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F e d e r a iL R e s e r v e B a n k
OF DALLAS
WILLIAM H. WALLACE
DALLAS, TEXAS 7 5 2 2 2
F IR S T VICE P R E S ID E N T
May 21, 1985
Ci rc ul ar 85-60
(corr ect ed)
TO: The Chief Executive Of fic er of a l l
s t a t e member banks, bank holding
companies, and others concerned in
the Eleventh Federal Reserve D i s t r i c t
SUBJECT
Capital Adequacy Guidelines
SUMMARY
The Board of Governors of the Federal Reserve System has announced
r e v i s i o n s , e f f e c t i v e May 15, 1985, to i t s guid eline s regarding c a p i t a l
adequacy f o r s t a t e member banks and bank holding companies. The guidelines
req u ire minimum primary and t o t a l c a p i t a l to t o t a l a s s e t s r a t i o s of 5.5
percent and 6.0 per cen t, r e s p e c t i v e l y , f o r a l l i n s t i t u t i o n s re g ar dl es s of
size.
Banking or gan izations are expected to operate above the minimum
primary and t o t a l c a p i t a l l e v e l s . In accordance with the "zone" concept fo r
c a p i t a l adequacy, i n s t i t u t i o n s with a t o t a l c a p i t a l to t o t a l a s s e t s r a t i o
exceeding 7.0 percent will gen erally be considered adequately c a p i t a l i z e d ,
unless there are s i g n i f i c a n t l y adverse f in a n c ia l or managerial f a c t o r s .
However, the Board may requ ire p a r t i c u l a r banks or bank holding companies to
maintain ad di ti ona l c a p i t a l i f the f in an ci al co ndi ti on , including fa c t o rs
such as of f- bal anc e sheet r i s k and l i q u i d i t y r i s k , management, or fu tu re
prospects of the i n s t i t u t i o n make a higher c a p i t a l level necessary and
app ro p ria te .
The Board also revised i t s d e f i n i t i o n of c a p i t a l f o r s t a t e member
banks order to define c a p i t a l more c o n s i s t e n t l y with the c a p it a l re g ul at io n s
of the OCC and the FDIC.
ATTACHMENTS
The Board's press re le a s e and the material as published in the
Federal Re gister are attached.
For additional copies of any circular please contact the Public Affairs Department at (214) 651-6289. Banks and others are
encouraged to use the following incoming WATS numbers in contacting this Bank (800) 442-7140 (intrastate) and (800)
527-9200 (interstate).
This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)
- 2 -
MORE INFORMATION
This cor rec ted C ir cu la r 85-60 i s sen t to you to c o r r e c t the
e f f e c t i v e date of May 15, 1984, to May 15, 1985, and to include also the
Board's press r e l e a s e .
Questions p er ta i n i n g to the Board's c a p i t a l adequacy guide line s
should be d ir e c t e d to the following Supervision & Regulation Department
p er so nn el :
S ta te member banks:
Marvin C. McCoy, (214) 651-6657
William C. Reddick, J r . , (214) 651-6652
Bank holding companies: Ann Worthy, (214) 651-6259.
Sincerely yours,
FEDERAL RESERVE press release
For Immediate r e l e a s e
A p r il 1 8 , 1 9 8 5
The Federal Reserve Board today announced r e v i si o n s t o I t s guid eline s
regarding c a p i t a l adequacy f o r s t a t e member banks and bank holding companies.
The rev ised gu id eli nes r a i s e the minimum c a p i t a l l e v e l s f o r mu ltinatio nal
and regional banking o r g a n i z a t i o n s .
By doing so, they el im i n a te th e d i s p a r i t y in
t h e minimum c a p i t a l requirements between th es e l a r g e r i n s t i t u t i o n s and smaller
community s t a t e member banks and bank holding companies by s e t t i n g a uniform minimum
r a t i o of primary c a p i t a l to t o t a l a s s e t s of 5.5 percent and a minimum r a t i o of
t o t a l c a p i t a l t o t o t a l a s s e t s of 6.0 p e r c e n t .
In ge ne r al , banking or gan izations are
expected t o operate above the minimum primary and t o t a l c a p i t a l l e v e l s .
This act io n p a r a l l e l s the recent actio ns of t h e Office of the Comptroller
of t h e Currency (OCC) and th e Federal Deposit Insurance Corporation (FDIC), r e s u l t i n g
in uniform minimum c a p i t a l leve ls being e s t a b l i s h e d f o r a l l f e d e r a l l y supervised
banking o r g a n i z a t i o n s .
Based on i t s experience, the Board has continued t o include the substan
t i v e c a p i t a l requirements f o r s t a t e member banks and bank holding companies in guide
l i n e s r a t h e r than in th e form of a r e g u l a t i o n .
In a d d i t i o n , t he Board has retain ed
the use of t o t a l c a p i t a l zones or t a r g e t ranges t h a t help t o define various le v el s
of c a p i t a l i z a t i o n .
The use of such zones or t a r g e t ranges provides the management
of banking or ga ni zat ion s with broad standards f o r f u t u r e c a p i t a l planning and
encourages banking org an iz at io ns to maintain t o t a l c a p i t a l l e v e l s in excess of the
mini num. These zones ar e g enerally defined as:
Zone 1 —
I n s t i t u t i o n s with t o t a l c a p i t a l equal t o a t l e a s t 7 percent of
t o t a l a s s e t s are g enerally considered adequately c a p i t a l i z e d ,
provided t h e i r primary c a p i t a l r a t i o s are considered adequate.
(over)
Zone 2 — I n s t i t u t i o n s operating with t o t a l c a p i t a l equal t o 6 t o 7 percent of
t h e i r t o t a l a s s e t s may be considered c a p i t a l i z e d a t a minimally ac
c ep ta bl e l e v e l , s u bj e ct t o co n s id er at i o n of ot h er f in a n c i a l f a c t o r s .
Zone 3 — Banking org ani zat io ns with t o t a l c a p i t a l equal t o l e s s than 6 percent
of t h e i r t o t a l a s s e t s are g en er all y considered u n d e r c a p i t a l i z e d , in
t he absence of c l e a r exten uat ing circumstances.
The Board has also included in the revised guid eline s a mored e t a i l e d
definitional
s e c ti o n dealing with mandatory c o n v e r t i b l e s e c u r i t i e s . F i n a l l y ,
the
Board has adopted a re g u l a ti o n e s t a b l i s h i n g procedures by which t h e Board may re quire
a banking o r ga ni za ti o n t o maintain the minimum c a p i t a l l e v e l s , as defined in the
rev ised g u i d e l i n e s , or higher le v el s f o r i n s t i t u t i o n s on a case-by-case b a s i s .
The Board has made t h r e e changes in i t s e x i s t i n g c a p i t a l guide line s f o r
s t a t e member banks in order t o define c a p i t a l more c o n s i s t e n t l y with the c a p i t a l
r e g u l a t i o n s of t h e OCC and FDIC.
S p e c i f i c a l l y , the Board has amended the c a p i t a l
g u ide li nes f o r s t a t e member banks but not f o r bank holding companies:
-
t o r eq u ire the automatic deduction of goodwill from primary
and t o t a l c a p i t a l ;
-
t o el i m i n at e equity commitment notes from primary c a p i t a l ; and
-
t o define the c a p i t a l r a t i o s in terms of average a s s e t s r a t h e r
than period-end f i g u r e s .
The gu id eli ne s s t a t e t h a t th e Federal Reserve wil l review l i q u i d i t y and
the r e l a t i o n s h i p of a l l on- and of f- bal anc e sheet r i s k s t o c a p i t a l , and will r eq u ir e
those i n s t i t u t i o n s with high or i n o r d in a t e l ev el s of r i s k t o hold ad di ti on al primary
capital.
The gu id eli nes suggest t h a t banking o rg an iz at io n s avoid the p r a c t i c e of
attempting t o meet c a p i t a l requirements by decreasing th e level of l i q u i d a s s e t s in
relation to total assets.
The gu idelines al so i n d i c a t e t h a t th e Federal Reserve will
continue t o review t h e need f o r more e x p l i c i t procedures f o r f a c t o r i n g on- and o f f balance sheet r i s k s i n t o th e assessment of c a p i t a l adequacy.
The Board's n o ti ce i s a t t a c h e d .
Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
FEDERAL RESERVE SYSTEM
12 CFR Parts 208,225 and 263
[Docket No. R-0526]
Membership of State Banking
Institutions; Bank Holding Companies
and Change In Bank Control; Capital
Maintenance; Rules of Procedure
AQENCY: Board of Governors of the
Federal Reserve System.
action : Final rulemaking.
summary: The
Board of Governors of
the Federal Reserve System has adopted
revised capital adequacy guidelines and
a procedural regulation to permit the
Board to enforce compliance with the
revised guidelines. The amended
guidelines and the procedural
enforcement regulation implement
section 908 of the International Lending
Supervision Act of 1983 (Pub. L. 98-181,
Title IX, 97 Stat. 1153, codified at 12
U.S.C. 3907), which directs the federal
bank supervisory agencies, i.e., the
Board, the Federal Deposit Insurance
Corporation ("the FDIC”) and the
Comptroller of the Currency (“the
Comptroller”), to establish minimum
and appropriate levels of capital for
federally supervised banking
institutions. Pursuant to its supervisory
authority, the Board is promulgating
revised capital guidelines for bank
holding companies and state-chartered
banks that are members of the Federal
Reserve System.
Capital adequacy is one of the critical
factors the Board is required to analyze
in taking action on various types of
applications, such as mergers and
acquisitions by banks and bank holding
companies, and in the conduct of the
Board’s various supervisory activities
related to the safety and soundness of
individual banks and bank holding
companies and to the stability of the
banking system.
In amending its capital guidelines, the
Board has adopted, with some changes,
the proposal published for comment on
July 30,1984 (49 FR 30317). The revised
guidelines: (a) Define capital and the
major components of capital, (b)
establish minimum capital ratios, and (c)
provide for capital zones or target
ranges for state member banks and bank
holding companies. In addition, the final
enforcement regulation establishes
16057
procedures under which the Board may
require banking organizations to achieve
and maintain the minimum capital levels
contained in the guidelines. The
regulation also provides procedures for
the Board to set capital requirements for
individual banking organizations at
levels higher than the uniform minimum
levels in the guidelines.
EFFECTIVE DATE: May 15,1985.
FOR FURTHER INFORMATION CONTACT:
Richard Spillenkothen, Assistant
Director, Division of Banking Su
pervision and Regulation (202/452-2594),
Anthony G. Comyn, Assistant Director,
Division of Banking Supervision and
Regulation (202/452-3354), or James E.
Scott, Senior Attorney, Legal Division
(202/452-3513).
SUPPLEMENTARY INFORMATION:
1. Background
The Need for Capital Adequacy
Standards
The Board, by reason of its
responsibilities as a banking regulator,
has historically had a critical interest in
the maintenance of adequate capital in
individual state member banks and
bank holding companies and in the
banking system in general. In the
Board’s view, capital provides a buffer
for individual banking organizations in
times of poor performance, helps to
maintain public confidence in particular
banking organizations and in the
banking system, promotes the safety of
depositors' funds, and supports the
reasonable growth of banking
organizations. An evaluation of capital
adequacy is one of the major purposes
of a bank or bank holding company
examination^ Capital is one component
of the Uniform Financial Institutions
Rating System used by the federal bank
supervisory agencies.
