Full text of Federal Reserve Bank of New York Circulars : 10751. Risk-Based Capital Guidelines

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FEDERAL RESERVE BANK
OF NEW YORK

[

Circular No. 10751 T
December 28, 1994

RISK-BASED CAPITAL GUIDELINES
— Netting Arrangements
— Net Unrealized Gains/Losses
on Securities Available for Sale
— Concentration of Credit Risk;
Risks of Nontraditional Activities

To A l l S t a t e M e m b e r B a n k s a n d B a n k H o l d i n g C o m p a n i e s
in th e S e c o n d F e d e r a l R e s e r v e D i s t r i c t , a n d O t h e r s C o n c e r n e d :

The Board of Governors of the Federal Reserve System has adopted amendments to its risk-based capital
guidelines, effective December 31, 1994, (a) to allow institutions to net the mark-to-market of interest and exchange
rate contracts subject to qualifying bilateral netting contracts, and (b) to direct institutions not to include in Tier 1
capital net unrealized gains and losses on securities available for sale. Also, effective January 17, 1995,
concentrations of credit risk and risks posed by nontraditional activities, as well as an institution’s ability to manage
these risks, will be explicitly identified as important factors in assessing capital adequacy. Printed below are the
texts of the Board’s announcements.
Netting arrangements

The Federal Reserve Board has issued amendments to its risk-based capital guidelines for state member banks and
bank holding companies to recognize the risk-reducing benefits of netting arrangements.
The amendments are effective December 31, 1994.
Under the amendments, institutions will be permitted to net, for risk-based capital purposes, the mark-to-market of
interest and exchange rate contracts subject to qualifying bilateral netting contracts.
The amendments will allow state member banks and bank holding companies to net positive and negative mark-tomarket values of rate contracts in determining the current exposure portion of the credit equivalent amount of such contracts
to be included in risk-weighted assets.
These amendments implement a recent revision to the Basle Accord that allow the recognition of such netting
arrangements.
Securities available for sale

The Federal Reserve Board has issued final amendments to its risk-based capital guidelines for state member banks
and bank holding companies.
The amendments are effective December 31, 1994.
Under this final rule, institutions are generally directed not to include in Tier 1 capital the component of common
stockholders equity (net unrealized holding gains and losses on securities available for sale).

(OVER)

This component was created by the Financial Accounting Standards Board (FASB) Statement No. 115, “Accounting
for Certain Investments in Debt Equity Securities.”
Net unrealized losses on marketable equity securities (equity securities with readily determinable fair values),
however, will continue to be deducted from Tier 1 capital. This rule has the general effect of valuing available-for-sale
securities at amortized cost (based on historical cost), rather than at fair value (generally at market value), for purposes
of calculating the risk-based and leverage capital ratios.
Concentration of risk; risks of nontraditional activities

The Federal Reserve Board has issued amendments to the Board’s risk-based capital guidelines for state member banks
regarding concentration of credit risk and risks of nontraditional activities.
The amendments are effective January 17, 1995.
The amendments implement Section 305 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA)
which directs each Federal banking agency to revise its risk-based capital standards to ensure that the standards take
adequate account of these risks.
As amended, the risk-based capital guidelines explicitly identify concentrations of credit risk and an institution’s
ability to manage them as important factors in assessing an institution’s overall capital adequacy.
The amendments also identify an institution’s ability to adequately manage the risks posed by nontraditional activities
as an important factor to consider in assessing an institution’s overall capital adequacy.
The Board initially approved these amendments on August 3, 1994. Publication of the joint final rule was delayed
to reach interagency agreement.
Enclosed — for state member banks, bank holding companies, and others who maintain sets of the Board’s
regulations — are the texts of the official notices of these changes, as published in the Federal Register, copies will
be furnished to others upon request directed to the Circulars Division of this Bank (Tel. No. 212-720-5215 or 5216).
In addition, copies can be obtained at this Bank (33 Liberty Street) from the Issues Division on the first floor.
Questions on these amendments may be directed to our Bank Analysis Department (Tel. No. 212-720-6710).

il l ia m

cD o n o u g h

President.

Thursday
December 8, 1994
Vol. 59, No. 235

Thursday
December 15, 1994
Vol. 59, No. 240

Pp. 62987-62995

Pp. 63241-63245

Pp. 64561-64564

• Netting Arrangements
Docket No. R-0837
Effective December 31, 1994
• Securities Available for Sale
Docket No. R-0823
Effective December 31, 1994
• Concentration of Credit Risk;
Risks of Nontraditional Activities
Docket No. R-0764
Effective January 17, 1994

Wednesday
December 7, 1994
Vol. 59, No. 234

RISK-BASED CAPITAL GUIDELINES
(Regs. H & Y)

[Enc. Cir. 10751]

tO ~ fS >
F e d e r a l R e g is t e r /

Vol.

59,

No.

234

Wednesday, December 7,

3544), 20th and C Streets, N.W.,
Washington, D.C. 20551.
SUPPLEMENTARY INFORMATION:
B ackground

FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-0837]

Capital; Capital Adequacy Guidelines
AGENCY: Board of Governors of the

Federal Reserve System.
ACTION: Final rule.
SUMMARY: The Board of Governors of the

Federal Reserve System (Board) is
amending its risk-based capital
guidelines'to recognize the riskreducing benefits o f qualifying bilateral
netting contracts. This final rule
implements a recent revision to the
Basle Accord permitting the recognition
of such netting arrangements. The effect
of the final rule is that state member
banks and bank holding companies
(banking organizations, institutions)
may net positive and negative mark-tomarket values of interest and exchange
rate contracts in determining the current
exposure portion of the credit
equivalent amount of such contracts to
be included in risk-weighted assets.

The Basle A ccord1established a riskbased capital framework which was
implemented for state member banks
and bank holding companies by the
Board in 1989. Under this framework,
off-balance-sheet interest rate and
exchange rate contracts (rate contracts)
are incorporated into risk weighted
assets by converting each contract into
a credit equivalent amount. This
amount is then assigned to the
appropriate credit risk category
according to the identity of the obligor
or counterparty or, if relevant, the
guarantor or the nature of the collateral.
The credit equivalent amount of an
interest or exchange rate contract can be
assigned to a maximum credit risk
category of 50 percent
The credit equivalent amount of a rate
contract is determined by adding
together the current replacement cost
(current exposure) and an estimate of
the possible increase in future
replacement cost in view of the
volatility of the current exposure over
the remaining life of the contract
(potential future exposure, also referred
to as the add-on).*2
For risk-based capital purposes, a rate
contract with a positive mark-to-market
value has a current exposure equal to
that market value. If the mark-to-market
value of a rate contract is zero or
negative, then there is no replacement
cost associated with the contract and the
current exposure is zero. The original
Basle Accord and the Board’s guidelines
provided that current exposure would
be determined individually for each rate
contract entered into by a banking
organization; institutions generally were
not permitted to offset, that is, net,
positive and negative market values of
multiple rate contracts with a single
counterparty to determine one current
credit exposure relative to that
counterparty.3

EFFECTIVE DATE: December 31,1994.
FOR FURTHER INFORMATION CONTACT:

Roger Cole, Deputy Associate Director
(202/452-2618), Norah Barger, Manager
(202/452-2402), Robert Motyka,
Supervisory Financial Analyst (202)/
452-3621), Barbara Bouchard,
Supervisory Financial Analyst (202/
452-3072), Division of Banking
Supervision and Regulation: or
Stephanie Martin, Senior Attorney (202/
452-3198), Legal Division. For the
hearing impaired only,
Telecommunications Device for the
Deaf, Dorothea Thompson (202/452-

1The Dasle Accord is a risk-based framework that
was proposed by the Basie Committee on Banking
Supervision (Basle Supervisors’ Committee) and
endorsed by the central bank governors of the
Group of Ten (0—10) countries in July 1988. The
Basle Supervisors’ Committee is comprised of
representatives of the central banks and supervisory
authorities from the G-10 countries (Belgium.
Canada. France. Germany, Italy, Japan. Netherlands.
Sweden. Switzerland, the United Kingdom, and the
United States) and Luxembourg.
JThis method of determining credit equivalent
amounts for rate contracts is identified in the Basle
Accord as the current exposure method, which is
used by most international banks.
3It was noted in the Accord that the legal
enforceability of certain netting arrangements was

1994

Rules and

R e g u la tio n s

62987

In April 1993 the Basle Supervisors’
Committee proposed a revision to the
Basle Accord, endorsed by the G-10
Governors in July 1994, that permits
institutions to net positive and negative
market values of rate contracts subject to
a qualifying, legally enforceable,
bilateral netting arrangement. Under the
revision, institutions with a qualifying
netting arrangement may calculate a
single net current exposure for purposes
of determining the credit equivalent
amount for the included contracts.45If
the net market value of the contracts
included in such a netting arrangement
is positive, then that market value
equals the current exposure for the
netting contract. If the net market value
is zero or negative, then the current
exposure is zero.
T h e B o a r d ’s P r o p o s a l

On May 20,1994, the Board and the
Office of the Comptroller of the
Currency (OCC) issued a joii^proposal
to amend their respective risk-based
capital standards (59 FR 26456) in
accordance with the Basle Supervisors’
Committee’s April 1993 proposal.3 The
joint proposal provided that for capital
purposes institutions regulated by the
Board and the OCC could net the
positive and negative market values of
interest and exchange rate contracts
subject to a qualifying, legally
enforceable, bilateral netting contract to
calculate one current exposure for that
netting contract (sometimes referred to
as the master netting contract).

The proposal provided that the net
current exposure would be determined
by adding together all positive and
negative market values of individual
contracts subject to the netting contract.
The net current exposure would equal
the sum of the market values if that sum
is a positive value, or zero if the sum of
unclear in soma Jurisdictions. The legal status of
netting by novation, however, was determined to be
settled and this limited type of netting was
recognized. Netting by novation is accomplished
under a written bilateral contract providing that any
obligation to deliver a given currency on a given
date is automatically amalgamated with all other
obligations for the same currency and value date.
The previously existing contracts are extinguished
and a new contract for the single net amount, in
effect, legally replaces the amalgamated gross
obligations.
4The revision to the Accord notes that national
supervisors must be satisfied about the legal
enforceability of a netting arrangement under the
laws of each jurisdiction relevant to the
arrangement. The Accord also states that, if any
supervisor is dissatisfied about enforceability under
its own laws, the netting arrangement does not
satisfy thi$ condition and neither counterparty may
obtain supervisory benefit.
5The Office of Thrift Supervision (OTS) issued a
similar netting proposal on June 14.1994 and the
Federal Deposit Insurance Corporation (FDIC)
issued its netting proposal on July 25. 1994.

62988 Federal Register / Vol. 59, No. 234 / Wednesday, December 7, 1994 / Rules and Regulations
the market values is zero or a negative
value. The proposals did not alter the
calculation method for potential future
exposure.6
Under the proposal, institutions
would be able to net for risk-based
capital purposes only with a written
bilateral netting contract that creates a
single legal obligation covering all
included individual rate contracts and
does not contain a walkaway clause.7
The proposal required an institution to
obtain a written and reasoned legal
opinion(s) stating that under the master
netting contract the institution would
have a claim to receive, or an obligation
to pay, only the net amount of the sum
of the positive and negative market
values of included individual contracts
if a counterparty failed to perform due
to default, insolvency, bankruptcy,
liquidation, or similar circumstances.
The proposal indicated that the legal
opinion must normally cover: (i) The
law of the jurisdiction in which the
counterparty is chartered, or the
equivalent location in the case of
noncorporate entities, and if a branch of
the counterparty is involved, the law of
the jurisdiction in which the branch is
located; (ii) the law that governs the
individual contracts covered by the
netting contract; and (iii) the law that
governs the netting contract.
The proposal provided that an
institution must maintain in its files
documentation adequate to support the
bilateral netting contract.
Documentation would typically include
a copy of the bilateral netting contract,
legal opinions and any related
translations. In addition, the proposal
required an institution to establish and
maintain procedures to ensure that the
legal characteristics of netting contracts
would be kept under, review.
Under the proposal, the Federal
Reserve could disqualify any or all
contracts from netting treatment for riskbased capital purposes if the
requirements of the proposal were not
satisfied. In the event of
disqualification, the affected contracts
would be treated as though they were
8 Potential future exposure is estimated by
multiplying the effective notional amount of a
contract by a credit conversion factor which is
based on the type of contract and the remaining
maturity of the contract. Under the Board/OCC
proposal, a potential future exposure amount would
be calculated for each individual contract subject to
the netting contract. The individual potential future
exposures would then be added together to arrive
at one total add-on amount.
7A walkaway clause is a provision in a netting
contract that permits a non-defaulting counterparty
to make lower payments than it would make
otherwise under the contract, or no payment at all,
to a defaulter or to the estate of a defaulter, even
if the defaulter or the estate of the defaulter is a net
creditor under the contract.

