The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
FEDERAL RESERVE B A «
OF NEW YORK
[
Circular No. 10232 1
March 22, 1988
REVISED PROPOSAL REGARDING RISK-BASED CAPITAL
Commemt Imvited by May 13
To All Depository Institutions and Bank Holding Companies
in the Second Federal Reserve District, and Others Concerned:
F o llo w in g is th e te x t o f a s ta te m e n t is s u e d b y th e B o a rd o f G o v e rn o rs o f th e F e d e r a l R e s e r v e
S y ste m :
The Federal Reserve Board has requested comment on a revised risk-based capital guidelines pro
posal for U.S. banking organizations. The proposal is based upon a framework developed by the Basle
Committee on Banking Regulations and Supervisory Practices. The Basle Committee includes supervi
sory authorities from 12 major industrial countries.
The revised proposal for U.S. banking organizations was developed in conjunction with the Office
of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.
Comments should be received by the Board on this matter by May 13, 1988.
The proposal is designed to achieve important goals long sought by the Board:
° Establish a uniform capital framework, applicable to all federally supervised banking organiza
tions, that is more sensitive to risk factors, including off-balance-sheet exposures;
9 Encourage international banking organizations to strengthen their capital positions; and,
° Reduce a source of competitive inequality arising from differences in supervisory requirements
among nations.
E n c lo s e d — fo r d e p o s ito ry in s titu tio n s , b a n k h o ld in g c o m p a n ie s , a n d b ra n c h e s a n d a g e n c ie s o f
fo re ig n b a n k s in th is D is tric t — is th e c o m p le te te x t o f th e p ro p o s a l, w h ic h h a s b e e n re p rin te d fro m
th e
Federal Register o f M a rc h 15 , 1 9 8 8 . C o p ie s o f th e e n c lo s u re w ill b e fu r n is h e d to o th e rs u p o n
re q u e s t d ire c te d to th e C irc u la rs D iv is io n o f th is B a n k (T e l. N o . 2 1 2 -7 2 0 -5 2 1 5 o r 5 2 1 6 ).
C o m m e n ts o n th e p ro p o s a l s h o u ld b e s e n t to th e a p p ro p ria te F e d e r a l b a n k in g a g e n c y a t th e
a d d re s s e s se t fo rth in th e n o tic e (th e O ffic e o f th e C o m p tr o lle r o f th e C u rre n c y , th e B o a rd o f G o v e rn
o rs o f th e F e d e ra l R e s e rv e S y s te m , o r th e F e d e ra l D e p o sit I n s u ra n c e C o rp o ra tio n ) b y M a y 1 3 ,1 9 8 8 .
Q u e stio n s c o n c e rn in g th is p ro p o s a l m a y b e d ire c te d to D o n a ld E . S c h m id , M a n a g e r, B a n k
A n a ly s is D e p a rtm e n t (T e l. N o . 2 1 2 -7 2 0 -6 6 1 1 ), o r J e ffre y B a rd o s , B a n k S u p e rv is io n S p e c ia lis t,
B a n k A n a ly s is D iv is io n (T e l. N o . 2 1 2 -7 2 0 -7 9 6 2 ).
E . G e r a l d C o r r ig a n ,
President.
T y @ td !ii^
ilarelh) 15, 1 i i i
Part D0
Departm ent ©f th@ Treasury
Office @f
C©mptr®0il@r ®f til® C um ncy.
fFddteraO Reserve System
F©(sl©raB 0©p@®it Insurance
Corporation
12 CFB [parte 3 , 2 2 5 and 3 2 5
Risk-Based Capital; Noli©® of P ro p o sed
© yid@ liiT)© s
855®
F ederal R egister / V ol. 53, N o. 50 / T u esd ay, M arch 15, 1988 / P rop osed R ules
DEPARTMENT OF THE TREASURY
Office ©f the Comptroller ©f the
Currency
12CFR Part 3
[ Docket No. 88-5]
FEDERAL RESERVE SYSTEM
12 CFR Part 225
[Regulation Y; Docket No. R-0628]
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 325
Capital; Risk-Based Capital Guidelines
AGENCIES: Office of the Comptroller of
the Currency, Department of the
Treasury; Board ofGovernors of the
Federal Reserve System; Federal
Deposit Insurance Corporation.
action: Notice of proposed guidelines.
Since the early 1980s, the
Board of Governors of the Federal
Reserve System ("Board”), the Federal
Deposit Insurance Corporation (“FDIC”),
and the Office of the Comptroller of the
Currency (“Office” or “OCC”)
(collectively, “the Federal banking
agencies” or “Agencies”) have
employed minimum supervisory ratios
of primary and total capital to total
assets in assessing the capital adequacy
of national and state-chartered banks
and bank holding companies
(collectively, "banking organizations”).
While these ratios of capital to total
assets have served as a useful tool for
assessing capital adequacy, the Federal
banking agencies believe that there is a
need for a measure that is more
sensitive to the risk profiles of
individual banking organizations. As a
result, the Federal banking agencies first
proposed in early 1986 the adoption of a
risk-based capital measure that took
explicit account of broad differences in
risks among a banking organization’s
assets and off-balance sheet items.
Based, in part, on comments received in
response to that earlier proposal, the
Federal banking agencies, in conjunction
with the Bank of England, published a
revised risk-based capital proposal in
early 1987, which would have
established risk-based capital standards
applicable to banking organizations in
the United States and the United
Kingdom (“U.S./U.K. proposal” or
“measure”). Implementation of the U.S./
U.K. proposal was deferred to enlist the
participation of additional countries in
the risk-based capital agreement.
SUMMARY:
The Federal banking agencies are now
seeking public comment on a revised
risk-based capital proposal in lieu of the
U.S./U.K. measure. The current proposal
is based upon a risk-based capital
framework developed jointly during the
past year by supervisory authorities
from 12 major industrial countries.
Adoption of this proposal would achieve
important goals long sought by the
Agencies. First, it would establish a
uniform risk-based capital framework,
applicable to all federally-supervised
banking organizations, that is more
sensitive to credit risk factors, including
off-balance sheetexposures. Second, it
would encourage international banking.
organizations to strengthen their capital
positions. Finally, it would mitigate a
source of competitive inequality arising
from differences in national supervisory
requirements.
This proposal represents a major step
in the process of coordinating with
regulatory authorities of other countries
to establish appropriate capital
standards for banking organizations, in
accordance with the International
Lending Supervision Act of 1983
(“ILSA”), 12 U.S.C. 3901 et seq.
date: Comments must be submitted on
or before May 13,1988.
addresses : Comments should be sent
to the appropriate Federal banking
agency at the following addresses:
OCC: Comments should be sent to
Docket No. 83-5, Communications
Division, Office of the Comptroller of the
Currency, 490L’Enfant Plaza East, SW„
Washington, DC 20219, Attention:
Lynette Carter. Telephone (202) 4471800. Comments will be available for
inspection and photocopying at the
same address.
Board: Comments should refer to
Docket No. R-0628, and should be
mailed to William W. Wiles, Secretary,
Board of Governors of the Federal
Reserve System, 20th Street and
Constitution Avenue, NW„ Washington,
DC 20551, or should be delivered to the
Office of the Secretary, Room 2223,
Eccles Building, 20th and Constitution
Avenue NW., between the hours of 9:00
a.m. and 5:00 p.m. weekdays; Comments
may be inspected in Room 1119, Eccles
Building, between 9:00 a.m. and 5:00 p.m.
weekdays.
FDIC: Comments should be sent to
Hoyle L. Robinson, Executive Secretary,
Federal Deposit Insurance Corporation,
550 17th Street, NW., Washington, DC
20429, or delivered to Room 6108 at the
same address between the hours of 9:00
a.m. and 5:00 p.m. on business days.
F©R FURTHER INFORMATION OONYAOH
OCC: Ed Irmler, Associate Director,
Economic and Policy Analysis Division,
(202/447-1924); Larry Senter, National
Bank Examiner, Commercial Activities
Division, (202/447-1164); C. Stewart
Goddin, Senior International Economic
Advisor, Multinational and Regional
Bank Division, (202/447-1747); Sanford
Brown, Attorney, Legal Advisory
Services Division, (202/447-1880), Office
of Comptroller of the Currency, 490
L’Enfant Plaza East, SW., Washington,
DC 20219.
Board: Richard Spillenkothen, Deputy
Associate Director (202/452-2594),
Anthony G. Comyn, Assistant Director
(202/452-3354), Stephen M. Lovette,
Manager (202/452-3622), Rhoger Pugh,
Manager 202/728-5883), Norah Barger,
Financial Analyst (202/452-2402), or
Kelly S. Shaw, Financial Analyst (202/
452-3054), Division of Banking
Supervision and Regulation, Board of
Governors., o r}. Virgil Mattingly,
Deputy General Counsel (202/452-3430),
or Michael J. O’Rourke, Senior Attorney
(202/452-3288), Legal Division, Board of
Governors; or Andrew Spindler, Vice
President (212/720-5846), Betsy B.
White, Vice President (212/720-5874),
Donald E. Schmid, Manager (212/7200611), or Jeffrey Bardos, Bank
Supervision Specialist (212/720-7882),
Federal Reserve Bank of New York. For
the hearing impaired only,
Telecommunication Device for the Deaf,
Eamestine Hill or Dorothea Thompson
(202/452-3544).
FDIC: Stephen G. Pfeifer, Examination
Specialist (202/898-6894) or Robert F.
Miailovich, Associate Director (202/8988918) Division of Bank Supervision; or
Claude A. Rollin, Attorney, Legal
Division (202/898-3985). Federal Deposit
Insurance Corporation, 55017th Street
NW., Washington, DC 20429.
I. Supplementary Information and
Background
The Purpose o f the Risk-Based Capital
Proposal
In 1986, the Federal banking agencies
Issued for public comment a risk-based
capital proposal applicable to U.S.
banks and bank holding companies. The
principal objectives of this early
proposal, as well as subsequent
proposals, were: (1) To develop more
systematic procedures for factoring onand off-balance sheet risks into
supervisory assessments of capital
adequacy; and (2) to foster coordination
among supervisory authorities from
major industrial countries, many of
which employ risk-sensitive capital
measures.
The risk-based capital proposal was
consistent with one of the major goals of
the International Lending Supervision
FeafessiS E©gist©ff / Vol. 53, No. SO / Tuesday, M arch 15, 1988 / Proposed Rules
Act of 1983, which was to strengthen the framework was endorsed by the Group
bank regulatory framework by
of Ten central bank governors and
encouraging greater coordination among recommended to each of the countries
regulatory authorities in different
represented on the Basle Supervisors’
countries, in addition to enhancing the
Committee as a basis for seeking
Federal banking agendas* authority to
comment on a risk-based capital
establish ®nd enforce minimum levels of adequacy measure applicable to
capital for U«S. banking organisations,
international banking organizations in
this Act instructed the Federal banking
the major industrial countries.
agencies to work with governments,
The risk-based capital guidelines
central banks, and regulatory authorities described in sections II through V of this
of other major countries to maintain
joint Notice constitute a proposal for
and, where necessary, strengthen die
applying the Basle capital framework to
capital positions of banking institutions
U.S. banking organizations. The text of
involved in international lending.
each Federal banking agency’s proposed
In 1987, the Federal banking agencies,
guidelines is attached to this Notice. The
in conjunction with the Bank of England, guidelines for national banks were
issued a revised risk-based capital
developed by the OOC, the guidelines
proposal ("U.S./UJC. proposal" or
for state-chartered non-member banks
“measure”! Shat would apply to U.S. and by the FDIC, and the guidelines for state
U.K. banking organizations.1 lik e the
member banks and bank holding
1986 proposal, a principal objective of
companies by the Federal Reserve. The
the U.S./U.K. measure was to promote
Federal banking agencies are seeking
the convergence of supervisory policies - comment on these risk-based capital
on capital adequacy assessments among guidelines which supersede the U.S./
countries with major banking centers. In U.K. proposal.
issuing the proposal, U.S. and UJC
The current proposal achieves the
supervisory authorities expressed the
principal objectives the Agencies have
hope that it would provide a reasonable
sought in connection with their previous
basis for working with other countries to proposals. In particular, the proposal
achieve a more consistent international
establishes a systematic analytical
framework for assessing capital
framework that: (1) Makes regulatory
adequacy.
capital requirements more sensitive to
The Federal basids^ agencies
differences in risk profiles among
deferred action on the U.S./U.K.
banking organizations: (2] takes offproposal in order to participate in the
balance sheet exposures into explicit
development of a snore broadly-based
account in assessing capital adequacy;
capital framework that would be
and (3) minimises disincentives to
applicable to international banking
holding liquid, low-risk assets.
organizations from the major iafctsteial
The development ©f a risk-based
' countries. The revised capital proposal . framework in conjunction with
described in this Bfefee ®f Proposed
■supervisory officials from other
Guidelines is based upon a risk-based
industrial countries acknowledges the
capital framework ("Basis capital
growing internationalization of major
framework"] developed by the Basle
banking and financial markets
Committee <m Banking Regulations and
throughout the world. The
Supervisory Practices ("Basle
harmonization and strengthening of
Supervisors’ Committee”).2 Officials
capital standards woridwide should
from each of the Federal banking
contribute to a more stable arsd resilient
agencies are members of the Basle
international banking system and help
Supervisors’ Committee aad have
mitigate a source of competitive
played an active role in the development inequality for international banks
of the Baste capital framework,3 Ib is
stemming from differences In national
smpsrvisory requirement,
1©a Mssscti 38, ass?. SiBSosrd, together wf& f e
In. addition t® international banks, &
Bank of England, oka feessda froposad to
Federal banking agencies ar© proposing
incorporate counterparty credit risks stemming from to extend the application o f the riskinterest rate and foreign exchange Tate contracts
based capital framework to all otter
into the pssgcsei U .SJU X . tMc^based cspiteS
U.S. banking organizations, regardless
a Tibsifeste-Sugsemesra’-SsEsi-ilte-e onsists of
of size. Although the Agendas rsco^psse
representatives of the central banks and
the weed to minimize the additional ■■
supervisory authorities from the Group «f T<sa
reporting and bookkeeping burden that
JE3Esafe) i®g&ghGi €esria, Steam, CssEssy. fely.
the risk-based capital framework mayJapm, M etekidk, fevotia. M
IMtesl fMafeaf!, SssSsE^md, and ikE^sffibEa^.
impose ©n small banks, the underlying
®Tfte®g3fei8255®tetfe3fi3^s^i8d3£sr!3d Isi a
rationale behisid the ms® of a risk-based
consultsi^ ea
% th e Stesfc
Superarajo' GosessSKsb essd sssssd fsa riy % Ska
F e d ^ ^ banki^agcs^ss^aD ^etnbsr'IO.tOSS'. A •
copy of tbe$3psreis&&e jafcaS press Kiissss are
available ttpcm request fro® tSe iFetferal fcaskf^g
agencies.
8551
capital approach applies to small
domestic banking institutions as well as
large international banking
organizations.
This proposal consists of a definition
of capital, a system for assigning assets
and off-balance sheet items to risk
categories, and a schedule for
establishing minimum supervisory
standards. The current proposal also
provides for transitional arrangements
and a phase-in period to facilitate
adoption and implementation of the
measure. Each of these areas is
described in greater detail in sections II
through ¥ below. Following is a brief
overview of the Basle capital framework
and a discussion of how the proposal, as
it applies to U.S. banking organizations,
relates to previous proposals.
Overview o f the Basle Capital
Framework
The framework, as already noted,
comprises four broad aspects:
(1) A common international definition
of core or Tier 1 capital (consisting of
common stockholders’ equity), and a
“menu” of internationally-accepted non
common equity items for supplementing
core capital (supplementary or Tier 2
capital components). The proposal
affords national supervisors a degree of
latitude, within prescribed parameters,
for determining which supplementary
components will qualify as capital.
(2) A general framework for assigning
assets and off-balance sheet items to
five broad risk categories (0,10,20, 50
and 100 percent) and procedures for
calculating a risk-based capital ratio.
(3) A schedule for achieving a
minimum risk-based capital ratio by the
end of 1990 of 7.25 percent (of which at
least 3.25 percentage points should be in
the form of common stockholders’
equity) and, by the end of 1992,8.0
percent (of which at least 4.0 percentage
points should be in the form of common
stockholders’ equity).
(4) Transitional arrangements and a
phase-in period (running through the end
of 1992) permitting banking
organizations to include some
supplementary items in core capital on a
temporary basis and providing time to
bring their capital positions into full
cossformity with the risk-based capital
definitions and minimum supervisory
standards.
fa setting out a system for measuring
and assessing capital adequacy, the
Basle capital framework does not
mandate a completely uniform streetere
to be employed -by all countries. Ratter,
the framework attempts t© recognise
and accommodate, within prescribed
limits, unique features of individual
§552
F ederal R egister / Vol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
countries arising from differences in
basic accounting procedures, in the
structure and evolution of banking and
financial markets, and in fundamental
supervisory methodologies and
techniques. While not eliminating these
differences, the Basle capital framework
nonetheless represents a significant step
toward the adoption of more consistent
international procedures for measuring
and evaluating capital adequacy in
relation to a broadly-accepted
international norm.
The Basle capital framework focuses
principally on broad categories of credit
risk, although it does provide latitude to
national supervisory authorities to take
into account interest rate risk associated
with certain assets in assigning them to
risk categories. The measure does not,
however, take account of other factors
that can affect an organization's
financial condition, such as overall
interest rate exposure; liquidity, funding
and market risks; the quality and level
of earnings; investment or loan portfolio
concentrations; the quality of loans and
investments; the effectiveness of loan
and investment policies; and
management’s overall ability to monitor
and control other financial and
operating risks. A final assessment of
capital adequacy must take account of
each of these considerations, including,
in particular, the level and severity of
problem and classified assets. Thus, the
risk-based capital ratio is but one
element in the assessment of capital
adequacy, and the final supervisory
judgment on an organization’s capital
adequacy may differ significantly from
conclusions that might be drawn solely
from the absolute level of the
organization’s risk-based Capital ratio.
The definitions and provisions of the
Basle capital framework, including the
definitions of supplementary capital
components, the provisions for assigning
assets to risk categories, and the interim
and final ratio standards, would
establish minimum supervisory
guidelines and standards. Supervisory
authorities in each country would be
responsible for determining how the
risk-based framework would apply to
organizations in that country, including
whether considerations of safety and
soundness or other factors, such as
national accounting procedures, justify .
departures from the Basle framework.
Such departures could involve the
establishment of definitional guidelines
or capital standards that are higher or
more restrictive than those incorporated
in the proposed Basle capital
framework.
Relationship o f the Current Proposal to
the Previous Proposal
The current risk-based capital
measure, based upon the Basle capital
framework, is similar to the previous
U.S./U.K. proposal in a number of
respects.
First, the general nature and
construction of the current proposal
broadly parallel the U.S./U.K. measure.
The current proposal takes the form of
supervisory guidelines rather than a
formal regulation. Under the current
proposal, an organization’s risk-based
capital ratio would continue to be
determined by dividing its capital base
by the sum of its weighted risk assets.
The proposal defines capital to include
core components, generally on an
unlimited basis, and other
supplementary elements, subject to
certain prudential limitations. Weighted
risk assets are determined by assigning
assets and credit equivalent amounts of
off-balance sheet items to one of five
risk categories (0,10, 20, 50 and 100
percent, based primarily upon broad
judgments of relative credit risk. (An
illustration of how the proposed ratio
would be calculated is contained in
Table I.)
Second, with the exception of some
important, differences noted below, the
general treatment accorded many assets
and off-balance sheet items in the
current proposal is broadly similar to
that of the U.S./U.K. proposal. As under
that earlier proposal, all short-term
claims on banks, both foreign and
domestic, would be given identical lowrisk treatment in recognition of the role
of interbank funding markets as an
important source of liquidity. With
respect to sovereign transfer risk, the
proposal generally opts for limiting lowrisk treatment to domestic central
governments. Claims by U.S. banking
organizations on any foreign
government involving an element of
transfer risk, without distinguishing
among countries, would be placed in the
standard (100 percent) risk category.
Third, like the U.S./U.K. measure, this
proposal also recognizes that the
calculation of a risk-based capital ratio
is but one step in the evaluation of an
organization’s overall capital adequacy.
Many other factors and risk
considerations must be taken into
account before a final judgment on an
organization’s capital adequacy can be
rendered. In this regard, the current riskbased capital proposal provides that,
initially, the Federal banking agencies
will continue to utilize their existing
ratios of primary and total capital to
total assets (leverage ratios).
Fourth, as was contemplated but not
specified in the U.S./U.K. measure, the
current proposal establishes a schedule
for achieving a minimum ratio of capital
(as defined in the proposal) to weighted
risk assets. Banking organizations,
under the revised proposal, would
generally be encouraged to operate
above the minimum risk-based ratio.
Fifth, the Federal banking agencies
intend to apply the proposed minimum
risk-based capital measure to all
banking organizations that they
supervise.4 As discussed in greater
detail in Section V below, however,
initial implementation efforts would
generally be directed toward large
international organizations. Moreover,
steps would be taken to minimize any
additional reporting or recordkeeping
burden associated with adoption of the
risk-based capital standard, especially
for smaller institutions.
Sixth, the revised proposal
incorporates explicit procedures for
factoring off-balance sheet risks into the
risk-based capital framework. As in the
U.S./U.K. proposal, the current proposal
first applies credit conversion factors to
the face value, or notional principal,
amounts of off-balance sheet exposures
and then assigns the resulting credit
equivalent amounts to the appropriate
risk category in a manner generally
similar to balance sheet assets. With
respect to the treatment of counterparty
credit risks associated with interest rate
and foreign exchange rate contracts, the
current proposal (as it applies to U.S.
banking organizations) adopts a
simplified version of the approach taken
in the U.S./U.K. proposal.
The current risk-based capital
proposal differs in some respects from
the U.S./U.K;. measure, as well as from
existing capital policies. These
differences have resulted primarily from
further consideration of key issues in
light of discussions with banking
supervisors in other countries and
comments received in response to
earlier risk-based capital proposals.
Following is a brief review of the
principal differences between the
current risk-based capital proposal and
the earlier U.S./U.K. measure.
First, while the current proposal, like
the U.S./U.K. measure, defines the
capital structure to comprise two basic
components (core and supplementary1
4 The risk-based capital guidelines w ould apply to
ban k holding com panies w ith less than $150 million
in consolidated a sse ts on a bank-only b asis unless:
(1) The holding com pany or any nonbank subsidiary
is engaged directly or indirectly in any nonbank
activity involving significant leverage or (2) the
holding com pany or any nonbank subsidiary h a s
outstanding d ebt held by the general public.
F ederal Register / V ol. 53, N o.
capital^ She cast-rent proposal provides
that, after tfestransition ported, c©r<e
capital is to be comprised solely qf
common ^faackholders’ equity findudfag
respited earnings} .and minority interest
in the common equity accounts of
consolidated subsidiaries.5 This is in
contrast to the Federal baakfag
agencies’present definition of primary
capital which includes both common
apdpejp^nal preferred stock, the
aiw w anceiw feran and lease fosses, and
mandatory convertible debt insifmnents.
The .current praspasai also differs from
tjhs UjS ./1JJC proposal whidfe iaskdsti
the allowance for team' and tease losses
(general tea s less reserves iia the UJC)
in h sse capital aioag with esm m on
stockholders" equity.
.
sssepiaesaent that ©ere c a r t e l
(Tier 1) ttaaM adtietatiefy fee made
exclusively ©f common stockholders’
equity is mat fiaeamt to s a f e s t te S other
eteiissife ©£capital, ®mda as fp^rpetaal
preferred stock, saaiEdafory convertible
teC«tt**es, ihealowiance for loan and .
lease losses, a®d subordinated debt do.
not impaat faiporterat strengths to an
organization’s capital position, Indeed,
these items continue to be included in
capital, under appropriate .camditionSo
within the supplementary components.
Rathsritbg predoiiiimant role afforded
coraanon s-ijackholders’ equity reflects
the fact that this dement provides
maximum strength and ifoxibffily to a
banking organisation experiencing
losses or other financial pressures. For
this reason, International supervisors
reached a consensus that a minimum
level of common stockholders’ equity ■
should serve as the foundation o f a
bank’s capital base. .
A second difference relates to the
treatment of the allowance for lean and
lease losses as a component of capital.
The Basle framework assigns genera!
loan loss reserves—defeted, as reserves
not attributed to, ot earmarked for,
specific assets and riot representing a
reduction in the value of particular
assets—to supplementary elements of
espial (Tie *?2}. I t also phases fa a
limitation on valuation reserves ° (that
is, hgsm loss reserves that represent
*aluaH*M adjustments fer groups of
assets m latent bat unidentified fosses
ipberent m the balance sheet). After the
Iranajlios period, these reserves, as an
element nf ©apifal, saay ©offistifate no
*0«fiRg fee tiaasilion period, as described in
^523l2?dsteiS in .Section Vbdow, non-cammon
80<sjij/-compeseats smy he included in core capital
asdsTfigsteis? conditions that call for Ahekphaseout
ijato.aMpplesi2aiary capital overlime.
*itetfe<^£V&.;/UJ£. msa dobsand ike ®aeb
capite-S k s s g s s m s k eisckide Irosn capita! allocated
reserves retEiSSsatit*® Identified .lasses a n (Sgtedfic
stssets.
50 J
T u esd a y , M arch 15,
more than 1.25 percent of weighted risk
assets within the supplementary
compoasefas.
In practice, it is very difficult to
distinguish between the portion of loan
loss reserves that is'freely available to
absorb future losses within the portfolio
and the portion that, in reality, may
reflect present or imminent losses,
perhaps in amounts as yet mnquantified,
on existing problem or troubled loans.
Thus, the Federal banking agencies
propose to limit the inclusion o f the
allowance for loan and lease losses, as
an element of capital, to no more than
1,25 percent of weighted risk assets
within the supplementarycomponents.7
This limitation represents an effort to
balance the present supervisory policy
©f including the allowance for loan
loss® in regulatory capital with the
need to minimize the possibility that
reserves reflecting a high level of
problem loans will play a prominent role
in an organization’s capital base. The
effect of tlie limitation is to bring the
proportion of regulatory capital that may
consist of the allowance for loan losses
more broadly into line with the
percentage role it played in bank capital
generally in the years prior to 1987. The
Federal banking agencies will continue
to work together, amd with banking
authorities fa other, countries, to ensure
over time that only reserves that are
freely available t© absorb future losses
qualify for inclusion in regulatory
capital.
. A third major difference from the
U.S./U.K. proposal relates to the
treatment of certain intangible assets.
While the current risk-based proposal,
like the U.S./U.K. measure, provides for
the deduction of goodwill from capital,89
other identifiable intangible assets, such
as purchased mortgage servicing nights,
would not necessarily be deducted in
calculating the risk-based capital ratio.
Rather, these identifiable intangibles
would be treated in accordance with
each Federal banking agency’s policies
and practices as set forth in their
respective proposed guidelines.®
7 C onsistent w ith the Basle capita! Era me work,
the Federal banking agencies are also proposing a n
interim lim itation on the allow ance for loan to sses
in capital. By -fee -e-rxil o f nS90, the aWowanoe for loan
lc o s s , a s a n ale-men t -ef capital, w ould b e idmated t@
1.5 percent o f w eighted risk a sse ts m ithto Tier 2. No
limit is being proposed on the role o flo a n loss
reserv es in capital fo r fhe initial p h a se of the
tran sition period.
s E ach of the F ederal banking agencies m ay
‘''grandfather'" goodwill to certain in stitutions -under
their individual jurisdiction in accordance with
term s a n d conditions spelled out in their respective
frroposed guidelines.
9 U nder current regulatory policy, th e Federal
R eserve gensraMy e v a lu a te s -identii&aMe intaEgabte
a s s e ts o s a © ase-by-caae b a s is and m akes
1908
/ P io p o ^ d . Rui.es
eiss
Fourth, anofaer significant change in
the current proposal is the role for
straight term subordinated debt, which
was not included in the U.S./U.K.
capital definition and which plays only
a very limited role in the Federal
banking agencies’ current definition of
total capital Subordinated debt at the
bank levelhelps to protect both
depositoxs and .the Fede ral dep osi t
insurance fund. At the holding company
level, subordinated debt provides a
cushion t© senior creditors, thereby
tending to promote funding stability.
Issuance of subordinated debt jn
prudent amounts can also enhance the .
role of market forces in disciplining the
affaire of banking organizations. Under
the current risk-based proposal, term
subordinated debt, together with
intermediate-term limited-life preferred
stock, may be included in
supplementary capital up to an amount
equal to 50 percent of core capital
Fifth, the risk-weighting framework of
the revised proposal, as applied to U.S.
banking organizations, provides for a
number of changes from the U.S./U JC
proposal, fa particular, under the revised
proposal, the major changes include:
—Securities issued by the U.S.
Government or its Agencies (defined
as agencies whose obligations are
explicitly guaranteed by the U.S.
Government! with remaining
maturities of .91 days -or less will be
assigned to the zero percent risk
category, rather than to the 10 percent
category.
—All -other US;. Government and
, Agency obligations -will be assigned to
the 10 percent risk category, rather
than assigning securities with
maturities o f under one year to the 10
percent category and securities with
maturities ©foyer one year to the next
higher risk category, (Portions of loans
and other assets guaranteed by -the
ILLS. Government or its Agencies, or
portions of loans collateralized by
cash or U,S. Government ©r Agency
debt, will also be assigned to the 10
percent risk categoryj.
—The weight of the category for short
term interbank claims has been
reduced from 25 to 20 percent,
©©during, at the same time, the risk
weight for other assets .assigned to
this category, fa addition, this
appropriate adjustm ents When the level o r recorded
value o f these intangibles ie .maon si stent wi th .the
•argam zatiaa's o verall ftoantia-l carrditton. The only
form -of id entifiable intangible a sse ts currently
perm itted For state non-m em ber .and national banks
by the FD1C and-OCC, respectively, are purchased
(mortgage servicing rights, with other in tangibles
cossirierad f a r andetsion only on a case-by-case
U S '!
______ F©d©ral E ggister / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
category also now includes long-term
claims on domestic, but not foreign,
depository institutions.
-r-The risk weight for securities issued
by U.S. Govemment-sponsoned
Agencies (defined as agencies
established by the U.S. Congress to
serve public purposes and whose debt
obligations are not explicitly
guaranteed by the U.S. Government}
and general obligations of U.S. local
governments (defined as debt
explicitly backed by the full faith and
credit of the taxing authority of U.S.
states, counties, or municipalities) has
been reduced from 50 percent to 20
percent.
_
—The effective risk weight for short*
j : term commitments has been reduced
to 0 percent, and unused retail credit
card lines unconditionally cancellable
by the bank at any time have been
defined to be short-term
commitments.
—The credit conversion factor for short
term, self-liquidating trade-related
contingencies, such as commercial
letters of credit, has been reduced
from 50 percent to 20 percent.
—Portions of assets guaranteed by, or
backed by the full faith and credit of,
domestic depository institutions will
be assigned to the risk category of the
guarantor (20 percent).
— The procedures for determining
capital requirements for interest rate
swaps and foreign exchange contracts
have been simplified and the capital
requirements have been reduced.
—The assignment of claims on foreign
banks to risk categories is based upon
original rather than remaining
maturity. (In addition, like t|ie U.S./
U.K. proposal, the assignment of
commitments to risk categories is also
based upon original maturity.)
In general, most of the changes made to
the proposed risk asset framework
result in lower effective risk weightings.
These changes were made in light of
public comments received on previous
proposals and to facilitate international
_ convergence by bringing the Federal
banking agencies’ risk-based capital
proposal into alignment with the Basle
capital framework.
Finally, the current proposal sets an
explicit schedule for achieving a
minimum level of capital to weighted
risk assets by the end of the transition
period. The proposal establishes an
interim target risk-based ratio by the
end of 1990 of 7.25 percent (of which 3.25
percentage points must be in the form of
comm©® stockholders’ equity) and a
minimum standard by the end of 1992 of
8 percent (of which at least one-half, or
4 percentage points, must be in the form
of common stockholders’ equity). While
the current proposal establishes no
initial standard, banking organizations
with ratios below the interim and final
supervisory minimums are generally
expected to avoid further reductions in
their capital positions and should adopt
plans and take steps to bring their
capital positions into compliance with
the risk-based minimums as soon as
reasonably possible.