Despite the recognition by the Board
and other Federal banking regulators of
the importance of capital, the period
from 1960 through 1980 was marked by a
gradual decline in the ratio of equity
capital to total assets in the United
States commerical banking system.
Concern about the decline in the ratio of
capital to bank assess before 1981,
particularly at the nation’s largest
banking organizations, prompted the
Board and the Comptroller in December
1981 to adopt capital adequacy
guidelines for national and state
member banks and bank holding
companies. These guidelines established
minimum capital levels and capital
“zones” which defined, for wellmanaged banking institutions without
significant financial weaknesses, those
institutions that were considered
16058
Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
adequately capitalized and those
presumed to be undercapitalized, absent
clear extenuating circumstances.
The guidelines have continued to
provide state member banks and bank
holding companies with targets or
objectives to be reached over time. The
Board has noted that many banks and
bank holding companies, including the
nation’s largest banking organizations,
have improved their capital positions to
comply with the guidelines.
Nevertheless, several recent
developments, including deregulation of
interest rates on bank liabilities,
weaking of loan portfolios of some
banking institutions occasioned by
economic shocks in certain industries or
geographic areas, and increased
competition in the financial services
areas, have combined to place
additional pressures on the profitability
of banking institutions and to
accentuate potential demands on the
capital of those institutions. The Board
has continued to stress the importance
of capital to banking organizations and
the importance of the capital guidelines
in setting standards of capital adequacy.
In June 1983, the Board amended its
guidelines to set explicit minimum
capital levels for multinational
organizations. In December 1983, the
Board republished the guidelines as
Appendix A of its Regulation Y (12 CFR
Part 225) (49 FR 794).
Reasons for Revision of the Guidelines
In November 1983, Congress enacted
the International Lending Supervision
Act of 1983 (12 U.S.C. 3901 et seq.)
(‘‘ILSA*’), which directed that the federal
banking agencies “. . . shall cause
banking institutions to achieve and
maintain adequate capital by
establishing minimum levels of capital
for such banking institutions and by
such other methods as the appropriate
Federal banking agency deem
appropriate.” (Section 908, U.S.C. 3907).
Pursuant to this authority, as well as the
authority of the Bank Holding Company
Act, 12 U.S.C. 1844(b), the Federal
Reserve Act, 12 U.S.C. 248, 324, 329, and
the Financial Institutions Supervisory
Act of 1966,12 U.S.C. 1818, the Board is
amending its capital adequacy
guidelines to increase the required
minimum primary and total capital
levels for the larger regional and
multinational bank holding companies
and state member banks and to
eliminate the disparate minimum capital
levels for large and small banking
organizations.
The amended guidelines, when
considered in conjunction with the
capital maintenance regulations of the
Comptroller and the FDIC, will establish
uniform minimum capital levels for all
federally supervised banking
organizations, including bank holding
companies, regardless of size, type of
charter, primary supervisor of
membership in the Federal Reserve
System. In addition, the guidelines have
been amended to define the components
of capital for state member banks more
consistently with the definitions
contained in the capital maintenance
regulations of the Comptroller and FDIC.
The Board is also adopting procedural
regulations that provide a mechanism to
enforce the substantive requirements of
the guidelines.
The Board will continue to require
bank holding companies to meet the
same minimum capital ratios as state
member banks. The Board has found
pursuant to section 910(a)(2) of ILSA (12
U.S.C. 3909(a)(2)) that application of
minimum capital levels and capital
zones to bank holding companies is
necessary to prevent evasions of the
purposes of ILSA. It serves no purpose
to increase the capital levels of a bank
while allowing its parent holding
company to operate with lower levels of
capital. The financial condition of a
bank holding company continues to be a
primary factor influencing the financial
condition of its subsidiary banks. The
Board's revision of the capital adequacy
guidelines for bank holding companies is
designed to increase the required
minimum primary and total capital
levels for the larger regional and
multinational bank holding companies,
and to establish uniform capital
requirements for all bank holding
companies regardless of size.
2. Comments Received
The Board’s proposal to amend its
capital adequacy guidelines was
announced on July 26,1984, and
published for comment, with the
comment period ending September 24,
1984. The FDIC and Comptroller
published similar capital maintenance
regulations at approximately the same
time, and the comment period on the
Comptroller’s proposed regulations
expired November 5,1984. In view of the
similarity of the issues raised by these
parallel proceedings and the fact that
several commenters filed comments
with all the federal banking agencies,
the Board considered comments
received after its commenlMDeriod but
before November 5,1984. The Board
received 89 comments from the public,
including 12 from multinational banks,
27 from regional banks, 29 from smaller
community banks (under $1 billion in
total assests), 7 from banking
associations ororganizations, 2 from
foreign banks, 3 from state bank
supervisors, 2 from nonbank financial
service organizations and 7 from other
organizations and individuals. In
addition, the Board received comments
from 10 of its Federal Reserve Banks.
The Board requested comments on
four specific issues. On the issue of
whether to promulgate guidelines or a
regulation dealing with maintenance of
adequate capital, 92 percent of those
commenting recommended that the
Board continue to employ guidelines. On
continued use of capital “zones” in
addition to a minimum capital level, 77
percent of those commenting endorsed
the zone concept. On the treatment of
intangible assets, 98 percent of those
commenting favored including all
intangibles in the definition of primary
capital for bank holding companies and
78 percent endorsed the same principle
for state member banks. Finally, on the
treatment of equity commitment notes,
91 percent of those commenting favored
including such commitment notes as
primary capital for bank holding
companies and 78 percent favored the
inclusion of such notes as primary
capital for commercial banks.
The comments covered a range of
other issues. The Board has reviewed
the comments and recommendations
received and has incorporated several
of the suggestions and recommendations
in the revising guidelines.
3. Resolution of Major Issues
Mininum Capital Ratios
The Board has revised its capital
adequacy guidelines, in accordance with
its July 1984 proposal, to require a
minimum ratio of primary capital to
total assets of 5.5 percent and a
minimum ratio of total capital to total
assets of 6.0 percent for all state
member banks and bank holding
companies. This requirement represents
an increase in the minimum primary
capital ratio from 5.0 to 5.5 percent for
regional (in excess of $1 billion in total
assets) and multinational banking
institutions and a decrease from 6.0 to
5.5 percent in the minimum primary
capital ratio for community banking
organizations (less than $1 billion in
total assets). It also represents an
increase in the minimum total capital
ratio of larger banking institutions 5.5 to
6.0 percent. The minimum total capital
ratio for community banking institutions
remains unchanged. The following table
summarizes the changes from the
minimum capital requirements in the
Board’s current capital adequacy
guidelines.
Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
Minimum primary capital:
Multinational and regional...... ..........
Community (under $1 billion in
total assets)............. .......... ...........
Minimum total capital:
Multinational and regional.................
Community..........................................
Current
guide
lines
(per
cent)
Amend
ed
guide
lines
(per
cent)
5.0
5.5
6.0
5.5
5.5
6.0
6.0
6.0
The Board did not receive any
significantly adverse comments on its
proposal to reduce the minimum primary
capital levels of smaller community
banking institutions. In view of the
importance the Board places on
maintaining a strong capital position,
the Board was reluctant to accept a
reduction in the minimum primary
capital level of smaller banking
organizations. However, the Board has
made this change for the overriding
reasons of achieving uniformity in the
capital requirements for larger and small
banking organizations, maintaining
consistency with the requirements of the
Comptroller and the FDIC, and adhering
to the objectives of Congress in enacting
ILSA. Total capital requirements for
these community institutions will remain
unchanged, and the Board will continue
to emphasize that all banking
institutions are expected to operate
above the minimum capital ratios. The
Board will also continue to scrutinize,
particularly in the course of proposals to
expand, any decline in the capital ratios
of banking organizations.
The Board did receive strong
objections from some larger banking
institutions to the proposal to raise their
minimum primary and total capital
ratios. In their comments, these regional
and multinational institutions
questioned not only the proposed
minimum capital levels, but also, in
some cases, the very concept of capital
ratios as a measure of a bank’s stability
and condition.
Some cOmmenters argued that the
emphasis on capital is misplaced and
that bank regulators should be
concerned with other factors such as
liquidity, interest rate exposure, and the
quality of the loan portfolio. They noted
that use of minimum capital levels is not
a suitable tool for management to risk
exposure and contended that capital
does not prevent bank failures. These
commenters also argued that higher
capital requirements would increase risk
by pressuring institutions to shift assets
toward higher yielding, but riskier, loans
in order to maintain earnings per share.
They further asserted that higher capital
levels would put large domestic banking
institutions at a competitive
disadvantage against thrifts and foreign
banking institutions. Finally, some
commenters argued that an increase in
minimum capital levels for larger
banking organizations is inappropriate,
because a 6 percent minimum primary
capital level was set for multinational
banking institutions in 1983 and no
subsequent increase in risk justifies the
increase.
The Board has long held that
adequate capital is a critical factor in
helping a banking institution weather
financial adversity and in promoting the
safety and soundness of the banking
system. Other things being equal, the
stronger an organization’s capital
position, the more likely it will be able
to withstand a period of financial stress
without experiencing a loss of public
confidence. Supervisory experience has
demonstrated that a strong capital
position is a critical element of bank
soundness and serves both to protect
depositors and to promote the safety of
the banking system. Moreover, in
enacting ILSA, Congress has established
the requirement of minimum capital
levels by law and has generally
mandated both greater uniformity in
capital requirements and an increase in
capital levels, particularly in view of its
concern about larger banking
institutions in the international arena.
Finally, higher capital ratio guidelines
need not mean any lessening of concern
or scrutiny by the Board with respect to
other risk factors. The amended
guidelines state explicitly that such
factors as liquidity, the degree of risk
associated with a banking institution's
assets, and off-balance sheet exposure
will be taken into account in assessing
capital adequacy and that the Board will
take other relevant factors into account
on a case-by-case basis in applying the
capital guidelines.
Based on the most recent available
data, only 17 state member banks and 61
bank holding companies with assets
over $150 million have primary capital
ratios (without deducting intangible
assets) below the 5.5 percent minimum
primary capital guideline. Thus, fewer
than 2 percent of all state member banks
and 8 percent of all holding companies
with assets over $150 million had
primary capital ratios below the
minimum benchmark. With respect to
total capital, 25 state member banks and
80 bank holding companies have total
capital ratios (without deducting
intangibles) below the 6.0 percent
minimum guideline. These numbers
pertaining to total capital include some
of the same banking organizations
whose primary capital ratios also fall
below the 5.5 percent minimum primary
16059
capital guideline. The figures for the
number of state member banks that fall
below the guidelines do not take
account of the Board's decision to
deduct goodwill from the capital of state
member banks.
The Continued Use of Total Capital
Zones
The Board has decided, in accordance
with its July 1984 proposal, to continue
using “zones" in assessing the adequacy
of total capital. Banking organizations
with a ratio of total capital to total
assets less than 6.0 percent will be
considered undercapitalized, if there are
no extenuating circumstances.
Institutions with a total capital to total
assets ratio of 6.0 to 7.0 percent may be
considered to be capitalized at an
acceptable level if the Federal Reserve’s
close scrutiny of other relevent financial
and managerial factors shows them to
be fully satisfactory. Finally, institutions
with a total capital to total assets ratio
exceeding 7.0 percent will generally be
considered adequately capitalized,
unless there are significantly adverse
financial or managerial factors.
