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F ederal reserve Ba n k DALLAS, TEXAS of D allas 75222 C ircular No. 81-224 November 25, 1981 FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL Recommended Definition of Bank Capital TO ALL STATE MEMBER BANKS AND BANK HOLDING COMPANIES IN THE ELEVENTH FEDERAL RESERVE DISTRICT: To prom ote uniformity among the th re e Federal bank regulatory agencies, th e Federal Financial Institutions Examination Council has re c ommended th a t the agencies adopt a broadened definition of bank cap ital in determ ining the adequacy of capital in the banks they supervise. The Council requested action by December 7, 1981. Printed on the following pages are copies recommended definition of com m ercial bank capital and which more fully explains their views. of the Council's the press release Questions regarding the recommended definition of bank capital should be directed to Marvin C. McCoy, Extension 6657, or U. (Earl) Anderson, Extension 6275, of this Bank's Bank Supervision and Regulations D epartm ent. Additional copies of this circular will be furnished upon request to the D epartm ent of Communications, Financial and Community Affairs of this Bank, Extension 6289. Sincerely yours, William H. Wallace First Vice President Banks and others are encouraged to use the following incoming W A T S numbers in contacting this Bank: 1-800-442-7140 (intrastate) and 1-800-527-9200 (interstate). For calls placed locally, please use 651 plus the extension referred to above. This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) Federal Financial Institutions Examination Council, Washington, D.C. 20219 Press Release For immediate r e le a s e November 9 , 1981 The Federal Financial I n s t i t u t i o n s Examination Council today recommended to the th re e bank reg u la to ry agencies represented on the Council—^ t h a t they adopt a broadened d e f i n i t i o n of bank c a p ita l in determining the adequacy o f c a p it a l in th e banks they su p e rv ise. The d e f i n i t io n is being recommended to promote uniform ity among the Federal bank r e g u la t o r s . The Council requested actio n by the agencies by December 7. The Council acted a f t e r receiv in g comment on a proposal published in June. The Council recommended t h a t bank c a p ita l should be defined as c o n s istin g o f two elements - - primary and secondary c a p i t a l , as follows: —Primary c a p ita l would c o n s is t o f common and perpetual p r e fe r r e d sto c k , surplus and undivided p r o f i t s , contingency and o th e r c a p it a l r e s e r v e s , mandatory c o n v e rtib le instruments and 100 p ercent of the allowances f o r p o ss ib le loan l o s s e s . —Secondary c a p it a l would c o n s is t o f l i m i t e d - l i f e p r e fe r r e d stock and subordinated notes and debentures. F u rth e r, secondary c a p i ta l would: --Amount to no more than 50 percent o f th e amount of primary c a p i t a l , and —Financing instruments in secondary c a p it a l would be phased out o f the bank's c a p ita l as they approached m a tu rity . 37 The Comptroller of the Currency (su p e rv iso r o f n ational banks), the Federal Reserve Board (su p e rv iso r o f S t a te ch a rte re d banks t h a t are members o f th e Federal Reserve System), and the Federal Deposit Insurance Corporation (su p e rv iso r o f insured S ta te nonmember banks). Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Federal Home Loan Bank Board, National Credit Union Administration, Office of the Comptroller of the Currency - 2 L im it e d - li f e p r e fe r r e d stock and subordinated notes and debentures were viewed by the Council as having some, but not a l l , of the c h a r a c t e r i s t i c s of c a p it a l and thus would be considered e l i g i b l e f o r co n s id e ra tio n as secondary c a p i ta l i f : 1. These instruments have an o r ig in a l weighted average m atu rity of a t l e a s t 7 y e a r s ; 2. Any s e r i a l or in s ta llm e n t repayments, once begun, a re made a t l e a s t an n u a lly , with each payment no le s s than th e previous one; 3. Together, such financing equals no more than h a l f o f the amount o f primary c a p i t a l ; and 4. The p ercen t o f such iss u e s considered as c a p it a l d e c lin e s by a f i f t h each y e a r when t h e i r m a tu rity i s le s s than f i v e y e ars d i s t a n t . This would mean t h a t such instruments would have no c a p i ta l value when they have a m aturity of le s s than a y e a r. The Council made c l e a r th a t,a lth o u g h i t s recommendation was aimed a t promoting uniform ity among the Federal bank r e g u l a t o r s , they have the