II. Proposed Definition of Capital
In accordance with the Basle capital
framework, the Federal banking
agencies propose a risk-based capital
ratio that relates an institution’s
qualifying capital base (the numerator of
the ratio) to its weighted risk assets (the
denominator). An institution’s qualifying
capital base consists of two types of
capital elements: “core capital
elements” (Tier 1) and “supplementary
capital elements” (Tier 2). These capital
elements and the various limits,
restrictions, and deductions to which
they are subject are discussed below.
The Components o f Qualifying Capital
1. Core Capital Elements (Tier 1)
Core capital elements consist of:
—Common stockholders’ equity
(common stockholders’ equity
includes common stock, surplus, and
retained earnings, including disclosed
capital reserves that represent an
appropriation of retained earnings);
—Minority interest in the common
stockholders’ equity accounts of
consolidated subsidiaries; and,
—Supplementary capital elements
(during a transitional period only and
subject to limitations set forth below
in Section V under “Transition and
Implementing Arrangements”).
At least 50 percent of the total
qualifying capital base (Tier 1 plus Tier
2) of a banking organization must
consist of core capital (Tier 1). Core
capital is defined as the sum of core
capital elements minus goodwill and
other disallowed intangible assets. A
detailed discussion of each Agency’s
treatment of goodwill and other
intangibles is contained in the
respective Agency’s proposed riskbased capital guidelines. Arrangements
for calculating the risk-based capital
ratio during the transitional period are
discussed in Section V below.
2. Supplementary Capital Elements (Tier
2)
A portion of an institution’s qualifying
capital base may consist of
supplementary capital elements.
Supplementary capital elements include:
—Allowance for loan and lease losses
(subject to limitations discussed
below);
—Perpetual and long-term preferred
stock (original maturity of at least 20
years);
—Hybrid capital instruments, including
perpetual debt and mandatory
convertible securities; and,
—Subordinated debt and intermediateterm preferred stock (original average
maturity of seven years or more).
The maximum amount of
supplementary components that may be
treated as capital for regulatory
purposes would be limited to 100
percent of core capital. In addition, tne
combined amount of subordinated debt
and intermediate-term preferred stock
that may be treated as capital for
regulatory purposes would be limited to
50 percent of core capital. Amounts in
excess of these limits may, of course, be
issued and, while not included in the
ratio calculation, would be taken into
account in the overall assessment of an
organization’s funding and capital
adequacy.
The Basle capital framework also
provides for the inclusion of
“revaluation reserves” as an element of
supplementary capital at the discretion
of national supervisory authorities.10
These items, as well as the other
components of supplementary capital,
are discussed in greater detail below.
Allowance for loan and lease losses.
Allowances for loan and lease losses
that have been established through a
charge against earnings to absorb future
losses on loans or lease financing
receivables are included within the
meaning of general reserves, which the
Basle capital framework assigns to Tier
2. Allowances for loan and lease losses
exclude “allocated transfer risk
reserves.” Allocated transfer risk
reserves are reserves that have been
established in accordance with section
10 The Basle capital fram ew ork also provides for
the inclusion of “undisclosed re serv es” in Tier 2. As
defined in the Basle A greem ent, undisclosed
reserves represent accum ulated after-tax retained
earnings th a t are not disclosed on the b alan ce sheet
of a bank. A part from the fact th a t these reserves
are not disclosed publicly, they are essentially of
the sam e quality and ch arac te r as retain ed earnings,
and, to be included in capital, such reserves m ust be
accepted by the banking organization’s home
supervisor. A lthough such undisclosed reserves are
com m on in som e countries, under generally
accepted accounting principles a nd long-standing
supervisory practice, these types of reserves are not
recognized for banks a nd bank holding com panies
in the U nited States. Foreign banking organizations
seeking to m ake acquisitions or conduct b usiness in
the U nited S tates w ould be expected to disclose
publicly a t least the degree of reliance on such
reserves in m eeting supervisory capital
requirem ents.
Federal R egister / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P ro p o sed R ules
905(a) of the International Lending
Supervision Act of 1983 against certain
assets whose value has been found by
the U.S. supervisory authorities to have
been significantly impaired by
protracted transfer risk problems.
Allowances for loan and lease losses
also exclude reserves against identified
losses or earmarked for a specified
asset.
As noted above, it is not always
possible to distinguish clearly between
loan loss reserves that are freely
available to absorb future losses within
the portfolio and the portion that, in
reality, may reflect present or imminent
losses on existing problem or troubled
loans. For this reason, the Federal
banking agencies, consistent with the
Basle capital framework, propose a
phasedown during the transition period
of the extent to which allowances for
loan and lease losses may be included
in an institution’s capital base. Initially
no limit will apply to these allowances.
However, at the end of 1990, allowances
for loan and lease losses, as a
component of capital, may constitute no
more than 1.5 percent of weighted risk
assets and, at the end of 1992 and
thereafter, no more than 1.25 percent of
risk weighted assets.
Perpetual and long-term referred
stock. Perpetual preferred stock is
defined as preferred stock without a
fixed maturity date and that cannot be
redeemed at the option of the holder.
Long-term preferred stock includes
limited-life preferred stock with an
original maturity of 20 years or more.
These preferred stock instruments
would qualify for inclusion in capital
provided that they can absorb losses
while the issuer operates as a going
concern (a fundamental characteristic of
equity capital) and provided the issuer
has the option to defer preferred
dividends if dividends on common stock
are eliminated. Given these conditions
and the perpetual or long-term nature of
the instruments, there is no limit on the
amount of these instruments that may
be included within Tier 2 capital.
Hybrid capital instruments. Hybrid
capital instruments include long-term
debt instruments that generally meet the
requirements set forth below:
(1) The instrument must be unsecured;
fully paid-up; and subordinated to
general creditors and, if issued by a
bank, also to depositors.
(2) The instrument must not be
redeemable at the option of the holder
prior to maturity, except with the prior
approval of the banking organization’s
primary Federal regulator.
(3) The instrument must be available
to participate in losses while the issuer
is operating as a going concern. (Straight
term subordinated debt would not meet
this requirement). To satisfy this
requirement, the instrument must
convert to common stock or perpetual or
long-term preferred stock in the event
that the sum of the retained earnings
and capital surplus accounts of the
issuer shows a negative balance.
(4)
The instrument must provide the
option for the issuer to defer interest
payments if: (a) The issuer does not
report a profit in the preceding annual
period (defined as combined profits forthe most recent four quarters) and (b)
the issuer eliminates cash dividends on
common and preferred stock. (This
provision is intended to provide the
issuer with the option of mitigating the
burden associated with interest
payments during a period of severe
financial stress.)
In addition to hybrid capital
instruments meeting the above
conditions, mandatory convertible
securities that meet the current criteria
for such instruments specified by the
banking organization’s primary Federal
regulatory authority 11 or that have been
previously approved as capital would
also be treated as qualifying hybrid
capital instruments under the proposal.
During the transition period, the Federal
banking agencies will review the criteria
for mandatory convertible securities in
light of the definitions contained in the
Basle capital framework. As a result of
this review, the agencies may modify the
mandatory convertible criteria as part of
their overall effort to implement the riskbased capital framework,
There is no limit on the amount of
hybrid capital instruments and
mandatory convertible securities that
may be included within Tier 2 capital.
Subordinated debt and intermediateterm preferred stock. The aggregate
amount of subordinated debt arid
intermediate-term preferred stock that
may be treated as capital for risk-based
capital purposes is limited to 50 percent
of core capital. Subordinated debt and
intermediate-term preferred stock must
have an original average maturity of at
least seven years to qualify as
supplementary capital.1112*In the case of
11 C riteria for instrum ents issued by state
m em ber banks and bank holding com panies are set
forth in 12 CFR Part 225, A ppendix A; those for
national b a n k s are set forth in 12 CFR 3.100(e)(5);
an d those for state non-m em ber banks a re set forth
in 12 CFR 325.2(e).
12 U nsecured d ebt issued by bank holding
com panies prior to M arch 12,1988, and qualifying as
capital at the time of issuance, w ould continue to
qualify as capital under the risk-based fram ew ork,
subject to the 50 percent of core capital lim itation.
Bank holding com pany term debt issued after this
d ate m ust be subordinated in order to qualify as
capital.
subordinated debt, the instrument must
be urisecured and must clearly state on
its face that it is not a deposit and is not
insured by the Federal Deposit
Insurance Corporation. To qualify as
capitaHn banks, debt must be
subordinated to depositors and general
creditors; in bank holding companies,
debt must be subordinated in right of
payment to all senior indebtedness of
the issuer. ;.,V
^
Discount o f supplementary capital
instruments. As a limited-life capital
instrument approaches maturity-it
begins to take on characteristics of a
short-term obligation and becomes less
like a component of capital. For this
reason, the outstanding amount of term
subordinated debt and long- and "
intermediate-term limited-life preferred
stock eligible for inclusion in Tier 2
would be adjusted downward, or
discounted, as it approaches maturity.
All such instruments would he
discounted by reducing the outstanding
amount of the capital instrument that
would count as supplementary capital
by a fifth of the original amount (less
redemptions) each year during the
instrument’s last five years before
maturity. Such instruments, -therefore,
would have no capital value when they
have a maturity of less than a year.
Revaluation reserves. Revaluation
reserves include "formal revaluation ;
reserves” and "latent revaluation
reserves.” Formal revaluation reserves
are created through a formal adjustment,
or restatement, of the amount at which
fixed assets are recorded on the balance
sheet to reflect a change in the market
value of the assets. Such reserves are
recognized as capital in some countries,
notably Great Britain, where banks are
permitted periodically to revalue their
own premises. Latent revaluation
reserves are hidden values (that is,
values that are not formally recorded on
the balance sheet) that reflect
unrealized capital appreciation on long
term holdings of equity securities. These
reserves are defined as the difference
between the current market value of the
securities and the carrying value of the >
securities based on historic cost i n
some countries, notably Japan, sudh .
revaluation reserves are substantial.
In the United States, banking
organizations for the most part follow
generally accepted accounting principles
(GAAP) when preparing their financial
statements, and GAAP generally does
not permit the use o f market-value
accounting. Consistent with this
approach, the Federal banking agencies
have not included unrealized asset,
values in capital ratio calculations,
although such values have long been *
S5S©
F ed eral R egister / V ol. 53, N o . 50 / Tuesday* M arch 15, 1988 / P ro p o sed R u les
taken into account in assessing an
organization’s overall financial health.
In addition to the fact that U.S.
accounting procedures have not
traditionally recognized revaluation
reserves, the uncertainty and volatility
that may be associated with the market
values of securities and buildings may
be viewed as inconsistent with the
emphasis on capital as a reliable and
determinable source of strength when
an organization is experiencing financial
adversity.
In light of these considerations, the
equivalent of revaluation reserves for
U.S. banking organizations will not be
formally recognized in supplementary
capital or in the calculation of the riskbased capital ratio. However, all
banking organizations are encouraged to
disclose publicly their equivalent of
premises and equity revaluation
reserves, and such values will be taken
into account as additional factors in
assessing overall capital adequacy and
financial condition. For example, other
things being equal, organizations with
significant and reliable revaluation
reserves may be permitted to operate
closer to the minimum risk-based capital
ratio than organizations without such
unrealized gains.
banks will be deducted from Tier 1
capital immediately*1415
Undercurrent policies, bank holding
company goodwill is. not deducted
automatically from capital for general supervisory purposes. Thus, goodwill
acquired by holding companies prior to
March 12,1988, would be
“grandfathered” during the transition
period (until the end of 1982). Any
goodwill acquired after March 12,1988,
and all goodwill (including previously
grandfathered goodwill) would be
deducted from Tier 1 capital after 1992.
The Federal banking agencies’
policies regarding other-identifiable
intangible assets are discussed in detail
in the Agencies’ respective proposed
risk-based capital guidelines.
As a general rule, the Federal banking
agencies believe that banking
organizations should maintain strong
tangible core capital bases in relation to
weighted risk assets. Banking
organizations that seek to expand
significantly, either through internal
growth or acquisition, will be expected
to maintain capital positions that are
above minimum supervisory levels, or
otherwise acceptable to their primary
Federal regulator, without undue
reliance on intangible assets.
Deductions from capital and other
adjustments. Certain assets would be
Any equity or debt capital investments
in banking or finance subsidiaries that
are not consolidated under regulatory
reporting requirements 19 would be
deducted from an organization’s total
capital base (i.e., the sum of core capital
and supplementary capital elements).16
For this purpose, a subsidiary generally
is defined as any banking or finance
company in which the reporting
institution holds more than 50 percent of
the outstanding common stock. The
assets of unconsolidated subsidiaries
are not fully reflected in a banking
organization’s consolidated total assets.
Such assets may be viewed as the
equivalent of off-balance sheet
exposures since the operations of an
unconsolidated subsidiary could expose
the parent organization and its
consolidated subsidiaries to
deducted from a banking organization’s
capital base for the purpose of
calculating the numerator of the riskbased capital ratio.13 These assets
include:
(1) Goodwill and other disallowed
intangibles—deducted from Tier 1;
(2) Capital investments in
unconsolidated banking and finance
subsidiaries and, on a case-by-case
basis, other subsidiaries or associated
companies at the discretion of the
supervisory authority—deducted from
the sum of Tier 1 and Tier 2; and
(3) Reciprocal holdings of capital
instruments of banking organizations—
deducted from the sum of Tier 1 and
Tier 2.
Goodwill and other intangible assets.
Goodwill is an intangible asset that
represents the excess of the purchase
price over the fair market value of net
assets acquired in acquisitions
accounted for under the purchase
method of accounting. Because banks
generally may not include goodwill in
regulatory capital under current
supervisory policies, all goodwill in
13
Any deductions-m ade against cap ital in
com puting the num erator of the ratio w ould also be
d educted from the ap p ro p riate a sse t categories in
computing the denom inator of the ratio.
Investments in certain subsidiaries.
14 G oodw ill acquired by banks in connection w ith
supervisory m ergers w ould continue to be included
in cap ital for risk-based capital purposes under
term s a nd conditions e stablished by the banking
organization’s prim ary Federal regulator. O ther
previously perm itted goodw ill w ould not be
d ed ucted from T ier 1 cap ital until y ear Mid 1992.
15 The requirem ents for consolidation are spelled
out in the instructions to the bank C onsolidated
R eports of C ondition a n d Incom e a nd the
C onsolidated Bank H olding Com pany FR Y-9
Report.
ia A n exception to this deduction w ould be m ade
in the c ase of shares acquired in the regular course
of securing or collecting a debt previously
co ntracted in good faith.
considerable risk. For this reason* it is
appropriate to view the capital invested
in these entities as primarily supporting
the risks inherent in these off-balance sheet assets, and not generally available
to support risks or additional leverage
elsewhere in the organization.
As a general rule, U.S. banking
organizations do not have
unconsolidated subsidiaries engaged in
banking or finance since generally
accepted accounting principles normally
require the consolidation of such
entities. Aside from these entities, the
deduction of equity arid debt capital
investments from the banking
organization’s capital may at some
future date be applied in the case of
other subsidiaries, such as securities
affiliates, if such action were necessary
to facilitate functional regulation j)f
financial service subsidiaries. This
approach may also be applied, on a
case-by-case basis, to certain
consolidated subsidiaries for the
purpose of determining whether the
banking organization meets the capital
standard without reliance on the capital
invested in these subsidiaries. Finally,
the Federal banking agencies may, at a
later date, seek public comment on the
extension of this approach to all
subsidiaries engaged in certain specified
activities for the purpose of assessing
the banking organization’s consolidated
capital position, exclusive of the capital
supporting these activities. In general,
when investments in a subsidiary are
deducted from a banking organization’s
capital, the subsidiary’s assets will also
be excluded from the assets of the
banking organization in order to assess
the latter's capital adequacy.
The Federal banking agencies had
contemplated deducting from capital
investments in all other unconsolidated
subsidiaries (such as those engaged in
businesses other than banking or
finance) as well as investments in joint
ventures and associated companies,
since the rationale set forth above is
also applicable to these entities.17*
Although the Agencies continue to
believe that unconsolidated subsidiaries
and associated companies may pose
special risks for banking organizations,
they have decided not to automatically
deduct such investments from Capital at
this time. Instead, the Agencies intend to
monitor the level and nature of such investments for individual banking
organizations and, on a case-by-case
17
Under regulatory reporting procedures,
associated companies and ioint ventures airs
generally defined as companies in which the
banking organization owns 20 to 50 percent o f1he
voting stock.
F ederal R egister / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
basis, may deduct such investments
from capital or apply an appropriate
risk-weighted capital charge against the
organization’s percentage share of the
assets of these entities.
Reciprocal holdings o f bank capital
instruments. Reciprocal holdings of
capital securities (i.e., capital
instruments that qualify as Tier 1 or Tier
2 capital) would be deducted from the
organizations’ total capital bases for the
purpose of determining the numerator of
the risk-based capital ratio. Reciprocal
holdings are cross-holdings or other
formal or informal arrangements in
which two or more banking
organizations swap, exchange, or
otherwise agree to hold each other’s
capital instruments. Generally, as this
definition implies, deductions would be
limited to intentional cross holdings.
The Federal banking agencies also
considered whether to deduct non
reciprocal holdings of capital securities
issued by other banking organizations
on the grounds that the purchase by one
banking organization of capital
securities issued by another
organization does not represent
additional capital to the banking system.
In addition, such purchases may
increase the interdependency of banking
institutions generally and thus increase
the possibility that problems could be
transmitted from one banking institution
to another. At present, the Agencies are
not proposing to deduct non-reciprocal
holdings of such capital instruments.
Rather, the Agencies intend to monitor
non-reciprocal holdings of other banking
organizations’ capital securities and to
provide information on such holdings to
the Basle Supervisors’ Committee as
called for under the Basle capital
framework.
Table II summarizes the definition of
capital for risk-based capital purposes.
III. Risk Weights for Assets and Off
Balance Sheet Items
Weighted risk assets are determined
by assigning assets and off-balance
sheet credit equivalent amounts to one
of five broad risk categories based
principally on the degree of credit risk
associated with the obligor. The five risk
categories are 0,10, 20, 50, and 100
percent—the latter representing the
standard risk category which contains
most loans to private sector entities.
Table III summarizes the assignment of
assets to risk categories.
In determining weighted risk assets,
the only forms of collateral that are
formally recognized by the risk asset
framework are cash on deposit in the
lending institution; securities issued by,
or guaranteed by, the U.S. Government
or its agencies; and securities issued by,
or guaranteed by, U.S. Governmentsponsored agencies. (See definitions
below.) The only guarantees that are
recognized are guarantees, or guaranteetype instruments, of the U.S.
Government or its agencies, U.S.
Government-sponsored agencies,
domestic state and local governments,
and domestic depository institutions.
While not formally factored into the
ratio, the existence of other forms of
collateral or guarantees would be taken
into account in making an overall
assessment of the risks inherent in an
organization’s loan portfolio. Maturity is
generally not a factor in assigning items
to risk categories with the exceptions of
securities issued by the U.S.
Government or its agencies, claims on
foreign banks, commitments, and
interest rate swaps and foreign
exchange contracts—all of which are
discussed in greater detail below.
The remainder of this section explains
in greater detail the assignm ent^
assets and off-balance sheet items to
risk categories.
R isk Weights for Balance Sheet Assets
Category 1—Zero percent. This
category includes cash (domestic and
foreign) owned and held in all offices of
a bank or in transit; claims on, and
balances due from, Federal Reserve
Banks; and, in light of their near-cash
characteristics, securities issued by the
U.S. Government or its agencies (direct
obligations) with a remaining maturity
of 91 days or less.18 Any foreign
currency held by banks should be
converted into U.S. dollar equivalents at
current exchange rates. Deposit reserves
and other balances at Federal Reserve
Banks are included in Category 1, but
Federal Reserve Bank stock is assigned
to Category 2, and carries a weight of 10
percent.
Category 2—10 percent. This category
includes securities issued by the U.S.
Government or its agencies with a
remaining maturity of over 91 days and
all other claims (including leases) on the
U.S.Government or its agencies.19
18 For this purpose, a U.S. G overnm ent agency is
defined as an instrum entality of the U.S.
G overnm ent w hose obligations are fully and
explicitly guaranteed as to the tim ely repaym ent of
principal and interest by the full faith a n d credit of
the U.S. G overnm ent.
19 Exam ples of U.S. G overnm ent agencies include
the G overnm ent N ational M ortgage A ssociation
(GNMA), the Small Business A dm inistration (SBA),
the V eterans A dm inistration, the Federal H ousing
A dm inistration, the Export-Im port Bank (Exim
Bank), and the O verseas Private Investm ent
C orporation (OPIC).
8S557
While these obligations bear no credit
risk, this treatment is generally
consistent with the latitude afforded by
the Basle capital framework to recognize
some degree of market and interest rate
risk. In addition, all securities and loans
guaranteed by the U.S. Government or
its agencies (including portions of such
assets guaranteed) are also included in
this category. Only that portion of the
loan that is guaranteed by a U.S.
Government agency is to be included in
this category; the remainder is to be
assigned to the risk category otherwise
appropriate to the obligor.
Category 2 also includes portions of
all loans and other assets that are
collateralized by securities issued by, or
guaranteed by, the U.S. Government or
its agencies or by cash on,deposit in the
lending institution. The degree or extent
of collateral backing is based upon the
current market value of the underlying
collateral. Those portions of claims not
secured by recognized collateral would
be assigned to the risk category
otherwise appropriate to the obligor.
The book value of paid-in stock of a
Federal Reserve Bank is also assigned to
Category 2.
Category 3—20percent. The principal
items in this category include short-term
(original maturity of one year or less)
claims on domestic depository
institutions 20 and foreign banks,21
including foreign central banks; cash
items in process of collection; long-term
(original maturity of more than one year)
claims on domestic depository
institutions; 22 and the portions of
20 D om estic depository institutions are defined to
include branches (foreign and dom estic) of banks
and depository institutions chartered and
h ead q u artered in the 50 states of the U nited States,
the D istrict of Columbia, Puerto Rico, and U.S.
territories and possessions. To be included in this
category, depository institutions m ust be federallyinsured. The definition encom passes banks, m utual
or stock savings banks, savings or building and loan
associations, cooperative banks, credit unions,
in ternational banking facilities of dom estic banks,
and U .S.-chartered depository institutions ow ned by
foreigners. H ow ever, this definition excludes both
b ra n c h es and agencies of foreign banks located in
the U.S. and bank holding com panies.
21 Foreign b anks are defined as institutions that
are organized under the law s of a foreign country;
engage in the business of banking; are recognized as
banks by the bank supervisory or m onetary
authorities of the country of their organization or
principal banking operations; receive deposits to a
substan tial extent in the regular course of business;
and have the pow er to accept dem and deposits.
Foreign b anks include U.S. branches and agencies
of foreign banks.
22 C laim s on foreign ban k s w ith an original
m aturity exceeding one y ear and claim s on bank
holding com panies are assigned to Category 5,
w hich carries a w eight of 100 percent.
855i
F ed eral R egister / Vo!. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P ro p o sed R u les
claims guaranteed hy, or backed by the
full faith and credit of, domestic
depository institutions. This category
also includes claims on, or portions of
claims guaranteed by, U.S. Governmentspansored agencies and portions of
claims collateralized by securities
issued by, or guaranteed by, U.S.
Government-sponsored agencies.23 (The
degree of collateralization in this regard
is based upon the market value of the
underlying.collateral.}; In addition, this
category includes general obligation
claims on, or portions of claims
guaranteed by the full faith and credit
of, U.S. state and local governments.
Finally, local currency claims on foreign
central governments to the extent the
bank has local currency liabilities in the
foreign country; 24 and claims on official
multilateral lending institutions or
regional development institutions in
which the U.S. Government is a
shareholder or a contributing member
are also assigned to Category 3.25
Claims on banks and depository
institutions consist of balances due from
such institutions, including demand
deposits and other transaction accounts,
savings deposits, and time certificates of
deposit; and federal funds sold and _
securities purchased under agreements
to resell for which a depository
institution is the counterparty. To the
extent that federal funds and resale
agreements are collateralized by U.S.
Government or agency securities, they
are to be included in Category 2, which
carries a weight of 10 percent.
23 For this purpose, U.S. Government-sponsored
agencies are defined as agencies originally
estab lish ed or chartered by the U.S. G overnm ent to
serve public purposes specified by the U.S.
C ongress but w hose obligations are not explicitly
guaranteed by the full faith arid credit of the U.S.
G overnm ent. Exam ples of such agencies include the
Federal Home Loan M ortgage C orporation
(FHLMC), th e Federal N ational M ortgage
A ssociation (FNMA), the Farm C redit System, the
Federal Home Loan Bank System, and the Student
Loan M arketing A ssociation.
24 A foreign central governm ent is defined to
include departm ents, m inistries, an d agencies of the
central governm ent. It does not include state,
provincial, or local governm ents; com m ercial
en terp rises ow ned by the central governm ent; or
private agencies sponsored by the central
governm ent. In addition, claim s on foreign central
governm ents do not include claim s on non-central
governm ent entities th at are gu aran teed by the
foreign central governm ent.
25 Claims on official m ultilateral lending
institutions or regional developm ent in stitu tio n s
include securities issued by in tern atio n al and
regional organizations to w hich the U.S. belongs.
Claims on such institutions include loans to the
International M onetary Fund, the International
Bank for R econstruction and D evelopm ent (W orld
Bank), the Bank for International Settlem ents, the
Inter-A m erican D evelopm ent Bank, and the A frican
D evelopm ent Bank, and b an k ers accep tan ces for
which the account party is one of th ese m ultilateral
or regional institutions.
Among other items considered to be
claims on depository institutions are
loans to such institutions, including
overdrafts and term federal funds;
holdings of the institution’s own
discounted acceptances for which the
account party is a depository institution;
holdings of bankers acceptances of
other banks; and securities issued by
depository institutions, except those that
qualify as capital (which are to be
excluded from this category and
included in Category 5}.
Category 3 also includes those
portions of loans or other assets
guaranteed by, or backed by the full
faith and credit of, a domestic
depository institution,2&such as
commercial paper or tax-exempt
securities backed by a standby letter of
credit. Risk participations in bankers
acceptances and standby letters of
credit conveyed to other domestic
depository institutions are equivalent to
financial guarantee-type instruments
issued by such institutions. Accordingly,
portions of customers’ liabilities to the
bank on outstanding acceptances
guaranteed through risk participations
conveyed to other domestic depository
institutions are to be netted from the
outstanding exposure to the underlying
account party and included in Category
3. Likewise, the credit equivalent
amount of standby letters of credit
conveyed to other domestic depository
institutions in the form of risk
participations is to be netted from the
exposure to the account party and
assigned to this category.27*If the
guarantee matures or expires and the
asset or off-balance sheet exposure is
still outstanding, the guaranteed portion
of the asset or off-balance sheet
exposure is to be reassigned to the risk
category appropriate to the underlying
obligor.
G e n e r a l o b lig a t io n s o f s t a t e s a n d
p o lit ic a l s u b d iv i s i o n s o f th e U .S . in c lu d e
lo a n s , l e a s e s , a n d s e c u r it ie s s u c h a s
n o t e s , b o n d s , a n d d e b e n t u r e s (in c lu d in g
t a x w a r r a n t s a n d t a x - a n t ic ip a t io n
n o t e s ) . B e c a u s e s u c h g e n e r a l o b lig a tio n
c la im s a r e s e c u r e d b y t h e fu ll fa ith a n d
c r e d it o f th e lo c a l ta x in g a u th o r ity , t h e y
a re a s s ig n e d to a lo w e r r is k w e ig h t
ze The B asle capital fram ew ork does not
recognize guarantees issued by foreign banks or
depository institutions. The treatm ent of g uarantees
by the issuing bank in the form of standby letters of
credit or acquisitions of risk participations is
d iscussed below in the off-balance sheet section.
27
This treatm ent w ould also apply to
p articipations in com m itm ents conveyed to other
dom estic depository institutions if the conveying
bank rem ains obligated to the custom er for the full
am ount of the com m itm ent in the event the
participating institution fails to fund its portion of
the commitment.
category than revenue bonds issued by
U.S. state or local governments, which
are repayable with revenues from the
specific projects financed. Public
purpose revenue (non-general
obligation) bonds for which the
underlying obligor is the state or local
governmental authority are assigned to
Category 4, which has a risk weight of
50 percent. Revenue bonds for which the
underlying obligor is &private entity are
assigned to Category 5, which has a risk
weight of 100 percent.
The Basle capital framework provides
flexibility to national supervisory
authorities in assigning risk weights to
claims on the domestic public sector
(e.g., Government-sponsored agencies
and state and local governmental units)
because risk characteristics of these
claims vary from country to country.
The assignment of claims on U.S.
Government-sponsored agencies and
general obligation claims on U.S. state
and local governments to this category,
rather than to the 10 percent category,
reflects the fact that while such claims
generally involve low risks, they are not
identical to claims that carry the explicit
full faith and credit guarantee of the U.S.
Government.
Category 4:50 percent. This category
includes revenue bonds or similar
obligations, including loans and leases,
that are obligations of U.S. state or local
governments, but for which the
government entity is committed to repay
the debt with revenues from the
facilities financed, rather than from
general tax funds.
Category 5:100percent. All assets not
classified in the categories above are
assigned to this category, which
comprises standard risk assets. This
category includes the bulk of the assets
typically found in a loan portfolio.
Category 5 consists of all claims on
foreign banks with an original maturity
exceeding one year, all non-local
currency claims on foreign governments,
and local currency claims on a foreign
central government that exceed local
currency liabilities held by the bank in
the foreign country. Thus, this category
includes all claims on foreign
governments that entail an element of
transfer risk. This category also includes
all claims on foreign and domestic
private sector obligors not included in
the categories above; claims on
commercial firms owned by the public
sector; customer liabilities to the bank
on acceptances outstanding involving
standard risk claims (that is, claims
F ederal R egister / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
assigned to the 100 percent category); 28
investments in fixed assets, premises,
and other real estate owned;
investments in unconsolidated
companies, joint ventures or associated
companies that have not been deducted
from capital; instruments that qualify as
capital issued by other banking
organizations; and common and
preferred stock of corporations,
including stock acquired for debts
previously contracted. Also included in
this category are industrial development
bonds and similar obligations issued by
U.S. state or local governments for the
benefit of a private party or enterprise
where that party or enterprise, not the
government, is committed to pay the
principal and interest
Finally, this category includes
commercial and individual mortgage
loans, including loans secured by 1-4
family residential mortgages. While the
Basle capital framework provides for the
assignment of the latter to the 50 percent
category, the Federal banking agencies,
consistent with past risk-based capital
proposals, intend to give these assets a
weight of 100 percent. The Federal
banking agencies, as a matter of general
policy, have long sought to avoid the
appearance or reality of regulatory
credit allocation among private sector
borrowers in formulating their capital
adequacy programs. Thus, the agencies
will continue the policy of not singling
out particular sectors or segments of the
private economy on an ex ante basis for
the purpose of according special lowrisk capital treatment The agencies
believe that decisions on allocating
credit among private sector borrowers
are better left to bank management.
However, for the purpose of supervisory
comparisons among major international
banking organizations, the Federal
banking agencies will take account of,
and, where appropriate, adjust for
holdings of residential mortgage loans
by U.S. banking organizations.
Treatment o f Off-Balance Sheet Items
Risk weights for all off-balance sheet
items are determined by a two-step
process. First, the notional principal, or
face value, amount of the off-balance
sheet item is generally multiplied by a
credit conversion factor to arrive at a
balance sheet “credit equivalent
amount”. Then the credit equivalent
amount is assigned, like any balance
sheet asset, to the appropriate risk
28
C ustom er liabilities on accep tan ces
outstanding involving claim s in o th er than the 100
percent category, such a s claim s on dom estic banks,
w ould be assigned to the risk category appropriate
to the identity of the obligor or the other relevant
ch aracteristics of the claim.
category, according to the obligor, or, if
relevant, the guarantor or the nature of
the collateral. T able IV sum m arizes the
treatm ent o f off-balanGe sheet
obligations.
