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F ederal Reserve Bank OF DALLAS R O B E R T D. M C T E E R , J R . DALLAS, TEXAS 75265-5906 P R E S ID E N T AND C H IE F E X E C U T I V E O F F IC E R March 13, 1995 Notice 95-31 TO: The Chief Executive Officer of each member bank and others concerned in the Eleventh Federal Reserve District SUBJECT Final Amendments to the Risk-based Capital Guidelines DETAILS The Board of Governors of the Federal Reserve System has issued a final rule amending its risk-based capital guidelines for state member banks and bank holding companies (banking organizations) to implement section 350 of the Riegle Community Development and Regulatory Improvement Act of 1994. This rule will limit the amount of capital required to be held against assets sold with low levels of recourse to the maximum amount of loss possible under the contractual terms of the recourse obligation. By limiting the amount of capital required for such transactions, the rule corrects the anomaly that currently exists in the risk-based capital treatment for recourse arrangements under which a banking organization could be required to hold capital in excess of its possible loss. The final rule is effective March 22, 1995. ATTACHMENT A copy of the Board’s notice as it appears on pages 8177-82, Vol. 60, No. 29, of the Federal Register dated February 13, 1995, is attached. For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal Reserve Bank of Dallas: Dallas Office (800) 333 -4460; E l Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012; Houston Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810. This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) MORE INFORMATION For more information, please contact Dorsey Davis at (214) 922-6051. For additional copies of this Bank’s notice, please contact the Public Affairs Department at (214) 922-5254. Sincerely yours, Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations 8177 bank holding companies (banking organizations) to implement section 350 of the Riegle Community Development and Regulatory Improvement Act of 1994 (Riegle Act). Section 350 states that the amount of risk-based capital required to be maintained by any insured depository institution, with respect to assets transferred with recourse, may not exceed the maximum amount of recourse for which the institution is contractually liable under the recourse agreement. This rule will have the effect of correcting the anomaly that currently exists in the risk-based capital treatment of recourse transactions under which an institution could be required to hold capital in excess of the maximum amount of loss possible under the contractual terms of the recourse obligation. EFFECTIVE DATE: March 22, 1995. FOR FURTHER INFORMATION CO N TAC T: Rhoger H Pugh, Assistant Director (202/ 728-5883), Thomas R. Boemio, Supervisory Financial Analyst (202/ 452-2982), or David Elkes (202/4525218), Senior Financial Analyst, Policy Development, Division of Banking Supervision and Regulation. For the hearing impaired only, Telecommunication Device for the Deaf (TDD), Dorothea Thompson (202/4523544), Board of Governors of the Federal Reserve System, 20th and C Streets NW., Washington, DC 20551. SUPPLEMENTARY INFORMATION: FEDER AL RESERVE SYSTEM 12 CFR Parts 208 and 225 [Regulations H and Y; Docket No. R-0835] Capital; Capital Adequacy Guidelines Board of Governors of the Federal Reserve System. ACTION: Final rule. AGENCY: SUMMARY: The Board of Governors of the Federal Reserve System (Board) is amending its risk-based capital guidelines for state member banks and Background The Board’s current regulatory capital guidelines are intended to ensure that banking organizations that transfer assets and retain the credit risk inherent in the assets maintain adequate capital to support that risk. For banks, this is generally accomplished by requiring that assets transferred with recourse continue to be reported on the balance sheet in regulatory reports. These amounts are thus included in the calculation of banks’ risk-based and leverage capital ratios. For bank holding companies, transfers of assets with recourse are reported in accordance with generally accepted accounting principles (GAAP), which treats most such transactions as sales, allowing the assets to be removed from the balance sheet.1 For purposes of calculating bank 1 The GAAP treatment focuses on the transfer of benefits rather than the retention of risk and, thus, allows a transfer of receivables with recourse to be accounted for as a sale if the transferor: (1) surrenders control of the future economic benefits of the assets; (2) is able to reasonably estimate its obligations under the recourse provision; and (3) is not obligated to repurchase the assets except pursuant to the recourse provision. In addition, the C on tin u ed 8178 Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations holding companies’ risk-based capital securities, adjusted for any double ratios, however, assets sold with counting. The NPR also addressed other issues recourse that have been removed from related to recourse transactions, the balance sheet in accordance with including equivalent capital treatment GAAP are included in risk-weighted of recourse