Regardless of the level of total capital a
banking organization with a primary
capital ratio below 5.5 percent will
generally be considered
undercapitalized.
The revised guidelines maintain the
same total capital zones for smaller
community banking organizations while
raising the requirements 0.5 percent in
each zone for regional and multinational
banking organizations. This increase in
the total capital zones for regional and
multinational banking organizations
was adopted to encourage such
organizations to strengthen their total
capital positions and to achieve
uniformity in the zone requirements for
all state member banks and bank
holding companies regardless of size.
The comments on the Board’s
proposal to continue using total capital
zones were overwhelmingly favorable.
Zones were perceived as being more
flexible than a single minimum capital
level and as providing management with
broad standards for future capital
planning. The Board will continue using
zones to provide guidance to the
management of banking organizations,
and to encourage such organizations to
maintain total capital levels in excess of
the minimum. Total capital zones may
also encourage institutions to substitute
subordinated debt for short-term
borrowings, which may induce greater
market discipline.
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Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
The Continued Use of Guidelines
The Board will continue its use of
guidelines rather than regulations to
embody its substantive capital
requirements, including minimum
capital ratios, capital zones, definitions
of primary and secondary capital and
treatment of such capital components as
intangible assets and mandatory
convertible instruments.
The Board’s decision to use capital
guidelines instead of a regulation is
based on its experience with the
existing guidelines. This supervisory
experience has demonstrated the benefit
in working with banking institutions on
capital adequacy matters rather than in
dealing with them on a more rigid basis
under a regulation. Guidelines give the
Board flexibility to adjust capital
requirements and definitions to changes
in the economy, in financial markets,
and in banking practices. Flexible
guidelines also permit the Federal
Reserve to take account of the
individual characteristics of a banking
institution. Failure to meet the minimum
capital levels should not automatically
be construed as a violation of a
regulation and therefore a violation of
law, particularly if the Federal Reserve
would have to consider capital
adequacy in the context of a broad
range of factors in acting upon
applications.
The comments received by the Board
overwhelmingly favored continued use
of guidelines instead of regulations.
Treatment of Intangible Assets
(a) State member banks. The Board
did not adopt a provision in its July 1984
proposal to require the deduction of all
intangible assets in calculating primary
(but not total) capital ratios. The Board
has decided instead to deduct only
goodwill in computing primary and total
capital ratios of state member banks.
Other intangibles, such as mortgage
servicing rights and favorable leases,
will generally be included in the
computation.of primary capital, although
the guidelines provide the Board with
authority and flexibility to make
adjustments to capital ratios on a caseby-case basis, based on the level,
quality, or nature of intangible assets in
relation to the bank’s overall financial
condition.
Historically, the Board has required
state member banks to charge off
goodwill immediately (except in those
instances where it was acquired in the
rescue of a failing bank, in which case a
15 year write-off has been required).
Aside from goodwill in the case of
banks, however, the Board has made no
automatic deduction of intangible assets
in computing the primary or total capital
ratios of banks or bank holding
companies, preferring instead to take
the character and level of such assets
into account in assessing the capital
adequacy of a particular institution.
The Board’s July 1984 proposal to
deduct all intangible assets from the
primary capital of state member banks
was designed to conform the Board’s
definition of primary capital to the
proposals of the FDIC and the
Comptroller. In taking this step,
however, the Board questioned the
desirability of such an approach. The
overwhelming majority of those
commenting opposed any deduction of
intangible assets from the primary
capital of banks or bank holding
companies, noting that intangible assets
have economic value and that generally
accepted accounting principles permit
intangible assets to be recorded in
financial statements. Commenters also
cited the fact that the deduction of all
intangible assets from primary capital
would fail to accord any value
whatsoever to intangible assets and
would not distinguish between different
types of intangible assets. Some
commenters suggested that concern over
intangible assets could be mitigated by
requiring appropriate amortization
periods. In general, most public
commenters viewed the deduction of
intangible assets from primary capital as
inhibiting sound acquisitions or business
transactions involving the booking of
intangible assets.
In light of the public comments
received and its reservations about the
deduction of all intangible assets, the
Board has modified its proposal with
respect to the treatment of intangibles in
banks. Instead of deducting all
intangibles from bank primary capital,
the Board will deduct only goodwill
from primary and total capital. (The
Federal Reserve may permit goodwill
acquired by a bank in connection with a
supervisory merger with a failing
institution to be included for capital
purposes if it is appropriately
amortized.)
Since the Board generally has
required state member banks to charge
off goodwill immediately, this approach
represents little change from existing
policy. The accounting treatment,
however, will differ from the existing
practice in that after the effective date
of the revised guidelines, state member
banks will be allowed to book and
amortize goodwill rather than charge it
off, in order to conform to the practice of
the FDIC and the Comptroller. As a
general principle, intangible assets in
state member banks are to be written off
over their estimated useful lives, not to
exceed 15 years.
Both the FDIC and the Comptroller
have amended their original proposals
to include at least one kind of intangible,
mortgage-servicing rights, in primary
capital. Apparently both agencies have
concluded that, among other things, the
value of the income flow from mortgage
servicing is sufficiently certain and
stable to warrant treating mortgage
servicing as tangible assets. In the
Board’s view, other intangibles (such as
favorable leases) have characteristics
more akin to mortgage-servicing rights
than to goodwill and should thus be
given similar consideration in assessing
an institution’s capital position.
The Board has included in the
guidelines for state member banks a
threshold for intangibles of 25 percent of
tangible primary capital, above which
any tangible assets will be subject to
close supervisory scrutiny. In addition to
deducting goodwill for the purpose of
assessing capital adequacy, the Federal
Reserve may, on a case-by-case basis,
make further adjustments to a bank’s
capital ratios based on the amount of
intangible assets (aside from goodwill)
over the 25 percent threshold or on the
specific character of the bank's
intangible assets in relation to its
overall financial condition. The Board
has previously used the 25 percent
threshold on a case-by-case basis. The
impact of this requirement appears to be
minimal. Although 48 state member
banks reported intangible assets as of
September 30,1984, only four such
banks (all community institutions under
$1 billion in total assets) had intangible
assets over 25 percent of tangible
primary capital.
(b) Bank Holding Companies. With
respect to bank holding companies, the
Board has substantially adopted its July
proposal. The Board will continue to
take the level and character of
intangible assets into account in
assessing capital adequacy, but will
avoid any automatic deduction of
goodwill or other intangible assets from
primary or total capital. Prudent banking
practices and the principle of the
diversification of risk suggest that
banking organizations should avoid
excessive balance sheet concentration
in any category or related categories of
intangible assets. Consistent with this
concern, the guidelines state that while
the Board will consider the amount and
nature of all intangible assets, those
holding companies with aggregate
intangible assets over 25 percent of
tangible primary capital or those
institutions with lesser but significant
amounts of goodwill will be subject to
Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
close scrutiny. In addition, the
guidelines state that the Federal Reserve
may, on a case-by-case basis, make
adjustments to an organization’s capital
ratios based on the amount of intangible
assets in excess of the 25 percent
threshold or on the specific character of
the organization's intangible assets in
relation to its overall financial
condition.
Four hundred and eighty-two bank
holding companies with consolidated
assets in excess of $150 million reported
intangible assets on their most recent
reports to the Board. Of this total,
however, 354 companies had intangible
assets less than 15 percent of tangible
primary capital. Seventy-six holding
companies with assets over $150 million
(20 regional institutions and 56
community institutions) had intangible
assets in excess of 25 percent of tangible
primary capital.
The guidelines provide that banking
organizations are expected to review
periodically the value at which
intangible assets are carried on their
balance sheets and the reasonableness
of the amortization periods of such
assets tu determine if there has been
impairment of value or if changing
circumstances warrant shortening the
amortization periods. Banking
organizations are instructed to make
appropriate reductions in carrying
values and amortization periods in light
of this review, and examiners will
evaluate the treatment of intangible
assets during inspections and
examinations.
Although the amended capital
guidelines for bank holding companies
generally do not require a specific
deduction of intangible assets for
supervisory purposes, the guidelines
state that banking organizations
contemplating expansion proposals
(including state member banks
contemplating mergers) should generally
ensure that pro forma capital ratios
exceed the minimum capital guidelines
without significant reliance on
intangibles, particularly goodwill. The
Board, in reviewing proposals to
undertake acquisitions, will take into
consideration both the stated primary
capital ratio and the primary capital
ratio after deducting intangibles. In
acting on applications, the Board will
evaluate intangible assets and will, as
appropriate, adjust capital ratios to
include certain intangible assets on a
case-by-case basis.
The Treatment of Equity Commitment
Notes
The Board, has adopted the guidelines
proposed in July that treat equity
commitment notes as primary capital for
bank holding companies but not for
state member banks. The Board's
current guidelines treat equity
commitment notes as a form of primary
capital for both bank holding companies
and state member banks. In proposing to
change the treatment for state member
banks, the Board cited an interest in
maintaining uniformity among federally
regulated banks in light of the proposed
exclusion of equity commitment notes
by the FDIC and the Comptroller in
computing the primary capital levels of
State nonmember banks and national
banks.
Equity commitment notes, a type of
mandatory convertible security, are
subordinated debt instruments that must
be converted into common or perpetual
preferred stock within a specified period
of time not to exceed 12 years. Equity
commitment notes allow for cash
redemption with proceeds from the sale
of newly issued common or perpetual
preferred stock. Such notes are
distinguished from equity contract notes,
which obligate the holder to take the
common or perpetual preferred stock of
the issuer in lieu of cash for repayment
of the notes. Under the amended
guidelines, equity contract notes
continue to be treated as primary capital
for bank holding companies and state
member banks.
The majority of those commenting on
this aspect of the proposal thought that
equity commitment notes should
continue to be counted as primary
capital for banks as well as for bank
holding companies. They thought that
equity commitment noteB are an
important vehicle for increasing equity
capital and that such notes provide
greater flexibility to banking
organizations in meeting capital
requirements. Some commenters
asserted there is no reason the Board
should take different positions on
commitment notes for bank holding
companies and for state member banks.
Several commenters, however,
opposed the treatment of commitment
notes as primary capital because the
instruments, in their view, represent
only a promise to issue equity.
Moreover, the holder of the nbtes is not
obligated to accept stock in place of the
notes as is the case with equity contract
notes. Some commenters expressed
concern that if a banking organization
encountered financial trouble before it
could honor its commitment to issue
equity, the banking organization would
have to cope with less equity than
would otherwise be the case.
While equity commitment notes serve
a useful purpose by encouraging bank
holding companies to make a
Commitment to issue common or
16061
perpetual preferred stock, there is valid
concern that some institutions may not
honor their commitment to issue equity:
The Board believes, however, that
commitment notes can be structured to
provide substantial guarantees of
conversion. To that end, the Board has
written a pre-maturity funding
requirement into its guidelines. Under
this requirement, a bank holding
company issuing such notes must issue
new common or perpetual preferred
stock sufficient to redeem or replace
one-third of the amount of the typical 12year commitment notes by the end of
the fourth year, another third by the end
of the eighth year, and the final third at
least 60 days before the notes mature.
Thus, most of the debt will have been
funded before maturity.
In addition, the Board has specifically
detailed other criteria for equity
commitment notes, including specific
sanctions and supervisory actions for
failure to meet the pre-maturity funding
requirements, a subordination
requirement for any guarantee of
commitment notes provided by a state
member bank or bank holding company,
and a limitation on the amount of such
notes for capital purposes to 10 percent
of primary capital excluding mandatory
convertible securities.