Items with a 100 Percent Conversion
Factor. Direct credit substitutes are any
irrevocable off-balance sheet
obligations in which a bank has
essentially the same credit risk as if it
had made a direct loan to the obligor or
account party.29 Direct credit
substitutes include guarantees, or
guarantee-type instruments, backing
financial claims, such as outstanding
securities, loans and other financial
liabilities. Thus, direct credit substitutes
include standby letters of credit, or
other equivalent irrevocable obligations
or surety arrangements, that back or
guarantee repayment of commercial
paper, tax-exempt securities,
commercial or individual loans or debt
obligations, commercial letters of credit,
or other off-balance sheet exposures
that require capital backing under the
risk-based capital framework. (Standby
letters of credit that are performancerelated are discussed below and have a
credit conversion factor of 50 percent.)
Direct credit substitutes are converted
at 100 percent and the resulting credit
equivalent amount is then assigned to
the appropriate risk category like any
other asset. For example, standby letters
of credit backing outstanding
commercial paper issued by a private
firm, or backing tax-exempt public
purpose municipal revenue bonds,
would be assigned to the 100 percent
and 50 percent categories, respectively.
The credit equivalent amount of risk
participations conveyed to other
domestic depository institutions would
be assigned to the 20 percent category.30
29 The focus in this context is on credit risk. For
exam ple, if Bank A guarantees, or equivalently
backs, a loan from B ank B (beneficiary) to Bank A ’s
custom er (account party) a nd the custom er defaults,
then Bank A m ust pay Bank B and Bank A ends up
w ith a problem loan to its custom er—the sam e
resu lt a s w ould have occurred if Bank A had m ade a
direct loan to its custom er. It is recognized that,
w hile financial guarantee-type instrum ents involve
credit risks sim ilar to direct loans, providing
financing through such instrum ents d oes not entail
funding risks unless the stan d b y is d raw n dow n.
The treatm ent of Financial guarantee-type
instrum ents and equivalent stan d b y letters of credit
in a m anner sim ilar to direct loans is consistent
w ith the fact that such exposures generally a re
covered by statutory limits on loans to a single
borrow er, w a rra n t the sam e credit review and
approval process as traditional loans, and are
treated and analyzed like loans by bank
supervisors.
30 This refers to participations in w hich the
originating bank rem ains liable to the beneficiary
for the full am ount of the standby if the
participating depository institution fails to perform
under the guarantee. Those participations that are
syndicated out, that is, w here each depository
institution is responsible only for its pro-rata share
8559
Standby letters of credit are
distinguished from loan commitments
(discussed below) in that standbys are
irrevocable obligations of the bank to
pay a third-party beneficiary when the
bank’s customer (account party) fails to
repay an outstanding loan or debt
instrument (direct credit substitute) or
fails to perform some other contractual
obligation (performance bond). A loan
commitment, on the other hand, involves
an obligation (irrevocable or revocable
under certain terms) of the bank to fund
its customer in the normal course of
business should the customer seek to
draw down the commitment. The
distinguishing characteristic of a
standby letter of credit for risk-based
capital purposes is, therefore, the
combination of irrevocability with the
notion that funding is triggered by some
failure to perform an obligation. Thus,
any commitment (by whatever name)
that involves an irrevocable 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 would be treated,
for risk-based capital purposes, as
respectively, a financial guarantee-type
standby letter of credit or a performance
standby.
The acquisition of risk participations
in bankers acceptances and
participations in financial guaranteetype standby letters of credit or other
direct credit substitutes also involve
assuming risks that are analogous to
direct loans to the account parties or
obligors. Participations acquired by a
bank in bankers acceptances and direct
credit substitutes (including standby
letters of credit) are converted at 100
percent and assigned to the appropriate
risk weight category depending upon the
identity of the account party or obligor.
Sale and repurchase agreements and
asset sales with recourse, if not already
included on the balance sheet, are
treated in the same way as direct credit
substitutes. The risk-based capital
definition of the sale of assets with
recourse, including the sale of one-tofour family residential mortgages,-is. i||£ 5
same as the definition contained U£it2&
instructions to the bank Consolid&ffd
Reports of Condition and Income (Call
Report).31
of the risk and there is no recourse to the originating
bank, w ould be excluded entirely from the '
originating ban k ’s w eighted risk assets.
31
In regulatory reports and under GAAP, bank
holding com panies are perm itted to treat some asset
sales with recourse as "true" sales, even though
sim ilar transactions by b anks m ust be reported as
borrow ings on the bank call report. For risk-based
Continued
SlSi©
F ederal R egister / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
For U.S.-chartered banks, assets sold
subject to an agreement to repurchase,
or for which any risk of loss is retained,
are generally required to remain on the
balance sheet of the “selling" bank and
the proceeds of the “sale" are recorded
as a borrowing in accordance with the
Gall Report instructions. Such assets
retained on the balance sheet are to be
assigned to a risk weight category
appropriate to the obligor, guarantor, or
collateral. So-called “loan strips” (i.e.,
short-term advances sold under long
term commitments) sold without direct
recourse are accorded the same
treatment as assets sold with recourse.
Forward agreements are legally
binding agreements (contractual
obligations) to purchase assets with
certain drawdown at a specified future
date. These obligations include forward
purchases, forward deposits, and partlypaid shares and securities; they do not
include commitments to make
residential mortgage loans. On the date
a bank enters into such an agreement, it
should convert the principal amount of
the assets to be purchased at ICO
percent and then assign this amount to
the risk category appropriate to the
obligor or guarantor of the item, or the
nature of the collateral.
Item s with a 50 Percent Conversion
Factor. Transaction-related
contingencies include bid bonds,
performance bonds, performance
standby letters of credit, warranties, and
standby letters of credit related to
particular transactions. These
instruments are different from financial
guarantee-type standby letters of credit
in that performance standbys generally
represent obligations backing the
performance of nonfinancial or
commercial contracts or undertakings.
To the extent permitted by law or
regulation, performance standby letters
©foredit include arrangements backing,
among other things, contractors’ and
suppliers’ performance, labor and
materials contracts, and construction
§>ids. These instruments generally
Involve guaranteeing the account party’s
Obligation to deliver a service or product
fejhe conduct of its day-to-day
Business.
-dUnused commitments with an original
inohagtg exceeding one year, including
updSraVriting commitments, and
commercial and consumer credit
commitments also are to be converted at
50 percent. Original maturity is defined
cap ital purposes, how ever, such a sse ts sold w ith
recourse a n d reported a s “tru e” sales by ban k
holding com panies w ould be converted a t 100
percent a n d assigned to the risk category
a p p ro p riate to the underlying obligor, provided the
tran sactio n s m et the definition of asse ts sold with
recourse c o n tain ed in the bank Report of Condition.
as the length of time between the date
the commitment is issued and the
earliest date oh which the following two
conditions hold: (1) The bank can, at its
option, unconditionally (without cause)
cancel the commitment, and (2) the bank
actually reviews the facility to
determine whether or not it should be
extended.32 Commitments with an
original maturity of one year or less are
deemed to involve low risk and,
therefore, are not assessed a capital
charge (that is, they are assigned a 0
percent credit conversion.factor). Such
short-term commitments are defined to
include unused lines of credit on retail
credit cards that can be unconditionally
cancelled by the bank at any time.
However, commitments with an original
maturity of over one year to extend
loans under home equity or mortgage
lines would be converted at 50 percent
and then assigned to the 100 percent risk
weight category.
For the purpose of calculating the riskbased capital ratio, commitments are
defined as any arrangements between a
banking organization and its customer
that legally obligate the banking
organization to extend credit to the
customer in the form of loans or leases,
the purchase of loans or securities, or
participation in loans and leases. They
also include such undertakings as
overdraft facilities, revolving credit, or
similar transactions. Normally,
commitments involve a written contract
or agreement, a commitment fee, or
some other form of consideration.
Commitments are included in weighted
risk assets regardless of whether they
contain “material adverse change"
clauses or other provisions that are
intended to relieve the bank of its
funding obligation under certain
conditions.
Commitments with material adverse
change clauses are included because
such commitments are nonetheless
binding and may involve risk if a bank
funds the commitment before the
customer’s condition deteriorates, or
before the deterioration is recognized.
Moreover, while the Federal banking
agencies do not wish to discourage the
use of material adverse change clauses,
some court decisions suggest that the
presence of a material adverse change
clause cannot necessarily be relied on in
all cases to relieve a bank of its
obligations pursuant to a commitment.
In the case of commitments structured
as syndications, the risk-based capital3
33 Facilities that a re unconditionally (w ithout
cause) cancellable a t any tim e by the bank are not
deem ed to b e com m itm ents, provided the bank
m akes a sep a ra te credit decision before each
draw ing under the facility
framework includes only the banking
organization’s proportional share of
such commitments. After conversion at
50 percent, participations in
commitments conveyed to other
domestic banks, but in which the
originating bank retains the full
obligation to the borrower if the
participating bank fails to perform,
would be assigned to the 20 percent risk
category. This treatment is analogous to
risk participations in standby letters of
credit.
Only the unused portion of
commitments are treated as off-balance
sheet items. Amounts that are already
drawn and outstanding under a
commitment appear on the balance
sheet and such amounts, therefore, are
not also to be included as commitments
for purposes of computing the risk asset
ratio.
Revolving underwriting facilities
RUFs and note issuance facilities (NIFs)
also are to be converted at 50 percent.
These are arrangements under which a
borrower can issue on a revolving basis
short-term paper in its own name but for
which the underwriting banks have a
legally binding commitment either to
purchase any notes the borrower is
unable to sell by the roll-over date or to
advance funds to the borrower. The
original maturity of the commitment
typically is five to seven years, while the
paper most frequently is issued for
maturities of three or six months. For
bank issuers, the paper usually takes the
form of short-term certificates of
deposit, for non-bank borrowers, it
usually takes the form of promissory
notes (commonly known as Euro-notes).
For the purpose of calculating the riskbased capital ratio, similar
arrangements such as note purchase
facilities and Euro-note facilities are to
be treated in the same manner as RUFs
and NIFs.
Items with a 20 Percent Conversion
Factor. Short-term, self-liquidating
trade-related contingencies which arise
from the movement of goods include
commercial letters of credit and other
documentary letters of credit
collateralized by the underlying
shipments.
Items with a Zero Percent Conversion
Factor. These include unused
commitments with an original maturity
of one year or less. Original maturity, as
noted above, is the earliest date after
the commitment is made that a bank: (1)
Can, at its option, unconditionally
(without cause) cancel the commitment
and (2) actually reviews the facility to
determine whether or not it should be
extended. Facilities that, at the bank’s
option, are unconditionally cancellable
F ederal R egister / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
at any time are not considered to be
commitments, provided that the bank
makes a separate credit decision before
each drawdown under the facility.
Unused retail credit card lines are
deemed to be short-term commitments if
the bank has the unconditional option to
cancel the card at any time.
Interest Rate and Foreign Exchange
Rate Contracts
Risk weights for interest rate and
exchange rate contracts are determined
by a two-step process. First, the notional
principal amount of the item is
converted into a balance sheet
equivalent measure which approximates
the amount of credit exposure involved.
Second, the resulting credit equivalent
amount is assigned to the appropriate
risk asset category, based primarily on
the identity of the obligor counterparty),
or, where relevant, on the nature of the
guarantee or the underlying collateral.
R isk Analysis. The treatment of
interest rate, foreign exchange rate, and
related contracts takes account of the
fact that the credit risks associated with
these contracts is generally not equal to
the notional value of the contracts.
Rather, the cost to a banking
organization of counterparty default on
an interest rate or exchange rate
contract is the cost of replacing the cash
flows specified by the contract. At the
time a contract is initiated, it can be
replaced at little or no cost because
interest rates or exchange rates
embodied in the contract reflect those
prevailing in the market. But as time
passes and market rates change, the
value of the cash flows that the banking
organization is entitled to receive from
the counterparty under the contract
terms often will exceed the value of the
cash flows it is obligated to pay. If the
counterparty were to default in such a
circumstance, the banking organization
would have to pay a premium to replace,
or reestablish, the cash flows specified
by the original contract.
A fundamental premise underlying the
treatment of off-balance sheet exposures
in the risk-based capital framework is
that capital support is required not only
for current exposure to losses, but also
for potential future increases in that
exposure. Accordingly, U.S. banking
organizations will be required to utilize
the current exposure method, as set
forth in the Basle capital framework, to
determine the capital necessary to
support their interest rate and exchange
rate contract portfolios. This method
requires banking organizations to
calculate the credit equivalent amount
by: (1) Determining the current
replacement cost of contracts having
positive value on the reporting date by
marking them to market, and (2) adding
to that amount an estimate (the “add
on”) of the potential increase in credit
exposure over the remaining life of all
contracts by multiplying the notional
value of all contracts by the conversion
factors prescribed below.33
Scope. Credit equivalent amounts
would be computed for the following:
I. Interest Rate Contracts
A. Single currency interest rate swaps.
B. Basis swaps.
C. Forward rate agreements.
D. Interest rate options purchased.
E. Any other instrument that gives rise
to similar credit risks.
II. Exchange Rate Contracts
A. Cross-currency interest rate swaps.
B. Forward foreign exchange
contracts.
C. Currency options purchased.
D. Any other instrument that gives
rise to similar credit risks.
Over-the-counter options purchased
would be treated in exactly the same
way as the other interest rate and
exchange rate contracts. That is, the
credit equivalent amount would be the
sum of the marked-to-market
replacement cost and the “add-on”
amount for potential future exposure.
Exceptions. Exchange rate contracts
with an original maturity of seven days
or less would be excluded. Also,
instruments traded on exchanges that
require daily payment of variation
margin would be excluded.
Calculation o f Credit Equivalent
Amounts. Credit equivalent amounts
would be calculated for contracts of the
types described under Scope above. To
calculate the credit equivalent amount
of its off-balance sheet interest rate and
33 D espite the w ide range of different instrum ents
in the m arket, the m ethodology used for assessing
the credit risk on all of the contracts is the sam e.
The analysis consists of exam ining the behavior of
m atched pairs of sw aps under different volatility
assum ptions, A m atched pair is a pair of contracts
w ith identical terms, for w hich the banking
organization is the buyer of one of the contracts and
the seller of the other. The analysis assum es that
estim ates ba se d on m atched pairs provide a m ore
accurate rep resen tatio n of credit exposure on a
portfolio of interest rate and exchange rate
co n tracts than estim ates ba se d on single contracts.
B ecause banking organizations often act as
interm ediaries betw een end-users of contracts, a
large share of their portfolios often consist of
m atched— or nearly m atched— pairs. The volatility
an alysis w as conducted by the staffs of the Bank of
England and the U.S. Federal bank supervisory
au thorities. This analysis involved estim ating the
volatility of interest rates and exchange rates. The
an alysis produced probability distributions of
potential replacem ent costs over the-rem aining life
of m atched pairs of contracts. Potential exposure
w as then defined in term s of confidence limits for
(percentiles of) these distributions. This analysis
provided the b asis for the "a dds-ons” included in
the Basle capital fram ew ork.
8561
exchange rate instruments, a bank
would sum:
(1) The current exposure, that is, the
mark-to-market value (positive values
only) of their contracts, and
(2) An estimate of the potential future
increases to credit exposure over the
remaining life of the instruments.
Examples of the calculation of credit
equivalent amounts for these
instruments are contained in Table V.
Current Exposure. Current exposure is
simply the mark-to-market value of a
contract on the reporting date, if
positive. The mark-to-market value is
the amount the banking organization
would have to pay to replace the net
payment stream specified by the
contract if the counterparty were to
default. Negative mark-to-market values
would not be taken into account in the
calculation of credit equivalent amounts.
The mark-to-market value would include
the value of interest that has accrued
but has not been received. Mark-tomarket values would be measured in
dollars, regardless of the currency or
currencies specified in the contracts.
Potential Future Exposure. Potential
future exposure represents the
additional exposure that may arise over
the remaining life of the contract as a
result of fluctuations in interest rates or
exchange rates. Such changes may
increase the market value of the
contract in the future and, therefore,
increase the cost of replacing it if the
counterparty, subsequently defaults.
Thus, these contracts entail a
commitment by the banking
organization to assume additional credit
exposure in the future. This commitment
requires capital support beyond what is
necessary to support the current
exposure on the reporting date. Potential
exposure on a contract is determined by
multiplying the notional principal
amount of the contract, including
contracts with negative mark-to-market
value, by one of the following credit
conversion factors, as appropriate:
Remaining maturity
Less than 1 year...............
1 year and over................
Interest
rate
contracts
(percent)
Exchange
rate
contracts
(percent)
0.5
1.0
5.0
Because exchange rate contracts
involve an exchange of principal upon
maturity and exchange rates are
generally more volatile than interest
rates, higher conversion factors are
proposed for foreign exchange
8502
Federal R egister / Vol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
instruments than for interest rate
contracts.
No potential credit exposure would be
calculated for single currency floating/
floating interest rate swaps; the credit
exposure on these contracts would be
evaluated solely on the basis of their
mark-to-market value.
Application o f Credit Equivalent
Amounts Within the Overall Risk
Framework. Table V provides examples
of how credit equivalent amounts for
several types of interest rate and foreign
exchange rate contracts would be
calculated. In each case, three pieces of
information are needed to calculate the
credit equivalent amount: the current
mark-to-market value, the notional
principal, and the remaining maturity of
the contract.
Once the credit equivalent amount for
interest rate and exchange rate
instruments has been determined, that
amount will be weighted within the
overall framework according to the
category of the counterparty, and, in
some cases, to the nature of any
underlying collateral or guarantees. In
accordance with the Basle capital
framework, the maximum weight
applied to the credit equivalent amount
would be 50 percent. However, the
Federal banking agencies intend to
monitor the quality of credits in the
interest rate and exchange rate markets
and, in the future, would consider, if
appropriate, assigning credit equivalent
amounts for contracts involving
standard risk obligors to the 100 percent
risk category, as is the case with other
off-balance-sheet instruments.
Accounting. In certain cases, credit
exposures arising from the interest rate
and exchange rate instruments covered
by this proposal may already be
reflected, in part, on the balance sheet.
For example, U.S. banking organizations
generally record current counterparty
credit exposures mark-to-market values
on forward foreign exchange contracts
on the balance sheet. In addition, some
U.S. banking organizations also include
certain counterparty credit exposures
that arise from interest rate swaps and
options purchased on the balance sheet.
To avoid double counting such
exposures in the assessment of capital
adequacy and, perhaps, assigning
inappropriate risk weights, counterparty
credit exposures arising from the types
of instruments covered by this proposal
may need to be excluded from balance
sheet assets in calculating banking
organizations’ total weighted risk asset
ratios. The Federal banking agencies
will address this issue in designing
reporting systems.
Collateral. The existence of collateral
is recognized in assigning credit
equivalent amounts for these contracts
to risk categories under the same
conditions and limitations as discussed
above for on-balance sheet claims.
Netting. In accordance with the terms
of the Basle capital framework, netting
of swaps and similar contracts will not
be recognized at this time. While the
Federal banking agencies encourage any
reasonable arrangements designed to
reduce the risks inherent in these
transactions, the Basle Supervisors’
Committee felt that the legal issues
posed by netting arrangements require
further consideration.
Relationship to Prior Proposals. The
“add-ons” contained in the Basle capital
framework differ in several respects
from the corresponding calculation for
potential future exposure incorporated
in the U.S./U.K. proposal.34 These
changes reflect in part recognition of
comments received on the U.S./U.K.
proposal, and have the effect of reducing
the capital requirements contained in
that earlier measure.
The proposed method of calculating
the potential exposure under the Basle
framework is significantly less complex
than that recommended in the U.S./U.K.
proposal. In simplifying the
methodology, assumptions about the
pattern of banks’ portfolios (including
the rates at which contracts have been
entered into and their average maturity)
have been introduced that have
involved a loss of some precision
relative to the U.S./U.K. measure.
However, the Federal banking agencies
believe that the current formula for
calculating the credit equivalent amount
for interest rate and exchange rate
contracts represents an acceptable
balance between the need to capture the
risks associated with these instruments
and the need to avoid unnecessary
complexity.
IV. Target Ratio Standard
After the transition period (by the end
of 1S92), all banking organizations
would be expected to meet a minimum
ratio of total capital to weighted risk
assets of 8 percent, of which at least 4.0
percentage points should be in the form
of core capital (Tier 1).
The maximum amount of
supplementary capital elements that
could qualify as Tier 2 capital would be
34 The fact that in-the-m oney interest rate
contracts tend to entail less potential future
exposure relative to other contracts is implicitly
recognized in the Basle fram ew ork. In addition, in
this fram ew ork, low er confidence levels are
em ployed, and, in the underlying technical analysis,
p o tential future exposures are discounted. Finally,
the maximum w eight assigned to credit equivalent
am ounts for stan d a rd risk obligors under the Basle
fram ew ork is 50 percent, rather than 100 percent.
limited to the total amount of core
capital. Within Tier 2, the maximum
amount of allowance for loan and lease
losses that would qualify as capital
would be limited to 1.25 percent of
weighted risk assets. In addition, the
combined maximum amount of
subordinated debt and intermediateterm preferred stock that would qualify
as Tier 2 capital would be limited to 50
percent of Tier 1 capital.
Total capital is calculated by adding
core, or Tier 1, capital (defined to
exclude goodwill and disallowed
intangibles) to supplementary, or Tier 2,
capital (limited to 100 percent of core
capital) and then deducting from this
sum any capital investments in
unconsolidated banking and finance
subsidiaries, reciprocal holdings of
banking organization capital securities,
or other items at the direction of the
supervisory authority.
A transition period has been provided
to give banking organizations time to
bring their capital positions into
conformity with the risk-based
standards and definitions. The
transition period would end December
31.1992. Banking organizations not
currently meeting the 8 percent
minimum would be expected to
undertake a sustained effort to meet that
standard by year-end 1992.
V. Transition and Implementing
Arrangements
Transition Arrangements
The proposed transition period is
designed to facilitate smooth adjustment
and phasing in of the risk-based capital
measure and the minimum ratio
standard within a wide variety of
supervisory systems. The transition
period would begin on the date that the
proposed risk-based capital framework
becomes effective and end on December
31.1992. In addition, there wrill be an
interim target ratio to be met by the end
of 1990.
Initial period to the end o f 1990. From
the beginning of the transition period
until the end of 1990, no formal riskbased capital standard or minimum
level will be set. As noted above, the
Federal banking agencies would expect
any organization that has a risk-based
ratio of less than 8 percent to move in
the direction of that target during the
transition period and meet the target by
the end of 1992. Banking organizations
with ratios of 8 percent or lower should
not make adjustments to their risk
profiles or undertake growth plans that
would lower their ratios.
As indicated, the Basle capital
framework establishes no initial
F ederal R egister / Vol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
standard. However, for the purpose of
calculating the ratio during the initial
period, the Basle capital framework
allows the core capital of an
organization to include some
supplementary capital elements.
Specifically, a maximum of 25 percent of
core capital (before any deduction of
goodwill and other disallowed
intangibles) may consist of
supplementary capital elements, with
the remainder consisting of common
stockholders' equity (including retained
earnings). By year-end 1990, banking
organizations would be expected to
reduce the amount of supplementary
capital included in core capital to no
more than 10 percent of core capital.
For bank holding companies, any
goodwill acquired before March 12,
1988, would be grandfathered until the
end of 1992. Goodwill acquired by
holding companies after this date, and
all goodwill on holding company books
after 1992, would be deducted from Tier
1 capital components to arrive at core
capital.
Initially, the allowance for loan and
lease losses may be included in a
banking organization’s supplementary
capital without limit. However, by the
end of 1990, such reserves counted in
supplementary capital may not exceed
1.5 percent of weighted risk assets.
Existing primary and total capital-tototal assets (leverage) ratios would
continue to be employed during this
initial period. The Federal banking
agencies will, prior to year-end 1990,
consider whether a leverage ratio will
continue to be employed in conjunction
with the implementation of the riskbased standard. If a leverage ratio is
employed after 1990, the Agencies may,
after appropriate consideration, adopt
for leverage ratio purposes the Tier 1
and Tier 2 capital definitions contained
in the risk-based capital guidelines.
Year-end 1990 through year-end 1992.
During this interval, banking
organizations would be expected to
meet a minimum total capital to
weighted risk asset ratio of 7.25 percent,
at least one-half of which should be in
the form of core capital. During this
period, up to 10 percent of an
organization’s core capital (before any
deduction of goodwill and disallowed
intangibles) may consist of
supplementary capital elements. Thus,
the interim target ratio implies a
minimum ratio of core capital to
weighted risk assets of 3.6 percent (onehalf of 7.25) and a minimum common
stockholders’ equity to weighted risk
assets ratio of 3.25 percent (nine-tenths
of the core capital ratio). Any
organization not meeting the minimum
supervisory ratios would be expected to
develop and discuss with its supervisory
authority a plan setting forth how the
organization intends to reach them.
By the end of 1992, an organization’s
required core capital must consist solely
of common stockholders’ equity.
During this period, the maximum
amount of allowance for loan and lease
losses that may qualify as
supplementary capital will be limited to
1.5 percent of weighted risk assets (that
is, 1.5 percentage points of the required
7.25 percent), dedining to 1.25 percent
by year-end 1992. Amounts in excess of
these limits may, of course, be
maintained, but would not be included
in an organization’s total capital base.
(The Federal banking agencies,
however, will continue to require
banking organizations to maintain
reserves at levels sufficient to cover
losses inherent in their loan portfolios.)
A summary of important aspects of
the transitional arrangements is
contained in Table VI.
Application and Implementation o f the
Risk-Based Capital Measure
The Basle capital framework
recommends that the risk-based
standard be applied to international
banks but recognizes that each national
supervisory authority may wish to apply
the framework to a broader class of
commercial banking organizations.
Since the condition or stability of any
institution is affected by its level of offbalance sheet exposure or the risk
composition of its asset portfolio, the
risk-based capital proposal outlined
above provides a systematic analytical
framework that is equally relevant for
large and small institutions.
For these reasons, the Federal
banking agencies intend to apply the
risk-based capital measure, including
the minimum supervisory ratio
guidelines, to all banking organizations
on a consolidated basis, regardless of
size.35 This will include an assessment
of risk-based capital ratios during
examinations and reviews of
supervisory applications. In
implementing the risk-based ratio, the
banking agencies will apply the
framework in a flexible manner, giving
banking organizations a reasonable
amount of time to develop the systems
and procedures necessary to calculate
the risk-based ratio.
While the risk-based standard will be
applied to banking organizations of all
35 Bank holding com panies w ith less than $150
million in consolidated assets w ould generally be
exem pt from the calculation and analysis of riskb ased ratios on a consolidated holding com pany
b asis under the sam e term s and conditions as
provided in the Federal R eserve’s current
G uidelines.
$I§§!
sizes, the principal impact of the
measure will generally fall on large
banking institutions and those with
significant off-balance sheet exposures.
Aside from the calculation of the riskbased ratio during on-site examinations,
the off-site supervisory data collection
and monitoring effort associated with
the risk-based standard could focus on
one of the following three options:
1. All banking organizations;
2. Banking organizations with either
(i) consolidated assets in excess of some
threshold amount, such as $150 million,
$1 billion, or $10 billion, or (ii) offbalance sheet exposure (after
adjustment based upon prescribed
credit conversion factors) in excess of 20
percent of common stockholders’ equity;
or
3. Banking organizations with
consolidated assets in excess of $20
billion.
Given the objectives of the banking
agencies and the Basle capital
framework, it would appear necessary
to modify the supervisory reporting
forms for, at least, the large banking
organizations, such.as those with
consolidated assets in excess of $1
billion, and for those with significant
off-balance sheet exposure. However,
the Federal banking agencies are
seeking public comment on which of the
three options above should serve as the
primary focus of the supervisory data
collection and monitoring effort.
During the transition period, the
Federal banking agencies will modify
appropriate supervisory reporting forms,
primarily for the larger institutions, to
bring regulatory reporting requirements
generally into line with the major
provisions of the risk-based capital
measure. In doing this, the Agencies will
endeavor to lessen the impact on
recordkeeping and reporting burden by
phasing in any new reporting
requirements, by allowing sufficient
time to modify internal recordkeeping
and reporting systems, and, under
appropriate conditions, by employing de
minimis exceptions or other
arrangements designed to minimize data
collection. The latter may be
particularly appropriate for smaller
banking organizations or those with
minimal off-balance sheet exposures.
All banking organizations, however, will
be expected to develop over time
internal recordkeeping and control
systems sufficient to allow supervisory
officials and examiners to evaluate the
organizations’ capital positions in a
manner generally Consistent with the
risk-based capital framework.
As noted above, this proposal,
consistent with the Basle capital
SS®4
F ederal R egister / V ol. 53, N o. 50- / T uesday,, March- 15, 198® / P?oposed R u les
framework, establishes no initial
minimum risk-based ratio’ and provides
for a transition period, running through
the end of 1992, during which banking
organizations are expected to bring their
capital positions into compliance with
the prescribed framework. As discussed
above, the proposed ratio does not take
explicit account of all factors affecting
an organization’s risk profile, such as
asset concentrations, overall interestrate exposure, asset quality problems or
other financial or operating weaknesses.
For this reason, banking organizations
will generally be encouraged to operate
above the minimum risk-based capital
ratio, and, as is currently the case, the
Federal banking agencies may establish
a specific target ratio for an individual
company that is above the minimum.
The transition arrangements,
including the length of the transition
period, are designed to provide banking
organizations with a degree of flexibility
in complying with the risk-based
framework. In particular, these
arrangements will minimize the
possibility that banking organizations
would be forced to take steps that could
be disruptive or inconsistent with
prevailing conditions in the capital
markets. While the proposal provides
for a phase-in period, banking
organizations, as already noted, are
encouraged to bring their capital
positions into compliance with minimum
supervisory benchmarks as soon as
reasonably possible.
Banking organizations will be able to
comply with the risk-based capital
guidelines in several ways, some of
which do not require raising new
external capital. For example, an
organization can moderate growth or
increase earnings retention. More
importantly, however, within a risksensitive capital standard, an
organization can raise its capital ratio
by reducing its overall risk profile. This
can be done by reducing off-balance
sheet exposure or by placing
proportionately greater emphasis on
those activities that carry lower risk
weights.
Relationship to Existing Capital
Guidelines
The Federal banking agencies will
maintain their existing minimum
primary and total capital-to-fofa/ assets
ratios of 5.5 and 6.0 percent,
respectively, until the end of 1990—
unless revisions to these leverage ratios
are made prior to this date. This is
appropriate because there is a need for
some total leverage guideline, especially
during the initial phase of the risk-based
transition period, when no minimum
risk-based ratio would be in effect. In
2. From-an analytical, standpoint and,1
to avoid possible “window dressing”,
the preferred approach to calculating
capital ratios would generally be to
utilize average, rather than period-end, ■
figures—at least for most of the items
upon which the ratio is based. However,
the determination of average balance
sheet figures may involve additional
recordkeeping burden for institutions*
Should the ratio be calculated from
average figures? For which items used in
calculating the ratio are average figures;
most important? How can the burden
involved in determining average figures
be minimized?
3. While the risk-based standard will
be applied to banking organizations of
all sizes, its principal impact will
generally fall on large banking
institutions and those with significant
off-balance sheet exposures. Aside from
the calculation of the risk-based ratio
during on-site examinations, the off-site
supervisory data collection and
monitoring effort associated with the;
risk-based framework could focus on
one of the following three classes of
organizations:
1. All banking organizations;
2. Banking organizations with either
(i) consolidated assets in excess of some
threshold amount, such as $150. million,
$1 billion, or $10 billion, or (ii) offbalance sheet exposure (after
adjustment based upon prescribed
credit conversion factors) in excess of 20
percent of common stockholders’ equity;
or
3. Banking organizations with
consolidated assets in excess of $20
billion.
Issues for Specific Comment
Given the objectives of the Federal
banking agencies and the Basle capital
The Federal banking agencies seek
comments on all aspects of the proposed framework, it would appear necessary
to modify the supervisory reporting
risk-based capital proposal. In addition,
forms for, at least, the large banking
however, the agencies invite comments
organizations, such as those with
on the following specific issues:
1.