not subject to the master netting
contract. The proposal indicated that
outstanding netting by novation
arrangements would not be
grandfathered, that is, such
arrangements would have to meet all of
the proposed requirements for
qualifying bilateral netting contracts.
The proposal requested general
comments as well as specific comments
on the nature of collateral arrangements
and the extent to which collateral might
be recognized in conjunction with
bilateral netting contracts.
Comments Received
The Board received nineteen public
comments on the proposed amendment.
Eleven comments were from banking
organizations and five were from
industry trade associations and
organizations. In addition, there were
three comments from law firms. A ll
commenters supported the expanded
recognition of bilateral netting contracts
for risk-based capital purposes. Several
commenters encouraged recognition of
such contracts as quickly as possible.
Many of the commenters concurred
with one of the principal underlying
tenets of the proposal, that is, that
legally enforceable bilateral netting
contracts can provide an efficient and
desirable means for institutions to
reduce or control credit exposure. A few
commenters noted that, in their view,
the recognition of bilateral netting
contracts would create an incentive for
market participants to use such
arrangements and would encourage
lawmakers to clarify the legal status of
netting arrangements in their
jurisdictions. One commenter noted that
the expanded recognition of bilateral
netting contracts would help keep U.S.
banking organizations competitive in
global derivatives markets.
While generally expressing their
endorsement for the expanded
recognition of bilateral netting contracts,
nearly all commenters offered
suggestions or requested clarification
regarding details of the proposals. In
particular, the commenters raised issues
concerning specifics of the required
legal opinions, the treatment of
collateral, and the grandfathering of
walkaway clauses and novation
agreements.
Legal Opinions
A’lmost all commenters addressed the
proposed requirement that institutions
obtain legal opinions concluding that
their bilateral netting contracts would
be enforceable in all relevant
jurisdictions. Commenters did not
object to the general requirement that
they secure legal opinions, rather they

raised a number of questions about the
form and substance of an acceptable
opinion.
F o r m . Several commenters requested
clarification as to the specific form of
the legal opinion. Commenters wanted
to know if a memorandum of law would
satisfy the requirement or if a legal
o p i n i o n would be required. They
questioned whether a memorandum or
opinion could be addressed to, or
obtained by, an industry group, and
whether a generic opinion or
memorandum relating to a standardized
netting contract would satisfy the legal
opinion requirement.
Several commenters suggested that an
opinion seemed on behalf of the
banking industry by an organization
should be sufficient so long as the
individual institution’s counsel concurs
with the opinion and concludes that the
opinion applies directly to the
institution’s specific netting contract
and to the individual contracts subject
to it. A few commenters requested
confirmation that legal opinions would
not have to follow a predetermined
format.
S c o p e . Several commenters identified
two possible interpretations of the
proposed language with regard to the
scope of the legal opinions. They asked
for clarification as to whether the
opinions would be required to discuss
only whether all relevant jurisdictions
would recognize the contractual choice
of law, or whether they must also
discuss the enforceability of netting in
bankruptcy or other instances of default.
One commenter suggested deleting the
requirement for a choice of law analysis.
A number of commenters objected, to
the proposed requirement that the legal
opinion for a multibranch netting
contract (that is, a netting contract
between multinational banks that
includes contracts with branches of the
parties located in various jurisdictions)
address the enforceability of netting
under the law of the jurisdiction where
each branch is located. These
commenters stated that it should be
sufficient for the legal opinion to
conclude that netting would be enforced
in the jurisdiction of the counterparty’s
home office if the master netting
contract provides that all transactions
are considered obligations of the home
office and the branch jurisdictions
recognize that provision.
S e v e r a b i l i t y . Several commenters
expressed concern about the proposed
treatment for netting contracts that
include contracts with branches in
jurisdictions where the enforceability of
netting is unclear. In such
circumstances, commenters asserted,
unenforceability or uncertainty in one

lO ~ lt >

Federal Register / Vol. 59, No. 234 / Wednesday, December 7, 1994 / Rules and Regulations 62989
jurisdiction should not invalidate the
entire netting contract for risk-based
capital netting treatment. These
commenters contended that contracts
with branches of a counterparty in
jurisdictions that recognize netting
arrangements should be netted and
contracts with branches in jurisdictions
where the enforceability of netting is not
supported by legal opinions should, for
risk-based capital purposes, be severed,
or removed from the master netting
contract and treated as though they were
not subject to that contract. These
commenters noted that this treatment
should only be available to the extent it
is supported by legal opinion.
C o n c l u s i o n s . The proposal required a
legal opinion to conclude that “relevant
court and administrative authorities
would find” the netting to be effective.
Many commenters that discussed this
aspect of the proposal expressed
concern that this standard was too high.
They suggested, instead, that the
opinions be required to conclude that
netting “should” be effective.
A few commenters requested
clarification regarding the proposed
requirement that the netting contract
must create a single legal obligation.
Collateral
Twelve commenters addressed the
proposal’s specific request for comment
on the nature of collateral and the extent
to which collateral might be recognized
in conjunction with bilateral netting
contracts. A ll of these commenters
believed collateral should be recognized
as a means of reducing credit exposure.
A few commenters noted that collateral
arrangements are increasingly being
used with derivative transactions.
Several commenters stated that for
netting contracts that call for the use of
collateral, the amount of required
collateral is determined from the net
mark-to-market value of the master
netting contract. A few commenters
added that mark-to-market collateral
often is used in conjunction with a
collateral “add-on” based on such
things as the notional amount of the
underlying contracts, the maturities of
the contracts, the credit quality of the
counterparty, and volatility levels.
A number of commenters offered their
opinions as to how collateral should be
recognized for risk-based capital
purposes. Some suggested that the
existing method of recognizing
collateral for purposes of assigning
credit equivalent amounts to risk
categories is applicable to derivative
transactions as well. Other commenters
expressed the view that collateral
should be recognized when assigning
risk weights to the extent it is legally

available to cover the total credit
exposure for the bilateral netting
contract in the event of default and that
this availability should be addressed in
the legal opinions.
Several other commenters suggested
separating the net current exposure and
potential future exposure of bilateral
netting contracts for determining
collateral coverage and appropriate risk
weights. One commenter favored
recognizing collateral for capital
purposes by allowing an institution to
offset net current exposure by the
amount of the collateral to further
reduce the credit equivalent amount.
Tw o commenters requested
clarification that contracts subject to
qualifying netting contracts could be
eligible for a zero percent risk weight if
the transaction is properly collateralized
in accordance with the Board’s
collateralized transactions rule.8
W alkaw ay Clauses
Several commenters addressed the
proposed prohibition against walkaway
clauses in contracts qualifying for
netting for risk-based capital purposes.
While most of these commenters agreed
that, ultimately, walkaway clauses
should be eliminated from master
netting contracts, they favored a phase
out period, during which outstanding
bilateral netting contracts containing
walkaway clauses could qualify for
capital netting treatment. Several
commenters contended that if a
defaulter is a net debtor under the
contract, the existence of a walkaway
clause would not affect the amount
owed to the non-defaulting creditor.
Novation
A few commenters expressed concern
that the proposal did not grandfather
outstanding novation agreements. These
commenters suggested a phase-in period
during which novation agreements
would not be required to be supported
by legal opinions.
Other Issues
One commenter requested greater
detail on the nature and extent of
examination review procedures. Two
commenters stated that in some
situations obtaining translations might*
*In December 1992 the Board issued an
amendment to its risk-based capital guidelines
permitting certain collateralized transactions to
qualify fora zero percent risk weight (57 FR 62180.
December 30,1992). In order to qualify for a zero
percent risk weight, an institution must maintain a
positive margin of qualifying collateral at all times.
Thus, the collateral arrangement should provide for
immediate liquidation of the claim in the event that
a positive margin of collateral is not maintained.
The OCC has issued a similar proposal (58 FR
43822. August J8. 19931.

be burdensome. Another commenter
suggested assurance that the Federal
Reserve would not disqualify netting
contracts in an unreasonable manner.
Approximately one-half of the
commenters expressed concern that the
proposal specifically was limited to
interest rate and exchange rate
contracts. A ll of these opposed limiting
the range of products that could be
included under qualifying netting
contracts. In this regard, one commenter
noted that where there is sufficient legal
support confirming the enforceability of
cross-product netting, such netting
should be recognized for capital
purposes.
A number of commenters used the
proposal as an opportunity to discuss
the manner in which the add-on for
potential future exposure is calculated.
They suggested netting contracts should
be recognized not only as a way to
reduce the current exposure to a
counterparty, but also the effects of such
netting contracts should be taken into
account to reduce the amount of capital
organizations must hold against the
potential future exposure to the
counterparty.
Final Rule
After considering the public
comments received and further
deliberating the issues involved, the
Board is adopting a final rule
recognizing, for capital purposes,
qualifying bilateral netting contracts.
This final rule is substantially the same
as proposed.
Legal Opinions
F o r m . The final rule requires that
institutions obtain a written and
reasoned legal opinion(s) concluding
that the netting contract is enforceable
in all relevant jurisdictions. This
requirement is aimed at ensuring there
is a substantial legal basis supporting
the legal enforceability of a netting
contract before reducing a banking
organization’s capital requirement based
on that netting contract. A legal opinion,
as generally recognized by the legal
community in the United States, can
provide such a legal basis. A
memorandum of law may be an
acceptable alternative as long as it
addresses all of the relevant issues in a
credible manner.
As discussed in the proposal, the legal
opinions may be prepared by either an
outside law firm or an institution’s inhouse counsel. The salient requirements
for an acceptable legal opinion are that
it: (i) Addresses all relevant
jurisdictions; and (ii) concludes with a
high degree of certainty that in the event
of a legal challenge the banking

62990 Federal Register / Vol. 59, No. 234 / Wednesday, December 7, 1994 / Rules and Regulations
organization’s claim or obligation would
be determined by the relevant court or
administrative authority to be the net
sum of the positive and negative markto-market values of all individual
contracts subject to the bilateral netting
contract. The subject matter and
complexity of required legal opinions
w ill vary.
To some extent, institutions may use
general, standardized opinions to help
support the legal enforceability of their
bilateral netting contracts. For example,
a banking organization may have
obtained a memorandum of law
addressing the enforceability of netting
provisions in a particular foreign
jurisdiction. This opinion may be used
as the basis for recognizing netting
generally in that jurisdiction. However,
with regard to an individual master
netting contract, the general opinion
would need to be supplemented by an
opinion that addresses issues such as
the enforceability of the underlying
contracts, Choice of law, and
severability.
For example, the Board does not
believe that a generic opinion prepared
for a trade association with respect to
the effectiveness of netting under the
standard form agreement issued by the
trade association, by itself, is adequate
to support a netting contract. Banking
organizations using such general
opinions would need to supplement
them with a review of the terms of the
specific netting contract that the
institution is executing.
S c o p e . With regard to the scope of the
legal opinions, that is, what areas of
analysis must be covered, the Board is
of the opinion that legal opinions must
address the validity and enforceability
of the entire netting contract. The
opinion must conclude that under the
applicable state or other jurisdictional
law the netting contract is a legal, valid,
and binding contract, enforceable in
accordance with its terms, even in the
event of insolvency, bankruptcy, or
similar proceedings. Opinions provided
on the law of jurisdictions outside of the
U.S. should include a discussion and
conclusion that netting provisions do
not violate the public policy or the law
of that jurisdiction.
The Board has further determined that
one of the most critical aspects of a
qualifying netting contract is the
contract's enforceability in any
jurisdiction whose law would likely be
applied in an enforcement action, as
well as the jurisdiction where the
counterparty’s assets reside. In this
regard, and in light of the policy in
some countries to liquidate branches of
foreign banking organizations
independent of the head office, the