arrangements and direct assets. Consequently, both banks and credit substitutes that provide first bank holding companies generally are dollar loss protection and definitions for required to maintain capital against the “recourse” and associated terms such as full risk-weighted amount of assets “standard representations and transferred with recourse. warranties.” The NPR was issued in In cases where an institution retains conjunction with an Advance Notice of a low level of recourse, the amount of Proposed Rulemaking (ANPR) that capital required under the Board’s riskoutlined a possible alternative approach based capital guidelines could exceed to deal comprehensively with the the institution’s maximum contractual capital treatment of recourse liability under the recourse agreement. transactions and securitizations. The This can occur in transactions in which comment period for the NPR and ANPR a banking organization contractually ended on July 25, 1994. limits its recourse exposure to less than During the agencies’ review of the the full effective risk-based capital comments received, the Riegle Act was requirement for the assets transferred— signed into law on September 2 3 ,1 9 9 4 . generally, 4 percent for mortgage assets Section 350 of the Act requires the and 8 percent for most other assets. federal banking agencies to issue The Federal Reserve and the other regulations limiting, as of March 22, federal banking agencies have long 1995, the amount of risk-based capital recognized this anomaly in the riskan insured depository institution is based capital guidelines. On May 25, required to hold for assets transferred 1994, the banking agencies, under the with recourse to the maximum amount auspices of the Federal Financial of recourse for which the institution is Institutions Examination Council contractually liable. In order to meet the (FFIEC), issued a Notice of Proposed statutory requirements of section 350, Rulemaking (NPR) (59 FR 27116) that the Federal Reserve is now issuing a was aimed principally at amending the rule that puts into final form only those risk-based capital guidelines to limit the portions of the NPR dealing with low capital charge in low level recourse level recourse transactions. transactions to an institution's Comments Received maximum contractual recourse liability. In response to the NPR and AN PR the The proposal for these types of Federal Reserve Board received letters transactions would effectively result in a dollar capital charge for each dollar of from 36 public commenters. Of these respondents, 27 addressed issues related low level recourse exposure, up to the to the NPR’s proposed low level full effective risk-based capital recourse capital treatment. These requirement on the underlying assets. commenters included 13 banking The proposal requested specific organizations, including 11 comment on whether an institution multinational and regional banking should be able to use the balance of the organizations, one community banking GAAP recourse liability account to organization, and one foreign banking reduce the dollar-for-dollar capital organization; eight trade associations; charge for the recourse exposure on two law firms; one governmentassets transferred with low level sponsored agency; and three other recourse.in a transaction recognized as commenters. Of these 27 respondents, a sale both under GAAP and for 23 specifically provided a favorable regulatory reporting purposes. In overall assessment of the low level addition, the proposal indicated that the recourse proposal. In general, these capital requirement for an exposure to respondents viewed the low level low level recourse retained in a proposal as a way of rationally transaction associated with a swap of correcting an anomaly in the existing mortgage loans for mortgage-related risk-based capital rules so that securities would be the lower of the institutions would not be required to capital charge for the swapped hold capital in excess of their mortgages or the combined capital contractual liability. charge for the low level recourse Ten of the commenters stated that, exposure and the mortgage-related while the proposed low level recourse capital treatment was a positive step, it transferor must establish a separate liability account still would result in too high of a capital equal to the estimated probable losses under the requirement for assets sold with limited recourse provision (GAAP recourse liability account). recourse. These respondents, which included eight of the thirteen banking organizations and two of the eight trade associations, expressed the view that the banking agencies should adopt the GAAP treatment of assets sold with recourse for purposes of calculating the regulatory capital ratios. These commenters maintained that the GAAP recourse liability account provides adequate protection against the risk of loss on assets sold with recourse, obviating the need for additional capital. The NPR specifically sought comment on five issues related to the proposed capital treatment of low level recourse transactions. Thirteen of the 27 respondents commented on the first issue, which concerned the treatment of the GAAP recourse liability account established for assets