The proposed risk-based frameworkconsolidated assets in excess of $1
billion, and for those with significant
assigns claims on foreign banks and
commitments to risk categories based, in off-balance sheet exposure. However,
the Federal banking agencies seek
part, on their original maturity. The
Federal banking agencies recognize that, public comment on which of the three
options above should serve as the
for this purpose, a case can be made to
primary focus of the supervisory data
utilize remaining, rather than original,
collection and monitoring effort.
maturity. Would remaining maturity be
4. The Basle capital framework
a better criterion to use in assigning
generally assigns the credit equivalent
bank claims and commitments to risk
amount of interest rate and foreign
categories?
exchange contracts involving standard
risk obligors to the 50 percent, rather
36 If a leverage ratio is a d opted in-conjunction
than ICQ percent, risk category. This m
w ith the risk-based capital m easure, banking
based upon the argument that obligors
o rganizations could, w ith the perm ission of their
supervisory authority, be allow ed to o p erate w ith
in these markets tend to be of high
capital-to-total a sse ts ratios below the minimum.
quality.
The- Federal banking agencies
Such organizations w ould have to be in com pliance
seek comments on the merits of this,
w ith the risk-based sta n d a rd a n d relativ ely free of
contention, and ivhether they arp T.
risks not captured by the rick-based m easure.
addition, maintenance of capital-to-total
assets standards will provide an
important element of continuity during
the implementation of the risk-based
framework.
By year-end 1990, the Federal banking
agencies will review the merits of
continuing to employ an overall leverage
constraint in tandem with the risk-based
capital ratio. In particular, the agencies
will consider whether the existing
capital-to-total assets ratios should be
reduced or eliminated. If the agencies
conclude that a total leverage constraint
should be maintained, the definition of
capital for leverage purposes may, after
appropriate consideration, be aligned
with the risk-based capital definitions.
Operation of a leverage guideline in
parallel with a risk-based capital
measure may be appropriate because
certain risks associated with high
leverage, such as interest rate exposure
and the possible depreciation in the
market value of certain assets, are not
fully factored into the risk-based
standard. Under a risk-based standard
by itself, a banking organization with a
preponderance of assets in the 20,10, or
zero percent risk categories (such as
U.S. Government securities) would be
subject to only a very minimal
constraint on total leverage—or, at least
in theory, to no leverage, constraint at
all, if all assets were held in the form of
instruments assigned to the zero percent
risk category. Therefore, in the absence
of capital-to-total assets guidelines, or
other prudential limits on total
borrowing in relation to capital, banking
organizations could assume an
unwarranted degree of leverage.36
Federal R egister / Vol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
the distinction offer banking
organizations viable and useful options
for maintaining minimum risk-based
capital requirements?
6.
The proposal assigns claims
(excluding obligations with a remaining
maturity of 91 days or less) on the U.S,
Treasury and U.S. Government agencies
to the 10 percent category, while claims
on U.S. Government-sponsored agencies
are placed in the 20 percent category.
Under the earlier U.S./U.K. proposal,
claims on Government-sponsored
sufficient to warrant the proposed
treatment.
5.
Under the proposed risk-based
capital framework, the amount of
intermediate-term preferred stock and
subordinated term debt that can be
included in supplementary capital is
limited to 50 percent of core capital.
Limited-life preferred stock with an
original maturity of at least 20 years
may be counted as supplementary
capital without limit. Is this distinction
between intermediate-term and long
term preferred stock appropriate? Does
8565
agencies were placed in the 50 percent
risk category. The distinction between
claims on the U.S. Treasury and claims
on Government-sponsored agencies is
based upon the fact that the latter lack
the explicit full faith and credit
guarantee of the U.S. Government. In
light of the absence of such a guarantee
and the proposed treatment of U.S.
Treasury obligations, what is the most
appropriate treatment of debt issued or
guaranteed by U.S. Governmentsponsored agencies?
T able I.—S am ple Calculatio n of R is k -B ased Ca p it a l Ratio
Amount
Example of a bank with $6,000 in total capital and the following assets and off-balance sheet items:
B alance S heet A ssets:
Balances at domestic banks...............................................................................................................................................................
Loans to private corporations.............................................................................................................................................................
$10,000
$20,000
5,000
65,000
Total Balance Sheet Assets.........................................................................................................................................................
$100,000
O ff-B alance S heet Item s:
Standby letters of credit (“SLCs”) backing general obligation debt issues of U.S. municipalities (“GOs").......................................................
Long-term commitments to private corporations.....................................................................................................................................
$10,000
20,000
Total Off-Balance Sheet Items......................................................................................................................................................
This bank’s total capital to to ta l assets ratio would be: ($6,000/_$t00,000) = 6.00%.
$30,000
OBS Item
To compute the bank's weighted risk assets:
- 1. Compute the credit equivalent amount of each off-balance sheet ("OBS”) item.
SLCs backing municipal GOs.......................................... .............................................................
Long-term commitments to private corporations........................................................................ .....
2. Multiply each balance sheet asset and the credit equivalent amount of each OBS item by the appropriate
risk weight.
0% C ategory: C a sh ....................................................................................................................
10% C ategory: Long-term U.S. Government securities.....................................................................
Credit
Equivalent
Amount
Conversion
Factor
Face Value
$10,000
$20,000
x
X
1.00
0.50
_
$10,000
$10,000
$10,000
$20,000
x
x
0
0.10
=
$0.
$2,000
X
0.20
_
$3,000
X
1.00
20% C ategory:
Balances at domestic banks...................... ........ ...................................................................
Credit equivalent amounts of SLCs backing GOs of U.S. municipalities........................................
Total.................................................................................................................. .........
$5,000
10,000
$15,000
50% C ategory: No items.
100% C ategory:
Loans to private corporations.................................................................................................
Credit equivalent amounts of long-term commitments to private corporations................................
$65,000
10,000
Total............................................................................................................................
$75,000
Total Risk-Weighted Assets.............................................................................................
This bank’s risk-b ased capital ratio would be: ($6,000/$80,000)=7.50%.
T able II.—D efin itio n of Q ualifying
C ap ital
Components
C ore C apita l ( Tier 1):
Common stockholders’
equity.
Minimum requirements
and limitations after
transition period
Must equal or exceed 4%
of weighted risk assets.
No limit.
T able II.—D efin itio n of Q ualifying
C ap ital — Continued
Components
Minority interest in
common equity
accounts of
consolidated
subsidiaries.
Less: Goodwill and
other disallowed
intangibles.1
Minimum requirements
and limitations after
transition period
No limit.
$75,000
$80,000
T able II.—D efin itio n of Q ualifying
Cap ital — Continued
Components
S upplem entary C apita l
(T ie r 2 ):
Allowance for loan and
lease losses.
Minimum requirements
and limitations after
transition period
Total of Tier 2 is limited to
100% of Tier 1.
Limited to 1.25% of
weighted risk assets.2
Federal R egister / Vol. 53, No. 50' / Tuesday,, M arch 15, 1983 / Proposed Rules
Taisle II.—D efinition of -Q ualifying.'
Capital—Continued
Components
Perpetual and long
term preferred stock
(original-maturity 20
years or more).
Minimum requirements
and limitations after
transition period
No limit within Tier 2,
long-term, preferred is
amortized for capital
purposes as it ap
proaches maturity.
No limit within Tier 2.
Hybrid capital
instruments
(including perpetual
debt mandatory
convertible
securities).
Subordinated debt and Subordinated debt and in
intermediate-term
termediate-term
pre
preferred stock
ferred stock are limited
to 50% of Tier 1 2; am
(original weighted
ortized for capital pur
average maturity of 7
years or more).
poses as they approach
maturity.
Revaluation reserves
Not included; regulators
(equity-and building).
would encourage banks
to
disclose;
would
evaluate on case-by
case basis for interna
tional comparisons; and
would take into account
in making overall as
sessment of capital.
D eductions (.from su m
o f Tier 1 a n d Tier 2 ):
Investments in
unconsolidated
banking and
finance
subsidiaries.
Reciprocal
holdings, of bank
issued capital
securities.
Other deductions
On case-by-case basis or
(such as other
as matter of policy after
subsidiaries or
formal rulemaking.
joint ventures) as
determined by
supervisory
authority.
Total C apita l ( Tier 1 +
Must equal or exceed 8%
Tier 2 -D e d u c tio n s ):
of weighted risk assets.
1Goodwill on books of bank holding companies
before March 12, 1988, would be “grandfathered”
for transition period. All goodwill and disallowed
intangibles in banks, except previously grandfathered
intangibles or goodwill approved in supervisory
mergers, would be deducted immediately as under
current policies. (See each Agency’s proposed
guidelines for a more thorough discussion of good
will and other intangibles). All deductions are for
capital adequacy purposes only; deductions would
not affect accounting treatment.
2Amounts in excess of limitations are permitted
but do not qualify as capital.
Table III.—Summary of Risk Weights
and Risk Categories
C a teg o ry 1: Z ero p e rc e n t
1. Cash (domestic and foreign).
2. Balances due from, and claims on,
Federal Reserve Banks.
3.. Securities (direct obligations) issued by
the U.S. Government or its agencies1*
1 For the purpose of calculating the risk-based
capital ratio, a U.S. G overnm ent agency is defined
as an instrum entality of the U.S. G overnm ent w hose
with a remaining maturity of 91 days or
less.
C a teg o ry 2 :1 0 p e rc e n t
1. Securities issued by the U.S. Government
or its agencies1 with remaining
maturities of over 91 days and all other
claims (loans and leases) on the U.S.
Government or its agencies.1
2. Securities and other claims guaranteed
by the U.S. Government or its agenices
(including portions of claims guaranteed).
3. Portions of loans and other assets
collateralized2 by securities issued by, or
guaranteed by, the U.S. Government or
its agencies, or by cash on deposit in the
leading institution.
4. Federal Reserve Bank stock.
C a teg o ry 3 :2 0 p e rc e n t
1. All claims (long- and short-term) on
domestic depository institutions.
2. Claims on foreign banks with an original
maturity of one year or less.
3. Claims guaranteed by, or backed by the
full faith and credit of, domestic
depository institutions.
4. Local currency claims on foreign central
governments to the extent the bank has
local currency liabilities in the foreign
country.
5. Cash items in the process of collection.
6. Securities and other claims on, or
guaranteed by, U.S. Governmentsp o n so r e d agencies (including portions of
claims guaranteed).3
7. Portions of loans and other assets
collateralized4 by securities issued by, or
guaranteed by, U.S. Governmentsponsored agencies.
8. General obligation claims on, and claims
guaranteed by, U.S. state and local
governments that are secured by the full
faith and credit of the state or local
taxing authority (including portions of
claims guaranteed).
9. Claims on official multilateral lending
institutions or regional development
institutions in which the U.S.
Government is a shareholder or a
contributing member.
C a teg o ry 4: 50 P ercen t
1. Revenue bonds or similar obligations,
including loans and leases, that are
obligations of U.S. state or local
governments, but for which the
government entity is committed to repay
the debt only out of revenues from the
facilities financed.
obligations are fully and explicitly guaranteed as to
the timely repaym ent of principal and interest by
the full faith and credit of the'U.S. G overnm ent.
2 Degree of collateralization is determ ined by
current m arket value.
3 For the purpose of calculating the risk-based
capital ratio, a U.S. G overnm ent -sponsored agency
is defined as an agency originally established or
chartered to serve public purposes specified by the
U.S. C ongress but w hose obligations are not
explicitly g u aran teed by the full faith a nd credit of
the U.S. G overnm ent.
4 Degree of collateralization is determ ined by
current m arket value.
2. Credit equivalent amounts of interest
rate and foreign exchange rate related
contracts, except for those assigned to a
lower risk category.
C a teg o ry 5 :1 0 0 P ercen t
1. All other claims-on private obligors.
2. Claims on foreign banks with an original
maturity exceeding one year.
3. Claims on foreign central governments
that are not included in item 4 of
Category 3.
4. Obligations issued by state or local
governments (including industrial
development authorities and similar
entities) repayable solely by a private
party or enterprise.
5. Premises, plant, and equipment; other
fixed assets; and other real estate
owned.
6. Investments in any unconsolidated
subsidiaries, joint ventures, or associated
companies—if not deducted from capital.
7. Instruments issued by other banking
organizations that qualify as capital.
8. All other assets (including claims on
commerieal firms owned by the public
sector).
Table IV.
Credit Conversion Factors for Off-Balance
Sheet Items
TOO P ercen t C on version F actor
1. Direct credit substitutes (general
guarantees of indebtedness and
guarantee-type instruments, including
standby letters of credit serving as
financial guarantees for, or supporting,
loans and securities).
2. Acquisitions of risk participations in
bankers acceptances and participations
in direct credit substitutes (e.g., standby
letters of credit).
3. Sale and repurchase agreements and
asset sales with recourse, if not already
included on the balance sheet.
4. Forward agreements (that is, contractual
obligations) to purchase assets, including
financing facilities with certa in
drawdown.
5 0 P ercen t C on version F actor
1. Transaction-related contingencies (e.g.,
bid bonds, performance bonds,
warranties, and standby letters of credit
related to a particular transaction).
2. Unused commitments with an original
maturity exceeding one year, including
underwriting commitments and
commercial credit lines.
3. Revolving underwriting facilities (RUFs),
note issuance facilities (NIFs) and other
similar arrangements.
20 P ercen t C o n version F acto r
1. Short-term, self-liquidating trade-related
contingences, including commercial
letters of credit.
Z ero P ercen t C on version F actor
1. Unused commitments with an original
maturity of one year or less or which are
unconditionally cancellable at any time.
Credit Conversion for Interest Rate and
Foreign Exchange Contracts
T h e to ta l r e p la c e m e n t c o s t o f c o n tr a c ts
F ederal R egister / ¥ p l. 53, N o. 5 0 / T u esd a y , M arch 15, 1S8& / P ro p o sed R ules
[obtained by summing the positive mark-tomarket values of contracts) would be added
to a measure of future potential increases in
credit exposure. This future potential
exposure measure would be calculated by
multiplying the total notional value of
contracts by one of the following credit
conversion factors, as appropriate:
Remaining maturity
Interest
rate
contracts
Exchange
rate
contracts
0
0.5%
1.0%
5.0%
Less than one year............
One year and over.............
No potential exposure would be calculated
for single currency floating/floating interest
_______ iff!? 7
rate eontraetsr the credit exposure on these
contracts would be evaluated solely on the
basis of their mark-to-market value.
Exchange rate contracts with ah original
maturity of seven days or less would be
excluded. Also, instruments traded on
exchanges that require daily payment of
variation margin would be excluded.
Table V.—C alculation of Credit Equivalent A m ounts
[Interest Rate and Foreign Exchange Rate Related Transactions]
Current exposure
Potential exposure
Type of contract (remaining maturity)
National
principal
(D
(1) 120-day forward foreign exchange..................................................
(2) 120-day forward foreign exchange..................................................
(3) 3-year single-currency fixed/floating interest rate swap......................
(4) 3-year single-currency fixed/floating interest rate swap......................
(5) 7-year cross-currency floating/floating interest rate swap...................
X
$5,000,000
6,000,000
10,000,000
10,000,000
20,000,000
Potential
exposure
conversion
factor
Potential
exposure
(dollars)
(2)
(3)
0.01
.01
.005
.005
.05
50.000
60.000
50.000
50.000
1,000,000
Current
Replacement exposure
cost1
(dollars)2
+
(4)
Credit
equivalent
amount
(5)
100,000
-120,000
200,000
-250,000
-1,300,000
100,000
0
200,000
0
0
$150,000
60,000
250,000
50,000
1,000,000
1,510,000
Total...-.................................. ....................................... „ ..... 51,000,000
1These numbers are purely for illustration.
2The larger of zero or a positive mark-to-market value.
Table VI
Transitional arrangements
Year-End 1990
Initial
1. Minimum standard of total capital to None.
weighted risk assets.
2. Definition of tier 1 capital.................... Common equity p lu s supplementary ele
ments 1 le ss goodwill and other disal
lowed intangibles2.
3. Minimum standard of tier 1 capital to None..................... ............................
weighted risk assets.
4. Minimum standard of common stock None.............................................. .....
holders' equity to weighted risk assets.
5. Limitations on supplementary capital
elements.
a. Allowance for loan and lease No limit within supplementary capital........
losses.
b. Subordinated debt and intermedi Combined maximum of 50 percent of tier
ate term preferred stock.
1.
c. Total qualifying supplementary cap May not exceed tier 1 capital..................
ital.
6. Definition total capital......................... Tier 1 p lu s tier 2 less:
—reciprocal holdings of banking orga
nization capital instruments.
—investments in unconsolidated
banking and finance subsidiaries.
Final arrangement: Year-End
1992
8.0 percent
7.25 percent..
Common equity p lu s supplementary ele Common equity le ss goodwill
and other disallowed intangi
ments 34
5
6le ss goodwill and other disal
bles.
lowed intangibles2.
3.625 percent....................................... 4.0 percent.
3.25 percent.................................. ....... 4.0 percent.
1.25 percent of weighted risk
assets.
Combined maximum of 50 percent of tier Combined maximum of 50 per
cent of tier 1.
1.
May not exceed tier 1 capital.................. May not exceed tier 1 capital.
1.5 percent of weighted risk assets..........
Tier 1 p lu s tier 2 less.
Tier 1 p lu s tier 2 less:
—reciprocal holdings of
—reciprocal holdings of banking orga
banking
organization
nization capital instruments.
capital instruments.
—investments in uncon
—investments in unconsolidated
solidated banking and fi
banking and finance subsidiaries.
nance subsidiaries.
1Up to 25 percent of Tier 1 (before deduction of goodwill and other disallowed intangibles) may consist of supplementary elements.
2 See the Notice of Proposed Guidelines and the actual text of the proposed guidelines for discussion of relevant definitions and grandfathering arrangements for
goodwill.
3 Up to 10 percent of Tier 1 (before deduction of goodwill and other disallowed intangibles) may consist of supplementary elements.
Regulatory Flexibility A ct Analysis
While all commercial banks would
presumably be required to make some
revisions to their reporting procedures to
permit supervisory monitoring of riskbased capital ratios, the Federal banking
agencies do not believe that adoption of
this proposal would have a significant
economic impact on a substantial
number of small business entities, in this
case small banking organizations, in
accord with the spirit and purposes of
the Regulatory Flexibility Act (5 U.S.C.
601 etseq.). In addition, this proposal
would generally not apply to bank
holding companies with consolidated
assets less than $150 million.
This proposal is designed primarily to
take account of those practices, such as
the increased use of off-balance sheet
risk and the decline in the holdings of
low-risk, liquid assets, which have been
engaged in primarily by certain larger
banking organizations. Moreover, rather
than requiring all banking organizations
to raise additional capital, this proposal
8568
F ederal R egister / Vol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
is directed.at institutions whose capital
positions are less than fully adequate in
relation to their risk profiles.
Executive Order 12291
The Comptroller of the Currency
certifies that the proposal, if adopted,
would not constitute a “major rule” and,
therefore, does not require the
preparation of a preliminary regulatory
impact analysis.
Comporting Changes to Part 3
If this proposal is adopted, it will,
when the Comptroller’s guidelines
become effective, necessitate certain
changes to the existing capital
maintenance provisions of 12 CFR Part
3. Specifically, it is anticipated that, at
least, portions of §§ 3.2, 3.3, 3.4, 3.6, 3.7
and 3.100 will require changes so as to
be consistent with this proposal.
List of Subjects
12 CFR Part 3
National banks, Capital, Risk.
12 CFR Part 225
Banks, Banking, Capital adequacy,
Federal Reserve system, Holding
companies, Reporting requirements,
State member banks.
12 CFR Part 325
Bank deposit insurance, Banks,
banking, Federal Deposit Insurance
Corporation, Capital adequacy, State
nonmember banks.
BILLING CODES 4S10-33-M; 6210-01-M; S714-01-C31
2
DEPARTMENT OF THE TREASURYOFFICE OF THE COMPTROLLER OF THE
CURRENCY
Authority and Issuance
For the reasons set forth in the
preamble, Part 3 of Chapter I of Title 12
of the Code of Federal Regulations is
proposed to be amended as follows:
PART 3—[AMENDED]
1. The authority citation for 12 CFR
Part 3 continues to read as follows:
Authority: 12 U.S.C. 1, et seq.; 12 U.S.C. 93a,
161,1818; and 12 U.S.C. 3907 and 3809.
2. A new Appendix A is added to Part
3 to read as follows:
Appendix A—Risk=Ba§ed Capital
Guidelines
Section 1. Purpose, Applicability of
Guidelines, and Definitions
(a) Purpose. (1) An important function of
the Office of the Comptroller of the Currency
(“OCC”) is to evaluate the adequacy of
capital maintained by each national bank.
Such an evaluation involves the
consideration of numerous factors, including
the riskiness of a bank’s assets and off-
balance sheet items. This Appendix A
implements the OCC’s risk-based capital
guidelines. The risk-based capital ratio
derived from these guidelines is more
systematically sensitive to the riskiness of
bank activities than are the capital-to-total
assets ratios presently required by 12 CFR
Part 3. A bank’s risk-based capital ratio is
obtained by dividing its capital base (as
defined in section 2 of this Appendix A) by
its average risk-weighted assets (as
calculated pursuant to section 3 of this
Appendix A). These guidelines were created
within the framework established by the
report issued by the Basle Committee on
Banking Regulations and Supervisory
Practices on December 10,1987. That report
had as its principal objectives the
establishment of a uniform capital framework
for the international banking system and the
mitigation of an important source of
competitive inequality for banks arising from
differences in the way countries required
their banking and finance companies to
maintain capital. The OCC believes that the
risk-based capital ratio is a useful tool in
evaluating the capital adequacy of all
national banks, not just those that are active
in the international banking system.
(2)
The purpose of this Appendix A is to
explain precisely (i) how a national bank’s
risk-based capital ratio is determined and (ii)
how these risk-based capital guidelines are
applied to national banks. The OCC will
review these guidelines periodically for
possible adjustments commensurate with its
experience with the risk-based capital ratio
and with changes in the economy, financial
markets and domestic and international
banking practices.
(b) Applicability. (1) The risk-based capital
ratio derived from these guidelines is an
important factor in the OCC’s evaluation of a
bank’s capital adequacy. However, the final
supervisory judgment on a bank’s capital
adequacy is based on numerous factors,
including those listed in 12 CFR 3.10, and may
differ significantly from conclusions that
might be drawn solely from the bank’s riskbased capital ratio.
(2)
Effective December 31,1990, these riskbased capital guidelines will apply to all
national banks. In the interim, banks must
maintain minimum capital-to-total assets
ratios as required by 12 CFR Part 3, and
should begin preparing for the
implementation of these risk-based capital
guidelines. In this regard, each national bank
that does not currently meet the interim ratio
established in section 4(a)(1) of this
Appendix A should establish a plan for
meeting that standard. By December 31,1990,
the OCC will determine the need for
operating these risk-based capital guidelines
in tandem with some minimum capital-tototal assets ratios. If a tandem system is
adopted, it is anticipated that any required
minimum capital-to-total assets ratios will be
based upon the capital definitions set forth in
section 2 of this Appendix A. Under such a
system, a national bank that meets the
standard set forth in these-risk-based capital
guidelines may be allowed to operate below
the capital-to-total assets ratios on a case-by
case basis, as long as the overall risk profile
of that bank is low.
(3)
These risk-based capital guidelines will
not be applied to federal branches and
agencies of foreign banks.
(c) D efin ition s. For purposes of this
Appendix A, the following definitions apply:
(1) “Allowance for loan and lease losses”
means the balance of the valuation reserve
on December 31,1968, plus additions to the
reserve charged to operations since that date,
less losses charged against the allowance net
of recoveries.
(2) "Associated company” means any
corporation, partnership, business trust, joint
venture, association or similar organization
in which a national bank directly or
indirectly holds a 20 to 50 percent ownership
interest.
(3) “Average risk-weighted assets” means a
daily average of a national bank’s riskweighted assets.
(4) “Banking and finance subsidiary”
means any subsidiary of a national bank that
engages in banking-and finance-related
activities.
(5) “Cash items in the process of
collection” means checks or drafts in the
process of collection that are drawn on
another depository institution, including a
central bank, and that are payable
immediately upon presentation in the country
in which the reporting bank’s office that is
clearing or collecting the check or draft is
located: U.S. Government checks that are
drawn on the United States Treasury or any
other U.S. Government or Governmentsponsored agency and that are payable
immediately upon presentation; broker’s
security drafts and commodity or bill-oflading drafts payable immediately upon
presentation in the United States or the
country in which the reporting bank's office
that is handling the drafts is located; and
unposted debits.
(6) “Commitment" means any arrangement
that obligates a national bank to: (i) Purchase
loans or securities; or (ii) extend credit in the
form of loans or leases, participations in
loans or leases, overdraft facilities, revolving
credit facilities, or similar transactions.
(7) “Common stockholders’ equity” means
common stock, common stock surplus,
undivided profits, and capital reserves, net of
foreign currency translation adjustment and
unrealized losses on non-current marketable
equity securities.
(8) “Domestic depository institution”
means all federally-insured offices (branch
and main, foreign and domestic) of banks and
other deposit-taking institutions chartered
and headquartered in any of the several
states of the United States of America, the
District of Columbia, Puerto Rico, and United
States territories and possessions. This
definition encompasses commercial banks,
mutual and stock savings banks, savings or
building and loan associations (stock and
mutual), cooperative banks, credit unions,
and international banking facilities of
domestic depository institutions. U.S.
branches and agencies of foreign banks are
excluded from this definition.
(9) "Exchange rate contracts” include:
Cross-currency interest rate swaps; forward
foreign exchange rate contracts; currency
options purchased; and any similar
F ed eral R egister / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
instrument that, in the opinion of the OCC,
gives rise to similar risks.
(10) “Foreign bank” means (i) a foreign
central bank or (ii) a financial institution
which is organized under the laws of a
foreign country; that engages in the business
of banking; that is recognized as a bank by
the bank supervisory or monetary authorities
of the country in which its principal banking
operations are organized; that receives
deposits to a substantial extent in the regular
course of business; and that has the power to
accept demand deposits. This includes U.S.
branches and agencies of foreign banks.
(11) “Foreign central government” means
the national governing authority of a country
other than the United States of America; it
includes the departments, ministries and
agencies of the central government. This
definition does not include the following:
State, provincial, or local governments;
commercial enterprises owned by the central
government, which are defined as entities
engaged in activities involving trade,
commerce or profit that are generally
conducted or performed in the private sector
of the United States economy; private
agencies sponsored by the central
government; and non-central government
entities that are guaranteed by the foreign
central government.
(12) “Goodwill” means an intangible asset
that represents the excess of the purchase
price over the fair market value of tangible
and identifiable intangible assets acquired in
purchases accounted for under the purchase
method of accounting.
(13) “Intangible assets” include, but are not
limited to, purchased mortgage servicing
rights, goodwill, favorable leaseholds, and
core deposit value.
(14) “Interest rate contracts” include:
Single currency interest rate swaps; basis
swaps; forward rate agreements; interest rate
options purchased; and any similar
instrument that, in the opinion of the OCC,
gives rise to similar risks.
(15) “Original maturity” means, with
respect to a commitment, the earliest possible
date after a commitment is made on which it
is unconditionally cancellable at the option of
the issuing bank.
(16) “Preferred stock” includes the
following instruments: (i) “Convertible
preferred stock,” which means preferred
stock that is mandatorily convertible into
either common or perpetual preferred stock;
(ii) “Intermediate-term preferred stock,”
which means preferred stock with an original
maturity of at least seven years, but less than
20 years; (iii) "Long-term preferred stock,”
which means preferred stock with an original
maturity of 20 years or more; and (iv)
“Perpetual preferred stock,” which means
preferred stock without a fixed maturity date
that cannot be redeemed at the option of the
holder. For purposes of these instruments,
preferred stock that can be redeemed at the
option of the holder is deemed to have an
“original maturity” of the earliest possible
date on which it may be so redeemed.
(17) “Reciprocal holdings of bank capital
instruments” means cross-holdings or other
formal or informal arrangements in which
two or more banking organizations swap,
exchange, or otherwise agree to hold each
other's capital instruments. This definition
does not include holdings of capital
instruments issued by other banking
organizations that were taken in satisfaction
of debts previously contracted, provided that
the reporting national bank has not held such
instruments for more than five years or such
longer period approved by the OCC.
(18) "State” means any one of the several
states of the United States of America, the
District of Columbia, Puerto Rico, and the
territories and possessions of the United
States.
(19) "Subsidiary” means any corporation,
partnership, business trust, joint venture,
association or similar organization in which a
national bank directly or indirectly holds
more than a 50% ownership interest. This
definition does not include ownership
interests that were taken in satisfaction of
debts previously contracted, provided that
the reporting bank has not held such interest
for more than five years or such longer period
approved by the OCC.
(20) “Total capital” is the sum of a national
bank's core (Tier 1) and supplementary (Tier
2) capital elements.
(21) “Unconditionally cancellable,” with
respect to a commitment-type lending
arrangement, including retail credit card
lines, means the bank may, at any time, with
or without cause, refuse to advance funds or
extend credit under the facility.
(22) “United States Government or its
agencies” means an instrumentality of the
U.S. Government whose debt obligations are
fully and explicitly guaranteed as to the
timely payment of principal and interest by
the full faith and credit of the United States
Government.
(23) “United States Government-sponsored
agency" means an agency originally
established or chartered to serve public
purposes specified by the United States
Congress but whose obligations are not
explicitly guaranteed by the full faith and
credit of the United States Government.
S ectio n 2. C om pon en ts o f C a p ita l
A national bank’s qualifying capital base
consists of two types of capital—core (Tier 1)
and supplementary (Tier 2).
(a) C ore (T ie r 1) C apital. The following
elements comprise a national bank’s core
(Tier 1) capital:
(1) Common stockholders’ equity; and
(2) Minority interests in the common
stockholders’ equity accounts of consolidated
subsidiaries.
(b) S u p p lem en ta ry (T ie r 2) C apital. The
following elements comprise a national
bank’s supplementary (Tier 2) capital:
(1) Allowance for loan and lease losses, up
to a maximum of 1.25 percent of riskweighted assets, subject to the transition
rules in section 4(a)(2) of this Appendix A.
(2) Perpetual preferred stock, long-term
preferred stock, and convertible preferred
stock, without limit, if the issuing national
bank has the option to defer payment of
dividends on these instruments. For long-term
preferred stock, the amount that is eligible to
be included as supplementary (Tier 2) capital
is reduced by 20% of the original amount of
the instrument (net of redemptions) at the
beginning of each of the last five years of the
life of the instrument.
8569
(3) Hybrid capital instruments, without
limit. Hybrid capital instruments are those
instruments which combine certain
characteristics of debt and equity, such as
perpetual debt. To be included as
supplementary (Tier 2) capital, these
instruments must meet the following
criteria: 1
(i) The instrument must be unsecured,
subordinated to the claims of depositors and
general creditors, and fully paid-up;
(ii) The instrument must not be redeemable
at the option or the holder prior to maturity,
except with the arior approval of the OCC;
(iii) The instrument must be available to
participate in losses while the issuer is
operating as a going concern (in this regard,
the instrument must automatically convert to
common or perpetual or long-term preferred
stock if the sum of the retained earnings and
capital surplus accounts of the issuer shows a
negative balance); and
(iv) The instrument must provide the option
for the issuer to defer principal and interest
payments, if
(A) the issuer does not report a net profit
for the most recent combined four quarters,
and
(B) the issuer eliminates cash dividends on
common and preferred stock.
(4) Term subordinated debt instruments
and intermediate-term preferred stock are
included in supplementary (Tier 2) capital,
but only to,a maximum of 50% of core (Tier 1)
capital. To be considered capital, term
subordinated debt instruments must meet the
requirements of 12 CFR'3.100(f)(1). Also, at
the beginning of each of the last five years of
the life of either type of instrument, the
amount that is eligible to be included as
supplementary capital is reduced by 20% of
the original amount of that instrument (net of
redemptions).
(c) D ed u ctio n s from capital. The following
items are deducted from the appropriate
segment of a national bank's capital base
when calculating its risk-based capital ratio.