Board is retaining its proposed
requirement that legal opinions address
the netting contract’s enforceability
under: (i) The law of the jurisdiction in
which the counterparty is chartered, or
the equivalent location in the case of
noncorporate entities, and if a branch of
the counterparty is involved, the law of
the jurisdiction in which the branch is
located; (ii) the law that governs the
individual contracts subject to the
bilateral netting contract; and (iii) the
law that governs the netting contract.
S e v e r a b i l i t y . The Board recognizes
that for some multibranch netting
contracts an organization may not be
able to obtain a legal opinion(s)
concluding that netting would be
enforceable in every jurisdiction where
branches covered under the master
netting contract are located. The Board
concurs with commenters that in such
situations it may be inefficient to
require institutions to renegotiate
netting contracts to ensure they cover
only those jurisdictions where netting is
clearly enforceable. The Board has
determined that, in certain
circumstances for capital purposes,
banking institutions may use master
bilateral netting contracts that include
contracts with branches across all
jurisdictions. Banking institutions
should calculate their net current
exposure for the contracts in those
jurisdictions where netting clearly is
enforceable as supported by legal
opinion(s). The remaining contracts
subject to the netting contract should be
severed from the netting contract and
treated as though they were not subject
to the netting contract for capital and
credit purposes. This approach of
essentially dividing contracts subject to
the netting contact into two categories—
those that clearly may be netted and
those that may not— is acceptable
provided that the banking organization’s
legal opinions conclude that the
contracts that do not qualify for netting
treatment are legally severable from the
master netting contract and that such
severance will not undermine the
enforceability of the netting contract for
the remaining qualifying contracts.
C o n c l u s i o n s . The Board has retained
the proposed language that legal
opinions must represent that netting
would be enforceable in all relevant
jurisdictions. In response to
commenters’ assertions that the
standard for this type of legal opinion is
too high, the Board notes that use of the
word “w ould” in the capital rules does
not necessarily mean that the legal
opinions must also use the word
“would” or that enforceability must be
determined to be an absolute certainty.
The intent, rather, is for banking

organizations to secure a legal opinion
concluding that there is a high degree of
certainty that the netting contract will
survive a legal challenge in any
applicable jurisdiction. The degree of
certainty should be apparent from the
reasoning set out in the opinion.
The Board notes that the requirement
for legal opinions to conclude that
netting contracts must create a single
legal obligation applies only to those
individual contracts that are covered by,
and included under, the netting contract
for capital purposes. As discussed
above, a netting contract may include
individual contracts that do not qualify
for netting treatment, provided that
these individual contracts are legally
severable from the contracts to be netted
for capital purposes.
Institutions generally must include all
contracts covered by a qualifying netting
contract in calculating the current
exposure of that netting contract. In the
event a netting contract covers
transactions that are normally excluded
from the risk-based ratio calculation—
for example, exchange rate contracts
with an original maturity of fourteen
calendar days or less or instruments
traded on exchanges that require daily
payment o f variation margin— an
institution may choose to either include
or exclude all mark-to-market values of
such contracts when determining net
current exposure, but this choice must
be followed consistently.
Collateral
The final rule permits, subject to
certain conditions, institutions to take
into account qualifying collateral when
assigning the credit equivalent amount
of a netting contract to the appropriate
risk weight category in accordance with
the procedures and requirements
currently set forth in the Board’s riskbased capital guidelines. The Board has
added language to the final rule
clarifying that collateral must be legally
available to cover the credit exposure of
the netting contract in the event of
default. For example, the collateral may
not be pledged solely against one
individual contract subject to the master
netting contract. The legal availability of
the collateral must be addressed in the
legal opinions.
W alkaw ay Clauses
The Board has considered the
suggestion made by some commenters
of a phase-out period for outstanding
contracts with walkaway clauses. The
Board continues to believe that
walkaway clauses do not reduce credit
risk. Accordingly, the final rule retains
the provision that bilateral netting
contracts with walkaway clauses are no*

lO~7ib

Federal Register / Vol. 59, No. 234 / Wednesday, December 7, 1994 / Rules and Regulations 62991
encompass commodity, precious metal,
and equity derivative contracts, the
Board, rather than automatically
disqualifying from capital netting
N o v a t io n
treatment an entire netting contract that
The proposal required all netting
includes non-rate-related transactions,
contracts, including netting by novation will permit institutions to apply the
agreements, to be supported by written
following treatment. In determining the
legal opinions. The Board does not agree current exposure of otherwise qualifying
with commenters that a grandfathering
netting contracts that include non-rateperiod for outstanding novation
related contracts, institutions w ill be
agreements is needed. Rather, the Board permitted to net the positive and
continues to believe that all netting
negative mark-to-market values of the
contracts must be held to the same
included interest and exchange rate
standards in order to promote certainty
contracts, while severing the non-rateas to the legal enforceability of the
related contracts and treating them for
contracts and to decrease the risks faced risk-based capital purposes as
by counterparties in the event of default. individual contracts that are not subject
Under the final rule, a netting by
to the master netting contract. (This
novation agreement must meet die
treatment is similar to the treatment
requirements for a qualifying bilateral
applied to a netting contract that
netting contract.
includes contracts in jurisdictions
where the enforceability of netting is not
O th er Is su e s
supported by legal opinion. With non
The Board has considered all of the
rate-related
contracts, however, legal
other issues raised by commenters. With
opinions on severability are not
regard to documentation, the Board
required.)
reiterates that, as with all provisions of
The Board notes that the regulatory
risk-based capital, a banking
language with regard to the calculation
organization must maintain in its files
of potential future exposure remains
appropriate documentation to support
essentially the same as that proposed.
any particular capital treatment
The Board has clarified an underlying
including netting of rate contracts.
premise of the current exposure method
Appropriate documentation typically
for calculating credit exposure as set
would include a copy of the bilateral
forth in the Basle Accord, that is, the
netting contract, supporting legal
add-on for potential future exposure
opinions, and any related translations.
must be calculated based on the
The documentation should be available
effective, rather than the apparent,
to examiners for their review.
notional
principal amount and the
The Board recognizes commenters’
notional amount an institution uses will
concerns that the proposed rule was
be subject to examiner review.9
limited specifically to interest and
exchange rate contracts. The Board
Regulatory Flexibility Act Analysis
notes that both the Basle Accord and the
Pursuant to section 605(b) of the
Board’s risk-based capital guidelines
Regulatory Flexibility Act, the Board
currently do not address derivatives
hereby certifies that this final rule will
contracts other than rate contracts. This
not have a significant impact on a
final rule does not attempt to go beyond
substantial number of small business
the scope of the existing risk-based
entities. Accordingly, a regulatory
capital framework and applies only to
flexibility analysis is not required.
netting contracts encompassing interest
rate and foreign exchange rate contracts. Paperwork Reduction Act and
The Board, however, notes that the
Regulatory Burden
Basle Supervisors’ Committee issued a
The Board has determined that this
proposal for public comment in July
final rule w ill not increase the
1994 to amend the Basle Accord that
regulatory paperwork burden of banking
explicitly would set forth the risk-based
organizations pursuant to the provisions
capital treatment for other types of
of the Paperwork Reduction Act (44
derivative transactions, such as
U.S.C. 3501 e t s e q .) .
commodity, precious metal, and equity
Section 302 of the Riegle Community
contracts. In this regard, the Board
Development and Regulatory
issued a similar proposal, based on the
Basle Supervisors’ Committee proposal,
9 The notional amount is, generally, a stated
to amend its risk-based capital
reference amount of money used to calculate
payment streams between the counterparties. In the
guidelines (59 FR 43508, August 24,
event that the effect of the notional amount is
1994).
leveraged or enhanced by the structure of the
Until the Basle Accord has been
transaction, institutions must use the actual, or
revised and the Board’s risk-based
effective, notional amount when determining
potential future exposure.
capital rules have been amended to
eligible for netting treatment for riskbased capital purposes and does not
provide for a phase-out period.

Improvement Act of 1994 (Pub. L. 103325,108 Stat. 2160) provides that the
federal banking agencies must consider
the administrative burdens and benefits
of any new regulation that imposes
additional requirements on insured
depository institutions. Section 302 also
requires such a rule to take effect on the
first day of the calendar quarter
following final publication of the rule,
unless the agency, for good cause,
determines an earlier effective date is
appropriate.
The new capital rule imposes certain
requirements on depository institutions
that wish to net the current exposures
of their rate contracts for purposes of
calculating their risk-based capital
requirements. For these institutions, any
burden of complying with the
requirements of netting under a legally
enforceable netting contract and
obtaining the necessary legal opinions
should be outweighed by the benefits
associated with a lower capital
requirement. The new rule w ill not
affect institutions that do not wish to
net for capital purposes. For these
reasons, the Board has determined that
an effective date of December 31,1994
is appropriate, in order to allow banking
organizations to take advantage of
netting in their year-end statements, if
they so desire. For these same reasons,
in accordance with 5 U.S.C. 553(d)(3)
the Board finds there is good cause not
to follow the 30-day notice requirements
of 5 U.S.C. 553(d) and to make the rule
effective on December 31,1994.
List of Subjects
12 CFR P a rt 2 0 8

Accounting, Agriculture, Banks,
banking, Branches, Capital adequacy,
Confidential business information,
Crime, Currency, Federal Reserve
System, Mortgages, Reporting and
recordkeeping requirements, Securities,
State member banks.
12 CFR P a rt 2 2 5

Administrative practice and
procedure, Banks, banking, Capital
adequacy, Federal Reserve System,
Holding companies, Reporting and
recordkeeping requirements, Securities.
Authority and Issuance
For the reasons set out in the
preamble, parts 208 and 225 of chapter
II of title 12 of the Code of Federal
Regulations are amended as set forth
below.

62992 Federal Register / Voi. 59, No. 234 / Wednesday, December 7, 1994 / Rules and Regulations
PART 208—MEMBERSHIP OF STATE
BANKING INSTITUTIONS IN THE
FEDERAL RESERVE SYSTEM
(REGULATION H)
1. The authority citation for part 208
is revised to read as follows:

Authority: 1Z U.S.C. 36, 248(aJ and 248(c),
321—338a, 37ld, 461, 481-486, 601, 611,
1814,1823(j), 1828(o), 1831o, 1831p-l, 3105,
3310, 3331-3351 and 3906-3909; 15 U.S.C.
78b, 781(b), 781(g), 78l(i), 78o-4{c)(5), 78q,
78q-l and 78w; 31 U.S.C. 5318.
2. Appendix A to part 208 is amended
by revising:
a. Section IILE.2.;
b. Section III.E.3;
c. Section 111X5.;
d. The last heading and two
subsequent paragraphs of Attachment
IV; and
e. Attachment V.
The revisions read as follows:
A p p e n d ix A t o P a r t 2 0 8 — C a p it a l
A d e q u a c y G u i d e li n e s f o r S t a t e M e m b e r
B a n k s : R is k - B a s e d M e a s u r e
*
*
*
*
*

III. * * *
E. * * *
12. Calculation o f credit equivalent
amounts, a. The credit equivalent amount of
an off-balance-sheet rate contract that is not
subject to a qualifying bilateral netting
contract in accordance with section IILE.5. of
this appendix A is equal to the sum of (r) the
current exposure (sometimes referred to as
the replacement co6t) of the contract; and (ii)
an estimate of the potential future credit
exposure over the remaining life of the
contract.
b. The current exposure is determined by
the mark-to-market value of the contract. If
the mark-to-market value is positive, then the
current exposure is that mark-to-market
value. If the mark-to-market value is zero or
negative, then the current exposure is zero.
Mark-to-market values are measured in
dollars, regardless of the currency or
currencies specified in the contract, and
should reflect changes in the relevant rates,
as well as counterparty credit quality.
c. The potential future credit exposure of
a contract, including a contract with a
negative mark-to-market value, is estimated
by multiplying the notional principal amount
of the contract by a credit conversion factor.
Banks should, subject to examiner review,
use the effective rather than the apparent or
stated notional amount in this calculation.
The conversion factors are:

Remaining maturity

One year or le s s ............
Over one y e a r .................

Interest
rate con
tracts
(percent)

Exchange
rate
con
tracts
(percent)

1.0

0.5

5.0

d. Examples of the calculation of credit
3. The law that governs the-netting
equivalent amounts for these instruments are contract.
iii. The bank establishes and maintains
contained in Attachment V of this appendix
procedures to ensure that the legal
A.
e. Because exchange rate contracts involve
characteristics of netting contracts are kept
an exchange of principal upon maturity, and
under review in the light of possible changes
exchange rates are generally more volatile
in relevant law.
than interest rates, higher conversion factors
iv. The bank maintains in- its files
have been established for foreign exchange
documentation adequate to support the
rate contracts than for interest rate contracts.
netting of rate contracts, including a copy off. No potential future credit exposure is
the bilateral netting contract and necessary
calculated for single currency interest rate
legal opinions.
swaps in which payments are made based
b. A contract containing a walkaway clause
upon two floating rate indices, so-called
is not eligible for netting for purposes of
floating/fioating or basis swaps; the credit
calculating the credit equivalent amount.30
exposure on these contracts is evaluated
c. By netting individual contracts for the
solely on the basis of their mark-to-market
purpose, o f calculating its credit equivalent
values.
amount, a bank represents that it has met the
3.
Bisk weights. Once the credit equivalent
requirements of this appendix A and all the
amount for an interest rate or exchange rate
appropriate documents are in the bank’s files
contract has been determined, that amount is and available for inspection by die Federal
assigned to the risk weight category
Reserve. The Federal Reserve may determine
appropriate to the counterparty, or, if
that a bank’s files are inadequate or that a
relevant, to the guarantor or the nature of any netting contract, or any of its underlying
collateral.49 However, the maximum weight
individual contracts, may not be legally
^that will be applied to the credit equivalent
enforceable under any one of the bodies of
*amount of such instruments is 50 percent
law described in paragraph 5.a.ii.t. through
*
*
*
*
*
5.a.ii.3. of section m of this appendix A. If
5.
Netting, a. For purposes of this appendixsuch a determination is made, the netting
contract may be disqualified from recognition
A, netting refers to die offsetting of positive
for risk-based capital purposes or underlying
and negative mark-to-market values in the
individual contracts may be treated as though
determination of a current exposure to be
they are not subject to the netting contract
used in the calculation of a ciW it equivalent
d. The credit equivalent amount of rate
amount Any legally enforceable form o f
bilateral netting (thatis, netting w ith a single contracts that are subject to a qualifying
bilateral netting contract is calculated by
counterparty) of rate contracts is recognized
adding (i) the current exposure of the netting
for purposes of calculating the credit
contract, and (ii) the sum of the estimates of
equivalent amount provided that
the potential future credit exposures an all
i. The netting is accomplished under a
individual contracts subject to the netting
written netting contract that creates a single
contract, estimated in accordance with
legal obligation, covering all included
section m.E.2. o f this appendix A.5051
individual contracts, with the effect that the
e. The current exposure o f the netting
bank would have a claim to receive, or
contract is determined bjr summing all
obligation to pay, only the net amount of the
positive and negative mark-to-market values
sum of the positive and negative mark-toof the individual contracts included in the
market values on included individual
netting contract If the net sum of the markcontracts in the event that a counterparty, or
a counterparty to whom the contract has been to-market values is positive, then the current
exposure of the netting contract is equal to
validly assigned, fails to perform due to any
that sum. If the net sum of the mark-toof the following events: Default, insolvency,
market values is zero or negative, then the
liquidation, or similar circumstances.
ii. The bank obtains a written and reasoned current exposure of the netting contract is
legal opinion(s) representing that in the event zero. The Federal Reserve may determine
that a netting contract qualifies for risk-based
of a legal challenge—including one resulting
capital netting treatment even though certain
from default, insolvency, liquidation, or
individual contracts may not qualify. In such,
similar circumstances—the relevant court
and administrative authorities would find the instances, the nonqualifying contracts should
be treated as individual contracts that are not
bank’s exposure to be such a net amount
subject to the netting contract.
under:
f. In the event a netting contract covers
1. The law of the jurisdiction in which the
contracts that are normally excluded from the
counterparty is chartered or the equivalent
location in die case of noncorporate entities,
50A walkaway clause is a provision in a netting
and if a branch of the counterparty is
contract that permits a non-defaulting counterparty
involved, then also under the law of the
to make lower payments than it would make
jurisdiction in which the branch is located;
otherwise under the contract, or no payment at all,
2. The law that governs the individual
to a defaulter or to the estate of a defaulter, even
contracts covered by the netting contract; and if the defaulter or the estate of the defaulter is a net
49For interest and exchange rate contracts,
sufficiency of collateral or guarantees is determined
by the market value of the collateral or the amount
of the guarantee in relation to the credit equivalent
amount. Collateral and guarantees are subject to the
same provisions noted under section QI.B. of this
appendix A. Collateral held against a netting
contract is not recognized for capital purposes
unless it is legally available to support the single
legal obligation created by the.netting contract.

