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FEDERAL RESERVE B A *
OF NEW YORK
[
Circular No. 9995 1
January 30, 1986
J
PRO PO SED SU PPLEM EN TA L A D JU STED C A PITA L M EA SU RE
Comment Requested by April 25, 1986
To All Depository Institutions in the Second
Federal Reserve District, and Others Concerned:
Our Circular No. 9989, dated January 22, 1986, contained the text of a joint statement issued by the Board of
Governors of the Federal Reserve System, the FDIC, and the Comptroller of the Currency indicating that the three
Federal bank regulatory agencies intend to request public comment on proposed standards for measuring capital on a
risk-adjusted basis. The Board of Governors of the Federal Reserve System has issued such a request, the text of
which follows:
The Federal Reserve Board has issued for public comment a proposal intended to bring its policies on bank capital into
better alignment with the risk profile of the banking industry. The overall objective of this Supplemental Adjusted Capital
Measure is to enhance the strength and promote the safety and soundness of the banking system.
Comment is requested by April 25, 1986.
The proposed guideline, which establishes categories for assets and off-balance sheet items, would supplement, but
not replace, the existing capital standards that the bank regulatory agencies have strengthened in recent years.
Specifically these proposed measures are designed to achieve the following policy objectives:
© to address off-balance sheet exposures, which have expanded rapidly at many large institutions over the last several
years;
© to temper disincentives inherent in the existing guidelines to hold low risk, relatively liquid assets;
© to move U .S. capital adequacy policies more closely in line with those of other major industrial countries; and
© to provide more explicit guidance to bankers and examiners for relating capital to risk profiles.
The proposed guideline would assign assets and certain off-balance sheet items to one of four broad risk categories.
The categories would be weighted according to their relative risk.
The aggregate dollar value o f the assets and off-balance sheet items in each category would be multiplied by the
weight assigned to that category. The sum of these weighted asset values would be the weighted risk asset total against
which actual primary capital would be compared. The resulting ratio would be used in tandem with the current primary and
total capital-to-total asset ratios as a guide to determining minimum capital requirements.
The proposed guideline is designed as an additional tool, in effect providing a “second opinion” , to encourage banks
to make adjustments in either the risk composition of their portfolios or their overall level of primary capital.
The proposal is not meant to take explicit account of all of the many types of risks to which banking organizations are
exposed. The proposed measure also is not intended to substitute for examiner judgment in the assessment of an organiza
tion’s capital adequacy.
In reaching a final judgment o f capital adequacy, examiners would be required to calculate and assess the Supplemen
tal Adjusted Capital Measure, consider all other qualitative risk factors, and, in particular, take into account the level and
severity of examiner-classified assets.
(OVER)
The four categories are briefly described as follows:
Cash and Equivalents — weight, zero percent. This category would include assets generally considered to be
riskless, such as vault cash and balances due from Federal Reserve Banks, balances due from foreign central banks in
immediately available funds, cash items in process of collection, transactions accounts due from U .S. depository institu
tions, and U .S. Treasury securities held in investment accounts with original or remaining maturities of one year or less.
Money Market Risk — weight, 30 percent. This category would cover those assets which generally have little or no
risk of default and a high degree of liquidity. Examples include all holdings of U .S. Treasury securities with over one year
to maturity, all U .S. Government agency securities, those portions of loans that are fully guaranteed by the U .S. Govern
ment, claims of 90 days or less on U .S. depository institutions (excluding those included in Cash and Equivalents), and
other specified money market instruments.
Moderate Risk — weight, 60 percent. This category would cover assets having more credit and liquidity risk than
Money Market Risk items, but significantly less than the standard commercial bank loan portfolio. Included are: all state,
county and municipal securities (except industrial development bonds); claims of over 90 days on U .S. depository institu
tions; all claims on governments and banks in twenty industrial countries; local currency claims on governments and banks
of non-industrial countries to the extent funded by local currency liabilities; commercial letters of credit; standby letters of
credit which are performance related, issued on a secured basis to support broker/dealers or in support of state, county and
municipal securities; and other moderate risk instruments.
Standard Risk — weight, 100 percent. This category would cover those assets generally found in a typical bank loan
portfolio and those not included in the previously listed categories. Included are all commercial and industrial loans and
lease financing receivables, customers’ acceptance liabilities, loans to individuals, loans secured by real estate, farmrelated loans, and all other claims on foreign borrowers. This category is additionally composed of all corporate securities
and commercial paper, industrial development bonds, and all other standby letters of credit that are not included in the
previously listed categories, and loans sold with recourse.
The following table illustrates the calculation of the Supplemental Adjusted Capital Measure with the amounts in
dollars. This example assumes a banking organization with $100,000 total assets, $50,000 in certain off-balance sheet
items, and $7,000 in primary capital.
Risk Category
Cash and equivalents
Money market risk
Moderate risk
Standard risk
Total (including $100,000 in total
assets and $50,000 in Off-Balance Sheet items)
Amount of Onand Off-Balance
Sheet Items
in Category
$
5,000
35,000
30,000
80,000
$150,000
Weighted
Risk Assets
and Off-Balance
Sheet Items
Risk
Weight
X
X
X
X
0
.30
.60
1.00
=
0
10,500
18,000
80,000
=
=
$108,500
Primary capital: $7,000
Primary capital to total assets ratio (as defined under existing guidelines): 7 ,000 = 100,000 = 7.0%
Supplemental Adjusted Capital Measure (as proposed): 7 ,0 0 0 = 108,500 = 6.5%
Enclosed, for depository institutions in this District, is the text of the Board’s official notice in this matter. It
will be published in the Federal Register, and copies will be furnished upon request directed to our Circulars Divi
sion (Tel. No. 212-791-5216). Questions concerning the proposal may be directed to Donald E. Schmid, Manager,
Bank Analysis Department (Tel. No. 212-791-6611). Comments on the proposal, which should refer to Docket
No. R -0567, should be submitted to William W. Wiles, Secretary, Board of Governors of the Federal Reserve Sys
tem, 20th and Constitution Avenue, N .W ., Washington, D.C. 20551.
E. G era ld C o rr ig a n ,
President.
FEDERAL RESERVE SYSTEM
12 CoFoRo Part 225, APPENDIX A
[Reg0 Y,° Docket N o 0 R-0567]
Capital Maintenance;
Supplemental Adjusted Capital Measure
AGENCY;
Board of Governors of the Federal Reserve System0
ACTION;
Proposed Rulemaking„
SUMMARY;
Capital adequacy is one of the critical factors the
Board of Governors of the Federal Reserve System is required to
analyze in taking action on various types of applications, such
as mergers and acquisitions by bank holding companies, and in
the
conduct
of
the Board's
various
supervisory
activities
related to safety and soundness of individual banks and bank
holding companies and the banking system.
In April 1985,
the
Board announced revised Guidelines for minimum and appropriate
levels
of
chartered
System,,
capital
banks
for
that
bank
are
holding
members
(50 Fed„ Reg„ 16057
of
(1985 ))
companies
the
and
Federal
state
Reserve
These revised Guidelines,
contained in Appendix A to the Board's Regulation Y, 12 C o F 0R 0
Part 225, were designed to establish,
in conjunction with other
federal bank regulatory agencies, uniform capital standards for
all
federally regulated
size0
banking
organizations
of
These uniform capital standards were based on ratios of
primary and total capital to total assets.