(1) Deductions from core (Tier 1) capital:
All intangible assets, including goodwill, are
deducted from core (Tier 1) capital before the
supplementary (Tier 2) portion of the
calculation is made, subject to the transition
rules contained in section 4(a)(l)(ii) of this
Appendix A; however, purchased mortgage
servicing rights are not deducted from core
(Tier 1) capital. In addition, the OCC might
not require national banks to deduct goodwill
that they acquire, or have previously
acquired, in connection with supervisory
mergers with problem or failed banks.
(2) Deductions from total capital:
(i) Reciprocal holdings of capital
instruments of banking organizations; and
(ii) Investments in the equity accounts of
unconsolidated banking and finance
subsidiaries.12
1 M andatory convertible debt instrum ents that
m eet the requirem ents of 12 CFR 3.100(e)(5), or that
have been previously approved as capital by the
OCC, a re treated a s qualifying hybrid capital
instrum ents, regardless of w hether they m eet the
requirem ents of this section 2(b)(3).
2 The OCC may require deduction, on a case-by
case basis, of investm ents in asso ciated com panies,
unless the bank can dem onstrate that it does not
exercise a significant influence over the entity.
E57®
F ederal R egister / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
S ectio n 3. R isk C a te g o r ie s/W e ig h ts f o r OnB a la n ce S h ee t A s s e ts a n d O ff-B alance S h eet
Item s
The denominator of the risk-based capital
ratio, i.e., a national bank’s average riskweighted assets, is derived by assigning that
bank’s assets and off-balance sheet items to
one of the five risk categories detailed in
section 3(a) of this Appendix A. Each
category has a specific risk weight. Before an
off-balance sheet item can be assigned a risk
weight, it must be converted to an on-balance
sheet credit equivalent amount in accordance
with section 3(b) of this Appendix A. The risk
weight assigned to a particular asset or onbalance sheet credit equivalent amount
determines the percentage of that asset/
credit equivalent that is included in the
denominator of the bank’s risk-based capital
ratio. Thus, an asset/credit equivalent
assigned to the 20% category is one against
which a national bank is expected to
maintain one-fifth of the capital it should
maintain against an asset/credit_equivalent
in the 100% category. Any asset deducted
from a bank’s capital in computing the
numerator of the risk-based capital ratio is
not included as part of the bank’s riskweighted assets.
(a) O n -B alan ce S h ee t A ss e ts. The following
are the risk categories/weights for onbalance sheet assets:
(1) Z ero p e rc e n t R isk W eight, (i) Cash,
including domestic and foreign currency
owned and held in all offices of a national
bank or in transit. Any foreign currency held
by a national bank should be converted into
U.S. dollar equivalents.
(ii) Deposit reserves and other balances at
Federal Reserve Banks.
(iii) Securities issued by the United States
Government or its agencies that have a '
remaining maturity of 91 days or less.
(2) 10 p e rc e n t R isk W eight, (i) Securities
issued by the United States Government or
its agencies that have a remaining maturity
greater than 91 days.
(ii) That portion of assets guaranteed by
the United States Government or its agencies.
(iii) That portion of assets collateralized by
the current market value of securities issued
or guaranteed by the United States
Government or its agencies.
(iv) The book value of paid-in Federal
Reserve Bank stock.
(v) Assets collateralized by cash in a
segregated deposit account held by the
reporting national bank.
(3) 20 p e rc e n t R isk W eight, (i) All claims on
domestic depository institutions, and all
assets backed by the full faith and credit of
domestic depository institutions. This
includes the credit equivalent amount of
participations in commitments and standby
letters of credit sold to other domestic
depository institutions, but only if the
originating bank remains liable to the
customer or beneficiary for the full amount of
the commitment or standby letter of credit.
Also included in this category are the credit
equivalent amounts of risk participations in
bankers’ acceptances conveyed to other
domestic depository institutions. However,
bank-issued securities that qualify as capital
of the issuing bank are not included in this
risk category but are assigned to the 100%
risk category of section 3(a)(5) of this
Appendix A.
(ii) Claim s on foreign banks w ith an
original maturity of one year or less.
(iii) Cash item s in the process o f collection.
(iv) Local currency claims on foreign
central governments, to the extent the bank
has local currency liabilities in that country.
Any amount of such claims that exceed the
amount of the bank’s local currency liabilities
is assigned to the 100% risk category of
section 3(a)(5) of this Appendix A.
(v) Claim s on U nited States Governm entsp onsored agen cies.
(vi) That portion o f a ssets guaranteed by
U nited S tates G overnm ent-sponsored
agencies.
(vii) That portion of a ssets collateralized
by the current market valu e of securities
issu ed or guaranteed by U nited States
G overnm ent-sponsored agen cies.
(viii) General obligations of any state or
any political subdivision thereof, within the
meaning of 12 CFR 1.3(g), and that portion of
any claims guaranteed by any such state or
political subdivision.
(ix) Claim s on official m ultilateral lending
institution s or regional develop m en t
institution s in w h ich the U nited States
G overnm ent is a shareholder or contributing
member.
(4) 5 0 p e r c e n t R isk W eight, (i) Revenue
bonds issued by any state or any political
subdivision thereof, within the meaning of 12
CFR 1.3(g), for which the underlying obligor is
the state or political subdivision, but which
are repayable solely from the revenues
generated by the project financed through the
issuance of the obligations.
(ii) The credit equivalent amount of interest
rate and foreign exchange rate contracts,
calculated in accordance with section 3(b)(5)
of this Appendix A, that do not qualify for
inclusion in a lower risk category.
(5) 100 percent Risk Weight. All other
assets not specified above, including, but not
limited to:
(i) Claim s on foreign banks w ith an original
maturity ex ceed in g one year;
(ii) All non-local currency claims on foreign
central governments, as well as local
currency claims on foreign central
governments that are not included in section
3(a)(3)(iv) of this Appendix A;
(iii) Instruments issued by other banking
organizations that qualify as capital of the
issuer;
(iv) Obligations issued by any state or any
political subdivision thereof, within the
meaning of 12 CFR 1.3(g), for the benefit of a
private party or enterprise where that party
or enterprise, rather than the issuing state or
political subdivision, is responsible for the
timely payment of principal and interest on
the obligations, e.g., industrial development
bonds;
(v) Any investments in unconsolidated
subsidiaries that are not required to be
deducted from the bank’s qualifying capital
base, pursuant to section 2(c)(3) of this
Appendix A;
(vi) A sse ts secured by com m ercial and
resid en tial real estate, including m ortgages
on one-to-four fam ily hom es; and
(vii) Claim s on foreign and dom estic
govern m en t-ow ned com m ercial enterprises.
(b) O ff-B alance S h e e t A c tiv itie s . The risk
weight assigned to an off-balance sheet
activity is generally determined by a two-step
process. First, the face amount of an offbalance sheet item is multiplied by the
appropriate credit conversion factor detailed
in this section. This calculation translates the
face amount of an off-balance sheet exposure
into an on-balance sheet credit equivalent
amount. Second, the resulting credit
equivalent amount is then assigned to the
proper risk category using the criteria
regarding obligors, guarantors and collateral
listed in section 3(a) of this Appendix A. The
following are the credit conversion factors
and the off-balance sheet items to which they
apply.
(1) 100p e rc e n t c r e d it con versio n fa cto r, (i)
Direct credit substitutes, including financial
guarantee-type standby letters of credit that
support financial claims on the account
party.3*The face amount of a direct credit
substitute is netted against the amount of any
participations sold in that item. The amount
not so sold is converted to an on-balance
sheet credit equivalent and assigned to the
proper risk category using the criteria
regarding obligors, guarantors and collateral
listed in section 3(a) of this Appendix A. If
the originating bank remains liable to the
beneficiary for the full amount of the standby
letter of credit, in the event the participant
fails to perform under its participation
agreement, the amount of participations sold
are converted to an on-balance sheet credit
equivalent with that amount then being
assigned to the risk category appropriate for
the purchaser of the participation, which, if
the purchaser is a domestic depository
institution, would be the 20% risk category of
section 3(a)(3) of this Appendix A. If the
participations are such that each participant
is responsible only for its pro-rata share of
the risk, and there is no recourse to the
originating bank, the full amount of the
participations sold is excluded from the
originating bank’s risk-weighted assets;
(ii) Risk participations purchased in
bankers’ acceptances and participations
purchased in direct credit substitutes;
(iii) Assets sold under an agreement to
repurchase and assets sold with recourse, to
the extent these assets are not reported on a
national bank’s statement of condition (this
includes loan strips sold without direct
recourse); and
(iv) Contingent obligations with a certain
draw down, e.g., legally binding agreements
to purchase assets at a specified future date.
(2) 5 0 p e r c e n t c r e d it co n versio n fa cto r, (i)
Transaction-related contingencies, including,
in te r alia, performance bonds and
performance-based standby letters of credit
3 For purposes of this section 3(b)(l)(i), a
“standby letter of credit" is any letter of credit, or
sim ilar arrangem ent, how ever nam ed or described,
w hich rep resen ts an irrevocable obligation to the
beneficiary on the p art of the issuer (1) to repay
m oney borrow ed by or advanced to or for the
account of the account party or (2) to m ake paym ent
on account of any indebtedness undertaken by the
account party, in the event that the account party
fails to fulfill its obligation to the beneficiary.
Perform ance-based standby letters of credit are
defined differently in section 3(b)(2)(i), infra.
F ederal R egister / Vol. 53, No. 50 / Tuesday, March 15, 1988 / Proposed Rules
related to a particular transaction.4 To the
extent permitted by law or regulation,
performance-based standby letters of credit
include such things as arrangements backing
subcontractors’ and suppliers’ performance,
labor and materials contracts, and
construction bids;
(ii) The unused portion of loan
commitments with an original maturity
exceeding one year, including home-equity
and mortgage lines of credit; and
(iii) Revolving underwriting facilities, note
issuance facilities, and similar arrangements
pursuant to which the bank’s customer can
issue short-term debt obligations in its own
name, but for which the bank has a legally
binding commitment to either:
(A) Purchase the obligations the customer
is unable to sell by a stated date; or
(B) Advance funds to its customer, if the
obligations cannot be sold.
(3) 2 0 p e r c e n t c re d it con versio n factor, (i)
Trade-related contingencies. These are short
term self-liquidating instruments used to
finance the movement of goods and are
collateralized by the underlying shipment. A
commercial letter of credit is an example of
such an instrument.
(4) Z ero p e rc e n t c re d it c o n versio n factor.
(i) Unused commitments with an original
maturity of one year or less;
(ii) Unused commitments with an original
maturity of greater than one year, if:
(A) They are unconditionally cancellable
by the bank, and
[B) The bank has the contractual right to,
and in fact does, make a separate credit
decision based upon the borrower’s current
financial condition, before each drawing
under the lending facility; and
(iii) Unused retail credit card lines that are
unconditionally cancellable by the bank.
(5) In te re st ra te a n d foreign exch an ge ra te
co n tra cts. The credit equivalent amount of
such contracts is the sum of two measures of
credit exposure—current and potential credit
exposure.
(i) Current c re d it ex p o su re —The daily
replacement cost of the contract is
determined by marking it to market (this
value is measured in U.S. dollars, regardless
of the currency specified in the contract).
Contracts with negative market value are
deemed to have no current credit exposure.
(ii) P o te n tia l c re d it exposu re —To complete
the calculation of the on-balance sheet credit
equivalent amount of a contract, an estimate
of the potential increase in credit exposure
over the remaining life of the contract is
added on (the “add-on”) to the contract’s
current credit exposure, including contracts
with no current credit exposure, The add-on
is calculated by multiplying the notional
4
For purposes of this section 3(b)(2)(i), a
“perform ance-based stan d b y letter of cre d it” is any
letter of credit, or sim ilar arrangem ent, how ever
nam ed or described, w hich rep resen ts an
irrevocable Obligation to the beneficiary on the part
of the issuer to m ake paym ent on account of any
default by the account party in the perform ance of a
nonfinancial or com m ercial obligation.
Participations in perform ance-based stan d b y letters
of credit are treated the sam e as participations in
financial guarantee-type stan d b y letters of credit.
Financial guarantee-type stan d b y letters of credit
are defined in section 3(b)(1)(f). supra.
principal amount of the item on a daily basis
by one of the following credit conversion
factors, as appropriate: 5
(A) Interest rate contracts—
(I) Zero percent, if the contract has less
than one year remaining until maturity, and
(II) 0.5 percent, for contracts with a
remaining maturity of one year or more;
(B) Foreign exchange rate contracts—
(I) 1.0 percent, if the contract has less than
one year remaining until maturity, and
(II) 5.0 percent, for contracts with a
remaining maturity of one year or more.
(iii) R isk w eigh tin g —The credit equivalent
amount, which is derived from sections
3(b)(5) (i) & (ii) of this Appendix A, is then
assigned to the proper risk category using the
criteria regarding obligors, guarantors, and
collateral listed in section 3(a) of this
Appendix A. However, the maximum risk
weight assigned to the credit equivalent
amount of an interest rate or foreign
exchange rate contract is 50%.
(iv) E x cep tio n s —The following contracts
are not subject to the above calculation and,
therefore, are not considered part of the
denominator of a national bank's risk-based
capital ratio:
(A) Exchange rate contracts with an
original maturity of seven days or less; and
(B) Any interest rate or exchange rate
contract that is traded on an exchange
requiring the daily payment of any variations
in the market value of the contract.
S ectio n 4. Im plem en tation , T ran sition R ules,
a n d T arget R a tio s
(a) D e c e m b e r 31, 1990 to D e c e m b e r 30,
1992. During this time period:
(1) All national banks are expected to
maintain a capital to risk-weighted assets
ratio of 7.25%.
(1) Fifty percent of this 7.25% must be made
up of core (Tier 1) capital; however, of this
50%, up to 10% can be comprised of
supplementary (Tier 2) capital elements.
(ii) Intangible assets, including goodwill,
that national banks have been allowed to
count as capital as a result of the transition
rules contained in 12 CFR 3.3 are
grandfathered until December 31,1992, and,
therefore, are not deducted from core (Tier 1)
capital until that date.
(2) Allowance for loan and lease losses can
be included in supplementary (Tier 2) capital
up to a maximum of 1.5% of a bank’s riskweighted assets.
(3) Supplementary (Tier 2) capital elements
that are not used as Part of core (Tier 1)
capital will qualify as part of a national
bank’s total capital base up to a maximum of
100% of that bank’s core (Tier 1) capital.
(b) On D e c e m b e r 31, 1992.
(1) All national banks are expected to
maintain a capital to risk-weighted assets
ratio of 8.0%.
(2) One half of a national bank's total
capital must consist of core (Tier 1) capital
elements.
(3) Supplementary (Tier 2) capital elements
qualify as part of a national bank’s total
5 No potential credit exposure is calculated for
single currency floating/floating interest rate sw aps;
rather, the on-balance sheet credit equivalent of
these contracts is e valuated solely on the b asis of
the am ount of their current credit exposure.
8571
capital base up to a maximum of 100% of that
bank’s core (Tier 1) capital.
Date: February 23, 1988.
Robert L. Clarke,
C o m p tro ller o f th e Currency.
BILLING CODE 4810-33-K!
BOARD OF GOVERNORS OF THE FEDERAL
RESERVE SYSTEM
PARI 22S—1AWK HOLD1N©
COMPANIES AMD C&MNCBE BN BAMK
CONTROL
1. The authority citation for Part 225
continues to read as follows:
Authority: 12 U.S.C. 1817(j)(13), 1818,
1843(c)(8), 1844(b), 3106, 3108, 3907, 3909.
A—[Amended]
2. The Board proposes to amend
Appendix A to Part 225 by adding at the
end of the title to Appendix A:
“Leverage Measure”.
Appendix B==[R@dl©sognated so Appendix
G]
3. The Board proposes to amend the
Appendices to Part 225 by redesignating
the current Appendix B as Appendix C
and adding a new Appendix B to read as
follows:
Appendix E -C ap ita! Adequacy
Guidelines for Bank Holding Companies
and State Member Banks: Risk-Based
Measure
J. O v e r v ie w
The Board of Governors of the Federal
Reserve System has adopted a risk-based
capital measure as part of the System’s
Capital Adequacy Guidelines. (Supervisory
leverage ratios relating primary and total
capital to total assets are outlined in
Appendix A of these Guidelines.) The riskbased capital measure is based upon a
framework developed jointly by supervisory
authorities from 12 major industrial countries
(“the Basle Supervisors’ Committee"). This
Basle capital framework was recommended
by the Group of Ten Central Bank Governors
as the basis for implementing a generally
consistent international approach to
assessing capital adequacy.
The principal objectives of the risk-based
measure are to: (i) Make regulatory capital
requirements more sensitive to differences in
risk profiles among banking organizations; (ii)
take off-balance sheet exposures into account
in assessing capital adequacy; (iii) minimize
disincentives to holding liquid, low-risk
assets; and (iv) achieve a greater degree of
consistency in the assessment of the capital
adequacy of major banking organizations
throughout the world.
The risk-based capital measure comprises
a definition of capital and a system for
calculating weighted risk assets by assigning
assets and off-balance sheet items to risk
categories. An institution’s risk-based capital
ratio is calculated by dividing its qualifying
capital base (the numerator of the ratio) by
its weighted risk assets (the denominator).
H572
— 3— —
Federal Register / Vol. 53, No. 50 / Tuesday, March 15, 1988 / Proposed Rules
l— ■ — ■ I —
— ——
The definition of qualifying capital is outlined
below in section II, and the procedures for
calculating weighted risk assets are
discussed in section III. Table I illustrates a
sample calculation of weighted risk assets
and the risk-based capital ratio. The riskbased guidelines also establish a schedule for
achieving a minimum supervisory standard
for the ratio of capital to weighted risk assets
and provide for transitional arrangements
during a phase-in period to facilitate adoption
and implementation of the measure. These
standards and transitional arrangements are
set forth in section IV.
The risk-based guidelines apply to all state
member banks and to bank holding
companies with consolidated assets of $150
million or more. Bank holding companies
with less than $150 million in consolidated
assets would generally be exempt from the
calculation and analysis of risk-based ratios
on a consolidated basis under the same terms
and conditions as described in Appendix A
(leverage measure) of the Capital Adequacy
Guidelines.
The risk-based guidelines are to be used in
the examination and supervisory process as
well as in the analysis of applications acted
upon by the Federal Reserve. Generally,
banking organizations are expected to
operate above the minimum risk-based
standard. Those institutions with high or
inordinate levels of risk should hold capital
commensurate with their levels of risk.
The risk-based capital ratio focuses
principally on broad categories of credit risk,
although it does take one limited aspect of
interest rate and market risk (maturity) into
account in assigning certain assets to risk
categories. The risk-based ratio (like the
leverage measure) does not, however, take
account of other factors that can affect an
organization’s financial condition. These
factors include: Overall interest rate
exposure; liquidity, funding and market risks;
the quality and level of earnings; investment
or loan portfolio concentrations; the quality
of loans and investments; the effectiveness of
loan and investment policies; and
management’s overall ability to monitor and
control other financial and operating risks.
In addition to evaluating capital ratios, an
overall assessment of capital adequacy must
take account of each of these other factors
including, in particular, the level and severity
of problem and classified assets. For this
reason, the final supervisory judgment on an
organization’s capital adequacy may differ
significantly from conclusions that might be
drawn solely from the absolute level of the
organization’s risk-based (or leverage-based)
capital ratio.
II. D efin ition o f C a p ita l fo r th e R isk -B a se d
C a p ita l R a tio
An institution's qualifying capital base
consists of two types of capital elements:
“core capital elements” (Tier 1) and
"supplementary capital elements” (Tier 2).
These capital elements and the various limits,
restrictions, and deductions to which they are
subject are discussed below and are set forth
in Table II.
A.
The C om ponents o f Q ualifying Capital
1.
C ore c a p ita l e le m en ts (T ie r 1). Core
capital elements consist of:
—
tm
—
I■
— A llo w a n ces for loan and lea se lo sse s
—Common stockholders’ equity (common
(subject to lim itations d iscu ssed below);
stockholders’ equity includes common
— Perpetual and long-term preferred stock
stock, surplus, and retained earnings,
(original maturity of at lea st 20 years);
including disclosed capital reserves that
—Hybrid capital instruments, including
represent an appropriation of retained
perpetual debt and mandatory convertible
earnings, net of treasury stock, and
securities; and
including foreign currency translation
—Term subordinated debt and intermediateadjustments);
term preferred stock (original average
—Minority interest in the common
maturity of seven years or more).
stockholders’ equity accounts of
The maximum amount of supplementary
consolidated subsidiaries; and
elements that may be treated as regulatory
—Supplementary capital elements (during the
capital will be limited to 100 percent of core
transition period only, and subject to
capital (after any deductions of goodwill). In
certain limitations set forth in Section IV
addition, the combined amount of term
below).
subordinated debt and intermediate-term
At least 50 percent of the qualifying capital
preferred stock that may be treated as
base of a bank holding company or state
supplementary capital for regulatory
member bank must consist of core capital.
purposes will be limited to 50 percent of core
For bank holding companies, core capital is
capital. Amounts in excess of these limits
may be issued and, while not included in the
defined, during the transition period (that is,
ratio calculation, will be taken into account
through year-end 1992), as the sum of core
capital elements minus any goodwill acquired in the overall assessment of an organization’s
funding and financial condition.
on or after March 12,1988. (During the
Redemptions of Tier 2 capital instruments
transition period, bank holding company
before stated maturity could have a
goodwill booked before March 12,1988,
significant impact on an organization’s
would be “grandfathered”, that is, would not
overall capital structure. Consequently, an
be deducted from core capital during the
organization should consult with the Federal
transition period.) State member banks
Reserve before redeeming perpetual preferred
generally are prohibited from including
stock or before redeeming any other Tier 2
goodwill in regulatory capital; thus, all bank
capital instrument prior to maturity.
goodwill is to be deducted immediately from
The components of supplementary capital
state member bank core capital without any
are discussed in greater detail below.
grandfather arrangements.1 After the
a.
A llo w a n c e f o r loan a n d le a s e lo sse s.
transition period (that is, after year-end 1992),
Allowances or loan and lease losses are
a ll bank holding company goodwill will be
reserves that have been established through a
deducted from the sum of the core capital
charge against earnings to absorb future
elements for purposes of determining core
losses on loans or lease financing
receivables. Allowances for loan and lease
capital and calculating the risk-based capital
losses exclude "allocated transfer risk
ratio.
2.
S u p p lem en ta ry c a p ita l e le m en ts (T ie r 2). reserves,” 3 and reserves created against
identified losses or earmarked for a specific
A portion of an institution’s qualifying capital
asset.
base may consist of supplementary capital
The risk-based capital guidelines provide a
elements. Supplementary capital elements
phasedown during the transition period of the
include: 2
extent to which the allowance for loan and
lease losses may be included in an
institution’s capital base. Initially, no limit
will apply to these reserves. However, by
year-end 1990, the allowance for loan and
1 An exception w ill continue to be m ade for
lease losses, as a component of capital, may
goodw ill acquired by state m em ber ban k s in
constitute no more than 1.5 percent of an
supervisory m ergers w ith troubled or failed b anks in
institution’s weighted risk assets and, at the
w hich the Federal Reserve h a s given the bank
perm ission to count goodw ill for capital purposes.
end of the transition period and thereafter, no
2 The B asle capital fram ew ork also provides for
more than 1.25 percent of weighted risk
the inclusion of “undisclosed reserv es” in Tier 2. As
assets.4
defined in the fram ew ork, undisclosed reserves
rep resen t accum ulated after-tax retained earnings
th at are not disclosed on the balance sheet of a
bank. A part from the fact th at these reserves are not
disclosed publicly, they are essentially of the sam e
quality a nd c h arac te r as retained earnings arid, to
be included in capital, such reserves m ust be
accepted by the banking organization’s hom e
supervisor. A lthough such undisclosed reserves are
common in som e countries, under generally
accep ted accounting principles and long-standing
supervisory practice, these types of reserves are not
recognized for banks and ban k holding com panies
in the U nited States. Foreign banking organizations
seeking to m ake acquisitions or conduct b usiness in
the U nited S tates w ould be expected to disclose
publicly a t least the degree of reliance on such
reserves in m eeting supervisory capital
requirem ents.
3 A llocated transfer risk reserves a re reserves
th a t have been e stablished in accordance w ith
Section 905(a) of the International Lending
Supervision A ct of 1983 against certain a sse ts
w hose value has been found by the U.S. supervisory
authorities to have been significantly im paired by
pro tracted transfer risk problem s.
4 The am ount of the a llo w a n ce for loan a n d lease
losses that m ay be included in cap ital is b a se d on a
percentage of gross risk w eighted assets. A banking
organization m ay deduct reserves for loan a n d lease
losses in excess of the am ount perm itted to be
included in capital, a s w ell as a llocated tran sfer risk
reserves, from the gross sum of w eighted risk a sse ta
a nd use the resulting net sum of w eighted risk
a sse ts in com puting the denom inator of the riskb a se d capital ratio.
F ederal R egister / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
b. P erp etu a l a n d long-term p r e fe r r e d sto c k .
Perpetual preferred stock is defined as
preferred stock without a fixed maturity date
a n d that cannot be redeemed at the option of
the holder. Long-term preferred stock
includes limited-life preferred stock with an
original maturity of 20 years or more. (If the
holder has a right to redeem the instrument
prior to the original stated maturity, maturity
would be defined for risk-based capital
purposes, as the earliest possible date on
which the holder can put the instrument back
to the issuing banking organization.) When
long-term preferred stock has a remaining
maturity of less than seven years, it should be
treated for capital purposes as intermediateterm preferred stock and subject to the 50
percent of core capital limitation described
below.
Perpetual preferred stock and long-term
limited-life preferred stock would qualify for
inclusion in capital provided that they can
absorb losses while the issuer operates as a
going concern (a fundamental characteristic
of equity capital) and provided the issuer has
the option to defer or reduce preferred
dividends if dividends on common stock are
eliminated or reduced, Given these conditions
and the perpetual or long-term nature of the
instruments, there is no limit on the amount of
these instruments that may be included
within Tier 2 capital.
c. H y b r id c a p ita l in stru m en ts. Hybrid
capital instruments include long-term debt
instruments that generally meet the
requirements set forth below:
(1) The instrument must be unsecured; fully
paid-up; and subordinated to general
creditors and; if issued by a bank, also to
depositors.
(2) The instrument must not be redeemable
at the option of the holder prior to maturity,
except with the prior approval of the Federal
Reserve. (Consistent with the Board’s criteria
for perpetual debt and mandatory convertible
securities, this requirement implies that
holders of such instruments may not
accelerate the payment of principal except in
the event of bankruptcy, insolvency, or
reorganization.)
(3) The instrument must be available to
participate in losses while the issuer is
operating as a going concern. (Straight term
subordinated debt would not meet this
requirement.) To satisfy this requirement, the
instrument must convert to common or
perpetual or long-term preferred stock in the
event that the sum of retained earnings and
capital surplus accounts of the issuer show a
negative balance.
(4) The instrument must provide the option
for the issuer to defer interest payments if: (a)
The issuer does not report a profit in the
preceding annual period (defined as
combined profits for the most recent four
quarters); a n d (b) the issuer eliminates cash
dividends on common and preferred stock.
Perpetual debt and mandatory convertible
securities that meet the criteria set forth in 12
CFR Part 225, Appendix A, will qualify as
hybrid capital instruments for state member
banks and bank holding companies. During
the transition period, the Federal Reserve will
r e v ie w the criteria for m a n d a to ry convertible
securities in light of the definitions contained
in the Basle capital framework. As a result of
this review, the Board may modify the
mandatory convertible criteria as part of its
overall program for implementing the riskbased capital ratio.
There is no limit on the amount of hybrid
capital instruments that may be included
within Tier 2 capital.
d. S u b o rd in a te d d e b t a n d in term e d ia te term p r e fe r r e d sto ck . The aggregate amount
of term subordinated debt (excluding
mandatory convertible debt) and
intermediate-term preferred stock that may
be treated as capital for risk-based capital
purposes is limited to 50 percent of core
capital. Subordinated debt and intermediateterm preferred stock must have an original
average maturity of at least seven years to
qualify as supplementary capital.5 (If the
holder has the option to redeem the
instrument prior to the original stated
maturity, maturity would be defined, for riskbased capital purposes, as the earliest
possible date on which the holder can put the
instrument back to the issuing banking
organization.) In the case of subordinated
debt, the instrument must be unsecured and
must clearly state on its face that it is not a
deposit and is not insured by a Federal
agency. To qualify as capital in banks, debt
must be subordinated to depositors and
general creditors; in bank holding companies,
debt must be subordinated in right of
payment to all senior indebtedness of the
issuer. Consistent with current regulatory
requirements, if a state member bank wishes
to redeem subordinated debt before the
stated maturity, it should receive prior
approval of the Federal Reserve.
e. D iscou n t o f su p p le m e n ta r y c a p ita l
in stru m en ts. As a limited-life capital
instrument approaches maturity, it begins to
take on characteristics of a short-term
obligation and becomes less like a
component of capital. For this reason, the
outstanding amount of term subordinated
debt and limited-life preferred stock eligible
for inclusion in Tier 2 would be adjusted
downward, or discounted, as these
instruments approach maturity. All such
instruments would be discounted by reducing
the outstanding amount of the capital
instrument that would count as
supplementary capital by a fifth of the
original amount, less redemptions, each year
during the instrument’s last five years before
maturity. Such instruments, or portions of
such instruments, therefore, would have no
capital value when they have a maturity of
less than one year.
f. R eva lu a tio n re se rv es. The Basle capital
framework addresses the role in capital of
revaluation reserves with respect to bank
premises and long-term holdings of equity
securities. When recognized, these reserves
result from the restatement of asset carrying
values to reflect current market values. In the
5
U nsecured term debt issued by bank holding
com panies prior to M arch 12,1988, and qualifying as
secondary capital at the time of issuance w ould
continue to qualify as capital under the risk-based
fram ew ork, subject to the 50 percent of core capital
lim itation. Bank holding com pany term debt issued
on or after M arch 12,1988, must be subordinated in
o rd er to qualify as capital.
m?3
United States, banks and bank holding
companies, for the most part, follow generally
accepted accounting principles (GAAP) when
preparing their financial statements, and
GAAP generally does not permit the use of
market-value accounting. For this and other
reasons the Federal Reserve has generally
not included unrealized asset values in
capital ratio calculations; although it has long
taken such values into account in assessing
the overall financial strength of a banking
organization.
The equivalent of revaluation reserves for
state member banks and bank holding
companies will not be formally recognized in
supplementary capital or in the calculation of
the risk-based capital ratio. However, all
banking organizations are encouraged to
disclose their equivalent of premises and
equity revaluation reserves, and such values
will be taken into account as additional
factors in assessing overall capital adequacy
and financial condition. For example, in the
absence of any notable supervisory,
financial, or operating problems,
organizations with significant and reliable
revaluation reserves may be permitted to
operate closer to minimum supervisory
capital ratios than organizations without such
values.
B. Deductions from Capital and Other
Adjustment
Certain assets are to be deducted from an
organization’s capital base for the purpose of
calculating the numerator of the risk-based
capital ratio.6 These assets include:
(1) Goodw’ill—deducted from Tier 1—(See
discussion below of limited grandfathering of
bank holding company goodwill during the
transition period);
(2) Investments in unconsolidated banking
and finance subsidiaries and, on a case-by
case basis, investments in other subsidiaries
or associated companies at the discretion of
the Federal Reserve—deducted from the sum
of Tier 1 and Tier 2; and
(3) Reciprocal holdings of capital
instruments of banking organizations—
deducted from the sum of Tier 1 and Tier 2.
1.
G o o d w ill a n d o th e r in ta n g ib le a ssets.
Goodwill is an intangible asset that
represents the excess of the purchase price
over the fair market value of net assets
acquired in acquisitions accounted for under
the purchase method of accounting.
a.
