conditions in this
paragraph (b) is satisfied. A [BANK] that meets these conditions must
hold risk-based capital against any credit risk of the exposures it
retains in connection with the synthetic securitization. A [BANK] that
fails to meet these conditions or chooses not to recognize the credit
risk mitigant for purposes of this section must hold risk-based capital
under this subpart against the underlying exposures as if they had not
been synthetically securitized. The conditions are:
(1) The credit risk mitigant is:
(i) Financial collateral; or
(ii) A guarantee that meets all of the requirements of an eligible
guarantee in Sec. --.2 except for paragraph (3) of the definition; or
(iii) A credit derivative that meets all of the requirements of an
eligible credit derivative except for paragraph (3) of the definition
of eligible guarantee in Sec. --.2.
(2) The [BANK] transfers credit risk associated with the underlying
exposures to third parties, and the terms and conditions in the credit
risk mitigants employed do not include provisions that:
(i) Allow for the termination of the credit protection due to
deterioration in the credit quality of the underlying exposures;
(ii) Require the [BANK] to alter or replace the underlying
exposures to improve the credit quality of the underlying exposures;
(iii) Increase the [BANK]'s cost of credit protection in response
to deterioration in the credit quality of the underlying exposures;
(iv) Increase the yield payable to parties other than the [BANK] in
response to a deterioration in the credit quality of the underlying
exposures; or
(v) Provide for increases in a retained first loss position or
credit enhancement provided by the [BANK] after the inception of the
securitization;
(3) The [BANK] obtains a well-reasoned opinion from legal counsel
that confirms the enforceability of the credit risk mitigant in all
relevant jurisdictions; and
(4) Any clean-up calls relating to the securitization are eligible
clean-up calls.
(c) Due diligence requirements for securitization exposures. (1)
Except for exposures that are deducted from common equity tier 1
capital and exposures subject to Sec. --.142(k), if a [BANK] is unable
to demonstrate to the satisfaction of the [AGENCY] a comprehensive
understanding of the features of a securitization exposure that would
materially affect the performance of the exposure, the [BANK] must
assign a 1,250 percent risk weight to the securitization exposure. The
[BANK]'s analysis must be commensurate with the complexity of the
securitization exposure and the materiality of the position in relation
to regulatory capital according to this part.
(2) A [BANK] must demonstrate its comprehensive understanding of a
securitization exposure under paragraph (c)(1) of this section, for
each securitization exposure by:
(i) Conducting an analysis of the risk characteristics of a
securitization exposure prior to acquiring the exposure and document
such analysis within three business days after acquiring the exposure,
considering:
(A) Structural features of the securitization that would materially
impact the performance of the exposure, for example, the contractual
cash flow waterfall, waterfall-related triggers, credit enhancements,
liquidity enhancements, fair value triggers, the performance of
organizations that service the position, and deal-specific definitions
of default;
(B) 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 loan-to-value ratio; and industry
and geographic diversification data on the underlying exposure(s);
(C) Relevant market data of the securitization, for example, bid-
ask spreads, 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
(D) For resecuritization exposures, performance information on the
underlying securitization exposures, for example, the issuer name and
credit quality, and the characteristics and
[[Page 62233]]
performance of the exposures underlying the securitization exposures;
and
(ii) On an on-going basis (no less frequently than quarterly),
evaluating, reviewing, and updating as appropriate the analysis
required under this section for each securitization exposure.
Sec. --.142 Risk-weighted assets for securitization exposures.
(a) Hierarchy of approaches. Except as provided elsewhere in this
section and in Sec. --.141:
(1) A [BANK] 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 any CEIO that does not
constitute after tax gain-on-sale;
(2) If a securitization exposure does not require deduction or a
1,250 percent risk weight under paragraph (a)(1) of this section, the
[BANK] must apply the supervisory formula approach in Sec. --.143 to
the exposure if the [BANK] and the exposure qualify for the supervisory
formula approach according to Sec. --.143(a);
(3) If a securitization exposure does not require deduction or a
1,250 percent risk weight under paragraph (a)(1) of this section and
does not qualify for the supervisory formula approach, the [BANK] may
apply the simplified supervisory formula approach under Sec. --.144;
(4) If a securitization exposure does not require deduction or a
1,250 percent risk weight under paragraph (a)(1) of this section, does
not qualify for the supervisory formula approach in Sec. --.143, and
the [BANK] does not apply the simplified supervisory formula approach
in Sec. --.144, the [BANK] must apply a 1,250 percent risk weight to
the exposure; and
(5) If a securitization exposure is a derivative contract (other
than protection provided by a [BANK] in the form of 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 [BANK] may choose to set the risk-weighted asset amount of the
exposure equal to the amount of the exposure as determined in paragraph
(e) of this section rather than apply the hierarchy of approaches
described in paragraphs (a)(1) through (4) of this section.
(b) Total risk-weighted assets for securitization exposures. A
[BANK]'s total risk-weighted assets for securitization exposures is
equal to the sum of its risk-weighted assets calculated using
Sec. Sec. --.141 through 146.
(c) Deductions. A [BANK] may calculate any deduction from common
equity tier 1 capital for a securitization exposure net of any DTLs
associated with the securitization exposure.
(d) Maximum risk-based capital requirement. Except as provided in
Sec. --.141(c), unless one or more underlying exposures does not meet
the definition of a wholesale, retail, securitization, or equity
exposure, the total risk-based capital requirement for all
securitization exposures held by a single [BANK] associated with a
single securitization (excluding any risk-based capital requirements
that relate to the [BANK]'s gain-on-sale or CEIOs associated with the
securitization) may not exceed the sum of:
(1) The [BANK]'s total risk-based capital requirement for the
underlying exposures calculated under this subpart as if the [BANK]
directly held the underlying exposures; and
(2) The total ECL of the underlying exposures calculated under this
subpart.
(e) Exposure amount of a securitization exposure. (1) The exposure
amount of an on-balance sheet securitization exposure that is not a
repo-style transaction, eligible margin loan, OTC derivative contract,
or cleared transaction is the [BANK]'s carrying value.
(2) Except as provided in paragraph (m) of this section, the
exposure amount of an off-balance sheet securitization exposure that is
not an OTC derivative contract (other than a credit derivative), repo-
style transaction, eligible margin loan, or cleared transaction (other
than a credit derivative) is the notional amount of the exposure. For
an off-balance-sheet securitization exposure to an ABCP program, such
as an eligible ABCP liquidity facility, the notional amount may be
reduced to the maximum potential amount that the [BANK] could be
required to fund given the ABCP program's current underlying assets
(calculated without regard to the current credit quality of those
assets).
(3) The exposure amount of a securitization exposure that is a
repo-style transaction, eligible margin loan, or OTC derivative
contract (other than a credit derivative) or cleared transaction (other
than a credit derivative) is the EAD of the exposure as calculated in
Sec. --.132 or Sec. --.133.
(f) Overlapping exposures. If a [BANK] has multiple securitization
exposures that provide duplicative coverage of the underlying exposures
of a securitization (such as when a [BANK] provides a program-wide
credit enhancement and multiple pool-specific liquidity facilities to
an ABCP program), the [BANK] is not required to hold duplicative risk-
based capital against the overlapping position. Instead, the [BANK] may
assign to the overlapping securitization exposure the applicable risk-
based capital treatment under this subpart that results in the highest
risk-based capital requirement.
(g) Securitizations of non-IRB exposures. Except as provided in
Sec. --.141(c), if a [BANK] has a securitization exposure where any
underlying exposure is not a wholesale exposure, retail exposure,
securitization exposure, or equity exposure, the [BANK]:
(1) Must deduct from common equity tier 1 capital any after-tax
gain-on-sale resulting from the securitization and apply a 1,250
percent risk weight to the portion of any CEIO that does not constitute
gain-on-sale, if the [BANK] is an originating [BANK];
(2) May apply the simplified supervisory formula approach in Sec.
--.144 to the exposure, if the securitization exposure does not require
deduction or a 1,250 percent risk weight under paragraph (g)(1) of this
section;
(3) Must assign a 1,250 percent risk weight to the exposure if the
securitization exposure does not require deduction or a 1,250 percent
risk weight under paragraph (g)(1) of this section, does not qualify
for the supervisory formula approach in Sec. --.143, and the [BANK]
does not apply the simplified supervisory formula approach in Sec.
--.144 to the exposure.
(h) Implicit support. If a [BANK] provides support to a
securitization in excess of the [BANK]'s contractual obligation to
provide credit support to the securitization (implicit support):
(1) The [BANK] must calculate a risk-weighted asset amount for
underlying exposures associated with the securitization as if the
exposures had not been securitized and must deduct from common equity
tier 1 capital any after-tax gain-on-sale resulting from the
securitization; and
(2) The [BANK] must disclose publicly:
(i) That it has provided implicit support to the securitization;
and
(ii) The regulatory capital impact to the [BANK] of providing such
implicit support.
(i) Undrawn portion of a servicer cash advance facility. (1)
Notwithstanding any other provision of this subpart, a [BANK] that is a
servicer under an eligible servicer cash advance facility is not
required to hold risk-based capital against potential future cash
advance payments that it may be required to
[[Page 62234]]
provide under the contract governing the facility.
(2) For a [BANK] that acts as a servicer, the exposure amount for a
servicer cash advance facility that is not an eligible servicer cash
advance facility is equal to the amount of all potential future cash
advance payments that the [BANK] may be contractually required to
provide during the subsequent 12 month period under the contract
governing the facility.
(j) Interest-only mortgage-backed securities. Regardless of any
other provisions in this part, the risk weight for a non-credit-
enhancing interest-only mortgage-backed security may not be less than
100 percent.
(k) Small-business loans and leases on personal property
transferred with recourse. (1) Notwithstanding any other provisions of
this subpart E, a [BANK] that has transferred small-business loans and
leases on personal property (small-business obligations) with recourse
must include in risk-weighted assets only the contractual amount of
retained recourse if all the following conditions are met:
(i) The transaction is a sale under GAAP.
(ii) The [BANK] establishes and maintains, pursuant to GAAP, a non-
capital reserve sufficient to meet the [BANK]'s reasonably estimated
liability under the recourse arrangement.
(iii) The loans and leases are to businesses that meet the criteria
for a small-business concern established by the Small Business
Administration under section 3(a) of the Small Business Act (15 U.S.C.
632 et seq.); and
(iv) The [BANK] is well-capitalized, as defined in [12 CFR 6.4
(OCC); 12 CFR 208.43 (Board)]. For purposes of determining whether a
[BANK] is well capitalized for purposes of this paragraph (k), the
[BANK]'s capital ratios must be calculated without regard to the
capital treatment for transfers of small-business obligations with
recourse specified in paragraph (k)(1) of this section.
(2) The total outstanding amount of recourse retained by a [BANK]
on transfers of small-business obligations subject to paragraph (k)(1)
of this section cannot exceed 15 percent of the [BANK]'s total capital.
(3) If a [BANK] ceases to be well capitalized or exceeds the 15
percent capital limitation in paragraph (k)(2) of this section, the
preferential capital treatment specified in paragraph (k)(1) of this
section will continue to apply to any transfers of small-business
obligations with recourse that occurred during the time that the [BANK]
was well capitalized and did not exceed the capital limit.
(4) The risk-based capital ratios of a [BANK] must be calculated
without regard to the capital treatment for transfers of small-business
obligations with recourse specified in paragraph (k)(1) of this
section.
(l) Nth-to-default credit derivatives--(1) Protection provider. A
[BANK] must determine a risk weight using the supervisory formula
approach (SFA) pursuant to Sec. --.143 or the simplified supervisory
formula approach (SSFA) pursuant to Sec. --.144 for an nth-to-default
credit derivative in accordance with this paragraph (l). In the case of
credit protection sold, a [BANK] must determine its exposure in the
nth-to-default credit derivative as the largest notional
amount of all the underlying exposures.
(2) For purposes of determining the risk weight for an
nth-to-default credit derivative using the SFA or the SSFA,
the [BANK] must calculate the attachment point and detachment point of
its exposure as follows:
(i) The attachment point (parameter A) is the ratio of the sum of
the notional amounts of all underlying exposures that are subordinated
to the [BANK]'s exposure to the total notional amount of all underlying
exposures. For purposes of the SSFA, parameter A is expressed as a
decimal value between zero and one. For purposes of using the SFA to
calculate the risk weight for its exposure in an nth-to-
default credit derivative, parameter A must be set equal to the credit
enhancement level (L) input to the SFA formula. In the case of a first-
to-default credit derivative, there are no underlying exposures that
are subordinated to the [BANK]'s exposure. In the case of a second-or-
subsequent-to-default credit derivative, the smallest (n-1) risk-
weighted asset amounts of the underlying exposure(s) are subordinated
to the [BANK]'s exposure.
(ii) The detachment point (parameter D) equals the sum of parameter
A plus the ratio of the notional amount of the [BANK]'s exposure in the
nth-to-default credit derivative to the total notional
amount of all underlying exposures. For purposes of the SSFA, parameter
W is expressed as a decimal value between zero and one. For purposes of
the SFA, parameter D must be set to equal L plus the thickness of
tranche T input to the SFA formula.
(3) A [BANK] that does not use the SFA or the SSFA to determine a
risk weight for its exposure in an nth-to-default credit
derivative must assign a risk weight of 1,250 percent to the exposure.
(4) Protection purchaser--(i) First-to-default credit derivatives.
A [BANK] that obtains credit protection on a group of underlying
exposures through a first-to-default credit derivative that meets the
rules of recognition of Sec. --.134(b) must determine its risk-based
capital requirement under this subpart for the underlying exposures as
if the [BANK] synthetically securitized the underlying exposure with
the lowest risk-based capital requirement and had obtained no credit
risk mitigant on the other underlying exposures. A [BANK] must
calculate a risk-based capital requirement for counterparty credit risk
according to Sec. --.132 for a first-to-default credit derivative that
does not meet the rules of recognition of Sec. --.134(b).
(ii) Second-or-subsequent-to-default credit derivatives. (A) A
[BANK] that obtains credit protection on a group of underlying
exposures through a nth-to-default credit derivative that
meets the rules of recognition of Sec. --.134(b) (other than a first-
to-default credit derivative) may recognize the credit risk mitigation
benefits of the derivative only if:
(1) The [BANK] also has obtained credit protection on the same
underlying exposures in the form of first-through-(n-1)-to-default
credit derivatives; or
(2) If n-1 of the underlying exposures have already defaulted.
(B) If a [BANK] satisfies the requirements of paragraph
(l)(3)(ii)(A) of this section, the [BANK] must determine its risk-based
capital requirement for the underlying exposures as if the bank had
only synthetically securitized the underlying exposure with the
nth smallest risk-based capital requirement and had obtained
no credit risk mitigant on the other underlying exposures.
(C) A [BANK] must calculate a risk-based capital requirement for
counterparty credit risk according to Sec. --.132 for a
nth-to-default credit derivative that does not meet the
rules of recognition of Sec. --.134(b).
(m) Guarantees and credit derivatives other than nth-to-default
credit derivatives--(1) Protection provider. For a guarantee or credit
derivative (other than an nth-to-default credit derivative)
provided by a [BANK] that covers the full amount or a pro rata share of
a securitization exposure's principal and interest, the [BANK] 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.
(2) Protection purchaser. (i) A [BANK] that purchases an OTC credit
derivative (other than an nth-to-default credit derivative)
that is recognized under
[[Page 62235]]
Sec. --.145 as a credit risk mitigant (including via recognized
collateral) is not required to compute a separate counterparty credit
risk capital requirement under Sec. --.131 in accordance with Sec.
--.132(c)(3).
(ii) If a [BANK] cannot, or chooses not to, recognize a purchased
credit derivative as a credit risk mitigant under Sec. --.145, the
[BANK] must determine the exposure amount of the credit derivative
under Sec. --.132(c).
(A) If the [BANK] purchases credit protection from a counterparty
that is not a securitization SPE, the [BANK] must determine the risk
weight for the exposure according Sec. --.131.
(B) If the [BANK] purchases the credit protection from a
counterparty that is a securitization SPE, the [BANK] must determine
the risk weight for the exposure according to this section, including
paragraph (a)(5) of this section for a credit derivative that has a
first priority claim on the cash flows from the underlying exposures of
the securitization SPE (notwithstanding amounts due under interest rate
or currency derivative contracts, fees due, or other similar payments.
Sec. --.143 Supervisory formula approach (SFA).
(a) Eligibility requirements. A [BANK] must use the SFA to
determine its risk-weighted asset amount for a securitization exposure
if the [BANK] can calculate on an ongoing basis each of the SFA
parameters in paragraph (e) of this section.
(b) Mechanics. The risk-weighted asset amount for a securitization
exposure equals its SFA risk-based capital requirement as calculated
under paragraph (c) and (d) of this section, multiplied by 12.5.
(c) The SFA risk-based capital requirement. (1) If KIRB
is greater than or equal to L + T, an exposure's SFA risk-based capital
requirement equals the exposure amount.
(2) If KIRB is less than or equal to L, an exposure's
SFA risk-based capital requirement is UE multiplied by TP multiplied by
the greater of:
(i) F [middot] T (where F is 0.016 for all securitization
exposures); or
(ii) S[L + T]-S[L].
(3) If KIRB is greater than L and less than L + T, the
[BANK] must apply a 1,250 percent risk weight to an amount equal to UE
[middot] TP (KIRB-L), and the exposure's SFA risk-based
capital requirement is UE multiplied by TP multiplied by the greater
of:
(i) F [middot] (T-(KIRB-L)) (where F is 0.016 for all
other securitization exposures); or
(ii) S[L + T]-S[KIRB].
(d) The supervisory formula:
[[Page 62236]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.049
(e) SFA parameters. For purposes of the calculations in paragraphs
(c) and (d) of this section:
(1) Amount of the underlying exposures (UE). UE is the EAD of any
underlying exposures that are wholesale and retail exposures (including
the amount of any funded spread accounts, cash collateral accounts, and
other similar funded credit enhancements) plus the amount of any
underlying exposures that are securitization exposures (as defined in
Sec. --.142(e)) plus the adjusted carrying value of any underlying
exposures that are equity exposures (as defined in Sec. --.151(b)).
(2) Tranche percentage (TP). TP is the ratio of the amount of the
[BANK]'s securitization exposure to the amount of the tranche that
contains the securitization exposure.
(3) Capital requirement on underlying exposures (KIRB). (i)
KIRB is the ratio of:
(A) The sum of the risk-based capital requirements for the
underlying exposures plus the expected credit losses of the underlying
exposures (as determined under this subpart E as if the underlying
exposures were directly held by the [BANK]); to
(B) UE.
(ii) The calculation of KIRB must reflect the effects of
any credit risk mitigant applied to the underlying exposures (either to
an individual underlying exposure, to a group of underlying exposures,
or to all of the underlying exposures).
(iii) All assets related to the securitization are treated as
underlying exposures, including assets in a reserve account (such as a
cash collateral account).
(4) Credit enhancement level (L). (i) L is the ratio of:
(A) The amount of all securitization exposures subordinated to the
tranche
[[Page 62237]]
that contains the [BANK]'s securitization exposure; to
(B) UE.
(ii) A [BANK] must determine L before considering the effects of
any tranche-specific credit enhancements.
(iii) Any gain-on-sale or CEIO associated with the securitization
may not be included in L.
(iv) Any reserve account funded by accumulated cash flows from the
underlying exposures that is subordinated to the tranche that contains
the [BANK]'s securitization exposure may be included in the numerator
and denominator of L to the extent cash has accumulated in the account.
Unfunded reserve accounts (that is, reserve accounts that are to be
funded from future cash flows from the underlying exposures) may not be
included in the calculation of L.
(v) In some cases, the purchase price of receivables will reflect a
discount that provides credit enhancement (for example, first loss
protection) for all or certain tranches of the securitization. When
this arises, L should be calculated inclusive of this discount if the
discount provides credit enhancement for the securitization exposure.
(5) Thickness of tranche (T). T is the ratio of:
(i) The amount of the tranche that contains the [BANK]'s
securitization exposure; to
(ii) UE.
(6) Effective number of exposures (N). (i) Unless the [BANK] elects
to use the formula provided in paragraph (f) of this section,
[GRAPHIC] [TIFF OMITTED] TR11OC13.050
where EADi represents the EAD associated with the ith
instrument in the underlying exposures.
(ii) Multiple exposures to one obligor must be treated as a single
underlying exposure.
(iii) In the case of a resecuritization, the [BANK] must treat each
underlying exposure as a single underlying exposure and must not look
through to the originally securitized underlying exposures.
(7) Exposure-weighted average loss given default (EWALGD). EWALGD
is calculated as:
[GRAPHIC] [TIFF OMITTED] TR11OC13.051
where LGDi represents the average LGD associated with all
exposures to the ith obligor. In the case of a resecuritization, an
LGD of 100 percent must be assumed for the underlying exposures that
are themselves securitization exposures.
(f) Simplified method for computing N and EWALGD. (1) If all
underlying exposures of a securitization are retail exposures, a [BANK]
may apply the SFA using the following simplifications:
(i) h = 0; and
(ii) v = 0.
(2) Under the conditions in Sec. Sec. .--143(f)(3) and (f)(4), a
[BANK] may employ a simplified method for calculating N and EWALGD.
(3) If C1 is no more than 0.03, a [BANK] may set EWALGD
= 0.50 if none of the underlying exposures is a securitization
exposure, or may set EWALGD = 1 if one or more of the underlying
exposures is a securitization exposure, and may set N equal to the
following amount:
[GRAPHIC] [TIFF OMITTED] TR11OC13.052
where:
(i) Cm is the ratio of the sum of the amounts of the `m'
largest underlying exposures to UE; and
(ii) The level of m is to be selected by the [BANK].
(4) Alternatively, if only C1 is available and
C1 is no more than 0.03, the [BANK] may set EWALGD = 0.50 if
none of the underlying exposures is a securitization exposure, or may
set EWALGD = 1 if one or more of the underlying exposures is a
securitization exposure and may set N = 1/C1.
Sec. --.144 Simplified supervisory formula approach (SSFA).
(a) General requirements for the SSFA. To use the SSFA to determine
the risk weight for a securitization exposure, a [BANK] must have data
that enables it to assign accurately the parameters described in
paragraph (b) of this section. Data used to assign the parameters
described in paragraph (b) of this section must be the most currently
available data; if the contracts governing the underlying exposures of
the securitization require payments on a monthly or quarterly basis,
the data used to assign the parameters described in paragraph (b) of
this section must be no more than 91 calendar days old. A [BANK] that
does not have the appropriate data to assign the parameters described
in paragraph (b) of this section must assign a risk weight of 1,250
percent to the exposure.
(b) SSFA parameters. To calculate the risk weight for a
securitization exposure using the SSFA, a [BANK] must have accurate
information on the following five inputs to the SSFA calculation:
(1) KG is the weighted-average (with unpaid principal
used as the weight for each exposure) total capital requirement of the
underlying exposures calculated using subpart D of this part.
KG is expressed as a decimal value between zero and one
(that is, an average risk weight of 100 percent represents a value of
KG equal to 0.08).
(2) Parameter W is expressed as a decimal value between zero and
one. Parameter W is the ratio of the sum of the dollar amounts of any
underlying exposures of the securitization that meet any of the
criteria as set forth in paragraphs (b)(2)(i) through (vi) of this
section to the balance, measured in dollars, of underlying exposures:
(i) Ninety days or more past due;
(ii) Subject to a bankruptcy or insolvency proceeding;
(iii) In the process of foreclosure;
(iv) Held as real estate owned;
(v) Has contractually deferred payments for 90 days or more, other
than principal or interest payments deferred on:
(A) Federally-guaranteed student loans, in accordance with the
terms of those guarantee programs; or
(B) 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; or
(vi) Is in default.
(3) Parameter A is the attachment point for the exposure, which
represents the threshold at which credit losses will first be allocated
to the exposure. Except
[[Page 62238]]
as provided in section 142(l) for nth-to-default credit
derivatives, parameter A equals the ratio of the current dollar amount
of underlying exposures that are subordinated to the exposure of the
[BANK] to the current dollar amount of underlying exposures. Any
reserve account funded by the accumulated cash flows from the
underlying exposures that is subordinated to the [BANK]'s
securitization exposure may be included in the calculation of parameter
A to the extent that cash is present in the account. Parameter A is
expressed as a decimal value between zero and one.
(4) Parameter D is the detachment point for the exposure, which
represents the threshold at which credit losses of principal allocated
to the exposure would result in a total loss of principal. Except as
provided in section 142(l) for nth-to-default credit
derivatives, parameter D equals parameter A plus the ratio of the
current dollar amount of the securitization exposures that are pari
passu with the exposure (that is, have equal seniority with respect to
credit risk) to the current dollar amount of the underlying exposures.
Parameter D is expressed as a decimal value between zero and one.
(5) A supervisory calibration parameter, p, is equal to 0.5 for
securitization exposures that are not resecuritization exposures and
equal to 1.5 for resecuritization exposures.
(c) Mechanics of the SSFA. KG and W are used to
calculate KA, the augmented value of KG, which
reflects the observed credit quality of the underlying exposures.
KA is defined in paragraph (d) of this section. The values
of parameters A and D, relative to KA determine the risk
weight assigned to a securitization exposure as described in paragraph
(d) of this section. The risk weight assigned to a securitization
exposure, or portion of a securitization exposure, as appropriate, is
the larger of the risk weight determined in accordance with this
paragraph (c), paragraph (d) of this section, and a risk weight of 20
percent.
(1) When the detachment point, 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;
(2) When the attachment point, parameter A, for a securitization
exposure is greater than or equal to KA, the [BANK] must
calculate the risk weight in accordance with paragraph (d) of this
section;
(3) When A is less than KA and D is greater than
KA, the risk weight is a weighted-average of 1,250 percent
and 1,250 percent times KSSFA calculated in accordance with
paragraph (d) of this section. For the purpose of this weighted-average
calculation:
[[Page 62239]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.053
Sec. --.145 Recognition of credit risk mitigants for securitization
exposures.
(a) General. An originating [BANK] that has obtained a credit risk
mitigant to hedge its securitization exposure to a synthetic or
traditional securitization that satisfies the operational criteria in
Sec. --.141 may recognize the credit risk mitigant, but only as
provided in this section. An investing [BANK] that has obtained a
credit risk mitigant to hedge a securitization exposure may recognize
the credit risk mitigant, but only as provided in this section.
(b) Collateral. (1) Rules of recognition. A [BANK] may recognize
financial collateral in determining the [BANK]'s risk-weighted asset
amount for a securitization exposure (other than a repo-style
transaction, an eligible margin loan, or an OTC derivative contract for
which the [BANK] has reflected collateral in its determination of
exposure amount under Sec. --.132) as follows. The [BANK]'s risk-
weighted asset amount for the collateralized securitization exposure is
equal to the risk-weighted asset amount for the securitization exposure
as calculated under the SSFA in Sec. --.144 or under the SFA in Sec.
--.143 multiplied by the ratio of adjusted exposure amount (SE*) to
original exposure amount (SE),
Where:
(i) SE* = max {0, [SE-C x (1-Hs-Hfx)]{time} ;
(ii) SE = the amount of the securitization exposure calculated under
Sec. --.142(e);
(iii) C = the current fair value of the collateral;
(iv) Hs = the haircut appropriate to the collateral type;
and
(v) Hfx = the haircut appropriate for any currency
mismatch between the collateral and the exposure.
[[Page 62240]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.054
(3) Standard supervisory haircuts. Unless a [BANK] qualifies for
use of and uses own-estimates haircuts in paragraph (b)(4) of this
section:
(i) A [BANK] must use the collateral type haircuts (Hs)
in Table 1 to Sec. --.132 of this subpart;
(ii) A [BANK] must use a currency mismatch haircut (Hfx)
of 8 percent if the exposure and the collateral are denominated in
different currencies;
(iii) A [BANK] must multiply the supervisory haircuts obtained in
paragraphs (b)(3)(i) and (ii) of this section by the square root of 6.5
(which equals 2.549510); and
(iv) A [BANK] must adjust the supervisory haircuts upward on the
basis of a holding period longer than 65 business days where and as
appropriate to take into account the illiquidity of the collateral.
(4) Own estimates for haircuts. With the prior written approval of
the [AGENCY], a [BANK] may calculate haircuts using its own internal
estimates of market price volatility and foreign exchange volatility,
subject to Sec. --.132(b)(2)(iii). The minimum holding period
(TM) for securitization exposures is 65 business days.
(c) Guarantees and credit derivatives--(1) Limitations on
recognition. A [BANK] may only recognize an eligible guarantee or
eligible credit derivative provided by an eligible guarantor in
determining the [BANK]'s risk-weighted asset amount for a
securitization exposure.
(2) ECL for securitization exposures. When a [BANK] recognizes an
eligible guarantee or eligible credit derivative provided by an
eligible guarantor in determining the [BANK]'s risk-weighted asset
amount for a securitization exposure, the [BANK] must also:
(i) Calculate ECL for the protected portion of the exposure using
the same risk parameters that it uses for calculating the risk-weighted
asset amount of the exposure as described in paragraph (c)(3) of this
section; and
(ii) Add the exposure's ECL to the [BANK]'s total ECL.
(3) Rules of recognition. A [BANK] may recognize an eligible
guarantee or eligible credit derivative provided by an eligible
guarantor in determining the [BANK]'s risk-weighted asset amount for
the securitization exposure as follows:
(i) Full coverage. If the protection amount of the eligible
guarantee or eligible credit derivative equals or exceeds the amount of
the securitization exposure, the [BANK] may set the risk-weighted asset
amount for the securitization exposure equal to the risk-weighted asset
amount for a direct exposure to the eligible guarantor (as determined
in the wholesale risk weight function described in Sec. --.131), using
the [BANK]'s PD for the guarantor, the [BANK]'s LGD for the guarantee
or credit derivative, and an EAD equal to the amount of the
securitization exposure (as determined in Sec. --.142(e)).
(ii) Partial coverage. If the protection amount of the eligible
guarantee or eligible credit derivative is less than the amount of the
securitization exposure, the [BANK] may set the risk-weighted asset
amount for the securitization exposure equal to the sum of:
(A) Covered portion. The risk-weighted asset amount for a direct
exposure to the eligible guarantor (as determined in the wholesale risk
weight function described in Sec. --.131), using the [BANK]'s PD for
the guarantor, the [BANK]'s LGD for the guarantee or credit derivative,
and an EAD equal to the protection amount of the credit risk mitigant;
and
(B) Uncovered portion. (1) 1.0 minus the ratio of the protection
amount of the eligible guarantee or eligible credit derivative to the
amount of the securitization exposure); multiplied by
(2) The risk-weighted asset amount for the securitization exposure
without the credit risk mitigant (as determined in Sec. Sec. --.142
through 146).
(4) Mismatches. The [BANK] must make applicable adjustments to the
protection amount as required in Sec. --.134(d), (e), and (f) for any
hedged securitization exposure and any more senior securitization
exposure that benefits from the hedge. In the context of a synthetic
securitization, when an eligible guarantee or eligible credit
derivative covers multiple hedged exposures that have different
residual maturities, the [BANK] must use the longest residual maturity
of any of the hedged exposures as the residual maturity of all the
hedged exposures.
Sec. Sec. --.146 through --.150 [Reserved]
Risk-Weighted Assets for Equity Exposures
Sec. --.151 Introduction and exposure measurement.
(a) General. (1) To calculate its risk-weighted asset amounts for
equity exposures that are not equity exposures to investment funds, a
[BANK] may apply either the Simple Risk Weight Approach (SRWA) in Sec.
--.152 or, if it qualifies to do so, the Internal Models Approach (IMA)
in Sec. --.153. A [BANK] must use the look-through approaches provided
in Sec. --.154 to calculate its risk-weighted asset amounts for equity
exposures to investment funds.
(2) A [BANK] must treat an investment in a separate account (as
defined in Sec. --.2), as if it were an equity exposure to an
investment fund as provided in Sec. --.154.
(3) Stable value protection. (i) Stable value protection means a
contract where the provider of the contract is obligated to pay:
(A) The policy owner of a 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, or
(B) The beneficiary of the contract an amount equal to the
shortfall between the fair value and book value of a specified
portfolio of assets.
(ii) A [BANK] 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 of the carrying value of its
separate account as an equity exposure to an investment fund.
[[Page 62241]]
(iii) A [BANK] that provides stable value protection must treat the
exposure as an equity derivative with an adjusted carrying value
determined as the sum of Sec. --.151(b)(1) and (2).
(b) Adjusted carrying value. For purposes of this subpart, the
adjusted carrying value of an equity exposure is:
(1) For the on-balance sheet component of an equity exposure, the
[BANK]'s carrying value of the exposure;
(2) For the off-balance sheet component of an equity exposure, the
effective notional principal amount of the exposure, the size of which
is equivalent to a hypothetical on-balance sheet position in the
underlying equity instrument that would evidence the same change in
fair value (measured in dollars) for a given small change in the price
of the underlying equity instrument, minus the adjusted carrying value
of the on-balance sheet component of the exposure as calculated in
paragraph (b)(1) of this section.
(3) For unfunded equity commitments that are unconditional, the
effective notional principal amount is the notional amount of the
commitment. For unfunded equity commitments that are conditional, the
effective notional principal amount is the [BANK]'s best estimate of
the amount that would be funded under economic downturn conditions.
Sec. --.152 Simple risk weight approach (SRWA).
(a) General. Under the SRWA, a [BANK]'s aggregate risk-weighted
asset amount for its equity exposures is equal to the sum of the risk-
weighted asset amounts for each of the [BANK]'s individual equity
exposures (other than equity exposures to an investment fund) as
determined in this section and the risk-weighted asset amounts for each
of the [BANK]'s individual equity exposures to an investment fund as
determined in Sec. --.154.
(b) SRWA computation for individual equity exposures. A [BANK] must
determine the risk-weighted asset amount for an individual equity
exposure (other than an equity exposure to an investment fund) by
multiplying the adjusted carrying value of the equity exposure or the
effective portion and ineffective portion of a hedge pair (as defined
in paragraph (c) of this section) by the lowest applicable risk weight
in this section.
(1) Zero percent risk weight equity exposures. An equity exposure
to an entity whose credit exposures are exempt from the 0.03 percent PD
floor in Sec. --.131(d)(2) is assigned a zero percent risk weight.
(2) 20 percent risk weight equity exposures. An equity exposure to
a Federal Home Loan Bank or the Federal Agricultural Mortgage
Corporation (Farmer Mac) is assigned a 20 percent risk weight.
(3) 100 percent risk weight equity exposures. The following equity
exposures are assigned a 100 percent risk weight:
(i) Community development equity exposures. An equity exposure that
qualifies as a community development investment under section 24
(Eleventh) of the National Bank Act, 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.
(ii) Effective portion of hedge pairs. The effective portion of a
hedge pair.
(iii) Non-significant equity exposures. Equity exposures, excluding
significant investments in the capital of an unconsolidated institution
in the form of common stock and exposures to an investment firm that
would meet the definition of a traditional securitization were it not
for the [AGENCY]'s application of paragraph (8) of that definition in
Sec. --.2 and has greater than immaterial leverage, to the extent that
the aggregate adjusted carrying value of the exposures does not exceed
10 percent of the [BANK]'s total capital.
(A) To compute the aggregate adjusted carrying value of a [BANK]'s
equity exposures for purposes of this section, the [BANK] may exclude
equity exposures described in paragraphs (b)(1), (b)(2), (b)(3)(i), and
(b)(3)(ii) of this section, the equity exposure in a hedge pair with
the smaller adjusted carrying value, and a proportion of each equity
exposure to an investment fund equal to the proportion of the assets of
the investment fund that are not equity exposures or that meet the
criterion of paragraph (b)(3)(i) of this section. If a [BANK] does not
know the actual holdings of the investment fund, the [BANK] may
calculate the proportion of the assets of the fund that are not equity
exposures based on the terms of the prospectus, partnership agreement,
or similar contract that defines the fund's permissible investments. If
the sum of the investment limits for all exposure classes within the
fund exceeds 100 percent, the [BANK] must assume for purposes of this
section that the investment fund invests to the maximum extent possible
in equity exposures.
(B) When determining which of a [BANK]'s equity exposures qualifies
for a 100 percent risk weight under this section, a [BANK] first must
include equity exposures to unconsolidated small business investment
companies or held through consolidated small business investment
companies described in section 302 of the Small Business Investment
Act, then must include publicly traded equity exposures (including
those held indirectly through investment funds), and then must include
non-publicly traded equity exposures (including those held indirectly
through investment funds).
(4) 250 percent risk weight equity exposures. Significant
investments in the capital of unconsolidated financial institutions in
the form of common stock that are not deducted from capital pursuant to
Sec. --.22(b)(4) are assigned a 250 percent risk weight.
(5) 300 percent risk weight equity exposures. A publicly traded
equity exposure (other than an equity exposure described in paragraph
(b)(6) of this section and including the ineffective portion of a hedge
pair) is assigned a 300 percent risk weight.
(6) 400 percent risk weight equity exposures. An equity exposure
(other than an equity exposure described in paragraph (b)(6) of this
section) that is not publicly traded is assigned a 400 percent risk
weight.
(7) 600 percent risk weight equity exposures. An equity exposure to
an investment firm that:
(i) Would meet the definition of a traditional securitization were
it not for the [AGENCY]'s application of paragraph (8) of that
definition in Sec. --.2; and
(ii) Has greater than immaterial leverage is assigned a 600 percent
risk weight.
(c) Hedge transactions--(1) Hedge pair. A hedge pair is two equity
exposures that form an effective hedge so long as each equity exposure
is publicly traded or has a return that is primarily based on a
publicly traded equity exposure.