(Enc. Cir. No. 9995]
regardless
2
The
factors
Board historically
in addition
has
to relying
on
taken
account
of
capital-to™ total
risk
assets
ratios, and the nature and degree of risk exposure have always
been
important
adequacy0
subjective
factors
in
assessing
capital
The Board believes that there is a need to modify
its capital policies to be more explicitly and systematically
sensitive
to
organizationso
the
risk
exposure
Consequently,
of
that
banking
the Board is proposing to amend
'its current Guidelines by adding the
adjusted capital measure
individual
following
the Board would
supplemental
consider
in
tandem with existing minimum primary and total capital“to-total
assets ratios in analyzing the capital levels of bank holding
companies and state chartered banks that are members of the
Federal Reserve SystemQ
pursuant
to
section
910
Supervision Act of 1983
The Board has previously determined
of
the
("ILSA")
international
(12 UoSoCo
Lending
390(a)(2))
that
application of capital standards to bank holding companies on
the same basis as banks
is necessary
to maintain
adequate
levels of capital in individual banking organizations and the
banking system and thus to meet the purposes and objectives of
ILSAo
DATE t
Comments must be received by April 25, 19860
ADDRESSs
All
comments,
which
should
refer
to Docket N o c
R-0567, should be mailed to William Wo Wiles, Secretary,
of
Governors
of
the
Federal
Reserve
System,
Constitution Avenue, NoW0, Washington, D„Co
20th
20551,
Board
and
or should
3 -
be delivered to the Office of the Secretary* Room 2200* Eccles
Building* 20th and Constitution Avenue* N 0W 0* between the hours
of 8§45 a 0m 0 and 5?15 p 0m o weekdays,.
Comments may be inspected
in Room 1122* Eccles Building between 8?45 a 0m 0 and 5 s15 p 0m 0
weekdays 0
FOR FURTHER INFORMATION CONTACT§
Associate Director
Director
Richard Spillenkothen* Deputy
(202/452-2594)* Anthony Go Cornyn* Assistant
(202/452-3354)* or Catherine Pich6 * Financial Analyst
(202/728-5871)* Division of Banking Supervision and Regulation
or
James
Eo
(202/452-3513)
Scott*
Senior
Attorney*
Legal
Division
of the Board's staff? or Andrew Spindler* Vice
President* Federal Reserve Bank of New York (212/791-5846)c
SUPPLEMENTARY INFORMATIONs
!o
BACKGROUND
The Need for a Supplemental Adjusted Capital Measure„
In announcing its revised Capital Adequacy Guidelines
in April 1985*
continuing
50 Fedo
concern
ratios based on
Interpreted
proposed
basis*
that
the
Reg0 16057*
the
total
to exclude
the Board expressed
emphasis
its
in the Guidelines
amount of assets
considerations
of
should
risko
on
not be
The
Board
to deal with the issue of risk on a case-by-case
stating?
(1 ) that it would assess the overall capital
position of a banking organization by taking account not only
of the volume of the organization's risk assets but also of its
off-balance-sheet
explicitly
risks
included
in
(although
the
capital
such
risks
ratios)?
were
(2 ) that
not
the
4 Guideline ratios were minimums and banking organizations with
high levels of on= or off-balance-sheet risk would be expected
to operate above the minimum ratios, and
organizations
would
be
expected
to
avoid
(3) that the banking
the
practice
of
attempting to meet the minimum ratios by decreasing the level
of liquid assets relative
to total assetsQ
The Board also
indicated that it would continue to review the need for more
explicit
procedures
for
factoring on=
and of £■-balance-sheet
risks into the assessment of capital adequaey0
In response to comments received
the 1985
Board
revisions
acknowledged
in connection with
to the Capital Adequacy Guidelines, the
that,
in addition
to
an
assessment
of
minimum and adequate capital levels based solely upon the total
quantity of assets, there would be significant analytical value
to a systematic evaluation of appropriate capital levels based
upon consideration of the degree of risk associated with such
assetso
Several developments over the last few years suggest
the need to modify the Board's capital policies to make them
more sensitive to certain risk exposures of individual banking
organizationso
First,
there has been a substantial growth in
off-balance-sheet risks--a phenomenon that does not appear to
have been significantly tempered by the subjective factoring of
these risks into overall assessments of capital adequacyQ
One
indication of this trend has been the growth In standby letters
of credit issued by multinational banks, which have Increased,
-
5
on average, from 5 08 percent of the aggregate assets of those
banking organizations at the end of 1981 to 1104 percent of
assets
at midyear
19850
Among
multinational
bank
holding
companies,, this one category of off“balance-sheet risk ranges
from less than five percent to well over 15 percent of total
assetSo
In absolute terms,
the volume of standby letters of
credit for the multinational institutions has more than doubled
from $49 billion in 1981 to $105 billion at midyear 19850
Significant
growth
binding loan commitments,
has
also
occurred
Interest
legally
including those issued in connection
with commercial paper programs and Euromarket
facilities,,
in
note
issuance
The advent of other financial innovations, such as
rate
significant
swaps,
has
also had
of f“balance-shoe t
the
result
exposure,.
of
Taken
creating
together,
off“balance-sheet items represent a very substantial exposure
that is not now factored explicitly into the Federal Reserve's
minimum capital ratios0
Second,
low-risk,
there is some evidence that the holdings of
liquid
assets
in
relation
to
total
assets,
particularly by the larger banking organizations, have declined
over recent yearsc
This suggests that, while capital to total
assets ratios may have improved over time, capital in relation
to risk exposure may not have improved commensurately„
multinational
banks,
liquid
assets
(defined
as
For the
bank
certificates of deposit, Fed funds sold and securities maturing
within one year)
have declined as a percent of total assets
6
from 15 06 percent
June 30* 1985„
at the end of 1981
to 12 08
percent
at
Beyond this* examiners have generally observed
decreases in liquid assets at banks regarded as more aggressive
with respect to capital management and growth* and it has been
argued
that existing capital policies provide
incentives
to
deemphasize low-risk* low-yield businessQ
While
there may be a number
of reasons
for
these
balance sheet adjustments* the Board is concerned that they may
be*
in
part*
a
response
to
the
imposition
of
capital
requirements that do not distinguish explicitly among various
risk
categories
allowance
for
of
the
assets
lessened
low-risk activitieso
to
be
reducing
Thus*
their
and
that
threat
do not
make
to capital
explicit
inherent
in
some banking organizations appear
holdings
of
low-risk
assets
and
deemphasizing their conduct of low-risk activities in an effort
to meet more stringent capital requirements0
Although
these
adjustments may improve or otherwise maintain capital ratios at
what appear to be acceptable levels* they do not* especially in
conjunction
strengthen
with
an
the
growth
organization's
adjustments could*
under
in
off-balance-sheet
risk
profileQ
risks*
Indeed*
certain circumstances*
such
undermine an
organization's financial conditionD
Third*
increased
competition
points
toward the need for a greater degree of convergence
in the
policies
of
various
adequacy
of
multinational
international
countries
for
banking
supervising
the
organizations0
capital
In
this
7
regard,
many
European
capital
measures,
and
countries
a
similar
have
developed
supervisory
risk-based
approach
is
evolving in JapanQ
Finally, the growth and change in the nature of risks
to which banking organizations have become exposed suggest the
need to provide more explicit guidance to bankers and examiners
for assessing capital needs in relation to riskQ
The
Purpose
of
the Proposed
Supplemental Adjusted
Capital
Measure o
The Board believes that adoption of a supplemental
adjusted capital measure based upon an assessment of distinct
but necessarily broad risk categories could provide a valuable
additional analytical tool in assessing the financial strength
and
stability of
individual
system as a whole0
organizations
and
the
banking
Even such a limited risk-adjusted measure
of capital adequacy would provide the Board with a supplemental
means of assessing whether
the capital
level of
individual
banks and bank holding companies is fully adequate to serve the
key functions of capital, namely to provide a buffer to absorb
losses in times of poor performance,
depositors"
funds,
to
help
maintain
to promote the safety of
public
confidence
in
banking organizations, and to support the reasonable growth of
such organizations.