B ank h oldin g co m p a n y g o o d w ill. Any
goodwill carried on the balance sheet of a
bank holding company after December 31,
1992, should be deducted from the sum of
core capital elements in determining Tier 1
capital. In addition, bank holding company
goodwill acquired as a result of a merger or
acquisition that is consummated on or after
March 12,1988, also will be deducted. For
bank holding companies, any goodwill in
existence before March 12,1988, would be
“grandfathered” during the transition period
and would not be deducted from Tier 1 until
December 31,1992.
6 Any assets deducted from capital in computing
the num erator of the ratio w ould not be included in
w eighted risk assets in com puting the denom inator
of the ratio.
8574
F sdsral Kegiiiteir / Vol. 53, No. 50 / Tuesday, M arch 15, 1988 / Proposed Rules
b. S ta te m em b e r b an k g o o d w ill. Since state
member banks, generally may not include
goodwill in regulatory capital under current
supervisory policies, all goodwill in state
member banks will be deducted from Tier 1
capital immediately.7
c. O th er in ta n gible a ssets. The Federal
Reserve is not proposing, as a matter of
general policy, to deduct any other intangible
assets from the capital of state member
banks and bank holding companies at this
time. The Federal Reserve, however, will
continue to monitor closely the level and
quality of other intangible assets—including
purchased mortgage servicing rights,
leaseholds, and core deposit value—and take
them into account in assessing the capital
adequacy of banking institutions. As with
any other asset banking organizations should
review periodically the carrying value of
intangible assets and make appropriate
adjustments in carrying values or related
amortization periods.
As a general rule, the Board believes that
banking organizations should maintain strong
tangible core capital bases in relation to
weighted risk assets. While all intangible
assets will be monitored, intangible assets
(other than goodwill) that exceed 25 percent
of core (Tier 1) capital will be subject to
particularly close scrutiny. In addition, the
Board will, on a case-by-case basis, continue
to consider the level of an individual
organization’s tangible capital ratio (after
deducting all intangible assets), together with
the quality and value of the organization’s
intangible assets, in making an overall
assessment of capital adequacy. Moreover,
the Board intends to continue its policy of
requiring banking organizations experiencing
substantial growth internally and by
acquisition to maintain strong capital
positions that are substantially above
minimum supervisory levels, without
significant reliance on intangible assets.
2.
In ve stm en ts in certa in s u b sid ia rie s —a.
U n co n so lid a te d ban kin g o r fin a n ce
su b sid ia ries. Any equity or debt capital
investments in banking or finance
subsidiaries 8 that are not consolidated under
regulatory reporting requirements are to be
deducted from an organization’s total capital
base, that is, from the sum of core capital and
supplementary capital elements.9 Inasmuch
7 An exception to this rule w ould be m ade for
those state m em ber b an k s th a t hav e acquired
goodw ill in connection w ith supervisory m ergers
w ith problem or failed ban k s a n d th at have been
perm itted to include such goodw ill in capital un d er
current policy. C onsistent w ith this approach, such
state m em ber b an k s w ould be allow ed to continue
to include goodw ill in cap ital for risk -b ased capital
purposes.
8 For this purpose, a sub sid iary generally is
defined a s any banking or finance com pany in
w hich the repoiting institution holds m ore th an 50
percen t of the outstanding common stock.
9 A n exception to this deduction w ould b e m ade
in the case of sh ares acquired in the regular course
of securing or collecting a d ebt previously
c o n tracted in good faith. The requirem ents for
consolidation are spelled out in the instructions to
the com m ercial b an k C onsolidated R eports of
C ondition and Income (Call Report) a n d the
C onsolidated Financial S tatem ents for Bank
Holding C om panies (Y -9C lep o rt).
as the assets of unconsolidated subsidiaries
are not fully reflected in a banking
organization’s consolidated total assets, such
assets may be viewed as the equivalent of
off-balance sheet exposures since the
operations of an unconsolidated subsidiary
could expose the parent organization and its
affiliates to considerable risk. For this reason,
it is appropriate to view the capital invested
in these unconsolidated entities as primarily
supporting the risks inherent in these offbalance sheet assets, and not generally
available to support risks or additional
leverage elsewhere in the organization.
b. O th er su b sid ia ries. The deduction of
equity and debt capital investments from the
banking organization's capital may also be
applied in the case of other subsidiaries, such
as securities affiliates, that, while
consolidated for accounting purposes, are not
deemed to be consolidated for certain other
purposes, such as to facilitate functional
regulation of financial or other subsidiaries.
The Federal Reserve will not automatically
deduct investments in other unconsolidated
subsidiaries (such as those engaged in
commercial activities) or investments in joint
ventures and associated companies.10*
Nonetheless, the capital invested in these
entities, like investments in unconsolidated
banking and finance subsidiaries, supports
assets not consolidated with the rest of the
banking organization's activities and,
therefore, may not be generally available to
support-additional leverage in the banking
organization. Moreover, experience has
shown that banking organizations stand
behind the losses of affiliated institutions,
such as joint ventures and associated
companies, in order to protect the reputation
of the organization as a whole. In some cases,
this has led to losses that have exceeded the
investments in such organizations.
For this reason, the Federal Reserve will
monitor the level and nature of such
investments for individual banking
organizations and, on a case-by-case basis,
may deduct such investments from capital,
apply an appropriate risk-weighted capital
charge against the organization’s
proportionate share of the assets of its
associated companies, or otherwise require
the organization to operate with a risk-based
capital ratio above the minimum.
In considering the appropriateness of such
adjustments or actions, the Federal Reserve
will take into account whether
(1) The subsidiary, joint venture, or
associated company has a name similar to
the banking organization;
(2) The banking organization has
significant influence over the financial or
managerial policies or operations of the
affiliated company;
(3) The banking organization is the largest
investor in the affiliated company; or
10
The definition of such entities is contained in
the instructions to the com m ercial bank
C onsolidated R eports of C ondition a nd Incom e and
the C onsolidated F inancial Statem ents for Bank
H olding Com panies. U nder regulatory reporting
procedures, asso ciated com panies and joint
ventures generally are defined as com panies in
w hich the banking organization ow ns 20 to 50
p ercent of the voting stock.
(4)
Other circumstances prevail that appear
to tie closely the activities of the affiliated
company to the investing banking
organization.
The Federal Reserve may, on a case-by
case basis, also deduct from capital debt and
equity investments in certain c o n so lid a te d
subsidiaries in order to determine if the
banking organization meets minimum
supervisory capital requirements without
reliance on the capital invested in the
subsidiaries. In addition, the Board may, at
some future date, seek public comment on the
extension of this approach to all subsidiaries
engaged in certain activities for the purpose
of assessing the banking organization’s
consolidated capital position.
In general, when investments in a
subsidiary are deducted from a banking
organization’s capital, the subsidiary's assets
will also be excluded from the assets of the
banking organization in order to assess the
latter’s capital adequacy.
3.
R e c ip ro c a l h o ld in g s o f b a n k c a p ita l
in stru m en ts. Reciprocal holdings of banking
organizations' capital instruments (that is,
instruments that qualify as Tier 1 or Tier 2
capital) are to be deducted from an
organization’s total capital base for the
purpose of determining the numerator of the
risk-based capital ratio. Reciprocal holdings
are cross-holdings resulting from formal or
informal arrangements in which two or more
banking organizations swap, exchange, or
otherwise agree to hold each other’s capital
instruments. Generally, as this discussion
implies, deductions would be limited to
intentional cross-holdings. At present, the
Board does not intend to require banking
organizations to deduct non-reciprocal
holdings of such capital instruments.11 The
Board, however, intends to monitor nonreciprocal holdings of other banking
organizations' capital instruments and to
provide information on such holdings to the
Basle Supervisors’ Committee, as called for
under the Basle capital framework.
III. P ro ced u res fo r C om puting W e ig h ted R isk
A s s e ts a n d O ffbalan ce S h e e t Item s U sed in
th e R isk -B a se d C a p ita l R a tio
A . Procedures
Balance sheet assets and credit equivalent
amounts of off-balance sheet items of state
member banks and bank holding companies
are assigned to one of five broad risk
categories. The aggregate dollar value of the
amount in each category is then multiplied by
the weight assigned to that category. The
resulting weighted values from each of the
five risk categories are added together and
this sum is the weighted risk assets total that
comprises the denominator of the risk-based
capital ratio. Table I provides a sample
calculation of this ratio.
11 D eductions of holdings of capital securities
also w ould not be m ade in the case of in terstate
“stak e out” investm ents that comply w ith the
B oard’s Policy S tatem ent on N onvoting Equity
Investm ents, 12 CFR 225.143. In addition, holdings of
capital instrum ents issued by other banking
organizations but taken in satisfaction of debts
previously contracted w ould be exem pt from any
deduction from capital.
Federal Register / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
Risk weights for all off-balance sheet items
are determined by a two-step process. First,
the “credit equivalent amount” of an offbalance sheet item is determined, in most
cases, by multiplying the off-balance sheet
item by a credit conversion factor. Second,
the credit equivalent amount generally is
assigned, like any balance sheet asset, to the
appropriate risk category according to the
obligor or, if relevant, the guarantor or the
nature of the collateral.
B. Collateral, Guarantees, and Other
Considerations
In determining the risk classification of
various assets, the only forms of collateral
that are formally recognized by the riskbased capital framework are cash on deposit
in the lending institution; securities issued by,
or guaranteed by, the U.S. Government or its
agencies; and securities issued by, or
guaranteed by, U.S. Government-sponsored
agencies. The extent to which recognized
securities may act as collateral is determined
by their current market value. If a claim is
partially collateralized, that is, the amount of
cash or the market value of the securities
serving as collateral is less than the face
amount of a balance sheet asset or the credit
equivalent amount of an off-balance sheet
item, then the portion of the claim that is not
collateralized is assigned to the risk category
appropriate to the obligor or, if relevant, the
guarantor. The portion that is collateralized is
assigned to the risk category that is
associated with the collateral. For example,
to the extent that an asset is collateralized by
U.S. Government securities, it would be
placed in the 10 percent risk category
(regardless of the maturity of those
securities). A claim secured by two types of
collateral that the risk-based capital
framework recognizes but places in different
risk categories, such as cash and U.S.
Government-sponsored agency securities,
should be apportioned between the tw’o risk
categories according to the amounts of each
of the two types of collateral securing the
claim.
Guarantees of the U.S. Government and its
agencies, U.S. Government-sponsored
agencies, domestic state and local
gdvernments, and domestic depository
institutions are also recognized. While not
formally factored into the ratio, the existence
of other forms of collateral or guarantees
would be taken into account in evaluating the
risks inherent in an organization’s loan
portfolio—which, in turn, would affect the
overall supervisory assessment of the
organization's capital adequacy. Maturity is
generally not a factor in assigning items to
risk categories with the exceptions of
securities (direct obligations) of the U.S.
Government or its agencies, claims on foreign
banks, commitments, and interest rate and
foreign exchange rate contracts.
Table III contains a listing of the risk
categories, a summary of the types of assets
to be included in each category and the
weight assigned to each category, that is, 0
percent, 10 percent, 20 percent, 50 percent
and 100 percent. A brief explanation of the
components of each category follows.
C. Risk Weights
1.
C a teg o ry I: Z ero P ercent. This category
includes cash (domestic and foreign*)<ewned
and held in all offices of a bank or in transit;
claims on, and balances due from, Federal
Reserve Banks; and, in light of their near
cash characteristics, direct securities issued
by the U.S. Government or its agencies
excluding any short-term loans guaranteed by
the U.S. Government or collateralized by
short-term Government debt with a
rem ain in g maturity of 91 days or less.12
2. C a teg o ry II: 10 P ercen t. This category
includes direct securities issued by the U.S.
Government or its agencies with a remaining
maturity of over 91 days; all other claims
(including leases) on the U.S. Government or
its agencies; all securities and portions of
loans guaranteed by the U.S. Government or
its agencies; and claims (including repurchase
agreements) collateralized by cash on deposit
in the lending institution or by securities
issued by, or guaranteed by, the U.S.
Government or its agencies.
The book value of paid-in stock of a
Federal Reserve Bank is also assigned to
Category 2.
3. C a teg o ry III: 20 P ercent. This category
includes short-term claims, (including demand
deposits) on domestic depository
institutions 13 and foreign banks 14 (including
foreign central banks); cash items in the
process of collection, both foreign and
domestic; local currency claims on foreign
central governments to the extent that a bank
has local currency liabilities booked in the
foreign country; long-term (original maturity
of more than one year) claims on domestic
depository institutions; 15 and portions of
12 For this purpose, a U.S. G overnm ent agency is
defined as an instrum entality of the U.S.
G overnm ent w hose obligations are fully and
explicitly g uaranteed as to the tim ely repaym ent of
principal and interest by the full faith a nd credit of
the U.S. G overnm ent. These include the
G overnm ent N ational M ortgage A ssociation
(GNMA), the V eterans A dm inistration (VA), the
F ederal H ousing A dm inistration (FHA), the ExportIm port Bank (EXIM Bank), the O verseas Private
Investm ent C orporation (OPIC), the Com m odity .
C redit C orporation (CCC), a nd the Small Business
A d m inistration (SBA).
13 D om estic depository institutions are defined to
include branches (foreign a nd dom estic) of
federally-insured banks and depository institutions
ch artered a nd head q u artered in the 50 states of the
U nited States, the D istrict of Colum bia, Puerto Rico,
a n d U.S. territories a nd possessions. T he definition
enco m passes banks, m utual or stock savings banks,
savings or building and loan associations,
cooperative banks, credit unions, and international
banking facilities of dom estic banks. U.S. chartered
depository institutions ow ned by foreigners are also
included in the definition; how ever, branches and
agencies of foreign b a n k s located in the U.S. and
bank holding com panies are excluded.
14 Foreign banks are defined as institutions that
are organized under the law s of a foreign country;
engage in the business of banking; are recognized as
b an k s by the bank supervisory or m onetary
authorities of the country o f their organization or
principal banking operations; receive deposits to a
su b stan tial ex ten t in the regular course of business;
a n d have the pow er to accept dem and deposits.
Claims on foreign banks include claim s on th e U.S.
b ran ch es and agencies of foreign banks.
15 C laim s on foreign banks w ith an original
m aturity exceeding one y e ar and all claim s on bank
holding com panies are assigned to C ategory V.
w hich carries a w eight of 100 percent.
8575
loans or other claims guaranteed by domestic
depository institutions.16
This category also includes claims on, or
portions of claims guaranteed by, U.S.
G o vern m en t-sp o n so red agencies 17 and
portions of claims collateralized by securities
issued by, or guaranteed by, U.S.
Government-sponsored agencies. Claims on
multilateral lending institutions or regional
development banks in which the U.S.
Government is a shareholder or contributing
member, as well as general obligation claims
on, or portions of claims guaranteed by, the
full faith and credit of states or other political
subdivisions of the United States, are also
assigned to this category.
4. C a teg o ry IV: 5 0 p ercen t. This category
includes reven u e (non-general obligation)
bonds or similar obligations, including loans
and leases, that are obligations of states or
other political subdivisions of the United
States, but for which the government entity is
committed to repay the debt with revenues
from the specific projects financed, rather
than from general tax funds.
Also included in this category are credit
equivalent amounts of interest rate and
foreign exchange rate contracts involving
standard risk obligors, not backed by
collateral or guarantees that would allow
them to be placed in lower risk weight
categories, as noted below in the discussion
of interest rate and foreign exchange rate
contracts.
5. C a teg o ry V: 100 P ercent. All assets not
included in the categories above are assigned
to this category, which comprises standard
risk assets. The bulk of the assets typically
found in a loan portfolio would be assigned
to the 100 percent category. Such assets
include long-term claims (over one year) on
foreign banks, as well as all non-local
currency claims on foreign governments and
local currency claims on a foreign central
government that exceed local currency
liabilities held by the bank in the foreign
country, that is, all claims on foreign
governments that entail some degree of
transfer risk.
This category also includes all claims on
foreign and domestic private sector obligors
not included in the categories above
(including loans to nondepository financial
institutions and bank holding companies);
claims on commercial firms owned by the
public sector; customer liabilities to the bank
on acceptances outstanding involving
standard risk claims; 18 investments in fixed
18
T hese include risk participations in bankers
acceptances and in any standby letters of credit, as
w ell a s participations in com m itm ents conveyed to
other dom estic banks.
17 For this purpose, U.S. Government-sponsored
agencies are defined as agencies originally
e stablished or chartered by the Federal governm ent
to serve public purposes specified by the U.S.
Congress but w hose obligations are not explicitly
guaranteed by the full faith a nd credit of the U.S.
G overnm ent. These agencies include the Federal
Home Loan M ortgage C orporation (FHLMC), the
Federal N ational M ortgage A ssociation (FNMA), the
Farm C redit System , the Federal Home Loan Bank
System, a nd the S tudent Loan M arketing
A ssociation (SLMA).
18 C ustom er liabilities on acceptances
outstanding involving n o n-standard risk claims,
Cont nued
Federal Register / Vol. 53, No. 50 / Tuesday, M arch 15, 1988 / Proposed Rules
assets, premises, and other real estate
owned; common and preferred stock of
corporations, including stock acquired for
debts previously contracted; and commercial
and consumer loans, including all residential
mortgage loans (except those assigned to
lower risk categories due to recognized
guarantees or collateral). The following
assets also are to be converted at 100 percent
if they have not been deducted from capital:
Investments in unconsolidated companies,
joint ventures or associated companies;
instruments that qualify as capital issued by
other banking organizations; and any
intangibles, including grandfathered goodwill.
Also included in this category are industrial
development bonds and similar obligations
issued under auspices of states or political
subdivisions of the United States for the
benefit of a private party or enterprise where
that party or enterprise, not the government,
is obligated to pay the principal and interest.
D. Off-Balance Sheet Items
The face amount of an off-balance sheet
item is generally multiplied by a credit
conversion factor and the resulting credit
equivalent amount is assigned to the
appropriate risk category according to the
obligor or, if relevant, the guarantor or the
nature of the collateral. Table IV sets forth
the conversion factors for various types of
off-balance sheet items.
1.
Item s W ith a 100 P ercen t C on version
Factor. A 100 percent conversion factor
applies to direct credit substitutes, which
include guarantees or equivalent instruments,
backing financial claims, such as outstanding
securities, loans, and other financial
liabilities, or backing off-balance sheet items
that require capital under the risk-based
capital framework. For example, these direct
credit substitutes include standby letters of
credit, other equivalent irrevocable
obligations, or surety arrangements, that
guarantee repayment of commercial paper,
tax-exempt securities, commercial or
individual loans, debt obligations, or
commercial letters of credit. They also
include the acquisition of risk participations
in bankers acceptances and standby letters
of credit, since both of these transactions, in
effect, constitute a guarantee by the acquiring
banking institution that the underlying
account party (obligor) will repay its
obligation to the originating, or issuing,
institution. (Standby letters of credit that are
performance-related are discussed below and
have a credit conversion factor of 50 percent.)
In the case of direct credit substitutes that
are participated out in the form of a
syndication (that is, where each bank is
responsible only for its p ro ra ta share of the
risk and there is no recourse to the
originating bank), participated portions
would be excluded entirely from the
originating bank’s weighted risk assets. A
such as claim s on dom estic depository institutions,
are to be assigned to the risk category appropriate
to the identity of the obligor or, if relevant, the
nature of the co llateral or g uarantees backing the
claims. Portions of accep tan ces conveyed as risk
p articipations to dom estic depository institutions
should be assigned to the 20 percent risk category
ap p ro p riate to claim s gu aran teed by dom estic
depository institutions.
are accorded the same treatment as assets
sold with recourse. Forward agreements are
legally binding agreements (contractual
obligations) to purchase assets with certa in
drawdown at a specified future date. These
obligations include forward purchases,
forward forward deposits, and partly-paid
shares and securities; they do not include
commitments to make residential mortgage
loans or forward foreign exchange contracts.
2.
Ite m s w ith a 50 P erce n t C o n versio n
Factor. Transaction-related contingencies are
to be converted at 50 percent. Such
contingencies include bid bonds, performance
bonds, warranties, standby letters of credit
related to particular transactions, and
performance standby letters of credit, as well
as acquisitions of risk participations in such
standby letters of credit. Performance
standby letters of credit represent obligations
backing the performance of nonfinancial or
commercial contracts or undertakings. To the
extent permitted by law or regulation,
performance standby letters of credit include
arrangements backing, among other things,
subcontractors’ and suppliers’ performance,
labor and materials contracts, and
construction bids.
The unused portion of commitments with
an orig in a l maturity exceeding one year,
including underwriting commitments, and
commercial and consumer credit
commitments also are to be converted at 50
percent. Original maturity is defined as the
length of time between the date the
commitment is issued and the earliest date on
which the following two conditions hold: (1)
The bank can, at its option, unconditionally
(without cause) cancel the commitment; and
(2) the bank is scheduled to (and as a normal
practice actually does) review the facility to
determine whether or not it should be
extended. Facilities that are unconditionally
cancellable (without cause) at any time by
the bank are not deemed to be commitments,
provided the bank makes a separate credit
decision before each drawing under the
facility. Commitments with an original
maturity of one year or less are deemed to
involve low risk and, therefore, are not
assessed a capital charge. Such short-term
commitments are defined to include unused
lines of credit on retail credit cards that a
bank can unconditionally cancel at any time.
Commitments are defined as any legally
binding arrangements that obligate a banking
organization to extend credit in the form of
loans or leases; to purchase loans, securities,
or other assets; or to participate in loans and
leases. They also include overdraft facilities,
revolving credit, or similar transactions.
Normally, commitments involve a written
contract or agreement and a commitment fee,
or some other form of consideration.
Commitments are included in weighted risk
assets regardless of whether they contain
“material adverse change” clauses or other
provisions that are intended to relieve the
issuer of its funding obligation under certain
conditions.
In the case of commitments structured as
19 T h at is, participations in w hich the originating
syndications, the risk asset framework
banking institution rem ains liable to the beneficiary
includes only the banking organization’s
for the full am ount of the direct credit substitute if
proportional share of such commitments.
the party th a t has acquired the participation fails to
After a commitment has been converted at 50
pay w hen the instrum ent is draw n.
banking organization that has conveyed risk
participations 19*in a direct credit substitute,
such as a standby letter of credit, to a third
party should convert the full amount of the
direct credit substitute at 100 percent without
deducting the risk participations conveyed.
Then, those portions of the credit equivalent
amount of the direct credit substitute that
have been conveyed as risk participations to
domestic depository institutions should be
assigned to the risk category appropriate to
claims guaranteed by domestic depository
institutions, that is, 20 percent, rather than to
the category appropriate to the account party
obligor. This treatment is accorded to these
conveyances because they replace, to the
extent of the participation or conveyance, the
originating bank’s exposure to the account
party obligor with an exposure to a domestic
depository institution. A bank acquiring a
risk participation in such a direct credit
substitute or bankers acceptance should
convert the amount of the acquisition at 100
percent and then assign the credit equivalent
amount to the risk weight category
appropriate to the account party obligor.
Standby letters of credit are distinguished
from loan commitments (discussed below) in
that standbys are irrevocable obligations of
the banking organization to pay a third-party
beneficiary when a customer (account party)
fa ils to r e p a y an outstanding loan or debt
instrument (direct credit substitute) or fa ils to
p erfo rm some other contractual obligation
(performance bond). A loan commitment, on
the other hand, involves an obligation (with
or without a material adverse change clause)
of the banking organization to fund its
customer in the n o rm a l cou rse of business
should the customer seek to draw down the
commitment.
The distinguishing characteristic of a
standby letter of credit for risk-based capital
purposes is the combination of irrevocability
with the notion that funding is triggered by
some failure to repay or perform an
obligation. Thus, any commitment (by
whatever name) that involves an irre v o c a b le
obligation to make a payment to the customer
or to a third party in the event the customer
fa ils to r e p a y an outstanding debt obligation
or f a ils to p erform a contractual obligation
would be treated for risk-based capital
purposes as, respectively, a financial
guarantee standby letter of credit or a
performance standby.
Sale and repurchase agreements and asset
sales with recourse, if not already included
on the balance sheet, as well as forward
agreements, also are to be converted at 100
percent.
The risk-based capital definition of the sale
of assets with recourse, including the sale of
one-to-four family residential mortgages, is
the same as the definition contained in the
instructions to the commercial bank
Consolidated Reports of Condition and
Income. So-called “loan strips” (that is, short
term advances sold under long-term
commitments) sold without direct recourse
Fedesal Register / Vol. 53, No. 50 / Tuesday, March 15, 1988 ,/ Proposed Rules
I J ■—
M. ......
—
M
—
M
M
percent, portions that have been conveyed to
other domestic depository institutions as
participations in which the originating
banking organization retains the full
obligation to the borrower if the participating
bank fails to pay when the instrument is
drawn, would be assigned to the 20 percent
risk category. This treatment is analogous to
that accorded the conveyances of risk
participations in standby letters of credit. The
acquisition of such a participation would be
converted at 50 percent and assigned to the
risk category appropriate to the account party
obligor.
Revolving underwriting facilities (RUFs),
note issuance facilities (NIFs), and other
similar arrangements also are converted at 50
percent. These are facilities under which a
borrower can issue on a revolving basis
short-term paper in its own name, but for
which the underwriting organizations have a
legally binding commitment either to
purchase any notes the borrower is unable to
sell by the roll-over date or to advance funds
to the borrower.
3. Item s w ith a 20 P erce n t C on version
Factor. Short-term, self-liquidating traderelated contingencies which arise from the
movement of goods are converted at 20
percent. Such contingencies include
commercial letters of credit and other
documentary letters of credit collateralized
by the underlying shipments.
4. Item s w ith a Z ero P ercen t C on version
Factor. These include unused commitments
with an original maturity of one year or less.
Unused retail credit card lines are deemed to
be short-term commitments if the bank has
the unconditional option to cancel the card at
any time.
E. Interest Rate and Foreign Exchange Rate
Contracts
1. Scope. Credit equivalent amounts are to
be computed for each of the following offbalance sheet interest rate and foreign
exchange rate instruments:
a. Interest Rate Contracts:
—Single currency interest rate swaps.
—Basis swaps.
—Forward rate agreements.
—Interest rate options purchased (including
caps, collars, and floors purchased).
—Any other instrument that gives rise to
similar credit risks (including when-issued
securities).
b. Exchange Rate Contracts:
—Cross-currency interest rate swaps.
-—■Forward foreign exchange contracts.
—Currency options purchased.
—Any other instrument that gives rise to
similar credit risks.
Over-the-counter options purchased would
be treated in the same way as the other
interest rate and exchange rate contracts.
Thai is, the credit equivalent amount would
be the sum of the marked-to-market
replacement cost and the “add-on” amount
for potential future exposure. Exchange rate
contracts with an original maturity of seven
days or less and instruments traded on
exchanges that require daily payment of
variation margin are excluded.
2. C alcu lation o f C re d it E q u iva len t
A m oun ts. Credit equivalent amounts are to
be calculated for each individual contract of
— —
|—
1—
11 —
1 1;r —
the types listed above. To calculate the credit
equivalent amount of its off-balance sheet
interest rate and exchange rate instruments, a
banking organization should, for each
contract, sum:
a. The mark-to-market value (positive
values only) of the contract (that is, its
current e x p o su r e )a n d ;
b. An estimate of the potential future
increases in credit exposure over the
remaining life of the instrument.
Potential exposure on a contract is
determined by multiplying the notional
principal amount of the contract, including
contracts with negative mark-to-market
values, by one of the following credit
conversion factors, as appropriate:
Remaining maturity
Less than one year.........
One year and over..........
m ?7
'.'‘jr.:....
Interest
rate
contracts
(percent)
0
0.5
Exchange
rate
contracts
(percent)
1.0
5.0
Examples of the calculation of credit
equivalent amounts for these instruments are
contained in Table V.
Because exchange rate contracts involve
an exchange of principal upon maturity, and
exchange rates are generally more volatile
than interest rates, higher conversion factors
have been established for foreign exchange
contracts than for interest rate contracts.
No potential future credit exposure should
be calculated for single currency floating/
floating interest rate swaps; the credit
exposure on these contracts should be
evaluated solely on the basis of their markto-market value.
3. R is k W eigh ts. Once the credit equivalent
amount for interest rate and exchange rate
instruments has been determined, that
amount should be assigned to a risk weight
category according to the identity of the
counterparty or, if relevant, the nature of
collateral or guarantees. In accordance with
the Basle capital framework, however, the
maximum weight applied to the credit
equivalent amount currently is 50 percent.
The Federal Reserve intends to monitor the
quality of credits in the interest rate and
exchange rate markets and, in the future,
would consider, if appropriate, assigning
credit equivalent amounts for contracts
involving standard risk obligors Ur the 100
percent risk category, as is the case with
other off-balance sheet instruments.
4. A ccou ntin g. In certain cases, credit
exposures arising from the interest rate and
exchange instruments covered by these
guidelines may already be reflected, in part,
on the balance sheet. To avoid double
counting such exposures in the assessment of
capital adequacy and, perhaps, assigning
inappropriate risk weights, counterparty
credit exposures arising from the types of
instruments covered by these guidelines may
need to be excluded from balance sheet
assets in calculating banking organizations’
total weighted risk asset ratios. The Federal
Reserve will address this issue in designing
appropriate reporting systems.
In accordance with the terms of the Basle
capital framework, netting of swaps and
similar contracts will not be recognized for
purposes of calculating the risk-based ratio at
this time. While the Federal Reserve
encourages any reasonable arrangements
designed to reduce the risks inherent in these
transactions, the Basle Supervisors'
Committee felt that the legal issues posed by
netting arrangements require further
Consideration prior to the implementation of
a netting mechanism on an international
basis.
IV.
T arget R a tio S ta n d a rd
A. Minimum Risk-Based Ratio After
Transition Period
As reflected in Table VI, by year-end 1992,
all bank holding companies 21 and state
member banks should meet a m in im u m ratio
of total capital to weighted risk assets of 8
percent, of which at least 4.0 percentage
points should be in the form of core capital
(Tier l).22 Core capital is defined as the sum
of common stockholders’ equity (including
retained earnings and any minority interest in
the common stockholders’ equity accounts of
consolidated subsidiaries) minus any
goodwill carried on an organization’s balance
sheet.23
The maximum amount of supplementary
(Tier 2) capital elements that would qualify
as capital is limited to 100 percent of the total
amount of core capital, that is, the sum of
Tier 1 capital components (net of goodwill).
Within Tier 2, the maximum amount of the
allowance for loan and lease losses that
would qualify as Tier 2 capital is limited to
1.25 percent of weighted risk assets. In
addition, the combined maximum amount of
subordinated debt and intermediate-term
preferred stock that qualifies as Tier 2 capital
is limited to 50 percent of Tier 1 capital.
Total capital is calculated by adding core
capital (defined to exclude goodwill) to
supplementary capital (limited to 100 percent
of core capital) and then deducting from this
sum any capital investments in
unconsolidated banking and finance
subsidiaries, reciprocal holdings of banking
organization capital securities, or other items
at the direction of the Federal Reserve.
B. Transitional Arrangements
The transition period, intended to facilitate
implementation of the risk-based capital
ratio, ends on December 31,1992. The
transitional arrangements include an interim
target risk-based capital ratio to be met by
year-end 1990. Any organization not meeting
the interim target or final supervisory ratios
21 A s noted above, bank holding com panies w ith
less than $150 million in consolidated a sse ts w ould
generally be exem pt from the calculation and
an aly sis of risk-based ratios on a consolidated
basis.
22 Section II contains definitions of capitalrelated terms used in this section.
23 G oodw ill that s ta te m em ber b anks are
20
M ark-to-m arket values should be m easured in perm itted to include in capital as a result of
dollars, regardless of the currency or currencies
supervisory m ergers w ith troublec or tailed banking
specified in the contract.
organizations w ould not be deducted.
Fedsffffl! Register / Vol. 53, No. 50 / Tuesday, March 15, 1988 / Proposed Rules
aattBasam— aaaaam am
■ r a wu■ —
would be expected to develop and discuss
with the Federal Reserve a plan setting forth
how the organization intends to reach the
minimum supervisory ratios.
1.
In itia l A rran gem en ts. No formal riskbased capital minimum level will be set
Initially. However, any organization that has
a risk-based ratio of less than 8 percent is
expected to undertake a sustained effort to
move in the direction of that target during the
transition period. Banking organizations with
ratios of 8 percent or lower should not make
adjustments to their risk profiles or undertake
growth plans that would lower their ratios.