(2) Effective hedge. Two equity exposures form an effective hedge
if the exposures either have the same remaining maturity or each has a
remaining maturity of at least three months; the hedge relationship is
formally documented in a prospective manner (that is, before the [BANK]
acquires at least one of the equity exposures); the documentation
specifies the measure of effectiveness (E) the [BANK] will use for the
hedge relationship throughout the life of the transaction; and the
hedge relationship
[[Page 62242]]
has an E greater than or equal to 0.8. A [BANK] must measure E at least
quarterly and must use one of three alternative measures of E:
(i) Under the dollar-offset method of measuring effectiveness, the
[BANK] must determine the ratio of value change (RVC). The RVC is the
ratio of the cumulative sum of the periodic changes in value of one
equity exposure to the cumulative sum of the periodic changes in the
value of the other equity exposure. If RVC is positive, the hedge is
not effective and E equals zero. If RVC is negative and greater than or
equal to -1 (that is, between zero and -1), then E equals the absolute
value of RVC. If RVC is negative and less than -1, then E equals 2 plus
RVC.
(ii) Under the variability-reduction method of measuring
effectiveness:
[GRAPHIC] [TIFF OMITTED] TR11OC13.055
(iii) Under the regression method of measuring effectiveness, E
equals the coefficient of determination of a regression in which the
change in value of one exposure in a hedge pair is the dependent
variable and the change in value of the other exposure in a hedge pair
is the independent variable. However, if the estimated regression
coefficient is positive, then the value of E is zero.
(3) The effective portion of a hedge pair is E multiplied by the
greater of the adjusted carrying values of the equity exposures forming
a hedge pair.
(4) The ineffective portion of a hedge pair is (1-E) multiplied by
the greater of the adjusted carrying values of the equity exposures
forming a hedge pair.
Sec. --.153 Internal models approach (IMA).
(a) General. A [BANK] may calculate its risk-weighted asset amount
for equity exposures using the IMA by modeling publicly traded and non-
publicly traded equity exposures (in accordance with paragraph (c) of
this section) or by modeling only publicly traded equity exposures (in
accordance with paragraphs (c) and (d) of this section).
(b) Qualifying criteria. To qualify to use the IMA to calculate
risk-weighted assets for equity exposures, a [BANK] must receive prior
written approval from the [AGENCY]. To receive such approval, the
[BANK] must demonstrate to the [AGENCY]'s satisfaction that the [BANK]
meets the following criteria:
(1) The [BANK] must have one or more models that:
(i) Assess the potential decline in value of its modeled equity
exposures;
(ii) Are commensurate with the size, complexity, and composition of
the [BANK]'s modeled equity exposures; and
(iii) Adequately capture both general market risk and idiosyncratic
risk.
(2) The [BANK]'s model must produce an estimate of potential losses
for its modeled equity exposures that is no less than the estimate of
potential losses produced by a VaR methodology employing a 99th
percentile one-tailed confidence interval of the distribution of
quarterly returns for a benchmark portfolio of equity exposures
comparable to the [BANK]'s modeled equity exposures using a long-term
sample period.
(3) The number of risk factors and exposures in the sample and the
data period used for quantification in the [BANK]'s model and
benchmarking exercise must be sufficient to provide confidence in the
accuracy and robustness of the [BANK]'s estimates.
(4) The [BANK]'s model and benchmarking process must incorporate
data that are relevant in representing the risk profile of the [BANK]'s
modeled equity exposures, and must include data from at least one
equity market cycle containing adverse market movements relevant to the
risk profile of the [BANK]'s modeled equity exposures. In addition, the
[BANK]'s benchmarking exercise must be based on daily market prices for
the benchmark portfolio. If the [BANK]'s model uses a scenario
methodology, the [BANK] must demonstrate that the model produces a
conservative estimate of potential losses on the [BANK]'s modeled
equity exposures over a relevant long-term market cycle. If the [BANK]
employs risk factor models, the [BANK] must demonstrate through
empirical analysis the appropriateness of the risk factors used.
(5) The [BANK] must be able to demonstrate, using theoretical
arguments and empirical evidence, that any proxies used in the modeling
process are comparable to the [BANK]'s modeled equity exposures and
that the [BANK] has made appropriate adjustments for differences. The
[BANK] must derive any proxies for its modeled equity exposures and
benchmark portfolio using historical market data that are relevant to
the [BANK]'s modeled equity exposures and benchmark portfolio (or,
where not, must use appropriately adjusted data), and such proxies must
be robust estimates of the risk of the [BANK]'s modeled equity
exposures.
(c) Risk-weighted assets calculation for a [BANK] using the IMA for
publicly traded and non-publicly traded equity exposures. If a [BANK]
models publicly traded and non-publicly traded equity exposures, the
[BANK]'s aggregate risk-weighted asset amount for its equity exposures
is equal to the sum of:
(1) The risk-weighted asset amount of each equity exposure that
qualifies for a 0 percent, 20 percent, or 100 percent risk weight under
Sec. --.152(b)(1) through (b)(3)(i) (as determined under Sec. --.152)
and each equity exposure to an investment fund (as determined under
Sec. --.154); and
(2) The greater of:
[[Page 62243]]
(i) The estimate of potential losses on the [BANK]'s equity
exposures (other than equity exposures referenced in paragraph (c)(1)
of this section) generated by the [BANK]'s internal equity exposure
model multiplied by 12.5; or
(ii) The sum of:
(A) 200 percent multiplied by the aggregate adjusted carrying value
of the [BANK]'s publicly traded equity exposures that do not belong to
a hedge pair, do not qualify for a 0 percent, 20 percent, or 100
percent risk weight under Sec. --.152(b)(1) through (b)(3)(i), and are
not equity exposures to an investment fund;
(B) 200 percent multiplied by the aggregate ineffective portion of
all hedge pairs; and
(C) 300 percent multiplied by the aggregate adjusted carrying value
of the [BANK]'s equity exposures that are not publicly traded, do not
qualify for a 0 percent, 20 percent, or 100 percent risk weight under
Sec. --.152(b)(1) through (b)(3)(i), and are not equity exposures to
an investment fund.
(d) Risk-weighted assets calculation for a [BANK] using the IMA
only for publicly traded equity exposures. If a [BANK] models only
publicly traded equity exposures, the [BANK]'s aggregate risk-weighted
asset amount for its equity exposures is equal to the sum of:
(1) The risk-weighted asset amount of each equity exposure that
qualifies for a 0 percent, 20 percent, or 100 percent risk weight under
Sec. Sec. --.152(b)(1) through (b)(3)(i) (as determined under Sec.
--.152), each equity exposure that qualifies for a 400 percent risk
weight under Sec. --.152(b)(5) or a 600 percent risk weight under
Sec. --.152(b)(6) (as determined under Sec. --.152), and each equity
exposure to an investment fund (as determined under Sec. --.154); and
(2) The greater of:
(i) The estimate of potential losses on the [BANK]'s equity
exposures (other than equity exposures referenced in paragraph (d)(1)
of this section) generated by the [BANK]'s internal equity exposure
model multiplied by 12.5; or
(ii) The sum of:
(A) 200 percent multiplied by the aggregate adjusted carrying value
of the [BANK]'s publicly traded equity exposures that do not belong to
a hedge pair, do not qualify for a 0 percent, 20 percent, or 100
percent risk weight under Sec. --.152(b)(1) through (b)(3)(i), and are
not equity exposures to an investment fund; and
(B) 200 percent multiplied by the aggregate ineffective portion of
all hedge pairs.
Sec. --.154 Equity exposures to investment funds.
(a) Available approaches. (1) Unless the exposure meets the
requirements for a community development equity exposure in Sec.
--.152(b)(3)(i), a [BANK] must determine the risk-weighted asset amount
of an equity exposure to an investment fund under the full look-through
approach in paragraph (b) of this section, the simple modified look-
through approach in paragraph (c) of this section, or the alternative
modified look-through approach in paragraph (d) of this section.
(2) The risk-weighted asset amount of an equity exposure to an
investment fund that meets the requirements for a community development
equity exposure in Sec. --.152(b)(3)(i) is its adjusted carrying
value.
(3) If an equity exposure to an investment fund is part of a hedge
pair and the [BANK] does not use the full look-through approach, the
[BANK] may use the ineffective portion of the hedge pair as determined
under Sec. --.152(c) as the adjusted carrying value for the equity
exposure to the investment fund. The risk-weighted asset amount of the
effective portion of the hedge pair is equal to its adjusted carrying
value.
(b) Full look-through approach. A [BANK] that is able to calculate
a risk-weighted asset amount for its proportional ownership share of
each exposure held by the investment fund (as calculated under this
subpart E of this part as if the proportional ownership share of each
exposure were held directly by the [BANK]) may either:
(1) Set the risk-weighted asset amount of the [BANK]'s exposure to
the fund equal to the product of:
(i) The aggregate risk-weighted asset amounts of the exposures held
by the fund as if they were held directly by the [BANK]; and
(ii) The [BANK]'s proportional ownership share of the fund; or
(2) Include the [BANK]'s proportional ownership share of each
exposure held by the fund in the [BANK]'s IMA.
(c) Simple modified look-through approach. Under this approach, the
risk-weighted asset amount for a [BANK]'s equity exposure to an
investment fund equals the adjusted carrying value of the equity
exposure multiplied by the highest risk weight assigned according to
subpart D of this part that applies to any exposure the fund is
permitted to hold under its prospectus, partnership agreement, or
similar contract that defines the fund's permissible investments
(excluding derivative contracts that are used for hedging rather than
speculative purposes and that do not constitute a material portion of
the fund's exposures).
(d) Alternative modified look-through approach. Under this
approach, a [BANK] may assign the adjusted carrying value of an equity
exposure to an investment fund on a pro rata basis to different risk
weight categories assigned according to subpart D of this part based on
the investment limits in the fund's prospectus, partnership agreement,
or similar contract that defines the fund's permissible investments.
The risk-weighted asset amount for the [BANK]'s equity exposure to the
investment fund equals the sum of each portion of the adjusted carrying
value assigned to an exposure class multiplied by the applicable risk
weight. If the sum of the investment limits for all exposure types
within the fund exceeds 100 percent, the [BANK] must assume that the
fund invests to the maximum extent permitted under its investment
limits in the exposure type with the highest risk weight under subpart
D of this part, and continues to make investments in order of the
exposure type with the next highest risk weight under subpart D of this
part until the maximum total investment level is reached. If more than
one exposure type applies to an exposure, the [BANK] must use the
highest applicable risk weight. A [BANK] may exclude derivative
contracts held by the fund that are used for hedging rather than for
speculative purposes and do not constitute a material portion of the
fund's exposures.
Sec. --.155 Equity derivative contracts.
(a) Under the IMA, in addition to holding risk-based capital
against an equity derivative contract under this part, a [BANK] must
hold risk-based capital against the counterparty credit risk in the
equity derivative contract by also treating the equity derivative
contract as a wholesale exposure and computing a supplemental risk-
weighted asset amount for the contract under Sec. --.132.
(b) Under the SRWA, a [BANK] may choose not to hold risk-based
capital against the counterparty credit risk of equity derivative
contracts, as long as it does so for all such contracts. Where the
equity derivative contracts are subject to a qualified master netting
agreement, a [BANK] using the SRWA must either include all or exclude
all of the contracts from any measure used to determine counterparty
credit risk exposure.
[[Page 62244]]
Sec. Sec. --.166 through --.160 [Reserved]
Risk-Weighted Assets for Operational Risk
Sec. --.161 Qualification requirements for incorporation of
operational risk mitigants.
(a) Qualification to use operational risk mitigants. A [BANK] may
adjust its estimate of operational risk exposure to reflect qualifying
operational risk mitigants if:
(1) The [BANK]'s operational risk quantification system is able to
generate an estimate of the [BANK]'s operational risk exposure (which
does not incorporate qualifying operational risk mitigants) and an
estimate of the [BANK]'s operational risk exposure adjusted to
incorporate qualifying operational risk mitigants; and
(2) The [BANK]'s methodology for incorporating the effects of
insurance, if the [BANK] uses insurance as an operational risk
mitigant, captures through appropriate discounts to the amount of risk
mitigation:
(i) The residual term of the policy, where less than one year;
(ii) The cancellation terms of the policy, where less than one
year;
(iii) The policy's timeliness of payment;
(iv) The uncertainty of payment by the provider of the policy; and
(v) Mismatches in coverage between the policy and the hedged
operational loss event.
(b) Qualifying operational risk mitigants. Qualifying operational
risk mitigants are:
(1) Insurance that:
(i) Is provided by an unaffiliated company that the [BANK] deems to
have strong capacity to meet its claims payment obligations and the
obligor rating category to which the [BANK] assigns the company is
assigned a PD equal to or less than 10 basis points;
(ii) Has an initial term of at least one year and a residual term
of more than 90 days;
(iii) Has a minimum notice period for cancellation by the provider
of 90 days;
(iv) Has no exclusions or limitations based upon regulatory action
or for the receiver or liquidator of a failed depository institution;
and
(v) Is explicitly mapped to a potential operational loss event;
(2) Operational risk mitigants other than insurance for which the
[AGENCY] has given prior written approval. In evaluating an operational
risk mitigant other than insurance, the [AGENCY] will consider whether
the operational risk mitigant covers potential operational losses in a
manner equivalent to holding total capital.
Sec. --.162 Mechanics of risk-weighted asset calculation.
(a) If a [BANK] does not qualify to use or does not have qualifying
operational risk mitigants, the [BANK]'s dollar risk-based capital
requirement for operational risk is its operational risk exposure minus
eligible operational risk offsets (if any).
(b) If a [BANK] qualifies to use operational risk mitigants and has
qualifying operational risk mitigants, the [BANK]'s dollar risk-based
capital requirement for operational risk is the greater of:
(1) The [BANK]'s operational risk exposure adjusted for qualifying
operational risk mitigants minus eligible operational risk offsets (if
any); or
(2) 0.8 multiplied by the difference between:
(i) The [BANK]'s operational risk exposure; and
(ii) Eligible operational risk offsets (if any).
(c) The [BANK]'s risk-weighted asset amount for operational risk
equals the [BANK]'s dollar risk-based capital requirement for
operational risk determined under sections 162(a) or (b) multiplied by
12.5.
Sec. Sec. --.163 through --.170 [Reserved]
Disclosures
Sec. --.171 Purpose and scope.
Sec. Sec. --.171 through --.173 establish public disclosure
requirements related to the capital requirements of a [BANK] that is an
advanced approaches [BANK].
Sec. --.172 Disclosure requirements.
(a) A [BANK] that is an advanced approaches [BANK] that has
completed the parallel run process and that has received notification
from the [AGENCY] pursuant to section 121(d) of subpart E of this part
must publicly disclose each quarter its total and tier 1 risk-based
capital ratios and their components as calculated under this subpart
(that is, common equity tier 1 capital, additional tier 1 capital, tier
2 capital, total qualifying capital, and total risk-weighted assets).
(b) A [BANK] that is an advanced approaches [BANK] that has
completed the parallel run process and that has received notification
from the [AGENCY] pursuant to section 121(d) of subpart E of this part
must comply with paragraph (c) of this section unless it is a
consolidated subsidiary of a bank holding company, savings and loan
holding company, 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.
(c)(1) A [BANK] described in paragraph (b) of this section must
provide timely public disclosures each calendar quarter of the
information in the applicable tables in Sec. --.173. If a significant
change occurs, such that the most recent reported amounts are no longer
reflective of the [BANK]'s capital adequacy and risk profile, then a
brief discussion of this change and its likely impact must be disclosed
as soon as practicable thereafter. Qualitative disclosures that
typically do not change each quarter (for example, a general summary of
the [BANK]'s risk management objectives and policies, reporting system,
and definitions) may be disclosed annually after the end of the fourth
calendar quarter, provided that any significant changes to these are
disclosed in the interim. Management may provide all of the disclosures
required by this subpart in one place on the [BANK]'s public Web site
or may provide the disclosures in more than one public financial report
or other regulatory reports, provided that the [BANK] publicly provides
a summary table specifically indicating the location(s) of all such
disclosures.
(2) A [BANK] described in paragraph (b) of this section must have a
formal disclosure policy approved by the board of directors that
addresses its approach for determining the disclosures it makes. The
policy must address the associated internal controls and disclosure
controls and procedures. The board of directors and senior management
are responsible for establishing and maintaining an effective internal
control structure over financial reporting, including the disclosures
required by this subpart, and must ensure that appropriate review of
the disclosures takes place. One or more senior officers of the [BANK]
must attest that the disclosures meet the requirements of this subpart.
(3) If a [BANK] described in paragraph (b) of this section believes
that disclosure of specific commercial or financial information would
prejudice seriously its position by making public information that is
either proprietary or confidential in nature, the [BANK] is not
required to disclose those specific items, but must disclose more
general information about the subject matter of the requirement,
together with the fact that, and the reason why, the specific items of
information have not been disclosed.
[[Page 62245]]
Sec. --.173 Disclosures by certain advanced approaches [BANK]s.
(a) Except as provided in Sec. --.172(b), a [BANK] described in
Sec. --.172(b) must make the disclosures described in Tables 1 through
12 to Sec. --.173. The [BANK] must make these disclosures publicly
available for each of the last three years (that is, twelve quarters)
or such shorter period beginning on January 1, 2014.
Table 1 to Sec. --.173--Scope of Application
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. The name of the top
corporate entity in
the group to which
subpart E of this
part applies.
(b).............. A brief description
of the differences
in the basis for
consolidating
entities\1\ for
accounting and
regulatory purposes,
with a description
of those entities:
(1) That are fully
consolidated;
(2) That are
deconsolidated and
deducted from total
capital;
(3) For which the
total capital
requirement is
deducted; and
(4) That are neither
consolidated nor
deducted (for
example, where the
investment in the
entity is assigned a
risk weight in
accordance with this
subpart).
(c).............. Any restrictions, or
other major
impediments, on
transfer of funds or
total capital within
the group.
Quantitative disclosures...... (d).............. The aggregate amount
of surplus capital
of insurance
subsidiaries
included in the
total capital of the
consolidated group.
(e).............. The aggregate amount
by which actual
total capital is
less than the
minimum total
capital requirement
in all subsidiaries,
with total capital
requirements and the
name(s) of the
subsidiaries with
such deficiencies.
------------------------------------------------------------------------
\1\ Such entities include securities, insurance and other financial
subsidiaries, commercial subsidiaries (where permitted), and
significant minority equity investments in insurance, financial and
commercial entities.
Table 2 to Sec. --.173--Capital Structure
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. Summary information
on the terms and
conditions of the
main features of all
regulatory capital
instruments.
Quantitative disclosures...... (b).............. The amount of common
equity tier 1
capital, with
separate disclosure
of:
(1) Common stock and
related surplus;
(2) Retained
earnings;
(3) Common equity
minority interest;
(4) AOCI (net of tax)
and other reserves;
and
(5) Regulatory
adjustments and
deductions made to
common equity tier 1
capital.
(c).............. The amount of tier 1
capital, with
separate disclosure
of:
(1) Additional tier 1
capital elements,
including additional
tier 1 capital
instruments and tier
1 minority interest
not included in
common equity tier 1
capital; and
(2) Regulatory
adjustments and
deductions made to
tier 1 capital.
(d).............. The amount of total
capital, with
separate disclosure
of:
(1) Tier 2 capital
elements, including
tier 2 capital
instruments and
total capital
minority interest
not included in tier
1 capital; and
(2) Regulatory
adjustments and
deductions made to
total capital.
------------------------------------------------------------------------
Table 3 to Sec. --.173--Capital Adequacy
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. A summary discussion
of the [BANK]'s
approach to
assessing the
adequacy of its
capital to support
current and future
activities.
Quantitative disclosures...... (b).............. Risk-weighted assets
for credit risk
from:
(1) Wholesale
exposures;
(2) Residential
mortgage exposures;
(3) Qualifying
revolving exposures;
(4) Other retail
exposures;
(5) Securitization
exposures;
(6) Equity exposures:
(7) Equity exposures
subject to the
simple risk weight
approach; and
(8) Equity exposures
subject to the
internal models
approach.
(c).............. Standardized market
risk-weighted assets
and advanced market
risk-weighted assets
as calculated under
subpart F of this
part:
(1) Standardized
approach for
specific risk; and
(2) Internal models
approach for
specific risk.
(d).............. Risk-weighted assets
for operational
risk.
(e).............. Common equity tier 1,
tier 1 and total
risk-based capital
ratios:
(1) For the top
consolidated group;
and
(2) For each
depository
institution
subsidiary.
(f).............. Total risk-weighted
assets.
------------------------------------------------------------------------
[[Page 62246]]
Table 4 to Sec. --.173--Capital Conservation and Countercyclical
Capital Buffers
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. The [BANK] must
publicly disclose
the geographic
breakdown of its
private sector
credit exposures
used in the
calculation of the
countercyclical
capital buffer.
Quantitative disclosures...... (b).............. At least quarterly,
the [BANK] must
calculate and
publicly disclose
the capital
conservation buffer
and the
countercyclical
capital buffer as
described under Sec.
--.11 of subpart
B.
(c).............. At least quarterly,
the [BANK] must
calculate and
publicly disclose
the buffer retained
income of the
[BANK], as described
under Sec. --.11
of subpart B.
(d).............. At least quarterly,
the [BANK] must
calculate and
publicly disclose
any limitations it
has on distributions
and discretionary
bonus payments
resulting from the
capital conservation
buffer and the
countercyclical
capital buffer
framework described
under Sec. --.11
of subpart B,
including the
maximum payout
amount for the
quarter.
------------------------------------------------------------------------
(b) General qualitative disclosure requirement. For each separate
risk area described in Tables 5 through 12 to Sec. --.173, the [BANK]
must describe its risk management objectives and policies, including:
(1) Strategies and processes;
(2) The structure and organization of the relevant risk management
function;
(3) The scope and nature of risk reporting and/or measurement
systems; and
(4) Policies for hedging and/or mitigating risk and strategies and
processes for monitoring the continuing effectiveness of hedges/
mitigants.
Table 5 \1\ to Sec. --.173--Credit Risk: General Disclosures
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. The general
qualitative
disclosure
requirement with
respect to credit
risk (excluding
counterparty credit
risk disclosed in
accordance with
Table 7 to Sec. --
.173), including:
(1) Policy for
determining past due
or delinquency
status;
(2) Policy for
placing loans on
nonaccrual;
(3) Policy for
returning loans to
accrual status;
(4) Definition of and
policy for
identifying impaired
loans (for financial
accounting
purposes).
(5) Description of
the methodology that
the entity uses to
estimate its
allowance for loan
and lease losses,
including
statistical methods
used where
applicable;
(6) Policy for
charging-off
uncollectible
amounts; and
(7) Discussion of the
[BANK]'s credit risk
management policy
Quantitative disclosures...... (b).............. Total credit risk
exposures and
average credit risk
exposures, after
accounting offsets
in accordance with
GAAP,\2\ without
taking into account
the effects of
credit risk
mitigation
techniques (for
example, collateral
and netting not
permitted under
GAAP), over the
period categorized
by major types of
credit exposure. For
example, [BANK]s
could use categories
similar to that used
for financial
statement purposes.
Such categories
might include, for
instance:
(1) Loans, off-
balance sheet
commitments, and
other non-derivative
off-balance sheet
exposures;
(2) Debt securities;
and
(3) OTC derivatives.
(c).............. Geographic \3\
distribution of
exposures,
categorized in
significant areas by
major types of
credit exposure.
(d).............. Industry or
counterparty type
distribution of
exposures,
categorized by major
types of credit
exposure.
(e).............. By major industry or
counterparty type:
(1) Amount of
impaired loans for
which there was a
related allowance
under GAAP;
(2) Amount of
impaired loans for
which there was no
related allowance
under GAAP;
(3) Amount of loans
past due 90 days and
on nonaccrual;
(4) Amount of loans
past due 90 days and
still accruing; \4\
(5) The balance in
the allowance for
loan and lease
losses at the end of
each period,
disaggregated on the
basis of the
entity's impairment
method. To
disaggregate the
information required
on the basis of
impairment
methodology, an
entity shall
separately disclose
the amounts based on
the requirements in
GAAP; and
(6) Charge-offs
during the period.
(f).............. Amount of impaired
loans and, if
available, the
amount of past due
loans categorized by
significant
geographic areas
including, if
practical, the
amounts of
allowances related
to each geographical
area,\5\ further
categorized as
required by GAAP.
(g).............. Reconciliation of
changes in ALLL.\6\
[[Page 62247]]
(h).............. Remaining contractual
maturity breakdown
(for example, one
year or less) of the
whole portfolio,
categorized by
credit exposure.
------------------------------------------------------------------------
\1\ Table 5 to Sec. --.173 does not cover equity exposures, which
should be reported in Table 9.
\2\ See, for example, ASC Topic 815-10 and 210-20 as they may be amended
from time to time.
\3\ Geographical areas may comprise individual countries, groups of
countries, or regions within countries. A [BANK] might choose to
define the geographical areas based on the way the company's portfolio
is geographically managed. The criteria used to allocate the loans to
geographical areas must be specified.
\4\ A [BANK] is encouraged also to provide an analysis of the aging of
past-due loans.
\5\ The portion of the general allowance that is not allocated to a
geographical area should be disclosed separately.
\6\ The reconciliation should include the following: A description of
the allowance; the opening balance of the allowance; charge-offs taken
against the allowance during the period; amounts provided (or
reversed) for estimated probable loan losses during the period; any
other adjustments (for example, exchange rate differences, business
combinations, acquisitions and disposals of subsidiaries), including
transfers between allowances; and the closing balance of the
allowance. Charge-offs and recoveries that have been recorded directly
to the income statement should be disclosed separately.
Table 6 to Sec. --.173--Credit Risk: Disclosures for Portfolios
Subject to IRB Risk-Based Capital Formulas
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. Explanation and
review of the:
(1) Structure of
internal rating
systems and relation
between internal and
external ratings;
(2) Use of risk
parameter estimates
other than for
regulatory capital
purposes;
(3) Process for
managing and
recognizing credit
risk mitigation (see
Table 8 to Sec. --
.173); and
(4) Control
mechanisms for the
rating system,
including discussion
of independence,
accountability, and
rating systems
review.
(b).............. Description of the
internal ratings
process, provided
separately for the
following:
(1) Wholesale
category;
(2) Retail
subcategories;
(i) Residential
mortgage exposures;
(ii) Qualifying
revolving exposures;
and
(iii) Other retail
exposures.
For each category and
subcategory above
the description
should include:
(A) The types of
exposure included in
the category/
subcategories; and
(B) The definitions,
methods and data for
estimation and
validation of PD,
LGD, and EAD,
including
assumptions employed
in the derivation of
these variables.\1\
Quantitative disclosures: risk (c).............. (1) For wholesale
assessment. exposures, present
the following
information across a
sufficient number of
PD grades (including
default) to allow
for a meaningful
differentiation of
credit risk: \2\
(i) Total EAD; \3\
(ii) Exposure-
weighted average LGD
(percentage);
(iii) Exposure-
weighted average
risk weight; and
(iv) Amount of
undrawn commitments
and exposure-
weighted average EAD
including average
drawdowns prior to
default for
wholesale exposures.
(2) For each retail
subcategory, present
the disclosures
outlined above
across a sufficient
number of segments
to allow for a
meaningful
differentiation of
credit risk.
Quantitative disclosures: (d).............. Actual losses in the
historical results. preceding period for
each category and
subcategory and how
this differs from
past experience. A
discussion of the
factors that
impacted the loss
experience in the
preceding period--
for example, has the
[BANK] experienced
higher than average
default rates, loss
rates or EADs.
(e).............. The [BANK]'s
estimates compared
against actual
outcomes over a
longer period.\4\ At
a minimum, this
should include
information on
estimates of losses
against actual
losses in the
wholesale category
and each retail
subcategory over a
period sufficient to
allow for a
meaningful
assessment of the
performance of the
internal rating
processes for each
category/
subcategory.\5\
Where appropriate,
the [BANK] should
further decompose
this to provide
analysis of PD, LGD,
and EAD outcomes
against estimates
provided in the
quantitative risk
assessment
disclosures
above.\6\
------------------------------------------------------------------------
\1\ This disclosure item does not require a detailed description of the
model in full--it should provide the reader with a broad overview of
the model approach, describing definitions of the variables and
methods for estimating and validating those variables set out in the
quantitative risk disclosures below. This should be done for each of
the four category/subcategories. The [BANK] must disclose any
significant differences in approach to estimating these variables
within each category/subcategories.
\2\ The PD, LGD and EAD disclosures in Table 6 (c) to Sec. --.173
should reflect the effects of collateral, qualifying master netting
agreements, eligible guarantees and eligible credit derivatives as
defined under this part. Disclosure of each PD grade should include
the exposure-weighted average PD for each grade. Where a [BANK]
aggregates PD grades for the purposes of disclosure, this should be a
representative breakdown of the distribution of PD grades used for
regulatory capital purposes.
\3\ Outstanding loans and EAD on undrawn commitments can be presented on
a combined basis for these disclosures.
\4\ These disclosures are a way of further informing the reader about
the reliability of the information provided in the ``quantitative
disclosures: Risk assessment'' over the long run. The disclosures are
requirements from year-end 2010; in the meantime, early adoption is
encouraged. The phased implementation is to allow a [BANK] sufficient
time to build up a longer run of data that will make these disclosures
meaningful.
[[Page 62248]]
\5\ This disclosure item is not intended to be prescriptive about the
period used for this assessment. Upon implementation, it is expected
that a [BANK] would provide these disclosures for as long a set of
data as possible--for example, if a [BANK] has 10 years of data, it
might choose to disclose the average default rates for each PD grade
over that 10-year period. Annual amounts need not be disclosed.
\6\ A [BANK] must provide this further decomposition where it will allow
users greater insight into the reliability of the estimates provided
in the ``quantitative disclosures: Risk assessment.'' In particular,
it must provide this information where there are material differences
between its estimates of PD, LGD or EAD compared to actual outcomes
over the long run. The [BANK] must also provide explanations for such
differences.
Table 7 to Sec. --.173--General Disclosure for Counterparty Credit
Risk of OTC Derivative Contracts, Repo-Style Transactions, and Eligible
Margin Loans
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures....... (a).............. The general
qualitative
disclosure
requirement with
respect to OTC
derivatives,
eligible margin
loans, and repo-
style transactions,
including:
(1) Discussion of
methodology used to
assign economic
capital and credit
limits for
counterparty credit
exposures;
(2) Discussion of
policies for
securing collateral,
valuing and managing
collateral, and
establishing credit
reserves;
(3) Discussion of the
primary types of
collateral taken;
(4) Discussion of
policies with
respect to wrong-way
risk exposures; and
(5) Discussion of the
impact of the amount
of collateral the
[BANK] would have to
provide if the
[BANK] were to
receive a credit
rating downgrade.
Quantitative Disclosures...... (b).............. Gross positive fair
value of contracts,
netting benefits,
netted current
credit exposure,
collateral held
(including type, for
example, cash,
government
securities), and net
unsecured credit
exposure.\1\ Also
report measures for
EAD used for
regulatory capital
for these
transactions, the
notional value of
credit derivative
hedges purchased for
counterparty credit
risk protection,
and, for [BANK]s not
using the internal
models methodology
in Sec. --.132(d)
, the distribution
of current credit
exposure by types of
credit exposure.\2\
(c).............. Notional amount of
purchased and sold
credit derivatives,
segregated between
use for the [BANK]'s
own credit portfolio
and for its
intermediation
activities,
including the
distribution of the
credit derivative
products used,
categorized further
by protection bought
and sold within each
product group.
(d).............. The estimate of alpha
if the [BANK] has
received supervisory
approval to estimate
alpha.
------------------------------------------------------------------------
\1\ Net unsecured credit exposure is the credit exposure after
considering the benefits from legally enforceable netting agreements
and collateral arrangements, without taking into account haircuts for
price volatility, liquidity, etc.
\2\ This may include interest rate derivative contracts, foreign
exchange derivative contracts, equity derivative contracts, credit
derivatives, commodity or other derivative contracts, repo-style
transactions, and eligible margin loans.
Table 8 To Sec. --.173--Credit Risk Mitigation 1 2
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. The general
qualitative
disclosure
requirement with
respect to credit
risk mitigation,
including:
(1) Policies and
processes for, and
an indication of the
extent to which the
[BANK] uses, on- or
off-balance sheet
netting;
(2) Policies and
processes for
collateral valuation
and management;
(3) A description of
the main types of
collateral taken by
the [BANK];
(4) The main types of
guarantors/credit
derivative
counterparties and
their
creditworthiness;
and
(5) Information about
(market or credit)
risk concentrations
within the
mitigation taken.
Quantitative disclosures...... (b).............. For each separately
disclosed portfolio,
the total exposure
(after, where
applicable, on- or
off-balance sheet
netting) that is
covered by
guarantees/credit
derivatives.
------------------------------------------------------------------------
\1\ At a minimum, a [BANK] must provide the disclosures in Table 8 in
relation to credit risk mitigation that has been recognized for the
purposes of reducing capital requirements under this subpart. Where
relevant, [BANK]s are encouraged to give further information about
mitigants that have not been recognized for that purpose.
\2\ Credit derivatives and other credit mitigation that are treated for
the purposes of this subpart as synthetic securitization exposures
should be excluded from the credit risk mitigation disclosures (in
Table 8 to Sec. --.173) and included within those relating to
securitization (in Table 9 to Sec. --.173).
Table 9 to Sec. --.173--Securitization
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. The general
qualitative
disclosure
requirement with
respect to
securitization
(including synthetic
securitizations),
including a
discussion of:
(1) The [BANK]'s
objectives for
securitizing assets,
including the extent
to which these
activities transfer
credit risk of the
underlying exposures
away from the [BANK]
to other entities
and including the
type of risks
assumed and retained
with
resecuritization
activity; \1\
(2) The nature of the
risks (e.g.
liquidity risk)
inherent in the
securitized assets;
(3) The roles played
by the [BANK] in the
securitization
process \2\ and an
indication of the
extent of the
[BANK]'s involvement
in each of them;
[[Page 62249]]
(4) The processes in
place to monitor
changes in the
credit and market
risk of
securitization
exposures including
how those processes
differ for
resecuritization
exposures;
(5) The [BANK]'s
policy for
mitigating the
credit risk retained
through
securitization and
resecuritization
exposures; and
(6) The risk-based
capital approaches
that the [BANK]
follows for its
securitization
exposures including
the type of
securitization
exposure to which
each approach
applies.
(b).............. A list of:
(1) The type of
securitization SPEs
that the [BANK], as
sponsor, uses to
securitize third-
party exposures. The
[BANK] must indicate
whether it has
exposure to these
SPEs, either on- or
off- balance sheet;
and
(2) Affiliated
entities:
(i) That the [BANK]
manages or advises;
and
(ii) That invest
either in the
securitization
exposures that the
[BANK] has
securitized or in
securitization SPEs
that the [BANK]
sponsors.\3\
(c).............. Summary of the
[BANK]'s accounting
policies for
securitization
activities,
including:
(1) Whether the
transactions are
treated as sales or
financings;
(2) Recognition of
gain-on-sale;
(3) Methods and key
assumptions and
inputs applied in
valuing retained or
purchased interests;
(4) Changes in
methods and key
assumptions and
inputs from the
previous period for
valuing retained
interests and impact
of the changes;
(5) Treatment of
synthetic
securitizations;
(6) How exposures
intended to be
securitized are
valued and whether
they are recorded
under subpart E of
this part; and
(7) Policies for
recognizing
liabilities on the
balance sheet for
arrangements that
could require the
[BANK] to provide
financial support
for securitized
assets.
(d).............. An explanation of
significant changes
to any of the
quantitative
information set
forth below since
the last reporting
period.
Quantitative disclosures...... (e).............. The total outstanding
exposures
securitized \4\ by
the [BANK] in
securitizations that
meet the operational
criteria in Sec. --
.141 (categorized
into traditional/
synthetic), by
underlying exposure
type \5\ separately
for securitizations
of third-party
exposures for which
the bank acts only
as sponsor.
(f).............. For exposures
securitized by the
[BANK] in
securitizations that
meet the operational
criteria in Sec. --
.141:
(1) Amount of
securitized assets
that are impaired
\6\/past due
categorized by
exposure type; and
(2) Losses recognized
by the [BANK] during
the current period
categorized by
exposure type.\7\
(g).............. The total amount of
outstanding
exposures intended
to be securitized
categorized by
exposure type.
(h).............. Aggregate amount of:
(1) On-balance sheet
securitization
exposures retained
or purchased
categorized by
exposure type; and
(2) Off-balance sheet
securitization
exposures
categorized by
exposure type.
(i).............. (1) Aggregate amount
of securitization
exposures retained
or purchased and the
associated capital
requirements for
these exposures,
categorized between
securitization and
resecuritization
exposures, further
categorized into a
meaningful number of
risk weight bands
and by risk-based
capital approach
(e.g. SA, SFA, or
SSFA).
(2) Exposures that
have been deducted
entirely from tier 1
capital, CEIOs
deducted from total
capital (as
described in Sec.
--.42(a)(1), and
other exposures
deducted from total
capital should be
disclosed separately
by exposure type.
(j).............. Summary of current
year's
securitization
activity, including
the amount of
exposures
securitized (by
exposure type), and
recognized gain or
loss on sale by
asset type.
(k).............. Aggregate amount of
resecuritization
exposures retained
or purchased
categorized
according to:
(1) Exposures to
which credit risk
mitigation is
applied and those
not applied; and
(2) Exposures to
guarantors
categorized
according to
guarantor
creditworthiness
categories or
guarantor name.
------------------------------------------------------------------------
\1\ The [BANK] must describe the structure of resecuritizations in which
it participates; this description must be provided for the main
categories of resecuritization products in which the [BANK] is active.
\2\ For example, these roles would include originator, investor,
servicer, provider of credit enhancement, sponsor, liquidity provider,
or swap provider.
\3\ For example, money market mutual funds should be listed
individually, and personal and private trusts, should be noted
collectively.