that
an
To achieve these purposes,
organization’s
capital
base
bear
a
it is essential
reasonable
relationship to the risk profile of that organization„
8
In addition to providing another
capital adequacy,
the proposed
tool for assessing
supplemental adjusted capital
measure will further certain policy objectives..
an
assessment
of
off-balance-sheet
risk
as
By including
part
of
the
supplemental adjusted capital ratio, this measure would permit
the Board
to address off-balance-sheet exposures,
which,
as
indicated above, have expanded rapidly over the last several
year So
The proposed measure would also temper
disincentives
inherent
in
the
existing
low-risk, relatively liquid assets0
somewhat the
Guidelines
In addition,
to hold
adoption of
this proposal would begin to move capital adequacy policies in
the United States more closely
major
industrial
countries0
in line with
Finally,
the
those of other
proposed
measure
would provide more explicit guidance to bankers and examiners
for relating capital to risk profiles..
2 .
DESCRIPTION OF THE PROPOSAL
Introduction and Overview
This
measure
proposal
that would
Guidelines.,
involves
supplement
a
risk-sensitive
the Board's
capital
existing
Capital
The proposal is based upon an additional capital
ratio, in this case a ratio of primary capital to total assets
adjusted for risk, that the Board will consider in tandem with,
rather than in place of, the minimum primary and total capital
ratios
defined
in
the
current
Guidelines.,
The
proposed
supplemental adjusted capital measure would be incorporated as
an
additional
section
of
the
current
Capital
Adequacy
Guidelines, Appendix A to Regulation Y, 12 C.FoR. Part 225•
9
Moreover, while the proposal endeavors to relate in a
more systematic fashion an organization's capital needs to its
overall
risk
profile,
the
proposed
supplemental
adjusted
capital ratio does not purport to take explicit account of all
of the many types of risks to which banking organizations are
exposedo
For example,
account
of
the
risks
the proposal does
associated
with
not
take explicit
significant
asset
concentrations, or with exposure to interest rate changesQ
addition,
the measure
examiner
judgment
capital
adequacyQ
is
in
the
If
the
not
intended
assessment
to
of
supplemental
an
substitute
In
for
organization's
capital
measure
is
adopted,
examiners and regulators will
consider
the
factors,
such as the quality of an organization's management,
entire
range
of
still be required
qualitative
and
subjective
internal systems and controls, and lending standards,
as other relevant financial factors,
to
as well
such as the quality of
assets and the strength, trend and variability of earnings and
liquidity,
in order to assess fully an organization's capital
adequacyo
The Supplemental Adjusted Capital Ratio„
The
proposed
supplemental
adjusted
capital
measure
would relate primary capital, as defined in the Board's current
Guidelines,
to total assets weighted for risk considerations.
To determine the asset portion of the supplemental adjusted
capital ratio, assets and certain off-balance-sheet items are
assigned
to one of four broad risk categories and weighted
10
according
to
the
relative
risk
of
that
category „
The
determination of asset groupings and the assignment of weights
primarily
reflect
credit
risk
considerations, with
sensitivity to liquidity concerns„
some
The types of assets and
off-balance=sheet items in each category and the rationale for
assigning certain items to a particular category are discussed
belowo
The proposed amendment to the Guidelines contains
a
listing of the components of each risk category and the weight
assigned to that categoryD
a°
Category Is
Cash and equivalents,
This category includes
assets generally considered to be riskless such as vault cash
and balances due from Federal Reserve Banks, balances due from
foreign central banks in immediately available funds, and "near
cash" assets, such as cash items in the process of collection
and
transaction
institutions ^
securities held
accounts
In
due
addition,
from
united
UoSo
depository
States
Treasury
in the investment account with original
or
remaining maturities of one year or less are included In this
category,,
These items are assigned a zero weight,,
The terms U.S, banks and U.S, depository institutions for
purposes of this proposal refer to depository institutions
chartered under the laws of the United states and include the
foreign branches of these institutions0 while banks chartered
in the U„So that are subsidiaries of foreign banking
organizations are also included in the definition, U»So
branches and agencies of foreign banks are not considered to be
U„So banks or depository institutions for purposes of the
supplemental adjusted capital measure,,
11
bo
Category II §
Money market risko
The assets included in
this category generally have little or no risk of default and a
high degree of liquidityQ
of
long-term
This category includes all holdings
(remaining maturity of over
one
year)
United
States Treasury securities, all United States government agency
securities,
and
guaranteed
by
short-term
(90
institutionso
those
portions
the United
days
Other
or
of
States
less)
money
loans
government,
claims
market
that
on
are
as
fully
well
as
U 0S G depository
instruments
comprise
a
significant portion of the remaining assets in this category,
including acceptances of other U«So banks, all Fed funds sold,
loans to broker/dealers secured by United States Treasury or
agency securities, and securities purchased under agreements to
resello
In
addition,
account assets,
this
which are
category
includes
typically marked
all
trading
to market on a
regular basisQ
Finally, all legally binding loan commitments,
including
note
issuance
categoryD
These items are assigned a 30 percent risk weighto
Co
Category Ills
2/
facilities—
Moderate risk0
are
included
in this
This category is composed of
those assets with more credit and liquidity risk than those in
Category II, but significantly less risk than the standard
2/ a note issuance facility is a medium-term (5 to 7 years)
commitment to help a borrower obtain short-term financing0
Participating banks commit to provide funds under a revolving
credit or standby arrangement if the client fails to sell notes
within a range of predetermined contractual rates0
12
commercial
bank
ares
state,
all
(excluding
loan
governments
county,
and
countries?
banks
development
of
in
this
industrial
longer-term
banks
(as defined
(as
In
defined
industrial
countries
to
Also
collateralized
by
the
extent
included
by other
the SEC), commercial
letters of credit which
are
funded
are
support
of
SCM
securities
Industrial development bonds)0
local
loans
marketable
letters
by
to
securities
of credit,
and
performance-related,
issued on a secured basis to support broker/dealers,
in
claims
all claims on
countries
of
category
("SCM") securities
bonds)?
acceptances
3 /
liabilities0— /
broker/dealers
standby
municipal
in
and local currency claims on governments and banks
non-industrial
currency
and
Included
on U»So depository institutions?
herein)? holdings
of
portfolio0
industrial
(over 90 days)
-
(excluding
those
or
or
issued
supporting
This risk category is assigned
a 60 percent weighto
do
Category
IV?
standard
riskQ
This
category
generally
comprises those assets found in a typical bank loan portfolio
and those not
included
in the categories
category includes commercial and
loans
to
individuals,
loans
aboveQ
Thus,
this
industrial loans and leases,
secured
by
real
estate,
farm-related loans, and all other claims on foreign borrowers,,
This category also includes loans to nondepository financial
2/
"Banks" are defined to include their foreign branches and
are categorized by the country under whose laws they are
chartered 0
13
-
institutions including insurance companies, mortgage companies,
finance companies and bank holding companies0
The category is
further
and
paper,
comprised of all corporate
securities
industrial development bonds,
commercial
and all other
standby
\
letters
of
credit
development bonds)
Finally,
the
(including
those
backing
industrial
that are not included in categories abovee
category
includes
loans
sold
with
recourse,
including those that, in the case of bank holding companies,
may not,
under
generally accepted accounting
retained as assets on the balance sheeto
principles,
(Under bank
be
call
report instructions, loans sold with recourse are not removed
from the balance sheeto)
This risk group contains the bulk of
banking assets, including many of significantly dissimilar risk
character isticso
This category is assigned a 100 percent risk
weigh t .