The Board has also spelled out in
more detail the general criteria for
mandatory convertible securities,
including a maximum 12-year term,
limitations on amounts allowable for
primary capital purposes, restrictions on
redemption, a general prohibition
against acceleration of payment, a
subordination requirement, and
dedication of stock proceeds upon
issuance. These requirements for
mandatory convertible securities in
general and the specific limits imposed
on equity commitment notes will
provide adequate safeguards to permit
reliance on such commitment notes as
primary capital for bank holding
companies.
The Board believes, however, that
federally supervised banks should be
treated uniformly with respect to debt
and equity instruments they issue. A
bank should not be encouraged to alter
its status as a national bank, state bank,
or member of the Federal Reserve
System or to “forum shop" by
structuring mergers or other transactions
to permit the treatment of debt or equity
instruments as primary capital. The
Board believes the need for uniformity
in the treatment of banks is sufficient
reason to exclude equity commitment
notes from the primary capital of state
member banks. The Board will continue
to include equity commitment notes as
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Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
primary capital for bank holding
companies.
The Board has “grandfathered” any
equity commitment notes issued by state
member banks prior to May 15,1985,
and it will continue to include such
notes in a bank’s primary capital.
Issues Relating to Secondary Capital
Equity commitment notes that do not
qualify for primary capital for state
member banks will qualify in many
cases as secondary capital. Secondary
capital consists of long-term, unsecured
dept (which, in the case of banks, must
be subordinated to deposits) and
limited-life preferred stock. In proposing
to amend the guidelines in July 1984, the
Board suggested no changes in the
treatment of secondary capital. In
particular, under current guidelines
secondary capital instruments are
required to have an original weighted
average maturity of at least seven years.
In addition, as these instruments
approach maturity, the outstanding
balance of the instruments included in
secondary capital is discounted. The
existing guidelines also limit the amount
of secondary capital of a state member
bank to 50 percent of the bank’s primary
capital. Several public comments
addressed these conditions of secondary
capital, and some commenters suggested
elimination of one or more of the three
conditions.
(a) Original Weighted Maturity of
Seven Years. The Board has decided to
retain the requirement that secondary
capital components have an original
weighted-average maturity of at least
seven years. (The method for
determining the weighted-average
maturity of a qualifying instrument is
defined in 2-419 of the Federal Reserve
Regulatory Service, 1976 Federal
Reserve Bulletin 603, 41 FR 26201 (June
25,1976).) This requirement is consistent
with the notion that secondary capital
instruments should provide a stable
source of funds with a reasonably long
maturity. Also, exemption from the
definition of a deposit under the Board’s
Regulations D and Q (12 CFR Parts 204
and 217, respectively), requires that
subordinated debt have weightedaverage maturity of at least seven years.
Retention of this requirement is
consistent with the positions of the FDIC
and the Comptroller.
(b) Discounting Requirements. The
Board has decided to eliminate the
requirement in its guidelines for explicit
discounting of secondary capital
instruments as they approach maturity.
The Board had discounted the
outstanding balance of subordinated
debt and limited-life preferred stock
instruments 20 percent each year during
the instruments’ last five years before
maturity. While this process has a
certain analytical appeal—that is, as
secondary components approach
maturity they become in some respects
less capital—it also complicates the
calculation of secondary and total
capital. Moreover, the information
necessary to make this calculation is
often difficult to obtain on a regular
basis from bank holding companies, and
the imposition of a new reporting
requirement could involve a
considerable burden not justified by the
resulting benefits. The Comptroller and
the FDIC have also elected not to
incorporate this discounting requirement
into their regulations. While the Board
will eliminate the explicit discounting
requirement, the amended guidelines
make it clear that the Board will
continue, on a case-by-case basis, and
particularly in cases of proposed
expansion, to evaluate the remaining
maturity of secondary capital
components in assessing the adequacy
of a banking organization’s total capital.
(c) Limiting Secondary Capital to 50
Percent of Primary Capital. The Board’s
current guidelines limit aggregate
secondary capital in an individual state
member bank to 50 percent of the bank’s
primary capital. The Board has not
imposed a similar limitation on the
amount of secondary capital
components that may be included in a
bank holding company’s total capital.
Banking organizations should be
encouraged to raise additional capital
funds through the issuance of
instruments subordinated to depositors.
Judicious use of subordinated debt can
improve a banking organization’s
overall funding by increasing the
maturity of its liabilities. Greater
reliance on subordinated debt as a
funding vehicle can also enhance the
role of capital markets in disciplining
the activities of banking organizations,
because subordinated debtholders have
an incentive to monitor the risks of the
banking organizations whose
obligations they hold and to charge
appropriate risk premiums for the funds
they provide.
Nevertheless, the FDIC and
Comptroller limit the use of such
subordinated debt (and limited-life
preferred stock) for secondary capital
purposes to 50 percent of primary
capital in the case of national banks and
state nonmember banks. This 50 percent
limitation on secondary capital arises in
part from a concern to limit total capital,
which is the base for determining a
national bank’s legal lending limit, and
in part from a concern that high total
capital ratios based on large amounts of
secondary capital could be misleading.
For any banking organization with a
minimally acceptable level of primary
capital, the 50 percent limit on
secondary capital will not become
operative until a bank’s total capital
ratio exceeds 8.25 percent, well into
capital zone 1. The 50 percent
requirement, therefore, has very limited
impact on a determination of a bank’s
capital adequacy.
As of September 30,1984, fewer than
15 banks had secondary capital of 50
percent or more of primary capital. The
average ratio of secondary capital to
primary capital for those banks issuing
secondary capital instruments was less
than 10 percent. Given the limited
impact of the 50-percent-of-primarycapital rule, the need to treat banks
uniformly whenever possible, and the
concerns expressed by the FDIC and the
Comptroller, the Board has decided to
continue its present practice of limiting
the secondary capital of state member
banks to 50 percent of the primary
capital of such banks. The Board will
not impose such a limit on bank holding
companies. State member banks are free
to issue subordinated debt of limited-life
preferred stock over the 50 percent limit,
but the Board will not include such
instruments in their capital.
4. Miscellaneous Issues and
Consideration*
A number of additional issues were
raised by those commenting on the
Board’s proposal. The Board has
considered these comments and
included certain changes in the
guidelines.
Use of Average Assets
In applying its captial guidelines, the
Board has computed primary and total
capital ratios of banks and bank holding
companies on the basis of financial data
available at the close of a particular
quarterly reporting period. The FDIC
and the Comptroller are planning to use
average total asset figures in the
denominators of their capital ratios and
period-end capital figures in the
numerators of the ratios. This approach
is prompted by coifcems that the use of
period-end asset figures may result in
inadvertent violations of the capital
requirements if assets should increase at
the end of a period in the normal course
of business. In addition, there is also a
concern that the use of period-end data
encourages “reverse window dressing,”
a practice whereby institutions reduce
holdings of liquid assets to boost capital
ratios on the last day of each quarter.
While the Board believes these
concerns may be dealt with a case-bycase basis, the legitimacy of the
Federal Register / Vol 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
concerns and the interest in uniformity
have prompted the Board to amend its
practice. The Board will use average
total asset figures in computing capital
ratios of state member banks. The Board
is concerned, however, that some bank
holding companies may not routinely
keep data that permit easy compilation
of quarterly average asset figures and
that such a change in computing the
capital ratios of bank holding companies
at this time may constitute an additional
reporting burden. Accordingly, the
Board will continue to use period-end
total asset figures for bank holding
companies while studying whether the
use of average total assest figures would
impose any substantial new
recordkeeping or reporting burdens.
Off-Balance Sheet Risk
The amended guidelines require that
state member banks or bank holding
companies with high or inordinate offbalance sheet exposure hold additional
primary capital to compensate for this
risk. The guidelines contain no explicit
quantitative method for taking offbalance sheet risk into consideration in
computing primary and total capital
ratios. Several commenters argued that
capital guidelines or regulations have
the unintended and undesirable effect of
encouraging banking institutions to
engage in activities and to employ
accounting techniques that are designed
to take or to keep assets off the balance
sheet. This practice, known as “offbalance sheet banking," results in higher
reported capital ratios but does not
reduce the risk to banking organizations.
To provide more guidance in the area
of off-balance sheet risk the Board has
included in the amended guidelines the
following language in place of the
general reference to off-balance sheet
banking in the current guidelines.
The Federal Reserve will also take into
account the sale of loans or other assets with
recourse and the volume and nature of all offbalance sheet risk. Particularly close
attention will be directed to risks associated
with standby letters of credit and
participation in joint venture activities. The
Federal Reserve will review the relationship
of all on- and off-balance sheet risks to
capital and will require those institutions
with high or inordinate levels of risk to hold
additional primary capital. In addition, the
Federal Reserve will continue to review the
need for more explicit procedures for
factoring on- and off-balance sheet risks into
the assessm ent of capital adequacy.
The Board intends to encourage
banking institutions to better monitor
and control risks on a voluntary basis
and thus to avoid the neceissity of more
formal limits or controls on off-balance
sheet activity. Moreover, examiners will
be instructed to review carefully the
nature and degree of all off-balance
sheet risks and take these risks into
account in assigning capital ratings
under the Uniform Financial Institutions
Rating System.
Risk-Based Capital Ratios
A number of commenters, particularly
some large bank holding companies,
indicated that a ratio of capital to risk
assets would.be of much greater
analytical value to regulators than a
capital to total assets ratio, and would
be consistent with regulatory trends in
other countries. These commenters
argued that a risk-based capital ratio
would exclude federal funds, short-term
U.S. Treasury securities and other
“riskless" assets from the asset base of
the ratio and, therefore, avoid
potentially adverse effects on liquidity.
These commenters generally
acknowledged, however, that the
techniques and definitions needed to
develop a risk-based capital ratio would
have to be predicated upon considerable
research and should probably include
some measurement of off-balance sheet
risk.
The'Board has not adopted capital
guidelines based on a ratio of capital to
risk assets at this time. The amended
guidelines indicate that the Board will
take the overall degree of risk
associated with an organization’s assets
into consideration in assessing
compliance with the capital guidelines.
The capital guidelines apply to sound,
well-managed banking organizations
operating with moderate risk in their
loan and investment portfolios.
Organizations operating with more risk
are expected to hold additional capital
to compensate for these risks. The Board
recognizes that risk must be taken into
consideration in assessing capital
adequacy. At this time, however, it is
more appropriate to do so on a case-bycase basis than with quantitative
standards.
Uniformity of Capital Requirements for
Banks and Thrift Institutions
Several comments emphasized the
competitive disadvantage of banks visa-vis thrift institutions because thrifts
may operate at lower capital levels. The
Federal Home Loan Bank Board has
recently adopted rules requiring
federally insured thrift institutions
undertaking significant growth to
increase their net worth positions. The
Board has stated its support of this
proposal and has urged that the Federal
Home Loan Bank Board recognize the
need to move toward higher capital-toassets ratios for thrifts as promptly as
possible. While there is a significant
disparity between the capital levels at
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which thrifts and banks are required to
operate, the appropriate way to deai
with this issue is to support higher ratios
for the thrift industry. To that end, the
establishment by the banking regulators
of uniform minimum capital levels; for all
federally supervised banking
organizations has provided a clear
statement of what they view as an
appropriate target for all depository
institutions.