[[Page 62250]]
\4\ ``Exposures securitized'' include underlying exposures originated by
the bank, whether generated by them or purchased, and recognized in
the balance sheet, from third parties, and third-party exposures
included in sponsored transactions. Securitization transactions
(including underlying exposures originally on the bank's balance sheet
and underlying exposures acquired by the bank from third-party
entities) in which the originating bank does not retain any
securitization exposure should be shown separately but need only be
reported for the year of inception.
\5\ A [BANK] is required to disclose exposures regardless of whether
there is a capital charge under this part.
\6\ A [BANK] must include credit-related other than temporary impairment
(OTTI).
\7\ For example, charge-offs/allowances (if the assets remain on the
bank's balance sheet) or credit-related OTTI of I/O strips and other
retained residual interests, as well as recognition of liabilities for
probable future financial support required of the bank with respect to
securitized assets.
Table 10 to Sec. --.173--Operational Risk
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. The general
qualitative
disclosure
requirement for
operational risk.
(b).............. Description of the
AMA, including a
discussion of
relevant internal
and external factors
considered in the
[BANK]'s measurement
approach.
(c).............. A description of the
use of insurance for
the purpose of
mitigating
operational risk.
------------------------------------------------------------------------
Table 11 to Sec. --.173--Equities Not Subject to Subpart F of This
Part
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. The general
qualitative
disclosure
requirement with
respect to the
equity risk of
equity holdings not
subject to subpart F
of this part,
including:
(1) Differentiation
between holdings on
which capital gains
are expected and
those held for other
objectives,
including for
relationship and
strategic reasons;
and
(2) Discussion of
important policies
covering the
valuation of and
accounting for
equity holdings not
subject to subpart F
of this part. This
includes the
accounting
methodology and
valuation
methodologies used,
including key
assumptions and
practices affecting
valuation as well as
significant changes
in these practices.
Quantitative disclosures...... (b).............. Carrying value on the
balance sheet of
equity investments,
as well as the fair
value of those
investments.
(c).............. The types and nature
of investments,
including the amount
that is:
(1) Publicly traded;
and
(2) Non-publicly
traded.
(d).............. The cumulative
realized gains
(losses) arising
from sales and
liquidations in the
reporting period.
(e).............. (1) Total unrealized
gains (losses) \1\
(2) Total latent
revaluation gains
(losses) \2\
(3) Any amounts of
the above included
in tier 1 and/or
tier 2 capital.
(f).............. Capital requirements
categorized by
appropriate equity
groupings,
consistent with the
[BANK]'s
methodology, as well
as the aggregate
amounts and the type
of equity
investments subject
to any supervisory
transition regarding
total capital
requirements.\3\
------------------------------------------------------------------------
\1\ Unrealized gains (losses) recognized in the balance sheet but not
through earnings.
\2\ Unrealized gains (losses) not recognized either in the balance sheet
or through earnings.
\3\ This disclosure must include a breakdown of equities that are
subject to the 0 percent, 20 percent, 100 percent, 300 percent, 400
percent, and 600 percent risk weights, as applicable.
Table 12 to Sec. --.173--Interest Rate Risk for Non-Trading Activities
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures....... (a).............. The general
qualitative
disclosure
requirement,
including the nature
of interest rate
risk for non-trading
activities and key
assumptions,
including
assumptions
regarding loan
prepayments and
behavior of non-
maturity deposits,
and frequency of
measurement of
interest rate risk
for non-trading
activities.
Quantitative disclosures...... (b).............. The increase
(decline) in
earnings or economic
value (or relevant
measure used by
management) for
upward and downward
rate shocks
according to
management's method
for measuring
interest rate risk
for non-trading
activities,
categorized by
currency (as
appropriate).
------------------------------------------------------------------------
Sec. Sec. --.174 through --.200 [Reserved]
Subpart F--Risk-Weighted Assets--Market Risk
Sec. --.201 Purpose, applicability, and reservation of authority.
(a) Purpose. This subpart F establishes risk-based capital
requirements for [BANK]s with significant exposure to market risk,
provides methods for these [BANK]s to calculate their standardized
measure for market risk and, if applicable, advanced measure for market
risk, and establishes public disclosure requirements.
(b) Applicability. (1) This subpart F applies to any [BANK] with
aggregate trading assets and trading liabilities (as reported in the
[BANK]'s most recent quarterly [regulatory report]), equal to:
(i) 10 percent or more of quarter-end total assets as reported on
the most recent quarterly [Call Report or FR Y-9C]; or
(ii) $1 billion or more.
(2) The [AGENCY] may apply this subpart to any [BANK] if the
[AGENCY] deems it necessary or appropriate because of the level of
market risk of the [BANK] or to ensure safe and sound banking
practices.
(3) The [AGENCY] may exclude a [BANK] that meets the criteria of
[[Page 62251]]
paragraph (b)(1) of this section from application of this subpart if
the [AGENCY] determines that the exclusion is appropriate based on the
level of market risk of the [BANK] and is consistent with safe and
sound banking practices.
(c) Reservation of authority (1) The [AGENCY] may require a [BANK]
to hold an amount of capital greater than otherwise required under this
subpart if the [AGENCY] determines that the [BANK]'s capital
requirement for market risk as calculated under this subpart is not
commensurate with the market risk of the [BANK]'s covered positions. In
making determinations under paragraphs (c)(1) through (c)(3) of this
section, the [AGENCY] will apply notice and response procedures
generally in the same manner as the notice and response procedures set
forth in [12 CFR 3.404, 12 CFR 263.202, 12 CFR 324.5(c)].
(2) If the [AGENCY] determines that the risk-based capital
requirement calculated under this subpart by the [BANK] for one or more
covered positions or portfolios of covered positions is not
commensurate with the risks associated with those positions or
portfolios, the [AGENCY] may require the [BANK] to assign a different
risk-based capital requirement to the positions or portfolios that more
accurately reflects the risk of the positions or portfolios.
(3) The [AGENCY] may also require a [BANK] to calculate risk-based
capital requirements for specific positions or portfolios under this
subpart, or under subpart D or subpart E of this part, as appropriate,
to more accurately reflect the risks of the positions.
(4) Nothing in this subpart limits the authority of the [AGENCY]
under any other provision of law or regulation to take supervisory or
enforcement action, including action to address unsafe or unsound
practices or conditions, deficient capital levels, or violations of
law.
Sec. --.202 Definitions.
(a) Terms set forth in Sec. --.2 and used in this subpart have the
definitions assigned thereto in Sec. --.2.
(b) For the purposes of this subpart, the following terms are
defined as follows:
Backtesting means the comparison of a [BANK]'s internal estimates
with actual outcomes during a sample period not used in model
development. For purposes of this subpart, backtesting is one form of
out-of-sample testing.
Commodity position means a position for which price risk arises
from changes in the price of a commodity.
Corporate debt position means a debt position that is an exposure
to a company that is not a sovereign entity, the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, a multilateral development bank, a
depository institution, a foreign bank, a credit union, a public sector
entity, a GSE, or a securitization.
Correlation trading position means:
(1) A securitization position for which all or substantially all of
the value of the underlying exposures is based on the credit quality of
a single company for which a two-way market exists, or on commonly
traded indices based on such exposures for which a two-way market
exists on the indices; or
(2) A position that is not a securitization position and that
hedges a position described in paragraph (1) of this definition; and
(3) A correlation trading position does not include:
(i) A resecuritization position;
(ii) A derivative of a securitization position that does not
provide a pro rata share in the proceeds of a securitization tranche;
or
(iii) A securitization position for which the underlying assets or
reference exposures are retail exposures, residential mortgage
exposures, or commercial mortgage exposures.
Covered position means the following positions:
(1) A trading asset or trading liability (whether on- or off-
balance sheet),\27\ as reported on [REGULATORY REPORT], that meets the
following conditions:
---------------------------------------------------------------------------
\27\ Securities subject to repurchase and lending agreements are
included as if they are still owned by the lender.
---------------------------------------------------------------------------
(i) The position is a trading position or hedges another covered
position; \28\ and
---------------------------------------------------------------------------
\28\ A position that hedges a trading position must be within
the scope of the bank's hedging strategy as described in paragraph
(a)(2) of section 203 of this subpart.
---------------------------------------------------------------------------
(ii) The position is free of any restrictive covenants on its
tradability or the [BANK] is able to hedge the material risk elements
of the position in a two-way market;
(2) A foreign exchange or commodity position, regardless of whether
the position is a trading asset or trading liability (excluding any
structural foreign currency positions that the [BANK] chooses to
exclude with prior supervisory approval); and
(3) Notwithstanding paragraphs (1) and (2) of this definition, a
covered position does not include:
(i) An intangible asset, including any servicing asset;
(ii) Any hedge of a trading position that the [AGENCY] determines
to be outside the scope of the [BANK]'s hedging strategy required in
paragraph (a)(2) of Sec. --.203;
(iii) Any position that, in form or substance, acts as a liquidity
facility that provides support to asset-backed commercial paper;
(iv) A credit derivative the [BANK] recognizes as a guarantee for
risk-weighted asset amount calculation purposes under subpart D or
subpart E of this part;
(v) Any position that is recognized as a credit valuation
adjustment hedge under Sec. --.132(e)(5) or Sec. --.132(e)(6), except
as provided in Sec. --.132(e)(6)(vii);
(vi) Any equity position that is not publicly traded, other than a
derivative that references a publicly traded equity and other than a
position in an investment company as defined in and registered with the
SEC under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.),
provided that all the underlying equities held by the investment
company are publicly traded;
(vii) Any equity position that is not publicly traded, other than a
derivative that references a publicly traded equity and other than a
position in an entity not domiciled in the United States (or a
political subdivision thereof) that is supervised and regulated in a
manner similar to entities described in paragraph (3)(vi) of this
definition;
(viii) Any position a [BANK] holds with the intent to securitize;
or
(ix) Any direct real estate holding.
Debt position means a covered position that is not a securitization
position or a correlation trading position and that has a value that
reacts primarily to changes in interest rates or credit spreads.
Default by a sovereign entity has the same meaning as the term
sovereign default under Sec. --.2.
Equity position means a covered position that is not a
securitization position or a correlation trading position and that has
a value that reacts primarily to changes in equity prices.
Event risk means the risk of loss on equity or hybrid equity
positions as a result of a financial event, such as the announcement or
occurrence of a company merger, acquisition, spin-off, or dissolution.
Foreign exchange position means a position for which price risk
arises from changes in foreign exchange rates.
General market risk means the risk of loss that could result from
broad market movements, such as changes in the general level of
interest rates, credit
[[Page 62252]]
spreads, equity prices, foreign exchange rates, or commodity prices.
Hedge means a position or positions that offset all, or
substantially all, of one or more material risk factors of another
position.
Idiosyncratic risk means the risk of loss in the value of a
position that arises from changes in risk factors unique to that
position.
Incremental risk means the default risk and credit migration risk
of a position. Default risk means the risk of loss on a position that
could result from the failure of an obligor to make timely payments of
principal or interest on its debt obligation, and the risk of loss that
could result from bankruptcy, insolvency, or similar proceeding. Credit
migration risk means the price risk that arises from significant
changes in the underlying credit quality of the position.
Market risk means the risk of loss on a position that could result
from movements in market prices.
Resecuritization position means a covered position that is:
(1) An on- or off-balance sheet exposure to a resecuritization; or
(2) An exposure that directly or indirectly references a
resecuritization exposure in paragraph (1) of this definition.
Securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying
exposures is transferred to one or more third parties;
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches that reflect different levels
of seniority;
(3) Performance of the securitization exposures depends upon the
performance of the underlying exposures;
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities);
(5) For non-synthetic securitizations, the underlying exposures are
not owned by an operating company;
(6) The underlying exposures are not owned by a small business
investment company described in section 302 of the Small Business
Investment Act;
(7) The underlying exposures are not owned by a firm an investment
in which qualifies as a community development investment under section
24(Eleventh) of the National Bank Act;
(8) The [AGENCY] may determine that a transaction in which the
underlying exposures are owned by an investment firm that exercises
substantially unfettered control over the size and composition of its
assets, liabilities, and off-balance sheet exposures is not a
securitization based on the transaction's leverage, risk profile, or
economic substance;
(9) The [AGENCY] may deem an exposure to a transaction that meets
the definition of a securitization, notwithstanding paragraph (5), (6),
or (7) of this definition, to be a securitization based on the
transaction's leverage, risk profile, or economic substance; and
(10) The transaction is not:
(i) An investment fund;
(ii) A collective investment fund (as defined in [12 CFR 208.34
(Board), 12 CFR 9.18 (OCC)]);
(iii) An employee benefit plan as defined in paragraphs (3) and
(32) of section 3 of ERISA, a ``governmental plan'' (as defined in 29
U.S.C. 1002(32)) that complies with the tax deferral qualification
requirements provided in the Internal Revenue Code, or any similar
employee benefit plan established under the laws of a foreign
jurisdiction; or
(iv) Registered with the SEC under the Investment Company Act of
1940 (15 U.S.C. 80a-1 et seq.) or foreign equivalents thereof.
Securitization position means a covered position that is:
(1) An on-balance sheet or off-balance sheet credit exposure
(including credit-enhancing representations and warranties) that arises
from a securitization (including a resecuritization); or
(2) An exposure that directly or indirectly references a
securitization exposure described in paragraph (1) of this definition.
Sovereign debt position means a direct exposure to a sovereign
entity.
Specific risk means the risk of loss on a position that could
result from factors other than broad market movements and includes
event risk, default risk, and idiosyncratic risk.
Structural position in a foreign currency means a position that is
not a trading position and that is:
(1) Subordinated debt, equity, or minority interest in a
consolidated subsidiary that is denominated in a foreign currency;
(2) Capital assigned to foreign branches that is denominated in a
foreign currency;
(3) A position related to an unconsolidated subsidiary or another
item that is denominated in a foreign currency and that is deducted
from the [BANK]'s tier 1 or tier 2 capital; or
(4) A position designed to hedge a [BANK]'s capital ratios or
earnings against the effect on paragraphs (1), (2), or (3) of this
definition of adverse exchange rate movements.
Term repo-style transaction means a repo-style transaction that has
an original maturity in excess of one business day.
Trading position means a position that is held by the [BANK] for
the purpose of short-term resale or with the intent of benefiting from
actual or expected short-term price movements, or to lock in arbitrage
profits.
Two-way market means 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.
Value-at-Risk (VaR) means the estimate of the maximum amount that
the value of one or more positions could decline due to market price or
rate movements during a fixed holding period within a stated confidence
interval.
Sec. --.203 Requirements for application of this subpart F.
(a) Trading positions--(1) Identification of trading positions. A
[BANK] must have clearly defined policies and procedures for
determining which of its trading assets and trading liabilities are
trading positions and which of its trading positions are correlation
trading positions. These policies and procedures must take into
account:
(i) The extent to which a position, or a hedge of its material
risks, can be marked-to-market daily by reference to a two-way market;
and
(ii) Possible impairments to the liquidity of a position or its
hedge.
(2) Trading and hedging strategies. A [BANK] must have clearly
defined trading and hedging strategies for its trading positions that
are approved by senior management of the [BANK].
(i) The trading strategy must articulate the expected holding
period of, and the market risk associated with, each portfolio of
trading positions.
(ii) The hedging strategy must articulate for each portfolio of
trading positions the level of market risk the [BANK] is willing to
accept and must detail the instruments, techniques, and strategies the
[BANK] will use to hedge the risk of the portfolio.
(b) Management of covered positions--(1) Active management. A
[BANK] must have clearly defined policies and procedures for actively
managing all covered positions. At a
[[Page 62253]]
minimum, these policies and procedures must require:
(i) Marking positions to market or to model on a daily basis;
(ii) Daily assessment of the [BANK]'s ability to hedge position and
portfolio risks, and of the extent of market liquidity;
(iii) Establishment and daily monitoring of limits on positions by
a risk control unit independent of the trading business unit;
(iv) Daily monitoring by senior management of information described
in paragraphs (b)(1)(i) through (b)(1)(iii) of this section;
(v) At least annual reassessment of established limits on positions
by senior management; and
(vi) At least annual assessments by qualified personnel of the
quality of market inputs to the valuation process, the soundness of key
assumptions, the reliability of parameter estimation in pricing models,
and the stability and accuracy of model calibration under alternative
market scenarios.
(2) Valuation of covered positions. The [BANK] must have a process
for prudent valuation of its covered positions that includes policies
and procedures on the valuation of positions, marking positions to
market or to model, independent price verification, and valuation
adjustments or reserves. The valuation process must consider, as
appropriate, unearned credit spreads, close-out costs, early
termination costs, investing and funding costs, liquidity, and model
risk.
(c) Requirements for internal models. (1) A [BANK] must obtain the
prior written approval of the [AGENCY] before using any internal model
to calculate its risk-based capital requirement under this subpart.
(2) A [BANK] must meet all of the requirements of this section on
an ongoing basis. The [BANK] must promptly notify the [AGENCY] when:
(i) The [BANK] plans to extend the use of a model that the [AGENCY]
has approved under this subpart to an additional business line or
product type;
(ii) The [BANK] makes any change to an internal model approved by
the [AGENCY] under this subpart that would result in a material change
in the [BANK]'s risk-weighted asset amount for a portfolio of covered
positions; or
(iii) The [BANK] makes any material change to its modeling
assumptions.
(3) The [AGENCY] may rescind its approval of the use of any
internal model (in whole or in part) or of the determination of the
approach under Sec. --.209(a)(2)(ii) for a [BANK]'s modeled
correlation trading positions and determine an appropriate capital
requirement for the covered positions to which the model would apply,
if the [AGENCY] determines that the model no longer complies with this
subpart or fails to reflect accurately the risks of the [BANK]'s
covered positions.
(4) The [BANK] must periodically, but no less frequently than
annually, review its internal models in light of developments in
financial markets and modeling technologies, and enhance those models
as appropriate to ensure that they continue to meet the [AGENCY]'s
standards for model approval and employ risk measurement methodologies
that are most appropriate for the [BANK]'s covered positions.
(5) The [BANK] must incorporate its internal models into its risk
management process and integrate the internal models used for
calculating its VaR-based measure into its daily risk management
process.
(6) The level of sophistication of a [BANK]'s internal models must
be commensurate with the complexity and amount of its covered
positions. A [BANK]'s internal models may use any of the generally
accepted approaches, including but not limited to variance-covariance
models, historical simulations, or Monte Carlo simulations, to measure
market risk.
(7) The [BANK]'s internal models must properly measure all the
material risks in the covered positions to which they are applied.
(8) The [BANK]'s internal models must conservatively assess the
risks arising from less liquid positions and positions with limited
price transparency under realistic market scenarios.
(9) The [BANK] must have a rigorous and well-defined process for
re-estimating, re-evaluating, and updating its internal models to
ensure continued applicability and relevance.
(10) If a [BANK] uses internal models to measure specific risk, the
internal models must also satisfy the requirements in paragraph (b)(1)
of Sec. --.207.
(d) Control, oversight, and validation mechanisms. (1) The [BANK]
must have a risk control unit that reports directly to senior
management and is independent from the business trading units.
(2) The [BANK] must validate its internal models initially and on
an ongoing basis. The [BANK]'s validation process must be independent
of the internal models' development, implementation, and operation, or
the validation process must be subjected to an independent review of
its adequacy and effectiveness. Validation must include:
(i) An evaluation of the conceptual soundness of (including
developmental evidence supporting) the internal models;
(ii) An ongoing monitoring process that includes verification of
processes and the comparison of the [BANK]'s model outputs with
relevant internal and external data sources or estimation techniques;
and
(iii) An outcomes analysis process that includes backtesting. For
internal models used to calculate the VaR-based measure, this process
must include a comparison of the changes in the [BANK]'s portfolio
value that would have occurred were end-of-day positions to remain
unchanged (therefore, excluding fees, commissions, reserves, net
interest income, and intraday trading) with VaR-based measures during a
sample period not used in model development.
(3) The [BANK] must stress test the market risk of its covered
positions at a frequency appropriate to each portfolio, and in no case
less frequently than quarterly. The stress tests must take into account
concentration risk (including but not limited to concentrations in
single issuers, industries, sectors, or markets), illiquidity under
stressed market conditions, and risks arising from the [BANK]'s trading
activities that may not be adequately captured in its internal models.
(4) The [BANK] must have an internal audit function independent of
business-line management that at least annually assesses the
effectiveness of the controls supporting the [BANK]'s market risk
measurement systems, including the activities of the business trading
units and independent risk control unit, compliance with policies and
procedures, and calculation of the [BANK]'s measures for market risk
under this subpart. At least annually, the internal audit function must
report its findings to the [BANK]'s board of directors (or a committee
thereof).
(e) Internal assessment of capital adequacy. The [BANK] must have a
rigorous process for assessing its overall capital adequacy in relation
to its market risk. The assessment must take into account risks that
may not be captured fully in the VaR-based measure, including
concentration and liquidity risk under stressed market conditions.
(f) Documentation. The [BANK] must adequately document all material
aspects of its internal models, management and valuation of covered
positions, control, oversight, validation and review processes and
results, and internal assessment of capital adequacy.
[[Page 62254]]
Sec. --.204 Measure for market risk.
(a) General requirement. (1) A [BANK] must calculate its
standardized measure for market risk by following the steps described
in paragraph (a)(2) of this section. An advanced approaches [BANK] also
must calculate an advanced measure for market risk by following the
steps in paragraph (a)(2) of this section.
(2) Measure for market risk. A [BANK] must calculate the
standardized measure for market risk, which equals the sum of the VaR-
based capital requirement, stressed VaR-based capital requirement,
specific risk add-ons, incremental risk capital requirement,
comprehensive risk capital requirement, and capital requirement for de
minimis exposures all as defined under this paragraph (a)(2), (except,
that the [BANK] may not use the SFA in section 210(b)(2)(vii)(B) of
this subpart for purposes of this calculation)[, plus any additional
capital requirement established by the [AGENCY]]. An advanced
approaches [BANK] that has completed the parallel run process and that
has received notifications from the [AGENCY] pursuant to Sec.
--.121(d) also must calculate the advanced measure for market risk,
which equals the sum of the VaR-based capital requirement, stressed
VaR-based capital requirement, specific risk add-ons, incremental risk
capital requirement, comprehensive risk capital requirement, and
capital requirement for de minimis exposures as defined under this
paragraph (a)(2) [, plus any additional capital requirement established
by the [AGENCY]].
(i) VaR-based capital requirement. A [BANK]'s VaR-based capital
requirement equals the greater of:
(A) The previous day's VaR-based measure as calculated under Sec.
--.205; or
(B) The average of the daily VaR-based measures as calculated under
Sec. --.205 for each of the preceding 60 business days multiplied by
three, except as provided in paragraph (b) of this section.
(ii) Stressed VaR-based capital requirement. A [BANK]'s stressed
VaR-based capital requirement equals the greater of:
(A) The most recent stressed VaR-based measure as calculated under
Sec. --.206; or
(B) The average of the stressed VaR-based measures as calculated
under Sec. --.206 for each of the preceding 12 weeks multiplied by
three, except as provided in paragraph (b) of this section.
(iii) Specific risk add-ons. A [BANK]'s specific risk add-ons equal
any specific risk add-ons that are required under Sec. --.207 and are
calculated in accordance with Sec. --.210.
(iv) Incremental risk capital requirement. A [BANK]'s incremental
risk capital requirement equals any incremental risk capital
requirement as calculated under section 208 of this subpart.
(v) Comprehensive risk capital requirement. A [BANK]'s
comprehensive risk capital requirement equals any comprehensive risk
capital requirement as calculated under section 209 of this subpart.
(vi) Capital requirement for de minimis exposures. A [BANK]'s
capital requirement for de minimis exposures equals:
(A) The absolute value of the fair value of those de minimis
exposures that are not captured in the [BANK]'s VaR-based measure or
under paragraph (a)(2)(vi)(B) of this section; and
(B) With the prior written approval of the [AGENCY], the capital
requirement for any de minimis exposures using alternative techniques
that appropriately measure the market risk associated with those
exposures.
(b) Backtesting. A [BANK] must compare each of its most recent 250
business days' trading losses (excluding fees, commissions, reserves,
net interest income, and intraday trading) with the corresponding daily
VaR-based measures calibrated to a one-day holding period and at a one-
tail, 99.0 percent confidence level. A [BANK] must begin backtesting as
required by this paragraph (b) no later than one year after the later
of January 1, 2014 and the date on which the [BANK] becomes subject to
this subpart. In the interim, consistent with safety and soundness
principles, a [BANK] subject to this subpart as of January 1, 2014
should continue to follow backtesting procedures in accordance with the
[AGENCY]'s supervisory expectations.
(1) Once each quarter, the [BANK] must identify the number of
exceptions (that is, the number of business days for which the actual
daily net trading loss, if any, exceeds the corresponding daily VaR-
based measure) that have occurred over the preceding 250 business days.
(2) A [BANK] must use the multiplication factor in Table 1 to Sec.
--.204 that corresponds to the number of exceptions identified in
paragraph (b)(1) of this section to determine its VaR-based capital
requirement for market risk under paragraph (a)(2)(i) of this section
and to determine its stressed VaR-based capital requirement for market
risk under paragraph (a)(2)(ii) of this section until it obtains the
next quarter's backtesting results, unless the [AGENCY] notifies the
[BANK] in writing that a different adjustment or other action is
appropriate.
Table 1 to Sec. --.204--Multiplication Factors Based on Results of
Backtesting
------------------------------------------------------------------------
Multiplication
Number of exceptions factor
------------------------------------------------------------------------
4 or fewer.............................................. 3.00
5....................................................... 3.40
6....................................................... 3.50
7....................................................... 3.65
8....................................................... 3.75
9....................................................... 3.85
10 or more.............................................. 4.00
------------------------------------------------------------------------
Sec. --.205 VaR-based measure.
(a) General requirement. A [BANK] must use one or more internal
models to calculate daily a VaR-based measure of the general market
risk of all covered positions. The daily VaR-based measure also may
reflect the [BANK]'s specific risk for one or more portfolios of debt
and equity positions, if the internal models meet the requirements of
paragraph (b)(1) of Sec. --.207. The daily VaR-based measure must also
reflect the [BANK]'s specific risk for any portfolio of correlation
trading positions that is modeled under Sec. --.209. A [BANK] may
elect to include term repo-style transactions in its VaR-based measure,
provided that the [BANK] includes all such term repo-style transactions
consistently over time.
(1) The [BANK]'s internal models for calculating its VaR-based
measure must use risk factors sufficient to measure the market risk
inherent in all covered positions. The market risk categories must
include, as appropriate, interest rate risk, credit spread risk, equity
price risk, foreign exchange risk, and commodity price risk. For
material positions in the major currencies and markets, modeling
techniques must incorporate enough segments of the yield curve--in no
case less than six--to capture differences in volatility and less than
perfect correlation of rates along the yield curve.
(2) The VaR-based measure may incorporate empirical correlations
within and across risk categories, provided the [BANK] validates and
demonstrates the reasonableness of its process for measuring
correlations. If the VaR-based measure does not incorporate empirical
correlations across risk categories, the [BANK] must add the separate
measures from its internal models used to calculate the VaR-based
measure for the appropriate market risk categories (interest rate risk,
credit spread risk, equity price risk, foreign exchange rate risk, and/
or
[[Page 62255]]
commodity price risk) to determine its aggregate VaR-based measure.
(3) The VaR-based measure must include the risks arising from the
nonlinear price characteristics of options positions or positions with
embedded optionality and the sensitivity of the fair value of the
positions to changes in the volatility of the underlying rates, prices,
or other material risk factors. A [BANK] with a large or complex
options portfolio must measure the volatility of options positions or
positions with embedded optionality by different maturities and/or
strike prices, where material.
(4) The [BANK] must be able to justify to the satisfaction of the
[AGENCY] the omission of any risk factors from the calculation of its
VaR-based measure that the [BANK] uses in its pricing models.
(5) The [BANK] must demonstrate to the satisfaction of the [AGENCY]
the appropriateness of any proxies used to capture the risks of the
[BANK]'s actual positions for which such proxies are used.
(b) Quantitative requirements for VaR-based measure. (1) The VaR-
based measure must be calculated on a daily basis using a one-tail,
99.0 percent confidence level, and a holding period equivalent to a 10-
business-day movement in underlying risk factors, such as rates,
spreads, and prices. To calculate VaR-based measures using a 10-
business-day holding period, the [BANK] may calculate 10-business-day
measures directly or may convert VaR-based measures using holding
periods other than 10 business days to the equivalent of a 10-business-
day holding period. A [BANK] that converts its VaR-based measure in
such a manner must be able to justify the reasonableness of its
approach to the satisfaction of the [AGENCY].
(2) The VaR-based measure must be based on a historical observation
period of at least one year. Data used to determine the VaR-based
measure must be relevant to the [BANK]'s actual exposures and of
sufficient quality to support the calculation of risk-based capital
requirements. The [BANK] must update data sets at least monthly or more
frequently as changes in market conditions or portfolio composition
warrant. For a [BANK] that uses a weighting scheme or other method for
the historical observation period, the [BANK] must either:
(i) Use an effective observation period of at least one year in
which the average time lag of the observations is at least six months;
or
(ii) Demonstrate to the [AGENCY] that its weighting scheme is more
effective than a weighting scheme with an average time lag of at least
six months representing the volatility of the [BANK]'s trading
portfolio over a full business cycle. A [BANK] using this option must
update its data more frequently than monthly and in a manner
appropriate for the type of weighting scheme.
(c) A [BANK] must divide its portfolio into a number of significant
subportfolios approved by the [AGENCY] for subportfolio backtesting
purposes. These subportfolios must be sufficient to allow the [BANK]
and the [AGENCY] to assess the adequacy of the VaR model at the risk
factor level; the [AGENCY] will evaluate the appropriateness of these
subportfolios relative to the value and composition of the [BANK]'s
covered positions. The [BANK] must retain and make available to the
[AGENCY] the following information for each subportfolio for each
business day over the previous two years (500 business days), with no
more than a 60-day lag:
(1) A daily VaR-based measure for the subportfolio calibrated to a
one-tail, 99.0 percent confidence level;
(2) The daily profit or loss for the subportfolio (that is, the net
change in price of the positions held in the portfolio at the end of
the previous business day); and
(3) The p-value of the profit or loss on each day (that is, the
probability of observing a profit that is less than, or a loss that is
greater than, the amount reported for purposes of paragraph (c)(2) of
this section based on the model used to calculate the VaR-based measure
described in paragraph (c)(1) of this section).
Sec. --.206 Stressed VaR-based measure.
(a) General requirement. At least weekly, a [BANK] must use the
same internal model(s) used to calculate its VaR-based measure to
calculate a stressed VaR-based measure.
(b) Quantitative requirements for stressed VaR-based measure. (1) A
[BANK] must calculate a stressed VaR-based measure for its covered
positions using the same model(s) used to calculate the VaR-based
measure, subject to the same confidence level and holding period
applicable to the VaR-based measure under Sec. --.205, but with model
inputs calibrated to historical data from a continuous 12-month period
that reflects a period of significant financial stress appropriate to
the [BANK]'s current portfolio.
(2) The stressed VaR-based measure must be calculated at least
weekly and be no less than the [BANK]'s VaR-based measure.
(3) A [BANK] must have policies and procedures that describe how it
determines the period of significant financial stress used to calculate
the [BANK]'s stressed VaR-based measure under this section and must be
able to provide empirical support for the period used. The [BANK] must
obtain the prior approval of the [AGENCY] for, and notify the [AGENCY]
if the [BANK] makes any material changes to, these policies and
procedures. The policies and procedures must address:
(i) How the [BANK] links the period of significant financial stress
used to calculate the stressed VaR-based measure to the composition and
directional bias of its current portfolio; and
(ii) The [BANK]'s process for selecting, reviewing, and updating
the period of significant financial stress used to calculate the
stressed VaR-based measure and for monitoring the appropriateness of
the period to the [BANK]'s current portfolio.
(4) Nothing in this section prevents the [AGENCY] from requiring a
[BANK] to use a different period of significant financial stress in the
calculation of the stressed VaR-based measure.
Sec. --.207 Specific risk.
(a) General requirement. A [BANK] must use one of the methods in
this section to measure the specific risk for each of its debt, equity,
and securitization positions with specific risk.
(b) Modeled specific risk. A [BANK] may use models to measure the
specific risk of covered positions as provided in paragraph (a) of
section 205 of this subpart (therefore, excluding securitization
positions that are not modeled under section 209 of this subpart). A
[BANK] must use models to measure the specific risk of correlation
trading positions that are modeled under Sec. --.209.
(1) Requirements for specific risk modeling. (i) If a [BANK] uses
internal models to measure the specific risk of a portfolio, the
internal models must:
(A) Explain the historical price variation in the portfolio;
(B) Be responsive to changes in market conditions;
(C) Be robust to an adverse environment, including signaling rising
risk in an adverse environment; and
(D) Capture all material components of specific risk for the debt
and equity positions in the portfolio. Specifically, the internal
models must:
(1) Capture event risk and idiosyncratic risk; and
(2) Capture and demonstrate sensitivity to material differences
[[Page 62256]]
between positions that are similar but not identical and to changes in
portfolio composition and concentrations.
(ii) If a [BANK] calculates an incremental risk measure for a
portfolio of debt or equity positions under section 208 of this
subpart, the [BANK] is not required to capture default and credit
migration risks in its internal models used to measure the specific
risk of those portfolios.
(2) Specific risk fully modeled for one or more portfolios. If the
[BANK]'s VaR-based measure captures all material aspects of specific
risk for one or more of its portfolios of debt, equity, or correlation
trading positions, the [BANK] has no specific risk add-on for those
portfolios for purposes of paragraph (a)(2)(iii) of Sec. --.204.
(c) Specific risk not modeled. (1) If the [BANK]'s VaR-based
measure does not capture all material aspects of specific risk for a
portfolio of debt, equity, or correlation trading positions, the [BANK]
must calculate a specific-risk add-on for the portfolio under the
standardized measurement method as described in Sec. --.210.
(2) A [BANK] must calculate a specific risk add-on under the
standardized measurement method as described in Sec. --.210 for all of
its securitization positions that are not modeled under Sec. --.209.
Sec. --.208 Incremental risk.
(a) General requirement. A [BANK] that measures the specific risk
of a portfolio of debt positions under Sec. --.207(b) using internal
models must calculate at least weekly an incremental risk measure for
that portfolio according to the requirements in this section. The
incremental risk measure is the [BANK]'s measure of potential losses
due to incremental risk over a one-year time horizon at a one-tail,
99.9 percent confidence level, either under the assumption of a
constant level of risk, or under the assumption of constant positions.
With the prior approval of the [AGENCY], a [BANK] may choose to include
portfolios of equity positions in its incremental risk model, provided
that it consistently includes such equity positions in a manner that is
consistent with how the [BANK] internally measures and manages the
incremental risk of such positions at the portfolio level. If equity
positions are included in the model, for modeling purposes default is
considered to have occurred upon the default of any debt of the issuer
of the equity position. A [BANK] may not include correlation trading
positions or securitization positions in its incremental risk measure.
(b) Requirements for incremental risk modeling. For purposes of
calculating the incremental risk measure, the incremental risk model
must:
(1) Measure incremental risk over a one-year time horizon and at a
one-tail, 99.9 percent confidence level, either under the assumption of
a constant level of risk, or under the assumption of constant
positions.
(i) A constant level of risk assumption means that the [BANK]
rebalances, or rolls over, its trading positions at the beginning of
each liquidity horizon over the one-year horizon in a manner that
maintains the [BANK]'s initial risk level. The [BANK] must determine
the frequency of rebalancing in a manner consistent with the liquidity
horizons of the positions in the portfolio. The liquidity horizon of a
position or set of positions is the time required for a [BANK] to
reduce its exposure to, or hedge all of its material risks of, the
position(s) in a stressed market. The liquidity horizon for a position
or set of positions may not be less than the shorter of three months or
the contractual maturity of the position.
(ii) A constant position assumption means that the [BANK] maintains
the same set of positions throughout the one-year horizon. If a [BANK]
uses this assumption, it must do so consistently across all portfolios.
(iii) A [BANK]'s selection of a constant position or a constant
risk assumption must be consistent between the [BANK]'s incremental
risk model and its comprehensive risk model described in section 209 of
this subpart, if applicable.
(iv) A [BANK]'s treatment of liquidity horizons must be consistent
between the [BANK]'s incremental risk model and its comprehensive risk
model described in section 209, if applicable.
(2) Recognize the impact of correlations between default and
migration events among obligors.
(3) Reflect the effect of issuer and market concentrations, as well
as concentrations that can arise within and across product classes
during stressed conditions.
(4) Reflect netting only of long and short positions that reference
the same financial instrument.
(5) Reflect any material mismatch between a position and its hedge.
(6) Recognize the effect that liquidity horizons have on dynamic
hedging strategies. In such cases, a [BANK] must:
(i) Choose to model the rebalancing of the hedge consistently over
the relevant set of trading positions;
(ii) Demonstrate that the inclusion of rebalancing results in a
more appropriate risk measurement;
(iii) Demonstrate that the market for the hedge is sufficiently
liquid to permit rebalancing during periods of stress; and
(iv) Capture in the incremental risk model any residual risks
arising from such hedging strategies.
(7) Reflect the nonlinear impact of options and other positions
with material nonlinear behavior with respect to default and migration
changes.
(8) Maintain consistency with the [BANK]'s internal risk management
methodologies for identifying, measuring, and managing risk.
(c) Calculation of incremental risk capital requirement. The
incremental risk capital requirement is the greater of:
(1) The average of the incremental risk measures over the previous
12 weeks; or
(2) The most recent incremental risk measure.
Sec. --.209 Comprehensive risk.
(a) General requirement. (1) Subject to the prior approval of the
[AGENCY], a [BANK] may use the method in this section to measure
comprehensive risk, that is, all price risk, for one or more portfolios
of correlation trading positions.