Table I contains a list of
off“balance-sheet
items
found
the types of assets
in each
risk
category
and
and
the
weighting of each category0
TABLE Is
RISK CATEGORIES AND WEIGHTS
CASH AND EQUIVALENTS (Weight 0%)
’ uoSo currency"and coin and balances due from Federal
Reserve banks
Cash items in process of collection and trans
action accounts due from u 0S 0 depository
institutions*
* UoSo depository Institutions refers to depository
institutions chartered under the laws of the United
States and the foreign branches of those institutions,
and such UoSo depository institutions that are
subsidiaries of foreign banking organizations0 UoS.
branches and agencies of foreign banks are not UoSo
depository institutions0
14
Short-term** u „ S 0 Treasury securities in investment
account
Foreign currency and balances due from central
banks in immediately available funds
MONEY MARKET RISK (Weight 30%)
Long-term UoS„ Treasury securities held in
investment account
UoSo Government agency securities held in investment
account
Those portions of loans that are fully guaranteed by u . S »
Government
Short-term claims (90 days or less) on u»S0 depository
institutions
Acceptances of other UoS. banks
All Fed funds sold
Loans to broker/dealers collateralized by
UoSo Treasury and agency securities, and
securities purchased under agreement to
resell (RPs)
Assets held in trading account
Legally binding loan commitments (including
note issuance facilities)
MODERATE. RISK (Weight 60%)
All state, county and municipal (SCM) securities
held in investment account (excluding industrial
development bonds)
All other claims on UoSo depository institutions
All claims on governments and banks of industrial
countries
Acceptances of banks in industrial countries
Local currency claims on governments and banks
of non-industrial countries***
Loans to broker/dealers collateralized by other
marketable securities
Commercial letters of credit
Standby LCs (net) backing SCM securities (excluding
those backing industrial development bonds),
supporting broker/dealers on secured basis or
performance related
** Short-term Treasury securities are those with an original
or remaining maturity of one year or less0
***
the extent funded by local currency liabilities,,
If
not funded by local currency liabilities, such local
currency claims are included in the Standard Risk
category„
to
15
STANDARD RISK (Weight 100%)
All assets found in a typical bank loan portfolio,
includ ing s
All commercial and industrial loans and leases
Residential real estate and individual loans
Loans to nondepository financial institutions
All other claims on foreign obligors
Corporate securities and commercial paper, and
industrial development bonds
Customers0 acceptance liabilities****
All assets not included elsewhere
All other standby LCs (net), including those
backing industrial development bonds
Loans sold with recourse*****
**** Include customers8 liabilities associated with acceptance
participations purchasedo
Participations sold are
included in Money Market Risk if the purchaser is a UoSo
depository institution, Moderate Risk if the purchaser is
a bank in an industrial country, and Standard Risk for
all other purchasers0
***** Include loans involved in transactions of the type that
are required to be reported as borrowings (as opposed to
sales) under bank call report instructions0 For purposes
of the supplemental adjusted capital measure, bank
holding companies should include the same type of items
in this category even if, under generally accepted
accounting principles, such loans sold with recourse may
be treated as sales and removed from the balance sheet „
16
The
aggregate
dollar
value
of
the
category would be multiplied
by the weight
categoryo
weighted
The
sum of
these
items
in
assigned
values
would
each
to
that
be
the
weighted risk asset and off-balance sheet total against which
actual primary capital would be compared0
dividing
primary
capital
by
this
The ratio derived by
weighted
total
would
defined as the supplemental adjusted capital ratio0
provides an example of how this supplemental
be
Table
II
adjusted capital
ratio would be calculated„
Table iis
Illustration of Calculation of Supplemental
Adjusted Capital Measure
Risk Category
Dollar Amount of
Items in.Category
Cash and equivalents
Risk
Weight
Weighted Risk
Assets and
Off-BalanceSheet I terns.
5,000
X
0
0
Money market risk
35,000
X
o30
10,500
Moderate risk
30,000
X
o60
18,000
Standard risk
.80,000
X
loOQ
80,000
108,500
150,000
Total (including
$100,000 in aggregate
assets and $50,000
in off-balance sheet items)
Aggregate primary capital
Primary capital to total
assets ratio (as defined
under existing Guidelines)
Supplemental adjusted
capital ratio
(as proposed)
7,000
7,000
100,000
7,000
108,500
-
7 o0 %
6 o5 %
Notes This example assumes a bank with total assets
(before
deducting the loan lose reserve) of $100,000, off-balance
sheet items of $50,000, and primary capital of $7,000o
17
The
choice
off-balance-sheet
reasonable risk
of
items
groupings
reflects
for
an
assets
effort
to
and
delineate
categories while avoiding excess complexity0
In addition, the Board paid close attention to the treatment
afforded assets and off-balance-sheet
asset systems abroad0
certain
Finally,
items and where
items
decisions
to set relative
in similar
on where
risk
risk
to slot
weights
were
influenced by a desire to avoid artificial pricing distortions
which might lead to awkward or undesirable changes in credit
flows or financing practices,
implied
capital
costs
and to temper
between
items
in
the gradation of
the
various
risk
categor ies 0
In developing this proposal,
policy decisions
off-balance-sheet
distinction
the Board made difficult
involving the treatment of country risk and
items„
between
claims
First,
on
the
proposal
governments
and
draws
a
banks
in
industrial countries, i.e0, those presently designated as such
by the international Monetary Fund
claims on governments and banks
This
distinction
represents
(IMF) and World Bank, versus
in all other
4 /
countries.*-'
the most acceptable
alternative
among a variety of possible groupings Intended to distinguish,
i/ industrial countries as currently designated by the IMF
and World Bank include Australia, Austria, Belgium, Canada,
Denmark, Finland, France, Iceland, Ireland, Italy, Japan,
Luxembourg, Netherlands, New Zealand, Norway, Spain, Sweden,
Switzerland, united Kingdom, West Germany.
18
in a broad sense, among differences in transfer risk, that is,
the possibility
that
an
asset
currency of payment because of
cannot
be
a lack of
serviced
in
the
foreign exchange
needed for payment in the country of the obligor 0
The Board
views the approach embodied in this proposal as more workable
than a country by country evaluation of transfer risk that
would require frequent updating and revision,,
All
claims on banks
countries would be included
and governments
in
industrial
in the Moderate Risk
category,,
This treatment is designed to minimize the possible distortions
in credit flows in the international
which
would
result
from
interbank money market
substantially
different
capital
requirements for claims on domestic and foreign banks competing
alongside one another in the marketo
countries
The list of industrial
includes just about all countries with significant
international banks, while excluding the countries viewed by
the market as likely to entail a meaningful degree of transfer
risk.
