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FEDERAL RESERVE BANK OF NEW YORK J Circular No. 10498 ~| December 11, 1991 [ INTERNATIONAL RISK-BASED CAPITAL ACCORD Inclusion of General Loan-Loss Reserves in the Definition of Capital To All State Member Banks, Bank Holding Companies, and Branches and Agencies o f Foreign Banks in the Second Federal Reserve District, and Others Concerned: Our Circular No. 10441, dated March 21, 1991, announced a proposal by the Basle Committee on Banking Supervision concerning the inclusion of general loan-loss reserves in the definition of capital under the international risk-based capital accord. Printed below is a joint agency press release — by the Comptroller of the Currency, the FDIC, and the Board of Governors of the Federal Reserve System — announcing the Basle Committee’s adoption of the proposal: The Basle Committee on Banking Supervision has released the attached amendment to the interna tional risk-based capital accord. The amendment gives greater precision to the inclusion of general loan loss reserves in the definition of capital under the international risk-based capital accord. The U.S. banking agencies regard the amendment as useful and consistent with the risk-based capital guidelines previously adopted by the U.S. agencies in 1989. Developed by the Basle Committee and endorsed by the Central Bank Governors of the Group of Ten countries in 1988, the accord serves as the basis for the risk-based capital framework adopted by the U.S. banking agencies and by bank supervisors in other major industrial countries. When the accord was originally published in 1988, the Basle Supervisors’ Committee indicated that work would continue on assuring consistent treatment of loan loss reserves and provisions eligible for inclusion in the risk-adjusted capital base. The attached amendment reflects results of these efforts. Since no change in existing U.S. risk-based capital guidelines will result from this amendment, the allowance for loan and lease losses of U.S. banks will continue to qualify for inclusion in Tier 2 capital under the 1.50 percent limitation until the end of 1992 and the 1.25 percent limitation beginning at yearend 1992. Enclosed — for member banks, bank holding companies, and branches and agencies o f foreign banks in this District — is a copy of the amendment by the Basle Committee. Copies of the enclosure will be furnished to others upon request directed to our Circulars Division (Tel. No. 212-720-5215 or 5216); additionally, single copies may be obtained at this Bank (33 Liberty Street) from the Issues Division on the first floor. Questions may be directed to Manuel J. Schnaidman, Staff Director, Bank Analysis Division (Tel. No. 212-720-6710). E. G e r a l d C o r r ig a n , President. B a s le Com m ittee on Banking S u p e r v is io n Amendment o f th e B a s le c a p i t a l a ccord in r e s p e c t o f th e i n c lu s i o n o f g e n e r a l p r o v i s i o n s / g e n e r a l l o a n - l o s s r e s e r v e s in c a p i t a l 1. Banking s u p e r v is o r s in th e Group o f Ten c o u n t r i e s , w ith th e a p p ro v a l o f t h e i r c e n tr a l-b a n k G overn ors, have a g reed t o im plem ent th e a tta c h e d ch an ges to th e B a s le c a p i t a l a cco rd o f J u ly 1988. The ch a n g es a f f e c t p aragrap h s 18-21 o f th e accord and two s e c t i o n s o f Annex 1, paragraph D. 2. The amended t e x t i s v i r t u a l l y th e same a s t h a t c o n ta in e d in th e p r o p o s a ls is s u e d on 2 1 s t F ebruary 1991. The o n ly change made h as been to r e p la c e th e word " fu tu re " w ith o th e r w ording in two p a r t s o f th e t e x t w h ich r e fe r r e d t o th e f a c t t h a t g e n e r a l p r o v is io n s a re c r e a t e d a g a in s t th e p o s s i b i l i t y o f f u tu r e l o s s e s . T h is i s b e c a u se th e a c c o u n tin g p r o f e s s i o n h as n o te d t h a t law and a c c o u n tin g p r a c t i c e in a number o f c o u n t r ie s p r o h i b i t s th e s e t t in g - u p o f p r o v is io n s f o r u n i d e n t if i e d l o s s e s t h a t r e l a t e t o unknown c o n d it io n s w hich c o u ld a r i s e in th e f u t u r e , r e q u ir in g t h i s t o be done by tr a n sfe r to a se p a r a te r e se r v e . 