(2) A [BANK] that measures the price risk of a portfolio of
correlation trading positions using internal models must calculate at
least weekly a comprehensive risk measure that captures all price risk
according to the requirements of this section. The comprehensive risk
measure is either:
(i) The sum of:
(A) The [BANK]'s modeled measure of all price risk determined
according to the requirements in paragraph (b) of this section; and
(B) A surcharge for the [BANK]'s modeled correlation trading
positions equal to the total specific risk add-on for such positions as
calculated under section 210 of this subpart multiplied by 8.0 percent;
or
(ii) With approval of the [AGENCY] and provided the [BANK] has met
the requirements of this section for a period of at least one year and
can demonstrate the effectiveness of the model through the results of
ongoing model validation efforts including robust benchmarking, the
greater of:
(A) The [BANK]'s modeled measure of all price risk determined
according to the requirements in paragraph (b) of this section; or
(B) The total specific risk add-on that would apply to the bank's
modeled correlation trading positions as calculated under section 210
of this subpart multiplied by 8.0 percent.
(b) Requirements for modeling all price risk. If a [BANK] uses an
internal
[[Page 62257]]
model to measure the price risk of a portfolio of correlation trading
positions:
(1) The internal model must measure comprehensive risk over a one-
year time horizon at a one-tail, 99.9 percent confidence level, either
under the assumption of a constant level of risk, or under the
assumption of constant positions.
(2) The model must capture all material price risk, including but
not limited to the following:
(i) The risks associated with the contractual structure of cash
flows of the position, its issuer, and its underlying exposures;
(ii) Credit spread risk, including nonlinear price risks;
(iii) The volatility of implied correlations, including nonlinear
price risks such as the cross-effect between spreads and correlations;
(iv) Basis risk;
(v) Recovery rate volatility as it relates to the propensity for
recovery rates to affect tranche prices; and
(vi) To the extent the comprehensive risk measure incorporates the
benefits of dynamic hedging, the static nature of the hedge over the
liquidity horizon must be recognized. In such cases, a [BANK] must:
(A) Choose to model the rebalancing of the hedge consistently over
the relevant set of trading positions;
(B) Demonstrate that the inclusion of rebalancing results in a more
appropriate risk measurement;
(C) Demonstrate that the market for the hedge is sufficiently
liquid to permit rebalancing during periods of stress; and
(D) Capture in the comprehensive risk model any residual risks
arising from such hedging strategies;
(3) The [BANK] must use market data that are relevant in
representing the risk profile of the [BANK]'s correlation trading
positions in order to ensure that the [BANK] fully captures the
material risks of the correlation trading positions in its
comprehensive risk measure in accordance with this section; and
(4) The [BANK] must be able to demonstrate that its model is an
appropriate representation of comprehensive risk in light of the
historical price variation of its correlation trading positions.
(c) Requirements for stress testing. (1) A [BANK] must at least
weekly apply specific, supervisory stress scenarios to its portfolio of
correlation trading positions that capture changes in:
(i) Default rates;
(ii) Recovery rates;
(iii) Credit spreads;
(iv) Correlations of underlying exposures; and
(v) Correlations of a correlation trading position and its hedge.
(2) Other requirements. (i) A [BANK] must retain and make available
to the [AGENCY] the results of the supervisory stress testing,
including comparisons with the capital requirements generated by the
[BANK]'s comprehensive risk model.
(ii) A [BANK] must report to the [AGENCY] promptly any instances
where the stress tests indicate any material deficiencies in the
comprehensive risk model.
(d) Calculation of comprehensive risk capital requirement. The
comprehensive risk capital requirement is the greater of:
(1) The average of the comprehensive risk measures over the
previous 12 weeks; or
(2) The most recent comprehensive risk measure.
Sec. --.210 Standardized measurement method for specific risk
(a) General requirement. A [BANK] must calculate a total specific
risk add-on for each portfolio of debt and equity positions for which
the [BANK]'s VaR-based measure does not capture all material aspects of
specific risk and for all securitization positions that are not modeled
under Sec. --.209. A [BANK] must calculate each specific risk add-on
in accordance with the requirements of this section. Notwithstanding
any other definition or requirement in this subpart, a position that
would have qualified as a debt position or an equity position but for
the fact that it qualifies as a correlation trading position under
paragraph (2) of the definition of correlation trading position in
Sec. --.2, shall be considered a debt position or an equity position,
respectively, for purposes of this section 210 of this subpart.
(1) The specific risk add-on for an individual debt or
securitization position that represents sold credit protection is
capped at the notional amount of the credit derivative contract. The
specific risk add-on for an individual debt or securitization position
that represents purchased credit protection is capped at the current
fair value of the transaction plus the absolute value of the present
value of all remaining payments to the protection seller under the
transaction. This sum is equal to the value of the protection leg of
the transaction.
(2) For debt, equity, or securitization positions that are
derivatives with linear payoffs, a [BANK] must assign a specific risk-
weighting factor to the fair value of the effective notional amount of
the underlying instrument or index portfolio, except for a
securitization position for which the [BANK] directly calculates a
specific risk add-on using the SFA in paragraph (b)(2)(vii)(B) of this
section. A swap must be included as an effective notional position in
the underlying instrument or portfolio, with the receiving side treated
as a long position and the paying side treated as a short position. For
debt, equity, or securitization positions that are derivatives with
nonlinear payoffs, a [BANK] must risk weight the fair value of the
effective notional amount of the underlying instrument or portfolio
multiplied by the derivative's delta.
(3) For debt, equity, or securitization positions, a [BANK] may net
long and short positions (including derivatives) in identical issues or
identical indices. A [BANK] may also net positions in depositary
receipts against an opposite position in an identical equity in
different markets, provided that the [BANK] includes the costs of
conversion.
(4) A set of transactions consisting of either a debt position and
its credit derivative hedge or a securitization position and its credit
derivative hedge has a specific risk add-on of zero if:
(i) The debt or securitization position is fully hedged by a total
return swap (or similar instrument where there is a matching of swap
payments and changes in fair value of the debt or securitization
position);
(ii) There is an exact match between the reference obligation of
the swap and the debt or securitization position;
(iii) There is an exact match between the currency of the swap and
the debt or securitization position; and
(iv) There is either an exact match between the maturity date of
the swap and the maturity date of the debt or securitization position;
or, in cases where a total return swap references a portfolio of
positions with different maturity dates, the total return swap maturity
date must match the maturity date of the underlying asset in that
portfolio that has the latest maturity date.
(5) The specific risk add-on for a set of transactions consisting
of either a debt position and its credit derivative hedge or a
securitization position and its credit derivative hedge that does not
meet the criteria of paragraph (a)(4) of this section is equal to 20.0
percent of the capital requirement for the side of the transaction with
the higher specific risk add-on when:
(i) The credit risk of the position is fully hedged by a credit
default swap or similar instrument;
(ii) There is an exact match between the reference obligation of
the credit
[[Page 62258]]
derivative hedge and the debt or securitization position;
(iii) There is an exact match between the currency of the credit
derivative hedge and the debt or securitization position; and
(iv) There is either an exact match between the maturity date of
the credit derivative hedge and the maturity date of the debt or
securitization position; or, in the case where the credit derivative
hedge has a standard maturity date:
(A) The maturity date of the credit derivative hedge is within 30
business days of the maturity date of the debt or securitization
position; or
(B) For purchased credit protection, the maturity date of the
credit derivative hedge is later than the maturity date of the debt or
securitization position, but is no later than the standard maturity
date for that instrument that immediately follows the maturity date of
the debt or securitization position. The maturity date of the credit
derivative hedge may not exceed the maturity date of the debt or
securitization position by more than 90 calendar days.
(6) The specific risk add-on for a set of transactions consisting
of either a debt position and its credit derivative hedge or a
securitization position and its credit derivative hedge that does not
meet the criteria of either paragraph (a)(4) or (a)(5) of this section,
but in which all or substantially all of the price risk has been
hedged, is equal to the specific risk add-on for the side of the
transaction with the higher specific risk add-on.
(b) Debt and securitization positions. (1) The total specific risk
add-on for a portfolio of debt or securitization positions is the sum
of the specific risk add-ons for individual debt or securitization
positions, as computed under this section. To determine the specific
risk add-on for individual debt or securitization positions, a [BANK]
must multiply the absolute value of the current fair value of each net
long or net short debt or securitization position in the portfolio by
the appropriate specific risk-weighting factor as set forth in
paragraphs (b)(2)(i) through (b)(2)(vii) of this section.
(2) For the purpose of this section, the appropriate specific risk-
weighting factors include:
(i) Sovereign debt positions. (A) In accordance with Table 1 to
Sec. --.210, a [BANK] must assign a specific risk-weighting factor to
a sovereign debt position based on the CRC applicable to the sovereign,
and, as applicable, the remaining contractual maturity of the position,
or if there is no CRC applicable to the sovereign, based on whether the
sovereign entity is a member of the OECD. Notwithstanding any other
provision in this subpart, sovereign debt positions that are backed by
the full faith and credit of the United States are treated as having a
CRC of 0.
Table 1 to Sec. --.210--Specific Risk-Weighting Factors for Sovereign
Debt Positions
------------------------------------------------------------------------
------------------------------------------------------------------------
Specific risk-weighting factor
(in percent)
------------------------------------------------------------------------
CRC:
0-1.......................... 0.0
--------------------------------------
2-3.......................... Remaining 0.25
contractual
maturity of 6
months or less.
Remaining 1.0
contractual
maturity of
greater than 6 and
up to and
including 24
months.
Remaining 1.6
contractual
maturity exceeds
24 months.
======================
4-6.......................... 8.0
======================
7............................ 12.0
==================================
OECD Member with No CRC.......... 0.0
==================================
Non-OECD Member with No CRC...... 8.0
==================================
Sovereign Default................ 12.0
------------------------------------------------------------------------
(B) Notwithstanding paragraph (b)(2)(i)(A) of this section, a
[BANK] may assign to a sovereign debt position a specific risk-
weighting factor that is lower than the applicable specific risk-
weighting factor in Table 1 to Sec. --.210 if:
(1) The position is denominated in the sovereign entity's currency;
(2) The [BANK] has at least an equivalent amount of liabilities in
that currency; and
(3) The sovereign entity allows banks under its jurisdiction to
assign the lower specific risk-weighting factor to the same exposures
to the sovereign entity.
(C) A [BANK] must assign a 12.0 percent specific risk-weighting
factor to a sovereign debt position immediately upon determination a
default has occurred; or if a default has occurred within the previous
five years.
(D) A [BANK] must assign a 0.0 percent specific risk-weighting
factor to a sovereign debt position if the sovereign entity is a member
of the OECD and does not have a CRC assigned to it, except as provided
in paragraph (b)(2)(i)(C) of this section.
(E) A [BANK] must assign an 8.0 percent specific risk-weighting
factor to a sovereign debt position if the sovereign is not a member of
the OECD and does not have a CRC assigned to it, except as provided in
paragraph (b)(2)(i)(C) of this section.
(ii) Certain supranational entity and multilateral development bank
debt positions. A [BANK] may assign a 0.0 percent specific risk-
weighting factor to a debt position that is an exposure to the Bank for
International Settlements, the European Central Bank, the European
Commission, the International Monetary Fund, or an MDB.
(iii) GSE debt positions. A [BANK] must assign a 1.6 percent
specific risk-weighting factor to a debt position that is an exposure
to a GSE. Notwithstanding the foregoing, a [BANK] must assign an 8.0
percent specific risk-weighting factor to preferred stock issued by a
GSE.
(iv) Depository institution, foreign bank, and credit union debt
positions. (A) Except as provided in paragraph (b)(2)(iv)(B) of this
section, a [BANK] must assign a specific risk-weighting factor to a
debt position that is an exposure to a depository institution, a
[[Page 62259]]
foreign bank, or a credit union, in accordance with Table 2 to Sec.
--.210, based on the CRC that corresponds to that entity's home country
or the OECD membership status of that entity's home country if there is
no CRC applicable to the entity's home country, and, as applicable, the
remaining contractual maturity of the position.
Table 2 to Sec. --.210--Specific Risk-Weighting Factors for Depository
Institution, Foreign Bank, and Credit Union Debt Positions
------------------------------------------------------------------------
------------------------------------------------------------------------
Specific risk-weighting factor
(in percent)
------------------------------------------------------------------------
CRC 0-2 or OECD Member with No Remaining contractual 0.25
CRC. maturity of 6 months
or less.
Remaining contractual 1.0
maturity of greater
than 6 and up to and
including 24 months.
Remaining contractual 1.6
maturity exceeds 24
months.
------------------------------------------------------------------------
CRC 3......................... 8.0
------------------------------------------------------------------------
CRC 4-7....................... 12.0
------------------------------------------------------------------------
Non-OECD Member with No CRC... 8.0
------------------------------------------------------------------------
Sovereign Default............. 12.0
------------------------------------------------------------------------
(B) A [BANK] must assign a specific risk-weighting factor of 8.0
percent to a debt position that is an exposure to a depository
institution or a foreign bank that is includable in the depository
institution's or foreign bank's regulatory capital and that is not
subject to deduction as a reciprocal holding under Sec. --.22.
(C) A [BANK] must assign a 12.0 percent specific risk-weighting
factor to a debt position that is an exposure to a foreign bank
immediately upon determination that a default by the foreign bank's
home country has occurred or if a default by the foreign bank's home
country has occurred within the previous five years.
(v) PSE debt positions. (A) Except as provided in paragraph
(b)(2)(v)(B) of this section, a [BANK] must assign a specific risk-
weighting factor to a debt position that is an exposure to a PSE in
accordance with Tables 3 and 4 to Sec. --.210 depending on the
position's categorization as a general obligation or revenue obligation
based on the CRC that corresponds to the PSE's home country or the OECD
membership status of the PSE's home country if there is no CRC
applicable to the PSE's home country, and, as applicable, the remaining
contractual maturity of the position, as set forth in Tables 3 and 4 of
this section.
(B) A [BANK] may assign a lower specific risk-weighting factor than
would otherwise apply under Tables 3 and 4 of this section to a debt
position that is an exposure to a foreign PSE if:
(1) The PSE's home country allows banks under its jurisdiction to
assign a lower specific risk-weighting factor to such position; and
(2) The specific risk-weighting factor is not lower than the risk
weight that corresponds to the PSE's home country in accordance with
Tables 3 and 4 of this section.
(C) A [BANK] must assign a 12.0 percent specific risk-weighting
factor to a PSE debt position immediately upon determination that a
default by the PSE's home country has occurred or if a default by the
PSE's home country has occurred within the previous five years.
Table 3 to Sec. --.210--Specific Risk-Weighting Factors for PSE
General Obligation Debt Positions
------------------------------------------------------------------------
------------------------------------------------------------------------
General obligation specific risk-
weighting factor
(in percent)
------------------------------------------------------------------------
CRC 0-2 or OECD Member with No Remaining contractual 0.25
CRC. maturity of 6 months
or less.
Remaining contractual 1.0
maturity of greater
than 6 and up to and
including 24 months.
Remaining contractual 1.6
maturity exceeds 24
months.
------------------------------------------------------------------------
CRC 3......................... 8.0
------------------------------------------------------------------------
CRC 4-7....................... 12.0
------------------------------------------------------------------------
Non-OECD Member with No CRC... 8.0
------------------------------------------------------------------------
Sovereign Default............. 12.0
------------------------------------------------------------------------
[[Page 62260]]
Table 4 to Sec. --.210--Specific Risk-Weighting Factors for PSE
Revenue Obligation Debt Positions
------------------------------------------------------------------------
------------------------------------------------------------------------
Revenue obligation specific risk-
weighting factor
(in percent)
------------------------------------------------------------------------
CRC 0-1 or OECD Member with No Remaining contractual 0.25
CRC. maturity of 6 months
or less.
Remaining contractual 1.0
maturity of greater
than 6 and up to and
including 24 months.
Remaining contractual 1.6
maturity exceeds 24
months.
------------------------------------------------------------------------
CRC 2-3....................... 8.0
------------------------------------------------------------------------
CRC 4-7....................... 12.0
------------------------------------------------------------------------
Non-OECD Member with No CRC... 8.0
------------------------------------------------------------------------
Sovereign Default............. 12.0
------------------------------------------------------------------------
(vi) Corporate debt positions. Except as otherwise provided in
paragraph (b)(2)(vi)(B) of this section, a [BANK] must assign a
specific risk-weighting factor to a corporate debt position in
accordance with the investment grade methodology in paragraph
(b)(2)(vi)(A) of this section.
(A) Investment grade methodology. (1) For corporate debt positions
that are exposures to entities that have issued and outstanding
publicly traded instruments, a [BANK] must assign a specific risk-
weighting factor based on the category and remaining contractual
maturity of the position, in accordance with Table 5 to Sec. --.210.
For purposes of this paragraph (b)(2)(vi)(A)(1), the [BANK] must
determine whether the position is in the investment grade or not
investment grade category.
Table 5 to Sec. --.210--Specific Risk-Weighting Factors for Corporate
Debt Positions Under the Investment Grade Methodology
------------------------------------------------------------------------
Specific risk-
Category Remaining contractual weighting factor
maturity (in percent)
------------------------------------------------------------------------
Investment Grade.............. 6 months or less...... 0.50
Greater than 6 and up 2.00
to and including 24
months.
Greater than 24 months 4.00
------------------------------------------------------------------------
Non-investment Grade.................................. 12.00
------------------------------------------------------------------------
(2) A [BANK] must assign an 8.0 percent specific risk-weighting
factor for corporate debt positions that are exposures to entities that
do not have publicly traded instruments outstanding.
(B) Limitations. (1) A [BANK] must assign a specific risk-weighting
factor of at least 8.0 percent to an interest-only mortgage-backed
security that is not a securitization position.
(2) A [BANK] shall not assign a corporate debt position a specific
risk-weighting factor that is lower than the specific risk-weighting
factor that corresponds to the CRC of the issuer's home country, if
applicable, in table 1 of this section.
(vii) Securitization positions. (A) General requirements. (1) A
[BANK] that is not an advanced approaches [BANK] must assign a specific
risk-weighting factor to a securitization position using either the
simplified supervisory formula approach (SSFA) in paragraph
(b)(2)(vii)(C) of this section (and Sec. --.211) or assign a specific
risk-weighting factor of 100 percent to the position.
(2) A [BANK] that is an advanced approaches [BANK] must calculate a
specific risk add-on for a securitization position in accordance with
paragraph (b)(2)(vii)(B) of this section if the [BANK] and the
securitization position each qualifies to use the SFA in Sec. --.143.
A [BANK] that is an advanced approaches [BANK] with a securitization
position that does not qualify for the SFA under paragraph
(b)(2)(vii)(B) of this section may assign a specific risk-weighting
factor to the securitization position using the SSFA in accordance with
paragraph (b)(2)(vii)(C) of this section or assign a specific risk-
weighting factor of 100 percent to the position.
(3) A [BANK] must treat a short securitization position as if it is
a long securitization position solely for calculation purposes when
using the SFA in paragraph (b)(2)(vii)(B) of this section or the SSFA
in paragraph (b)(2)(vii)(C) of this section.
(B) SFA. To calculate the specific risk add-on for a securitization
position using the SFA, a [BANK] that is an advanced approaches [BANK]
must set the specific risk add-on for the position equal to the risk-
based capital requirement as calculated under Sec. --.143.
(C) SSFA. To use the SSFA to determine the specific risk-weighting
factor for a securitization position, a [BANK] must calculate the
specific risk-weighting factor in accordance with Sec. --.211.
(D) Nth-to-default credit derivatives. A [BANK] must determine a
specific risk add-on using the SFA in paragraph (b)(2)(vii)(B) of this
section, or assign a specific risk-weighting factor using the SSFA in
paragraph (b)(2)(vii)(C) of this section to an nth-to-
default credit derivative in accordance with this paragraph
(b)(2)(vii)(D), regardless of whether the [BANK] is a net protection
buyer or net protection seller. A [BANK] must determine its position in
the nth-to-default credit derivative as the largest notional
amount of all the underlying exposures.
(1) For purposes of determining the specific risk add-on using the
SFA in paragraph (b)(2)(vii)(B) of this section or the specific risk-
weighting factor for an
[[Page 62261]]
nth-to-default credit derivative using the SSFA in paragraph
(b)(2)(vii)(C) of this section the [BANK] must calculate the attachment
point and detachment point of its position as follows:
(i) The attachment point (parameter A) is the ratio of the sum of
the notional amounts of all underlying exposures that are subordinated
to the [BANK]'s position to the total notional amount of all underlying
exposures. For purposes of the SSFA, parameter A is expressed as a
decimal value between zero and one. For purposes of using the SFA in
paragraph (b)(2)(vii)(B) of this section to calculate the specific add-
on for its position in an nth-to-default credit derivative,
parameter A must be set equal to the credit enhancement level (L) input
to the SFA formula in section 143 of this subpart. In the case of a
first-to-default credit derivative, there are no underlying exposures
that are subordinated to the [BANK]'s position. In the case of a
second-or-subsequent-to-default credit derivative, the smallest (n-1)
notional amounts of the underlying exposure(s) are subordinated to the
[BANK]'s position.
(ii) The detachment point (parameter D) equals the sum of parameter
A plus the ratio of the notional amount of the [BANK]'s position in the
nth-to-default credit derivative to the total notional
amount of all underlying exposures. For purposes of the SSFA, parameter
A is expressed as a decimal value between zero and one. For purposes of
using the SFA in paragraph (b)(2)(vii)(B) of this section to calculate
the specific risk add-on for its position in an nth-to-
default credit derivative, parameter D must be set to equal the L input
plus the thickness of tranche T input to the SFA formula in Sec.
--.143 of this subpart.
(2) A [BANK] that does not use the SFA in paragraph (b)(2)(vii)(B)
of this section to determine a specific risk-add on, or the SSFA in
paragraph (b)(2)(vii)(C) of this section to determine a specific risk-
weighting factor for its position in an nth-to-default
credit derivative must assign a specific risk-weighting factor of 100
percent to the position.
(c) Modeled correlation trading positions. For purposes of
calculating the comprehensive risk measure for modeled correlation
trading positions under either paragraph (a)(2)(i) or (a)(2)(ii) of
Sec. --.209, the total specific risk add-on is the greater of:
(1) The sum of the [BANK]'s specific risk add-ons for each net long
correlation trading position calculated under this section; or
(2) The sum of the [BANK]'s specific risk add-ons for each net
short correlation trading position calculated under this section.
(d) Non-modeled securitization positions. For securitization
positions that are not correlation trading positions and for
securitizations that are correlation trading positions not modeled
under Sec. --.209, the total specific risk add-on is the greater of:
(1) The sum of the [BANK]'s specific risk add-ons for each net long
securitization position calculated under this section; or
(2) The sum of the [BANK]'s specific risk add-ons for each net
short securitization position calculated under this section.
(e) Equity positions. The total specific risk add-on for a
portfolio of equity positions is the sum of the specific risk add-ons
of the individual equity positions, as computed under this section. To
determine the specific risk add-on of individual equity positions, a
[BANK] must multiply the absolute value of the current fair value of
each net long or net short equity position by the appropriate specific
risk-weighting factor as determined under this paragraph (e):
(1) The [BANK] must multiply the absolute value of the current fair
value of each net long or net short equity position by a specific risk-
weighting factor of 8.0 percent. For equity positions that are index
contracts comprising a well-diversified portfolio of equity
instruments, the absolute value of the current fair value of each net
long or net short position is multiplied by a specific risk-weighting
factor of 2.0 percent.\29\
---------------------------------------------------------------------------
\29\ A portfolio is well-diversified if it contains a large
number of individual equity positions, with no single position
representing a substantial portion of the portfolio's total fair
value.
---------------------------------------------------------------------------
(2) For equity positions arising from the following futures-related
arbitrage strategies, a [BANK] may apply a 2.0 percent specific risk-
weighting factor to one side (long or short) of each position with the
opposite side exempt from an additional capital requirement:
(i) Long and short positions in exactly the same index at different
dates or in different market centers; or
(ii) Long and short positions in index contracts at the same date
in different, but similar indices.
(3) For futures contracts on main indices that are matched by
offsetting positions in a basket of stocks comprising the index, a
[BANK] may apply a 2.0 percent specific risk-weighting factor to the
futures and stock basket positions (long and short), provided that such
trades are deliberately entered into and separately controlled, and
that the basket of stocks is comprised of stocks representing at least
90.0 percent of the capitalization of the index. A main index refers to
the Standard & Poor's 500 Index, the FTSE All-World Index, and any
other index for which the [BANK] can demonstrate to the satisfaction of
the [AGENCY] that the equities represented in the index have liquidity,
depth of market, and size of bid-ask spreads comparable to equities in
the Standard & Poor's 500 Index and FTSE All-World Index.
(f) Due diligence requirements for securitization positions. (1) A
[BANK] must demonstrate to the satisfaction of the [AGENCY] a
comprehensive understanding of the features of a securitization
position that would materially affect the performance of the position
by conducting and documenting the analysis set forth in paragraph
(f)(2) of this section. The [BANK]'s analysis must be commensurate with
the complexity of the securitization position and the materiality of
the position in relation to capital.
(2) A [BANK] must demonstrate its comprehensive understanding for
each securitization position by:
(i) Conducting an analysis of the risk characteristics of a
securitization position prior to acquiring the position and document
such analysis within three business days after acquiring position,
considering:
(A) Structural features of the securitization that would materially
impact the performance of the position, for example, the contractual
cash flow waterfall, waterfall-related triggers, credit enhancements,
liquidity enhancements, fair value triggers, the performance of
organizations that service the position, and deal-specific definitions
of default;
(B) 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 loan-to-value ratio; and industry
and geographic diversification data on the underlying exposure(s);
(C) Relevant market data of the securitization, for example, bid-
ask spreads, 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
(D) For resecuritization positions, performance information on the
underlying securitization exposures, for example, the issuer name and
credit
[[Page 62262]]
quality, and the characteristics and performance of the exposures
underlying the securitization exposures.
(ii) On an on-going basis (no less frequently than quarterly),
evaluating, reviewing, and updating as appropriate the analysis
required under paragraph (f)(1) of this section for each securitization
position.
Sec. --.211 Simplified supervisory formula approach (SSFA).
(a) General requirements. To use the SSFA to determine the specific
risk-weighting factor for a securitization position, a [BANK] must have
data that enables it to assign accurately the parameters described in
paragraph (b) of this section. Data used to assign the parameters
described in paragraph (b) of this section must be the most currently
available data; if the contracts governing the underlying exposures of
the securitization require payments on a monthly or quarterly basis,
the data used to assign the parameters described in paragraph (b) of
this section must be no more than 91 calendar days old. A [BANK] that
does not have the appropriate data to assign the parameters described
in paragraph (b) of this section must assign a specific risk-weighting
factor of 100 percent to the position.
(b) SSFA parameters. To calculate the specific risk-weighting
factor for a securitization position using the SSFA, a [BANK] must have
accurate information on the five inputs to the SSFA calculation
described in paragraphs (b)(1) through (b)(5) of this section.
(1) KG is the weighted-average (with unpaid principal
used as the weight for each exposure) total capital requirement of the
underlying exposures calculated using subpart D. KG is
expressed as a decimal value between zero and one (that is, an average
risk weight of 100 percent represents a value of KG equal to
0.08).
(2) Parameter W is expressed as a decimal value between zero and
one. Parameter W is the ratio of the sum of the dollar amounts of any
underlying exposures of the securitization that meet any of the
criteria as set forth in paragraphs (b)(2)(i) through (vi) of this
section to the balance, measured in dollars, of underlying exposures:
(i) Ninety days or more past due;
(ii) Subject to a bankruptcy or insolvency proceeding;
(iii) In the process of foreclosure;
(iv) Held as real estate owned;
(v) Has contractually deferred payments for 90 days or more, other
than principal or interest payments deferred on:
(A) Federally-guaranteed student loans, in accordance with the
terms of those guarantee programs; or
(B) 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; or
(vi) Is in default.
(3) Parameter A is the attachment point for the position, which
represents the threshold at which credit losses will first be allocated
to the position. Except as provided in Sec. --.210(b)(2)(vii)(D) for
nth-to-default credit derivatives, parameter A equals the
ratio of the current dollar amount of underlying exposures that are
subordinated to the position of the [BANK] to the current dollar amount
of underlying exposures. Any reserve account funded by the accumulated
cash flows from the underlying exposures that is subordinated to the
position that contains the [BANK]'s securitization exposure may be
included in the calculation of parameter A to the extent that cash is
present in the account. Parameter A is expressed as a decimal value
between zero and one.
(4) Parameter D is the detachment point for the position, which
represents the threshold at which credit losses of principal allocated
to the position would result in a total loss of principal. Except as
provided in Sec. --.210(b)(2)(vii)(D) for nth-to-default
credit derivatives, parameter D equals parameter A plus the ratio of
the current dollar amount of the securitization positions that are pari
passu with the position (that is, have equal seniority with respect to
credit risk) to the current dollar amount of the underlying exposures.
Parameter D is expressed as a decimal value between zero and one.
(5) A supervisory calibration parameter, p, is equal to 0.5 for
securitization positions that are not resecuritization positions and
equal to 1.5 for resecuritization positions.
(c) Mechanics of the SSFA. KG and W are used to
calculate KA, the augmented value of KG, which
reflects the observed credit quality of the underlying exposures.
KA is defined in paragraph (d) of this section. The values
of parameters A and D, relative to KA determine the specific
risk-weighting factor assigned to a position as described in this
paragraph (c) and paragraph (d) of this section. The specific risk-
weighting factor assigned to a securitization position, or portion of a
position, as appropriate, is the larger of the specific risk-weighting
factor determined in accordance with this paragraph (c), paragraph (d)
of this section, and a specific risk-weighting factor of 1.6 percent.
(1) When the detachment point, parameter D, for a securitization
position is less than or equal to KA, the position must be
assigned a specific risk-weighting factor of 100 percent.
(2) When the attachment point, parameter A, for a securitization
position is greater than or equal to KA, the [BANK] must
calculate the specific risk-weighting factor in accordance with
paragraph (d) of this section.
(3) When A is less than KA and D is greater than
KA, the specific risk-weighting factor is a weighted-average
of 1.00 and KSSFA calculated under paragraphs (c)(3)(i) and
(c)(3)(ii) of this section. For the purpose of this calculation:
(i) The weight assigned to 1.00 equals
[[Page 62263]]
[GRAPHIC] [TIFF OMITTED] TR11OC13.057
Sec. --.212 Market risk disclosures.
(a) Scope. A [BANK] must comply with this section unless it is a
consolidated subsidiary of a bank holding company or a depository
institution that is subject to these requirements or of a non-U.S.
banking organization that is subject to comparable public disclosure
requirements in its home jurisdiction. A [BANK] must make timely public
disclosures each calendar quarter. If a significant change occurs, such
that the most recent reporting amounts are no longer reflective of the
[BANK]'s capital adequacy and risk profile, then a brief discussion of
this change and its likely impact must be provided as soon as
practicable thereafter. Qualitative disclosures that typically do not
change each quarter may be disclosed annually, provided any significant
changes are disclosed in the interim. If a [BANK] believes that
disclosure of specific commercial or financial information would
prejudice seriously its position by making public certain information
that is either proprietary or confidential in nature, the [BANK] is not
required to disclose these specific items, but must disclose more
general information about the subject matter of the requirement,
together with the fact that, and the reason why, the specific items of
information have not been disclosed. The [BANK]'s management may
provide all of the disclosures required by this section in one place on
the [BANK]'s public Web site or may provide the disclosures in more
than one public financial report or other regulatory reports, provided
that the [BANK] publicly provides a summary table specifically
indicating the location(s) of all such disclosures.
(b) Disclosure policy. The [BANK] must have a formal disclosure
policy approved by the board of directors that addresses the [BANK]'s
approach for determining its market risk disclosures. The policy must
address the associated internal controls and disclosure controls and
procedures. The board of directors and senior management must ensure
that appropriate verification of the disclosures takes place and that
effective internal controls and disclosure controls and procedures are
maintained. One or more senior officers of the [BANK] must attest that
the disclosures meet the requirements of this subpart, and the board of
directors and senior management are responsible for establishing and
maintaining an effective internal control structure over financial
reporting, including the disclosures required by this section.
[[Page 62264]]
(c) Quantitative disclosures. (1) For each material portfolio of
covered positions, the [BANK] must provide timely public disclosures of
the following information at least quarterly:
(i) The high, low, and mean VaR-based measures over the reporting
period and the VaR-based measure at period-end;
(ii) The high, low, and mean stressed VaR-based measures over the
reporting period and the stressed VaR-based measure at period-end;
(iii) The high, low, and mean incremental risk capital requirements
over the reporting period and the incremental risk capital requirement
at period-end;
(iv) The high, low, and mean comprehensive risk capital
requirements over the reporting period and the comprehensive risk
capital requirement at period-end, with the period-end requirement
broken down into appropriate risk classifications (for example, default
risk, migration risk, correlation risk);
(v) Separate measures for interest rate risk, credit spread risk,
equity price risk, foreign exchange risk, and commodity price risk used
to calculate the VaR-based measure; and
(vi) A comparison of VaR-based estimates with actual gains or
losses experienced by the [BANK], with an analysis of important
outliers.
(2) In addition, the [BANK] must disclose publicly the following
information at least quarterly:
(i) The aggregate amount of on-balance sheet and off-balance sheet
securitization positions by exposure type; and
(ii) The aggregate amount of correlation trading positions.
(d) Qualitative disclosures. For each material portfolio of covered
positions, the [BANK] must provide timely public disclosures of the
following information at least annually after the end of the fourth
calendar quarter, or more frequently in the event of material changes
for each portfolio:
(1) The composition of material portfolios of covered positions;
(2) The [BANK]'s valuation policies, procedures, and methodologies
for covered positions including, for securitization positions, the
methods and key assumptions used for valuing such positions, any
significant changes since the last reporting period, and the impact of
such change;
(3) The characteristics of the internal models used for purposes of
this subpart. For the incremental risk capital requirement and the
comprehensive risk capital requirement, this must include:
(i) The approach used by the [BANK] to determine liquidity
horizons;
(ii) The methodologies used to achieve a capital assessment that is
consistent with the required soundness standard; and
(iii) The specific approaches used in the validation of these
models;
(4) A description of the approaches used for validating and
evaluating the accuracy of internal models and modeling processes for
purposes of this subpart;
(5) For each market risk category (that is, interest rate risk,
credit spread risk, equity price risk, foreign exchange risk, and
commodity price risk), a description of the stress tests applied to the
positions subject to the factor;
(6) The results of the comparison of the [BANK]'s internal
estimates for purposes of this subpart with actual outcomes during a
sample period not used in model development;
(7) The soundness standard on which the [BANK]'s internal capital
adequacy assessment under this subpart is based, including a
description of the methodologies used to achieve a capital adequacy
assessment that is consistent with the soundness standard;
(8) A description of the [BANK]'s processes for monitoring changes
in the credit and market risk of securitization positions, including
how those processes differ for resecuritization positions; and
(9) A description of the [BANK]'s policy governing the use of
credit risk mitigation to mitigate the risks of securitization and
resecuritization positions.
Sec. Sec. --.213 through --.299 [Reserved]
Subpart G--Transition Provisions
Sec. --.300 Transitions.
(a) Capital conservation and countercyclical capital buffer. (1)
From January 1, 2014 through December 31, 2015, a [BANK] is not subject
to limits on distributions and discretionary bonus payments under Sec.
--.11 of subpart B of this part notwithstanding the amount of its
capital conservation buffer or any applicable countercyclical capital
buffer amount.
(2) Beginning January 1, 2016 through December 31, 2018 a [BANK]'s
maximum payout ratio shall be determined as set forth in Table 1 to
Sec. --.300.
Table 1 to Sec. --.300
----------------------------------------------------------------------------------------------------------------
Maximum payout ratio (as
Transition period Capital conservation buffer a percentage of eligible
retained income)
----------------------------------------------------------------------------------------------------------------
Calendar year 2016.................... Greater than 0.625 percent (plus 25 percent of No payout ratio
any applicable countercyclical capital buffer limitation applies
amount). under this section.
Less than or equal to 0.625 percent (plus 25 60 percent.
percent of any applicable countercyclical
capital buffer amount), and greater than
0.469 percent (plus 17.25 percent of any
applicable countercyclical capital buffer
amount).
Less than or equal to 0.469 percent (plus 40 percent.
17.25 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 12.5 20 percent.
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 6.25 0 percent.
percent of any applicable countercyclical
capital buffer amount).
Calendar year 2017.................... Greater than 1.25 percent (plus 50 percent of No payout ratio
any applicable countercyclical capital buffer limitation applies
amount). under this section.
Less than or equal to 1.25 percent (plus 50 60 percent.
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).
[[Page 62265]]
Less than or equal to 0.938 percent (plus 37.5 40 percent.
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 25 20 percent.
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 12.5 0 percent.
percent of any applicable countercyclical
capital buffer amount).
Calendar year 2018.................... Greater than 1.875 percent (plus 75 percent of No payout ratio
any applicable countercyclical capital buffer limitation applies
amount). under this section.
Less than or equal to 1.875 percent (plus 75 60 percent.
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 percent.
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 37.5 20 percent.
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 percent.
18.75 percent of any applicable
countercyclical capital buffer amount).
----------------------------------------------------------------------------------------------------------------
(b) Regulatory capital adjustments and deductions. Beginning
January 1, 2014 for an advanced approaches [BANK], and beginning
January 1, 2015 for a [BANK] that is not an advanced approaches [BANK],
and in each case through December 31, 2017, a [BANK] must make the
capital adjustments and deductions in Sec. --.22 in accordance with
the transition requirements in this paragraph (b). Beginning January 1,
2018, a [BANK] must make all regulatory capital adjustments and
deductions in accordance with Sec. --.22.
(1) Transition deductions from common equity tier 1 capital.
Beginning January 1, 2014 for an advanced approaches [BANK], and
beginning January 1, 2015 for a [BANK] that is not an advanced
approaches [BANK], and in each case through December 31, 2017, a
[BANK], must make the deductions required under Sec. --.22(a)(1)-(7)
from common equity tier 1 or tier 1 capital elements in accordance with
the percentages set forth in Table 2 and Table 3 to Sec. --.300.