Claims involving transfer risk on banks and governments
in non-industrial countries, and all claims on pr ivate nonbank
borrowers
in
Standard
Risk
industrial
foreign
countries,
category,,
countries
for
would
Although
risk
the
asset
be
included
proposed
purposes
in
group
the
of
currently
comprises those nations designated as such by the IMF and World
Bank, developments in the future could warrant a modification
of this designation,,
Thus,
the designation
for
risk
asset
19
purposes may not at all times coincide with the IMF and World
Bank listso
The
proposed
treatment
of
claims
on
foreign
banks
incorporated in this proposal differs from the typical approach
in
risk-based
countrieso
capital
measures
Generally speaking,
used
in
other
those measures
industrial
assign
a very
low (often zero) risk weight to claims on their own government,
while
assigning
claims
on
all
other
governments
equivalent of a standard risk categoryQ
claims,
however,
the typical approach
to
the
in terms of interbank
is to combine claims on
all foreign and domestic banks and place both of these types of
assets in the same relatively low risk category,,
this
latter
approach
was
developed
prior
to
the
By and large,
advent
significant concerns over country or transfer riskQ
it
does
not
recognize
how
countries can be affected
claims
by
of
Therefore,
on
banks
in
different
transfer
risk,
including
those
claims on banks in the less developed countries which have been
involved in extensive debt restructurings»
Moreover,
such an
approach has the anomalous effect of placing claims on foreign
banks in a lower risk category than claims on the governments
that are generally viewed as providing the safety net for these
bankso
Finally, assigning a lower risk treatment to claims on
foreign banks than on their governments could create unintended
incentives to substitute claims on banks
for claims on other
parties that may be involved in debt restructurings„
For these
reasons, the Board felt it necessary to depart from the more or
less typical approach to the treatment of interbank claims0
20
The Board also made certain basic decisions involving
the treatment of various types of off-balance-sheet items„
proposal divides
componentso
standby letters
of credit
into
The
two broad
The first such component, which is included in the
Moderate Risk category, consists of performance bonds, secured
letters
of
credit
supporting
those
state
and
supporting
component,
category,
supporting
local
government
industrial
which
would
consists
of
be
and
securities
other
to
the
standbys,
industrial
standbys
(excluding
development bonds)„
assigned
all
backing commercial paper,
broker/dealers,
The
Standard
including
second
Risk
those
development bonds,
and
other financial instruments and loans included in the standard
Risk category,.
of
This broad distinction is based on the nature
the underlying
credit risk
and how
that risk
treated if it were on the balance sheet0
is
generally
consistent with
the
way
off-balance-sheet items are treated
would
be
The distinction also
in which
comparable
in risk asset
frameworks
abroad„
The proposal places two other off-balance-sheet items,
legally binding commitments and note issuance facilities in the
Money Market Risk category0
the Money Market Risk
The placement of these items in
category,
rather
than a higher
risk
category, was influenced by the following considerations?
these
commitments
contingent,
often
character
retain
a conditional,
as a consequence of
as well
(1)
as
"adverse material
change" clauses and other covenants which may enable banks to
-
21
avoid losses by avoiding or curtailing drawdowns;
standby letters of credit,
when drawings
(2) unlike
on commitments
do
occur they carry a greater likelihood that the resulting assets
will be of higher quality;
(3) supervisors should be evaluating
the volume of these commitments in terms of the overall funding
capacity of a bank, not just its capital adequacy; and, perhaps
most importantly,
(4) it seems more appropriate
relatively low capital charge
to impose a
to give banks time to adjust
their commitment policies to any amendment to the Guidelines
that includes off-balance-sheet risk0
There
associated
are other
with
aspects
securities
and
of
off-balance-sheet
foreign
exchange
activities and managing interest rate risk,
rate swaps0
risk
trading
including interest
In this regard, adoption of a supplemental capital
measure that takes account of some types of risk may require
the use of more refined supervisory techniques to measure
risk
involved
In
securities
and
foreign
exchange
activities at those banking organizations which
Involved in such activities,
and
(2)
(1)
trading
are heavily
interest rate exposure
resulting from the rate sensitivity of assets, liabilities and
off-balance-sheet activities„
As discussed below, the Board is
seeking comment on how some of these risks might be assessed
within the proposed supplemental adjusted capital framework0
Administration of a Risk-Based Capital Measure,
As the current
Guidelines emphasize with respect to primary and total capital
ratios, the proposed supplemental adjusted capital ratio would
22
be used as a guideline in the assessment of capital adequacy,,
The
Board
wishes
calculation
of
to
emphasize
that
a supplemental
the
capital
introduction
measure
and
adjusted
to
account for some forms of risk would in no way lessen the need
for
supervisors and examiners to make
judgments on capital
adequacy— judgments which reflect a broad mix of qualitative
and
quantitative
considerations0
Thus,
in
assessing
an
organization's capital adequacy, examiners must consider, among
other things,
the quality,
trend and variability of earnings?
liquidity and the structure of liabilities?
vulnerability to
interest rate changes?
the quality of management,
systems
and
and
controls
operating
internal
procedures?
effectiveness of loan and investment policies?
the
and the quality
of loans and investments*,
In the assessment of capital adequacy,
considerations are especially criticalo
composition
and profile of
These include the risk
the loan portfolio,
sovereign risk concentrations,
examiners
of
must
including,
capital
take
adequacy
into
credit
and
and the level and severity of
examiner classified and criticized assets,.
assessment
asset quality
can
account
be
all
Before an overall
made,
of
therefore,
these
factors,
in particular, the level and severity of classified
assets o
The Board proposes to use the supplemental adjusted
capital ratio
in tandem with the current primary and total
capital^ to- total assets
adopted,
individual
ratios,,
banking
Thus,
if this proposal
organizations
would
still
is
be
23
subject to an overall constraint on total leverage,
with the
supplemental adjusted capital measure used as an additional
guideline designed to encourage banking organizations to make
appropriate adjustments in either the risk composition of their
portfolios or
their overall
level of primary
capitals,
To
minimize public confusion and facilitate tandem operation, this
proposal
contemplates
eliminating
existing
zones
for
total
capital, while retaining the current minimum guidelines for the
primary and
total capital
ratios,
at 5 05 percent
and
6 o0
percent, respectively, for all banking organizations.