sold with recourse reported as sales for regulatory reporting purposes. These 13 commenters favored reducing the capital requirement for low level recourse transactions by the balance of its GAAP recourse liability account—which would continue to be excluded from an institution’s regulatory capital. In their view, not taking this account into consideration would result in double coverage of the portion of the risk provided for in that account. Fourteen commenters, including five banking organizations and five trade associations, responded to the second issue, which sought comment on whether a dollar-for-dollar capital requirement would be too high for low level recourse transactions. Eleven commenters indicated that such a capital charge would be too high since it was unlikely that an institution would incur losses up to its maximum contractual liability. Two others responded that whether the capital treatment was too high depended upon the credit quality of the underlying asset pool and the structure of the securitization. One commenter stated that the dollar-for-dollar capital charge would not be too onerous. The third issue dealt with ways of demonstrating that the dollar-for-dollar capital requirement might be too high and possible methods for reducing this requirement without jeopardizing safety and soundness. The eight commenters on this issue indicated that historical ■analysis, examiner review, and “depression scenario” stress testing would show whether the capital requirement would be too high relative to historical losses. The fourth issue concerned ways the banking agencies could handle the increased probability of loss to the insurance fund if less than dollar-fordollar capital is maintained against low Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations level recourse transactions. The eight commenters on this issue stated that as long as the amount of required capital held against the low level recourse transactions was prudently assessed based upon expected losses, actual losses would seldom, if ever, exceed the capital requirement. Thus, the insurance funds would not likely experience losses. The fifth issue sought comment on whether the proposed low level recourse capital treatment would reduce transaction costs or otherwise help to facilitate the sale or securitization of banking organizations’ assets. The eight commenters that responded to this issue were all of the opinion that the low level capital treatment generally yould help lower transaction costs and help facilitate securitization. Final Rule After consideration of the comments received and further deliberation on the issues involved, particularly the requirements of section 350 of the Riegle Act, the Board is adopting a final rule amending the risk-based capital guidelines with respect to the treatment of low level recourse transactions. Specifically, the final amendments implement section 350 by reducing the capital requirements for all recourse transactions in which a state member bank contractually limits its recourse exposure to less than the full, effective risk-based capital requirement for the assets transferred. Although section 350 explicitly extends only to depository institutions, the Board, consistent with its proposal, is also issuing a parallel final amendment to its risk-based capital guidelines for bank holding companies.2 The final rule applies to low level recourse transactions involving all types of assets, including small business loans, commercial loans, and residential mortgages. In this regard, the Board notes that previously under the riskbased capital guidelines residential mortgage loans transferred with recourse were excluded from riskweighted assets if the institution did not retain significant risk of loss. As proposed, this treatment would no longer apply and the low level recourse capital treatment the Board is now issuing would extend to these types of mortgage loan transfers. 2 In addition U>amending the risk-based capital guidelines to reduce the capital requirement for low level recourse transactions (see paragraph g of section HI.D.1. of the guidelines), the Board is also making some technical, nonsubstantive changes to that section of the guidelines by identifying each paragraph in the section with a letter designation. 8179 Under the low level recourse rule, a view, the GAAP recourse liability banking organization that contractually account would be an inadequate limits its maximum recourse obligation substitute for maintaining capital at a to less than the full effective risk-based level commensurate with the risks. One capital requirement for the transferred of the principal purposes of regulatory assets would be required to hold riskcapital is to provide a cushion against based capital equal to the contractual unexpected losses. In contrast, the maximum-amount of its recourse GAAP recourse liability account is, in obligation. This requirement limits to effect, a specific reserve that is intended one dollar the capital charge for each to cover only an institution’s probable dollar of low-level recourse exposure. expected losses under the recourse Under this dollar-for-dollar capital provision. In this regard, the Board requirement, the capital charge for