(i) A [BANK] must deduct the following items from common equity
tier 1 and additional tier 1 capital in accordance with the percentages
set forth in Table 2 to Sec. --.300: goodwill (Sec. --.22(a)(1)),
DTAs that arise from net operating loss and tax credit carryforwards
(Sec. --.22(a)(3)), a gain-on-sale in connection with a securitization
exposure (Sec. --.22(a)(4)), defined benefit pension fund assets
(Sec. --.22(a)(5)), expected credit loss that exceeds eligible credit
reserves (for advanced approaches [BANK]s that have completed the
parallel run process and that have received notifications from the
[AGENCY] pursuant to Sec. --.121(d) of subpart E) (Sec. --.22(a)(6)),
and financial subsidiaries (Sec. --.22(a)(7)).
Table 2 to Sec. --.300
----------------------------------------------------------------------------------------------------------------
Transition deductions Transition deductions under Sec. --.22(a)(3)-(6)
under Sec. --.22(a)(1) ---------------------------------------------------
and (7)
Transition period -------------------------- Percentage of the Percentage of the
Percentage of the deductions from common deductions from tier 1
deductions from common equity tier 1 capital capital
equity tier 1 capital
----------------------------------------------------------------------------------------------------------------
Calendar year 2014................ 100 20 80
Calendar year 2015................ 100 40 60
Calendar year 2016................ 100 60 40
Calendar year 2017................ 100 80 20
Calendar year 2018, and thereafter 100 100 0
----------------------------------------------------------------------------------------------------------------
(ii) A [BANK] must deduct from common equity tier 1 capital any
intangible assets other than goodwill and MSAs in accordance with the
percentages set forth in Table 3 to Sec. --.300.
(iii) A [BANK] must apply a 100 percent risk-weight to the
aggregate amount of intangible assets other than goodwill and MSAs that
are not required to be deducted from common equity tier 1 capital under
this section.
[[Page 62266]]
Table 3 to Sec. --.300
------------------------------------------------------------------------
Transition deductions under Sec. --
Transition period .22(a)(2)--percentage of the deductions
from common equity tier 1 capital
------------------------------------------------------------------------
Calendar year 2014.......... 20
Calendar year 2015.......... 40
Calendar year 2016.......... 60
Calendar year 2017.......... 80
Calendar year 2018, and 100
thereafter.................
------------------------------------------------------------------------
(2) Transition adjustments to common equity tier 1 capital.
Beginning January 1, 2014 for an advanced approaches [BANK], and
beginning January 1, 2015 for a [BANK] that is not an advanced
approaches [BANK], and in each case through December 31, 2017, a
[BANK], must allocate the regulatory adjustments related to changes in
the fair value of liabilities due to changes in the [BANK]'s own credit
risk (Sec. --.22(b)(1)(iii)) between common equity tier 1 capital and
tier 1 capital in accordance with the percentages set forth in Table 4
to Sec. --.300.
(i) If the aggregate amount of the adjustment is positive, the
[BANK] must allocate the deduction between common equity tier 1 and
tier 1 capital in accordance with Table 4 to Sec. --.300.
(ii) If the aggregate amount of the adjustment is negative, the
[BANK] must add back the adjustment to common equity tier 1 capital or
to tier 1 capital, in accordance with Table 4 to Sec. --.300.
Table 4 to Sec. --.300
----------------------------------------------------------------------------------------------------------------
Transition adjustments under Sec. --.22(b)(2)
-------------------------------------------------------------------------
Transition period Percentage of the adjustment
applied to common equity tier 1 Percentage of the adjustment
capital applied to tier 1 capital
----------------------------------------------------------------------------------------------------------------
Calendar year 2014.................... 20 80
Calendar year 2015.................... 40 60
Calendar year 2016.................... 60 40
Calendar year 2017.................... 80 20
Calendar year 2018, and thereafter.... 100 0
----------------------------------------------------------------------------------------------------------------
(3) Transition adjustments to AOCI for an advanced approaches
[BANK] and a [BANK] that has not made an AOCI opt-out election under
Sec. --.22(b)(2). Beginning January 1, 2014 for an advanced approaches
[BANK], and beginning January 1, 2015 for a [BANK] that is not an
advanced approaches [BANK] that has not made an AOCI opt-out election
under Sec. --.22(b)(2), and in each case through December 31, 2017, a
[BANK] must adjust common equity tier 1 capital with respect to the
transition AOCI adjustment amount (transition AOCI adjustment amount):
(i) The transition AOCI adjustment amount is the aggregate amount
of a [BANK]'s:
(A) Unrealized gains on available-for-sale securities that are
preferred stock classified as an equity security under GAAP or
available-for-sale equity exposures, plus
(B) Net unrealized gains or losses on available-for-sale securities
that are not preferred stock classified as an equity security under
GAAP or available-for-sale equity exposures, plus
(C) 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 [BANK]'s option, the portion relating to pension
assets deducted under section 22(a)(5)), plus
(D) 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, plus
(E) Net unrealized gains or losses on held-to-maturity securities
that are included in AOCI.
(ii) A [BANK] must make the following adjustment to its common
equity tier 1 capital:
(A) If the transition AOCI adjustment amount is positive, the
appropriate amount must be deducted from common equity tier 1 capital
in accordance with Table 5 to Sec. --.300.
(B) If the transition AOCI adjustment amount is negative, the
appropriate amount must be added back to common equity tier 1 capital
in accordance with Table 5 to Sec. --.300.
Table 5 to Sec. --.300
------------------------------------------------------------------------
Percentage of the transition AOCI
Transition period adjustment amount to be applied to common
equity tier 1 capital
------------------------------------------------------------------------
Calendar year 2014.......... 80
Calendar year 2015.......... 60
Calendar year 2016.......... 40
Calendar year 2017.......... 20
Calendar year 2018 and 0
thereafter.................
------------------------------------------------------------------------
[[Page 62267]]
(iii) A [BANK] may include in tier 2 capital the percentage of
unrealized gains on available-for-sale preferred stock classified as an
equity security under GAAP and available-for-sale equity exposures as
set forth in Table 6 to Sec. --.300.
Table 6 to Sec. --.300
------------------------------------------------------------------------
Percentage of unrealized gains on
available-for-sale preferred stock
classified as an equity security under
Transition period GAAP and available-for-sale equity
exposures that may be included in tier 2
capital
------------------------------------------------------------------------
Calendar year 2014.......... 36
Calendar year 2015.......... 27
Calendar year 2016.......... 18
Calendar year 2017.......... 9
Calendar year 2018 and 0
thereafter.................
------------------------------------------------------------------------
(4) Additional transition deductions from regulatory capital. (i)
Beginning January 1, 2014 for an advanced approaches [BANK], and
beginning January 1, 2015 for a [BANK] that is not an advanced
approaches [BANK], and in each case through December 31, 2017, a
[BANK], must use Table 7 to Sec. --.300 to determine the amount of
investments in capital instruments and the items subject to the 10 and
15 percent common equity tier 1 capital deduction thresholds (Sec.
--.22(d)) (that is, MSAs, DTAs arising from temporary differences that
the [BANK] could not realize through net operating loss carrybacks, and
significant investments in the capital of unconsolidated financial
institutions in the form of common stock) that must be deducted from
common equity tier 1 capital.
(ii) Beginning January 1, 2014 for an advanced approaches [BANK],
and beginning January 1, 2015 for a [BANK] that is not an advanced
approaches [BANK], and in each case through December 31, 2017, a [BANK]
must apply a 100 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 under this section. As set
forth in Sec. --.22(d)(2), beginning January 1, 2018, a [BANK] must
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 7 to Sec. --.300
------------------------------------------------------------------------
Transitions for deductions under Sec. --
Transition period .22(c) and (d)--Percentage of additional
deductions from regulatory capital
------------------------------------------------------------------------
Calendar year 2014.......... 20
Calendar year 2015.......... 40
Calendar year 2016.......... 60
Calendar year 2017.......... 80
Calendar year 2018 and 100
thereafter.................
------------------------------------------------------------------------
(iii) For purposes of calculating the transition deductions in this
paragraph (b)(4) beginning January 1, 2014 for an advanced approaches
[BANK], and beginning January 1, 2015 for a [BANK] that is not an
advanced approaches [BANK], and in each case through December 31, 2017,
a [BANK]'s 15 percent common equity tier 1 capital deduction threshold
for MSAs, DTAs arising from temporary differences that the [BANK] could
not realize through net operating loss carrybacks, and significant
investments in the capital of unconsolidated financial institutions in
the form of common stock is equal to 15 percent of the sum of the
[BANK]'s common equity tier 1 elements, after regulatory adjustments
and deductions required under Sec. --.22(a) through (c) (transition 15
percent common equity tier 1 capital deduction threshold).
(iv) Beginning January 1, 2018, a [BANK] must calculate the 15
percent common equity tier 1 capital deduction threshold in accordance
with Sec. --.22(d).
(c) Non-qualifying capital instruments--(1) Depository institution
holding companies with total consolidated assets of more than $15
billion as of December 31, 2009 that were not mutual holding companies
prior to May 19, 2010. The transition provisions in this paragraph
(c)(1) apply to debt or equity instruments that do not meet the
criteria for additional tier 1 or tier 2 capital instruments in Sec.
--.20, but that were issued and included in tier 1 or tier 2 capital,
respectively prior to May 19, 2010 (non-qualifying capital
instruments), and that were issued by a depository institution holding
company with total consolidated assets greater than or equal to $15
billion as of December 31, 2009 that was not a mutual holding company
prior to May 19, 2010 (2010 MHC) (depository institution holding
company of $15 billion or more).
(i) A depository institution holding company of $15 billion or more
may include in tier 1 and tier 2 capital non-qualifying capital
instruments up to the applicable percentage set forth in Table 8 to
Sec. --.300 of the aggregate outstanding principal amounts of non-
qualifying tier 1 and tier 2 capital instruments, respectively, that
are outstanding as of January 1, 2014, beginning January 1, 2014, for a
depository institution holding company of $15 billion or more that is
an advanced approaches [BANK] that is not a savings and loan holding
company, and beginning January 1, 2015, for all other depository
institution holding companies of $15 billion or more.
(ii) A depository institution holding company of $15 billion or
more must apply the applicable percentages set forth in Table 8 to
Sec. --.300 separately to
[[Page 62268]]
the aggregate amounts of its tier 1 and tier 2 non-qualifying capital
instruments.
(iii) The amount of non-qualifying capital instruments that must be
excluded from additional tier 1 capital in accordance with this section
may be included in tier 2 capital without limitation, provided the
instruments meet the criteria for tier 2 capital set forth in Sec.
--.20(d).
(iv) Non-qualifying capital instruments that do not meet the
criteria for tier 2 capital set forth in Sec. --.20(d) may be included
in tier 2 capital as follows:
(A) A depository institution holding company of $15 billion or more
that is not an advanced approaches [BANK] may include non-qualifying
capital instruments that have been phased-out of tier 1 capital in tier
2 capital, and
(B) During calendar years 2014 and 2015, a depository institution
holding company of $15 billion or more that is an advanced approaches
[BANK] may include non-qualifying capital instruments in tier 2 capital
that have been phased out of tier 1 capital in accordance with Table 8
to Sec. --.300. Beginning January 1, 2016, a depository institution
holding company of $15 billion or more that is an advanced approaches
[BANK] may include non-qualifying capital instruments in tier 2 capital
that have been phased out of tier 1 capital in accordance with Table 8,
up to the applicable percentages set forth in Table 9 to Sec. --.300.
(2) Mergers and acquisitions. (i) A depository institution holding
company of $15 billion or more that acquires either a depository
institution holding company with total consolidated assets of less than
$15 billion as of December 31, 2009 (depository institution holding
company under $15 billion) or a depository institution holding company
that is a 2010 MHC, may include in regulatory capital the non-
qualifying capital instruments issued by the acquired organization up
to the applicable percentages set forth in Table 8 to Sec. --.300.
(ii) If a depository institution holding company under $15 billion
acquires a depository institution holding company under $15 billion or
a 2010 MHC, and the resulting organization has total consolidated
assets of $15 billion or more as reported on the resulting
organization's FR Y-9C for the period in which the transaction
occurred, the resulting organization may include in regulatory capital
non-qualifying instruments of the resulting organization up to the
applicable percentages set forth in Table 8 to Sec. --.300.
Table 8 to Sec. --.300
------------------------------------------------------------------------
Percentage of non-qualifying capital
instruments includable in additional tier
Transition period (calendar 1 or tier 2 capital for a depository
year) institution holding company of $15 billion
or more
------------------------------------------------------------------------
Calendar year 2014.......... 50
Calendar year 2015.......... 25
Calendar year 2016 and 0
thereafter.................
------------------------------------------------------------------------
(3) Depository institution holding companies under $15 billion and
2010 MHCs. (i) Non-qualifying capital instruments issued by depository
institution holding companies under $15 billion and 2010 MHCs prior to
May 19, 2010 may be included in additional tier 1 or tier 2 capital if
the instrument was included in tier 1 or tier 2 capital, respectively,
as of January 1, 2014.
(ii) Non-qualifying capital instruments includable in tier 1
capital are subject to a limit of 25 percent of tier 1 capital
elements, excluding any non-qualifying capital instruments and after
applying all regulatory capital deductions and adjustments to tier 1
capital.
(iii) Non-qualifying capital instruments that are not included in
tier 1 as a result of the limitation in paragraph (c)(3)(ii) of this
section are includable in tier 2 capital.
(4) Depository institutions. (i) Beginning on January 1, 2014, a
depository institution that is an advanced approaches [BANK], and
beginning on January 1, 2015, all other depository institutions, 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 Sec. --.20 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) up
to the percentage of the outstanding principal amount of such non-
qualifying capital instruments as of January 1, 2014 in accordance with
Table 9 to Sec. --.300.
(ii) Table 9 to Sec. --.300 applies separately to tier 1 and tier
2 non-qualifying capital instruments.
(iii) The amount of non-qualifying capital instruments that cannot
be included in additional tier 1 capital under this section may be
included in tier 2 capital without limitation, provided that the
instruments meet the criteria for tier 2 capital instruments under
Sec. --.20(d).
Table 9 to Sec. --.300
----------------------------------------------------------------------------------------------------------------
Percentage of non-qualifying capital
Transition period (calendar year) instruments includable in additional tier
1 or tier 2 capital
---------------------------------------------------------------------------------------------------------------
Calendar year 2014................................................ 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
----------------------------------------------------------------------------------------------------------------
[[Page 62269]]
(d) Minority interest--(1) Surplus minority interest. Beginning
January 1, 2014 for an advanced approaches [BANK], and beginning
January 1, 2015 for a [BANK] that is not an advanced approaches [BANK],
and in each case through December 31, 2017, a [BANK] may include in
common equity tier 1 capital, tier 1 capital, or total capital the
percentage of the common equity tier 1 minority interest, tier 1
minority interest and total capital minority interest outstanding as of
January 1, 2014 that exceeds any common equity tier 1 minority
interest, tier 1 minority interest or total capital minority interest
includable under Sec. --.21 (surplus minority interest), respectively,
as set forth in Table 10 to Sec. --.300.
(2) Non-qualifying minority interest. Beginning January 1, 2014 for
an advanced approaches [BANK], and beginning January 1, 2015 for a
[BANK] that is not an advanced approaches [BANK], and in each case
through December 31, 2017, a [BANK] may include in tier 1 capital or
total capital the percentage of the tier 1 minority interest and total
capital minority interest outstanding as of January 1, 2014 that does
not meet the criteria for additional tier 1 or tier 2 capital
instruments in Sec. --.20 (non-qualifying minority interest), as set
forth in Table 10 to Sec. --.300.
Table 10 to Sec. --.300
------------------------------------------------------------------------
Percentage of the amount of surplus or non-
qualifying minority interest that can be
Transition period included in regulatory capital during the
transition period
------------------------------------------------------------------------
Calendar year 2014.......... 80
Calendar year 2015.......... 60
Calendar year 2016.......... 40
Calendar year 2017.......... 20
Calendar year 2018 and 0
thereafter.................
------------------------------------------------------------------------
(e) Prompt corrective action. For purposes of [12 CFR Part 6 (OCC);
12 CFR 208, subpart D (Board)], a [BANK] must calculate its capital
measures and tangible equity ratio in accordance with the transition
provisions in this section.
End of Common Rule.
List of Subjects
12 CFR Part 3
Administrative practice and procedure, Capital, National banks,
Reporting and recordkeeping requirements, Risk.
12 CFR Part 5
Administrative practice and procedure, National banks, Reporting
and recordkeeping requirements, Securities.
12 CFR Part 6
National banks.
12 CFR Part 165
Administrative practice and procedure, Savings associations.
12 CFR Part 167
Capital, Reporting and recordkeeping requirements, Risk, Savings
associations.
12 CFR Part 208
Confidential business information, Crime, Currency, Federal Reserve
System, Mortgages, reporting and recordkeeping requirements,
Securities.
12 CFR Part 217
Administrative practice and procedure, Banks, Banking, Capital,
Federal Reserve System, Holding companies, Reporting and recordkeeping
requirements, Risk.
12 CFR Part 225
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
Adoption of Common Rule
The adoption of the final common rules by the agencies, as modified
by the agency-specific text, is set forth below:
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Chapter I
Authority and Issuance
For the reasons set forth in the common preamble and under the
authority of 12 U.S.C. 93a and 5412(b)(2)(B), the Office of the
Comptroller of the Currency amends part 3 of chapter I of title 12,
Code of Federal Regulations as follows:
PART 3--CAPITAL ADEQUACY STANDARDS
0
1. The authority citation for part 3 is revised to read as follows:
Authority: 12 U.S.C. 93a, 161, 1462, 1462a, 1463, 1464, 1818,
1828(n), 1828 note, 1831n note, 1835, 3907, 3909, and 5412(b)(2)(B).
0
2. Revise the heading of part 3 to read as set forth above.
Subpart A [Removed]
0
3. Remove subpart A, consisting of Sec. Sec. 3.1 through 3.4.
Subpart B [Removed]
0
4. Remove subpart B, consisting of Sec. Sec. 3.5 through 3.8.
Subparts C through E [Redesignated as Subparts H through J]
0
5a. Redesignate subparts C through E as subparts H through J.
0
5b. Revise newly redesignated subparts H through J to read as follows:
Subpart H--Establishment of Minimum Capital Ratios for an Individual
Bank or Individual Federal Savings Association
Sec.
3.401 Purpose and scope.
3.402 Applicability.
3.403 Standards for determination of appropriate individual minimum
capital ratios.
3.404 Procedures.
3.405 Relation to other actions.
Subpart H--Establishment of Minimum Capital Ratios for an
Individual Bank or Individual Federal Savings Association
Sec. 3.401 Purpose and scope.
The rules and procedures specified in this subpart are applicable
to a proceeding to establish required minimum capital ratios that would
otherwise be applicable to a national bank or Federal savings
association under subpart B of this part. The OCC is authorized under
12 U.S.C. 1464(s)(2) and 3907(a)(2) to establish such minimum capital
requirements for a national bank or Federal savings
[[Page 62270]]
association as the OCC, in its discretion, deems appropriate in light
of the particular circumstances at that national bank or Federal
savings association. Proceedings under this subpart also may be
initiated to require a national bank or Federal savings association
having capital ratios above those set forth in subpart B of this part,
or other legal authority to continue to maintain those higher ratios.
Sec. 3.402 Applicability.
The OCC may require higher minimum capital ratios for an individual
national bank or Federal savings association in view of its
circumstances. For example, higher capital ratios may be appropriate
for:
(a) A newly chartered national bank or Federal savings association;
(b) A national bank or Federal savings association receiving
special supervisory attention;
(c) A national bank or Federal savings association that has, or is
expected to have, losses resulting in capital inadequacy;
(d) A national bank or Federal savings association with significant
exposure due to the risks from concentrations of credit, certain risks
arising from nontraditional activities, or management's overall
inability to monitor and control financial and operating risks
presented by concentrations of credit and nontraditional activities;
(e) A national bank or Federal savings association with significant
exposure to declines in the economic value of its capital due to
changes in interest rates;
(f) A national bank or Federal savings association with significant
exposure due to fiduciary or operational risk;
(g) A national bank or Federal savings association exposed to a
high degree of asset depreciation, or a low level of liquid assets in
relation to short term liabilities;
(h) A national bank or Federal savings association exposed to a
high volume of, or particularly severe, problem loans;
(i) A national bank or Federal savings association that is growing
rapidly, either internally or through acquisitions; or
(j) A national bank or Federal savings association that may be
adversely affected by the activities or condition of its holding
company, affiliate(s), or other persons or institutions, including
chain banking organizations, with which it has significant business
relationships.
Sec. 3.403 Standards for determination of appropriate individual
minimum capital ratios.
The appropriate minimum capital ratios for an individual national
bank or Federal savings association cannot be determined solely through
the application of a rigid mathematical formula or wholly objective
criteria. The decision is necessarily based in part on subjective
judgment grounded in agency expertise. The factors to be considered in
the determination will vary in each case and may include, for example:
(a) The conditions or circumstances leading to the OCC's
determination that higher minimum capital ratios are appropriate or
necessary for the national bank or Federal savings association;
(b) The exigency of those circumstances or potential problems;
(c) The overall condition, management strength, and future
prospects of the national bank or Federal savings association and, if
applicable, its holding company and/or affiliate(s);
(d) The national bank's or Federal savings association's liquidity,
capital, risk asset and other ratios compared to the ratios of its peer
group; and
(e) The views of the national bank's or Federal savings
association's directors and senior management.
Sec. 3.404 Procedures.
(a) Notice. When the OCC determines that minimum capital ratios
above those set forth in subpart B of this part or other legal
authority are necessary or appropriate for a particular national bank
or Federal savings association, the OCC will notify the national bank
or Federal savings association in writing of the proposed minimum
capital ratios and the date by which they should be reached (if
applicable) and will provide an explanation of why the ratios proposed
are considered necessary or appropriate for the national bank or
Federal savings association.
(b) Response. (1) The national bank or Federal savings association
may respond to any or all of the items in the notice. The response
should include any matters which the national bank or Federal savings
association would have the OCC consider in deciding whether individual
minimum capital ratios should be established for the national bank or
Federal savings association, what those capital ratios should be, and,
if applicable, when they should be achieved. The response must be in
writing and delivered to the designated OCC official within 30 days
after the date on which the national bank or Federal savings
association received the notice. The OCC may shorten the time period
when, in the opinion of the OCC, the condition of the national bank or
Federal savings association so requires, provided that the national
bank or Federal savings association is informed promptly of the new
time period, or with the consent of the national bank or Federal
savings association. In its discretion, the OCC may extend the time
period for good cause.
(2) Failure to respond within 30 days or such other time period as
may be specified by the OCC shall constitute a waiver of any objections
to the proposed minimum capital ratios or the deadline for their
achievement.
(c) Decision. After the close of the national bank's or Federal
savings association's response period, the OCC will decide, based on a
review of the national bank's or Federal savings association's response
and other information concerning the national bank or Federal savings
association, whether individual minimum capital ratios should be
established for the national bank or Federal savings association and,
if so, the ratios and the date the requirements will become effective.
The national bank or Federal savings association will be notified of
the decision in writing. The notice will include an explanation of the
decision, except for a decision not to establish individual minimum
capital requirements for the national bank or Federal savings
association.
(d) Submission of plan. The decision may require the national bank
or Federal savings association to develop and submit to the OCC, within
a time period specified, an acceptable plan to reach the minimum
capital ratios established for the national bank or Federal savings
association by the date required.
(e) Change in circumstances. If, after the OCC's decision in
paragraph (c) of this section, there is a change in the circumstances
affecting the national bank's or Federal savings association's capital
adequacy or its ability to reach the required minimum capital ratios by
the specified date, the national bank or Federal savings association
may propose to the OCC, or the OCC may propose to the national bank or
Federal savings association, a change in the minimum capital ratios for
the national bank or Federal savings association, the date when the
minimums must be achieved, or the national bank's or Federal savings
association's plan (if applicable). The OCC may decline to consider
proposals that are not based on a significant change in circumstances
or are repetitive or frivolous. Pending a decision on reconsideration,
the OCC's original decision and any plan required
[[Page 62271]]
under that decision shall continue in full force and effect.
Sec. 3.405 Relation to other actions.
In lieu of, or in addition to, the procedures in this subpart, the
required minimum capital ratios for a national bank or Federal savings
association may be established or revised through a written agreement
or cease and desist proceedings under 12 U.S.C. 1818 (b) or (c) (12 CFR
19.0 through 19.21 for national banks and 12 CFR part 109 for Federal
savings associations) or as a condition for approval of an application.
Subpart I--Enforcement
Sec. 3.501 Remedies.
A national bank or Federal savings association that does not have
or maintain the minimum capital ratios applicable to it, whether
required in subpart B of this part, in a decision pursuant to subpart H
of this part, in a written agreement or temporary or final order under
12 U.S.C. 1818 (b) or (c), or in a condition for approval of an
application, or a national bank or Federal savings association that has
failed to submit or comply with an acceptable plan to attain those
ratios, will be subject to such administrative action or sanctions as
the OCC considers appropriate. These sanctions may include the issuance
of a Directive pursuant to subpart J of this part or other enforcement
action, assessment of civil money penalties, and/or the denial,
conditioning, or revocation of applications. A national bank's or
Federal savings association's failure to achieve or maintain minimum
capital ratios in subpart B of this part may also be the basis for an
action by the Federal Deposit Insurance Corporation to terminate
Federal deposit insurance. See 12 CFR part 308, subpart F.
Subpart J--Issuance of a Directive
Sec.
3.601 Purpose and scope.
3.602 Notice of intent to issue a directive.
3.603 Response to notice.
3.604 Decision.
3.605 Issuance of a directive.
3.606 Change in circumstances.
3.607 Relation to other administrative actions.
Subpart J--Issuance of a Directive
Sec. 3.601 Purpose and scope.
(a) This subpart is applicable to proceedings by the OCC to issue a
directive under 12 U.S.C. 3907(b)(2) or 12 U.S.C. 1464(s), as
appropriate. A directive is an order issued to a national bank or
Federal savings association that does not have or maintain capital at
or above the minimum ratios set forth in subpart B of this part, or
established for the national bank or Federal savings association under
subpart H of this part, by a written agreement under 12 U.S.C. 1818(b),
or as a condition for approval of an application. A directive may order
the national bank or Federal savings association to:
(1) Achieve the minimum capital ratios applicable to it by a
specified date;
(2) Adhere to a previously submitted plan to achieve the applicable
capital ratios;
(3) Submit and adhere to a plan acceptable to the OCC describing
the means and time schedule by which the national bank or Federal
savings association shall achieve the applicable capital ratios;
(4) Take other action, such as reduction of assets or the rate of
growth of assets, or restrictions on the payment of dividends, to
achieve the applicable capital ratios; or
(5) A combination of any of these or similar actions.
(b) A directive issued under this rule, including a plan submitted
under a directive, is enforceable in the same manner and to the same
extent as an effective and outstanding cease and desist order which has
become final as defined in 12 U.S.C. 1818(k). Violation of a directive
may result in assessment of civil money penalties in accordance with 12
U.S.C. 3909(d).
Sec. 3.602 Notice of intent to issue a directive.
The OCC will notify a national bank or Federal savings association
in writing of its intention to issue a directive. The notice will
state:
(a) Reasons for issuance of the directive; and
(b) The proposed contents of the directive.
Sec. 3.603 Response to notice.
(a) A national bank or Federal savings association may respond to
the notice by stating why a directive should not be issued and/or by
proposing alternative contents for the directive. The response should
include any matters which the national bank or Federal savings
association would have the OCC consider in deciding whether to issue a
directive and/or what the contents of the directive should be. The
response may include a plan for achieving the minimum capital ratios
applicable to the national bank or Federal savings association. The
response must be in writing and delivered to the designated OCC
official within 30 days after the date on which the national bank or
Federal savings association received the notice. The OCC may shorten
the 30-day time period:
(1) When, in the opinion of the OCC, the condition of the national
bank or Federal savings association so requires, provided that the
national bank or Federal savings association shall be informed promptly
of the new time period;
(2) With the consent of the national bank or Federal savings
association; or
(3) When the national bank or Federal savings association already
has advised the OCC that it cannot or will not achieve its applicable
minimum capital ratios.
(b) In its discretion, the OCC may extend the time period for good
cause.
(c) Failure to respond within 30 days or such other time period as
may be specified by the OCC shall constitute a waiver of any objections
to the proposed directive.
Sec. 3.604 Decision.
After the closing date of the national bank's or Federal savings
association's response period, or receipt of the national bank's or
Federal savings association's response, if earlier, the OCC will
consider the national bank's or Federal savings association's response,
and may seek additional information or clarification of the response.
Thereafter, the OCC will determine whether or not to issue a directive,
and if one is to be issued, whether it should be as originally proposed
or in modified form.
Sec. 3.605 Issuance of a directive.
(a) A directive will be served by delivery to the national bank or
Federal savings association. It will include or be accompanied by a
statement of reasons for its issuance.
(b) A directive is effective immediately upon its receipt by the
national bank or Federal savings association, or upon such later date
as may be specified therein, and shall remain effective and enforceable
until it is stayed, modified, or terminated by the OCC.
Sec. 3.606 Change in circumstances.
Upon a change in circumstances, a national bank or Federal savings
association may request the OCC to reconsider the terms of its
directive or may propose changes in the plan to achieve the national
bank's or Federal savings association's applicable minimum capital
ratios. The OCC also may take such action on its own motion. The OCC
may decline to consider requests or proposals that are not based on a
significant change in circumstances or are repetitive or frivolous.
Pending a decision on reconsideration, the
[[Page 62272]]
directive and plan shall continue in full force and effect.
Sec. 3.607 Relation to other administrative actions.
A directive may be issued in addition to, or in lieu of, any other
action authorized by law, including cease and desist proceedings, civil
money penalties, or the conditioning or denial of applications. The OCC
also may, in its discretion, take any action authorized by law, in lieu
of a directive, in response to a national bank's or Federal savings
association's failure to achieve or maintain the applicable minimum
capital ratios.
0
5c. Add a new Subpart K to read as follows:
Subpart K--Interpretations
Sec. 3.701 Capital and surplus.
For purposes of determining statutory limits that are based on the
amount of a national bank's capital and/or surplus, the provisions of
this section are to be used, rather than the definitions of capital
contained in subparts A through J of this part.
(a) Capital. The term capital as used in provisions of law relating
to the capital of national banks shall include the amount of common
stock outstanding and unimpaired plus the amount of perpetual preferred
stock outstanding and unimpaired.
(b) Capital Stock. The term capital stock as used in provisions of
law relating to the capital stock of national banks, other than 12
U.S.C. 101, 177, and 178 shall have the same meaning as the term
capital set forth in paragraph (a) of this section.
(c) Surplus. The term surplus as used in provisions of law relating
to the surplus of national banks means the sum of paragraphs (c)(1),
(2), (3), and (4) of this section:
(1) Capital surplus; undivided profits; reserves for contingencies
and other capital reserves (excluding accrued dividends on perpetual
and limited life preferred stock); net worth certificates issued
pursuant to 12 U.S.C. 1823(i); minority interests in consolidated
subsidiaries; and allowances for loan and lease losses; minus
intangible assets;
(2) Mortgage servicing assets;
(3) Mandatory convertible debt to the extent of 20 percent of the
sum of paragraphs (a) and (c) (1) and (2) of this section;
(4) Other mandatory convertible debt, limited life preferred stock
and subordinated notes and debentures to the extent set forth in
paragraph (f)(2) of this section.
(d) Unimpaired surplus fund. The term unimpaired surplus fund as
used in provisions of law relating to the unimpaired surplus fund of
national banks shall have the same meaning as the term surplus set
forth in paragraph (c) of this section.
(e) Definitions. (1) Allowance for loan and lease losses means the
balance of the valuation reserve on December 31, 1968, plus additions
to the reserve charged to operations since that date, less losses
charged against the allowance net of recoveries.
(2) Capital surplus means the total of those accounts reflecting:
(i) Amounts paid in in excess of the par or stated value of capital
stock;
(ii) Amounts contributed to the national bank other than for
capital stock;
(iii) Amounts transferred from undivided profits pursuant to 12
U.S.C. 60; and
(iv) Other amounts transferred from undivided profits.
(3) Intangible assets means those purchased assets that are to be
reported as intangible assets in accordance with the Instructions--
Consolidated Reports of Condition and Income (Call Report).
(4) Limited life preferred stock means preferred stock which has a
maturity or which may be redeemed at the option of the holder.
(5) Mandatory convertible debt means subordinated debt instruments
which unqualifiedly require the issuer to exchange either common or
perpetual preferred stock for such instruments by a date at or before
the maturity of the instrument. The maturity of these instruments must
be 12 years or less. In addition, the instrument must meet the
requirements of paragraphs (f)(1)(i) through (v) of this section for
subordinated notes and debentures or other requirements published by
the OCC.
(6) Minority interest in consolidated subsidiaries means the
portion of equity capital accounts of all consolidated subsidiaries of
the national bank that is allocated to minority shareholders of such
subsidiaries.
(7) Mortgage servicing assets means the national bank-owned rights
to service for a fee mortgage loans that are owned by others.
(8) Perpetual preferred stock means preferred stock that does not
have a stated maturity date and cannot be redeemed at the option of the
holder.
(f) Requirements and restrictions: Limited life preferred stock,
mandatory convertible debt, and other subordinated debt--(1)
Requirements. Issues of limited life preferred stock and subordinated
notes and debentures (except mandatory convertible debt) shall have
original weighted average maturities of at least five years to be
included in the definition of surplus. In addition, a subordinated note
or debenture must also:
(i) Be subordinated to the claims of depositors;
(ii) State on the instrument that it is not a deposit and is not
insured by the FDIC;
(iii) Be unsecured;
(iv) Be ineligible as collateral for a loan by the issuing national
bank;
(v) Provide that once any scheduled payments of principal begin,
all scheduled payments shall be made at least annually and the amount
repaid in each year shall be no less than in the prior year; and
(vi) Provide that no prepayment (including payment pursuant to an
acceleration clause or redemption prior to maturity) shall be made
without prior OCC approval unless the national bank remains an eligible
bank, as defined in 12 CFR 5.3(g), after the prepayment.
(2) Restrictions. The total amount of mandatory convertible debt
not included in paragraph (c)(3) of this section, limited life
preferred stock, and subordinated notes and debentures considered as
surplus is limited to 50 percent of the sum of paragraphs (a) and (c)
(1), (2) and (3) of this section.
(3) Reservation of authority. The OCC expressly reserves the
authority to waive the requirements and restrictions set forth in
paragraphs (f)(1) and (2) of this section, in order to allow the
inclusion of other limited life preferred stock, mandatory convertible
notes and subordinated notes and debentures in the capital base of any
national bank for capital adequacy purposes or for purposes of
determining statutory limits. The OCC further expressly reserves the
authority to impose more stringent conditions than those set forth in
paragraphs (f)(1) and (2) of this section to exclude any component of
tier 1 or tier 2 capital, in whole or in part, as part of a national
bank's capital and surplus for any purpose.
(g) Transitional rules. (1) Equity commitment notes approved by the
OCC as capital and issued prior to April 15, 1985, may continue to be
included in paragraph (c)(3) of this section. All other instruments
approved by the OCC as capital and issued prior to April 15, 1985, are
to be included in paragraph (c)(4) of this section.
(2) Intangible assets (other than mortgage servicing assets)
purchased prior to April 15, 1985, and accounted for in accordance with
OCC instructions, may continue to be included as surplus up to 25
percent of
[[Page 62273]]
the sum of paragraphs (a) and (c)(1) of this section.
0
6. Add subparts A through G to part 3, as set forth at the end of the
common preamble.
Appendix C to Part 3 [Removed]
0
7. Remove appendix C.
0
8. Subparts A through G, as set forth at the end of the common
preamble, are amended as follows:
0
A. Remove ``[AGENCY]'' and add ``OCC'' in its place, wherever it
appears;
0
B. Remove ``[BANK]'' and add ``national bank or Federal savings
association'' in its place, wherever it appears;
0
C. Remove ``[BANKS]'' and ``[BANK]s'' and add ``national banks and
Federal savings associations'' in their places, wherever they appear;
0
D. Remove ``[BANK]'s'' and add ``national bank's or Federal savings
association's'' in their places, wherever they appear;
0
E. Remove ``[PART]'' and add ``part'' in its place, wherever it
appears; and
0
F. Remove ``[REGULATORY REPORT]'' and add ``Call Report'' in its place,
wherever it appears;
0
G. Remove ``[other Federal banking agencies]'' wherever it appears and
add ``Federal Deposit Insurance Corporation and Federal Reserve Board''
in its place;
0
9. In Sec. 3.1:
0
A. In paragraph (e), remove ``[12 CFR 3.404, (OCC); 12 CFR 263.202
(Board)]'' and add ``Sec. 3.404'' in its place;
0
B. In paragraph (f)(1)(ii)(A), remove ``[12 CFR part 3, appendix A and,
if applicable, 12 CFR part 3, subpart F (national banks), or 12 CFR
part 167 and, if applicable, 12 CFR part 3, subpart F (Federal savings
associations)(OCC); 12 CFR part 225, appendix A (Board)]'' and add
``appendix A to this part and, if applicable, subpart F of this part
(national banks), or 12 CFR part 167 and, if applicable, subpart F of
this part (Federal savings associations)'' in its place;
0
C. In footnote 1 in paragraph (f)(1)(ii)(A), remove ``[12 CFR part 3,
appendix A, Sec. 3 and, if applicable, 12 CFR part 3, subpart F
(national banks), or 12 CFR part 167 and, if applicable, 12 CFR part 3,
subpart F (Federal savings associations) (OCC);, 12 CFR parts 208 and
225, and, if applicable, appendix E to this part (state member banks or
bank holding companies, respectively (Board)]'' and add ``appendix A to
this part, Sec. 3 and, if applicable, subpart F of this part (national
banks), or 12 CFR part 167 and, if applicable, subpart F of this part
(Federal savings associations)'' in its place;
0
D. In paragraph (f)(1)(ii)(B), remove ``[12 CFR part 3, appendix B,
section 4(a)(3) (national banks) (OCC); 12 CFR parts 208 or 225,
appendix E, section 4(a)(3) (state member banks or bank holding
companies, respectively) (Board); and 12 CFR part 325, appendix C,
section 4(a)(3) (state nonmember banks and state savings
associations)]'' and add ``appendix B to this part, section 4(a)(3)
(national banks)'' in its place.