Applicability of the Guidelines to
Bankers’Banks
Several commenters requested
clarification on whether the capital
guidelines apply to “bankers’ banks." A
number of commenters indicated that
the bankers’ banks should be exempt
from the guidelines because they
generally engage in “low risk” activities.
However, bankers’ banks are not
prohibited from taking risks;
consequently, the Board has taken no
action to exclude bankers’ banks from
the uniform capital standards in its
guidelines.
Treatment of Foreign Banks Under the
Guidelines
A number of commenters raised the
issue of the application of the capital
guidelines to foreign-domiciled banking
organizations with banking operations
in the United States. While some
commenters suggested it would be
preferable for such foreign banks to be
subject to the Board’s capital guidelines,
it was also requested that foreign banks
be specifically excluded from coverage,
at least until the Board has completed
its discussions with foreign bank
supervisors on capital and international
lending issues as required by ILSA.
The Board is discussing with foreign
bank supervisors appropriate capital
standards for banks operating
internationally. Pending completion of
those discussions, the Board has
decided to review the financial
condition, including the capital
adequacy, of foreign banks with
operations in the United States on a
case-by-case basis. The Board will
continue to scrutinize the capital of such
foreign banking organizations with
special care when those institutions
propose to expand operations or make
additional acquisitions in the United
States. The capital guidelines apply to
any state member bank or bank holding
company (other than a qualifying foreign
banking organization as defined by
Regulation K), regardless of ownership.
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Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
Technical Changes to Criteria for
Mandatory Convertible Securities
The Board has made certain technical
changes in the existing guidelines with
respect to mandatory convertible
securities. The modifications for the
most part are designed to update the
guidelines to reflect existing policy and
to correct deficiencies in the existing
criteria. The modifications are as
follows:
a. The guidelines have been amended
to allow specifically for the treatment of
"hybrid mandatqry convertibles” as
primary capital. These instruments
combine features of equity commitment
notes with those of equity contract
notes. For purposes of the guidelines,
such instruments would be treated as
equity contract notes.
b. The guidelines have been amended
to indicate that a bank or bank holding
company issuing equity generally must
decide during the quarter in which the
securities are issued whether or not the
proceeds are to be used to satisfy the
requirement to issue stock under an
equity commitment or equity contract
note. This dedication requirement is
designed to reduce the possibility that
the primary capital ratio of an
institution might be overstated. An
institution’s primary capital Would be
overstated if the issuer counts both the
mandatory convertible securities and
the stock issued to replace those
securities as primary capital at the same
time. Whenever stock is issued and is
dedicated to satisfy a note funding
requirement, the amount of outstanding
mandatory convertible debt that counts
as primary capital is reduced by the
amount of stock issued. In general, any
dedication of the proceeds of a common
or perpetual preferred stock issuance to
satisfy a funding requirement must be
made in the quarter in which the stock is
issued. As a general rule, if the
dedication is not made Within the
prescribed period, then the stock issued
cannot later be dedicated to satisfy any
fundingrequirement.
c. The guidelines have been amended
to indicate that documentation certified
by an authorized agent of the issuer
showing the amount of stock issued, the
dates of issue, and the amounts of such
issues dedicated to the retirement or
redemption of mandatory convertible
securities will satisfy the dedication
requirement.
d. The guidelines have been amended
to state that failure to meet the funding
requirements of an equity commitment
note will be viewed as a breach of a
regulatory commitment, will result in
appropriate supervisory action, and will
be taken into consideration by the Board
in acting on statutory applications. This
provision is designed to ensure that the
issuer will honor its commitment to
issue equity.
e. The guidelines have been amended
to indicate that common or perpetual
preferred stock issued under dividend
reinvestment plans, or issued to finance
acquisitions, including acquisitions of
business entities, may be dedicated to
satisfy any mandatory convertible note
funding requirements.
Perpetual Debt
Several institutions have urged the
Board to consider treating "perpetual
debt” as a form of primary capital. The
Board’s ]uly proposal did not make any
reference to perpetual debt. Although it
appears that no commercial bank or
bank holding company in the United
States has ever issued perpetual debt,
interest in perpetual debt has increased
recently as a result of a ruling by the
Bank of England that would permit
United Kingdom institutions to count
perpetual subordinate debt as primary
capital under certain conditions. The
Board has decided that perpetual debt
will not be afforded the status of
primary capital at this time. The Board,
however, will continue to study the
issue to determine whether to seek
publfe comment.
5. The Procedural Regulation
The Board has adopted, with only
minor .wording or technical changes, the
procedural regulation it proposed in July
1984, to require compliance with the
capital guidelines and, in particular,
with the minimum capital ratios. The
basic procedures parallel those of the
FDIC and the Comptroller.
The Board has added a definitional
provision to the procedural regulation to
clarify that the capital directive
procedures and those procedures for
setting capital levels for individual
institutions are intended to apply to the
individual nonbank subsidiaries of bank
holding companies as well as to the
holding companies on a consolidated
basis. While the amended guidelines
have not applied substantive capital
requirements to the nonbank
subsidiaries of bank holding companies,
the amended guidelines emphasize that
"the Board is placing greater weight on
the building-block approach for
assessing capital requirements” and that
the “nonbank subsidiaries of a banking
organization should maintain levels of
capital consistent with levels that have
been established by industry norms or
standards, by Federal or State
regulatory agencies . . . or that may be
established by the Board after taking
into account risk factors of a particular
industry.” The procedural regulation
will permit the Board to enforce its
capital requirements for nonbank
subsidiaries of bank holding companies
on an industry-wide basis or in
individual cases. Hie Report of the
Senate Committee on Banking, Housing
and Urban Affairs accompanying ILSA,
S. Rep. 98-122, 98th Congress, 1st
Session, 17 (1983), demonstrates that
ILSA provides authority for extending
capital requirements to nonbank
affiliates of banks, stating: " ... any of
the provisions of the bill may be applied
by the appropriate federal banking
agency to any affiliate of any insured
bank, including any bank holding
company individually or on a
consolidated basis for its non-bank
subsidiaries. . .”
Initial Implementation
The procedural regulation requires
that any state member bank or bank
holding company not meeting the
uniform minimum capital standards in
the guidelines at the time they become
effective, must submit to the Reserve
Bank within 90 days a plan indicating
how the banking organization intends to
increase its capital to the required level
within a reasonable period of time.
Certain administrative and judicial
enforcement procedures are outlined in
the regulation for failure to submit a
capital plan.
Some commenters expressed concern
over the time that banking organizations
will be given to meet the guidelines. In
accordance with its concern for
flexibility, the Board has avoided
establishing a fixed rule defining a
reasonable time for compliance in all
cases. The Board will assess each
organization’s plan on a case-by-case
basis. Nevertheless, the Board believes
that, in general, banking organizations
should comply with the minimum ratios
within 12 to 18 months of the effective
date of the revised guidelines.
Establishing Capital Requirements
Above the Uniform Minimum
The Board may also require particular
banks or bank holding companies to
maintain more than the minimum level
of capital if the financial condition,
management, or future prospects of the
institution make a higher capital level
necessary and appropriate. The
amended guidelines indicate the Board
will pay particular attention to risk
factors, including off-balance sheet risk,
and to liquidity. The Board will
discourage the practice of meeting
capital guidelines by reducing the level
of liquid assets relative to total assets of
the institution. The process of
Federal Register / Vol. 50,-No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
determining the adequacy of an
institution’s capital will begin with a
qualitative evaluation of the critical
variables that directly bear on its
overall financial condition. These
variables include the quality, type, and
diversification of assets; current and
historical earnings; liquidity; appropriate
policies for loan charge-offs; risks
arising from interest rate mismatches;
the quality of management; and other
activities that may expose the bank to
risks, including off-balance sheet risks.
Institutions with significant weaknesses
in one or more of these areas will be
expected to maintain higher capital
levels than the minimums set forth in the
guidelines. Institutions currently or
prospectively under any formal
administrative action, final order, or
condition or agreement that sets forth a
more stringent capital requirement shall
continue to meet the requirement
therein.
In addition to procedures now used by
the Board to require a higher capital
level (e.g. written agreements or
memoranda between the Board and the
financial institution, cease and desist
orders, and conditions attached to
orders issued on applications or
notices), the amended regulation
provides for a specific notice and
comment and directive procedure. The
Board may consider failure to meet the
minijnum capital requirement or a higher
capital requirement set by the Board as
bearing adversely upon applications or
notices that a bank or bank holding
company may file.
companies to be printed as an appendix
to the Board’s Regulation Y, 12 CFR Part
225. Because they are so similar, the
Board will continue to include them in
one document, published as Appendix A
to Regulation Y, 12 CFR Part 225. This
will avoid duplication in the Code of
Federal Regulations. The Board will add
a section to Regulation H, 12 CFR 208.13,
noting that state member bank capital
requirements are in Regulation Y.
To summarize, the amended capital
adequacy guidelines distinguish
between state member banks and bank
holding companies in four specific areas,
as follows:
a. Intangibles. The guidelines require
the automatic deduction of goodwill
from primary and total capital for state
member banks but not for bank holding
companies.
b. Equity Commitment notes. The
amended guidelines treat equity
commitment notes as primary capital for
bank holding companies but not for
state member banks.
c. Secondary capital. The amended
guidelines limit secondary capital,
including subordinated debt and limitedlife preferred stock, to 50 percent of
primary capital for state member banks
but not for bank holding companies.
d. Average Assets. For state member
banks the Board will use average total
assets of the quarterly reporting period
in the denominator of primary and total
capital ratios. The Board will continue
to use period-end asset figures in the
denominator of capital ratios for bank
holding companies.
Directives
Regulatory Flexibility Analysis—
Paperwork Reduction Act. The Board
Section 908 of ILSA (12 U.S.C. 3907)
certified that adoption of these amended
authorizes the appropriate banking
guidelines is not expected to have a
agency to issue a directive to a banking
significant economic impact on a 1
institution that fails to meet the
substantial number of small entities
minimum capital requirement. A
within the meaning of the Regulatory
directive may require a plan for
achieving such requirement. A directive, Flexibility Act (5 U.S.C. 601 et seq.). The
amended guidelines may have a
including a capital adequacy plan
substantial impact on a comparatively
submitted thereunder, is a final order
small number of regional or
enforceable in the same manner as a
multinational banking organizations, but
final cease and desist order issued
that impact will be minimized by the
under 12 U.S.C. 1818(b). The issuance of
extended phase-in period and the
a directive is discretionary, and a
substantial advance notice of adoption
directive may be issued in lieu of, in
of these guidelines. Moreover, the
conjunction with, or in addition to
potential impact on certain
existing enforcement tools. The Board
organizations is outweighed by the
has adopted notice and comment
benefits of uniform capital standards,
procedures for issuance of a directive.
improved safety and soundness of large
6. Adoption of a Single Set of Guidelines banking organizations, and increased
for Member Banks and Bank Holding
stability of the banking system.
Companies
The Board is required to consider
The Board has amended its July
capital in a number of situations. These
proposal to require separate guidelines
include applications for acquisitions by
for state member banks to be printed as
bank holding companies, application for
an appendix to the Board’s Regulation
mergers with state member banks,
H, 12 CFR Part 208 and for bank holding
applications for membership in the
16065
Federal Reserve System, and
supervisory actions when necessary. In
addition, 12 U.S.C. 3907(a)(1) requires
the Board to “cause banking institutions
to achieve and maintain adequate
capital by establishing minimum levels
of capital for such banking institutions
and by using such other methods as the
appropriate federal banking agency
deems appropriate.”