a 100 notes that the capital guidelines percent risk-weighted asset transferred explicitly state that specific reserves with 3 percent recourse would be 3 may not be included in regulatory percent of the value of the transferred capital. assets, rather than the 8 percent In addition, the amount of credit risk that is typically retained in a recourse previously required. Thus, a banking transaction greatly exceeds the normal organization's capital requirement on a expected losses associated with the low level recourse transaction would transferred assets. Thus, even though a not exceed the contractual maximum amount it could lose under the recourse transferring institution may reduce its exposure to potential catastrophic losses obligation. Under the final rule, an institution by limiting the amount of recourse it may reduce the dollar-for-dollar capital provides, it may still retain, in many charge held against the recourse cases, the bulk of the risk inherent in exposure on assets transferred with low the assets. For example, an institution level recourse for a transaction transferring high quality assets with a recognized as a sale under GAAP and reasonably estimated expected loss rate for regulatory reporting purposes by the of one percent that retains ten percent balance of any associated non-capital recourse in the normal course of GAAP recourse liability account. In business will sustain the same amount adopting this aspect of the final rule, the of losses it would have had the assets Board concurs with commenters that not been transferred. This occurs indicated that nonrecognition of the because the amount of exposure under liability account would result in double the recourse provision is very high coverage of the portion of the credit risk relative to the amount of expected provided for in that account. losses. The Board believes that in such In applying the final rule, the Board transactions the transferor has not will, as proposed, limit the capital significantly reduced its risk for requirement for an exposure to low level purposes of assessing regulatory capital recourse retained in a transaction and should continue to be assessed associated with a swap of mortgage regulatory capital as though the assets loans for mortgage-related securities to had not been transferred. the lower of the capital charge for the The GAAP reliance on reasonable swapped mortgages or the combined estimates of all probable credit loeses capital charge for the low level recourse over the life of the receivables exposure and the mortgage-related transferred poses additional concerns to securities, adjusted for any double the Board. While it may be possible to counting. make such estimates for pools of In setting forth this final rule, the consumer loans or residential Board has considered the arguments mortgages, the Board is of the view that that several commenters made for it is currently difficult to do so for other adopting for regulatory capital purposes tyges of loans. Even if it is possible to the GAAP treatment for all assets sold make a reasonable estimate of probable with recourse, including those sold with credit losses at the time an asset or asset low levels of recourse. Under such a pool is transferred, the ability of an treatment, assets sold with recourse in institution to make a reasonable estimate may change over the life of the accordance with GAAP would have no transferred assets. capital requirement, but the GAAP Finally, the Board is concerned that recourse liability account would provide some level of protection against an institution transferring assets with recourse might estimate that it would losses. The Board continues to believe it not have an y losses under the recourse would not be appropriate to adopt for provision, in which case it would not establish any GAAP recourse liability regulatory capital purposes the GAAP treatment of recourse transactions, even account for the exposure. If the if the transferring bank retains only a transferor recorded either no liability or only a nominal liability in the GAAP low level of-recourse. In the Board’s 8180 Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations credit that are performance-related are discussed below and have a credit 12 CFR Part 208 conversion factor of 50 percent.) b. The full amount of a direct credit Accounting, Agriculture, Banks, substitute is converted at 100 percent and the banking, Confidential business resulting credit equivalent amount is information, Crime, Currency, Federal assigned to the risk category appropriate to Reserve System, Mortgages, Reporting the obligor or, if relevant, the guarantor or the and recordkeeping requirements, nature of the collateral. In the case of a direct Securities. credit substitute in which a risk participation42 has been conveyed, the full 12 CFR Part 225 amount is still converted at 100 percent. Administrative practice and However, the credit equivalent amount that procedure, Banks, Banking, Federal has been conveyed is assigned to whichever risk category is lower: the risk category Reserve System, Holding companies, appropriate to the obligor, after giving effect Reporting and recordkeeping to any relevant guarantees or collateral, or the