creditor under the contract.
51 For purposes of calculating potential future
credit exposure to a netting counterparty for foreign
exchange contracts and other similar contracts in
which notional principal is equivalent to cash
flows, total notional principal is defined as the net
receipts falling due on each value date in each
currency. The reason for this is that offsetting
contracts in the same currency maturing on the
same date will have lower potential future exposure
as well as lower current exposure.

I
Federal Register / Vol. 59, No. 234 / Wednesday, December 7, 1994 / Rules and Regulations 62993
risk-based ratio calculation—for example,
exchange rate contracts with an original
maturity of fourteen calendar days or less, or
instruments traded on exchanges that require
daily payment of variation margin—an
institution may elect to consistently either
include or exclude all mark-to-market values
of such contracts when determining net
current exposure.
g.
An example of the calculation of the
credit equivalent amount for rate contracts
subject to a qualifying netting contract is
contained in Attachment V of this appendix
A.

Attachment IV—Credit Conversion Factors
for Off-Balance-Sheet Items for State
Member Banks
* * * * *

Credit Conversion for Interest Rate and
Exchange Rate Contracts
1. The credit equivalent amount of a rate
contract is the sum of the current credit
exposure of the contract and an estimate of
potential future increases in credit exposure.
The current exposure is the positive mark-tomarket value of the contract (or zero if the
mark-to-market value is zero or negative). For
rate contracts that are subject to a qualifying
bilateral netting contract the current
exposure is, generally, the net sum of the
positive and negative mark-to-market values
of the contracts included in the netting
contract (or zero if the net sum of the markto-market values is zero or negative). The
potential future exposure is calculated by
multiplying the effective notional amount of
a contract by one of the following credit
conversion factors, as appropriate:

Interest
rate
con
tracts
(per
cent)

Remaining maturity

O ne year or le s s ..............
O ver one y e a r ...................

Ex
change
rate
con
tracts
(per
cent)

1.0

0.5

5.0

2. No potential future exposure is
calculated for single currency interest rate
swaps in which payments are made based
upon two floating indices, that is, so called
floating/floating or basis swaps. The credit
exposure on these contracts is evaluated
solely on the basis of their mark-to-market
value. Exchange rate contracts with an
original maturity of fourteen days or less are
excluded. Instruments traded on exchanges
that require daily payment of variation
margin are also excluded.

A T T A C H M E N T V — C A L C U LA TIO N O F C R E D IT E Q U IV A L E N T A M O U N T S FOR IN T E R E S T R A T E AN D E X C H A N G E R A T E -R E L A T E D

T r a n s a c t io n s

for

S t at e M em ber B a n k s
+

Potential ex
posure
Type of contract (remaining maturity)
Notional prin
cipal (dollars)
( 1) 120 -day forward foreign exchange ............
(2 ) 120 -day forward foreign exchange ............
(3) 3-year single-currency interest-rate swap .
(4) 3-year single-currency fixed/floating interest-rate swap ......................................................
(5) 7-year cross-currency floating/floating interest-rate swap .................................................

Conversion
factor

5,000,000
6 ,000,000
10 ,000,000

.01
.01

Current expo
sure
Potential ex
posure (dol
lars)

Mark-to-m ar
ket value

100,000

Current ex
posure (dol
lars)

200,000

100,000
0
200,000

150,000
60,000
2 5 0,000

5 0,000

- 2 5 0 ,0 0 0

5 0,000

1,000,000

-1 ,3 0 0 ,0 0 0

1,000,000

300,000

1,510,000

- 120,000

.005

5 0 ,0 0 0
60 ,00 0
5 0 ,00 0

10 ,000,000

.005

20 ,000,000

.05

1 ,210,000

Total ..............................................................

Credit equiva
lent amount

If contracts (1) through (5) above are subject to a qualifying bilateral netting contract, then the following applies:
Potential fu
ture exposure
(from above)
( 1)
(2 )
(3)
(4)
(5)

.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................
.......................................................................................................................

1,000,0000

T o t a l......................................................................................................

1,210,000

N et current
exposure 1

Credit equiva
lent amount

50.000
60.000
50.000
50.000

1,210,000

1The total of the mark-to-market values from above is - 1 ,3 7 0 ,0 0 0 . Since this is a negative amount, the net current exposure is zero.

★

PART 225—-BANK HOLDING
COMPANIES AND CHANGE IN BANK
CONTROL (REGULATION Y)

c. Section IJI.E.5.;
d. The last heading and subsequent
two paragraphs of Attachment IV; and
e. Attachment V.
The revisions read as follows:

1. The authority citation for part 225
is revised to read as follows:

A p p e n d i x A to P a r t 2 2 5 — C a p ita l
A d e q u a c y G u i d e li n e s fo r B a n k H o ld in g
C o m p a n ie s : R is k - B a s e d M e a s u r e
*
*
*
*
★

2. Appendix A to part 225 is amended
by revising:
a. Section III.E.2.;
b. Section III.E.3.;

E. * * *

Authority: 12 U.S.C. 1817(j)(13), 1818,
1831i, 1831p-l, 1843(c)(8), 1844(b), 1972(1).
3106. 3108, 3310. 3331-3351,3907, and
3909.

III.----2. Calculation o f credit equivalent
amounts, a. The credit equivalent amount of
an off-balance sheet rate contract that is not

subject to a qualifying bilateral netting
contract in accordance with section III.E.5. of
this appendix A is equal to the sum of (i) the
current exposure (sometimes referred to as
the replacement cost) of the contract; and an
(ii) estimate of the potential future credit
exposure over the remaining life of the
contract.
b.
The current exposure is determined by
the mark-to-market value of the contract. If
the mark-to-market value is positive, then the
current exposure is that mark-to-market
value. If the mark-to-market value is zero or
negative, then the current exposure is zero.
Mark-to-market values are measured in
dollars, regardless of the currency or
currencies specified in the contract, and

62994 Federal Register / Vol. 59, No. 234 / Wednesday, December 7, 1994 / Rules and Regulations
amount of the stun, of the positive and
negative mark-to-market values on included
individual contracts in the event that a
counterparty, or a counterparty to whom the
contract has been validly assigned, fails to
perform due to any of the following events:
default, bankruptcy, liquidation, or similar
circumstances.
ii. The banking organization obtains a
written and reasoned legal, opinionfs)
representing that in the event of a legal
challenge—including one resulting from
Ex
Interest
default, bankruptcy, liquidation, or similar
change
rate
circumstances—the relevant court and
rate
con
administrative authorities would find the
Remaining maturity
con
tracts
banking organization’s exposure to be such a
tracts
(per
(per
net amount under:
cent)
cent)
1. The law of the jurisdiction in which the
counterparty is chartered or the equivalent
O ne year or le s s ...............
0
t.O location in the case of noncorporate entities,
O ver one y e a r ....... ............
0.5
5.0 and if a branch o f the counterparty is
involved, then also under the law of the
d. Examples of the calculation of credit
equivalent amounts for these instruments are jurisdiction in which the branch is located;
2. The law that governs the individual
contained in Attachment V of this appendix
contracts covered by the netting contract; and
A.
3. The law that governs the netting
e. Because exchange rate contracts involve
contract.
an exchange of principal upon maturity, and
iii. The banking organization establishes
exchange rates are generally more volatile
and maintains procedures to ensure that the
than interest rates, higher conversion factors
legal characteristics of netting contracts are
have been established for exchange rate
kept under review in the light of possible
contracts than for interest rate contracts.
changes in relevant law.
f. No potential future credit exposure is
iv. The banking organization maintains in
calculated for single currency interest rate
swaps in which payments are mads based
its files documentation adequate to support
upon two floating rate indices, so-called
the netting of rate contracts, including a copy
floating/floating or basis swaps; the credit
of the bilateral netting contract and necessary
exposure on these contracts is evaluated
legal opinions.
solely on the basis of their mark-to-market
b. A contract containing a walkaway clause
values.
is not eligible for netting for purposes of
3.
Risk weights. Once the credit equivalentcalculating the credit equivalent amount.34
amount for an interest rate or exchange rate
c. By netting individual contracts for the
contract has been determined, that amount is purpose of calculating its credit equivalent
assigned to the risk weight category
amount, a banking organization represents
appropriate to the counterparty or, if
that it has met the requirements of this
relevant, to the guarantor or the nature of any appendix A and all the appropriate
collateral.53 However, the maximum weight
documents are in the organization’s files and
that will be applied to the credit equivalent
available for inspection by the Federal
amount of such instruments is 50 percent.
Reserve. The Federal Reserve may determine
*
*
*
*
*
that a banking organization’s files are
5.
Netting, a. For purposes of this appendixinadequate or that a netting contract, or any
A, netting refers to the offsetting of positive
of its underlying individual contracts, may
and negative mark to-market values in the
not be legally enforceable under any one of
determination of a current exposure to be
the bodies of law described in paragraph
used in the calculation of a credit equivalent
5.a.ii.l. through 5.a.ii.3. of section III of this
amount. Any legally enforceable form of
appendix A. If such a determination is made,
bilateral netting (that is, netting with a single the netting contract may be disqualified from
counterparty) of rate contracts is recognized
recognition for risk-based capital purposes or
for purposes of calculating the credit
underlying individual contracts may be
equivalent amount provided that:
treated as though they are not subject to the
i. The netting is accomplished under a
netting contract
written netting contract that creates a single
d. The credit equivalent amount of rate
legal obligation, covering all included
contracts that are subject to a qualifying
individual contracts, with the effect that the
bilateral netting contract is calculated by
organization would have a claim to receive,
adding (i) the current exposure of the netting
or obligation to receive or pay, only the net
contract, and (ii) the sum of the estimates of
the potential future credit exposures on all
53 For interest and exchange rate contracts,
individual contracts subject to the netting
should reflect changes in the relevant rates,
as well as counterparty credit quality.
c.
The potential future credit exposure of
a contract, including a contract with a
negative mark-to-market value, is estimated
by multiplying the notional principal amount
of the contract by a credit conversion factors.
Ranking organizations should, subject to
examiner review, use the effective rather than
the apparent or stated notional amount in
this calculation. The conversion factors are:

sufficiency of collateral or guarantees is determined
by the market value of the collateral or the amount
of the guarantee in relation to the credit equivalent
amount. Collateral and guarantees are subject to the
same provisions noted under section 1H.B. of this
appendix A. Collateral held against a netting
contract is not recognized for capital purposes
unless it is legally available to support the single
legal obligation created by the netting contract.