0
E. In paragraph (f)(1)(ii)(C), remove ``[12 CFR part 3, appendix A,
and, if applicable, appendix B (national banks), or 12 CFR part 167
(Federal savings associations) (OCC)); 12 CFR parts 208 or 225,
appendix A, and, if applicable, appendix E (state member banks or bank
holding companies, respectively) (Board)]'' and add in its place
``appendix A to this part, and, if applicable, appendix B to this part
(national banks), or 12 CFR part 167 (Federal savings associations)
0
F. In footnote 2 in paragraph (f)(1)(ii)(C), remove ``[12 CFR part 3,
appendix A, Sec. 3, appendix A, section 3 and, if applicable, 12 CFR
part 3, appendix B (national banks), or 12 CFR part 167 (Federal
savings associations) (OCC); 12 CFR parts 208 and 225, appendix A and,
if applicable, appendix E (state member banks or bank holding
companies, respectively) (Board)]'' and add ``appendix A to this part
and, if applicable, subpart F of this part (national banks), or 12 CFR
part 167 and, if applicable, subpart F of this part (Federal savings
associations)'' in its place; and
0
G. Add paragraph (f)(4).
The addition and revision read as follows:
Sec. 3.1 Purpose, applicability, reservations of authority, and
timing.
* * * * *
(f) * * *
(4) No national bank or Federal savings association that is not an
advanced approaches bank or advanced approaches savings association is
subject to this part 3 until January 1, 2015.
0
10. Section 3.2 is amended by:
0
A. Adding definitions of ``Core capital'', ``Federal savings
association'', and '' Tangible capital means'' in alphabetical order;
0
B. In paragraph (2)(i) of the definition of ``high volatility
commercial real estate (HVCRE) exposure'', remove ``[12 CFR part 25
(national bank), 12 CFR part 195 (Federal savings association) (OCC);
12 CFR part 228 (Board)]'' and add ``12 CFR parts 25 (national banks)
and 195 (Federal savings associations)'' in its place;
0
C. In paragraph (2)(ii) of the definition of ``high volatility
commercial real estate (HVCRE) exposure'', remove ``[12 CFR part
25.12(g)(3) (national banks) and 12 CFR part 195.12(g)(3) (Federal
savings associations) (OCC); 12 CFR part 208.22(a)(3) or 228.12(g)(3)
(Board)]'' and add ``12 CFR 25.12(g)(3) (national banks) and 12 CFR
195.12(g)(3) (Federal savings associations)'' in its place;
0
D. In paragraph (4)(i) of the definition of ``high volatility
commercial real estate (HVCRE) exposure'', remove ``[12 CFR part 34,
subpart D (national banks) and 12 CFR part 160, subparts A and B
(Federal savings associations) (OCC); 12 CFR part 208, appendix C
(Board)]'' and add ``12 CFR part 34, subpart D (national banks) and 12
CFR part 160, subparts A and B (Federal savings associations)'' in its
place; and
0
E. In paragraph (10)(ii) of the definition of ``traditional
securitization'', remove ``[12 CFR 9.18 (national bank) and 12 CFR
151.40 (Federal saving association) (OCC); 12 CFR 208.34 (Board)]'' and
add ``12 CFR 9.18 (national banks), 12 CFR 151.40 (Federal saving
associations)'' in its place.
The additions read as follows:
Sec. 3.2 Definitions.
* * * * *
Core capital means tier 1 capital, as calculated in accordance with
subpart B of this part.
* * * * *
Federal savings association means an insured Federal savings
association or an insured Federal savings bank chartered under section
5 of the Home Owners' Loan Act of 1933.
* * * * *
Tangible capital means the amount of core capital (tier 1 capital),
as calculated in accordance with subpart B of this part, plus the
amount of outstanding perpetual preferred stock (including related
surplus) not included in tier 1 capital.
* * * * *
0
11. Section 3.10,is amended by:
0
A. Adding paragraphs (a)(6), (b)(5), and (c)(5) to read as follows;
0
B. In paragraph (d)(1), removing ``[12 CFR 3.10 (national banks), 12
CFR 167.3(c) (Federal savings associations) and 12 CFR 208.4 (state
member banks)]'' and adding ``this section (national banks), 12 CFR
167.3(c) (Federal savings associations)'' in its place.
The additions read as follows:
Sec. 3.10 Minimum capital requirements.
(a) * * *
(6) For Federal savings associations, a tangible capital ratio of
1.5 percent.
[[Page 62274]]
(b) * * *
(5) Federal savings association tangible capital ratio. A Federal
savings association's tangible capital ratio is the ratio of the
Federal savings association's core capital (tier 1 capital) to average
total assets as calculated under this subpart B. For purposes of this
paragraph (b)(5), the term ``total assets'' means ``total assets'' as
defined in part 6, subpart A of this chapter, subject to subpart G of
this part.
(c) * * *
(5) Federal savings association tangible capital ratio. A Federal
savings association's tangible capital ratio is the ratio of the
Federal savings association's core capital (tier 1 capital) to average
total assets as calculated under this subpart B. For purposes of this
paragraph (c)(5), the term ``total assets'' means ``total assets'' as
defined in part 6, subpart A of this chapter, subject to subpart G of
this part.
* * * * *
Sec. 3.11 [Amended]
0
12. In Sec. 3.11, in paragraph (a)(4)(v), remove ``12 CFR part 3,
subparts H and I; 12 CFR part 5.46, 12 CFR part 5, subpart E; 12 CFR
part 6 (OCC); 12 CFR 225.4; 12 CFR 225.8; 12 CFR 263.202 (Board)'' and
add ``subparts H and I of this part; 12 CFR 5.46, 12 CFR part 5,
subpart E; 12 CFR part 6'' in its place;
0
13. Section 3.20 is amended by:
0
A. Revising paragraphs (b)(1)(v) and (c)(1)(viii);
0
B. In paragraph (c)(3), removing ``[12 CFR part 3, appendix A (national
banks), 12 CFR 167 (Federal savings associations) (OCC); 12 CFR part
208, appendix A, 12 CFR part 225, appendix A (Board)]'' and add
``appendix A to this part (national banks), 12 CFR part 167 (Federal
savings associations)'' in its place; and
0
C. In paragraph (d)(4), removing ``12 CFR part 3, appendix A, 12 CFR
167 (OCC); 12 CFR part 208, appendix A, 12 CFR part 225, appendix A
(Board)'' and adding ``appendix A to this part, 12 CFR part 167'' in
its place.
The revisions read as follows:
Sec. 3.20 Capital components and eligibility criteria for regulatory
capital instruments.
* * * * *
(b) * * *
(1) * * *
(v) Any cash dividend payments on the instrument are paid out of
the [BANK]'s net income or retained earnings and are not subject to a
limit imposed by the contractual terms governing the instrument.
* * * * *
(c) * * *
(1) * * *
(viii) Any cash dividend payments on the instrument are paid out of
the [BANK]'s net income or retained earnings and are not subject to a
limit imposed by the contractual terms governing the instrument.
* * * * *
0
14. Section 3.22 is amended by adding paragraph (a)(8) to read as
follows:
Sec. 3.22 Regulatory capital adjustments and deductions.
(a) * * *
(8)(i) A Federal savings association must deduct the aggregate
amount of its outstanding investments (both equity and debt) in, and
extensions of credit to, subsidiaries that are not includable
subsidiaries as defined in paragraph (a)(8)(iv) of this section and may
not consolidate the assets and liabilities of the subsidiary with those
of the Federal savings association. Any such deductions shall be
deducted from assets and common equity tier 1 except as provided in
paragraphs (a)(8)(ii) and (iii) of this section.
(ii) If a Federal savings association has any investments (both
debt and equity) in, or extensions or credit to, one or more
subsidiaries engaged in any activity that would not fall within the
scope of activities in which includable subsidiaries as defined in
paragraph (a)(8)(iv) of this section may engage, it must deduct such
investments and extensions of credit from assets and, thus, common
equity tier 1 in accordance with paragraph (a)(8)(i) of this section.
(iii) If a Federal savings association holds a subsidiary (either
directly or through a subsidiary) that is itself a domestic depository
institution, the OCC may, in its sole discretion upon determining that
the amount of common equity tier 1 that would be required would be
higher if the assets and liabilities of such subsidiary were
consolidated with those of the parent Federal savings association than
the amount that would be required if the parent Federal savings
association's investment were deducted pursuant to paragraphs (a)(8)(i)
and (ii) of this section, consolidate the assets and liabilities of
that subsidiary with those of the parent Federal savings association in
calculating the capital adequacy of the parent Federal savings
association, regardless of whether the subsidiary would otherwise be an
includable subsidiary as defined in paragraph (a)(8)(iv) of this
section.
(iv) For purposes of this section, the term includable subsidiary
means a subsidiary of a Federal savings association that:
(A) Is engaged solely in activities not impermissible for a
national bank;
(B) Is engaged in activities not permissible for a national bank,
but only if acting solely as agent for its customers and such agency
position is clearly documented in the Federal savings association's
files;
(C) Is engaged solely in mortgage-banking activities;
(D)(1) Is itself an insured depository institution or a company the
sole investment of which is an insured depository institution; and
(2) Was acquired by the parent Federal savings association prior to
May 1, 1989; or
(E) Was a subsidiary of any Federal savings association existing as
a Federal savings association on August 9, 1989:
(1) That was chartered prior to October 15, 1982, as a savings bank
or a cooperative bank under state law; or
(2) That acquired its principal assets from an association that was
chartered prior to October 15, 1982, as a savings bank or a cooperative
bank under state law.
* * * * *
Sec. 3.42 [Amended]
0
15. In Sec. 3.42(h)(1)(iv) and (h)(3), remove ``[12 CFR 6.4 (OCC); 12
CFR 208.43 (Board)]'' and add ``12 CFR 6.4'' in its place.
Sec. 3.100 [Amended]
0
16. In Sec. 3.100(b)(2), remove ``[12 CFR 3.404 (OCC), 12 CFR 263.202
(Board), and 12 CFR 324.5 (FDIC)]'' and add ``12 CFR 3.404'' in its
place.
Sec. 3.142 [Amended]
0
17. Section 3.142(k)(1)(iv) is amended by removing ``[12 CFR 6.4 (OCC);
12 CFR 208.43 (Board)]'' and by adding ``12 CFR 6.4'' in its place.
Sec. 3.201 [Amended]
0
18. In Sec. 3.201(c)(1), remove ``[12 CFR 3.404, 12 CFR 263.202, 12
CFR 324.5(c)]'' and add ``12 CFR 3.404'' in its place.
Sec. 3.300 [Amended]
0
19. Section 3.300 is amended:
0
A. In paragraph (b)(1) introductory text, by removing ``Sec.
--.22(a)(1)-(7)'' and adding ``Sec. 3.22(a)(1)-(8)'' in its place;
0
B. In paragraph (b)(1)(i), by removing at the end of the paragraph,
``and financial subsidiaries (Sec. --.22(a)(7)).'' and adding in its
place the phrase ``and financial subsidiaries (Sec. 3.22(a)(7)), and
nonincludable subsidiaries of a Federal savings association (Sec.
3.22(a)(8)).''; and in Table 2 to Sec. 3.300, adding at the end of the
heading in the second column the phrase ``and (8)'';
[[Page 62275]]
0
C. By removing and reserving paragraphs (c)(1) through (c)(3); and
0
D. In paragraph (e), by removing ``[12 CFR Part 6 (OCC); 12 CFR 208
(Board)]'', and adding ``12 CFR part 6'' in its place.
PART 5--RULES, POLICIES, AND PROCEDURES FOR CORPORATE ACTIVITIES
0
20. The authority citation for part 5 continues to read as follows:
Authority: 12 U.S.C. 1 et seq., 93a, 215a-2, 215a-3, 481, and
section 5136A of the Revised Statutes (12 U.S.C. 24a).
0
21. Section 5.39 is amended by revising paragraph (h)(1) and
republishing paragraph (h)(2) to read as follows:
Sec. 5.39 Financial subsidiaries.
* * * * *
(h) * * *
(1) For purposes of determining regulatory capital the national
bank may not consolidate the assets and liabilities of a financial
subsidiary with those of the bank and must deduct the aggregate amount
of its outstanding equity investment, including retained earnings, in
its financial subsidiaries from regulatory capital as provided by Sec.
3.22(a)(7) of this chapter;
(2) Any published financial statement of the national bank shall,
in addition to providing information prepared in accordance with
generally accepted accounting principles, separately present financial
information for the bank in the manner provided in paragraph (h)(1) of
this section;
* * * * *
0
22. Part 6 is revised to read as follows:
PART 6--PROMPT CORRECTIVE ACTION
Subpart A--Capital Categories
Sec.
6.1 Authority, purpose, scope, other supervisory authority,
disclosure of capital categories, and transition procedures.
6.2 Definitions.
6.3 Notice of capital category.
6.4 Capital measures and capital category definition.
6.5 Capital restoration plan.
6.6 Mandatory and discretionary supervisory actions.
Subpart B--Directives To Take Prompt Corrective Action
6.20 Scope.
6.21 Notice of intent to issue a directive.
6.22 Response to notice.
6.23 Decision and issuance of a prompt corrective action directive.
6.24 Request for modification or rescission of directive.
6.25 Enforcement of directive.
Authority: 12 U.S.C. 93a, 1831o, 5412(b)(2)(B).
Subpart A--Capital Categories
Sec. 6.1 Authority, purpose, scope, other supervisory authority,
disclosure of capital categories, and transition procedures.
(a) Authority. This part is issued by the Office of the Comptroller
of the Currency (OCC) pursuant to section 38 (section 38) of the
Federal Deposit Insurance Act (FDI Act) as added by section 131 of the
Federal Deposit Insurance Corporation Improvement Act of 1991 (Pub. L.
102-242, 105 Stat. 2236 (1991)) (12 U.S.C. 1831o).
(b) Purpose. Section 38 of the FDI Act establishes a framework of
supervisory actions for insured depository institutions that are not
adequately capitalized. The principal purpose of this subpart is to
define, for insured national banks and insured Federal savings
associations, the capital measures and capital levels, and for insured
Federal branches, comparable asset-based measures and levels, that are
used for determining the supervisory actions authorized under section
38 of the FDI Act. This part 6 also establishes procedures for
submission and review of capital restoration plans and for issuance and
review of directives and orders pursuant to section 38.
(c) Scope. This subpart implements the provisions of section 38 of
the FDI Act as they apply to insured national banks, insured Federal
branches, and insured Federal savings associations. Certain of these
provisions also apply to officers, directors, and employees of these
insured institutions. Other provisions apply to any company that
controls an insured national bank, insured Federal branch, or insured
Federal savings association and to the affiliates of an insured
national bank, insured Federal branch, or insured Federal savings
association.
(d) Other supervisory authority. Neither section 38 nor this part
in any way limits the authority of the OCC under any other provision of
law to take supervisory actions to address unsafe or unsound practices,
deficient capital levels, violations of law, unsafe or unsound
conditions, or other practices. Action under section 38 of the FDI Act
and this part may be taken independently of, in conjunction with, or in
addition to any other enforcement action available to the OCC,
including issuance of cease and desist orders, capital directives,
approval or denial of applications or notices, assessment of civil
money penalties, or any other actions authorized by law.
(e) Disclosure of capital categories. The assignment of an insured
national bank, insured Federal branch, or insured Federal savings
association under this subpart within a particular capital category is
for purposes of implementing and applying the provisions of section 38.
Unless permitted by the OCC or otherwise required by law, no national
bank or Federal savings association may state in any advertisement or
promotional material its capital category under this subpart or that
the OCC or any other Federal banking agency has assigned the national
bank or Federal savings association to a particular capital category.
(f) Transition procedures--(1) Definitions applicable before
January 1, 2015, for certain national banks and Federal savings
associations. Before January 1, 2015, notwithstanding any other
requirement in this subpart and with respect to any national bank that
is not an advanced approaches bank and any Federal savings association
that is not an advanced approaches Federal savings association:
(i) The definitions of leverage ratio, tangible equity, tier 1
capital, tier 1 risk-based capital, and total risk-based capital as
calculated or defined under appendix A to part 3 of this chapter,
remain in effect for purposes of this subpart; and
(ii) The definition of total assets means quarterly average total
assets as reported in a national bank's or Federal savings
association's Consolidated Reports of Condition and Income (Call
Report), minus intangible assets except mortgage servicing assets as
provided in the definition of tangible equity. The OCC reserves the
right to require a national bank or Federal savings association to
compute and maintain its capital ratios on the basis of actual, rather
than average, total assets when computing tangible equity.
(2) Timing. On January 1, 2015 and thereafter, the calculation of
the definitions of common equity tier 1 capital, the common equity tier
1 risk-based capital ratio, the leverage ratio, the supplementary
leverage ratio, tangible equity, tier 1 capital, the tier 1 risk-based
capital ratio, total assets, total leverage exposure, the total risk-
based capital ratio, and total risk-weighted assets under this subpart
is subject to the timing provisions at 12 CFR Sec. 3.1(f) and the
transitions at 12 CFR part 3, subpart G.
Sec. 6.2 Definitions.
For purposes of this subpart, except as modified in this section or
unless the context otherwise requires, the terms used have the same
meanings as set
[[Page 62276]]
forth in section 38 and section 3 of the FDI Act.
Advanced approaches national bank or advanced approaches Federal
savings association means a national bank or Federal savings
association that is subject to subpart E of part 3 of this chapter.
Common equity tier 1 capital means common equity tier 1 capital, as
defined in accordance with the OCC's definition in subpart A of part 3
of this chapter.
Common equity tier 1 risk-based capital ratio means the ratio of
common equity tier 1 capital to total risk-weighted assets, as
calculated in accordance with subpart B of part 3 of this chapter, as
applicable.
Control. (1) Control has the same meaning assigned to it in section
2 of the Bank Holding Company Act (12 U.S.C. 1841), and the term
controlled shall be construed consistently with the term control.
(2) Exclusion for fiduciary ownership. No insured depository
institution or company controls another insured depository institution
or company by virtue of its ownership or control of shares in a
fiduciary capacity. Shares shall not be deemed to have been acquired in
a fiduciary capacity if the acquiring insured depository institution or
company has sole discretionary authority to exercise voting rights with
respect thereto.
(3) Exclusion for debts previously contracted. No insured
depository institution or company controls another insured depository
institution or company by virtue of its ownership or control of shares
acquired in securing or collecting a debt previously contracted in good
faith, until two years after the date of acquisition. The two-year
period may be extended at the discretion of the appropriate Federal
banking agency for up to three one-year periods.
Controlling person means any person having control of an insured
depository institution and any company controlled by that person.
Federal savings association means an insured Federal savings
association or an insured Federal savings bank chartered under section
5 of the Home Owners' Loan Act of 1933.
Leverage ratio means the ratio of tier 1 capital to average total
consolidated assets, as calculated in accordance with subpart B of part
3 of this chapter.\30\
---------------------------------------------------------------------------
\30\ Before January 1, 2015, the leverage ratio of a national
bank or Federal savings association that is not an advanced
approaches national bank or advanced approaches Federal savings
association is the ratio of tier 1 capital to average total
consolidated assets, as calculated in accordance with appendix A to
part 3 of this chapter.
---------------------------------------------------------------------------
Management fee means any payment of money or provision of any other
thing of value to a company or individual for the provision of
management services or advice to the national bank or Federal savings
association or related overhead expenses, including payments related to
supervisory, executive, managerial, or policymaking functions, other
than compensation to an individual in the individual's capacity as an
officer or employee of the national bank or Federal savings
association.
National bank means all insured national banks and all insured
Federal branches, except where otherwise provided in this subpart.
Supplementary leverage ratio means the ratio of tier 1 capital to
total leverage exposure, as calculated in accordance with subpart B of
part 3 of this chapter.
Tangible equity means the amount of tier 1 capital, as calculated
in accordance with subpart B of part 3 of this chapter, plus the amount
of outstanding perpetual preferred stock (including related surplus)
not included in tier 1 capital.\31\
---------------------------------------------------------------------------
\31\ Before January 1, 2015, the tangible equity of a national
bank or Federal savings association that is not an advanced
approaches national bank or advanced approaches Federal savings
association is the amount of tier 1 capital elements as defined in
appendix A to part 3 of this chapter, plus the amount of outstanding
cumulative perpetual preferred stock (including related surplus)
minus all intangible assets except mortgage servicing assets to the
extent permitted in tier 1 capital, as calculated in accordance with
appendix A to part 3 of this chapter. The OCC reserves the right to
require a national bank or Federal savings association to compute
and maintain its capital ratios on the basis of actual, rather than
average, total assets when computing tangible equity.
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Tier 1 capital means the amount of tier 1 capital as defined in
subpart B of part 3 of this chapter.\32\
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\32\ Before January 1, 2015, the tier 1 capital of a national
bank or Federal savings association that is not an advanced
approaches national bank or advanced approaches Federal savings
association (as an advanced approaches national bank or advanced
approaches Federal savings association is defined in this Sec. 6.2)
is calculated in accordance with appendix A to part 3 of this
chapter.
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Tier 1 risk-based capital ratio means the ratio of tier 1 capital
to risk-weighted assets, as calculated in accordance with subpart B of
part 3 of this chapter.\33\
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\33\ Before January 1, 2015, the tier 1 risk-based capital ratio
of a national bank or Federal savings association that is not an
advanced approaches national bank or advanced approaches Federal
savings association (as an advanced approaches national bank or
advanced approaches Federal savings association is defined in this
Sec. 6.2) is calculated in accordance with appendix A to part 3 of
this chapter.
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Total assets means quarterly average total assets as reported in a
national bank's or Federal savings association's Consolidated Reports
of Condition and Income (Call Report), minus any deductions as provided
in Sec. 3.22(a), (c), and (d) of this chapter. The OCC reserves the
right to require a national bank or Federal savings association to
compute and maintain its capital ratios on the basis of actual, rather
than average, total assets when computing tangible equity.\34\
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\34\ Before January 1, 2015, total assets means, for a national
bank or Federal savings association that is not an advanced
approaches national bank or advanced approaches Federal savings
association (as an advanced approaches national bank or advanced
approaches Federal savings association is defined in this Sec.
6.2), quarterly average total assets as reported in a bank's or
savings association's Call Report, minus all intangible assets
except mortgage servicing assets to the extent permitted in tier 1
capital, as calculated in accordance with appendix A to part 3 of
this chapter. The OCC reserves the right to require a national bank
or Federal savings association to compute and maintain its capital
ratios on the basis of actual, rather than average, total assets
when computing tangible equity.
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Total leverage exposure means the total leverage exposure, as
calculated in accordance with subpart B of part 3 of this chapter.
Total risk-based capital ratio means the ratio of total capital to
total risk-weighted assets, as calculated in accordance with subpart B
of part 3 of this chapter.\35\
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\35\ Before January 1, 2015, the total risk-based capital ratio
of a national bank or Federal savings association that is not an
advanced approaches national bank or advanced approaches Federal
savings association (as an advanced approaches national bank or
advanced approaches Federal savings association is defined in this
Sec. 6.2) is calculated in accordance with appendix A to part 3 of
this chapter.
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Total risk-weighted assets means standardized total risk-weighted
assets, and for an advanced approaches national bank or advanced
approaches Federal savings association also includes advanced
approaches total risk-weighted assets, as defined in subpart B of part
3 of this chapter.
Sec. 6.3 Notice of capital category.
(a) Effective date of determination of capital category. A national
bank or Federal savings association shall be deemed to be within a
given capital category for purposes of section 38 of the FDI Act and
this part as of the date the national bank or Federal savings
association is notified of, or is deemed to have notice of, its capital
category pursuant to paragraph (b) of this section.
(b) Notice of capital category. A national bank or Federal savings
association shall be deemed to have been notified of its capital levels
and its capital category as of the most recent date:
(1) A Consolidated Reports of Condition and Income (Call Report) is
required to be filed with the OCC;
[[Page 62277]]
(2) A final report of examination is delivered to the national bank
or Federal savings association; or
(3) Written notice is provided by the OCC to the national bank or
Federal savings association of its capital category for purposes of
section 38 of the FDI Act and this part or that the national bank's or
Federal savings association's capital category has changed pursuant to
paragraph (c) of this section, or Sec. 6.4(e) and with respect to
national banks, subpart M of part 19 of this chapter, and with respect
to Federal savings associations Sec. 165.8 of this chapter.
(c) Adjustments to reported capital levels and capital category--
(1) Notice of adjustment by national bank or Federal savings
association. A national bank or Federal savings association shall
provide the OCC with written notice that an adjustment to the national
bank's or Federal savings association's capital category may have
occurred no later than 15 calendar days following the date that any
material event has occurred that would cause the national bank or
Federal savings association to be placed in a lower capital category
from the category assigned to the national bank or Federal savings
association for purposes of section 38 and this part on the basis of
the national bank's or Federal savings association's most recent Call
Report or report of examination.
(2) Determination to change capital category. After receiving
notice pursuant to paragraph (c)(1) of this section, the OCC shall
determine whether to change the capital category of the national bank
or Federal savings association and shall notify the national bank or
Federal savings association of the OCC's determination.
Sec. 6.4 Capital measures and capital category definition.
(a) Capital measures--(1) Capital measures applicable before
January 1, 2015. On or before December 31, 2014, for purposes of
section 38 and this part, the relevant capital measures for all
national banks and Federal savings associations are:
(i) Total Risk-Based Capital Measure: the total risk-based capital
ratio;
(ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based
capital ratio; and
(iii) Leverage Measure: the leverage ratio.
(2) Capital measures applicable on and after January 1, 2015. On
January 1, 2015 and thereafter, for purposes of section 38 and this
part, the relevant capital measures are:
(i) Total Risk-Based Capital Measure: the total risk-based capital
ratio;
(ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based
capital ratio;
(iii) Common Equity Tier 1 Capital Measure: the common equity tier
1 risk-based capital ratio; and
(iv) The Leverage Measure:
(A) The leverage ratio; and
(B) With respect to an advanced approaches national bank or
advanced approaches Federal savings association, on January 1, 2018,
and thereafter, the supplementary leverage ratio.
(b) Capital categories applicable before January 1, 2015. On or
before December 31, 2014, for purposes of the provisions of section 38
and this part, a national bank or Federal savings association shall be
deemed to be:
(1) Well capitalized if:
(i) Total Risk-Based Capital Measure: the national bank or Federal
savings association has a total risk-based capital ratio of 10.0
percent or greater;
(ii) Tier 1 Risk-Based Capital Measure: the national bank or
Federal savings association has a tier 1 risk-based capital ratio of
6.0 percent or greater;
(iii) Leverage Ratio: the national bank or Federal savings
association has a leverage ratio of 5.0 percent or greater; and
(iv) The national bank or Federal savings association is not
subject to any written agreement, order or capital directive, or prompt
corrective action directive issued by the OCC or the former OTS
pursuant to section 8 of the FDI Act, the International Lending
Supervision Act of 1983 (12 U.S.C. 3907), the Home Owners' Loan Act (12
U.S.C. 1464(t)(6)(A)(ii)), or section 38 of the FDI Act, or any
regulation thereunder, to meet and maintain a specific capital level
for any capital measure.
(2) Adequately capitalized if:
(i) Total Risk-Based Capital Measure: the national bank or Federal
savings association has a total risk-based capital ratio of 8.0 percent
or greater;
(ii) Tier 1 Risk-Based Capital Measure: the national bank or
Federal savings association has a tier 1 risk-based capital ratio of
4.0 percent or greater;
(iii) Leverage Ratio:
(A) The national bank or Federal savings association has a leverage
ratio of 4.0 percent or greater; or
(B) The national bank or Federal savings association has a leverage
ratio of 3.0 percent or greater if the national bank or Federal savings
association is rated composite 1 under the CAMELS rating system in the
most recent examination of the national bank and or Federal savings
association; and
(iv) Does not meet the definition of a ``well capitalized''
national bank or Federal savings association.
(3) Undercapitalized if:
(i) Total Risk-Based Capital Measure: the national bank or Federal
savings association has a total risk-based capital ratio of less than
8.0 percent; or
(ii) Tier 1 Risk-Based Capital Measure: the national bank or
Federal savings association has a tier 1 risk-based capital ratio of
less than 4.0 percent; or
(iii) Leverage Ratio:
(A) Except as provided in paragraph (b)(2)(iii)(B) of this section,
the national bank or Federal savings association has a leverage ratio
of less than 4.0 percent; or
(B) The national bank or Federal savings association has a leverage
ratio of less than 3.0 percent, if the national bank or Federal savings
association is rated composite 1 under the CAMELS rating system in the
most recent examination of the national bank or Federal savings
association.
(4) Significantly undercapitalized if:
(i) Total Risk-Based Capital Measure: the national bank or Federal
savings association has a total risk-based capital ratio of less than
6.0 percent; or
(ii) Tier 1 Risk-Based Capital Measure: the national bank or
Federal savings association has a tier 1 risk-based capital ratio of
less than 3.0 percent; or
(iii) Leverage Ratio: the national bank or Federal savings
association has a leverage ratio of less than 3.0 percent.
(5) Critically undercapitalized if the national bank or Federal
savings association has a ratio of tangible equity to total assets that
is equal to or less than 2.0 percent.
(c) Capital categories applicable on and after January 1, 2015. On
January 1, 2015, and thereafter, for purposes of the provisions of
section 38 and this part, a national bank or Federal savings
association shall be deemed to be:
(1) Well capitalized if:
(i) Total Risk-Based Capital Measure: the national bank or Federal
savings association has a total risk-based capital ratio of 10.0
percent or greater;
(ii) Tier 1 Risk-Based Capital Measure: the national bank or
Federal savings association has a tier 1 risk-based capital ratio of
8.0 percent or greater;
(iii) Common Equity Tier 1 Capital Measure: the national bank or
Federal savings association has a common equity tier 1 risk-based
capital ratio of 6.5 percent or greater;
(iv) Leverage Ratio: the national bank or Federal savings
association has a leverage ratio of 5.0 or greater; and
(v) The national bank or Federal savings association is not subject
to any written agreement, order or capital directive, or prompt
corrective action directive issued by the OCC pursuant to section 8 of
the FDI Act, the
[[Page 62278]]
International Lending Supervision Act of 1983 (12 U.S.C. 3907), the
Home Owners' Loan Act (12 U.S.C. 1464(t)(6)(A)(ii)), or section 38 of
the FDI Act, or any regulation thereunder, to meet and maintain a
specific capital level for any capital measure.
(2) Adequately capitalized if:
(i) Total Risk-Based Capital Measure: the national bank or Federal
savings association has a total risk-based capital ratio of 8.0 percent
or greater;
(ii) Tier 1 Risk-Based Capital Measure: the national bank or
Federal savings association has a tier 1 risk-based capital ratio of
6.0 percent or greater;
(iii) Common Equity Tier 1 Capital Measure: the national bank or
Federal savings association has a common equity tier 1 risk-based
capital ratio of 4.5 percent or greater;
(iv) Leverage Measure:
(A) The national bank or Federal savings association has a leverage
ratio of 4.0 percent or greater; and
(B) With respect to an advanced approaches national bank or
advanced approaches Federal savings association, on January 1, 2018 and
thereafter, the national bank or Federal savings association has an
supplementary leverage ratio of 3.0 percent or greater; and
(v) The national bank or Federal savings association does not meet
the definition of a ``well capitalized'' national bank or Federal
savings association.
(3) Undercapitalized if:
(i) Total Risk-Based Capital Measure: the national bank or Federal
savings association has a total risk-based capital ratio of less than
8.0 percent;
(ii) Tier 1 Risk-Based Capital Measure: the national bank or
Federal savings association has a tier 1 risk-based capital ratio of
less than 6.0 percent;
(iii) Common Equity Tier 1 Capital Measure: the national bank or
Federal savings association has a common equity tier 1 risk-based
capital ratio of less than 4.5 percent; or
(iv) Leverage Measure:
(A) The national bank or Federal savings association has a leverage
ratio of less than 4.0 percent; or
(B) With respect to an advanced approaches national bank or
advanced approaches Federal savings association, on January 1, 2018,
and thereafter, the national bank or Federal savings association has a
supplementary leverage ratio of less than 3.0 percent.
(4) Significantly undercapitalized if:
(i) Total Risk-Based Capital Measure: the national bank or Federal
savings association has a total risk-based capital ratio of less than
6.0 percent;
(ii) Tier 1 Risk-Based Capital Measure: the national bank or
Federal savings association has a tier 1 risk-based capital ratio of
less than 4.0 percent;
(iii) Common Equity Tier 1 Capital Measure: the national bank or
Federal savings association has a common equity tier 1 risk-based
capital ratio of less than 3.0 percent; or
(iv) Leverage Ratio: the national bank or Federal savings
association has a leverage ratio of less than 3.0 percent.
(5) Critically undercapitalized if the national bank or Federal
savings association has a ratio of tangible equity to total assets that
is equal to or less than 2.0 percent.
(d) Capital categories for insured Federal branches. For purposes
of the provisions of section 38 of the FDI Act and this part, an
insured Federal branch shall be deemed to be:
(1) Well capitalized if the insured Federal branch:
(i) Maintains the pledge of assets required under 12 CFR 347.209;
and
(ii) Maintains the eligible assets prescribed under 12 CFR 347.210
at 108 percent or more of the preceding quarter's average book value of
the insured branch's third-party liabilities; and
(iii) Has not received written notification from:
(A) The OCC to increase its capital equivalency deposit pursuant to
Sec. 28.15 of this chapter, or to comply with asset maintenance
requirements pursuant to Sec. 28.20 of this chapter; or
(B) The FDIC to pledge additional assets pursuant to 12 CFR 347.209
or to maintain a higher ratio of eligible assets pursuant to 12 CFR
347.210.
(2) Adequately capitalized if the insured Federal branch:
(i) Maintains the pledge of assets prescribed under 12 CFR 347.209;
(ii) Maintains the eligible assets prescribed under 12 CFR 347.210
at 106 percent or more of the preceding quarter's average book value of
the insured branch's third-party liabilities; and
(iii) Does not meet the definition of a well capitalized insured
Federal branch.
(3) Undercapitalized if the insured Federal branch:
(i) Fails to maintain the pledge of assets required under 12 CFR
347.209; or
(ii) Fails to maintain the eligible assets prescribed under 12 CFR
347.210 at 106 percent or more of the preceding quarter's average book
value of the insured branch's third-party liabilities.
(4) Significantly undercapitalized if it fails to maintain the
eligible assets prescribed under 12 CFR 347.210 at 104 percent or more
of the preceding quarter's average book value of the insured Federal
branch's third-party liabilities.
(5) Critically undercapitalized if it fails to maintain the
eligible assets prescribed under 12 CFR 347.210 at 102 percent or more
of the preceding quarter's average book value of the insured Federal
branch's third-party liabilities.
(e) Reclassification based on supervisory criteria other than
capital. The OCC may reclassify a well capitalized national bank or
Federal savings association as adequately capitalized and may require
an adequately capitalized or an undercapitalized national bank or
Federal savings association to comply with certain mandatory or
discretionary supervisory actions as if the national bank or Federal
savings association were in the next lower capital category (except
that the OCC may not reclassify a significantly undercapitalized
national bank or Federal savings association as critically
undercapitalized) (each of these actions are hereinafter referred to
generally as reclassifications) in the following circumstances:
(1) Unsafe or unsound condition. The OCC has determined, after
notice and opportunity for hearing pursuant to subpart M of part 19 of
this chapter with respect to national banks and Sec. 165.8 of this
chapter with respect to Federal savings associations, that the national
bank or Federal savings association is in unsafe or unsound condition;
or
(2) Unsafe or unsound practice. The OCC has determined, after
notice and opportunity for hearing pursuant to subpart M of part 19 of
this chapter with respect to national banks and Sec. 165.8 of this
chapter with respect to Federal savings associations, that in the most
recent examination of the national bank or Federal savings association,
the national bank or Federal savings association received, and has not
corrected a less-than-satisfactory rating for any of the categories of
asset quality, management, earnings, or liquidity.
Sec. 6.5 Capital restoration plan.
(a) Schedule for filing plan--(1) In general. A national bank or
Federal savings association shall file a written capital restoration
plan with the OCC within 45 days of the date that the national bank or
Federal savings association receives notice or is deemed to have notice
that the national bank or Federal savings association is
undercapitalized, significantly undercapitalized, or critically
undercapitalized, unless the OCC notifies the national bank or Federal
savings association in writing that the plan is to be filed within a
different period. An adequately capitalized national bank or Federal
savings
[[Page 62279]]
association that has been required, pursuant to Sec. 6.4 and subpart M
of part 19 of this chapter with respect to national banks, and
Sec. Sec. 6.4 and 165.8 of this chapter with respect to Federal
savings associations, to comply with supervisory actions as if the
national bank or Federal savings association were undercapitalized is
not required to submit a capital restoration plan solely by virtue of
the reclassification.