requirements, Securities. risk category appropriate to the institution For the reasons set forth in the acquiring the participation. Any remainder is preamble, the Board amends 12 CFR assigned to the risk category appropriate to Regulatory Flexibility Act parts 208 and 225 as set forth below: the obligor, guarantor, or collateral. For example, the portion of a direct credit The purpose of this final rule is to PART 208— MEMBERSHIP OF S T A T E substitute conveyed as a risk participation to reduce the risk-based capital BANKING INSTITUTIONS IN TH E a U.S. domestic depository institution or requirement on transfers of assets with foreign bank is assigned to the risk category FEDERAL RESERVE SYSTEM low levels of recourse. Therefore, appropriate to claims guaranteed by those (REGULATION H) pursuant to section 605(b) of the institutions, that is, the 20 percent risk 1. The authority citation for part 208 Regulatory Flexibility Act, the Board category.43 This approach recognizes that such conveyances replace the originating hereby certifies that this rule will have . continues to read as follows: bank’s exposure to the obligor with an a beneficial economic impact on small Authority: 12 U.S.C. 36, 248(a), 248(c), exposure to the institutions acquiring the risk business entities (in this case, small 321-338a, 371d, 461, 4 8 1-486, 601, 611, 1 8 1 4 ,1823(j), 1828(o), 1 8 3 1 0 ,1 8 3 1 p -l, 3105, participations.44 banking organizations) that sell assets c. In the case of direct credit substitutes 3310, 3331-3351 and 3906-3909; 15 U.S.C. with low levels of recourse. The riskthat take the form of a syndication as defined 78b, 781(b), 781(g), 78l(i), 78o-4(c)(5), 78q, based capital guidelines generally do in the instructions to the commercial bank 78q—1 and 78w; 31 U.S.C 5318. not apply to bank holding companies Call Report, that is, where each bank is 2. In Part 208, Appendix A, section with consolidated assets of less than obligated only for its p ro rata share of the III.D.l. is revised to read as follows: $150 million; thus, this rule will not risk and there is no recourse to the originating bank, each bank will only include affect such companies. Appendix A to Part 208— Capital its p ro rata share of the direct credit Adequacy Guidelines for State Member substitute in its risk-based capital Paperwork Reduction Act and Banks: Risk-Based Measure Regulatory Burden calculation. * * * * * d. Financial standby letters of credit are The Board has determined that this distinguished from loan commitments III. * * * final rule will not increase the (discussed below) in that standbys are D. * * * regulatory paperwork burden of banking irrevocable obligations of the bank to pay a 1. Item s with a 100 p ercen t conversion organizations pursuant tq the provisions facto r. third-party beneficiary when a customer of the Paperwork Reduction Act (44 a. A 100 percent conversion factor applies (account party) fails to repay an outstanding loan or debt instrument (direct credit U.S.C. 3501 etseq .). to direct credit substitutes, which include substitute). Performance standby letters of guarantees, or equivalent instruments, Section 302 requires that new regulations take effect on the first day of backing financial claims, such as outstanding credit (performance bonds) are irrevocable obligations of the bank to pay a third-party securities, loans, and other financial the calendar quarter following beneficiary when a customer (account party) liabilities, or that back off-balance sheet publication of the rule, unless, inter fails to perform some other contractual nonitems that require capital under the riskalia, the regulation, pursuant to any financial obligation. based capital framework. Direct credit other Act of Congress, is required to take substitutes include, for example, financial e. The distinguishing characteristic of a effect on a date other than the date standby letter of credit for risk-based capital standby letters of credit, or other equivalent purposes is the combination of irrevocability determined under section 302. Section irrevocable undertakings or surety with the fact that funding is triggered by arrangements, that guarantee repayment of 350 of the Riegle Act requires that some failure to repay or perform an financial obligations such as: commercial before the end of the 180-day period obligation. Thus, any commitment (by paper, tax-exempt securities, commercial or beginning on the date of enactment of individual loans or debt obligations, or the Act, or in this case no later than standby or commercial letters of credit. 