As is the case under the Board's current Guidelines,
this
proposal
envisions
that
supplemental
adjusted
capital
ratios would be calculated for all state member banks and bank
holding
companies
on
a consolidated
basis,,
(Bank
holding
companies with less than $150 million in consolidated assets
would be exempt under the same terms and conditions as provided
in the current Guidelines0)
The risk asset framework would be
employed to evaluate the capital of all banking organizations
regardless of size since the rationale
needs
to risk
institutions„
profiles
applies
Nonetheless,
to
primarily
adjusted
operative
at
both
large
and
small
it is important to point out that
many of the considerations driving
supplemental
for relating capital
capital
larger
institutions
the development of
measure
banking
have
at
this
time
organizations0
particular,
these
been
the
participants
in those off-balance-sheet activities
this
are
In
primary
that the
proposed standards seek to address, and these organizations in
24
recent years have also decreased
their relative holdings of
liquid assetSo
In light of these considerations, the Board proposes
to establish
numerical
zones
for
the
supplemental
adjusted
capital ratio, but to limit the application of such zones to
banking organizations with assets of $1 billion or more
regional
and
multinational
institutions)0
For
(the
smaller
organizations, those with assets totaling less than $1 billion,
supplemental adjusted capital ratios would be computed
in the
same manner as for larger institutions, but zones would not be
employedo
Rather
a
smaller
organization's
supplemental
adjusted capital ratio would be calculated and considered in
light of the quality and diversification of its loan portfolio
and other local risk consider at ions»
In this regard,
it is
important to note that the proposed risk-adjusted asset measure
is not
exposure
particularly
within
mar kets-*=exposures
susceptible,,
with
to
local
to
which
asset
operate
to
large
concentrations
communities
small
Therefore, small
significant
expected
sensitive
and
banks
minimum
capital-to-total assets ratios,
lending
particularly
(as well as large) organizations
concentrations
above
are
of
will
primary
generally
and
be
total
even if they have relatively
high supplemental adjusted capital ratios0
For organizations with assets of $1 billion or more,
the tandem operation of the supplemental adjusted capital ratio
and the minimum primary capital ratio is illustrated by the
-
following
proposed
zone
25 -
descriptions
for
the
supplemental
adjusted capital ratios
lo
Zone 1 - Organizations with supplemental adjusted
capital ratios in this zone would be presumed to
have adequate capital in relation to risk,
barring significant asset quality or other
financial or operating concerns,
including
excessive asset concentrations0
For these
organizations, assets could be increased even if
the primary capital-to-total asset ratio dropped
close to the existing minimum threshold of 5 05
percent„
2o
Zone 2 - Organizations with supplemental adjusted
capital ratios in this zone would be considered
to have acceptable capital in relation to risk,
depending upon where they were within the zone,
as well as how the institution fared on the basis
of qualitative and financial considerations„
Particularly for organizations in the upper half
of the zone, there might be scope for asset
growth
and
declines
in
the
primary
capital-to-total asset ratio,
barring asset
quality or other financial concernSo
3c
Zone 3 - Supplemental adjusted capital ratios in
this zone would be below the minimum acceptable
levelo
Organizations with such supplemental
adjusted ratios would be presumed to have
inadequate capital in relation to risk even if
their primary capital-to-total assets ratios were
above
the
5 C5 percent
minimum,,
Such
organizations would be expected to develop and
submit to their supervisory authorities plans to
bring their supplemental adjusted ratios to an
adequate level, either by raising new capital or
by adjusting the risk profile of their activitiesQ
The proposal does not specify at this time the actual
ratio cutoffs
for
zoneso
Instead,
receive
and
the various
supplemental
it would appear
evaluate
public
adjusted
capital
to be more appropriate
comments
on
the
to
supplemental
adjusted capital measure and to use the information received in
establishing numerical zonesc
The Board hopes
to encourage
26
commenters to focus their comments on
the underlying policy
considerations of this proposal rather than on the mechanical
featureso
The Board will provide an additional opportunity for
public comment on the numerical zones0
The Board does invite comment on the factors that it
should consider
in setting the numerical zones0
To that end,
the Board offers the following comments on how it proposes to
set the zoneso
Since a principal goal of the supplemental
adjusted capital measure
is to relate capital needs
to risk
profiles,, the Board will attempt to establish zones at levels
that would affect primarily any
institution
with
assets
in
excess of $1 billion whose capital position is less than fully
adequate in relation to its risk profile0
will attempt to establish numerical
consistent with
banking
system
prevailing
and
with
zones
aggregate
the
Moreover, the Board
that are broadly
capital
banking
levels
system's
in
ability
the
to
generate capital from retained earnings and from the issuance
of primary capital securities,,
Banking organizations
will
be able
to comply with
supplemental adjusted capital measures in several ways* some of
which
do not
require
raising
new
external
capital„
For
example, institutions can moderate their growth and/or increase
their earnings retention,,
More importantly, however, within a
risk sensitive capital framework, an organization can raise its
supplemental
adjusted
capital
ratio
by
reducing
its
risk
profile over
time, even though such on- or off-balance-sheet
27
adjustments may not necessarily result in lower
total ass@tsQ
This could be done by reducing off=balance=sheet
risk
or
by
placing proportionately greater emphasis on those balance sheet
activities that carry lower risk weightsc
For all of these reasons,
with certainty how much,
to be raised
it is not possible to state
if any, additional capital would have
in response to the advent of this proposal0
It
can be said, however, that a measure that relates capital needs
to
risk
profiles
should
temper
the
unintended
incentives
associated with sole reliance on capital” to-total asset ratios
and will encourage those organizations with high risk profiles
either
to raise
additional primary capital
or
to
curtail
the
to support
scope
of
their
risk-bearing
activities
these
activitieSo
The Board believes both of these responses will
enhance the financial strength of individual organizations and
promote the safety and soundness of the banking sysfcenu
3o
ISSUES FOR FURTHER CONSIDERATION0
While
proposal,
seeking public comments on all aspects of the
the Board requests comment in sis specific areas as
described below0
First,
Risk
category
should
by
the Board
adding
an
further
additional
refine
category
the Standard
that
would
contain certain specified assets that entail risks higher
those typically associated with
the Standard Risk group?
than
In
particular, should the Board include a category to take account
of
the
higher
risks
associated
with
certain
nonbanking
activities and the holding of nontraditional loans or assets?
28
The Board could,
for example,
assign a weight substantially
above 100 percent for all assets held by a particular banking
organization
not
in connection with certain high risk activities
considered
organizationso
traditional
activities
In the alternative,
for
banking
the Board could consider
such nontraditional, high risk activities on a nonconsolidated
basis and require appropriately higher capital levels for these
nontraditional
^required
to
assets
support
organization„
separate
the
and
other
apart
assets
from
of
the
the
capital
banking
Another option would be to deduct the capital
invested in these high risk subsidiaries from the consolidated
organization's
primary
capital
before
calculating
the
supplemental adjusted capital ratio0
Similarly,
the Board
seeks
comments
on whether
it
should attempt to identify certain types of loans that would be
moved from the Standard Risk category and placed in a separate
category with a risk weight below 100 percent?
By grouping
Standard
Risk
together
category,
the
a wide array of risks
proposed
supplemental
in the
adjusted
capital measure could still have some unintended incentives for
banks
to
pursue
riskier
types
of
lending
nontraditional activities to bolster
income,
or
high
while,
risk
possibly,
curtailing loans to high quality, low risk borrowers0
In light
of this concern, consideration was given to grouping certain
assets
felt
separate
to be significantly
high
risk
category with
riskier
a risk
than
others
weight
above
in a
100
29
percento
Similarly, as already noted,
several types of assets
included in the Standard Risk category,
such as loans to high
quality, high rated borrowers, arguably could be included in a
lower risk categoryQ
The principal benefit of such an approach
would be that it would relate capital needs more closely to an
organization’s risk profile,,
It could also serve to discourage
certain high risk activities while avoiding disincentives
to
direct bank lending to high quality, low risk customers^
The major practical drawback, on the other hand, would
be the difficulty of defining the boundary line between the
types of financing activities that would be included in high or
low risk categorieSo
More
heighten
concern
adjusted
capital measure evolving
device,
over
importantly,
the
potential
this approach
for
the
supplemental
into a credit
and could be interpreted by some
could
allocation
institutions as an
indication that they were free to expand the volume of high
risk lending provided they held the "correct" amount of capital
to support that lending„
This would go far beyond the intent
of the proposed supplemental adjusted capital measure and could
potentially undercut other
sources of supervisory discipline
designed to limit excessive risk-taking0
Board
did
category
not
propose
into either
the division
an
additional
of
For these reasons the
the
higher
Standard
or
lower
Risk
risk
category.