While the Basle capital framework does
not establish an initial standard for the
minimum level of capital during this period, it
does permit the core capital of an
organization to include some limited
supplementary capital elements. Specifically,
a maximum of 25 percent of core capital
(before any deduction of goodwill) may
consist of supplementary capital elements,
with the remainder consisting of common
stockholders’ equity. By year-end 1990,
banking organizations would be expected to
reduce the amount of supplementary capital
included in core capital to no more than 10
percent of core capital.
For bank holding companies, any goodwill
acquired before March 12,1988, would be
grandfathered until year-end 1992. Goodwill
acquired by holding companies on or after
March 12,1988, and all goodwill on holding
company books after year-end 1992, would be
— —
■ —
■ mmmmmmmmmmmmmmmmmmmmmmmmmmammKmmmmasamm
deducted from Tier 1 capital components to
compute core capital.
State member banks are generally not
permitted to recognize goodwill on their
balance sheets or to include goodwill for
capital purposes under current policies. Thus,
all goodwill in state member banks would be
deducted immediately from Tier 1
components to determine core capital, except
for goodwill acquired and approved in
connection with supervisory mergers with
troubled or failed banks.
Initially, the allowance for loan and lease
losses may be included in an organization’s
supplementary capital without limit.
However, by year-end 1990, loan loss
reserves counted in supplementary capital
may not exceed 1.5 percent of weighted risk
assets.
The existing supervisory capital-to-fota/
assets ratios, as outlined in Appendix A (the
leverage measure) of the Capital-Adequacy
Guidelines, would continue to be employed
during this initial period. The Board will,
prior to year-end 1990, consider whether a
maximum leverage ratio will continue to be
employed in conjunction with the
implementation of the risk-based standard. If
a maximum leverage ratio is employed after
year-end 1990, the Board may, after
appropriate consideration, adopt definitions
of capital for leverage purposes that are
consistent with the definitions in the riskbased capital guidelines.
2. Y ear-en d 1990 through y e a r -e n d 1992. By
year-end 1990, banking organizations would
be expected to meet a minimum interim
target ratio for total capital to weighted risk
assets of 7.25 percent, at least one-half of
which should be in the form of core capital.
In addition, as noted above, during this
period up to 10 percent of an organization’s
core capital (before any deduction for
goodwill) may consist of supplementary
capital elements. Thus, the 7.25 percent
interim target ratio implies a minimum ratio
of core capital to weighted risk assets of 3.6
percent (one-half of 7.25) and a minimum
common stockholders’ equity to weighted risk
assets ratio of 3.25 percent (nine-tenths of the
core capital ratio). By year-end 1992, an
organization’s required core capital must
consist s o le ly of common stockholders’
equity, including minority interest in common
equity accounts of consolidated subsidiaries.
The maximum amount of the allowance for
loan and lease losses reserves that may
qualify as supplementary capital will be
limited to 1.5 percent of weighted risk assets
(that is, 1.5 percentage points of the minimum
required total of 7.25 percent), declining to
1.25 percent by year-end 1992. Allowances for
loan and lease losses in excess of these limits
may, of course, be maintained, but would not
be included in an organization’s total capital
base. The Federal Reserve will continue to
require banks and bank holding companies to
maintain reserves at levels fully sufficient to
cover losses inherent in their loan portfolios.
Table I.—S ample Calculation of R isk-B ased C apital Ratio
Example of a bank with $6,000 in total capital and the following assets and off-balance sheet items:
Balance Sheet Assets:
Cash............................................................................................
........................................................................................
Long-term U.S. Government securities.................................................................................................................................................
.....
.
.......................................................................
Balances at domestic banks...................................
Loans to private corporations.............................................................................................................................................................
Total Balance Sheet Assets.........................................................................................................................................................
Off-Balance Sheet Items
Long-term commitments to private corporations.............................................................. .............................................. ........................
$10,000
20,000
5,000
65,000
$100,000
$10,000
20,000
$30,000
This bank’s total capital to to ta l assets ratio would be: ($6,000/$100,000)=6.00%.
OBS Item
To compute the bank’s weighted risk assets:
1. Compute the credit equivalent amount of each off-balance sheet (“OBS”) item.
SLC's backing municipal GO’S............................................................................................................
2. Multiply each balance sheet asset and the credit equivalent amount of each OBS item by the appropriate risk
weight.
10% Category: Long-term U.S. Government securities............................. ...................... .......................
Face Value
Credit
Equivalent
Amount
Conversion
Factor
$10,000 X
$20,000 X
1.00
0.50 =
$10,000 X
$20,000 X
0
0.10
$10,000
$10,000
$0
$2,000
20% Category:
Credit equivalent amounts of SLC’s backing GO’Sof U.S. municipalities..............................................
Total....................................................................................................................................
50% Category: No items.
- 100% Category:
Credit equivalent amounts of long-term commitments to private corporations.......................................
$5,000
$10,000
$15,000 X
$65,000
$10,000
0.20
=
$3,000
F ederal R egister / Vol. 53, No. 5G / T uesday, M arch 15, 1 9 8 8 ./ Proposed. Rules
OBS Item
Face Value
Total...................................................................................................................................
Conversion
Factor
$75,000
Total Risk-Weighted Assets.....................................................................................................
This bank’s risk-b a se d capital ratio would be: ($6,000/880,000)=7.50%.
T able II. Definition of Qualifying
Capital
Minimum requirements
and limitations after
.transition period
Components
C ore C a p ita l ( Tier
/)..
Common stockholders’
equity.
Minority interest in
common equity
accounts of
consolidated
subsidiaries.
Less: Goodwill and
other disallowed
intangibles '.
S upplem entary C apita l
(T ie r 2 ).
Allowance for loan and
lease losses.
Perpetual and long
term preferred stock
(original maturity 20
yrs. or mdre).
Hybrid capital
instruments
(including perpetual
debt and mandatory
convertible
securities).
Subordinated debt and
intermediate-term
preferred stock
(original weighted
average maturity of 7
years or more).
Revaluation reserves
(equity and building).
Must equal or exceed 4%
of weighted risk assets.
No limit.
No limit.
Total of Tier 2 is limited to
100% of Tier 1.2
Limited to 1.25% of
weighted risk assets.2
No limit within Tier 2,
long-term preferred is
amortized for capital
purposes as it ap
proaches maturity.
No limit within Tier 2.
Subordinated debt and in
termediate-term
pre
ferred stock are limited
to 50% of Tier 1 2; am
ortized for capital pur
poses as they approach
maturity.
Not included; regulators
would encourage banks
to
disclose;
would
evaluate on case-bycase basis for interna
tional comparisons; and
would take into account
in making overall as
sessment of capital.
D eductions (fro m sum
o f Tier 1 an d Tier 2 ):
Investments in
unconsolidated
banking and
finance
subsidiaries.
Reciprocal
holdings of bank
issued capital
securities.
On case-by-case basis or
Other deductions
(such as other
as matter of policy after
formal rulemaking.
subsidiaries or
joint ventures) as
determined by
supervisory
authority.
To tal C a p ita l ( Tier 1 +
Must equal or exceed 8%
of weighted risk assets.
Tier 2 —D eductions).
1Goodwill on books of bank holding companies
before march 12, 1988, would be “grandfathered"
for transition period. All goodwill and disallowed
intangibles in banks, except previously grandfathered
intangibles or goodwill approved in supervisory
mergers, would be deducted immediately as under
current policies. All deductions are for capital ade
quacy purposes only; deductions would not affect
accounting treatment.
2Amounts in excess of limitations are permitted
but do not qualify as capital.
Table III.—Summary of Risk Weights
and Risk Categories
C a teg o ry 1: Z ero p e rc e n t
1. Cash (domestic and foreign).
2. Balances due from, and claims on,
Federal Reserve Banks.
3. Securities (direct obligations) issued by
the U.S. Government or its agencies 1
with a remaining maturity of 91 days or
less.
C a teg o ry 2 :1 0 p e rc e n t
1. Securities issued by the U.S. Government
or its agencies* with remaining
maturities of over 91 days and all other
claims (loans and leases) on the U.S.
Government or its agencies*.
2. Securities and other claims guaranteed
by the U.S. Government or its agencies
(including portions of claims guaranteed).
3. Portions of loans and other assets
collateralized 2 by securities issued by,
or guaranteed by, the U.S. Government
or its agencies, or by cash on deposit in
the lending institution.
4. Federal Reserve Bank stock.
C a teg o ry 3 :2 0 p e r c e n t
1. All claims (long- and short-term) on
domestic depository institutions.
2. Claims on foreign banks with an original
maturity of one year or less.
3. Claims guaranteed by, or backed by the
full faith and credit of, domestic
depository institutions.
4. Local currency claims on foreign central
governments to the extent the bank has
local currency liabilities in the foreign
country.
5. Cash items in the process of collection.
8. Securities and other claims on, or
guaranteed by U.S. Governmentsp o n so r e d agencies (including portions of
claims guaranteed).3
<8S>7§)
1.00
.
Credit
Equivalent
Amount
$75,000
$80,000
7. Portions of loans and other assets
collateralized 4 by securities issued by,
or guaranteed by, U.S. Governmentsponsored agencies.
8. General obligation claims on, and claims
guaranteed by, U.S., state and local
, governments that are secured by the full
faith and credit of the state or local
taxing authority (including portions of
claims guaranteed).
9. Claims on official multilateral lending
institutions or regional development
institutions in which the U.S.
Government is a shareholder or a
contributing member.
C a teg o ry 4 :5 0 P ercen t
1. Revenue bonds or similar obligations,
including loans and leases, that are
obligations of U.S. state or local
governments, but for which the
government entity is committed to repay
the debt only out of revenues from the
facilities financed.
2. Credit equivalent amounts of interest
rate and foreign exchange rate related
contracts, except for those assigned to a
lower risk category.
C a teg o ry 5 :100 P ercen t
1. All other claims on private obligors.
2. Claims on foreign banks with an original
maturity exceeding one year.
3. Claims on foreign central governments
that are not included in item 4 of
Category 3,
4. Obligations issued by state or local
governments (including industrial
development authorities and similar
entities) repayable solely by a private
party or enterprise.
5. Premises, plant, and equipment; other
fixed assets; and other real estate
owned.
6. Investments in any unconsolidated
subsidiaries, joint ventures, or associated
companies—if not deducted from capital.
7. Instruments issued by other banking
organizations that qualify as capital.
8. All other assets (including claims on
commercial firms owned by the public
sector).
Table IV.
1 For the purpose of calculating the risk-based
cap ital ratio, a U.S. G overnm ent agency is defined
as an instrum entality of the U.S. G overnm ent w hose
obligations are fully and explicitly guaranteed as to.
the timely repaym ent of principal and interest by
the full faith and credit of the U.S. G overnm ent.
2 Degree of collateralization is determ ined by
current m arket value.
3 For the purpose of calculating the risk-based
capital ratio, a U.S. G overnm ent-sponsored agency
is defined as an agency originally established or
ch artered to serve public purposes specified by the
U.S. C ongress but w hose obligations are not
explicitly guaranteed by the full faith and credit of
the U.S. G overnm ent.
Credit Conversion Factors for Off-Balance
Sheet Items
100 Percent Conversion Factor
1. Direct credit substitutes (general
guarantees of indebtedness and
guarantee-type instruments, including
standby letters of credit serving as
financial guarantees for, or supporting,
loans and securities).
2. Acquisitions of risk participations in
bankers acceptances and participations
4 Degree of collaterization is determ ined by
current m arket value.
8580
Federal Register / Vol. 53, No. 50 / Tuesday, M arch 15, 1988 / Proposed Rules
in direct credit substitutes (e.g., standby
letters of credit).
3. Sale and repurchase agreements and
asset sales with recourse, if not already
included on the balance sheet.
4. Forward agreements (that is, contractual
obligations) to purchase assets, including
financing facilities with certa in
drawdown.
50 P ercen t C on version F actor
1. Transaction-related contingencies (e.g.,
bid bonds, performance bonds,
warranties, and standby letters of credit
related to a particular transaction).
2. Unused commitments with an original
maturity exceeding one year, including
underwriting commitments and
commercial credit lines.
3. Revolving underwriting facilities (RUFs),
note issuance facilities (NIFs) and other
similar arrangements.
contracts by one of the following credit
conversion factors, as appropriate:
20 P ercen t C on version F actor
1. Short-term, selfdiquidating trade-related
contingences, including commercial
letters of credit.
Zero Percent Conversion Factor
1. Unused commitments with an original
maturity of one year or less or which are
unconditionally cancellable at any time.
Credit Conversion for Interest Rate and
Foreign Exchange Contracts
The Total replacement cost of contracts
(obtained by summing the positive mark-tomarket values of contracts) would be added
to a measure of future potential increases in
credit exposure. This future potential
exposure measure would be calculated by
multiplying the total notional value of
Table V. Calculation
of
Remaining Maturity
Interest
rate
contracts
Exchange
rate
contracts
0
0.5%
1.0%
5.0%
Less than one year............
One year and over.............
No potential exposure would be calculated
for single currency floating/fioating interest
rate contracts; the credit exposure on these
contracts would be evaluated solely on the
basis of their mark-to-market value.
Exchange rate contracts with an original
maturity of seven days or less would be
excluded. Also, instruments traded on
exchanges that require daily payment of
variation margin would be excluded.
Credit Equivalent Amounts
[Interest Rate and Foreign Exchange Rate Related Transactions]
Current exposure
Potential exposure
Type of contract (remaining maturity)
National
principal
(1) 120-day forward foreign exchange.................................... .............
(2) 120-day forward-foreign exchange............................... ............... .
(3) 3-year single-currency fixed/floafing interest rate swap......................
(4) 3-year single-currency fixed/floating interest rate swap......................
(5) 7-year cross-currency floating/fioating interest rate swap...................
$5,000,000
6,000,000
10,000,000
10,000,000
20,000,000
Total.....................................................................................
51,000,000
(D
X
Potential
exposure
conversion
factor
Potential
exposure
(dollars)
<2)
(3)
0.01
.01
.005
.005
.05
50,000
60,000
50,000
50,000
1,000,000
Current
Replacement exposure
cost1
(dollars) 2
+
Credit
equivalent
amount
(5)
(4)
100,000
-120,000
200,000
-250,000
-1,300,000
100,000
0
200,000
0
0
$150,000
60,000
250,000
50,000
1,000,000
$1,510,000
1These numbers are purely for illustration.
2The larger of zero or a positive mark-to-market value.
T able VI
Transitional arrangements
Initial
1. Minimum standard of total capital to None....................................................
weighted risk assets.
2. Definition of tier 1 capital..................... Common equity p lu s supplementary elements 1 le ss goodwill and other disal
lowed intangibles.2.
3. Minimum standard of tier 1 capital to None...................................................
weighted risk assets.
4. Minimum standard of common stock- None...................................................
holders’ equity to weighted risk assets.
5. Limitations on supplementary capital
elements.
a. Allowance for loan and lease No limit within supplementary capital.........
losses.
b. Subordinated debt and intermedi- Combined maximum of 50% of tier 1........
ate term preferred stock,
c. Total qualifying supplementary cap May not exceed tier 1 capital.......... ,.......
ital.
6. Definition total capital.......................... Tier 1 p lu s tier 2 less-.
—reciprocal holdings of banking orga
nization capital instruments.
Year-End 1990
Final arrangement: Year-End
1992
7.25%......... ........................................ 8.0%.
Common equity p lu s supplementary ele- Common equity le ss goodwill
and other disallowed intangi
ments 3 less goodwill and other disal
bles.
lowed intangibles.2.
3 625%................................................ 4.0%.
3.25%.................................................. 4.0%.
1.5% of weighted risk assets................... 1.25% of weighted risk assets.
Combined maximum of 50% of tier 1........ Combined maximum of 50% of
tier 1.
May not exceed tier 1 capital................... May not exceed tier 1 capital.
Tier 1 p lu s tier 2 less:
Tier 1 p lu s tier 2 less:
—reciprocal holdings of banking orga
—reciprocal holdings of
banking
organization
nization capital instruments.
capital instruments,
—investments in uncon
—investments in unconsolidated
—investments in unconsolidated
solidated banking and fi
banking and finance subsidiaries.
banking and finance subsidiaries.
nance subsidiaries.
1Up to 25% of Tier 1 (before deduction of goodwill and other disallowed intangibles) may consist of supplementary elements.
2 See the Notice of Proposed Guidelines and the actual text of the proposed .guidelines for discussion of relevant definitions and grandfathering arrangements for
goodwill.
2Up to 10% of Tier 1 (before deduction of goodwill and other disallowed intangibles) may consist of supplementary elements.
Federal Register / Vol. 53, No. 50 / Tuesday, M arch 15, 1988 / Proposed Rules
Board o f G overnors of the Federal R eserve
System , effectiv e M arch 1,1988.
William W. Wiles,
Secretary of the Board.
BILLING CODE S210-01-CS
FEDERAL DEPOSIT INSURANCE
CORPORATION
PART 325—CAPITAL MAINTENANCE
1. The authority citation for Part 325
continues to read as follows:
Authority: 12 U.S.C. 1815(a), 1815(b), 1816,
1818(a), 1818(b), 1819 (Tenth), 1828(c), 1828(d),
1828(i), 3907, 3909.
2. The Federal Deposit Insurance
Corporation proposes to amend Part 325
by adding an Appendix A to Part 325 to
read as follows:
Appendix A—Statement of Policy on Risk-
Based Capital
Capital adequ acy is one of the critical
factors that the FDIC is required to an alyze
w h en taking action on various types of
app lication s and w h en conducting various
supervisory a ctivities related to the safety
and sou n d n ess o f individual banks and the
banking system . In v ie w of this, the FDIC’s
Board o f D irectors adopted a capital
regulation in February o f 1985 that set forth
(1) minimum stan dards of capital adequ acy
for insured state nonm em ber banks and (2)
standards for determ ining w h en an insured
bank is in an unsafe or unsound condition by
reason o f the am ount of its capital (50 FR
11128) (1985)).
This regulation, contained in Part 325 of the
FDIC’s rules and regulations, was designed to
establish, in conjunction with other Federal
bank regulatory agencies, uniform capital
standards for all federally-regulated banking
organizations, regardless of size. These
uniform capital standards are based on ratios
of primary and total capital to total assets.
W hile these leverage ratios have served as
a useful tool for a ssessin g capital adequacy,
the FDIC b eliev es there is a n eed for a capital
m easure that is more exp licitly and
system a tica lly sen sitiv e to the risk profiles of
individual banking organizations. A s a result,
the FDIC’s Board o f D irectors has adopted
this Statem ent of Policy on Risk-Based
Capital.
The framework set forth in this statement
of policy consists of (1) a definition of capital
for risk-based capital purposes, (2) a system
for calculating risk-weighted assets by
assigning assets and off-balance sheet items
to risk categories, and (3) a schedule, which
includes transitional arrangements during a
phase-in period, for achieving a minimum
supervisory target ratio of capital to riskweighted assets. An institution’s risk-based
capital ratio is calculated by dividing its
qualifying capital base (the numerator of the
ratio) by its risk-weighted assets (the
denominator).
This statem en t o f p olicy app lies to all
FDIC-insured state-chartered banks
(excluding insured branches of foreign banks)
that are not m em bers of the Federal R eserve
System , hereafter referred to as ‘‘state
nonm em ber banks," regardless o f size, and to
all circumstances in which the FDIC is
required to evaluate the capital of a banking
organization. Therefore, the risk-based
capital framework set forth in this statement
of policy will be used in the examination and
supervisory process as well as in the analysis
of applications that the FDIC is required to
act upon. Generally, banking organizations
are expected to operate above the minimum
target risk-based capital ratio and those
institutions with high or inordinate levels of
risk should hold capital commensurate with
their risk profiles.
The risk-based capital ratio focuses
principally on broad categories of credit risk;
however, the ratio does not take account of
many other factors that can affect an
organization’s financial condition. These
factors include overall interest rate risk
exposure; liquidity, funding and market risks;
the quality and level of earnings; investment
or loan portfolio concentrations; the quality
of loans and investments; the effectiveness of
loan and investment policies; and
management’s overall ability to monitor and
control other financial and operating risks.
In addition to evaluating capital ratios, an
overall assessment of capital adequacy must
take account of each of these other factors,
including, in particular, the level and severity
of problem and adversely classified assets.
For this reason, the final supervisory
judgment on an organization’s capital
adequacy may differ significantly from the
conclusions that might be drawn solely from
the absolute level of the organization’s riskbased capital ratio.
I. Definition of Capital for the Risk-Based
Capital Ratio
An institution’s qualifying capital base
consists of two types of capital elements:
"core capital elements" (Tier 1) and
"supplementary capital elements" (Tier 2).
These capital elements and the various limits,
restrictions, and deductions to which they are
subject are discussed below.
A.
The C om ponents o f Q ualifying Capital
1.
Core capital elements (Tier 1) consist of:
— Com m on stock h old ers’ equity capital
(includes com m on stock, surplus, undivided
profits, d isclo sed capital reserves that
represent a segregation o f undivided
profits, and foreign currency translation
adjustm ents);
—Minority interests in the common
stockholders’ equity capital accounts of
consolidated subsidiaries; and
—Supplementary capital elements (during the
transition period only, and subject to
certain limitations set forth in section III
below).
At least 50 percent of the qualifying capital
base of a state nonmember bank should
consist of core capital. Core capital is defined
as the sum of core capital elements minus all
intangible assets other than mortgage
servicing rights.1
1 An exception will continue to be allow ed for
intangible a sse ts that have been explicitly approved
by the FDIC as part of the b a n k 's regulatory capital
on a specific case basis. T hese intangibles will b e
included in capital for risk-based capital purposes
under the term s and conditions that w ere
specifically approved by the FDIC.
2.
Supplementary capital elements (Tier 2)
consist of:
—Allowances for loan and lease losses
(subject to limitations discussed below);
—Perpetual and long-term preferred stock
(original maturity of at least 20 years);
—Hybrid capital instruments, including
mandatory convertible securities; and
—Term subordinated debt and intermediateterm preferred stock (original average
maturity of seven years or more).
The definition of supplementary capital
does not include revaluation reserves or
hidden reserves that represent unrealized
appreciation on such assets as bank premises
and equity securities. Although such reserves
will not be explicitly recognized when
calculating a state nonmember bank’s riskbased capital ratio, these reserves may be
taken into account as additional factors when
assessing a banking organization’s overall
capital adequacy.
The maximum amount of supplementary
elements that may be recognized for riskbased capital purposes is limited to 100
percent of core capital (after any deductions
for disallowed intangibles). In addition, the
combined amount of term subordinated debt
and intermediate-term preferred stock that
may be treated as part of supplementary
capital for risk-based capital purposes is
limited to 50 percent of core capital. Amounts
in excess of these limits may be issued but
are not included in the calculation of the riskbased capital ratio.
Allowance for loan and lease losses.
Allowances for loan and lease losses are
reserves that have been established through a
charge against earnings to absorb future
losses on loans or lease financing
receivables. Allowances for loan and lease
losses exclude “allocated transfer risk
reserves," 2 and reserves created against
identified losses or earmarked for a specific
asset.
This risk-based capital framework provides
a phasedown during the transition period of
the extent to which the allowance for loan
and lease losses may be included in an
institution's capital base. Initially, no limit
will apply to these reserves. However, by
year-end 1990, the allowance for loan and
lease losses, as a component of
supplementary capital, may constitute no
more than 1.5 percent of risk-weighted assets
and, by year-end 1992, no more than 1.25
percent of risk-weighted assets.3
2 A llocated transfer risk reserves are reserves
that have been e stablished in accordance w ith
section 905(a) of the International Lending
Supervision Act of 1983 against certain assets
w hose value has been found by the U.S. supervisory
authorities to have been significantly im paired by
pro tracted transfer risk problem s.
3 The am ount of the allow ance for loan and lease
losses that m ay be included in supplem entary
capital is ba se d on a percentage of gross riskw eighted assets. A banking organization may
deduct reserves for loan and lease losses that are in
excess of the am ount perm itted to be included in
capital, as w ell as a llocated tra n s fe r r is k re s e r v e s ,
from the sum of risk-w eighted a sse ts w hen
com puting the denom inator of the risk-based capital
ratio.
8582
Federal Register / Vol. 53, No. 50 / Tuesday, M arch 15, 1988 / Proposed Rules
P erp etu a l a n d long-term p r e fe r r e d stock.
Perpetual preferred stock is defined as
preferred stock without a fixed maturity date
a n d that cannot be redeemed at the option of
the holder. Long-term preferred stock
includes limited-life preferred stock with an
original maturity of 20 years or more. When
long-term preferred stock has a remaining
maturity of less than seven years, it should be
treated for risk-based capital purposes as
intermediate-term preferred stock, which is
discussed below.
Perpetual preferred stock and long-term
preferred stock qualify for inclusion in
supplementary capital provided that the
instruments can absorb losses while the
issuer operates as a going concern (a
fundamental characteristic of equity capital)
and provided the issuer has the option to
defer or reduce preferred dividends if
dividends on common,stock are eliminated or
reduced. Given these conditions, and the
perpetual or long-term nature of the
instruments, there is no limit on the amount
of these preferred stock instruments that may
be included within Tier 2 capital.
H y b r id ca p ita l in stru m en ts. Hybrid capital
instruments include long-term debt
instruments that generally meet the
requirements set forth below:
(1) The instrument should be unsecured,
subordinated to depositors and general
creditors, and fully paid-up.
(2) The instrument should not be
redeemable at the option of the holder prior
to maturity, except with the prior approval of
the FDIC.
(3) The instrument should be available to
participate in losses while the issuer is
operating as a going concern. {Straight term
subordinated debt would not meet this
requirement.) To satisfy this requirement, the
instrument should convert to common or
perpetual preferred or long-term preferred
stock in the event that the sum of the
Undivided profits and capital surplus
accounts of the issuer results in a negative
balance.
(4) The instrument should provide the
option for the issuer to defer interest
payments if: (a) The issuer does not report a
profit in the preceding annual period, defined
as combined profits (i.e., net income) for the
most recent four quarters, a n d (b) the issuer
eliminates cash dividends on common a n d
preferred stock.
Mandatory convertible securities that meet
the criteria set forth in 12 CFR 325.2(e) will
qualify as hybrid capital instruments for state
nonmember banks. There is no limit on the
amount of hybrid capital instruments that
may be included within Tier 2 capital.
Term su b o rd in a te d d e b t a n d in term e d ia te term p r e fe r r e d sto c k . The aggregate amount
of term subordinated debt (excluding
mandatory convertible securities) and
intermediate-term preferred stock that may
be treated as supplementary capital for riskbased capital purposes is limited to 50
percent of core capital. Term subordinated
debt and intermediate-term preferred stock
should have an original average maturity of
at least seven years tq qualify as
supplementary capital.
■In the case of subordinated debt, the
instrument should be unsecured.
subordinated to all depositors and general
creditors, and clearly state on its face that it
is not a deposit and is not insured by the
Federal Deposit Insurance Corporation. To
qualify as supplementar capital, such
instruments issued by state nonmember
banks should also meet the criteria for
subordinated debt set forth in 12 CFR 325.2(j).
D isco u n t o f su p p le m e n ta r y lim ite d -life
c a p ita l in stru m en ts: As a limited-life capital
instrument approaches maturity, the
instrument begins to take on characteristics
of a short-term obligation and becomes less
like a component of capital. Therefore, for
risk-based capital purposes, the outstanding
amount of term subordinated debt and
limited-life preferred stock eligible for
inclusion in Tier 2 will be adjusted
downward, or discounted, as the instruments
approach maturity. Each limited-life capital
instrument will be discounted by reducing the
outstanding amount of the capital instrument
eligible for inclusion as supplementary
capital by a fifth of the original amount (less
redemptions) each year during the
instrument’s last five years before maturity.
Such instruments, therefore, will have no
capital value when they have a remaining
maturity of less than a year.
B. Deductions From Capital and Other
Adjustments
Certain assets are deducted from an
organization’s capital base for the purpose of
calculating the numerator of the risk-based
capital ratio.4
These assets include:
(1) All intangible assets other than
mortgage servicing rights.5 These disallowed
intangibles are deducted from the core
capital (Tier 1) elements.
(2) Investments in u n co n so lid a te d banking
and finance subsidiaries.6*This includes any
4 A ny asse ts deducted w hen com puting the
n um erator of the risk -b ased capital ratio w ill also
be excluded from risk-w eighted assets w hen
com puting the denom inator of the ratio.
5 In addition to mortgage servicing rights, certain
other intangibles m ay be allow ed if explicitly
approved by the FDIC a s p art of the b a n k ’s
regulatory cap ital on a specific case basis.
0 For risk-based capital purposes, these
subsidiaries are generally defined as any banking or
finance company in which the reporting banking
organization owns more than 50 percent of the
outstanding voting stock. In addition to investments
in unconsolidated banking and finance subsidiaries,
the FDIC may, on a ease-by-case basis, deduct
investments in associated companies or joint
ventures, which are generally defined as any
companies in which the reporting banking
organization, either directly or indirectly, owns 2D to
50 percent of the outstanding voting stock.
Alternatively, the FDIC may, in certain cases, apply
an appropriate risk-weighted capital charge against
a banking organization’s proportionate interest in
the assets of associated companies and joint
ventures. The definitions for subsidiaries,
associated companies and joint ventures are
contained in the instructions for the preparation of
the Consolidated Reports of Condition and Income.
equity or debt capital investments in banking
or finance subsidiaries if the subsidiaries are
not consolidated for regulatory capital
requirements. These investments are
deducted from the banking organization’s
total (Tier 1 plus Tier 2) capital base.
The FDIC may also deduct certain
investments in nonbanking or nonfinancial
subsidiaries. Investments by state
nonmember banks in securities subsidiaries
established pursuant to 12 CFR 337.4 will be
deducted from capital for risk-based capital
purposes. The FDIC may also consider
deducting other investments in subsidiaries,
either on a case-by-case basis or, as with
securities subsidiaries, based on the general
characteristics or functional nature of the
subsidiaries.
(3)
Reciprocal holdings of capital
instruments of banking organizations that
represent intentional cross-holdings by the
banking organizations. These holdings are
deducted from the banking organization’s
total capital base.
II. P rocedu res f o r C om putin g R isk -W e ig h te d
A s s e ts
U nder the risk-based capital fram ework, a
banking organization’s b a lan ce sh eet a ssets
and credit equivalen t am ounts o f off-balance
sh eet item s are assign ed to one o f five broad
risk categories. The aggregate dollar am ount
in each category is then m ultiplied b y the risk
w eigh t assign ed to that category. The
resulting w eigh ted valu es from each o f the
five risk categories are ad d ed together and
this sum is the risk-w eighted a ss e ts total that,
as adjusted, com prises the denom inator of
the risk-based capital ratio.
Risk w eigh ts for all off-balance sh eet item s
are determ ined by a tw o-step process. First,
the notion al principal, or face value, am ount
o f ea ch off-balance sh eet item generally is
m ultiplied by a credit con version factor to
arrive at a b alan ce sh eet “credit equivalen t
am ount.” S econd, the credit equivalen t
am ount generally is assig n ed to the
appropriate risk category, like any b a lan ce
sh eet a sset, according to the obligor or, if
relevant, the guarantor or the nature o f the
collateral.
In determ ining risk w eig h ts o f variou s
a ssets, the only form s o f c o lla te r a l that are
form ally recognized by the-risk-based capital
fram ew ork are cash on d ep o sit in the lending
institution; secu rities issu ed by, or
guaranteed by, the U .S. G overnm ent or its
agencies; and secu rities issu ed by, or
guaranteed by, U.S. G overnm ent-sponsored
agen cies. T he exten t to w h ich th ese secu rities
are recognized a s collateral for risk-based
cap ital pu rp oses is determ ined by their
current m arket valu e. If a claim is partially
collateralized , the portion o f the claim that is
not collateralized is a ssig n ed to the risk
category appropriate to the obligor or, if
relevant, the guarantor. A claim secu red by
tw o typ es o f collateral that the risk-based
capital fram ew ork recogn izes but p la ces i s
different risk categories sh ould be
apportioned to the tw o risk ca tegories
according t© the am ounts o f e a ch type o f
collateral that secure the claim .