42 That is, a participation in which the originating March 22,1995, the amount of riskbank remains liable to the beneficiary for the full Direct credit substitutes also include the * ' based capital required to be maintained, acquisition of risk participations in bankers amount of the direct credit substitute if the party that has acquired the participation fails to pay when under regulations prescribed by the acceptances and standby letters of credit, the instrument is drawn. appropriate Federal banking agency, by since both of these transactions, in effect, 43 Risk participations with a remaining maturity constitute a guarantee by the acquiring bank any insured depository institution of over one year that are conveyed to non-OECD that the underlying account party (obligor) transferring assets With recourse be banks are to be assigned to the 100 percent risk will repay its obligation to the originating, or limited to the maximum amount of category, unless a lower risk category is appropriate issuing, institution.41 (Standby letters of to the obligor, guarantor, or collateral. recourse for which such institution is 44 A risk participation in bankers acceptances contractually liable under the recourse 41 Credit equivalent amounts of acquisitions of conveyed to other institutions is also assigned to agreement. Accordingly, the Board has the risk category appropriate to the institution risk participations are assigned to the risk category determined that an effective date of acquiring the participation or, if relevant, the appropriate to the account party obligor, or, if guarantor or nature of the collateral. relevant, the nature of the collateral or guarantees. March 22,1995 is appropriate. recourse liability account for a succession of asset transfers; it could accumulate large amounts of credit risk that would not be reflected, or would be only partially reflected, on the balance sheet. The Board is issuing this final rule now in order to implement section 350 of the Riegle Act in accordance with the statutory deadline. Consequently, the rule deals with only those portions of the NPR concerned with low level recourse transactions. The Board will continue to consider, on an interagency basis, the other aspects of the NPR, as well as all aspects of the ANPR that was issued in conjunction with the NPR. List of Subjects Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations whatever name) that involves an irrev ocable obligation to make a payment to the customer or to a third party in the event the customer fails to repay an outstanding debt obligation or fails to perform a contractual obligation is treated, for risk-based capital purposes, as respectively, a financial guarantee standby letter o f credit or a performance standby. f. A loan commitment, on the other hand, involves an obligation (with or without a material adverse change or similar clause) of the bank to fund its customer in the normal course of business should the customer seek to draw down the commitment. g. Sale and repurchase agreements and asset sales with recourse (to the extent not included on the'balance sheet) and forward agreements also are converted at 100 percent. The risk-based capital definition of the sale of assets with recourse, including the sale of 1- to 4-family residential mortgages, is the same as the definition contained in the instructions to the commercial bank Call Report. Accordingly, the entire amount of any assets transferred with recourse that are not already included on the balance sheet, including pools o f 1- to 4-family residential mortgages, are to be converted at 100 percent and assigned to the risk weight appropriate to the obligor, or if relevant, the nature of any collateral or guarantees. The terms of a transfer of assets with recourse may contractually limit the amount of the institution’s liability to an amount less than the effective risk-based capital requirement for the assets being transferred with recourse. If such a transaction (including one that is reported as a financing, i.e., the assets are not removed from the balance sheet) meets the criteria for sales treatment under GAAP, the amount of total capital required is equal to the maximum amount of loss possible under the recourse provision. If the transaction is also treated as a sale for regulatory reporting purposes, then the required amount of capital may be reduced by the balance of any associated non-capital liability account established pursuant to GAAP to cover estimated probable losses under the recourse provision. So-called “loan strips” (that is, short-term advances sold under long-term commitments without direct recourse) are defined in the instructions to the commercial bank Call Report and for risk-based capital purposes as assets sold with recourse. h. Forward agreements are legally binding contractual obligations to purchase assets with certain drawdown at a specified future date. Such obligations include forward purchases, forward forward deposits placed,45 and partly-paid shares and securities; they do not include commitments to make residential mortgage loans or forward foreign exchange contracts. i. Securities lent by a bank are treated in one of two ways, depending upon whether the lender is at risk of loss. If a bank, as agent for a customer, lends the customer’s securities and does not indemnify the customer against loss, then the transaction is excluded from the risk-based capitalcalculation. If, alternatively, a bank lends its own securities or, acting as agent for a 45Forward forward deposits accepted are treated as interest rate contracts. 