54A walkaway clause is a provision in a netting
contract that permits a non-defaulting counterparty
to make lower payments than it would make
otherwise under the contract, or no payment at all,
to a defaulter or to the estate of a defaulter even if
the defaulter or the estate of the defaulter is a net
creditor uncier the contract.

contract, estimated in accordance with
section. UI.E.2. of this appendix AA4
a.
The current exposure of the netting
contract is determined by summing all
positive and negative mark-to-market values
of the individual contracts included in the
netting contract If the net sum of the markto-market values is positive, then the current
exposure of the netting contract is equal to
that sum. If the net sum of the mark-tomarket values is zero or negative, then the
current exposure of the netting contract is
zero. The Federal Reserve may determine
that a netting contract qualifies for risk-based
capital netting treatment even thpugh certain
individual contracts may not qualify. In such
instances, the nonqualifying contracts should
be treated as individual contracts that are not
subject to the netting contract.
f. In the event a netting contract covers
contracts that are normally excluded from the
risk-based ratio calculation—for example,
exchange rate contracts with an original
maturity of fourteen calendar days or less, or
instruments traded on exchanges that require
daily payment of variation margin—an
institution may elect to consistently either
include or exclude all mark-to-market values
o f such contracts when determining net
current exposure.
g. An example of the calculation of the
credit equivalent amount for rate contracts
subject to a qualifying netting contract is
contained in Attachment V of this appendix
A.

Attachment IV—Credit Conversion Factors
for Off-Balance-Sheet Items for Bank
Holding Companies
it

C r e d it C o n v e r s io n f o r I n te r e s t R a te a n d
E x c h a n g e R a te C o n tr a c ts

1. The credit equivalent amount of a rate
contract is the sum of the current credit
exposure of the contract and an estimate of
potential future increases in credit exposure.
The current exposure is the positive mark-tomarket value of the contract (or zero if the
mark-to-market value is zero or negative). For
rate contracts that are subject to a qualifying
bilateral netting contract the current
exposure is the net sum o f the positive and
negative mark-to-market values of the
contracts included in the netting contract (or
zero if the net sum of the mark-to-market
values is zero or negative). The potential
future exposure is calculated by multiplying
the effective notional amount of a contract by
one of the following credit conversion
factors, as appropriate;
53For purposes of calculating potential future
credit exposure to a netting counterparty for foreign
exchange contracts and other similar contracts in
which notional principal is equivalent to cash
flows, total notional principal is defined as the net
receipts falling due on each value date in each
currency. The reason for this is that offsetting
contracts in the same currency maturing on the
same date vviil have lower potential future exposure
as well as lower current exposure.

t o n s

Federal Register / Vol. 59, No. 234 / Wednesday, December 7, 1994 / Rules and Regulations 62995
Interest
rate
con
tracts
(per
cent)

Remaining maturity

O ne year or le s s ...............
O ver one y e a r ............ —

Attachm

ent

V .— C

Ex
change
rate
con
tracts
(per
cent)

1.0

0.5

5.0

a l c u l a t io n o f

r e d it

r a n s a c t io n s

u iv a l e n t
fo r

ounts

Ba n k H

fo r

o l d in g

(1) 120-day forward foreign exchange ............
(2) 120-day forward foreign e x c h a n g e ............
(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 .................................................

o m p a n ie s

Potential exposure
Type of contract (remaining maturity)

In t e r e s t R a t e
C

Notional prin
cipal (dollars)

Conversion
Factor

5,000 ,0 0 0
,000,000

.01
.01

50,000
60,000

.005

50,000

.005

50,000

6
10,000,000
10,000,000
20,000,000

Potential ex
posure (dol
lars)

.05

Total ..............................................................

1,000,000
1,210,000

Ex c h a n g

and

R a te -R

elated

Current expo
sure

Mark-to-m ar
ket value

Current ex
posure (dol
lars)

100,000
- 1 2 0 ,0 0 0

200,000
- 2 5 0 ,0 0 0
-1 ,3 0 0 ,0 0 0

Credit equiva
lent amount

100,000
0
200,000
0
0

1,000,000

300,000

1,510,000

150,000
60,000
250,000
50,000

If contracts (1) through (5) above are
subject to a qualifying bilateral netting
contract, then the following applies:
Potential fu
ture exposure
(from above)
(1) ...................................... ........................................................ .......................
(2) ........................ .............................................................................................
(4) ............................................. ................... .....................................................
(5) ...... ....... .................
Total ......................................................................................................

1T he
*

total of the mark-to-market values from

By order of the Board of Governors of the
Federal Reserve System, December 1,1994.
William W. Wiles,

Secretary of the Board.
[FR Doc. 94-30040 Filed 12-6-94; 8:45 am)
BILUNG CODE 6210-01-P

above

N et current
exposure1

Credit equiva
lent amount

5 0 .00 0
6 0.000
5 0 .00 0
5 0.000
,000,000

1
1,210,000

is -1 ,3 7 0 ,0 0 0 . Since this is a negative amount, the net current exposure is zero.

1,210,000

___________________________________________________________________________________ 6 3 2 4 1

Rules and Regulatibns

Federal Register
Vol. 59, No. 235
Thursday, December 8, 1994

This section of the FED ER A L R EG IS TE R
contains regulatory documents having general
applicability and legal effect, most of which
are keyed to and codified in the Code of
Federal Regulations, which is published under
50 titles pursuant to 44 U .S .C . 1510.

3544), Board of Governors of the Federal
Reserve System, 20th and C Streets NVV,
Washington, DC 20551.
SUPPLEMENTARY INFORMATION:

Background

gains and losses on available-for-sale
debt securities were not included in
regulatory capital, and the amortized
cost rather than the fair value of
available-for-sale debt securities
generally continued to be used in the
calculation of both capital ratios.
Moreover, equity securities with readily
determinable fair values continued to be
valued at the lower of cost or fair value
for regulatory capital purposes. Both the
Federal Deposit Insurance Corporation
(FDIC) and the Office of the Comptroller
of the Currency (OCC) followed this
interim capital treatment.

On December 28,1993, the Board of
Governors issued for public comment a
proposal to amend its risk-based capital
guidelines1 for state member banks and
bank holding companies to include in
Tier 1 capital the “net unrealized
FEDERAL RESERVE SYSTEM
holding gains and losses on securities
available for sale” (58 FR 68563,
12 CFR Parts 208 and 225
December 28,1993). The proposal
[Regulations H and Y; Docket No. R-0823]
would have had the effect of valuing
FAS 115
securities available for sale at market
FAS 115 divides securities held by
Capital; Capital Adequacy Guidelines
value for purposes of calculating the
banking organizations among three
risk-based
and
leverage
capital
ratios.
In
AGENCY: Board of Governors of the
categories: (1) Securities held to
its proposal, the Board offered several
Federal Reserve System.
maturity; (2) trading account securities:
alternative
treatments,
one
of
which
was
ACTION: Final rule.
to not include such net unrealized gains and (3) securities available for sale.
Under-FAS 115, trading securities are
SUMMARY: The Board of Governors of the and losses in the calculation of
defined as those securities that an
Federal Reserve System is amending its regulatory capital. It is this alternative
institution buys and holds principally
treatment that the Board is adopting as
risk-based capital guidelines for state
for the purpose of selling in the near
a final rule. The comment period ended
member banks and bank holding
term. As under earlier accounting
on
January
21,1994.
companies. Under this final rule,
standards, these securities are to be
The proposal was in response to the
institutions are generally directed to not
reported at fair value (i.e., generally at
issuance of FAS 115 on M ay.31,1993,
include in regulatory capital the “net
market value), with net unrealized
which established “net unrealized
unrealized holding gains (losses) on
changes in their value reported directly
holding gains (losses) on securities
securities available for sale,” the new
in the income statement as part of an
available for sale” as a new element of
common stockholders’ equity account
institution’s earnings.
common stockholders’ equity. All
created by Statement of Financial
Under FAS 115, securities held to
banking organizations were required to
Accounting Standards Number 115
maturity are to be recorded at amortized
adopt FAS 115, for both generally
(FAS 115), Accounting for Certain
cost. However, FAS 115 states that a
accepted accounting principles (GAAP)
Investments in Debt and Equity
banking organization may include a
and regulatory reporting purposes, as of security in the held-to-maturity category
Securities. Net unrealized losses on
marketable equity securities (i.e., equity January 1,1994, or the beginning of
only if management has “the positive
securities with readily determinable fair their first fiscal year thereafter, if later.
intent and ability to hold the security to
values), however, will continue to be*
Earlier adoption was permitted.
m aturity.”
Since the final capital treatment of
deducted from Tier 1 capital. This rule
Securities meeting the definition of
such net unrealized gains and losses on
has the general effect of valuing
the ayailable-for-sale category (i.e., all
available-for-sale securities at amortized available-for-sale securities was not in
securities not held for trading that an
effect by year-end 1993, the Board
cost (i.e., based on historical cost),
institution cannot justify categorizing as
directed state member banks and bank
rather than at fair value (i.e., generally
held-to-maturity) are to be reported at
holding companies to continue
at market value), for purposes of
fair value. Changes in the fair value of
calculating the risk-based and leverage
calculating the risk-based and leverage
securities available for sale are to be
capital ratios.
capital ratios on a pre-FAS 115 basis.
reported, net of tax effects, directly in a
Accordingly, the net unrealized holding separate component of common
EFFECTIVE DATE: December 31,1994.
FOR FURTHER INFORMATION CONTACT:
stockholders’ equity. Consequently, any
1The Board’s risk-based capital guidelines
Rhoger H Pugh, Assistant Director (202/
unrealized appreciation or depreciation
implement, for state member banks and bank
728-5883), Norah M. Barger, Manager
in the value of securities in the
holding companies, the international bank capital
(202/452-2402), Arleen E. Lustig,
standards as set forth in the Basle Accord. The
available-for-sale category has no impact
Basle Accord is a risk-based capital framework that
Supervisory Financial Analyst (202/
on the reported earnings of an
was proposed by the Basle Committee on Banking
452-2987), and John M. Freeh,
institution,
but affects its GAAP equityRegulations and Supervisory Practices and
Supervisory Financial Analyst (202/
capital position.
endorsed by the central bank governors of the
452-2275), Division of Banking
Group of Ten (G-10) countries in July 1988. The
Initial Proposal
Committee is comprised of representatives of the
Supervision and Regulation, Board of
central banks and supervisory authorities from the
Governors of the Federal Reserve
In late December 1993, the Board
G-10 countries (Belgium, Canada, France, Germany,
System. For the hearing impaired only,
proposed amending the capital
Italy. Japan, Netherlands, Sweden, Switzerland, the
adequacy guidelines for state member
Telecommunication Device for the Deaf United Kingdom, and the United States) and
(TDD), Dorothea Thompson (202/452banks and bank holding companies to
Luxembourg.
The Code of Federal Regulations is sold by
the Superintendent of Documents. Prices of
new books are listed in the first FEDERAL
R E G IS TE R issue of each week.

63242

Federal Register / Vol. 59, No. 235 / Thursday, December 8, 1994 / Rules and Regulations

reflect the provisions of FAS 115 (58 FR
68563, December 28,1993). Under the
proposed amendment, the net amount of
unrealized gains and losses, adjusted for
the effects of income taxes, on securities
held in the available-for-sale account
would be included in Tier 1 capital2
and such securities would be booked at
fair value rather than at amortized cost
for purposes of calculating the riskbased and leverage capital ratios.
The Board proposed inclusion of net
unrealized gains and losses on
available-for-sale securities in Tier 1
capital because it would make the
definition of Tier 1 capital more
equivalent to the GAAP definition of
equity capital. In addition, the proposed
Tier 1 capital treatment for unrealized
changes in the value of securities
available for sale could be viewed as an
extension of the capital treatment
currently applied to net unrealized
gains and losses on trading securities,
which are recognized in Tier 1 capital.
This recognition has long been viewed
as consistent with the Basle Accord.
Thus, it could be argued that inclusion
of unrealized gains and losses on
securities available for sale in Tier 1
capital is also consistent with the Basle
Accord.
The Board also noted in its initial
proposal that the inclusion of net
unrealized changes in the value of
securities available for sale in Tier 1
capital would affect the calculation of
capital for purposes of a num ber of laws
and regulations that are based, in part,
o n the institution’s capital levels. Such
laws and regulations include prompt
corrective action (12 CFR part 208,
Subpart B), brokered deposit restrictions
(12 CFR 337.6), and the risk-related
insurance premium system (12 CFR part
327).
While proposing Tier 1 capital
treatment for net unrealized gains and
losses on available-for-sale securities,
the Board also sought public comment
on several alternative treatments. The
other options included:
(a) Excluding from regulatory capital
all changes in the value of securities
available for sale, which would have the
same effect as valuing these securities
on an amortized cost basis;
(b) Including losses in Tier 1 capital,
while not recognizing any gains for
capital purposes, which would have the
2The Board’s risk-based capital guidelines set
forth a definition of Tier 1 capital that includes
common stockholders' equity. These guidelines
further state that common stockholders’ equity
includes: (1) Common stock: (2) related surplus:
and (3) retained earnings, including capital reserves
and adjustments for the cumulative effect of foreign
currency translation, net of treasury stock.

effect of valuing securities available for
sale on lower of cost or market basis:
(c) Including both the gains and losses
in Tier 2 capital; and
(d) Including losses in Tier 1 capital,
while including gains in Tier 2 capital.