3. It is in te n d e d t h a t t h e s e amendments be f u l l y im plem ented by member c o u n t r ie s as soon as p o s s i b l e , and a t t h e l a t e s t by t h e end o f 19 93. U n t i l th a t d a te th e e x i s t i n g arrangem ents w i l l a p p ly , t h a t i s t o sa y th e l i m i t s in paragraph 21 o f th e 1988 paper w i l l a p p ly in t h e p e r io d betw een th e end o f 1990 and th e end o f 1993. A. In o rd er t o e n su r e t h a t th e p r o p o s a ls a r e h a v in g th e d e s ir e d e f f e c t o f a c h ie v in g f u r th e r c o n v erg en ce and im proving th e q u a l i t y o f c a p i t a l , th e Com m ittee w i l l k eep t h e s e arran gem en ts u n d er p e r i o d i c Such a r e v ie w w ould in c lu d e , a sp e c ts: [Enc. Cir. No. 10498] r e v ie w . i n t e r a l i a , an a s s e s s m e n t o f t h e f o llo w in g 2 (i) th a t d i s c l o s e d r e s e r v e s and e q u iv a le n t g e n e r a l funds (su c h as th e EC's Fund f o r g e n e r a l banking r i s k s ) a r e b e in g or are l i k e l y to be u sed in th e way a n t ic ip a t e d ; (ii) th a t th e l e v e l o f th e l i m i t on g e n e r a l p r o v i s i o n s / g e n e r a l l o a n - l o s s r e s e r v e s in t i e r 2 c a p i t a l i s a p p r o p r ia te ; (iii) t h a t d i f f e r i n g ta x arrangem ents a r e a d e q u a te ly c a te r e d f o r . 6th November 1991 3 B a s le Com m ittee on Banking S u p e r v is io n Amendments t o th e B a s le c a p i t a l a c c o r d A. R eplacem en t f o r p a ra g ra p h s 18-21 (iii) 18. G en era l p r o v i s i o n s / g e n e r a l l o a n - l o s s r e s e r v e s G en era l p r o v i s i o n s or g e n e r a l l o a n - l o s s r e s e r v e s a r e c r e a t e d a g a in s t t h e p o s s i b i l i t y o f l o s s e s n o t y e t i d e n t i f i e d . Where th e y do n o t r e f l e c t a known d e t e r i o r a t i o n in th e v a lu a t io n o f p a r t i c u l a r a s s e t s , t h e s e r e s e r v e s q u a l i f y f o r i n c l u s i o n in t i e r 2 c a p i t a l . Where, h ow ever, p r o v is io n s or r e s e r v e s h a v e been c r e a t e d a g a in s t i d e n t i f i e d l o s s e s o r in r e s p e c t o f an i d e n t i f i e d d e t e r i o r a t i o n in t h e v a lu e o f any a s s e t or group o r s u b s e t s o f a s s e t s , th e y a r e n o t f r e e l y a v a i l a b l e t o m eet u n i d e n t i f i e d l o s s e s w hich may s u b s e q u e n t ly a r i s e e ls e w h e r e in th e p o r t f o l i o and do n o t p o s s e s s an e s s e n t i a l c h a r a c t e r i s t i c o f c a p i t a l . Such p r o v i s i o n s o r r e s e r v e s sh o u ld t h e r e f o r e n o t be in c lu d e d in t h e c a p i t a l b a s e . 19. The s u p e r v is o r y a u t h o r i t i e s r e p r e s e n te d on t h e Com m ittee u n d erta k e t o e n s u r e t h a t t h e s u p e r v is o r y p r o c e s s t a k e s due a c c o u n t o f any i d e n t i f i e d d e t e r i o r a t i o n in v a lu e . They w i l l a l s o e n s u r e t h a t g e n e r a l p r o v is io n s o r g e n e r a l l o a n - l o s s r e s e r v e s w i l l o n ly be in c lu d e d in c a p i t a l i f th e y a r e n o t in te n d e d t o d e a l w ith t h e d e t e r i o r a t i o n o f p a r t i c u l a r a s s e t s , w h eth er in d i v id u a l o r grou p ed . 