(2) Additional capital restoration plans. Notwithstanding paragraph
(a)(1) of this section, a national bank or Federal savings association
that has already submitted and is operating under a capital restoration
plan approved under section 38 and this subpart is not required to
submit an additional capital restoration plan based on a revised
calculation of its capital measures or a reclassification of the
institution pursuant to Sec. 6.4 and subpart M of part 19 of this
chapter with respect to national banks and Sec. Sec. 6.4 and 165.8 of
this chapter with respect to Federal savings associations, unless the
OCC notifies the national bank or Federal savings association that it
must submit a new or revised capital plan. A national bank or Federal
savings association that is notified that it must submit a new or
revised capital restoration plan shall file the plan in writing with
the OCC within 45 days of receiving such notice, unless the OCC
notifies the national bank or Federal savings association in writing
that the plan must be filed within a different period.
(b) Contents of plan. All financial data submitted in connection
with a capital restoration plan shall be prepared in accordance with
the instructions provided on the Call Report, unless the OCC instructs
otherwise. The capital restoration plan shall include all of the
information required to be filed under section 38(e)(2) of the FDI Act.
A national bank or Federal savings association that is required to
submit a capital restoration plan as the result of a reclassification
of the national bank or Federal savings association, pursuant to Sec.
6.4 and subpart M of part 19 of this chapter with respect to national
banks, and Sec. Sec. 6.4 and 165.8 of this chapter with respect to
Federal savings associations, shall include a description of the steps
the national bank or Federal savings association will take to correct
the unsafe or unsound condition or practice. No plan shall be accepted
unless it includes any performance guarantee described in section
38(e)(2)(C) of that Act by each company that controls the national bank
or Federal savings association.
(c) Review of capital restoration plans. Within 60 days after
receiving a capital restoration plan under this subpart, the OCC shall
provide written notice to the national bank or Federal savings
association of whether the plan has been approved. The OCC may extend
the time within which notice regarding approval of a plan shall be
provided.
(d) Disapproval of capital restoration plan. If a capital
restoration plan is not approved by the OCC, the national bank or
Federal savings association shall submit a revised capital restoration
plan within the time specified by the OCC. Upon receiving notice that
its capital restoration plan has not been approved, any
undercapitalized national bank or Federal savings association (as
defined in Sec. 6.4) shall be subject to all of the provisions of
section 38 and this part applicable to significantly undercapitalized
institutions. These provisions shall be applicable until such time as a
new or revised capital restoration plan submitted by the national bank
or Federal savings association has been approved by the OCC.
(e) Failure to submit a capital restoration plan. A national bank
or Federal savings association that is undercapitalized (as defined in
Sec. 6.4) and that fails to submit a written capital restoration plan
within the period provided in this section shall, upon the expiration
of that period, be subject to all of the provisions of section 38 and
this part applicable to significantly undercapitalized national banks
or Federal savings associations.
(f) Failure to implement a capital restoration plan. Any
undercapitalized national bank or Federal savings association that
fails, in any material respect, to implement a capital restoration plan
shall be subject to all of the provisions of section 38 and this part
applicable to significantly undercapitalized national banks or Federal
savings associations.
(g) Amendment of capital restoration plan. A national bank or
Federal savings association that has submitted an approved capital
restoration plan may, after prior written notice to and approval by the
OCC, amend the plan to reflect a change in circumstance. Until such
time as a proposed amendment has been approved, the national bank or
Federal savings association shall implement the capital restoration
plan as approved prior to the proposed amendment.
(h) Notice to FDIC. Within 45 days of the effective date of OCC
approval of a capital restoration plan, or any amendment to a capital
restoration plan, the OCC shall provide a copy of the plan or amendment
to the Federal Deposit Insurance Corporation.
(i) Performance guarantee by companies that control a national bank
or Federal savings association--(1) Limitation on liability--(i) Amount
limitation. The aggregate liability under the guarantee provided under
section 38 and this subpart for all companies that control a specific
national bank or Federal savings association that is required to submit
a capital restoration plan under this subpart shall be limited to the
lesser of:
(A) An amount equal to 5.0 percent of the national bank's or
Federal savings association's total assets at the time the national
bank or Federal savings association was notified or deemed to have
notice that the national bank or Federal savings association was
undercapitalized; or
(B) The amount necessary to restore the relevant capital measures
of the national bank or Federal savings association to the levels
required for the national bank or Federal savings association to be
classified as adequately capitalized, as those capital measures and
levels are defined at the time that the national bank or Federal
savings association initially fails to comply with a capital
restoration plan under this subpart.
(ii) Limit on duration. The guarantee and limit of liability under
section 38 and this subpart shall expire after the OCC notifies the
national bank or Federal savings association that it has remained
adequately capitalized for each of four consecutive calendar quarters.
The expiration or fulfillment by a company of a guarantee of a capital
restoration plan shall not limit the liability of the company under any
guarantee required or provided in connection with any capital
restoration plan filed by the same national bank or Federal savings
association after expiration of the first guarantee.
(iii) Collection on guarantee. Each company that controls a given
national bank or Federal savings association shall be jointly and
severally liable for the guarantee for such national bank or Federal
savings association as required under section 38 and this subpart, and
the OCC may require payment of the full amount of that guarantee from
any or all of the companies issuing the guarantee.
(2) Failure to provide guarantee. In the event that a national bank
or Federal savings association that is controlled by any company
submits a capital restoration plan that does not contain the guarantee
required under section 38(e)(2) of the FDI Act, the national bank or
Federal savings association shall, upon submission of the plan, be
subject to the provisions of section 38 and this part that are
applicable to
[[Page 62280]]
national banks or Federal savings associations that have not submitted
an acceptable capital restoration plan.
(3) Failure to perform guarantee. Failure by any company that
controls a national bank or Federal savings association to perform
fully its guarantee of any capital plan shall constitute a material
failure to implement the plan for purposes of section 38(f) of the FDI
Act. Upon such failure, the national bank or Federal savings
association shall be subject to the provisions of section 38 and this
part that are applicable to national banks or Federal savings
associations that have failed in a material respect to implement a
capital restoration plan.
(j) Enforcement of capital restoration plan. The failure of a
national bank or Federal savings association to implement, in any
material respect, a capital restoration plan required under section 38
and this section shall subject the national bank or Federal savings
association to the assessment of civil money penalties pursuant to
section 8(i)(2)(A) of the FDI Act.
Sec. 6.6 Mandatory and discretionary supervisory actions.
(a) Mandatory supervisory actions--(1) Provisions applicable to all
national banks and Federal savings associations. All national banks and
Federal savings associations are subject to the restrictions contained
in section 38(d) of the FDI Act on payment of distributions and
management fees.
(2) Provisions applicable to undercapitalized, significantly
undercapitalized, and critically undercapitalized national banks or
Federal savings associations. Immediately upon receiving notice or
being deemed to have notice, as provided in Sec. 6.3, that the
national bank or Federal savings association is undercapitalized,
significantly undercapitalized, or critically undercapitalized, the
national bank or Federal savings association shall become subject to
the provisions of section 38 of the FDI Act:
(i) Restricting payment of distributions and management fees
(section 38(d));
(ii) Requiring that the OCC monitor the condition of the national
bank or Federal savings association (section 38(e)(1));
(iii) Requiring submission of a capital restoration plan within the
schedule established in this subpart (section 38(e)(2));
(iv) Restricting the growth of the national bank's or Federal
savings association's assets (section 38(e)(3)); and
(v) Requiring prior approval of certain expansion proposals
(section 38(e)(4)).
(3) Additional provisions applicable to significantly
undercapitalized, and critically undercapitalized national banks or
Federal savings associations. In addition to the provisions of section
38 of the FDI Act described in paragraph (a)(2) of this section,
immediately upon receiving notice or being deemed to have notice, as
provided in this subpart, that the national bank or Federal savings
association is significantly undercapitalized, or critically
undercapitalized, or that the national bank or Federal savings
association is subject to the provisions applicable to institutions
that are significantly undercapitalized because it has failed to submit
or implement, in any material respect, an acceptable capital
restoration plan, the national bank or Federal savings association
shall become subject to the provisions of section 38 of the FDI Act
that restrict compensation paid to senior executive officers of the
institution (section 38(f)(4)).
(4) Additional provisions applicable to critically undercapitalized
national banks or Federal savings associations. In addition to the
provisions of section 38 of the FDI Act described in paragraphs (a)(2)
and (3) of this section, immediately upon receiving notice or being
deemed to have notice, as provided in Sec. 6.3, that the national bank
or Federal savings association is critically undercapitalized, the
national bank or Federal savings association shall become subject to
the provisions of section 38 of the FDI Act:
(i) Restricting the activities of the national bank or Federal
savings association (section 38 (h)(1)); and
(ii) Restricting payments on subordinated debt of the national bank
or Federal savings association (section 38 (h)(2)).
(b) Discretionary supervisory actions. In taking any action under
section 38 that is within the OCC's discretion to take in connection
with a national bank or Federal savings association that is deemed to
be undercapitalized, significantly undercapitalized, or critically
undercapitalized, or has been reclassified as undercapitalized or
significantly undercapitalized; an officer or director of such national
bank or Federal savings association; or a company that controls such
national bank or Federal savings association, the OCC shall follow the
procedures for issuing directives under subpart B of this part and
subpart N of part 19 of this chapter with respect to national banks and
subpart B of this part and Sec. 165.9 of this chapter with respect to
Federal savings associations, unless otherwise provided in section 38
of the FDI Act or this part.
Subpart B--Directives To Take Prompt Corrective Action
Sec. 6.20 Scope.
The rules and procedures set forth in this subpart apply to insured
national banks, insured Federal branches, Federal savings associations,
and senior executive officers and directors of national banks and
Federal savings associations that are subject to the provisions of
section 38 of the Federal Deposit Insurance Act (section 38) and
subpart A of this part.
Sec. 6.21 Notice of intent to issue a directive.
(a) Notice of intent to issue a directive--(1) In general. The OCC
shall provide an undercapitalized, significantly undercapitalized, or
critically undercapitalized national bank or Federal savings
association prior written notice of the OCC's intention to issue a
directive requiring such national bank, Federal savings association, or
company to take actions or to follow proscriptions described in section
38 that are within the OCC's discretion to require or impose under
section 38 of the FDI Act, including section 38(e)(5), (f)(2), (f)(3),
or (f)(5). The national bank or Federal savings association shall have
such time to respond to a proposed directive as provided under Sec.
6.22.
(2) Immediate issuance of final directive. If the OCC finds it
necessary in order to carry out the purposes of section 38 of the FDI
Act, the OCC may, without providing the notice prescribed in paragraph
(a)(1) of this section, issue a directive requiring a national bank or
Federal savings association immediately to take actions or to follow
proscriptions described in section 38 that are within the OCC's
discretion to require or impose under section 38 of the FDI Act,
including section 38(e)(5), (f)(2), (f)(3), or (f)(5). A national bank
or Federal savings association that is subject to such an immediately
effective directive may submit a written appeal of the directive to the
OCC. Such an appeal must be received by the OCC within 14 calendar days
of the issuance of the directive, unless the OCC permits a longer
period. The OCC shall consider any such appeal, if filed in a timely
matter, within 60 days of receiving the appeal. During such period of
review, the directive shall remain in effect unless the OCC, in its
sole discretion, stays the effectiveness of the directive.
(b) Contents of notice. A notice of intention to issue a directive
shall include:
[[Page 62281]]
(1) A statement of the national bank's or Federal savings
association's capital measures and capital levels;
(2) A description of the restrictions, prohibitions or affirmative
actions that the OCC proposes to impose or require;
(3) The proposed date when such restrictions or prohibitions would
be effective or the proposed date for completion of such affirmative
actions; and
(4) The date by which the national bank or Federal savings
association subject to the directive may file with the OCC a written
response to the notice.
Sec. 6.22 Response to notice.
(a) Time for response. A national bank or Federal savings
association may file a written response to a notice of intent to issue
a directive within the time period set by the OCC. The date shall be at
least 14 calendar days from the date of the notice unless the OCC
determines that a shorter period is appropriate in light of the
financial condition of the national bank or Federal savings association
or other relevant circumstances.
(b) Content of response. The response should include:
(1) An explanation why the action proposed by the OCC is not an
appropriate exercise of discretion under section 38;
(2) Any recommended modification of the proposed directive; and
(3) Any other relevant information, mitigating circumstances,
documentation, or other evidence in support of the position of the
national bank or Federal savings association regarding the proposed
directive.
(c) Failure to file response. Failure by a national bank or Federal
savings association to file with the OCC, within the specified time
period, a written response to a proposed directive shall constitute a
waiver of the opportunity to respond and shall constitute consent to
the issuance of the directive.
Sec. 6.23 Decision and issuance of a prompt corrective action
directive.
(a) OCC consideration of response. After considering the response,
the OCC may:
(1) Issue the directive as proposed or in modified form;
(2) Determine not to issue the directive and so notify the national
bank or Federal savings association; or
(3) Seek additional information or clarification of the response
from the national bank or Federal savings association, or any other
relevant source.
(b) [Reserved]
Sec. 6.24 Request for modification or rescission of directive.
Any national bank or Federal savings association that is subject to
a directive under this subpart may, upon a change in circumstances,
request in writing that the OCC reconsider the terms of the directive,
and may propose that the directive be rescinded or modified. Unless
otherwise ordered by the OCC, the directive shall continue in place
while such request is pending before the OCC.
Sec. 6.25 Enforcement of directive.
(a) Judicial remedies. Whenever a national bank or Federal savings
association fails to comply with a directive issued under section 38,
the OCC may seek enforcement of the directive in the appropriate United
States district court pursuant to section 8(i)(1) of the FDI Act.
(b) Administrative remedies. Pursuant to section 8(i)(2)(A) of the
FDI Act, the OCC may assess a civil money penalty against any national
bank or Federal savings association that violates or otherwise fails to
comply with any final directive issued under section 38 and against any
institution-affiliated party who participates in such violation or
noncompliance.
(c) Other enforcement action. In addition to the actions described
in paragraphs (a) and (b) of this section, the OCC may seek enforcement
of the provisions of section 38 or this part through any other judicial
or administrative proceeding authorized by law.
PART 165--PROMPT CORRECTIVE ACTION
0
23. The authority citation for part 165 continues to read as follows:
Authority: 12 U.S.C. 1831o, 5412(b)(2)(B).
Sec. Sec. 165.1 through 165.7 [Removed and Reserved]
0
24. Sections 165.1 through 165.7 are removed and reserved.
Sec. 165.8 [Amended]
0
25. Section 165.8 is amended in paragraphs (a)(1)(i)(A) introductory
text and (a)(1)(ii) by removing the phrases ``Sec. 165.4(c) of this
part'' and ``Sec. 165.4(c)(1)'' respectively, and adding in their
place the phrase ``12 CFR 6.4(d)''.
Sec. 165.9 [Amended]
0
26a. Section 165.9(a) is amended by removing ``section 165.7'' and
adding in its place ``subpart B of part 6 of this chapter''.
Sec. 165.10 [Removed and Reserved]
0
26b. Section 165.10 is removed and reserved.
PART 167--CAPITAL
0
27. The authority citation for part 167 continues to read as follows:
Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1467a, 1828
(note), 5412(b)(2)(B).
Appendix C to Part 167 [REMOVED]
0
28. Under the authority of 12 U.S.C. 93a and 5412(b)(2)(B), Appendix C
to part 167 is removed.
Board of Governors of the Federal Reserve System
12 CFR CHAPTER II
Authority and Issuance
For the reasons set forth in the common preamble, parts 208, 217,
and 225 of chapter II of title 12 of the Code of Federal Regulations
are amended as follows:
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)
0
29. The authority citation for part 208 is revised to read as follows:
Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-
338a, 371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9),
1833(j), 1828(o), 1831, 1831o, 1831p-1, 1831r-1, 1831w, 1831x,
1835a, 1882, 2901-2907, 3105, 3310, 3331-3351, 3905-3909, and 5371;
15 U.S.C. 78b, 78I(b), 78l(i), 780-4(c)(5), 78q, 78q-1, and 78w,
1681s, 1681w, 6801, and 6805; 31 U.S.C. 5318; 42 U.S.C. 4012a,
4104a, 4104b, 4106 and 4128.
Subpart A--General Membership and Branching Requirements
0
29a. In Sec. 208.2, revise paragraph (d) to read as follows:
Sec. 208.2 Definitions.
* * * * *
(d) Capital stock and surplus means, unless otherwise provided in
this part, or by statute, tier 1 and tier 2 capital included in a
member bank's risk-based capital (as defined in Sec. 217.2 of
Regulation Q) and the balance of a member bank's allowance for loan and
lease losses not included in its tier 2 capital for calculation of
risk-based capital, based on the bank's most recent Report of Condition
and Income filed under 12 U.S.C. 324.\2\
---------------------------------------------------------------------------
\2\ Before January 1, 2015, capital stock and surplus for a
member bank that is not an advanced approaches bank (as defined in
Sec. 208.41) means unless otherwise provided in this part, or by
statute, tier 1 and tier 2 capital included in a member bank's risk-
based capital (under the guidelines in appendix A of this part) and
the balance of a member bank's allowance for loan and lease losses
not included in its tier 2 capital for calculation of risk-based
capital, based on the bank's most recent consolidated Report of
Condition and Income filed under 12 U.S.C. 324.
---------------------------------------------------------------------------
* * * * *
[[Page 62282]]
Sec. 208.3 [Amended]
0
29b. In Sec. 208.3 (a), redesignate footnote 2 as footnote 3:
0
29c. Revise Sec. 208.4 to read as follows:
Sec. 208.4 Capital adequacy.
(a) Adequacy. A member bank's capital, calculated in accordance
with part 217, shall be at all times adequate in relation to the
character and condition liabilities and other corporate
responsibilities.\4\ If at any time, in light of all the circumstances,
the bank's capital appears inadequate in relation to its assets,
liabilities, and responsibilities, the bank shall increase the amount
of its capital, within such period as the Board deems reasonable, to an
amount which, in the judgment of the Board, shall be adequate.
---------------------------------------------------------------------------
\4\ Before January 1, 2015, the capital of a member bank that is
not an advanced approaches bank (as defined in Sec. 208.41) is
calculated in accordance with appendices A, B, and E to this part,
as applicable.
---------------------------------------------------------------------------
(b) Standards for evaluating capital adequacy. Standards and
measures, by which the Board evaluates the capital adequacy of member
banks for risk-based capital purposes and for leverage measurement
purposes, are located in part 217 of this chapter.\5\
---------------------------------------------------------------------------
\5\ Before January 1, 2015, the standards and measures by which
the Board evaluates the capital adequacy of member banks that are
not advanced approaches banks (as defined in Sec. 208.41) for risk-
based capital purposes and for leverage measurement purposes are
located in appendices A, B, and E to this part, as applicable.
---------------------------------------------------------------------------
Sec. 208.5 [Amended]
0
29d. In Sec. 208.5. redesignate footnotes 3 and 4 as footnotes 6 and 7
respectively.
Subpart B--Investments and Loans
Sec. 208.21 [Amended]
0
29e. In Sec. 208.21,redesignate footnote 5 as footnote 8.
0
29f. In Sec. 208.23, revise paragraph (c) to read as follows:
Sec. 208.23 Agricultural loan loss amortization.
* * * * *
(c) Accounting for amortization. Any bank that is permitted to
amortize losses in accordance with paragraph (b) of this section may
restate its capital and other relevant accounts and account for future
authorized deferrals and authorization in accordance with the
instructions to the FFIEC Consolidated Reports of Condition and Income.
Any resulting increase in the capital account shall be included in
capital pursuant to part 217 of this chapter.
* * * * *
Sec. 208.24 [Amended]
0
29g. In Sec. 208.24(a)(3), redesignate footnote 6 as footnote 9.
Subpart D--Prompt Corrective Action
0
30-31. Add paragraph (e) to Sec. 208.40 to read as follows:
Sec. 208.40 Authority, purpose, scope, other supervisory authority,
and disclosure of capital categories.
* * * * *
(e) Transition procedures--(1) Definitions applicable before
January 1, 2015, for certain banks. Before January 1, 2015,
notwithstanding any other requirement in this subpart and with respect
to any bank that is not an advanced approaches bank:
(i) The definitions of leverage ratio, tier 1 capital, tier 1 risk-
based capital, and total risk-based capital as calculated or defined
under Appendix A to this part or Appendix B to this part, as
applicable, remain in effect for purposes of this subpart;
(ii) The definition of total assets means quarterly average total
assets as reported in a bank's Report of Condition and Income (Call
Report), minus all intangible assets except mortgage servicing assets
to the extent that the Federal Reserve determines that mortgage
servicing assets may be included in calculating the bank's tier 1
capital. At its discretion the Federal Reserve may calculate total
assets using a bank's period-end assets rather than quarterly average
assets; and
(iii) The definition of tangible equity of a member bank that is
not an advanced approaches bank is the amount of core capital elements
as defined in appendix A to this part, plus the amount of outstanding
cumulative perpetual preferred stock (including related surplus) minus
all intangible assets except mortgage servicing assets to the extent
that the Board determines that mortgage servicing assets may be
included in calculating the bank's tier 1 capital, as calculated in
accordance with Appendix A to this part.
(2) Timing. The calculation of the definitions of common equity
tier 1 capital, the common equity tier 1 risk-based capital ratio, the
leverage ratio, the supplementary leverage ratio, tangible equity, tier
1 capital, the tier 1 risk-based capital ratio, total assets, total
leverage exposure, the total risk-based capital ratio, and total risk-
weighted assets under this subpart is subject to the timing provisions
at 12 CFR 217.1(f) and the transitions at 12 CFR part 217, subpart G.
0
32. Revise Sec. 208.41 to read as follows:
Sec. 208.41 Definitions for purposes of this subpart.
For purposes of this subpart, except as modified in this section or
unless the context otherwise requires, the terms used have the same
meanings as set forth in section 38 and section 3 of the FDI Act.
(a) Advanced approaches bank means a bank that is described in
Sec. 217.100(b)(1) of Regulation Q (12 CFR 217.100(b)(1)).
(b) Bank means an insured depository institution as defined in
section 3 of the FDI Act (12 U.S.C. 1813).
(c) Common equity tier 1 capital means the amount of capital as
defined in Sec. 217.2 of Regulation Q (12 CFR 217.2).
(d) Common equity tier 1 risk-based capital ratio means the ratio
of common equity tier 1 capital to total risk-weighted assets, as
calculated in accordance with Sec. 217.10(b)(1) or Sec. 217.10(c)(1)
of Regulation Q (12 CFR 217.10(b)(1), 12 CFR 217.10(c)(1)), as
applicable.
(e) Control--(1) Control has the same meaning assigned to it in
section 2 of the Bank Holding Company Act (12 U.S.C. 1841), and the
term controlled shall be construed consistently with the term control.
(2) Exclusion for fiduciary ownership. No insured depository
institution or company controls another insured depository institution
or company by virtue of its ownership or control of shares in a
fiduciary capacity. Shares shall not be deemed to have been acquired in
a fiduciary capacity if the acquiring insured depository institution or
company has sole discretionary authority to exercise voting rights with
respect to the shares.
(3) Exclusion for debts previously contracted. No insured
depository institution or company controls another insured depository
institution or company by virtue of its ownership or control of shares
acquired in securing or collecting a debt previously contracted in good
faith, until two years after the date of acquisition. The two-year
period may be extended at the discretion of the appropriate Federal
banking agency for up to three one-year periods.
(f) Controlling person means any person having control of an
insured depository institution and any company controlled by that
person.
[[Page 62283]]
(g) Leverage ratio means the ratio of tier 1 capital to average
total consolidated assets, as calculated in accordance with Sec.
217.10 of Regulation Q (12 CFR 217.10).\10\
---------------------------------------------------------------------------
\10\ Before January 1, 2015, the leverage ratio of a member bank
that is not an advanced approaches bank is the ratio of tier 1
capital to average total consolidated assets, as calculated in
accordance with Appendix B to this part.
---------------------------------------------------------------------------
(h) Management fee means any payment of money or provision of any
other thing of value to a company or individual for the provision of
management services or advice to the bank, or related overhead
expenses, including payments related to supervisory, executive,
managerial, or policy making functions, other than compensation to an
individual in the individual's capacity as an officer or employee of
the bank.
(i) Supplementary leverage ratio means the ratio of tier 1 capital
to total leverage exposure, as calculated in accordance with Sec.
217.10 of Regulation Q (12 CFR 217.10).
(j) Tangible equity means the amount of tier 1 capital, plus the
amount of outstanding perpetual preferred stock (including related
surplus) not included in tier 1 capital.\11\
---------------------------------------------------------------------------
\11\ Before January 1, 2015, the tangible equity of a member
bank that is not an advanced approaches bank is the amount of core
capital elements as defined in appendix A to this part, plus the
amount of outstanding cumulative perpetual preferred stock
(including related surplus) minus all intangible assets except
mortgage servicing assets to the extent that the Board determines
that mortgage servicing assets may be included in calculating the
bank's tier 1 capital, as calculated in accordance with Appendix A
to this part.
---------------------------------------------------------------------------
(k) Tier 1 capital means the amount of capital as defined in Sec.
217.20 of Regulation Q (12 CFR 217.20).\12\
---------------------------------------------------------------------------
\12\ Before January 1, 2015, the tier 1 capital of a member bank
that is not an advanced approaches bank (as defined in Sec. 208.41)
is calculated in accordance with Appendix A to this part.
---------------------------------------------------------------------------
(l) Tier 1 risk-based capital ratio means the ratio of tier 1
capital to total risk-weighted assets, as calculated in accordance with
Sec. 217.10(b)(2) or Sec. 217.10(c)(2) of Regulation Q (12 CFR
217.10(b)(2), 12 CFR 217.10(c)(2)), as applicable.\13\
---------------------------------------------------------------------------
\13\ Before January 1, 2015, the tier 1 risk-based capital ratio
of a member bank that is not an advanced approaches bank (as defined
in Sec. 208.41) is calculated in accordance with Appendix A to this
part.
---------------------------------------------------------------------------
(m) Total assets means quarterly average total assets as reported
in a bank's Call Report, minus items deducted from tier 1 capital. At
its discretion the Federal Reserve may calculate total assets using a
bank's period-end assets rather than quarterly average assets.\14\
---------------------------------------------------------------------------
\14\ Before January 1, 2015, total assets means, for a member
bank that is not an advanced approaches bank (as defined in Sec.
208.41), quarterly average total assets as reported in a bank's Call
Report, minus all intangible assets except mortgage servicing assets
to the extent that the Federal Reserve determines that mortgage
servicing assets may be included in calculating the bank's tier 1
capital. At its discretion the Federal Reserve may calculate total
assets using a bank's period-end assets rather than quarterly
average assets.
---------------------------------------------------------------------------
(n) Total leverage exposure means the total leverage exposure, as
calculated in accordance with Sec. 217.11 of Regulation Q (12 CFR
217.11).
(o) Total risk-based capital ratio means the ratio of total capital
to total risk-weighted assets, as calculated in accordance with Sec.
217.10(b)(3) or Sec. 217.10(c)(3) of Regulation Q (12 CFR
217.10(b)(3), 12 CFR 217.10(c)(3)), as applicable.\15\
---------------------------------------------------------------------------
\15\ Before January 1, 2015, the total risk-based capital ratio
of a member bank that is not an advanced approaches bank (as defined
in Sec. 208.41) is calculated in accordance with appendix A to this
part.
---------------------------------------------------------------------------
(p) Total risk-weighted assets means standardized total risk-
weighted assets, and for an advanced approaches bank also includes
advanced approaches total risk-weighted assets, as defined in Sec.
217.2 of Regulation Q (12 CFR 217.2).
0
33. In Sec. 208.43, revise paragraphs (a) and (b), redesignate
paragraph (c) as paragraph (d), and add a new paragraph (c) to read as
follows:
Sec. 208.43 Capital measures and capital category definitions.
(a) Capital measures. (1) Capital measures applicable before
January 1, 2015. On or before December 31, 2014, for purposes of
section 38 and this subpart, the relevant capital measures for all
banks are:
(i) Total Risk-Based Capital Measure: the total risk-based capital
ratio;
(ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based
capital ratio; and
(iii) Leverage Measure: the leverage ratio.
(2) Capital measures applicable after January 1, 2015. On January
1, 2015, and thereafter, for purposes of section 38 and this subpart,
the relevant capital measures are:
(i) Total Risk-Based Capital Measure: The total risk-based capital
ratio;
(ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based
capital ratio;
(iii) Common Equity Tier 1 Capital Measure: the common equity tier
1 risk-based capital ratio; and
(iv) Leverage Measure:
(A) The leverage ratio, and
(B) With respect to an advanced approaches bank, on January 1,
2018, and thereafter, the supplementary leverage ratio.
(b) Capital categories applicable before January 1, 2015. On or
before December 31, 2014, for purposes of section 38 of the FDI Act and
this subpart, a member bank is deemed to be:
(1) ``Well capitalized'' if:
(i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of 10.0 percent or greater;
(ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of 6.0 percent or greater;
(iii) Leverage Measure: the bank has a leverage ratio of 5.0
percent or greater; and
(iv) The bank is not subject to any written agreement, order,
capital directive, or prompt corrective action directive issued by the
Board pursuant to section 8 of the FDI Act, the International Lending
Supervision Act of 1983 (12 U.S.C. 3907), or section 38 of the FDI Act,
or any regulation thereunder, to meet and maintain a specific capital
level for any capital measure.
(2) ``Adequately capitalized'' if:
(i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of 8.0 percent or greater;
(ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of 4.0 percent or greater;
(iii) Leverage Measure:
(A) The bank has a leverage ratio of 4.0 percent or greater; or
(B) The bank has a leverage ratio of 3.0 percent or greater if the
bank is rated composite 1 under the CAMELS rating system in the most
recent examination of the bank and is not experiencing or anticipating
any significant growth; and
(iv) Does not meet the definition of a ``well capitalized'' bank.
(3) ``Undercapitalized'' if:
(i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of less than 8.0 percent;
(ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of less than 4.0 percent; or
(iii) Leverage Measure:
(A) Except as provided in paragraph (b)(2)(iii)(B) of this section,
the bank has a leverage ratio of less than 4.0 percent; or
(B) The bank has a leverage ratio of less than 3.0 percent, if the
bank is rated composite 1 under the CAMELS rating system in the most
recent examination of the bank and is not experiencing or anticipating
significant growth.
(4) ``Significantly undercapitalized'' if:
(i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of less than 6.0 percent; or
(ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of less than 3.0 percent; or
(iii) Leverage Measure: the bank has a leverage ratio of less than
3.0 percent.
[[Page 62284]]
(5) ``Critically undercapitalized'' if the bank has a ratio of
tangible equity to total assets that is equal to or less than 2.0
percent.
(c) Capital categories applicable to advanced approaches banks and
to all member banks on and after January 1, 2015. On January 1, 2015,
and thereafter, for purposes of section 38 and this subpart, a member
bank is deemed to be:
(1) ``Well capitalized'' if:
(i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of 10.0 percent or greater;
(ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of 8.0 percent or greater;
(iii) Common Equity Tier 1 Capital Measure: the bank has a common
equity tier 1 risk-based capital ratio of 6.5 percent or greater;
(iv) Leverage Measure: the bank has a leverage ratio of 5.0 or
greater; and
(v) The bank is not subject to any written agreement, order,
capital directive, or prompt corrective action directive issued by the
Board pursuant to section 8 of the FDI Act, the International Lending
Supervision Act of 1983 (12 U.S.C. 3907), or section 38 of the FDI Act,
or any regulation thereunder, to meet and maintain a specific capital
level for any capital measure.
(2) ``Adequately capitalized'' if:
(i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of 8.0 percent or greater;
(ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of 6.0 percent or greater;
(iii) Common Equity Tier 1 Capital Measure: the bank has a common
equity tier 1 risk-based capital ratio of 4.5 percent or greater;
(iv) Leverage Measure:
(A) The bank has a leverage ratio of 4.0 percent or greater; and
(B) With respect to an advanced approaches bank, on January 1,
2018, and thereafter, the bank has a supplementary leverage ratio of
3.0 percent or greater; and
(v) The bank does not meet the definition of a ``well capitalized''
bank.
(3) ``Undercapitalized'' if:
(i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of less than 8.0 percent;
(ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of less than 6.0 percent;
(iii) Common Equity Tier 1 Capital Measure: the bank has a common
equity tier 1 risk-based capital ratio of less than 4.5 percent; or
(iv) Leverage Measure:
(A) The bank has a leverage ratio of less than 4.0 percent; or
(B) With respect to an advanced approaches bank, on January 1,
2018, and thereafter, the bank has a supplementary leverage ratio of
less than 3.0 percent.
(4) ``Significantly undercapitalized'' if:
(i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of less than 6.0 percent;
(ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of less than 4.0 percent;
(iii) Common Equity Tier 1 Capital Measure: the bank has a common
equity tier 1 risk-based capital ratio of less than 3.0 percent; or
(iv) Leverage Measure: the bank has a leverage ratio of less than
3.0 percent.
(5) ``Critically undercapitalized'' if the bank has a ratio of
tangible equity to total assets that is equal to or less than 2.0
percent.
* * * * *
Subpart G--Financial Subsidiaries of State Member Banks
0
34-35. In Sec. 208.73:
0
A. Revise the heading in paragraph (a).
0
B. Redesignate paragraphs (b) through (e) as paragraphs (c) through
(f); and add new paragraph (b).
The revision and addition read as follows:
Sec. 208.73 What additional provisions are applicable to state member
banks with financial subsidiaries?
(a) Capital deduction required prior to January 1, 2015, for state
member banks that are not advanced approaches banks (as defined in
Sec. 208.41). * * *
(b) Capital requirements for advanced approaches banks (as defined
in Sec. 208.41) and, after January 1, 2015, all state member banks.
Beginning on January 1, 2014, for a state member bank that is an
advanced approaches bank, and beginning on January 1, 2015 for all
state member banks, a state member bank that controls or holds an
interest in a financial subsidiary must comply with the rules set forth
in Sec. 217.22(a)(7) of Regulation Q (12 CFR 217.22(a)(7)) in
determining its compliance with applicable regulatory capital standards
(including the well capitalized standard of Sec. 208.71(a)(1)).
* * * * *
Sec. 208.77 [Amended]
0
36a. In Sec. 208.77, remove and reserve paragraph (c).
Sec. 208.102 [Amended]
0
36b. In Sec. 208.102, redesignate footnote 7 as footnote 16.
Sec. 208.111 [Amended]
0
36c. In Sec. 208.111, redesignate footnotes 8 and 9 as footnotes 17
and 18 respectively.
Appendix A to Part 208--[Removed and Reserved]
0
37. Effective January 1, 2015, appendix A to part 208 is removed and
reserved.
Appendix B to Part 208--[Removed and Reserved]
0
38. Effective January 1, 2015, appendix B to part 208 is removed and
reserved.
0
39. In Appendix C to part 208, under Loans In Excess of the Supervisory
Loan-To-Value Limits, footnote 2 is revised to read as follows:
Appendix C to Part 208--Interagency Guidelines for Real Estate Lending
Policies
* * * * *
\2\ For advanced approaches banks (as defined in 12 CFR 208.41)
and, after January 1, 2015, for all state member banks, the term
``total capital'' refers to that term as defined in subpart A of 12
CFR part 217. For insured state nonmember banks and state savings
associations, ``total capital'' refers to that term defined in
subpart A of 12 CFR part 324. For national banks and Federal savings
associations, the term ``total capital'' refers to that term as
defined in subpart A of 12 CFR part 3. Prior to January 1, 2015, for
state member banks that are not advanced approaches banks (as
defined in 12 CFR 208.41), the term ``total capital'' means ``total
risk-based capital'' as defined in appendix A to 12 CFR part 208.
For insured state non-member banks, ``total capital'' refers to that
term described in table I of appendix A to 12 CFR part 325. For
national banks, the term ``total capital'' is defined at 12 CFR
3.2(e). For savings associations, the term ``total capital'' is
defined at 12 CFR 567.5(c)
* * * * *
Appendix E to Part 208--[Removed and Reserved]
0
40. Effective January 1, 2015, appendix E to part 208 is removed and
reserved.
Appendix F to Part 208--[Removed and Reserved]
0
41. Effective January 1, 2014, Appendix F to part 208 is removed and
reserved.
PART 217--CAPITAL ADEQUACY OF BANK HOLDING COMPANIES, SAVINGS AND
LOAN HOLDING COMPANIES, AND STATE MEMBER BANKS (REGULATION Q)
0
42. The authority citation for part 217 is added to read as follows:
[[Page 62285]]
Authority: 12 U.S.C. 248(a), 321-338a, 481-486, 1462a, 1467a,
1818, 1828, 1831n, 1831o, 1831p-l, 1831w, 1835, 1844(b), 1851, 3904,
3906-3909, 4808, 5365, 5371.
0
43. Add Part 217 as set forth at the end of the common preamble.
0
44. Part 217 is amended as set forth below:
0
A. Remove ``[AGENCY]'' and add ``Board'' in its place wherever it
appears.
0
B. Remove ``[BANK]'' and add ``Board-regulated institution'' in its
place wherever it appears.
0
C. Remove ``[BANKS]'' and ``[BANK]s'' and add ``Board-regulated
institutions'' in its place, wherever they appear;
0
D. Remove ``[BANK]'s'' and add ``Board-regulated institution's'' in
their place, wherever they appear;
0
E. Remove ``[PART]'' and add ``part'' wherever it appears.
0
F. Remove ``[REGULATORY REPORT]'' wherever it appears and add in its
place ``Call Report, for a state member bank, or the Consolidated
Financial Statements for Bank Holding Companies (FR Y-9C), for a bank
holding company or savings and loan holding company, as applicable'' in
Sec. --.10(b)(4) and ``Call Report, for a state member bank, or FR Y-
9C, for a bank holding company or savings and loan holding company, as
applicable'' every time thereafter;
0
G. Remove ``[other Federal banking agencies]'' wherever it appears and
add ``Federal Deposit Insurance Corporation and Office of the
Comptroller of the Currency'' in its place''.