Comments Received
The Federal Reserve received letters
from 59 public commenters. Comments
were received from 17 m ultinational
and large regional banking
organizations, 24 community banking
organizations, seven foreign banks, six
banking trade associations, two state
banking supervisors, two consultants,
and one law firm. Twenty-one of the
public commenters supported the
proposal to include “net unrealized
holding gains (losses) on securities
available for sale,” in Tier 1 capital,
while 38 opposed the proposal,
including all seven foreign banks.
Public commenters opposed to the
proposal included 18 out of the 24
community banks, 5 out of the 17
multinational and large regional
banking organizations, all seven foreign
banking organizations, three banking
trade associations, two state banking
supervisory organizations, two
consultants, and one law firm. Some of
the common reasons cited for opposing
the proposal included:
(1) Tne additional volatility to capital
resulting from marking-to-market the
available-for-sale securities and
consequent fluctuations for some
institutions in their single borrower
lender limits;
(2) The potential for temporary
changes in interest rates to have an
adverse effect on the risk-based and
leverage capital ratios that would result
in a lower prompt corrective action
category or higher FDIC risk-based
insurance premiums;
(3) The distorting effect of applying
market value accounting to some items
on only one side of the institution’s
balance sheet, particularly since interest
rate changes that cause changes in asset
values often give rise to offsetting
changes to the value of the deposit base,
which existing accounting standards do
not recognize; and
(4) The potential for organizations to
become critically undercapitalized and
subject to closure as a result of
temporary changes in the market values
of securities that the banking
organization has no intention of selling.
All seven foreign banks that
commented on the proposal opposed
the inclusion of the net unrealized gains
and losses on available-for-sale
securities in Tier 1 on the grounds that
such treatment for the new equity
account is inconsistent with the Basle

Accord. In their view,.this account is
more comparable to securities
revaluation reserves, which, under the
Accord, are substantially discounted
and accorded Tier 2 status, rather than •
disclosed reserves, which receive an
unlim ited Tier 1 treatment under the
Accord.
Twelve of the 17 multinational and
large regional banking organizations
commented favorably on the proposal,
as did three banking trade associations.
However, five multinational and large
regional banking organizations opposed
the proposal citing concerns similar to
those given by smaller institutions. The
21 commenters favoring the proposal
gave two main reasons for their support:
(1) The proposed Tier 1 treatment of
the new account would parallel the
GAAP equity treatment for unrealized
gains and losses and, thus, institutions
could avoid having to maintain two sets
of accounting records for available-forsale securities; and
(2) Tier 1 treatment would be
consistent with the intent of section 121
of the Federal Deposit Insurance
Corporation Improvement Act of 1991
(FDICIA), w hich stipulates that
regulatory accounting standards be no
less stringent than GAAP.
In its proposal, the Board asked for
specific comment on six issues. Ten
public commenters commented on the
first issue, which concerned the extent
to which FAS 115 may permit an
institution to sell securities from the
held-to-maturity account without
calling into question the institution’s
intent or ability to continue to hold
other securities reported in that account
All 10 commenters stated that FAS 115
provides a specific set of circumstances
under which banking organizations can
sell securities from the held-to-maturity
account without tainting the remaining
securities in that account.
Seven banking institutions
commented on the second issue, which
concerned requests for examples of
isolated, nonrecurring, and unusual
events involving demands for liquidity
that would permit the sale or transfer of
held-to-maturity securities under FAS
115. The most common examples cited
were changes in tax law, deterioration
in the credit-worthiness of a security
issuer, and natural disasters.
The third issue concerned alternatives
to the proposed Tier 1 capital treatment.
Twenty-three organizations commented
on the alternatives included in the
Board’s request for public comment.
These alternatives included: Excluding
all such changes from capital; deducting
losses from Tier 1 capital, and either not
recognizing any gains for capital
purposes or including them in Tier 2

(015 1
Federal Register / Vol. 59, No. 235 / Thursday, December 8, 1994 / Rules and Regulations 63243
capital; and including both the gains
and losses in Tier 2 capital.
Of the 23 commenters, six were
m ultinational or large regional banking
organizations that supported the
proposal. Generally, these organizations
did not favor any of the alternatives.
However, 13 commenters, including the
seven foreign banks that opposed the
proposal, stated that they preferred Tier
2 treatment for net unrealized gains and
losses on available-for sale securities
over Tier 1 treatment. Four commenters
preferred not including the net
unrealized gains and losses on
available-for-sale securities in regulatory
capital.
The fourth issue concerned the extent
to which the above alternatives might
create an incentive for banking
organizations to sell securities that have
appreciated to realize the gains in Tier
1 capital, while holding securities that
have depreciated to avoid reductions in
Tier 1 capital. Six commenters offered
views on this issue. Most of these
commenters felt that including
unrealized gains and losses in
regulatory capital would provide some
disincentive for banks not to pursue
such a strategy. Another commenter
stated that while the exclusion of the
net unrealized gains and losses could
lead a company to selectively sell only
securities in which it had a gain, the
Securities and Exchange Commission
(SEC) would question such a practice.
In setting forth the fifth issue, the
Board asked commenters to suggest the
appropriate manner for m aintaining an
Allocated Transfer Risk Reserve (ATRR)
for certain foreign debt securities (e.g*.
“Brady Bonds”) held as securities
available for sale. Three multinational
banking institutions responded to this
issue. All three organizations stated that
the ATRR should not be applied to such
foreign securities since such securities
are reflected on banks’ financial
statements at market value.
The last issue concerned the
importance of maintaining consistent
application of the Basle capital
standards. Fourteen banking
organizations and associations
commented on this issue. Seven
commenters, all of which were foreign
banks, stated that the proposal to
include the new common equity
component in Tier 1 was inconsistent
with the provisions of the Basle Accord.
They stated that Tier 1 treatment could
create competitive inequality with
international banks. Moreover, they
stated that Tier 1 treatment could cause
inconsistency between the Tier 1
measure applied to U.S. banks and the
Tier 1 measure applied by other banks
regulated by different accounting rules,

reducing the meaningfulness of the
capital adequacy comparisons.
However, three banking organizations,
all of which supported the Tier 1
proposal, stated that the proposal was
consistent with the Basle Accord and,
therefore, would not reduce the
meaningfulness of comparisons.

agencies at the time FAS 115 was
proposed, that the standard could
produce distorted financial statements
because it marked some balance sheet
items to market but ignored changes in
the market value of other items,
including liabilities, that could have
offsetting price changes. In addition, the
Board has long opposed proposals to
Final Rule
adopt mark-to-market accounting
After consideration of the public
because of the difficulty in determining
comments and further deliberation on
the market values of various assets and
the issues involved, the Board is
liabilities and the inappropriateness of
adopting a final rule that amends the
using this accounting method for
risk-based capital guidelines to
institutions that do not actively trade in
explicitly state that net unrealized gains marketable financial assets.
and losses on available-for-sale
The Board believes that not including
.securities generally are not be included
the FAS 115 net unrealized gains and
in capital. Under the final rule,
losses in capital is consistent with the
however, unrealized losses on
Basle Accord, which (except for trading
marketable equity securities would
account assets) generally does not
continue to be deducted from Tier 1
permit Tier 1 capital to be increased by
capital. This final rule was developed in unrealized gains on securities. In
close coordination with the other
addition, the Board finds that FDICLA
federal banking agencies and results in
121’s requirement that the accounting
a capital treatment for net unrealized
principles used in regulatory reports be
gains and losses on securities available
no less stringent than GAAP does not
for sale that is the same as the interim
apply to the Board’s definition of
capital treatment agreed to by the
regulatory capital. This finding suggests
agencies in December 1993.
that excluding net gains and losses from
The Board is adopting one of the
regulatory
capital is consistent with
alternative capital treatments suggested
FDICLA 121. Moreover, consistent with
in December 1993 as a final rule rather
past opinions expressed by the Board,
than the Tier 1 treatment proposed for
the
Board is not convinced that marking
a number of reasons. First, most
to market available-for-sale securities as
commenters opposed the Board’s
FAS 115 requires is necessarily a more
proposal to include the FAS 115 net
stringent reporting treatment than
unrealized gains and losses in riskvaluing such securities at amortized
based capital calculations because of
cost. While mark-to-market treatment
concerns about the potential volatility
results in the recognition of unrealized
in regulatory capital. As discussed
losses in GAAP equity capital, it also
under the section entitled “Comments
permits the unlimited recognition of
Received,” commenters noted that the
unrealized gains in such capital
inclusion of the net unrealized gains
Furthermore, the Board believes that
and losses on available-for-sale
concerns about not deducting net
securities would result in fluctuations
unrealized losses on available-for-sale
in regulatory capital due to temporary
securities are overstated since the
changes in interest rates. Thus, an
regulatory reports filed by banking
institution’s capital as calculated for
organizations that are available to the
prompt corrective action, risk-based
public have long collected information
insurance deposit premiums, lending
limits, and other limits based on capital on the amortized cost and market value
would be affected by unrealized changes of all securities held in their portfolios
in the value of securities that it may not (including those held as long-term
investments). Thus, examiners and
intend or need to sell.
analysts can readily take any
Some commenters also expressed
depreciation, as well as any
concerns about having to reflect in
regulatory capital changes in the market appreciation, in a banking
organization’s securities portfolio into
value of selected items on one side of
the balance sheet but not the other side. consideration in the determination of
the institution’s overall capital
In this regard, the Board notes that it
and the other banking agencies opposed adequacy.
FAS 115 as representing piecemeal
Finally, the Board has decided to
adoption of mark-to-market accounting
continue to deduct net unrealized losses
when it was issued for public comment. on marketable equity securities since,
By not adopting FAS 115 for regulatory
unlike debt securities, equities have no
capital purposes, the Board is taking an
maturity date and an uncertain final
action that is consistent with the
value. This decision is consistent with
position, which was taken by the
longstanding supervisory practice.

63244

Federal Register / Vol. 59, No. 235 / Thursday, December 8, 1994 / Rules and Regulations

Regulatory Flexibility Act Analysis
Pursuant to section 605(b) of the
Regulatory Flexibility Act, the Board
hereby certifies that this final rule will
not have a significant impact on a
substantial number of small business
entities (in this case, small banking
organizations). The risk-based capital
guidelines generally do not apply to
bank holding companies with
consolidated assets of less than $150
million; thus, the final rule will not
affect such companies.

Paperwork Reduction Act and
Regulatory Burden
The Board has determined that this
final rule will not increase the
regulatory paperwork burden of banking
organizations pursuant to the provisions
of the Paperwork Reduction Act (44
U.S.C. 3501 et seq.).
Section 302 of the Riegle Community
Development and Regulatory
Improvement Act of 1994 (Pub. L. 103325,108 Stat. 2160) provides that the
federal banking agencies must consider
the administrative burdens and benefits
of any new regulations that impose
additional requirements on insured
depository institutions. Section 302 also
requires such a rule to take effect on the
first day of the calendar quarter
following final publication of the rule,
unless the agency, for good cause,
determines an earlier effective date is
appropriate.
The new capital rule does not impose
any new requirements on depository
institutions of bank holding companies
for purposes of calculating their riskbased and leverage capital ratios. The
amended rule clarifies the capital
treatment of a common stockholders’
equity component, “net unrealized
holding gains (losses) on securities
available for sale,” CTeated by FAS 115,
but does not change current treatment.
For these reasons, the Board has
determined that an effective date of
December 31,1994, is appropriate. For
these same reasons, in accordance with
5 U.S.C. 553(d)(3), the Board finds there
is good cause not to follow the 30-day
notice requirements of 5 U.S.C. 553(d)
and to make the rule effective on
December 31,1994.
List of Subjects
12 CFR Part 208
Accounting, Agriculture, Banks,
Banking, Confidential business
information, Crime, Currency, Federal
Reserve System, Mortgages, Reporting
and recordkeeping requirements.
Securities.

12 CFR Part 225
Administrative practice and
procedure, Banks, Banking, Federal
Reserve System, Holding companies,
Reporting and recordkeeping
requirements, Securities.
For the reasons set forth in the
preamble, the Board is amending 12
CFR parts 208 and 225 as set forth
below:

PART 208—MEMBERSHIP OF STATE
BANKING INSTITUTIONS IN THE
FEDERAL RESERVE SYSTEM
(REGULATION H)
1. The authority citation for part 208
is revised to read as follows:
Authority: 12 U.S.C. 36, 248(a), 248(c),
321-338a, 371d, 461,481-486,601,611,
1814, 1823(j), 1828(o), 18310,1831p-l, 3105,
3310, 3331-3351 and 3906-3909: 15 U.S.C
78b. 781(b), 781(g), 78l(i), 78o-4(c)(5), 78q,
78q-l and 78w; 31 U.S.C 5318.