Guarantees o f the U.S. G overnm ent and it®
agen cies, U.S. G overnm ent-sponsored
Federal R egister / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R u les
agencies, domestic state and local
governments, and domestic depository
institutions are also recognized. M a tu r ity is
generally not a factor in assigning items to
risk categories with the exceptions of
securities (direct claims) on the U.S.
Government or its agencies, claims on foreign
banks, commitments, and interest rate and
foreign exchange related contracts. Provided
below is a discussion of the risk weights and
credit equivalent conversion factors that are
used in the risk-based capital framework.
A. Risk Weights for Balance Sheet Assets
The risk-based capital framework sets
forth five risk weight categories—0 percent,
10 percent, 20 percent, 50 percent and 100
percent. An explanation of the components of
each category and a summary of the types of
assets included in each category follows.
C a teg o ry 1—Z ero P erce n t R isk W e ig h t
This category includes cash (domestic and
foreign) owned and held in all offices of a
bank or in transit; claims on, and balances
due from, Federal Reserve Banks; and, in
light of their near-cash characteristics,
securities issued by the U.S. Government or
its agencies with a rem ain in g maturity of 91
days or less.
C a teg o ry 2— 10 P erce n t R isk W eight. This
category includes securities issued by the
U.S. Government or its agencies 7 with a
remaining maturity of over 91 days; all other
claims (including leases) on the U.S.
Government or its agencies; all securities and
portions of loans guaranteed by the U.S.
Government or its agencies; and claims
(including repurchase agreements)
collateralized by cash on deposit in the
lending institution or by securities issued by,
or guaranteed by, the U.S. Government or its
agencies.
C a teg o ry 3—20 P erce n t R isk W e ig h t This
category includes short-term claims
(including demand deposits) on domestic
depository institutions 8 and short-term
F
y
i
y
7 For risk-based capital purposes, a U.S.
Government agency is defined as an instrumentality
of the U.S. Government whose debt obligations are
fully and explicitly guaranteed as to the timely
repayment of principal and interest by the full faith
and credit of the U.S. Government. These agencies
include the Government National Mortgage
Association (GNMA), the Veterans Administration
(VA), the Federal Housing Administration (FHA),
the Farmers Home Administration (FmHA), the
Export-Import Bank (Exim Bank), the Overseas
Private Investment Corporation (OPIC), the
Commodity Credit Corporation (CCC), and the
Small Business Administration (SBA).
8 Domestic depository institutions are defined to
include branches (foreign and domestic) of
federally-insured banks and depository institutions
chartered and headquartered in the 50 states of the
United States, the District of Columbia, Puerto Rico,
and U.S. territories and possessions. The definition
encompasses banks, mutual or stock savings banks,
savings or building and loan associations,
cooperative banks, credit unions, international
banking facilities of domestic banks, and U.S.chartered depository institutions owned by
foreigners. However, this definition excludes
branches and agencies of foreign banks located in
the U.S. and bank holding companies.
claims on all foreign banks 9 (including
foreign central banks); cash items in process'
of collection, both foreign and domestic; local
currency claims on foreign central
governments to the extent that a bank has
local currency liabilities booked in the
foreign country; long-term (original maturity
of more than one year) claims on domestic
depository institutions; 101and portions of
loans or other claims guaranteed fey, or
backed by the full faith and credit ©£,
domestic depository institutions.11
This category also indudes claims on,
or portions of claims guaranteed by, U.S.
Government-sponsorec/ agencies, and
portions of claims collateralized by
securities issued by, or guaranteed by,
U.S. Government-sponsored agencies.12*
In addition, this category includes
claims on multilateral lending
institutions or regional development
banks in which the U.S. Government is a
shareholder or contributing member.
General obligation claims on, or
portions of claims guaranteed by, the
full faith and credit of states or political
subdivisions of the United States are
also assigned to this 20 percent risk
category.
C a teg o ry 4— 50 P erce n t R isk W eight. This
category includes re v en u e (non-general
obligation) bonds or similar obligations,
including loans and leases, that are
obligations of state or political subdivisions
of the United States, but for which the
government entity is committed to repay the
debt with revenues from the specific projects
financed, rather than from general tax funds.
C a teg o ry 5—100 P erce n t R is k W eight. All
assets not included in the categories above
are assigned to this category, which
comprises standard risk assets. Many assets
typically found in a banking organization’s
loan portfolio are assigned to the ICO percent
risk category. Such assets include long-term
dadms (over one year) on foreign banks, and
9 Foreign banks are defined as institutions that
are organized under the laws of a foreign country;
engage in the business of banking; are recognized as
banks by the bank supervisory or monetary
authorities of the country of their organization or
principal banking operations; receive deposits to a
substantial extent in the regular course of business,
and have the power to accept demand deposits.
Claims on foreign banks indude claims on U.S.
branches and agencies of foreign banks.
10 Claims on foreign banks with an original
maturity exceeding one year and claims on bank
holding companies are assigned to Category 5,
which carries a risk weight of 100 percent.
11 This includes risk participations in bankers
acceptances and in any standby letters of credit and
participations in commitments c o n v ey e d to other
domestic depository institutions.
12 For risk-based capital purposes, U.S.
Government-s/wmsored agencies are defined as
agencies originally established or chartered by the
U.S. Government to serve public purposes specified
by the U.S. Congress but whose debt obligations are
not e x p lic itly guaranteed by the full faith and credit
of the U.S. Government. These agencies include the
Federal Home Loan Mortgage Corporation
(FHLMC), the Federal National Mortgage
Association (FNMA), the Farm Credit System, the
Federal Home Loan Bank System, and the Student
Loan Marketing Association (SLMA).
all claims on foreign governments that entail
some degree of transfer risk, such as nonlocal
currency claims on foreign governments ami
local currency claims on a foreign central
government that exceed local currency
liabilities held by the bank in the foreign
country.
This category also includes all claims on
foreign and domestic private sector obligors
not included in the categories above
(including loans to nondepository financial
institutions and bank holding companies);
claims on commercial firms owned by the
public sector; customer liabilities to the bank
on acceptances outstanding involving
standard risk claims;iis investments in fixed
assets, premises and other real estate owned;
common and preferred stock of corporations,
including stock acquired for debts previously
contracted; and commercial and consumer
loans, including all residential mortgage
loans (except those assigned to lower risk
categories due to recognized guarantees or
collateral).
Unless already deducted from capital for
risk-based capital purposes, the following
assets also are included in the 100 percent
risk category: investments in unconsolidated
companies, joint ventures or associated
companies; instruments that qualify as
capital issued by other banking
organizations; and mortgage servicing rights
and other allowed intangibles. Also included
in this category are industrial development
bonds and similar obligations issued by
states and political subdivisions of the United
States for the benefit of a private party or
enterprise where that party or enterprise,
rather than the government, is obligated to
pay the principal and interest
B. Credit Equivalent Conversion Factors for
Off-Balance Sheet items
The face amount of an off-balance sheet
item is generally multiplied by a credit
conversion factor and the resulting credit
equivalent amount is assigned to the
appropriate risk category according to the
obligor or, if relevant, the guarantor or the
nature of the collateral.
1. Item s W ith a 100 P erce n t C o n versio n
Factor. A 100 percent conversion factor
applies to d ir e c t c r e d it su b stitu te s, which
include g u a ra n tee s, or equivalent
instruments, backing fin a n c ia l claims, such
as outstanding securities, loans or other
fin a n c ia l obligations, or backing off-balance
sheet items that require capital under the
risk-based capital framework. These direct
credit substitutes include standby letters of
credit, or other equivalent irrevocable
obligations or surety arrangements, that
effectively guarantee repayment of
commercial paper, tax-exempt securities.
13
Customer liabilities -on acceptances
outstanding involving non-standard risk clataia,
such as claims ©n domestic depository ksstitetiesa,
are assigned to the risk category appropriate to the
identity of the obligor or, if relevant, the natere -e-f
the collateral or guarantees backing the eta mas.
Portions of acceptances conveyed as m k
participations to domestic depository msdto&sss
should be assqjned to the 2Qperc®$t risk category
that is appropriate to cis-iras guaranteed fey
domestic depository institutions.
8S 84
Federal R egister / V ol. 53, N o, 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
commercial or individual loans or other debt
obligations, or commercial letters of credit.
Direct credit substitutes also include the
acquisition of risk p a r tic ip a tio n s in bankers
acceptances and standby letters of credit.
(Standby letters of credit that are
performance-related have a credit conversion
factor of 50 percent.)
In the case of direct credit substitutes that
are structured in the form of a syndication,
that is, where each bank is responsible only
for its p ro ra ta share of the risk and there is
no recourse to the originating bank, the
participated portions would be excluded
entirely from the originating bank’s riskweighted assets. A banking organization that
has conveyed risk participations 14*in a
direct credit substitute to a third party should
convert the full amount of the direct credit
substitute at a 100 percent conversion factor
without deducting the risk participations
conveyed. However, portions of direct credit
substitutes that have been conveyed as risk
participations to domestic depository
institutions may then be assigned to the 20
percent risk category that is appropriate for
claims guaranteed by domestic depository
institutions, rather than to the risk category
appropriate to the account party obligor. A
bank acquiring a risk participation in a direct
credit substitute or bankers acceptance
should convert the participation at 100
percent and then assign the credit equivalent
amount to the risk weight category that is
appropriate to the account party obligor.
For risk-based capital purposes, standby
letters of credit are distinguished from loan
commitments (discussed below) in that
standbys are irrevocable obligations of the
banking organization to pay a third-party
beneficiary when a customer (account party)
f a ils to re p a y an outstanding loan or debt
instrument (direct credit substitute) or fa ils to
p erfo rm some other contractual obligation
(performance bond). A loan commitment, on
the other hand, involves an obligation (with
or without a material adverse change clause)
of the banking organization to provide funds
to its customer in th e n o rm a l cou rse of
business should the customer seek to draw
down the commitment.
Therefore, the distinguishing characteristic
of a standby letter of credit for risk-based
capital purposes is the combination of
irrevocability with the notion that funding is
triggered by some failure to repay or perform
on an obligation. Thus, any commitment (by
whatever name) that involves an irre v o ca b le
obligation to make a payment to the customer
or to a third party in the event the customer
fa ils to r e p a y an outstanding debt obligation
or fa ils to p e rfo rm on a contractual obligation
would be treated, for risk-based capital
purposes as, respectively, a financial
guarantee-type standby letter of credit (ICO
percent conversion factor) or a performance
standby (50 percent conversion factor).
S a le a n d rep u rch a se a g re e m e n ts and a s s e t
s a le s w ith recou rse, if not already included
on the balance sheet, and fo r w a r d
a g reem en ts are also converted at 100 percent.
For risk-based capital purposes, the
definition of sales of assets with recourse,
including the sales of participations in pools
of residential mortgages, is consistent with
the definition contained in the instructions
for the preparation of the Consolidated
Reports of Condition and Income. “Loan
strips" and similar arrangements involving
short-term loans sold by a bank without
direct recourse but subject to long-term loan
commitments by the bank are accorded the
same treatment as assets sold with recourse.
Forward agreements are legally binding
agreements (contractual obligations) to
purchase assets with certa in drawdown at a
specified future date. These obligations
include forward purchases, forward deposits,
and partly-paid shares and securities but do
not include forward foreign exchange rate
contracts.
2. Item s W ith a 50 P erce n t C on version
Factor. Transaction-related contingencies are
to be converted at 50 percent. Such
contingencies include bid bonds, performance
bonds, warranties, and p erfo rm a n ce standby
letters of credit related to particular
transactions, as well as acquisitions of risk
participations in such standby letters of
credits. Performance standby letters of credit
represent obligations backing the
performance of n o n fin a n cia l or c o m m e rcia l
contracts or undertakings. To the extent
permitted by law or regulation, performance
standby letters of credit include
arrangements backing, among other things,
subcontractors’ and suppliers’ performance,
labor and materials contracts, and
construction bids.
The unused portion of c o m m itm e n ts with
an orig in a l maturity exceeding one year,
including underwriting commitments, and
commercial and consumer credit
commitments, also are to be converted at 50
percent. Original maturity is defined as the
length of time between the date the
commitment is issued and the earliest date on
which the following two conditions hold: (1)
The bank can, at its option, u n co n d itio n a lly
(without cause) cancel the commitment, and
(2) the bank is scheduled to (and as a normal
practice actually does) review the facility to
determine whether or not it should be
extended. Facilities that are unconditionally
cancellable (without cause) at any time by
the bank are not deemed to be commitments,
provided the bank makes a separate credit
decision before each drawing under the
facility.
Commitments, for risk-based capital
purposes, are defined as any arrangements
that obligate a banking organization to
extend credit in the form of loans or lease
financing receivables; to purchase loans,
securities, or other assets; or to participate in
loans and leases. Commitments also include
overdraft facilities, revolving credit, or
similar transactions. Normally, commitments
involve a written contract or agreement and a
commitment fee, or some other form of
consideration. Commitments are included in
14 That is, participations in which the originating
risk-weighted assets regardless of whether
banking organization remains liable to the
they contain “material adverse change"
beneficiary for the full amount of the direct credit
clauses or similar provisions that are
substitute if the party that has acquired the
intended to relieve the issuer of its funding
participation fails to pay when the instrument is •
drawn upon.
obligation under certain conditions.
In the case of commitments structured as
syndications, the risk-based capital
framework includes only the banking
organization’s proportional share of such
commitments. After a commitment has been
converted at 50 percent, portions of
commitments that have been conveyed to
other d o m e s tic depository institutions, but in
which the originating banking organization
retains the full obligation to the borrower if
the participating bank fails to pay when the
commitment is drawn upon, will be assigned
to the 20 risk category. The acquisition of
such a participation would be converted at 50
percent and the credit equivalent amount
would be assigned to the risk category that is
appropriate for the account party obligor.
Revolving underwriting facilities (RUFs),
note issuance facilities (NIFs), and other
similar arrangements also are converted at 50
percent. These are facilities under which a
borrower can issue on a revolving basis
short-term notes in its own name, but for
which the underwriting banking
organizations have a legally binding
commitment either to purchase any notes the
borrower is unable to sell by the rollover date
or to advance funds to the borrower.
3. Ite m s W ith a 20 P ercen t C o n versio n
Factor. Short-term, self-liquidating traderelated contingencies which arise from tne
movement of goods are converted at 20
percent. Such contingencies include
c o m m e rc ia l le tte r s o f c r e d it and other
documentary letters of credit collateralized
by the underlying shipments.
4. Item s W ith a Z ero P ercen t C o n versio n
Factor. These include unused commitments
with an original maturity of one year or less.
Unused r e ta il credit card lines and related
plans are deemed to be short-term
commitments if the bank has the
unconditional option to cancel the credit line
at any time.
C. Conversion Factors and Risk Weights for
Interest Rate and Foreign Exchange Rate
Related Contracts
Credit equivalent amounts are to be
computed for each of the following offbalance sheet interest rate and foreign
exchange rate related instruments:
Interest Rate Related Contracts:
(1) Single currency interest rate swaps.
(2) Basis swaps.
(3) Forward rate agreements.
(4) Interest rate options purchased
(including caps, collars and floors
purchased).
(5) Any other instrument that gives rise to
similar credit risks (including when-issued
securities).
Foreign Exchange Rate Related Contracts:
(1) Cross-currency interest rate swaps.
(2) Forward foreign exchange contracts.
(3) Currency options purchased
(4) Any other instrument that gives rise to
similar credit risks.
Over-the-counter options purchased would
be treated in the same way as the other
interest rate and foreign exchange rate
contracts. That is, the credit equivalent
amount would be the sum of the marked-tomarket replacement cost and the “add-on"
amount for the potential future exposure.
Federal R egister / V ol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
For risk-based capital purposes, foreign
exchange rate contracts with an original
maturity of seven days or less and
instruments traded on exchanges that require
daily payment of variation margin are
excluded.
1. C re d it E q u iva len t A m o u n ts fo r In terest
R a te a n d Foreign E xchange C on tracts. Credit
equivalent amounts aroto be calculated for
each individual contract of the types listed
above. To calculate the credit equivalent
amount of its off-balance sheet interest rate
and foreign exchange rate instruments, a
banking organization should, for each
contract, sum:
(a) The mark-to-market value (positive
values only) of the contract (that is, its
cu rren t exposure) 15 and
(b) An estimate of the -poten tial future
increases in credit exposure over the
remaining life of the instrument.
For risk-based capital purposes, potential
exposure on a contract is determined by
multiplying the notional principal amount of
the contract, including contracts with
negative mark-to-market values, by one of
the following credit conversion factors, as
appropriate:
Remaining maturity
Less than one year........... ........
One year and over..... ....... ......
interest
rate
contracts
(percent)
Foreign
ex
change
rate
con
tracts
(per
cent)
0
0.5
1.0
5.0
Because foreign exchange rate contracts
involve an exchange of principal upon
maturity, and exchange rates are generally
more volatile than interest rates, higher
conversion factors have been established for
foreign exchange rate contracts than for
interest rate contracts.
No potential credit exposure should be
calculated for single currency floating/
floating interest rate swaps: rather, the credit
equivalent amount on these contracts should
be calculated solely on the basis of their
mark-to-market value (positive values only).
2. R isk W eig h ts f o r In te re st R a te a n d
Foreign E xchange C on tracts. Once the credit
equivalent amount for interest rate and
foreign exchange rate instruments has been
determined, that amount generally should be
assqpasd to a risk weight category according
to the identity of the counterparty or, if
relevant, the nature of collateral or
guarantees. However, the m axim u m risk
weight that will be applied to fee credit
equivalent amount of ssda issstasisffits is 50
percent.
In certain cases, credit exposures arising
from fee interest rate and foreign exchange
rate instruments may already be reflected, in
part, on the balance sheet. To avoid the
double counting of such exposures in the
assessment of capita! adequacy and in the
assigning of risk weights, counterparty credit
15 Mark-to-markst values should be rssasered in
dollars, segsrdfe® of fits casssacy or c a a e a c in
specified in the contract.
exposures arising from these instruments
may need to be excluded from balance sheet
assets when calculating a banking
organization’s total risk-weighted asset
figure. However, the n ettin g of offsetting
positions in swaps and similar contracts will
not be recognized for purposes of calculating
the risk-based capital ratio.
III. M inim um T a rg et R isk -B a se d C a p ita l
R a tio
A . Minimum Target Risk-Based Capital Ratio
After Transition Period
State nonmember banks generally will be
expected to meet a minimum target ratio of
total capital to risk-weighted assets of 8
percent, of which at least 4 percentage points
should be in the form of core capital (Tier 1).
Core capital is defined as the sum of common
stockholders equity capital (including any
minority interests in the common
stockholders equity capital accounts of
consolidated subsidiaries) minus all
intangible assets other than mortgage
servicing rights.16
The maximum amount of supplementary
capital elements that qualify as Tier 2 capital
is limited to 100 percent of core capital.
Within Tier 2, the maximum amount of the
allowance for loan and lease losses that
qualifies as supplementary capital is limited
to 1.25 percent of risk-weighted assets. In
addition, the combined maximum amount of
term subordinated debt and intermediateterm preferred stock that qualifies as
supplementary capital is limited to 50 percent
of core capital.
T o ta l c a p ita l is calculated by adding core
capital (defined to exclude disallowed
intangibles) to supplementary capital (limited
to 100 percent of core capital) and then
deducting from this sum any capital
investments in unconsolidated banking and
finance subsidiaries, any intentional,
reciprocal cross-holdings of banking
organizations’ capital securities, and any
other items that are deducted at the direction
of the FDIC.
B. Transitional Arrangements
The transition period commences with the
adoption of this statement of policy and ends
on December 31,1992. The transitional
arrangements include an interim minimum
target ratio that becomes effective on
December 31,1990. Any state nonmember
bank not meeting the interim or final
minimum target risk-based capital ratios
generally will be expected to develop a
capital plan acceptable to the FDIC that sets
forth how the organization intends to reach
the minimum target ratios.
1. T ra n sitio n a l arran gem en ts— In itial
p e r io d to y e a r -e n d 1990. No formal minimum
target ratio for the risk-based capital
framework will exist during the initial phase
of the transition period. However, any state
nonmembe? bank that has a risk-based
capital ratio of less than 0 percent generally
will be expected to undertake a sustained
effort to move in the direction of meeting that
16 In addition to mortgage servicing rights, certain
other intangibles may be allowed m core capital if
explicitly approved by tfea FDIC as part of tbs
bank's regulatory capital on a specific ease basis.
8585
ratio during the transition period. State
nonmember banks with ratios of 8 percent or
lower generally should not make adjustments
to their risk profiles or undertake growth
plans that would lower their ratios.
During the initial phase of the transition
period, a maximum of 25 percent of core
capital (before any deduction of disallowed
intangibles) may consist of supplementary
capital elements, with the remainder
consisting of common stockholders’ equity
capital. By year-end 1990, however, state
nonmember banks will be expected to reduce
the amount of supplementary capital
elements included in core capital to no more
than 10 percent of core capital.
During the initial transition period, the
allowance for loan and lease losses may be
included in supplementary capital without
limit. However, by the end of 1990, the
amount of the allowance for loan and lease
losses that is eligible for inclusion in
supplementary capital may not exceed 1.5
percent of risk-weighted assets.
2. T ra n sitio n a l a rran gem en ts —y e a r -e n d
1990 through y e a r -e n d 1992. Beginning with
the second and final phase of the transition
period, state nonmember banks generally will
be expected to meet a minimum total capital
to risk-weighted asset ratio of 7.25 percent, at
least one-half of which should be in the form
of core capital. In addition, during this period,
up to 10 percent of an organization’s core
capital (before any deduction for disallowed
intangibles) may consist of supplementary
capital elements. Thus, the 7.25 percent
interim target ratio implies a minimum ratio
of core capital to risk-weighted assets of 3.6
percent (or one-half of 7.25) and a minimum
common stockholders’ equity capital to riskweighted assets ratio of 3.25 percent (or ninetenths of the core capital ratio). By the end of
1992, a state nonmember bank’s core capital
should consist s o le ly of common
stockholders’ equity capital.
During this final phase of the transition
period, the maximum amount of the
allowance for loan and lease losses that may
qualify as supplementary capital will be
limited to 1.5 percent of risk-weighted assets
(that is, 1.5 percentage points of the 7.25
percent interim target risk-based capital
ratio) and this percentage limitation will
decline to 1.25 percent when the transitional
arrangements end on December 31,1992. For
risk-based capital purposes, allowances for
loan and lease losses in excess of these limits
will not be included in a state nonmember
bank's total capital base, even though state
nonmember banks shall continue to maintain
loan loss reserves at levels sufficient to cover
the losses inherent in their loan portfolios.
This Statement of Policy on Risk-Based
Capital does not replace or eliminate the
existing Part 325 capital-to-total assets ratios,
although the FDIC may subsequently
consider whether these Part 325 leverage
ratios should continue to be employed once
the risk-based capital framework is fully
implemented. If the leverage requirements are
to be permanently maintained in tandem with
the risk-based ‘capital framework, fee FDIC
may also consider whether the Part 323
definitions ©£ capital for leverage purposes
should be revised to more closely conform
Federal Register / Vol. 53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
with the definitions of capital that are used
for risk-based capital purposes.
i
able
I.—Definition
Capital
Components
Core Capital ( Tier 1)....
Common stockholders’
equity capital.
Minority interests in
common equity
capital accounts of
consolidated
subsidiaries.
Less: AH intangible
assets other than
mortgage servicing
rights
Supplem entary Capital
(.Tier 2).
Alfowance for loan and
lease losses.
Perpetual and long
term preferred stock
(original maturity of
20 years or more).
Hybrid capital
instruments
(including mandatory
convertible
securities).
Term subordinated
debt and
intermediate-term
preferred stock
(original weighted
average maturity of 7
years or more).
of
Q ualifying
Minimum requirements
and limitations after
transition period
Must equal or exceed 4%
of risk-weighted assets.
No limit.
No limit.
Total of Tier 2 is limited to
100% of Tier 1.2
Limited to 1.25% of riskweighted assets.2
No limit within Tier 2;
long-term preferred is
amortized for capital
purposes as it ap
proaches maturity.
No limit within Tier 2.
Total Capital (T ie r
1 + T ie r
2 -D e d u c tio n s ).
Table II.—S ummary of Risk Weights
and Risk Categories
C a teg o ry 1— Z ero P ercen t R isk W eigh t
(1) Cash (domestic and foreign)
(2) Balances due from, and claims on,
Federal Reserve Banks
(3) Securities issued by the U.S.
Government or its agencies 1 with a
remaining maturity of 91 days or less
C a teg o ry 2— 10 P ercen t R isk W eigh t
Term subordinated debt
and
intermediate-term
preferred stock are limit
ed to 50% of Tier 1 2
and amortized for cap
ital purposes as they
approach maturity.
Deductions (fro m the
sum o f Tier 1 plus
Tier 2).
Investments in
unconsolidated
banking and finance
subsidiaries.
Intentional, reciprocal
cross-holdings of
capita! securities
issued by banking
organizations.
Other deductions (such
as investments in
other subsidiaries or
in joint ventures) as
determined by
supervisory authority.
conversion factors that are summarized in
Tables II and III.
When determining the amount of riskweighted assets, balance sheet assets are
assigned an appropriate risk weight (see
Table II) and off-balance sheet items are first
converted to a credit equivalent amount (see
Table III) and then assigned to one of the risk
weight categories set forth in Table II.
The balance sheet assets and the credit
equivalent amount of off-balance sheet items
are then multiplied by the appropriate risk
weight percentages and the sum of these riskweighted amounts is the gross risk-weighted
asset figure used in determining the
denominator of the risk-based capital ratio.
Any items deducted from capital when
determining the amount of qualifying capital
may also be deducted from the gross riskweighted asset figure when determining the
denominator for the risk-based capital ratio.
(1) Securities issued by the U.S.
Government or its agencies 1 with
remaining maturities of over 91 days and
all other claims (loans and leases) on the
U.S. Government or its agencies 1
(2) Securities and other claims guaranteed
by the U.S. Government or its agencies
(including portions of claims guaranteed)
(3) Portions of loans and other assets
collateralized 12 by securities issued by,
or guaranteed by, the U.S. Government
or its agencies, or by cash on deposit in
the lending institution
(4) Federal Reserve Bank stock
C a teg o ry 3—20 P erce n t R isk W eigh t
On case-by-case basis or
as matter of policy after
formal consideration of
relevant issues.
Must equal or exceed 8%
of risk-weighted assets.
1 In addition to mortgage servicing rights, certain
other intangibles may be allowed in core capital if
explicitly approved by the FDIC on a specific case
basis. AH deductions are for capital adequacy pur
poses only; deductions would not affect accounting
treatment.
2 Amounts in excess of limitations are permitted
but do not qualify as capital.
When calculating the risk-based capital
ratio under the framework set forth in this
statement of policy, qualifying capital (the
numerator) is divided by risk-weighted assets
(the denominator). The process of
determining the numerator for the ratio is
summarized in Table I. The calculation of the
denominator is based on the risk weights and
(1) All claims (long- and short-term) on
domestic depository institutions
(2) Claims on foreign banks with an
original maturity of one year or less
(3) Claims guaranteed by, or backed by the
full faith and credit of, domestic
depository institutions
(4) Local currency claims on foreign central
governments to the extent tHe bank has
local currency liabilities in the foreign
country
(5) Cash items in the process of collection
(6) Securities and other claims on, or
guaranteed by, U.S. Governmentsponsored agencies (including portions of
claims guaranteed) 3
1For the purpose of calculating the risk-based
capital ratio, a U.S. Government agency is defined
as an instrumentality of the U.S. Government whose
obligations are fully and explicitly guaranteed as to
the timely repayment of principal and interest by
the full faith and credit of the U.S. Government.
2 Degree of collateralization is determined by
current market value.
3 For the purpose of calculating the risk-based
capital ratio, a U.S. Government-sponsored agency
(7) Portions of loans and other assets
collateralized 4 by securities issued by,
or guaranteed by, U.S. Governmentsponsored agencies
(8) General obligation claims on, and
claims guaranteed by, U.S. State and
local governments that are secured by
the full faith and credit of the State or
local taxing authority (including portions
of claims guaranteed)
(9) Claims on official multilateral lending
institutions or regional development
institutions in which the U.S.
Government is a shareholder or a
contributing member
C a teg o ry 4— 50 P ercen t R isk W eigh t
(1) Revenue bonds or similar obligations,
including loans and leases, that are
obligations of U.S. State or local
governments, but for which the
government entity is committed to repay
the debt only out of revenues from the
specific projects financed
(2) Credit equivalent amounts of interest
rate and foreign exchange rate related
contracts, except for those assigned to a
lower risk category
C a teg o ry 5— 100 P ercen t R isk W eig h t
(1) All other claims on private obligors
(2) Claims on foreign banks with an
original maturity exceeding one year
(3) Claims on foreign central governments
that are not included in item 4 of
Category 3
(4) Obligations issued by State or local
governments (including industrial
development authorities and similar
entities) repayable solely by a private
party or enterprise
(5) Premises, plant, and equipment; other
fixed assets; and other real estate owned
(6) Investments in any unconsolidated
subsidiaries, joint ventures, or associated
companies—if not deducted from capital
(7) Instruments issued by other banking
organizations that qualify as capital
(8) All other assets (including claims on
commercial firms owned by the public
sector)
Table III —Credit Conversion
Factors for Off-Balance Sheet Items
100 P ercen t C on version F actor
(1) Direct credit substitutes (general
guarantees of indebtedness and
guarantee-type instruments, including
standby letters of credit that effectively
guarantee the repayment of loans,
securities and commercial letters of
credit)
(2) Acquisitions of risk participations in
bankers acceptances and standby letters
of credit
(3) Sale and repurchase agreements and
asset sales with recourse, if not already
included on the balance sheet
is defined as an agency originally established or
chartered to serve public purposes specified by the
U.S. Congress but whose obligations are not
explicitly guaranteed by the full faith and credit of
the U.S. Government.
4 Degree of collateralization is determined by
current market value.
F ederal R egister / V ol. -53, N o. 50 / T u esd a y , M arch 15, 1988 / P rop osed R ules
(4) Forward agreements (that is,
contractual obligations) to purchase
assets with certa in drawdown at a
specified future date
50 P ercen t C o n version F actor
(1) Transaction-related contingencies (e.g.,
bid bonds, performance bonds,
warranties, and performance standby
letters of credit related to particular
transactions)
(2) Unused commitments with an original
maturity exceeding one year, including
underwriting commitments and
commercial credit lines
(3) Revolving underwriting facilities
(RUFs), note issuance facilities (NIFs)
and other similar arrangements
20 P ercen t Con version F actor
C red it C on version f o r In te re st R a te a n d
Foreign E xch an ge R a te R e la te d C o n tracts
The total replacement cost of contracts
(obtained by summing the positive mark-tomarket values of contracts) would be added
to a measure of future potential increases in
credit exposure. This future potential
measure would be calculated by multiplying
the total notional value of contracts by one of
the following credit conversion factors, as
appropriate:
Remaining maturity
(1) Short-term, self-liquidating trade-related
contingencies, including commercial
letters of credit
Z ero P ercen t C o n version F actor
(1) Unused commitments with an original
maturity of one year or less or which are
unconditionally cancellable at any time
Less than one year...................
One year and over....................
Interest
rate
contracts
(percent)
0
0.5
Foreign
ex
change
rate
con
tracts
(per
cent)
1.0
5.0
No potential exposure would be calculated
for single currency floating/floating interest
rate contracts; the credit exposure on these
contracts would be evaluated solely on the
basis of their market-to-market value.
Exchange rate contracts with an original
maturity of seven days or less would be
excluded. Also, instruments traded on
exchanges that require daily payment of
variation margin would be excluded.
By.order of the Board of Directors, this first
day of March 1988.
Federal Deposit Insurance Corporation.
Hoyle L. Robinson,
E x e cu tiv e S ecreta ry.
[FR Doc. 88-5333 Filed 3-14-88; 8:45 am]
BILLING CODE 6714-01-£3
@FedFRASER