f l e x i b i l i t y to d ep art from the g u id e lin e s when th e circumstances o f a p a r t i c u l a r case it. warrant With r e s p e c t to any e x i s t i n g secondary c a p i t a l , th e Council suggested t h a t in implementing the r e s t r i c t i o n s on secondary c a p i t a l , the agencies give c o n s id e ra tio n to th e supervisory p o l i c i e s in e f f e c t a t the time of is s u e . A la rg e m ajo rity of those commenting .on the C ouncil's proposed d e f i n i t i o n supported the d iv is io n o f c a p i ta l in to primary and secondary components and agreed with th e C o uncil's placement of subordinated debt and l i m i t e d - l i f e p r e fe r r e d stock in th e secondary c a p it a l category. - 3 Based on comments received, the Council decided to drop i t s proposed requirement t h a t secondary c a p ita l instruments have an o rig in a l f in a l maturity o f 10 y e a rs. Commentors noted t h a t t h i s requirement seemed redundant in view of the requirement t h a t secondary c a p ita l issu es have an o rig in a l weighted average maturity o f 7 years and the required am ortization schedule f o r c a p it a l e l i g i b i l i t y . The Council had asked f o r comments on four s p e c i f i c questions in a d d itio n to general comments on i t s proposal. comments, the Council decided t h a t : A fter a review of the public (1) l i m i t e d - l i f e p re fe rre d stock was properly placed in the secondary c a p ita l category; (2) subordinated debt and l i m i t e d - l i f e p re fe rre d stock iss u e s t h a t are c o n v e rtib le in to primary c a p ita l instrum ents, but do not have a mandatory c o n v e r tib le f e a t u r e , should continue to be regarded as secondary c a p ita l u n til such conversion a c tu a l ly i s e f f e c te d ; (3) a minimum s iz e on subordinated debt issues higher than th e one c u r re n tly imposed by Federal Reserve Regulations D and Q and FDIC Regulation 329.10 should not be adopted, and (4) no l i m i t should be placed on the amount o f debt t h a t a bank can s e l l to o th e r banks. The Council's recommended d e f i n i t i o n of commercial bank c a p ita l is attach ed . Attachment RECOMMENDED DEFINITION OF BANK CAPITAL TO BE USED IN DETERMINING CAPITAL ADEQUACY Primary Components of Bank Capital The primary components o f bank c a p i t a l are considered to be: 0 common stock • perpetual p r e fe r r e d stock • surplu s • undivided p r o f i t s 0 contingency and o th e r c a p ita l reserv es 0 mandatory c o n v e r tib le instruments ( c a p i t a l instrum ents with covenants mandating conversion in t o common o r perpetual p r e f e r r e d stock) 0 allowance f o r p o s s ib le loan lo sses Secondary Components o f Bank Capital I t is recognized t h a t o th e r f in a n c ia l instruments can, with c e r t a i n r e s t r i c t i o n s , be considered as p a r t o f bank c a p ita l because they possess some, though not a l l , o f th e f e a tu re s o f c a p i t a l . These instruments a re : 0 L im it e d - li f e p r e fe r r e d stock 0 Subordinated notes and debentures R e s tr ic tio n s R elating to Secondary Components The secondary components w ill be considered as bank c a p ita l under the conditions l i s t e d below. - 2 • The issue must have an o r ig in a l weighted average m aturity of a t l e a s t seven y e a r s . t I f the iss u e has a s e r i a l or instalm en t repayment program, a l l scheduled repayments s h a ll be made a t l e a s t annually, once contractu al repayment o f p rin c ip a l begins, and the amount repaid in a given year s h a ll be no le s s than the amount repaid in the previous y e a r . • The aggregate amount of l i m i t e d - l i f e p r e fe r r e d stock and subordinated debt q u a lify in g as secondary c a p ita l may not exceed 50 p ercen t of the amount of primary c a p i t a l . • As the secondary components approach m a tu rity , redemption or payment, the outstanding balance o f a l l such instruments - including those with s e r i a l note payments, sinking fund p r o v is io n s , or an am ortization schedule — w ill be amortized in accordance with the following schedule: Percent o f Issue Considered Capital Years to Maturity G reater than or equal to 5 100 Less than 5but g r e a t e r than or equal to 4 80 Less than 4but g r e a t e r than o r equal to 3 60 Less than 3but g r e a t e r than o r equal to 2 40 Less than 2 but g r e a t e r than o r equal to 1 20 Less than 1 0 (No adjustment in the book amount o f the iss u e is required or expected by t h i s schedule. Adjustment w ill be made by a memorandum account.)
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