0
45. In Sec. 217.1,
0
A. Revise paragraphs (a) and (b) and (c)(1);
0
B. Redesignate paragraphs (c)(2) through (c)(4) as paragraphs (c)(3)
through (c)(5) respectively;
0
C. Add new paragraph (c)(2);
0
D. Revise paragraphs (e) and (f)(1)(ii)(A) through (C); and
0
E. Add new paragraph (f)(4) to read as follows:
Sec. 217.1 Purpose, applicability, and reservations of authority.
(a) Purpose. This part establishes minimum capital requirements and
overall capital adequacy standards for entities described in paragraph
(c)(1) of this section. This part includes methodologies for
calculating minimum capital requirements, public disclosure
requirements related to the capital requirements, and transition
provisions for the application of this part.
(b) Limitation of authority. Nothing in this part shall be read to
limit the authority of the Board to take action under other provisions
of law, including action to address unsafe or unsound practices or
conditions, deficient capital levels, or violations of law or
regulation, under section 8 of the Federal Deposit Insurance Act,
section 8 of the Bank Holding Company Act, or section 10 of the Home
Owners' Loan Act.
(c) Applicability. (1) This part applies on a consolidated basis to
every Board-regulated institution that is:
(i) A state member bank;
(ii) A bank holding company domiciled in the United States that is
not subject to 12 CFR part 225, appendix C, provided that the Board may
by order apply any or all of this part 217 to any bank holding company,
based on the institution's size, level of complexity, risk profile,
scope of operations, or financial condition; or
(iii) A covered savings and loan holding company domiciled in the
United States. For purposes of compliance with the capital adequacy
requirements and calculations in this part, savings and loan holding
companies that do not file the FR Y-9C should follow the instructions
to the FR Y-9C.
(2) Minimum capital requirements and overall capital adequacy
standards. Each Board-regulated institution must calculate its minimum
capital requirements and meet the overall capital adequacy standards in
subpart B of this part.
* * * * *
(e) Notice and response procedures. In making a determination under
this section, the Board will apply notice and response procedures in
the same manner and to the same extent as the notice and response
procedures in 12 CFR 263.202.
(f) * * *
(1) * * *
(ii) * * *
(A) Calculate risk-weighted assets in accordance with the general
risk-based capital rules under 12 CFR parts 208 or 225, appendix A,
and, if applicable, appendix E (state member banks or bank holding
companies, respectively) \1\ and substitute such risk-weighted assets
for standardized total risk-weighted assets for purposes of Sec.
217.10;
---------------------------------------------------------------------------
\1\ For the purpose of calculating its general risk-based
capital ratios from January 1, 2014 to December 31, 2014, an
advanced approaches Board-regulated institution shall adjust, as
appropriate, its risk-weighted asset measure (as that amount is
calculated under 12 CFR parts 208 and 225, and, if applicable,
appendix E (state member banks or bank holding companies,
respectively) in the general risk-based capital rules) by excluding
those assets that are deducted from its regulatory capital under
Sec. 217.22.
---------------------------------------------------------------------------
(B) If applicable, calculate general market risk equivalent assets
in accordance with 12 CFR parts 208 or 225, appendix E, section 4(a)(3)
(state member banks or bank holding companies, respectively) and
substitute such general market risk equivalent assets for standardized
market risk-weighted assets for purposes of Sec. 217.20(d)(3); and
(C) Substitute the corresponding provision or provisions of 12 CFR
parts 208 or 225, appendix A, and, if applicable, appendix E (state
member banks or bank holding companies, respectively) for any reference
to subpart D of this part in: Sec. 217.121(c); Sec. 217.124(a) and
(b); Sec. 217.144(b); Sec. 217.154(c) and (d); Sec. 217.202(b)
(definition of covered position in paragraph (b)(3)(iv)); and Sec.
217.211(b); \2\
---------------------------------------------------------------------------
\2\ In addition, for purposes of Sec. 217.201(c)(3), from
January 1, 2014 to December 31, 2014, for any circumstance in which
the Board may require a Board-regulated institution to calculate
risk-based capital requirements for specific positions or portfolios
under subpart D of this part, the Board will instead require the
Board-regulated institution to make such calculations according to
12 CFR parts 208 and 225, appendix A and, if applicable, appendix E
(state member banks or bank holding companies, respectively).
---------------------------------------------------------------------------
* * * * *
(4) This part shall not apply until January 1, 2015, to any Board-
regulated institution that is not an advanced approaches Board-
regulated institution or to any covered savings and loan holding
company.
0
46. In Sec. 217.2:
0
A. Add definitions of ``Board'', ``Board-regulated institution'',
``non-guaranteed separate account'', ``policy loan'', ``state bank'',
and ``state member bank or member bank'' in alphabetical order;
0
B. Add paragraphs (12) and (13) to the definition of ``corporate
exposure'';
0
C. Revise paragraphs (2)(i), (2)(ii) and (4)(i) of the definition of
``high volatility commercial real estate (HVCRE) exposure'', paragraph
(4) of the definition of ``pre-sold construction loan'', paragraph (1)
of the definition of ``total leverage exposure'', and paragraph
(10)(ii) of the definition of ``traditional securitization''.
The additions and revisions read as follows:
* * * * *
Sec. 217.2 Definitions.
* * * * *
Board means the Board of Governors of the Federal Reserve System.
Board-regulated institution means a state member bank, bank holding
company, or savings and loan holding company.
* * * * *
Corporate exposure * * *
[[Page 62286]]
(12) A policy loan; or
(13) A separate account.
* * * * *
High volatility commercial real estate (HVCRE) exposure * * *
(2) * * *
(i) Would qualify as an investment in community development under
12 U.S.C. 338a or 12 U.S.C. 24 (Eleventh), as applicable, or as a
``qualified investment'' under 12 CFR part 228, and
(ii) Is not an ADC loan to any entity described in 12 CFR
208.22(a)(3) or 228.12(g)(3), unless it is otherwise described in
paragraph (1), (2)(i), (3) or (4) of this definition;
* * * * *
(4) * * *
(i) The loan-to-value ratio is less than or equal to the applicable
maximum supervisory loan-to-value ratio in the Board's real estate
lending standards at 12 CFR part 208, appendix C;
* * * * *
Non-guaranteed separate account means a separate account where the
insurance company:
(1) Does not contractually guarantee either a minimum return or
account value to the contract holder; and
(2) Is not required to hold reserves (in the general account)
pursuant to its contractual obligations to a policyholder.
* * * * *
Policy loan means a loan by an insurance company to a policy holder
pursuant to the provisions of an insurance contract that is secured by
the cash surrender value or collateral assignment of the related policy
or contract. A policy loan includes:
(1) A cash loan, including a loan resulting from early payment
benefits 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 that is made in
accordance with policy provisions which provide that delinquent premium
payments are automatically paid from the cash value at the end of the
established grace period for premium payments.
* * * * *
Pre-sold construction loan means * * *
(4) The purchaser has not terminated the contract; however, if the
purchaser terminates the sales contract, the Board must immediately
apply a 100 percent risk weight to the loan and report the revised risk
weight in the next quarterly Call Report, for a state member bank, or
the FR Y-9C, for a bank holding company or savings and loan holding
company, as applicable,
* * * * *
State bank means any bank incorporated by special law of any State,
or organized under the general laws of any State, or of the United
States, including a Morris Plan bank, or other incorporated banking
institution engaged in a similar business.
State member bank or member bank means a state bank that is a
member of the Federal Reserve System.
* * * * *
Total leverage exposure * * *
(1) The balance sheet carrying value of all of the Board-regulated
institution's on-balance sheet assets, as reported on the Call Report,
for a state member bank, or the FR Y-9C, for a bank holding company or
savings and loan holding company, as applicable, less amounts deducted
from tier 1 capital under Sec. 217.22 (a), (c) and (d);
Traditional securitization * * *
(10) * * *
(ii) A collective investment fund (as defined in 12 CFR 208.34);
* * * * *
0
47. In Sec. 217.10, revise paragraph (d) to read as follows:
Sec. 217.10 Minimum capital requirements.
* * * * *
(d) Capital adequacy. (1) Notwithstanding the minimum requirements
in this part, a Board-regulated institution must maintain capital
commensurate with the level and nature of all risks to which the Board-
regulated institution is exposed. The supervisory evaluation of the
Board-regulated institution's capital adequacy is based on an
individual assessment of numerous factors, including the character and
condition of the institution's assets and its existing and prospective
liabilities and other corporate responsibilities.
(2) A Board-regulated institution must have a process for assessing
its overall capital adequacy in relation to its risk profile and a
comprehensive strategy for maintaining an appropriate level of capital.
0
48. In Sec. 217.11, revise paragraphs (a)(2)(i) and (a)(4)(v) to read
as follows:
Sec. 217.11 Capital conservation buffer and countercyclical capital
buffer amount.
* * * * *
(a) * * *
(2) * * *
(i) Eligible retained income. The eligible retained income of a
Board-regulated institution is the Board-regulated institution's net
income for the four calendar quarters preceding the current calendar
quarter, based on the Board-regulated institution's quarterly Call
Report, for a state member bank, or the FR Y-9C, for a bank holding
company or savings and loan holding company, as applicable, net of any
distributions and associated tax effects not already reflected in net
income. Net income, as reported in the Call Report or the FR Y-9C, as
applicable, reflects discretionary bonus payments and certain
distributions that are expense items (and their associated tax
effects).
* * * * *
(4) * * *
(v) Other limitations on distributions. Additional limitations on
distributions may apply to a Board-regulated institution under 12 CFR
225.4, 12 CFR 225.8, and 12 CFR 263.202.
* * * * *
0
49. In Sec. 217.20:
0
A. Revise paragraphs (b)(1)(v), (c)(1)(viii), (c)(3), and (e)(2); and
0
B. In paragraph (d)(4), remove '' [12 CFR part 3, appendix A, 12 CFR
167 (OCC); 12 CFR part 208, appendix A, 12 CFR part 225, appendix A
(Board)]'' and add ``12 CFR part 208, appendix A, 12 CFR part 225,
appendix A'' in its place.
The revisions read as follows:
Sec. 217.20 Capital components and eligibility criteria for
regulatory capital instruments.
* * * * *
(b) * * *
(1) * * *
(v) Any cash dividend payments on the instrument are paid out of
the Board-regulated institution's net income, retained earnings, or
surplus related to common stock, and are not subject to a limit imposed
by the contractual terms governing the instrument. State member banks
are subject to other legal restrictions on reductions in capital
resulting from cash dividends, including out of the capital surplus
account, under 12 U.S.C. 324 and 12 CFR 208.5.
* * * * *
(c) * * *
(1) * * *
(viii) Any distributions on the instrument are paid out of the
Board-regulated institution's net income, retained earnings, or surplus
related to other additional tier 1 capital instruments. State member
banks are subject to other legal restrictions on reductions in capital
resulting from cash dividends, including out of the capital surplus
account, under 12 U.S.C. 324 and 12 CFR 208.5.
* * * * *
(3) Any and all instruments that qualified as tier 1 capital under
the Board's general risk-based capital rules
[[Page 62287]]
under 12 CFR part 208, appendix A or 12 CFR part 225, appendix A, as
then in effect, that were issued under the Small Business Jobs Act of
2010 \10\ or prior to October 4, 2010, under the Emergency Economic
Stabilization Act of 2008.\11\
---------------------------------------------------------------------------
\10\ Public Law 111-240; 124 Stat. 2504 (2010).
\11\ Public Law 110-343, 122 Stat. 3765 (2008).
---------------------------------------------------------------------------
* * * * *
(e) * * *
(2) When considering whether a Board-regulated institution may
include a regulatory capital element in its common equity tier 1
capital, additional tier 1 capital, or tier 2 capital, the Federal
Reserve Board will consult with the FDIC and OCC.
* * * * *
0
50. In Sec. 217.22, revise paragraphs (a)(7), (b)(2)(ii) through
(b)(2)(iii), and (b)(2)(iv) introductory text, add paragraph (b)(3),
and revise paragraph (d)(1)(i) to read as follows:
Sec. 217.22 Regulatory capital adjustments and deductions.
* * * * *
(a) * * *
(7) Financial subsidiaries. (i) A state member bank must deduct the
aggregate amount of its outstanding equity investment, including
retained earnings, in its financial subsidiaries (as defined in 12 CFR
208.77) and may not consolidate the assets and liabilities of a
financial subsidiary with those of the state member bank.
(ii) No other deduction is required under Sec. 217.22(c) for
investments in the capital instruments of financial subsidiaries.
(b) * * *
(2) * * *
(ii) A Board-regulated institution that is not an advanced
approaches Board-regulated institution must make its AOCI opt-out
election in the Call Report, for a state member bank, FR Y-9C or FR Y-
9SP, as applicable, for bank holding companies or savings and loan
holding companies, filed by the Board-regulated institution for the
first reporting period after the Board-regulated institution is
required to comply with subpart A of this part as set forth in Sec.
217.1(f).
(iii) Each depository institution subsidiary of a Board-regulated
institution that is not an advanced approaches Board-regulated
institution must elect the same option as the Board-regulated
institution pursuant to paragraph (b)(2).
(iv) With prior notice to the Board, a Board-regulated institution
resulting from a merger, acquisition, or purchase transaction may make
a new AOCI opt-out election in the Call Report (for a state member
bank), or FR Y-9C or FR Y-9SP, as applicable (for bank holding
companies or savings and loan holding companies) filed by the resulting
Board-regulated institution for the first reporting period after it is
required to comply with subpart A of this part as set forth in Sec.
217.1(f) if:
* * * * *
(3) Regulatory capital requirement for insurance underwriting
risks. A bank holding company or savings and loan holding company must
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. The bank holding
company or savings and loan holding company must take the deduction 50
percent from tier 1 capital and 50 percent from tier 2 capital. If the
amount deductible from tier 2 capital exceeds the Board-regulated
institution's tier 2 capital, the Board-regulated institution must
deduct the excess from tier 1 capital.
* * * * *
(d) * * *
(1) * * *
(i) DTAs arising from temporary differences that the Board-
regulated institution could not realize through net operating loss
carrybacks, net of any related valuation allowances and net of DTLs, in
accordance paragraph (e) of this section. A Board-regulated institution
is not required to deduct from the sum of its common equity tier 1
capital elements DTAs (net of any related valuation allowances and net
of DTLs, in accordance with Sec. 217.22(e)) arising from timing
differences that the Board-regulated institution could realize through
net operating loss carrybacks. The Board-regulated institution must
risk weight these assets at 100 percent. For a state member bank that
is a member of a consolidated group for tax purposes, the amount of
DTAs that could be realized through net operating loss carrybacks may
not exceed the amount that the state member bank could reasonably
expect to have refunded by its parent holding company.
* * * * *
0
51. In Sec. 217.32, revise paragraphs (g)(1)(ii), (k) introductory
text, (l)(1) and (l)(6) introductory text, and add new paragraph (m) to
read as follows:
Sec. 217.32 General risk weights.
* * * * *
(g) * * *
(1) * * *
(ii) Is made in accordance with prudent underwriting standards,
including relating to the loan amount as a percent of the appraised
value of the property; A Board-regulated institution must base all
estimates of a property's value on an appraisal or evaluation of the
property that satisfies subpart E of 12 CFR part 208.
* * * * *
(k) Past due exposures. Except for an exposure to a sovereign
entity or a residential mortgage exposure or a policy loan, if an
exposure is 90 days or more past due or on nonaccrual:
* * * * *
(l) Other assets. (1)(i) A bank holding company or savings and loan
holding company must assign a zero percent risk weight to cash owned
and held in all offices of subsidiary depository institutions or in
transit, and to gold bullion held in a subsidiary depository
institution's own vaults, or held in another depository institution's
vaults on an allocated basis, to the extent the gold bullion assets are
offset by gold bullion liabilities.
(ii) A state member bank must assign a zero percent risk weight to
cash owned and held in all offices of the state member bank or in
transit; to gold bullion held in the state member bank's own vaults or
held in another depository institution's vaults on an allocated basis,
to the extent the gold bullion assets are offset by gold bullion
liabilities; and to exposures that arise from the settlement of cash
transactions (such as equities, fixed income, spot foreign exchange and
spot commodities) with a central counterparty where there is no
assumption of ongoing counterparty credit risk by the central
counterparty after settlement of the trade and associated default fund
contributions.
* * * * *
(6) Notwithstanding the requirements of this section, a state
member bank may assign an asset that is not included in one of the
categories provided in this section to the risk weight category
applicable under the capital rules applicable to bank holding companies
and savings and loan holding companies under this part, provided that
all of the following conditions apply:
* * * * *
(m) Insurance assets--(1) Assets held in a separate account. (i) A
bank holding company or savings and loan holding company must risk-
weight the individual assets held in a separate account that does not
qualify as a non-guaranteed separate account as if the individual
assets were held directly by the bank holding company or savings and
loan holding company.
[[Page 62288]]
(ii) A bank holding company or savings and loan holding company
must assign a zero percent risk weight to an asset that is held in a
non-guaranteed separate account.
(2) Policy loans. A bank holding company or savings and loan
holding company must assign a 20 percent risk weight to a policy loan.
0
52. In Sec. 217.42:
0
A. Revise paragraph (h)(1)(iv); and
0
B. In paragraph (h)(3), remove ``[12 CFR 6.4 (OCC); 12 CFR 208.43
(Board)]'' and add ``12 CFR 208.43'' in its pace.
The revision reads as follows:
Sec. 217.42 Risk-weighted assets for securitization exposures.
* * * * *
(h) * * *
(1) * * *
(iv)(A) In the case of a state member bank, the bank is well
capitalized, as defined in 12 CFR 208.43. For purposes of determining
whether a state member bank is well capitalized for purposes of this
paragraph (h), the state member bank's capital ratios must be
calculated without regard to the capital treatment for transfers of
small-business obligations under this paragraph (h).
(B) In the case of a bank holding company or savings and loan
holding company, the bank holding company or savings and loan holding
company is well capitalized, as defined in 12 CFR 225.2. For purposes
of determining whether a bank holding company or savings and loan
holding company is well capitalized for purposes of this paragraph (h),
the bank holding company or savings and loan holding company's capital
ratios must be calculated without regard to the capital treatment for
transfers of small-business obligations with recourse specified in
paragraph (k)(1) of this section.
* * * * *
0
53. In Sec. 217.52, revise paragraph (b)(3)(i) to read as follows:
Sec. 217.52 Simple risk-weight approach (SRWA).
* * * * *
(b) * * *
(3) * * *
(i) Community development equity exposures. (A) For state member
banks and bank holding companies, an equity exposure that qualifies as
a community development investment under 12 U.S.C. 24 (Eleventh),
excluding equity exposures to an unconsolidated small business
investment company and equity exposures held through a consolidated
small business investment company described in section 302 of the Small
Business Investment Act of 1958 (15 U.S.C. 682).
(B) For savings and loan holding companies, an equity exposure that
is designed primarily to promote community welfare, including the
welfare of low- and moderate-income communities or families, such as by
providing services or employment, and excluding equity exposures to an
unconsolidated small business investment company and equity exposures
held through a small business investment company described in section
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *
0
54. In Sec. 217.100, revise paragraphs (b)(1) introductory text,
(b)(1)(i) through (iii), and (b)(2) to read as follows:
Sec. 217.100 Purpose, applicability, and principle of conservatism.
* * * * *
(b) Applicability. (1) This subpart applies to:
(i) A top-tier bank holding company or savings and loan holding
company domiciled in the United States that:
(A) Is not a consolidated subsidiary of another bank holding
company or savings and loan holding company that uses 12 CFR part 217,
subpart E, to calculate its risk-based capital requirements; and
(B) That:
(1) Has total consolidated assets (excluding assets held by an
insurance underwriting subsidiary), as defined on schedule HC-K of the
FR Y-9C, equal to $250 billion or more;
(2) Has consolidated total on-balance sheet foreign exposure at the
most recent year-end equal to $10 billion (excluding exposures held by
an insurance underwriting subsidiary). Total on-balance sheet foreign
exposure equals total cross-border claims less claims with head office
or guarantor located in another country plus redistributed guaranteed
amounts to the country of head office or guarantor plus local country
claims on local residents plus revaluation gains on foreign exchange
and derivative products, calculated in accordance with the Federal
Financial Institutions Examination Council (FFIEC) 009 Country Exposure
Report); or
(3) Has a subsidiary depository institution that is required, or
has elected, to use 12 CFR part 3, subpart E (OCC), 12 CFR part 217,
subpart E (Board), or 12 CFR part 325, subpart E (FDIC) to calculate
its risk-based capital requirements;
(ii) A state member bank that:
(A) Has total consolidated assets, as reported on the most recent
year-end Consolidated Report of Condition and Income (Call Report),
equal to $250 billion or more;
(B) Has consolidated total on-balance sheet foreign exposure at the
most recent year-end equal to $10 billion or more (where total on-
balance sheet foreign exposure equals total cross-border claims less
claims with head office or guarantor located in another country plus
redistributed guaranteed amounts to the country of head office or
guarantor plus local country claims on local residents plus revaluation
gains on foreign exchange and derivative products, calculated in
accordance with the Federal Financial Institutions Examination Council
(FFIEC) 009 Country Exposure Report);
(C) Is a subsidiary of a depository institution that uses 12 CFR
part 3, subpart E (OCC), 12 CFR part 217, subpart E (Board), or 12 CFR
part 325, subpart E (FDIC) to calculate its risk-based capital
requirements; or
(D) Is a subsidiary of a bank holding company or savings and loan
holding company that uses 12 CFR part 217, subpart E, to calculate its
risk-based capital requirements; and
(iii) Any Board-regulated institution that elects to use this
subpart to calculate its risk-based capital requirements.
* * * * *
(2) A bank that is subject to this subpart shall remain subject to
this subpart unless the Board determines in writing that application of
this subpart is not appropriate in light of the Board-regulated
institution's asset size, level of complexity, risk profile, or scope
of operations. In making a determination under this paragraph (b), the
Board will apply notice and response procedures in the same manner and
to the same extent as the notice and response procedures in 12 CFR
263.202.
* * * * *
0
55. In Sec. 217.121, revise paragraph (a) to read as follows:
Sec. 217.121 Qualification process.
(a) Timing. (1) A Board-regulated institution that is described in
Sec. 217.100(b)(1)(i) and (ii) must adopt a written implementation
plan no later than six months after the date the Board-regulated
institution meets a criterion in that section. The implementation plan
must incorporate an explicit start date no later than 36 months after
the date the Board-regulated institution meets at least one criterion
under Sec. 217.100(b)(1)(i) and (ii). The Board may extend the start
date.
(2) A Board-regulated institution that elects to be subject to this
subpart under
[[Page 62289]]
Sec. 217.101(b)(1)(iii) must adopt a written implementation plan.
* * * * *
0
56. In Sec. 217.122(g), revise paragraph (g)(3)(ii) to read as
follows:
Sec. 217.122 Qualification requirements.
* * * * *
(g) * * *
(3) * * *
(ii) With the prior written approval of the Board, a state member
bank may generate an estimate of its operational risk exposure using an
alternative approach to that specified in paragraph (g)(3)(i) of this
section. A state member bank proposing to use such an alternative
operational risk quantification system must submit a proposal to the
Board. In determining whether to approve a state member bank's proposal
to use an alternative operational risk quantification system, the Board
will consider the following principles:
(A) Use of the alternative operational risk quantification system
will be allowed only on an exception basis, considering the size,
complexity, and risk profile of the state member bank;
(B) The state member bank must demonstrate that its estimate of its
operational risk exposure generated under the alternative operational
risk quantification system is appropriate and can be supported
empirically; and
(C) A state member bank must not use an allocation of operational
risk capital requirements that includes entities other than depository
institutions or the benefits of diversification across entities.
* * * * *
0
57. In Sec. 217.131, revise paragraph (b) and paragraphs (e)(3)(i) and
(ii), and add a new paragraph (e)(5) to read as follows:
Sec. 217.131 Mechanics for calculating total wholesale and retail
risk-weighted assets.
* * * * *
(b) Phase 1--Categorization. The Board-regulated institution must
determine which of its exposures are wholesale exposures, retail
exposures, securitization exposures, or equity exposures. The Board-
regulated institution must categorize each retail exposure as a
residential mortgage exposure, a QRE, or another retail exposure. The
Board-regulated institution must identify which wholesale exposures are
HVCRE exposures, sovereign exposures, OTC derivative contracts, repo-
style transactions, eligible margin loans, eligible purchased wholesale
exposures, cleared transactions, default fund contributions, and
unsettled transactions to which Sec. 217.136 applies, and eligible
guarantees or eligible credit derivatives that are used as credit risk
mitigants. The Board-regulated institution must identify any on-balance
sheet asset that does not meet the definition of a wholesale, retail,
equity, or securitization exposure, any non-material portfolio of
exposures described in paragraph (e)(4) of this section, and for bank
holding companies and savings and loan holding companies, any on-
balance sheet asset that is held in a non-guaranteed separate account.
* * * * *
(e) * * *
(3) * * *
(i) A bank holding company or savings and loan holding company may
assign a risk-weighted asset amount of zero to cash owned and held in
all offices of subsidiary depository institutions or in transit; and
for gold bullion held in a subsidiary depository institution's own
vaults, or held in another depository institution's vaults on an
allocated basis, to the extent the gold bullion assets are offset by
gold bullion liabilities.
(ii) A state member bank may assign a risk-weighted asset amount to
cash owned and held in all offices of the state member bank or in
transit and for gold bullion held in the state member bank's own
vaults, or held in another depository institution's vaults on an
allocated basis, to the extent the gold bullion assets are offset by
gold bullion liabilities.
* * * * *
(5) Assets held in non-guaranteed separate accounts. The risk-
weighted asset amount for an on-balance sheet asset that is held in a
non-guaranteed separate account is zero percent of the carrying value
of the asset.
0
58. In Sec. 217.142, revise the section heading and paragraph
(k)(1)(iv) to read as follows:
Sec. 217.142 Risk-based capital requirement for securitization
exposures.
* * * * *
(k) * * *
(1) * * *
(iv)(A) In the case of a state member bank, the bank is well
capitalized, as defined in section 208.43 of this chapter. For purposes
of determining whether a state member bank is well capitalized for
purposes of this paragraph, the state member bank's capital ratios must
be calculated without regard to the capital treatment for transfers of
small-business obligations with recourse specified in this paragraph
(k)(1).
(B) In the case of a bank holding company or savings and loan
holding company, the bank holding company or savings and loan holding
company is well capitalized, as defined in 12 CFR 225.2. For purposes
of determining whether a bank holding company or savings and loan
holding company is well capitalized for purposes of this paragraph, the
bank holding company or savings and loan holding company's capital
ratios must be calculated without regard to the capital treatment for
transfers of small-business obligations with recourse specified in this
paragraph (k)(1).
* * * * *
0
59. In Sec. 217.152, revise paragraph (b)(3)(i) to read as follows:
Sec. 217.152 Simple risk weight approach (SRWA).
* * * * *
(b) * * *
(3) * * *
(i) Community development equity exposures. (A) For state member
banks and bank holding companies, an equity exposure that qualifies as
a community development investment under 12 U.S.C. 24 (Eleventh),
excluding equity exposures to an unconsolidated small business
investment company and equity exposures held through a consolidated
small business investment company described in section 302 of the Small
Business Investment Act of 1958 (15 U.S.C. 682).
(B) For savings and loan holding companies, an equity exposure that
is designed primarily to promote community welfare, including the
welfare of low- and moderate-income communities or families, such as by
providing services or employment, and excluding equity exposures to an
unconsolidated small business investment company and equity exposures
held through a small business investment company described in section
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *
0
60. In Sec. 217.201:
0
A. Revise paragraph (b)(1) introductory text.
0
B. In paragraph (c)(1), remove [12 CFR 3.404, 12 CFR 263.202, 12 CFR
325.6(c)]'' and add ``12 CFR 263.202'' in its place.
The revision reads as follows:
Sec. 217.201 Purpose, applicability, and reservation of authority.
* * * * *
(b) Applicability. (1) This subpart applies to any Board-regulated
institution with aggregate trading assets
[[Page 62290]]
and trading liabilities (as reported in the Board-regulated
institution's most recent quarterly Call Report, for a state member
bank, or FR Y-9C, for a bank holding company or savings and loan
holding company, as applicable, any savings and loan holding company
that does not file the FR Y-9C should follow the instructions to the FR
Y-9C) equal to:
* * * * *
0
61. In Sec. 217.202(b):
0
A. Revise the introductory text of paragraph (1) of the definition of
``covered position''; and
0
B. In paragraph (10)(i) of the definition of ``securitzation'', remove
``[12 CFR 208.34 (Board), 12 CFR 9.18 (OCC)]'' and adding in its place
``12 CFR 208.34''.
The revision reads as follows:
Sec. 217.202 Definitions.
* * * * *
Covered position means the following positions:
(1) A trading asset or trading liability (whether on- or off-
balance sheet),\27\ as reported on Schedule RC-D of the Call Report or
Schedule HC-D of the FR Y-9C (any savings and loan holding companies
that does not file the FR Y-9C should follow the instructions to the FR
Y-9C), that meets the following conditions:
---------------------------------------------------------------------------
\27\ Securities subject to repurchase and lending agreements are
included as if they are still owned by the lender.
---------------------------------------------------------------------------
* * * * *
0
62. In Sec. 217.300, revise paragraph (c)(1), revise the heading to
paragraph (c)(3), add introductory text to paragraph (c)(3), revise
paragraph (e), and add new paragraph (f), to read as follows:
Sec. 217. 300 Transitions.
* * * * *
(c) * * *
(1) Depository institution holding companies with total
consolidated assets of more than $15 billion as of December 31, 2009
that were not mutual holding companies prior to May 19, 2010. The
transition provisions in this paragraph (c)(1) apply to debt or equity
instruments that do not meet the criteria for additional tier 1 or tier
2 capital instruments in Sec. 217.20, but that were issued and
included in tier 1 or tier 2 capital, respectively (or, in the case of
a savings and loan holding company, would have been included in tier 1
or tier 2 capital if the savings and loan holding company had been
subject to the general risk-based capital rules under 12 CFR part 225,
appendix A), prior to May 19, 2010 (non-qualifying capital
instruments), and that were issued by a depository institution holding
company with total consolidated assets greater than or equal to $15
billion as of December 31, 2009 that was not a mutual holding company
prior to May 19, 2010 (2010 MHC) (depository institution holding
company of $15 billion or more).
* * * * *
(3) Transition adjustments to AOCI. From January 1, 2014 through
December 31, 2017, a Board-regulated institution that has not made an
AOCI opt-out election under Sec. 217.22(b)(2) must adjust common
equity tier 1 capital with respect to the aggregate amount of
unrealized gains on available-for-sale preferred stock classified as an
equity security under GAAP and available-for-sale equity exposures,
plus net unrealized gains or losses on available-for-sale securities
that are not preferred stock classified as equity securities under GAAP
or equity exposures, plus 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 Board-regulated institution's option, the
portion relating to pension assets deducted under Sec. 217.22(a)(5)),
plus accumulated net unrealized gains or losses on cash flow hedges
related to items that are reported on the balance sheet at fair value
included in AOCI, plus net unrealized gains or losses on held-to-
maturity securities that are included in AOCI (the transition AOCI
adjustment amount) as reported on the Board-regulated institution's
most recent Call Report, for a state member bank, or the FR Y-9C, for a
bank holding company or savings and loan holding company, as
applicable, as follows:
* * * * *
(e) Prompt corrective action. For purposes of 12 CFR part 208,
subpart D, a Board-regulated institution must calculate its capital
measures and tangible equity ratio in accordance with the transition
provisions in this section.
(f) Until July 21, 2015, this part will not apply to any bank
holding company subsidiary of a foreign banking organization that is
currently relying on Supervision and Regulation Letter SR 01-01 issued
by the Board (as in effect on May 19, 2010).
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
0
63. The authority citation for part 225 continues to read as follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-
1, 1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907,
and 3909; 15 U.S.C. 1681s, 1681w, 6801 and 6805.
Subpart A--General Provisions
0
64. Effective January 1, 2015, in Sec. 225.1, remove and reserve
paragraphs (c)(12), (c)(13) and (c)(15) to read as follows:
Sec. 225.1 Authority, purpose, and scope.
* * * * *
(c) * * *
(12) [Reserved]
* * * * *
(14) [Reserved]
(15) [Reserved]
* * * * *
0
65. In Sec. 225.2, revise paragraphs (r)(1)(i) and (ii) to read as
follows:
Sec. 225.2 Definitions.
* * * * *
(r) * * *
(1) * * *
(i) On a consolidated basis, the bank holding company maintains a
total risk-based capital ratio of 10.0 percent or greater, as defined
in 12 CFR 217.10; \3\
---------------------------------------------------------------------------
\3\ Before January 1, 2015, the total risk-based capital ratio
of a bank holding company that is not an advanced approaches bank
holding company (as defined in 12 CFR 217.100(b)(1)) is calculated
in accordance with appendix A to this part.
---------------------------------------------------------------------------
(ii) On a consolidated basis, the bank holding company maintains a
tier 1 risk-based capital ratio of 6.0 percent or greater, as defined
in 12 CFR 217.10; \4\ and
---------------------------------------------------------------------------
\4\ Before January 1, 2015, the tier 1 risk-based capital ratio
of a bank holding company that is not an advanced approaches bank
holding company (as defined in 12 CFR 217.100(b)(1)) is calculated
in accordance with appendix A to this part.
---------------------------------------------------------------------------
* * * * *
0
66. In Sec. 225.4, revise paragraph (b)(4)(ii) to read as follows:
Sec. 225.4 Corporate practices.
* * * * *
(b) * * *
(4) * * *
(ii) In determining whether a proposal constitutes an unsafe or
unsound practice, the Board shall consider whether the bank holding
company's financial condition, after giving effect to the proposed
purchase or redemption, meets the financial standards applied by the
Board under section 3 of the BHC Act, including 12 CFR part 217,\1\ and
the Board's Policy Statement for Small
[[Page 62291]]
Bank Holding Companies (appendix C of this part).
---------------------------------------------------------------------------
\1\ Before January 1, 2015, the Board will consider the
financial standards at 12 CFR part 225 appendices A, C, and E for a
bank holding company that is not an advanced approaches bank holding
company.
---------------------------------------------------------------------------
* * * * *
Subpart B--Acquisition of Bank Securities or Assets
0
67a. In Sec. 225.12:
0
a. In paragraph (d)(3)(i)(B), redesignate footnote 1 as footnote 2;
0
b. Revise paragraph (d)(2)(iv) and add a new footnote 1 to read as
follows:
Sec. 225.12 Transactions not requiring Board approval.
* * * * *
(d) * * *
(2) * * *
(iv) Both before and after the transaction, the acquiring bank
holding company meets the requirements of 12 CFR part 217; \1\
---------------------------------------------------------------------------
\1\ Or before January 1, 2015, if the acquiring company, after
giving effect to the transaction, meets the requirements of appendix
A to this part, and the Board has not previously notified the
acquiring company that it may not acquire assets under the exemption
in this paragraph.
---------------------------------------------------------------------------
* * * * *
Sec. 225.14 [Amended]
0
67b. In Sec. 225.14, redesignate footnote 2 as footnote 3.
Sec. 225.17 [Amended]
0
67c. In Sec. 225.17, redesignate footnotes 3 through 5 as footnotes 4
through 6 respectively.
Subpart C--Nonbanking Activities and Acquisitions by Bank Holding
Companies
0
68a. In Sec. 225.22, revise paragraph (d)(8)(v) and add footnote 1 to
read as follows:
Sec. 225.22 Exempt nonbanking activities and acquisitions.
* * * * *
(d) * * *
(8) * * *
(v) The acquiring company, after giving effect to the transaction,
meets the requirements of 12 CFR part 217, and the Board has not
previously notified the acquiring company that it may not acquire
assets under the exemption in this paragraph (d).\1\
---------------------------------------------------------------------------
\1\ Before January 1, 2015, the maximum marginal tier 1 capital
charge applicable to merchant banking investments held by a
financial holding company that is not an advanced approaches bank
holding company (as defined in 12 CFR 217.100(b)(1)) is calculated
in accordance with appendix A to this part.
---------------------------------------------------------------------------
* * * * *
Sec. 225.23 [Amended]
0
68b. In Sec. 225.23, redesignate footnote 1 as footnote 2.
Sec. 225.28 [Amended]
0
68c. In Sec. 225.23, redesignate footnotes 2 through 18 as footnotes 3
through 19 respectively.
Subpart J--Merchant Banking Investments
0
69. In Sec. 225.172, revise paragraph (b)(6)(i)(A) and add footnote 1
to read as follows:
Sec. 225.172 What are the holding periods permitted for merchant
banking investments?
* * * * *
(b) * * *
(6) * * *
(i) * * *
(A) Higher than the maximum marginal tier 1 capital charge
applicable under part 217 to merchant banking investments held by that
financial holding company; \1\ and
---------------------------------------------------------------------------
\1\ Before January 1, 2015, the Board will consider the
financial standards at 12 CFR part 225 appendices A, C, and E for a
bank holding company that is not an advanced approaches bank holding
company.
---------------------------------------------------------------------------
* * * * *
Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Risk-Based Measure
0
70. Effective January 1, 2019, appendix A to part 225 is removed and
reserved.
Appendix B to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies and State Member Banks: Leverage Measure [Removed and
Reserved]
0
71. Appendix B to part 225 is removed and reserved.
Appendix D to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Tier 1 Leverage Measure
0
72. Effective January 1, 2015, appendix D to part 225 is removed and
reserved.
Appendix E to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Market Risk Measure
0
73. Effective January 1, 2015, Appendix E to part 225 is removed and
reserved.
Appendix G to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Internal-Ratings-Based and Advanced Measurement Approaches
0
74. Effective January 1, 2014, Appendix G to part 225 is removed and
reserved.
Dated: July 9, 2013.
Thomas J. Curry,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System, August 30, 2013.
Robert deV. Frierson,
Secretary of the Board.
[FR Doc. 2013-21653 Filed 10-10-13; 8:45 a.m.]
BILLING CODE 4810-33-P