2. Appendix A to part 208 is amended
by revising sections II.A.l.a. and II.A.2.f
to read as follows:

Appendix A to Part 208—Capital
Adequacy Guidelines for State Member
Banks: Risk-Based Measure
* * * * *
n. * * *
A. * * *

1. * * *
a. Common stockholders’ equity For
purposes of calculating the risk-based capital
ratio, common stockholders’ equity is limited
to common stock; related surplus; and
retained earnings, including capital reserves
and adjustments for the cumulative effect of
foreign currency translation, net of any
treasury stock; less net unrealized holding
losses on available-for-sale equity securities
with readily determinable fair values. For
this purpose, net unrealized holding gains on
such equity securities and net unrealized
holding gains (losses) on available-for-sale
debt securities are not included in common
stockholders' equity
*
*
*
*
*

2 . . *
f. Revaluation reserves i Such reserves
reflect the formal balance sheet restatement
or revaluation for capital purposes of asset
earn ing values to reflect current market
values. The federal banking agencies
generally have not included unrealized asset
appreciation in capital ratio calculations,
although they have long taken such values
into account as a separate factor in assessing
the overall financial strength of a bank.
ii. Consistent with long-standing
supervisory practice, the excess of market
values over book values for assets held by
state member banks will generally not be
recognized in supplementary capital or in the
calculation of the risk-based capital ratio.
However, all banks are encouraged to
disclose their equivalent of premises
(building) and security revaluation reserves.
The Federal Reserve will consider any

appreciation, as well as any depreciation, in
specific asset values as additional
considerations in assessing overall capital
strength and financial condition.
*
*
*
*
*

PART 225—BANK HOLDING
COMPANIES AND CHANGE IN BANK
CONTROL (REGULATION Y)
1. The authority citation for part 225
is revised to read as follows:
Authority: 12 U.S.C. 1817(j)(13). 1818,
1831 i, 1831p-l, 1843(c)(8), 1844(b), 1972(1),
3106, 3108, 3310, 3331-3351. 3907, and
3909.

2. Appendix A to part 225 is amended
by revising sections II.A.l.a. and II.A.2.f
ttf read as follows:

Appendix A to Part 225—Capital
Adequacy Guidelines for Bank Holding
Companies: Risk-Based Measure
* * * * *
11. * * *
A. * * *

1 * * *
a. Common stockholders’ equity For
purposes of calculating the risk-based capital
ratio, common stockholders’ equity is limited
to common stock; related surplus; and
retained earnings, including capital reserves
and adjustments for the cumulative effect of
foreign currency translation, net of any
treasury stock, less net unrealized holding
losses on available-for-sale equity securities
with readily determinable fairvalues. For
this purpose, net unrealized holding gains on
such equity securities and net unrealized
holding gains (losses) on available-for-sale
debt securities are not included in common
stockholders’ equity
*
*
*
*
*

2 * * *
f. Revaluation reserves i. Such reserves
reflect the formal balance sheet restatement
or revaluation for capital purposes of asset
carrying values to reflect current market
values. The Federal Reserve generally has not
included unrealized asset appreciation in
capital ratio calculations, although it has long
taken such values into account as a separate
factor in assessing the overall financial
strength of a banking organization
ii Consistent with long-standing
supervisory practice, the excess of market
values over book values for assets held by
bank holding companies will generally not be
recognized in supplementary capital or in the
calculation of the risk-based capital ratio.
However, all bank holding companies are
encouraged to disclose their equivalent of
premises (building) and security revaluation
reserves. The Federal Reserve will consider
any appreciation, as well as any depreciation,
in specific asset values as additional
considerations in assessing overall capital
strength and financial condition.
*
*
*
*
*

|0 ~ i 5
F e d e r a l R e g is t e r

/ Vol. 59; No. 235 / Thursday, December

Board of Governors of the Federal Reserve
System. December 2,1994.

Barbara R. Lowrey,
Associate Secretary o f the B o a r d .

|FR Doc. 94-30156: Filed 12-7-94; 8:45 amj
BILLING CODE 6210-01-P

1994 / Rules and Regulations

I
63245

ions'I
Federal Register / Vol. 59, No, 240 / Thursday, December 15, 1994 / Rules and Regulations 64561
EFFECTIVE DATE: January 1 7 .1 9 9 5 .
FOR FURTHER INFORMATION CONTACT:

DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
12 CFR Part 3
{Docket No. 94-22]
RIN 1557-AB14

FEDERAL RESERVE SYSTEM
12 CFR Part 208
[Regulation H; Docket No. R -0764]

FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 325
RIN 3064-AB15

DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
12 CFR Part 557
[No. 94-152]
RIN 1550-AA59

Risk-Based Capital Standards;
Concentration of Credit Risk and Risks
of Nontraditional Activities
AGENCIES: Office of the Comptroller o f

the Currency (OCC), Treasury; Board of
Governors of the Federal Reserve
System (Board); Federal Deposit
Insurance Corporation (FDIC); and
Office of Thrift Supervision (OTS),
Treasury.
ACTION: Final rule.
SUMMARY: The OCC, the Board, the FDIC
and the OTS (collectively “the
agencies") are issuing this final rule to
implement the portions of section 305 of
the Federal Deposit Insurance
Corporation Improvement Act of 1991
(FDICIA) that require the agencies to
revise their risk-based capital standards
for insured depository institutions to
ensure that those standards take
adequate account of concentration of
credit risk and the risks of
nontraditional activities. The final rule
amends the risk-based capital standards
by explicitly identifying concentration
of credit risk and certain risks arising
from nontraditional activities, as well as
an institution’s ability to manage these
risks, as important factors in assessing
an institution’s overall capital adequacy.

OCC: For issues relating to
concentration of credit risk and the risks
of nontraditional activities, Roger Tufts,
Senior Economic Advisor (202/8745070) , Office of the Chief National Bank
Examiner. For legal issues, Ronald
Shimabukuro, Senior Attorney, Bank
Operations and Assets Division (202/
874-4460), Office of the Comptroller of
the Currency, 250 E Street, S.W.,
Washington, DC 20219.
Board: For issues related to
concentration of credit risk. David
Wright. Supervisory Financial Analyst,
(202/728-5854) and for issues related to
the risks of nontraditional activities,
William Treacy, Supervisory Financial
Analyst, (202/452-3859), Division of
Ra n k in g Supervision and Regulation;
Scott G. Alvarez, Associate General
Counsel (202/452-3583), Gregory A.
Baer, Managing Senior Counsel (202/
452-3236), Legal Division, Board of
Governors of the Federal Reserve
System. For the hearing impaired only.
Telecommunication Device for the Deaf
(TDD), Dorothea Thompson (202/4523544), Board of Governors o f the Federal
Reserve System, 20th and C Streets,
NW., Washington. DC 20551.
FDIC: Daniel M. Gautsch,
Examination Specialist (202/898-6912),
Stephen G. Pfeifer, Examination
Specialist (202/898-8904), Division of
Supervision, or Fred S. Cams, Chief,
Financial Markets Section, Division of
Research and Statistics (202/898-3930).
For legal issues, Pamela E. F LeCren,
Senior Counsel (202/898-3730) or
Claude A. Rollin, Senior Counsel (202/
898-3985), Legal Division, Federal
Deposit Insurance Corporation, 550 17th
Street, NW ., Washington, DC 20429.
OTS: John Connolly, Senior Program
Manager, Capital Policy (202) 906-6465;
Dorene Rosenthal, Senior Attorney,
Regulations, Legislation and Opinions
Division (202) 906—7268, Office of Thrift
Supervision, 1700 G Street, NW.,
Washington, DC 20552.
SUPPLEMENTARY INFORMATION:

I. Background
The risk-based capital standards
adopted by the agencies tailor an
institution’s minimum capital
requirement to broad categories of credit
risk embodied in its assets and offbalance-sheet instruments. These
standards require institutions to have
total capital equal to at least 8 percent
of their risk-weighted assets.1
Institutions with high or inordinate
' As defined, risk-weighted assets include credit
exposures contained m off-balance-sheet
instruments.

levels o f risk are expected to operate
above minimum capital standards.
Currently, each agency addresses capital
adequacy through a variety of
supervisory actions and considers the
risks o f credit concentrations and
nontraditional activities in taking those
varied supervisory actions.
Section 305(b) of FDICIA, Pub. L.
102-242 (12 U.S.C. 1828 note), requires
the agencies to revise their risk-based
capital standards for insured depository
institutions to ensure that those
standards take adequate account of
interest rate risk, concentration of credit
risk and the risks of nontraditional
activities. This final rule addresses
concentration of credit risk and the risks
of nontraditional activities. The
agencies are addressing interest rate risk
through separate rulemakings. See OCC,
Board and FDIC joint notice of proposed
rulemaking, 58 FR 48206 (September 14,
1993) and OTS final rulemaking, 58 FR
45799 (August 31,1993). In addition,
the agencies issued separate final rules
to implement the section 305
requirement that risk-based capital
standards reflect the actual performance
and expected risk of loss of multifamily
mortgages.
For the risks related to concentration
of credit and nontraditional activities,
the agencies published a joint notice of
proposed rulemaking on February 22,
1994. S e e 5 9 F R 8420. The agencies
received 54 comments, including
duplicate comments among the
agencies. A description of the joint
proposed rule along with a discussion of
the comments follows.
II. Concentration o f Credit Risk
A . P ro p o sed A p p ro a ch

In the joint proposed rule, the
agencies stated that it was not currently
feasible to quantify the risk related to
concentrations of credit for use in a
formula-based capital calculation.
Although most institutions can identify
and track large concentrations of credit
risk by individual or related groups of
borrowers, and some can identify
concentrations by industry, geographic
area, country, loan type or other
relevant factors, there is no generally
accepted approach to identifying and
quantifying the magnitude of risk
associated with concentrations of credit.
In particular, definitions and analyses of
concentrations are not uniform within
the industry and are based in part on the
subjective judgments of each institution
using its experience and knowledge of
its specific borrowers, market areas and
products.
Nonetheless, techniques do exist to
identify broad classes of concentrations

64562 Federal Register / Vol. 59, No. 240 / Thursday, December 15, 1994 / Rules and Regulations
and to recognize significant exposures.
The effective tracking and management
of such risk is important to ensuring the
safety and soundness of financial
institutions. Institutions with significant
concentrations of credit risk require
capital above the regulatory minimums.
As new developments in identifying
and measuring concentration of credit
risk emerge, the agencies will consider
potential refinements to the risk-based
capital standards.
Accordingly, the agencies proposed to
take account of concentration of credit
risk in their risk-based capital
guidelines or regulations by amending
the standards to explicitly cite
concentrations of credit risk and an
institution’s ability to monitor and
control them as important factors in
assessing an institution’s overall capital
adequacy. The joint proposed rule
contemplated that in addition to
reviewing concentrations of credit risk
pursuant to section 305, the agencies
also may review an institution’s
management of concentrations of credit
risk for adequacy and consistency with
safety and soundness standards
regarding internal controls, credit
underwriting or other relevant
operational and managerial areas to be
promulgated pursuant to section 132 of
FDICIA.
B. C o m m e n ts

The vast majority of commenters
supported the agencies’ decision not to
propose any quantitative formula or
standard. Many commenters, however,
expressed a general concern as to how
the agencies would implement and
interpret the joint proposed rule.
Commenters noted with approval the
agencies’ observation that rulemaking in
this area could inadvertently create false
incentives or unintended consequences
that might decrease the safety and
soundness of the banking and thrift
industries or unnecessarily reduce the
availability of credit to potential •
borrowers. Several commenters,
particularly smaller banks, agreed with
the agencies that, while portfolio
diversification is a desirable goal, it may
also increase an institution’s overall risk
if accomplished by lending in
unfamiliar market areas to out-ofterritory borrowers or by rapid
expansion of new loan products for
which the institution does not have
adequate expertise.
A significant number of commenters
went further, however, suggesting that
any requirement for institutions to hold
additional capital for significant
concentrations of credit risk, including
the case-by-case approach proposed by
the agencies, would hurt small banks

with limited portfolios and would
encourage unhealthy diversification.
Under the “Qualified Thrift Lender”
test, for example, thrifts must hold 65
percent of their assets in qualifying
categories. This requirement necessarily
“concentrates” a thrift’s portfolio in
certain types of assets. Agricultural
banks described their position as
similar, and therefore opposed any
requirement of additional capital in
order to compensate for exposures to
concentrations of credit.
One commenter felt that the potential
risk of loss from concentrations of credit
should be reflected in the allowance for
loan and lease losses (ALLL). As
described in the December 21,1993
Interagency Policy Statement regarding
the ALLL, the current amount of the
loan and lease portfolio that is not likely
to be collected should be reflected in the
ALLL. In making a determination as to
the appropriate level for the ALLL, the
policy statement identifies
concentrations of credit risk as one of
several factors to be taken into account
by an institution. While both the ALLL
and capital serve as a cushion against
losses, the difference between the ALLL
and capital is that the ALLL should be
maintained at a level that is adequate to
absorb estimated losses, while capital is
meant to provide an additional cushion
for unexpected future losses. Because
the magnitude and timing of losses from
concentrations are hard to predict and
therefore come unexpectedly,
institutions with significant levels of
concentrations of credit risk should
hold capital above the regulatory
minimums. At the same time,
institutions with concentrations of
credit that are experiencing a
deterioration in credit quality and
collectability should reflect the
increased risk in those concentrations in
the ALLL. Any identifiable loan and
lease losses should be recognized
immediately by reducing the asset’s
value and the ALLL.
C. F i n a l R u l e s