In carrying out its supervisory
responsibilities and in approving
individual mergers and acquistions, the
Board has always considered capital
adequacy. In December 1981, the Board
issued capital adequacy guidelines to
inform banks, bank holding companies,
and the public of its policies on capital
and capital adequacy. The Board is now
amending those guidelines to establish
more uniform standards for large and
small banking institutions and for
greater uniformity among federal
banking agencies.
Historically, the Board has required
higher capital ratios for small banks and
bank holding companies than for larger
ones. To the extent that this regulation
equalizes requirements, it will lessen the
burden on small banks and small bank
holding companies.
In accordance with section 3507 of the
Paperwork Reduction Act of 1980 and 5
CFR 1320.13, the proposed information
collection requirement in the regulation
was approved by the Board under
authority delegated by the Office of
Management and Budget.
List of Subjects
12 CFR Part 208
Banks, Banking, Federal Reserve
System, Reporting and recordkeeping
requirements, Securities.
12 CFR Part 225
Banks, Banking, Federal Reserve
System, Holding companies, Reporting
and recordkeeping requirements.
12 CFR Part 263
Administrative practice and
procedure, Federal Reserve System.
Pursuant to the Board’s authority
under the International Lending
Supervision Act of 1983,12 U.S.C. 3907
and 3909; section 5(b) of the Bank
Holding Company Act of 1956,12 U.S.C.
1844(b); the Financial Institutions
Supervisory Act of 1966,12 U.S.C. 1818;
and sections 9 and 11(a) of the Federal
Reserve Act, 12 U.S.C. 248, 324 and 329,
the Board hereby amends 12 CFR Parts
208, 225 and 263 as set forth below:
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Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
PART 208—MEMBERSHIP OF STATE
BANKING INSTITUTIONS IN THE
FEDERAL RESERVE SYSTEM
1.12 CFR Part 208 is amended by
revising the authority for the part, and
by adding a new § 208.13 to read as
follows:
Authority: 12 U .S.C 248, 321-338, 486,1814,
3907, 3909, unless otherwise noted.
§ 208.13 Capital adequacy.
The standards and guidelines by
which the capital adequacy of state
member banks will be evaluated by the
Board are set forth in Appendix A to the
Board’s Regulation Y, 12 CFR Part 225.
PART 225—BANK HOLDING
COMPANIES AND CHANGE IN BANK
CONTROL
2.12 CFR Part 225 is amended, under
authority cited in this part including 12
U.S.C. 1844(b), 1817(j)(13), 1818(b), and
Pub. L. 98-181, Title IX (12 U.S.C. 3907
and 3909), by revising Appendix A to
read as follows:
Appendix A—Capital Adequacy
Guidelines for Bank Holding Companies
and State Member Banks
The Board o f Governors of the Federal
Reserve System has adopted minimum
capital ratios and guidelines to provide a
framework for assessing the adequacy of the
capital o f bank holding companies and state
member banks (collectively "banking
organizations”). The guidelines generally
apply to all state member banks and bank
holding com panies regardless o f size and are
to be used in the examination and
supervisory process a s w ell as in the analysis
of applications acted upon by the Federal
Reserve. The Board of Governors will review
the guidelines from time to time for possible
adjustment commensurate with changes in
the economy, financial markets, and banking
practices.
Two principal measurements of capital are
used—the primary capital ratio and the total
capital ratio. The definitions of primary and
total capital for banks and bank holding
companies and formulas for calculating the
capital ratios are set forth below in the
definitional sections of these guidelines.
Capital Guidelines
The Board has established a minimum level
of primary capital to total assets of 5.5
percent and a minimum level of total capital
to total assets o f 6.0 percent. Generally,
banking organizations are expected to
operate above the minimum primary and
total capital levels. Those organizations
w hose operations involve or are exposed to
high or inordinate degrees of risk will be
expected to hold additional capital to
com pensate for these risks.
In addition, the Board has established the
following three zones for total capital for
banking organizations o f aH sizes:
T o t a l C a p it a l R a t io
tin percent]
Zone 1.......................................... Above 7.0.
Zone 2 ........................................... 6.0 to 7.0.
Zone 3 ........................................... Betow 6.0.
The capital guidelines assum e adequate
liquidity and a moderate amount of risk in the
loan and investment portfolios and in offbalance sheet activities. The Board is
concerned that some banking organizations
may attempt to comply with the guidelines in
w ays that reduce their liquidity or increase
risk. Banking organizations should avoid the
practice of attempting to meet the guidelines
by decreasing the level of liquid assets in
relation to total assets. In assessing
compliance with the guidelines, the Federal
Reserve w ill take into account liquidity and
the overall degree of risk associated with an
organization’s operations, including the
volume of assets exposed to risk.
The Federal Reserve will also take into
account the sale of loans or other a ssets with
recourse and the volume and nature Of all offbalance sheet risk. Particularly d o se
attention will be directed to risks associated
with standby letters of credit and
participation in joint venture activities. The
Federal Reserve will review the relationship
of all on- and off-balance sheet risks to
capital and will require those institutions
with high or inordinate levels o f risk to hold
additional primary capital. In addition, the
Federal Reserve will continue to review the
need for more explicit procedures for
factoring on- and off-balance sheet risks into
the assessm ent of capital adequacy.
The capital guidelines apply to both banks
and bank holding companies on a
consolidated b asis.1 Some banking
organizations are engaged in significant
nonbanking activities that typically require
capital ratios higher than those of commercial
banks alone. The Board believes that, as a
matter of both safety and soundness and
competitive equity, the degree of leverage
common in banking should not automatically
extend to nonbanking activities.
Consequently, in evaluating the consolidated
capital positions of banking organizations,
the Board is placing greater weight on the
building-block approach for assessing capital
requirements. This approach generally
provides that nonbank subsidiaries of a
banking organization should maintain levels
of capital consistent with the levels that have
been established by industry norms or
standards, by Federal or State regulatory
agencies for similar firms that are not
affiliated with banking organizations, or that
1The guidelines will apply to bank holding
companies with less than $150 million in
consolidated assets on a bank-only basis unless (1)
the holding company or any nonbank subsidiary is
engaged directly or indirectly in any nonbank
activity involving significant leverage or (2) the
holding coiApany or any nonbank subsidiary has
outstanding significant debt held by the general
public. Debt held by the general public is defined to
mean debt held by parties other than financial
institutions, officers, directors, and principal
shareholders of the banking organization or their
related interests.
may be established by the Board after taking
into account risk factors of a particular
industry. The assessm ent of an organization's
consolidated capital adequacy must take into
account the amount and nature of all
nonbank activities, and an institution's
consolidated capital position should at least
equal the sum of the capital requirements of
the organization’s bank and nonbank
subsidiaries as w ell as those of the parent
company.
Supervisory Action
The nature and intensity of supervisory
action will be determined by an
organization’s compliance with the required
minimum primary capital ratio as w ell as by
the zone in which the company’s total capital
ratio falls. Banks and bank holding
companies with primary capital ratios below
the 5.5 percent minimum will be considered
undercapitalized unless they can
demonstrate clear extenuating circumstances.
Such banking organizations will be required
to submit an acceptable plan for achieving
compliance with the capital guidelines and
will be subject to denial of applications and
appropriate supervisory enforcement actions.
The zone in which an organization’s total
capital ratio falls will normally trigger the
following supervisory responses, subject to
qualitative analysis:
For institutions operating in Zone 1, the
Federal Reserve will:
—Consider that capital is generally adequate
if the primary capital ratio is acceptable to
the Federal Reserve and is above the 5.5
percent minimum.
For institutions operating in Zone 2, the
Federal Reserve will:
—Pay particular attention to financial factors,
such as asset quality, liquidity, off-balance
sheet risk, and interest rate risk, as they
relate to the adequacy of capital. If these
areas are deficient and the Federal Reserve
concludes capital is not fully adequate, the
Federal Reserve will intensify its
monitoring and take appropriate
supervisory action.
For institutions operating in Zone 3, the
Federal Reserve will:
—Consider that the institution is
undercapitalized, absent clear extenuating
circumstances;
—Require the institution to submit a
comprehensive capital plan, acceptable to
the Federal Reserve, that includes a
program for achieving compliance with the
required minimum ratios within a
reasonable time period; and
—Institute appropriate supervisory and/or
administrative enforcement action, which
may include the issuance of a capital
directive or denial of applications, unless a
capital plan acceptable to the Federal
Reserve has been adopted by the
institution.
Treatment o f Intangible A ssets for the
Purpose o f A ssessing the Capital Adequacy
of Bank Holding Companies and State
Member Banks
In considering the treatment of intangible
assets for the purpose of assessing capital
Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
adequacy, the Federal Reserve recognizes
that the determination o f the future benefits
and useful lives of certain intangible assets
may involve a degree of uncertainty that is
not normally associated with other banking
assets. Supervisory concern over intangible
a ssets derives from this uncertainty and from the possibility that, in the event an
organization experiences financial
difficulties, such assets may not provide the
degree of support generally associated with
other assets. For this reason, the Federal
Reserve will carefully review the level and
specific character of intangible assets in
evaluating the capital adequacy of state
member banks and bank holding companies.
The Federal Reserve recognizes that
intangible assets may differ with respect to
predictability of any income stream directly
associated with a particular asset, the
existence of a market for the asset, the ability
to sell the asset, or the reliability of any
estim ate of the asset’s useful life. Certain
intangible assets have predictable income
streams and objectively verifiable values and
may contribute to an organization’s
profitability and overall financial strength.
The value of other intangibles, such as
goodwill, may involve a number of
assumptions and may be more subject to
changes in general economic circumstances
or to changes in an individual institution's
future prospects. Consequently, & e valufrof
such intangible assets may be difficult to
ascertain. Consistent with prudent banking
practices and the principle of the
diversification o f risks, banking organizations
should avoid excessive balance sheet
concentration in any category or related
categories of intangible assets.
Bank Holding Companies
W hile the Federal Reserve will consider
the amount and nature of all intangible
assets, those holding com panies with
aggregate intangible assets in ex cess of 25
percent of tangible primary capital (i.e.,
stated primary capital less all intangible
assets) or those institutions with lesser,
although still significant, amounts o f goodwill
will be subject to close scrutiny. For the
purpose of assessing capital adequacy, the
Federal Reserve may, on a case-by-case
basis, make adjustments to an organization's
capital ratios based upon the amount of
intangible assets in excess of the 25 percent
threshold level or upon the specific character
of the organization’s intangible assets in
relation to its overall financial condition.
Such adjustments may require some
organizations to raise additional capital.
The Board expects banking organizations
(including state member banks)
contemplating expansion proposals to ensure
that pro forma capital ratios exceed the
minimum capital levels without significant
reliance on intangibles, particularly good w ill
Consequently, in reviewing acquisition
proposals, the Board will take into
consideration both the stated primary capital
ratio (that is, the ratio without any
adjustment for intangible assets) and the
primary capital ratio after deducting
intangibles. In acting on applications, the
Board will take into account the nature and
amount of intangible assets and will, as
appropriate, adjust capital ratios to include
certain intangible assists on a case-by-case
basis.