Second,
should
the
supplemental
adjusted
capital
measure attempt to take account of concentration of assets?
A
30
major
factor
in
analyzing
the
overall
risk
of
banking
organizations is the degree of diversification in the loan and
investment
portfolios0
Because
undue
asset
concentrations
violate the widely accepted principle of risk diversification,
in theory the supplemental adjusted
capital ratio could
be
further refined by including an explicit factor for the level
of
asset
however,
concentrationso
Practical
difficulties
exist,
in defining appropriate business categories for risk
assessment
purposes
and
in assigning
a meaningful
primary
business classification to companies that have diversified into
many different types of financial and nonfinancial activities0
While
the proposal contemplates
policy
whereby
concentrations,
concentrations
examiners
the
Board
should
be
continuation of
subjectively
seeks
evaluate
comment
factored
the current
on
asset
whether
explicitly
asset
into
the
supplemental adjusted capital ratio and, if so, how this might
be done on a practical basis«
Third, the treatment of country risk in the proposal
represents a choice among imperfect alternatives0
The decision
to segregate industrial economies from all others was based on
the view that,
minimize
among
possible
the alternatives
distortions
in
considered,
credit
interbank market and among countries,
flows
it would
within
the
The Board also seeks
comment on the most appropriate way to deal with broad country
risk considerationso
31
attempts
risk,
Fourth,
while
to deal
with
the
supplemental
the major
forms
adjusted
measure
of off-balance
sheet
some off-balance sheet activities that typically involve
« credit risk are not included
interest rate swaps,
in the framework„
For
example,
in which a bank acts as a counterparty in
arranging the exchange of interest payment streams between
third-party borrowers,
and the bank
can involve risk
in
if one party defaults
is obligated to assume the role of the defaulting
party and replace the stream of cash
rateso
two
light
of
these
flows at current market
considerations,
the
Board
seeks
comment on how best to assess and incorporate the credit risks
associated
with
supplemental
are
also
interest
adjusted
asked
to
rate
capital
identify
swaps
into
measure„
other
the
proposed
Moreover,
significant
commenters
types
off-balance-sheet risks not addressed by the proposal
of
and how
such risks could best be factored into the proposed measure»
An additional example of risk exposure not captured in
the
proposed
supplemental
unconsolidated
adjusted
joint ventures„
capital
Banking
measure
involves
organizations
can
be
exposed to considerable risks through such unconsolidated joint
ventures
if these entities
issue
significant amounts of debt
and undertake risk-bearing activities.
such
risks
may
not
be
fully
consolidated balance sheet,
effect,
be obligated
reflected
the banking
to support
share of the risk assets of the
Despite
at
on
the
the
its
that
bank's
organization
least
fact
may,
in
proportionate
joint venture or
all of
the
32 -
joint venture's assets if the joint venture encounters problems
and the other
assistanceo
deduct
joint venture partners are unable
The Board
investments
in
seeks
public
comment on
unconsolidated
joint
whether
ventures
primary capital for the purpose of calculating
adjusted capital ratios or whether
to provide
to
from
supplemental
to employ an alternative
technique to capture the exposure of banking organizations to
such joint ventures0
Fifth,
proposed
capital
it would
be
measure
with
measure the risk involved
desirable
more
to
supplement
refined
techniques
involved
applying
in
these
to
in securities and foreign exchange
trading activities at those banking organizations
heavily
the
activities0
This
which
could
are
entail
to banking organizations some of the guidelines and
principles on evaluating trading risks that have been developed
by the Federal Reserve Bank of New York for evaluating risk at
UoSc
Government securities
comment on techniques
dealers„
Thus,
for evaluating
the Board
foreign
seeks
exchange
risk,
including how the supplemental adjusted capital measure could
treat
(i)
exchange
rate
and
interest
counterparty credit risk, and (iii)
rate
risk,
(ii)
futures, options and swaps
used in foreign exchange operations,,
Similarly,
it may be appropriate
systematic approach to assessing overall
(as distinct
sensitivity
from
of
credit
assets,
risks)
to develop a more
interest rate risks
resulting
liabilities,
and
from
the
rate
off-balance-sheet
- 33 -
activities,,
Such an approach might be used in conjunction with
an
capital
adjusted
measure
changes in interest rates,,
on how to factor
to
evaluate
Therefore,
interest rate risk
vulnerability
to
the Board seeks comment
into the assessment of
capital adequacy0
Finally,
the
Board
seeks
comment
on
the
long-run
administration of the supplemental adjusted capital measure in
relation
to
the
capital-to-total
existing
assets
minimum
ratios.
As
primary
and
indicated
total
above,
supplemental adjusted capital ratio is to be used
the
in tandem
with the Board’s existing minimum primary and total capital
ratioso
balance
However,
as banking organizations restructure their
sheets and reduce
their
risk profiles,
capital-to-total assets ratio may become binding
the minimum
and prevent
further leveraging, even though an individual organization may
have a high and strong supplemental adjusted capital ratioQ
experience
measure,
is gained with
the supplemental
adjusted
it may be appropriate to place greater
As
capital
emphasis on
this measure over time relative to the capital-to-total assets
ratios,
In this regard,
it may be appropriate in the long-run
to reconsider the role of the capi tal-to-total assets ratios,
especially if the supplemental adjusted ratio proves to be a
reliable measure of capital needs in relation to overall risk0
Regulatory Flexibility Act Analysis
The Board does
proposal
would
have
not believe
a significant
that adoption
economic
impact
of
on
this
a
-
34 -
substantial number of small business entities*
in this case
small bank holding companies and state member banks* within the
meaning of the Regulatory Flexibility Act
sego) ,
would
et
(5 U o S 0C o 601
While all bank holding companies and state member banks
presumably
requirements
be
required
to permit
and
revise
quarterly
adjusted capital ratios*
regional
to
their
reporting
of
supplemental
tracking
the proposal contemplates only
multinational
banking
organizations
those in excess of $1 billion in assets)
for
(that
is*
the establishment of
objective zones for the proposed supplemental adjusted capital
ratiOo
In addition*
this proposal clearly indicates that it
is designed primarily to take account of those practices*
such
as the increased use of off“balance-sheet risk and the decline
in the holdings of low-risk*
engaged
liquid assets*
which have been
in primarily by certain larger banking organizations
and that it is directed at institutions whose capital positions
are
less
than
profileso
be
fully
Moreover*
established
adequate
In
relation
to
their
risk
the Board has indicated that zones would
at levels
that are broadly
consistent
with
prevailing aggregate capital levels in the banking industry and
with the banking system0s ability
retained earnings and from the
securitieSo
to generate capital
from
issuance of primary capital
It is not anticipated* therefore* that adoption of
this proposal would require a substantial number of banking
organizations*
including
raise additional capitalo
smaller
banking
organizations*
to
35
This proposal contemplates a new measure of capital
adequacy
that
supplements, but does
capital measureso
conflict
with
any
not
replace,
existing
This proposal does not duplicate, overlap or
existing
federal
laws
and
regulations
governing state member banks and bank holding companies0
List, of .Subjects
in 12 .C.F.Ro, Part „225 «,
Federal Reserve System;
Holding Companies,
Banks,
banking?