After careful consideration of all the
comments, the agencies have decided to
adopt the proposed rules on
concentration of credit risk without
modification. The agencies believe that
there is not currently an acceptable
method to add a quantitative formula to
the risk-based capital standards in order
to measure concentration of credit risk.
However, the agencies also believe that
institutions identified through the
examination process as having
significant exposure to concentration of
credit risk or as not adequately
managing concentration risk, should

hold capital in excess of the regulatory
minimums.
The agencies have reached this
conclusion for two reasons. First,
although the agencies recognize that in
some cases concentrations of credit are
inevitable, they nonetheless can pose
important risks. Other things being
equal, an institution that is not
diversified faces risks that a diversified
institution does not, and accordingly
presents risks to the deposit insurance
fund that a diversified institution does
not. Second, Congress in section 305 of
FDICIA clearly mandated that these
risks be taken into account in
determining an institution’s capital
adequacy/ OTS, however, does not
believe it is appropriate to, and will not,
implement section 305 in a way that
penalizes thrift institutions for
complying with the statutory Qualified
Thrift Lender test. In addition, the
agencies are not encouraging out-of
territory lending as a response to
diversification concerns.
III. Risks of Nontraditional Activities
A . P ro p o sed A p proach

The agencies proposed to take
account of the risks posed by
nontraditional activities by ensuring
that, as members of the industry began
to engage in, or significantly expand
their participation in, a non^aditional
activity, the risks of that activity would
be promptly analyzed and the activity
given appropriate capital treatment. The
agencies also proposed to amend their
risk-based capital standards to explicitly
cite the risks arising from nontraditional
activities, and management’s ability to
monitor and control these risks, as
important factors to consider in
assessing an institution’s overall capital
adequacy.
New developments in technology and
financial markets have introduced
significant changes to the banking
industry, and in some cases have led
institutions to engage in activities not
traditionally considered part of their
business. Both in the risk-based capital
regulations and guidelines adopted by
the agencies in 1989 and in subsequent
revisions and interpretations, the
agencies have adopted measures to take
adequate account of the risks of
nontraditional activities under the riskbased capital standards. For example,
the FRB, FDIC and the OCC have
recently published for comment a
proposal to change the way that the
counterparty credit risks are measured
and incorporated into a risk-based
capital ratio for equity index,
commodity, and precious metals offbalance sheet instruments. These

ions I
Federal Register / Vol. 59, No. 240 / Thursday, December 15, 1994 / Rules and Regulations 64 5 6 3
proposed changes were unique for each
of the distinct products. The OTS
intends to issue a parallel proposal in
the near future. As nontraditional
activities develop in the future, the
agencies will address each activity on a
case-by-case basis. Thus, to the extent
that section 305 constitutes a mandate
to the agencies to make certain that riskbased capital standards are kept current
with industry practices, the agencies
have been acting consistently with the
intent of section 305.
B . C o m m e n ts a n d F in a l R u le s

While most comments focused on
concentration of credit risk rather than
nontraditional activities, some
commenters noted their approval of the
agencies’ approach with regard to both
parts of the rulemaking. Only a few
commenters criticized the agencies’
proposal on nontraditional activities,
expressing concern that the agencies’
proposals were too vague for examiners
to apply or that the proposals were too
inflexible.
After careful consideration of all the
comments, the agencies are adopting the
joint proposed rule on nontraditional
activities without modification. The
agencies believe that this final rule
appropriately recognizes that the effect
of a nontraditional activity on an
institution’s capital adequacy depends
on the activity, the profile of the
institution, and the institution’s ability
to monitor and control the risks arising
from that activity. The agencies will
continue their efforts to incorporate
nontraditional activities into risk-based
capital. In addition, to the extent
appropriate, the agencies will issue
examination guidelines on new
developments in nontraditional
activities or concentrations of credit to
ensure that adequate account is taken of
the risks of these activities.
IV . P a p e r w o r k R e d u c t io n A c t

No collections of information
pursuant to section 3504(h) of the
Paperwork Reduction Act (44 U.S.C.
3501 e t s e q . ) are contained in this final
rule. Consequently, no information has
been submitted to the Office of
Management and Budget for review.
V . R e g u la t o r y F le x i b il it y A c t S ta t e m e n t

Each agency hereby certifies pursuant
to section 605b of the Regulatory
Flexibility Act (5 U.S.C. 605(b)) that the
final rule will not have a significant
economic impact on a substantial
number of small entities within the
meaning of the Regulatory Flexibility
Act (5 U.S.C. 601 e t s e q .) . This final rule
does not necessitate the development of
sophisticated recordkeeping or reporting

systems by small institutions; nor will
small institutions need to seek out the
expertise of specialized accountants,
lawyers, or managers in order to comply
with the regulation.
V I.

E x e c u t iv e O r d e r 1 2 8 6 6

The OCC and OTS have determined
that this final rule does not constitute
“significant regulatory action” for
purposes of Executive Order 12866.
L is t o f S u b je c t s
12 CFR P a rt 3

Administrative practice and
procedure, Capital risk, National banks,
Reporting and recordkeeping
requirements.
12 CFR P a rt 2 0 8

Accounting, Agriculture, Banks,
Banking, Confidential business
information, Crime, Currency, Federal
Reserve System, Mortgages, Reporting
and recordkeeping requirements,
Securities.
12 CFR P a rt 3 2 5

Bank deposit insurance, Banks,
Banking, Capital adequacy, Reporting
and recordkeeping requirements,
Savings associations, State nonmember
banks.
12 CFR P a rt 5 6 7

Capital, Reporting and recordkeeping
requirements, Savings associations.

(b) A bank receiving special
supervisory attention;
(c) A bank that has, or is expected to
have, losses resulting in capital
inadequacy;
(d) A bank with significant exposure
due to interest rate risk, the risks from
concentrations of credit, certain risks
arising from nontraditional activities, or
management’s overall inability to
monitor and control financial and
operating risks presented by
concentrations of credit and
nontraditional activities;
(e) A bank with significant exposure
due to fiduciary or operational risk;
(f) A bank exposed to a high degree
of asset depreciation, or a low level of
liquid assets in relation to short-term
liabilities;
(g) A bank exposed to a high volume
of, or particularly severe, problem loans;
(h) A bank that is growing rapidly,
either internally or through acquisitions;
or
(i) A bank that may be adversely
affected by the activities or condition of
its holding company, affiliate(s), or
other persons or institutions including
chain banking organizations, with
which it has significant business
relationships.
Dated: N ovem ber 18, 1994.

Eugene A. Ludwig,
Comptroller of the Currency.
FEDERAL RESERVE SYSTEM

A u t h o r it y a n d I s s u a n c e

12 CFR Chapter II

OFFICE OF THE COMPTROLLER OF THE
CURRENCY

For the reasons set forth in the joint
preamble, 12 CFR Part 208 is amended
as set forth below:

12 CFR Chapter I

For the reasons set out in the joint
preamble, 12 CFR part 3 is amended as
set forth below:

PART 3—MINIMUM CAPITAL RATIOS;
ISSUANCE OF DIRECTIVES
1. The authority citation for part 3 is
revised to read as follows:
Authority: 12 U.S.C. 93a, 161, 1818.
1828(n), 1828 note, 1831n note, 3907 and
3909.

2. Section 3.1 is revised to read as
follows:
This part is issued under the authority
of 12 U.S.C. 1 e t s e q . , 93a, 161,1818.
3907 and 3909.
3. Section 3.10 is revised to read as
follows:
§ 3 .10

Applicability.

The OCC may require higher
minimum capital ratios for an
individual bank in view of its
circumstances. For example, higher
capital ratios may be appropriate for
(a) A newly chartered bank;

PART 208—MEMBERSHIP OF STATE
BANKING INSTITUTIONS IN THE
FEDERAL RESERVE SYSTEM
(REGULATION H)
1. The authority citation for Part 208
continues to read as follows:
Authority: 12 U.S.C. 36, 248(a), 248(c),
321—338a, 371d,461.481-486, 601, 611,
1814, 1823(j), 1828(o), 18310, 1831p-l, 3105,
3310, 3331-3351. and 3906-3909: 15 U.S.C.
78b, 781(b), 781(g), 78l(i), 78o-4(c)(5), 78q,
78q -l, and 78w; 31 U.S.C. 5318.

2. Appendix A to Part 208 is amended
by revising the fifth and sixth
paragraphs under “I. Oxren rieiv” to read
as follows:
Appendix A to Part 208— Capital
Adequacy Guidelines for State Member
Banks: Risk-Based Measure
I. Overview
*

The risk-based capital ratio focuses
principally on broad categories of credit risk
although the framework for assigning assets
and off-balance-sheet items to risk categories

64564 Federal Register / Vol. 59, No. 240 / Thursday, December 15, 1994 / Rules and Regulations
d oes in* orporate elem en ts o f transfer risk as
w ell as lim ited mstan< es o f interest rate and
market risk T he framework incorporates
risks arising from traditional banking
activities as w e ll as risks arising from
nontraditional a ctiv ities T he risk-based ratio
d oes not h ow ever incorporate other factors
that can affect an in stitu tion ’s financial
co n d itio n T h ese factors in clu d e overall
interest rate exp osu re, liq u id ity, fun d in g and
market n sk s. the qu ality and level of
earnm gs, in vestm en t, loan portfolio, and
other con cen tration s o f credit risk, certain
n sk s arising from n ontraditional activities,
the qualitv o f loan s and in vestm en ts, the
effectiven ess o f loan and in vestm en t p olicies,
and m anagem ent s overall ab ility to m onitor
and control financial and operating risks,
in clu d in g the risks presented by
con cen tration s o f credit and nontraditional
activities
In addition to evalu atin g capital ratios, an
overall a ssessm en t o f capital adequacy m ust
take account o f th o se factors, in clu d in g, in
particular the lev el and severity o f problem
and cla ssified a ssets For th is reason, the
final supervisory judgem ent on a bank’s
capital adequacy m ay differ sign ifican tly
from co n clu sio n s that m ight be drawn so le ly
from the level o f its risk-based capital ratio.
*
*
*
*
*
Bv order o f the Board o f G overnors o f the
Federal Reserve S ystem , D ecem ber 9,1994

Barbara R. Lowrey,
Associate Secretary of the Board
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Chapter III

For the reasons set forth in the joint
preamble, 12 CFR Part 325 is amended
as follows.
PART 325—CAPITAL MAINTENANCE
1 The authority citation for part 325
is revised to read as follows*
Authority: 12 V S C 1815(a), 1815(b),
1816.1818(a), 1818(b), 1818(c). 1818(t),
1819(Tenth), 1828(c), 1828(d), 1828(i),
1828(n), 1828(o), 1828 note, 1831n note,
18310, 3907, 3909

§ 325.3 [Amended]
2 Section 325 3(a) is amended in the
fourth sentence by adding “significant
risks from concentrations of credit or
nontraditional activities,” immediately
after “funding risks,” and by adding
“will take these other factors into
account in analyzing the bank’s capital
adequacy and” immediately after
‘FDIC” and before “may”
3 The fifth paragraph of the
introductory text of Appendix A to Part
325 is revised to read as follows
Appendix A to Part 325—Statement of
Policy on Risk-Based Capital
* * * * *

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 a bank’s
financial condition These factors include
overall interest rale risk exposure, liquidity
funding and market risks, the quality and
level of earnings, investment loan portfolio,
and other roncentrations of credit risk,
certain risks arising from nontraditional
activities, the quality of loans and
investments, the effectiveness of loan and
investment policies, and management’s
overall ability to monitor and control
financial and operating risks, including the
risk presented by concentrations of credit
and nontraditional activities. 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 a bank’s capital adequacy may
differ significantly from the conclusions that
might be drawn solely from the absolute level
of the bank’s risk-based capital ratio.
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By order of the Board of Directors.
Dated at Washington, DC, this 9th day of
August 1994
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Acting Executive Secretary
OFFICE OF THRIFT SUPERVISION
12 CFR Chapter V

For the reasons set forth in the joint
preamble, 12 CFR Part 567 is amended
as follows:
SUBCHAPTER D— REGULATIONS
APPLICABLE TO ALL SAVINGS
ASSOCIATIONS

PART 567—CAPITAL
1. The authority citation for part 567
continues to read as follows:
Authority: 12 U.S C 1462, 1462a, 1463,
1464, 1467a, 1828 (note).

2. Section 567.3 is amended by
revising paragraphs (b)(3) and (b)(9) to
read as follows:
§567.3 Individual minimum capital
requirements.

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(b)* * *
(3)
A savings association that has a
high degree of exposure to interest rate
risk, prepayment risk, credit risk,
concentration of credit risk, certain risks
arising from nontraditional activities, or
similar risks; or a high proportion of offbalance sheet risk, especially standby
letters of credit;
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(9)
A savings association that has a
record of operational losses that exceeds

the average of other, similarly situated
savings associations; has management
deficiencies, including failure to
adequately monitor and control
financial and operating risks,
particularly the risks presented by
concentrations of credit and
nontraditional activities, or has a poor
record of supervisory compliance
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Dated A ugust 12,1994
By th e O ffice o f Thrift Su p ervision

Jonathan L. Fiechter,
Acting Director

|FR Doc. 94 '30771 Filed 12-14-94, 8*45 amj
BILLING COOES: OCC 4810-33-P; Board 6210-01-P;
FDIC 6714-01-P; OTS 6720-01-P

Full text of Federal Reserve Bank of New York Circulars : 10751. Risk-Based Capital Guidelines

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