State Member Banks
State member banks with intangible assets
in excess of 25 percent of intangible primary
capital will be subject to close scrutiny. In
addition, for the purpose of calculating
capital ratios of state member banks, the
Federal Reserve w ill deduct goodw ill from
primary capital and total capital. The Federal
Reserve may, on a case-by-case basis, make
further adjustments to a bank's capital ratios
based on the amount of intangible assets
(aside from goodwill) in excess o f the 25
percent threshold level or on the specific
character of the bank's intangible assets in
relation to its overall financial condition.
Such adjustments may require som e banks to
raise additional capital.
In addition, state member banks and bank
holding com panies are expected to review
periodically the value at which intangible
assets are carried on their balance sheets to
determine whether there has been any
impairment of value or whether changing
circumstances warrant a shortening of
amortization periods. Institutions should
make appropriate reductions in carrying
values and amortization periods in light of
this review, and examiners w ill evaluate the
treatment of intangible assets during on-site
examinations.
Definition of Capital To Be Used in
Determining Capital Adequacy of Bank
Holding Companies and State Member Banks
Primary Capital Components
The components of primary capital are:
— Common stock,
—Perpetual preferred stock (preferred stock
that does not have a stated maturity date
and that may not be redeemed at the
option of the holder),
—Surplus (excluding surplus relating to
limited-life preferred stock),
—Undivided profits,
— Contingency and other capital reserves,
—Mandatory convertible instruments *,
—A llow ance for possible loan and lease
losses (exclusive of allocated transfer risk
reserves)^
—Minority interest in equity accounts of
consolidated subsidiaries.
Secondary Capital Components
The components o f secondary capital are:
-L im ited -life preferred stock (including
related surplus) and
—Bank subordinated notes and debentures
and unsecured long-term debt o f the parent
company and its nonbank subsidiaries.
Restrictions Relating to Capital Components
To qualify as primary or secondary capital,
a capital instrument should not contain or be
covered by any convenants, terms, or
restrictions that are inconsistent w ith safe
and sound banking practices. Examples of
such terms are those regarded as unduly
* See the definitional section below that lists the
criteria for mandatory convertible instruments to
qualify as primary capital.
10067
interfering with the ability o f the bank or
holding company to conduct normal banking
operations or those resulting in significantly
higher dividends or interest payments in the
event of a deterioration in the financial
condition o f the issuer.
The secondary components must m eet the
following conditions to qualify as capital:
—The instrument must have an original
weighted-average maturity of at least
seven years.
—The instrument must be unsecured.
—The instrument must clearly state on its
face that it is not a deposit and is not
insured by a federal agency.
—Bank debt instruments must be
subordinated to claims of depositors.
—For banks only, the aggregate amount of
limited-life preferred stock and subordinate
debt qualifying as capital may not exceed
50 percent of the amount of the bank’s
primary capital.
A s secondary capital components
approach maturity, the banking organization
must plan to redeem or replace the
instruments while maintaining an adequate
overall capital position. Thus, the remaining
maturity of secondary capital components
will be an important consideration in
assessing the adequacy of total capital.
Capital Ratios
The primary and total capital ratios for
bank holding companies are computed as
follows:
Primary capital ratio:
Primary capital com ponents/Total assets +
A llow ance for loan and lease losses
(exclusive o f allocated transfer risk
reserves)
Total capital ratio:
Primary capital components + Secondary
capital com ponents/Total assets +
A llow ance for loan and lease losses
(exclusive o f allocated transfer risk
reserves)
The primary and total capital ratios for
state member banks are computed a s follows:
Primary capital ratio:
Primary capital components— G oodw ill/
Average total assets + A llowance for
loan and lease losses (exclusive of
allocated transfer risk reserves)—
Goodwill
Total capital ratio:
Primary capital coiltponents + Secondary
capital components—G oodwill/A verage
total assets + A llow ance for loan and
lease losses (exclusive of allocated
transfer risk reserves)—Goodwill
Generally, period-end amounts w ill be used
to calculate bank holding company ratios.
H owever, the Federal Reserve w ill
discourage temporary balance sheet
adjustments or any other “w indow dressing”
practices designed to achieve transitory
compliance with the guidelines. Banking
organizations are expected to maintain
adequate capital positions at all times. Thus,
the Federal Reserve will, on a case-by-case
basis, use average total assets in the
calculation o f bank holding company capital
ratios whenever this approach provides a
■16068
Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
more meaningful indication of an individual
holding company's capital position.
For the calculation of bank capital ratios,
"average total assets" will generally be
defined as the quarterly average total assets
figure reported on the bank's Report of
Condition. If warranted, however, the Federal
Reserve may calculate bank capital ratios
based upon total assets as o f period-end. All
other components of the bank’s capital ratios
will be based upon period-end balances.
Criteria for D eterm ining the Primary Capital
Status of Mandatory Convertible Securities of
Bank Holding Companies and State Member
Banks
Mandatory convertible securities are
subordinated debt instruments that are
eventually transformed into common or
perpetual preferred stock within a specified
period of time, not to exceed 12 years. To be
counted as primary capital, mandatory
convertible securities must meet the criteria
set forth below. Thes^ criteria cover the two
basic types of mandatory convertible
securities: “equity contract notes"—securities
that obligate the holder to take common or
perpetual preferred stock of the issuer in lieu
o f cash for repayment of principal, and
“equity commitment notes”—securities that
are redeemable only with the proceeds from
the sale of common or perpetual preferred
stock. Both equity commitment notes and
equity contract notes qualify as primary
capital for bank holding companies, but only
equity contract notes qualify' as primary
capital for banks.3
Criteria Applicable to Both Types of
Mandatory Convertible Securities
a. The securities must mature in 12 years or
less.
b. The maximum amount of mandatory
convertible securities that may be counted as
primary capital is limited to 20 percent of
primary capital, exclusive of mandatory
convertible securities.4 (Amounts outstanding
in excess of the 20 percent limitation may be
counted as secondary capital provided they
meet the requirements of secondary capital
instruments.)
c. The issuer may redeem securities prior to
maturity only with the proceeds from the sale
of common or perpetual preferred stock of the
bank or bank holding company. Any
exception to this rule must be approved by
the Federal Reserve. The securities may not
be redeemed with the proceeds of another
issue of mandatory convertible securities.
Nor may the issuer repurchase or acquire its
ow n mandatory convertible securities for
resale or reissuance.
d. Holders of the securities may not
accelerate the payment of principal except in
the event of bankruptcy, insolvency, or
reorganization.
e. The securities must be subordinate in
right of payment to all senior indebtedness of
the issuer. In the event that the proceeds of
* Equity commitment notes that were issued by
state member banks prior to May 15,1985 will
continue to be included in primary capital.
4The maximum amount of equity commitment
notes that may be counted as primary capital is
limited to 10 percent of primary capital exclusive of
mandatory convertible securities.
the securities are reloaned to an affiliate, the
loan must be subordinated to the same
degree as the original issue.
f. An issuer that intends to dedicate the
proceeds of an issue of common or perpetual
preferred stock to satisfy the funding
requirements o f an issue of mandatory
convertible securities (i.e. the requirement to
retire or redeem the notes with the proceeds
from the issuance of common or perpetual
preferred stock) generally must make such a
dedication during the quarter in which the
new common or preferred stock is issued.5 A s
a general rule, if the dedication is not made
within the prescribed period, then the
securities issued may not at a later date be
dedicated to the retirement or redemption of
the mandatory convertible securities.6
Additional Criteria Applicable to Equity
Contract Notes
a. The note must contain a contractual
provision (or must be issued with a
mandatory stock purchase contract) that
requires the holder of the instrument to take
the common or perpetual stock of the issuer
in lieu of cash in satisfaction of the claim for
principal repayment. The obligation of the
holder to take the common or perpetual
preferred stock of the issuer may be w aived
if, and to the extent that, prior to the maturity
date of the obligation, the issuer sells new
common or perpetual preferred stock and
dedicates the proceeds to the retirement or
redemption of the notes. The dedication
generally must be made during the quarter in
which the new common or preferred stock is
issued.
b. A stock purchase contract may be
separated from a security only if: (1) The
holder o f the contract provides sufficient
collateral7 to the issuer, or to an independent
* Common or perpetual preferred stock issued
under dividend reinvestment plans or issued to
finance acquisitions, including acquisitions of
business entities, may be dedicated to the
retirement or redemption of the mandatory
convertible securities. Documentation certified by
an authorized agent of the issuer showing the
amount of common stock or perpetual preferred
stock issued, the dates of issue, and amounts of
such issues dedicated to the retirement or
redemption of mandatory convertible securities will
satisfy the dedication requirement.
'The dedication procedure is necessary to ensure
that the primary capital of the issuer is not
overstated. For each dollar of common or perpetual
preferred proceeds dedicated to the retirement or
redemption of the notes, there is a corresponding
reduction in the amount of outstanding mandatory
securities that may qualify as primary capital. De
minimis amounts (in relation to primary capital) of
common or perpetual preferred stock issued under
arrangements in which the amount of Btock issued is
not predictable, such as dividend reinvestment
plans and employee stock option plans (but
excluding public stock offerings and stock issued in
connection with acquisitions), should be dedicated
by no later than the company's fiscal year end.
1Collateral is defined as: (1) Cash or certificates
of deposit; (2) U.S. government securities that will
mature prior to or simultaneous with the maturity of
the equity contract and that have a par or maturity
value at least equal to the amount of the holder’s
obligation under the stock purchase contract; (3)
standby letters of credit issued by an insured U.S.
bank that is not an affiliate of the issuer; or (4) other
collateral as may be designated from time to time
by the Federal Reserve.
trustee for the benefit of the issuer, to assure
performance under the contract and (2) the
stock purchase contract requires the
purchase of common or perpetual preferred
stock.
Additional Criteria Applicable to Equity
Commitment Notes
a. The indenture or note agreement must
contain the following two provisions:
1. The proceeds o f the sale of common or
perpetual preferred stock will be the sole
source of repayment for the notes, and the
issuer must dedicate the proceeds for the
purpose of repaying the notes.
(Documentation certified by an authorized
agent o f the issued showing the amount of
common or perpetual preferred stock issued,
the dates of issue, and amounts of such
issues dedicated to the retirement or
redemption of mandatory convertible
securities will satisfy the dedication
requirement.)
2. By the time that one-third of the life of
the securities has run, the issuer must have
raised and dedicated an amount equal to onethird of the original principal of the securities.
By the time that two-thirds of the life of the
securities has run, the issuer must have
raised and dedicated an amount equal to
two-thirds o f the original principal of the
securities. At least 60 days prior to the
maturity of the securities, the issuer must
have raised and dedicated an amount equal
to the entire original principal o f the
securities. Proceeds dedicated to redemption
or retirement o f the notes must come only
from the sale o f common or perpetual
preferred stock.8
b. If the issuer fails to meet any of these
periodic funding requirements, the Federal
Reserve immediately w ill cease to treat the
unfunded securities as primary capital and
will take appropriate supervisory action. In
addition, failure to meet the funding
requirements w ill be view ed as a breach of a
regulatory commitment and will be taken into
consideration by the Board in acting on
statutory applications.
c. If a security is issued by a subsidiary of
a bank or bank holding company, any
guarantee of the principal by that
subsidiary's parent bank or bank holding
company must be subordinate to the same
degree as the security issued by the
subsidiary and limited to repayment o f the
principal amount of the security at its final
maturity.
d. The maximum amount of equity
commitment notes that may be counted as
primary capital for a bank holding company
is limited to 10 percent o f primary capital
exclusive o f mandatory convertible
securities. Amounts outstanding in excess of
the 10 percent limitation may be counted as
secondary capital provided they meet the
requirements of secondary capital
instruments.