20. T h is w ould mean t h a t a l l e le m e n ts in g e n e r a l p r o v i s i o n s or g e n e r a l lo a n l o s s r e s e r v e s d e s ig n e d t o p r o t e c t a bank from i d e n t i f i e d d e t e r i o r a t i o n in th e q u a l i t y o f s p e c i f i c a s s e t s (w h e th e r f o r e i g n or d o m e s tic ) sh o u ld be i n e l i g i b l e f o r i n c l u s i o n in c a p i t a l # In p a r t i c u l a r , e le m e n ts t h a t r e f l e c t i d e n t i f i e d d e t e r i o r a t i o n in a s s e t s s u b j e c t t o c o u n tr y r is k , in r e a l e s t a t e le n d in g and in o t h e r problem s e c t o r s w ou ld be e x c lu d e d from c a p i t a l . 4 21. G en er a l p r o v i s i o n s / g e n e r a l l o a n - l o s s r e s e r v e s t h a t q u a l i f y f o r i n c lu s i o n in t i e r 2 under th e term s d e s c r ib e d above do so s u b j e c t t o a l i m i t o f 1 . 2 5 p e r c e n ta g e p o in t s o f w e ig h te d r i s k a s s e t s . B. Amendments t o Paragraph D o f Annex 1 Indent ( i ) ( f i r s t s e n te n c e ) T ie r 1: in c lu d e s o n ly perm anent s h a r e h o ld e r s ' e q u it y ( i s s u e d and f u l l y p a id o r d in a r y shares/com m on s to c k and p e r p e tu a l n o n -c u m u la tiv e p r e f e r e n c e s h a r e s ) and d i s c l o s e d r e s e r v e s ( c r e a t e d or in c r e a s e d by a p p r o p r ia tio n s o f r e t a in e d e a r n in g s or o th e r s u r p lu s , e . g . sh a r e prem ium s, r e t a i n e d p r o f i t , g e n e r a l r e s e r v e s and l e g a l r e s e r v e s ) . D is c lo s e d r e s e r v e s a l s o in c lu d e g e n e r a l fu n d s (s u c h as a Fund f o r g e n e r a l bank ing r i s k s in c e r t a i n EC c o u n t r ie s ) o f t h e same q u a l i t y t h a t m eet t h e f o llo w in g c r i t e r i a : a l l o c a t i o n s t o th e funds must be made o u t o f p o s t - t a x r e t a in e d e a r n in g s or o u t o f p r e - t a x e a r n in g s a d j u s te d f o r a l l p o t e n t i a l ta x l i a b i l i t i e s ; t h e fu n d s and movements in t o or o u t o f them m ust be d i s c l o s e d s e p a r a t e l y in th e bank’ s p u b lis h e d a c c o u n ts ; t h e fu n d s must be a v a i l a b l e t o a bank t o m eet l o s s e s f o r u n r e s t r i c t e d and im m ediate u se a s soon as t h e y o c c u r ; l o s s e s ca n n o t be ch arged d i r e c t l y t o th e fu n d s b u t must be ta k e n th r o u g h t h e p r o f i t and l o s s a c c o u n t. In d e n t ( i i ) ( c ) General provisions/general loan-loss reserves: p r o v i s i o n s o r l o a n - l o s s r e s e r v e s h e ld a g a i n s t p r e s e n t l y u n i d e n t i f i e d l o s s e s a r e f r e e l y a v a i l a b l e t o m eet l o s s e s w h ich s u b s e q u e n tly m a t e r i a l i s e and t h e r e f o r e q u a l i f y f o r i n c l u s i o n w it h in su p p lem en ta ry e le m e n ts . P r o v is io n s a s c r i b e d t o i d e n t i f i e d d e t e r i o r a t i o n o f p a r t ic u l a r a s s e t s or known l i a b i l i t i e s , w h eth er i n d i v id u a l or g ro u p ed , s h o u ld be e x c lu d e d . F u rth erm ore, g e n e r a l p r o v i s i o n s / g e n e r a l l o a n - l o s s r e s e r v e s e l i g i b l e f o r i n c lu s i o n in t i e r 2 w i l l b e l im it e d t o a maximum o f 1 . 2 5 p e r c e n ta g e p o in t s o f w e ig h te d r i s k a s s e t s . C. Amendment t o t h e t r a n s i t i o n a l arran gem en ts ( s e c t i o n IV and Annex A) The t r a n s i t i o n a l arran gem en ts w i l l rem ain a s s p e c i f i e d in th e a g r e em e n t, s u b j e c t t o th e e x t e n s io n o f t h e t r a n s i t i o n a l p e r io d u n t i l en d -1 9 9 3 f o r t h e im p le m e n ta tio n o f th e arra n g em en ts d e s c r ib e d ab o v e. # # //
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