8181 and have a credit conversion factor of SO percent.) b. The full amount of a direct credit substitute is converted at 100 percent and the resulting credit equivalent amount is assigned to the risk category appropriate to the obligor or, if relevant, the guarantor or the nature of the collateral. In the case of a direct credit substitute in which a risk participation 45 has been conveyed, the full amount is still converted at 100 percent. However, the credit equivalent amount that has been conveyed is assigned to whichever risk category is lower: the risk category appropriate to the obligor, after giving effect to any relevant guarantees or collateral, or the risk category appropriate to the institution acquiring the participation. Any remainder is assigned to the risk category appropriate to the obligor, guarantor, or collateral. For example, the portion of a direct credit substitute conveyed as a risk participation to * * * * * a U.S. domestic depository institution or foreign bank is assigned to the risk category PART 225— BANK HOLDING appropriate to claims guaranteed by those COMPANIES AND CHANGE IN BANK institutions, that is, the 20 percent risk C O N TR O L (REGULATIO N Y) category.4* This approach recognizes that such conveyances replace the originating 1. The authority citation fo^part 225 banking organization's exposure to the continues to read as follows: obligor with an exposure to the institutions Authority: 12 U.S.C. 1817(j)(13), 1818, acquiring the risk participations.47 1831i. 1 8 3 1 p -l, 1843(c)(8), 1844(b), 1972(1), c. In the case of direct credit substitutes 3106. 3108, 3310, 3331-3351, 3907, and that take the form of a syndication, that is, 3909. where each banking organization if obligated only for its p ro rata share of the risk and 2. In Part 225, Appendix A, section there is no recourse to the originating III.D.l. is revised to read as follows: banking organization, each banking organization will only include its p ro rata Appendix A to Part 225—Capital Adequacy Guidelines for Bank Holding share of the direct credit substitute in its riskbased capital calculation. Companies: Risked-Based Measure d. Financial standby letters of credit are * * * * * distinguished from loan commitments (discussed below) in that standbys are III. * * * Q * * * irrevocable obligations of the banking organization to pay a third-party beneficiary 1. Item s with a 100 p ercen t con version when a customer (account party) fa ils to factor. a. A 100 percent conversion factor applies rep ay an outstanding loan or debt instrument (direct credit substitute). Performance to direct credit substitutes, which include standby letters of credit (performance bonds) guarantees, or equivalent instruments, backing financial claims, such as outstanding are irrevocable obligations of the banking organization to pay a third-party beneficiary securities, loans, and other financial when a customer (account party) fa ils to liabilities, or that back off-balance sheet perform some other contractual non-financial items that require capital under the riskobligation. based capital framework. Direct credit e. The distinguishing characteristic of a substitutes include, for example, financial standby letter of credit for risk-based capital standby letters of credit, or other equivalent purposes is the combination of irrevocability irrevocable undertakings or surety with the fact that funding is triggered by arrangements, that guarantee repayment of some failure to repay or perform an financial obligations such as: commercial obligation. Thus, any commitment (by paper, tax-exempt securities, commercial or whatever name) that involves an irrev ocable individual loans or debt obligations, or standby or commercial letters of credit. Direct credit substitutes also include the 45 That is, a participation in which the originating acquisition of risk participations in bankers banking organization remains liable to the beneficiary for tha full amount of the direct credit acceptances and standby letters of credit, substitute if the party that has acquired the since both of these transactions, in effect, participation fails to pay when the instrument is constitute a guarantee by the acquiring drawn. banking organization that the underlying 46Risk participations with a remaining maturity account party (obligor) will repay its of over one year that are conveyed to non-OECD obligation to the originating, or issuing, banks are to be assigned to the 100 percent risk institution.44 (Standby letters of credit that category, unless a lower risk category is appropriate are performance-related are discussed below to the obligor, guarantor, or collateral. 47 A risk participation in bankers acceptances conveyed to other institutions is also assigned to "Credit equivalent amounts of acquisitions of the risk category appropriate to the institution risk participations are assigned to the risk category acquiring the participation or, if relevant, the appropriate to the account party obligor, or, if guarantor or nature of the collateral. relevant, the nature of the collateral or guarantees. customer, lends the customer’s securities and indemnifies the customer against loss, the transaction is converted at 100 percent and assigned to the risk weight category appropriate to the obligor, to any collateral delivered to the lending bank, or, if applicable, to the independent custodian acting on the lender’s behalf. Where a bank is acting as agent for a customer in a transaction involving the lending or sale of securities that is collateralized by cash delivered to the bank, the transaction is deemed to be collateralized by cash on deposit in the bank for purposes of determining the appropriate risk-weight category, provided that any indemnification is limited to no more than the difference between the market value of the securities and the cash collateral received and any reinvestment risk associated with that cash collateral is borne by the customer. 