3.12 CFR Part 263 is amended by
adding a new Subpart D, including a
'The funded portions of the securities will be
deducted from primary capital to avoid double
counting.
Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules and Regulations
section of the authority under which the
subpart is issued, to read as follows:
PART 263—RULES OF PRACTICE FOR
HEARINGS
*
*
*
*
*
Subpart D—Procedures for Issuance and
Enforcement of Directives Te Maintain
Adequate Capital
Sec.
263.35 Authority, purpose and scope.
263.36 Definitions.
263.37 Establishment of minimum capital
levels.
263.38 Procedures for requiring maintenance
of adequate capital.
263.39 Enforcement of directive.
263.40 Establishment of increased capital
level for individual bank or bank holding
company.
Authority: International Lending
Supervision Act of 1983 (“ILSA”). 12 U.S.C.
3907; section 5(b), Bank Holding Company
Act (“BHC Act”), 12 U.S.C. 1844(b); Financial
Institutions Supervisory Act of 1966 (“FIS
A ct”), 12 U.S.C. 1818(b)--(n); and sections 9
and ll(i). Federal Reserve Act, 12 U.S.C. 248,
324. 329.
Subpart D—Procedures for Issuance
and Enforcement of Directives To
Maintain Adequate Capital
§ 263.35 Authority, purpose, and scope.
(a) Authority. This subpart is issued
under authority of the International
Lending Supervision Act of 1983
("ILSA”), 12 U.S.C 3907, 3909; section
5(b) of the Bank Holding Company Act
(“BHC Act”), 12 U.S.C. 1844(b); the
Financial Institutions Supervisory Act of
1966 ("FIS Act”), 12 U.S.C. 1818(b)-(n);
and sections 9 and ll(i) of the Federal
Reserve Act, 12 U.S.C. 248, 324, 329.
(b) Purpose and scope. This subpart
establishes procedures under which the
Board may issue a directive or take
other action to require a state member
bank or a bank holding company to
achieve and maintain adequate capital.
The information collection requirement
contained in this requlation has been
approved by the Office of Management
and Budget under the provisions of 44
U.S.C. Chapter 35 and has been assigned
OMB No. 7100-0209.
§263.36 Definitions.
(a) “Bank holding company” means
any company that controls a bank as
defined in section 2 of the BHC Act, 12
U.S.C. 1841, and in the Board's
Regulation Y (12 CFR 225.2(b)) or any
direct or indirect subsidiary thereof
other than a bank subsidiary as defined
in section 2(c) of the BHC Act, 12 U.S.C.
1841(c), and in the Board’s Regulation Y
(12 CFR 225.2(a)).
(b) “Capital Adequacy Guidelines”
means those guidelines for bank holding
companies and state member banks
contained in Appendix A to the Board’s
Regulation Y (12 CFR Part 225).
(c) “Directive” means a final order
issued by the Board pursuant to ILSA
(12 U.S.C. 3907(b)(2)) requiring a state
member bank or bank holding company
to increase capital, to or maintain capital
at the minimum level set forth in the
Board’s Capital Adequacy Guidelines or
as otherwise established under
procedures described in §263.40 of this
subpart.
(d) “State member bank” means any
state-chartered bank that is a member of
the Federal Reserve System.
§ 263.37 Establishment of minimum capital
levels.
The Board has established minimum
capital levels for state member banks
and bank holding companies in its
Capital Adequacy Guidelines. The
Board may set higher capital levels as
necessary and appropriate for a
particular state member bank or bank
holding company based upon its
financial condition, managerial
resources, prospects, or similar factors,
pursuant to the procedures set forth in
§263.40 of this subpart.
§ 263.38 Procedures for requiring
maintenance of adequate capital.
(a) Submission of capital
improvement plan. Any state member
bank or bank holding company that may
not be in compliance with the Board’s
Capital Adequacy Guidelines on the
date that this regulation becomes
effective shall, within 90 days, submit to
its appropriate Federal Reserve Bank for
review a plan describing the means and
the time schedule by which the bank or
bank holding company shall achieve the
required minimum level of capital.
(b) Issuance of directive—(1) Notice
of intent to issue directive. If a state
member bank or bank holding company
is operating with less than the minimum
level of capital established in the
Board’s Capital Adequacy Guidelines, or
as otherwise established under the
procedures described in § 263.40 of this
subpart, the Board may issue and serve
upon such state member bank or bank
holding company written notice of the
Board’s intent to issue a directive to
require the bank or bank holding
company to achieve and maintain
adequate capital within a specified time
period.
(2) Contents of notice. The notice of
intent to issue a directive shall include:
(i.) The required minimum level of
capital to be achieved or maintained by
the institution;
(ii) Its current level of capital;
16069
, (iii) The proposed increase in capital
needed to meet the minimum
requirements;
(iv) The proposed date or schedule for
meeting these minimum requirements;
(v) When deemed appropriate,
specific details of a proposed plan for
meeting the minimum capital
requirements; and
(vi) The date for a written response by
the bank or bank holding company to
the proposed directive, which shall be at
least 14 days from the date of issuance
of the notice unless the Board
determines a shorter period is necessary
because of the financial condition of the
bank or bank holding company.
(3) Response to notice. The bank or
bank holding company may file a
written response to the notice within the
time period set by the Board. The
response may include:
(i) An explanation why a directive
should not be issued;
(ii) Any proposed modification of the
terms of the directive;
(iii) Any relevant information,
mitigating circumstances,
documentation or other evidence in
support of the institution’s position
regarding the proposed directive; and
(iv) The institution’s plan for attaining
the required level of capital.
(4) Failure to file response. Failure by
the bank or bank holding company to
file a written response to the notice of
intent to issue a directive within the
specified time period shall constitute a
waiver of the opportunity to respond
and shall constitute consent to the
issuance of such directive.
(5) Board consideration of response.
After considering the response of the
bank or bank holding company, the
Board may:
(i) Issue the directive as originally
proposed or in modified form;
(ii) Determine not to issue a directive
and so notify the bank or bank holding
company; or
(iii) Seek additional information or
clarification of the response by the bank
or bank holding company.
(6) Contents of directive. Any
directive issued by the Board may order
the bank or bank holding company to:
(i) Achieve or maintain the minimum
capital requirement established
pursuant to the Board’s Capital
Adequacy Guidelines or the procedures
in § 263.40 of this subpart by a certain
date;
(ii) Adhere to a previously submitted
plan or submit for approval and adhere
to a plan for achieving the minimum
capital requirement by a certain date;
(iii) Take other specific action as the
Board directs to achieve the minimum
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Federal Register / Vol. 50, No. 79 / Wednesday, April 24, 1985 / Rules &nd Regulations
capital levels, including requiring a
reduction of assets or asset growth or
restriction on the payment of dividends;
or
(iv) A combination of the above
actions.
(7) Request for reconsideration of
directive. Any state member bank or
bank holding company, upon a change
in circumstances, may request the Board
to reconsider the terms of a directive
and may propose changes in the plan
under which it is operating to meet the
required minimum capital level. The
directive and plan continue in effect
while such request is pending before the
Board.
§ 263.39 Enforcement of directive.
(a) Judicial and administrative
remedies. (1) Whenever a bank or bank
holding company fails to follow a
directive issued under this subpart, or to
submit or adhere to a capital adequacy
plan as required by such directive, the
Board may seek enforcement of the
directive, including the capital adequacy
plan, in the appropriate United State
district court, pursuant to section 908
(b)(2)(B)(ii) of ILSA (12 U.S.C.
3907(b)(2)(B)(ii) and to section 8(i) of the
Federal Deposit Insurance Act (12 U.S.C.
1818(i)), in the same manner and to the
same extent as if the directive were a
final cease and desist order.
(2) The Board, pursuant to section
910(d) of ILSA (12 U.S.C. 3909(d)), may
also assess civil money penalties for
violation of the directive against any
bank or bank holding company and any
officer, director, employee, agent, or
other person participating in the conduct
of the affairs of the bank or bank
holding company, in the same manner
and to the same extent as if the directive
were a final cease and desist order.
(b) Other enforcement actions. A
directive may be issued separately, in
conjunction with, or in addition to any
other enforcement actions available to
the Board, including issuance of cease
and desist orders, the approval or denial
of applications or notices, or any other
actions authorized by law.
(c) Consideration in application
proceedings. In acting upon any
application or notice submitted to the
Board pursuant to any statute
administered by the Board, the Board
may consider the progress of a state
member bank or bank holding company
or any subsidiary thereof in adhering to
any directive or capital adequacy plan
required by the Board pursuant to this
subpart, or by any other appropriate
banking supervisory agency pursuant to
ILSA. The Board shall consider whether
approval or a notice of intent not to
disapprove would divert earnings.
diminish capital, or otherwise impede
the bank or bank holding company in
achieving its required minimum capital
level or complying with its capital
adequacy plan.
§ 263.40 Establishment of increased
capital level for Individual bank or bank
holding company.
(a) Establishment of capital levels for
individual institutions. The Board may
establish a capital level higher than that
specified in the Board’s Capital
Adequacy Guidelines for an individual
bank or bank holding company pursuant
to:
(1) A written agreement or
memorandum of understanding between
the Board or the appropriate Federal
Reserve Bank and the bank or bank
holding company;
(2) A temporary or final cease and
desist order issued pursuant to section
8(b) or (c) of the FIS Act (12 U.S.C.
1818(b) or (c));
(3) A condition for approval of an
application or issuance of a notice of
intent not to disapprove a proposal;
(4) Or other similar means; or
(5) The procedures set forth in
subsection (b) of this section.
(b) Procedure to establish higher
capital requirement—(1) Notice. When
the Board determines that capital levels
above those in the Board's Capital
Adequacy Guidelines may be necessary
and appropriate for a particular bank or
bank holding company under the
circumstances, the Board shall give the
bank or bank holding company notice of
the proposed higher capital requirement
and shall permit the bank or bank
holding company an opportunity to
comment upon the proposed capital
level, whether it should be required and,
if so, under what time schedule. The
notice shall contain the Board's reasons
for proposing a higher level of capital.
(2) Response. The bank or bank
holding company shall be allowed at
least 14 days to respond, unless the
Board determines that a shorter period
is necessary because of the financial
condition of the bank or bank holding
company. Failure by the bank or bank
holding company to file a written
response to the notice within the time
set by the Board shall constitute a
waiver of the opportunity to respond
and shall constitute consent to issuance
of a directive containing the required
minimum capital level.
(3) Board decision. After considering
the response of the institution, the Board
may issue a written directive to the
bank or bank holding company setting
an appropriate capital level and the date
on which this capital level will become
effective. The Board may require the
bank or bank holding company to
submit and adhere to a plan for
achieving such higher captial level as
the Board may set.
(4)
Enforcement of higher capital
level. The Board may enforce the capital
level established pursuant to the
procedures described in this section and
any plan submitted to achieve that
capital level through the procedures set
forth in § 263.39 of this subpart.
Board of Governors o f the Federal Reserve
System, April 17,1985.
William.W. Wile*,
Secretary of the Board.
[FR Doc. 85-9694 Filed 4-23-85; 8:45 am]
BILLING COOC 6210-01-M