8182 Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations obligation to make a payment to the customer or to a third party in the event the customer fa ils to rep a y an outstanding debt obligation or fa ils to perform a contractual obligation i$ treated, for risk-based capital purposes, as respectively, a financial guarantee standby letter of credit or a performance standby. f. A loan commitment, on the other hand, involves an obligation (with or without a material adverse change or similar clause) of the banking organization to fund its customer in th e norm al course of business should the customer seek to draw down the commitment. g. Sale and repurchase agreements and asset sales with recourse (to the extent not included on the balance sheet) and forward agreements also are converted at 100 percent.48 So-called “loan strips” (that is, short-term advances sold under long-term commitments without direct recourse) are treated for risk-based capital purposes as assets sold with recourse and, accordingly, are also converted at 100 percent. h. Forward agreements are legally binding contractual obligations to purchase assets with certain drawdown at a specified future date. Such obligations include forward purchases, forward forward deposits placed,49 and partly-paid shares and securities; they do not include commitments to make residential mortgage loans or forward foreign exchange contracts. i. Securities lent by a banking organization are treated in one of two ways, depending upon whether the lender is at risk of loss. If a banking organization, as agent for a customer, lends the customer’s securities and does not indemnify the customer against loss, then the transaction is excluded from the risk-based capital calculation. If, 48In regulatory reports and under GAAP, bank holding companies are permitted to treat some asset sales with recourse as "true” sales. For risk-based capital purposes, however, such assets sold with recourse and reported as “true” sales by bank holding companies are converted at 100 percent and assigned to the risk category appropriate to the underlying obligor or, if relevant, the guarantor or nature of the collateral, provided that the transactions meet the definition of assets sold with recourse (including assets sold subject to pro rata and other loss sharing arrangements), that is contained in the instructions to the commercial bank Consolidated Reports of Condition and Income (Call Report). This treatment applies to any assets, including the sale of 1- to 4-family and multifamily residential mortgages, sold with recourse. Accordingly, the entire amount of any assets transferred with recourse that are not already included on the balance sheet, including pools of 1- to 4-family residential mortgages, are to be converted at 100 percent and assigned to the risk category appropriate to the obligor, or if relevant, the nature of any collateral or guarantees. The terms of a transfer of assets with recourse may contractually limit the amount of the institution's liability to an amount less than the effective riskbased capital requirement for the assets being transferred with recourse. If such a transaction is recognized as a sale under GAAP, the amount of total capital required is equal to the maximum amount of loss possible under the recourse provision, less any amount held in an associated non-capital liability account established pursuant to GAAP to cover estimated probable losses under the recourse provision. 49Forward forward deposits accepted are treated as interest rate contracts. alternatively, a banking organization lends its own securities or, acting as agent for a customer, lends the customer’s securities and indemnifies the customer against loss, the transaction is converted at 100 percent and assigned to the risk weight category appropriate to the obligor, to any collateral delivered to the lending banking organization, or, if applicable, to the independent custodian acting on the lender’s behalf. Where a banking organization is acting as agent for a customer in a transaction involving the lending or sale of securities that is collateralized by cash delivered to the banking organization, the transaction is deemed to be collateralized by cash on deposit in a subsidiary lending institution for purposes of determining the appropriate riskweight category, provided that any indemnification is limited to no more than the difference between the market value of the securities and the cash collateral received and any reinvestment risk associated with that cash collateral is borne by the customer. * * M * * By order of the Board of Governors of the Federal By Reserve System, February 7,1995. William W. Wiles, Secretary o f the B oard. [FR Doc. 95-3469 Filed 2 -1 0 -9 5 ; 8:45 ami BILUNG CODE 6 2 1 0 -0 1 -P
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