Capital Adequacy;
State Members Banks„
For the reasons outlined above,
amend Appendix A of 12 CoFoRo Part 225
the Board proposes to
(Regulation y) as set
forth -below;
Part 225 - BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
lo
The authority citation for Part 225 is revised to read as
follows i
Authority;
12 UoSoCo 1844(b), 3106,
1817(j) (13), 1818(b), 3907 and 3909o
2o
3108,
In Part 225, it Is proposed to amend Appendix A by deleting
the description of total capital zones as follows
(Current
regulatory language proposed to be deleted appears In brackets0)
Appendix, A
- Capital Adequacy,Guidelines, .for
Bank, Holding
Companies and State Member Banks
& * *
Capital, guidelines
The Board has established a minimum level of primary
capital to total assets of 5o5 percent and a minimum level of
total capital
to total assets
of 6„0
percento
Generally,
36 -
banking organizations are expected to operate above the minimum
primary and total capital levels0
Those organizations whose
operations involve or are exposed to high or inordinate degrees
of
risk
will
be
expected
to
hold
additional
capital
to
compensate for these risks0
[In addition, the Board has established the following
three zones for total capital for banking organizations of all
sizes?
Total Capital Ratio
Zone 1
Above 7„0%
Zone 2
6 o0% to 7 o0%
Zone 3
Below 6 o0%]
The capital guidelines assume adequate liquidity and a
moderate amount of risk in the loan and investment portfolios
and in off-balance sheet activities..
* * *
Supervisory Action
The nature and intensity of supervisory action will be
determined by an organization's compliance with
the required
minimum primary capital ratio as well as by the zone in which
the
company's
total
capital
ratio
falls„
Banks
and
bank
holding companies with primary capital ratios below the 5o5
percent minimum will be considered undercapitalized unless they
can demonstrate clear extenuating circumstances0
Such banking
organizations will be required to submit an acceptable plan for
achieving compliance with the capital guidelines and will be
-
37
subject to denial of applications and appropriate supervisory
enforcement actions0
[The
zone
in which
an organization's
ratio falls will normally trigger
the
total
following
capital
supervisory
responses, subject to qualitative analysis^
For institutions operating
Reserve wills
in Zone
1,
the
Federal
-- consider that capital is generally adequate if the
primary capital ratio is acceptable to the Federal
Reserve and is above the 5 05 percent minimum0
For institutions
Reserve wills
operating
in Zone
2,
the
Federal
-- pay particular attention to financial factors, such
as asset quality, liquidity, off-balance sheet
risk, and interest rate risk, as they relate to the
adequacy of capitalo
If these areas are deficient
and the Federal Reserve concludes capital is not
fully adequate, the Federal Reserve will intensify
its monitoring and take appropriate supervisory
action 0
For institutions
Reserve wills
operating
in Zone
3,
the
Federal
-- consider the institution is undercapitalized,
absent clear extenuating circumstances;
—
require the institution to submit a comprehensive
capital plan, acceptable to the Federal Reserve,
that includes a program for achieving compliance
with the required minimum ratios within a
reasonable time period; and
--- institute
appropriate
supervisory
and/or
administrative enforcement action, which may
include the issuance of a capital directive or
denial of applications, unless a capital plan
acceptable to the Federal Reserve has been adopted
by the institution0]
*
*
*
38
30
In Part 225, it is proposed to amend Appendix A by adding a
Supplemental Adjusted Capital Measure as follows?
Supplemental Adjusted Capital. Measure
In addition to its reliance on the ratios of primary
capital and total capital
to total
assets, the Board will
assess the capital adequacy of bank holding companies and state
chartered banks that are members of the Federal Reserve System,
on the basis of a ratio of primary capital
to total assets
(including certain off-balance sheet items) adjusted for risk„
For
purposes
of
the
"primary capital"
supplemental
adjusted
capital
ratio
is comprised of
the same
components
and
calculated in the same manner as defined above in the section
of these Guidelines entitled "Definition of Capital to be used
in Determining Capital Adequacy of Bank Holding Companies and
State Member Banks«,"
The
assets
component
of
the
supplemental
adjusted
capital ratio is computed in accordance with the following list
of risk categories and weights„
company
or
state
member
The assets of a bank holding
bank,
as
well
as
certain
off-balance-sheet items are assigned to one of four broad risk
categories0
The aggregate dollar
value of
the
assets
and
off-balance-sheet items in each category is multiplied by the
weight assigned to that category0
The sum of these weighted
values would be the weighted risk asset and off-balance sheet
total against which actual capital
is compared.,
The ratio
derived by dividing primary capital by this weighted total is
the supplemental adjusted capital ratio,.
39
TABLE I :
RISK.CATEGORIES, AND WEIGHTS
CASH AND, EQUIVALENTS (Weight 0%)
U 0So currency and coin and balances due from Federal Reserve
banks
Cash items in process of collection and trans
action accounts due from U.So depository
institutions*
Short-term** u»S0 Treasury securities in investment
account
Foreign currency and balances due from central
banks in immediately available funds
MONEY MARKET, RISK (Weight 30%)
Long-term UoSo Treasury securities held In
Investment account
UoSo Government agency securities held in Investment
account
Those; portions of loans that are fully guaranteed by u»So
Government
Short-term claims (90 days or less) on u eS 0 depository
institutions
Acceptances of other U 9S 0 banks
All Fed funds sold
Loans to broker/dealers collateralized by
UoS0 Treasury and agency securities, and
securities purchased under agreement to
resell (RPs)
Assets held In trading account
Legally binding loan commitments (including
note issuance facilities)
MODERATE RISK (Weight 60%)
All state, county and municipal (SCM) securities
held in investment account (excluding industrial
development bonds)
All other claims on UoSo depository institutions
All claims on governments and banks of industrial
countr ies
* UoSo depository institutions refers to depository
institutions chartered under the laws of the United
States and the foreign branches of those institutions,
and such UoSo depository institutions that are
subsidiaries of foreign banking organizations„ UoSo
branches and agencies of foreign banks are not UoSo
depository institutions0
** Short-term Treasury securities are those with an original
or remaining maturity of one year or less0
40
Acceptances of banks in industrial countries
Local currency claims on governments and banks
of non-industrial countries***
Loans to broker/dealers collateralized by other
marketable securities
Commercial letters of credit
Standby LCs (net) backing SCM securities (excluding
those backing industrial development bonds)*
supporting broker/dealers on secured basis or
performance related
STANDARD RISK (Weight 100%)
All assets found in a typical bank loan portfolio*
including s
All commercial and industrial loans and leases
Residential real estate and individual loans
Loans to nondepository financial institutions
All other claims on foreign obligors
Corporate securities and commercial paper* and
industrial development bonds
Customers' acceptance liabilities****
All assets not included elsewhere
All other standby LCs (net)* including those
backing industrial development bonds
Loans sold with recourse*****
*** To the extent funded by local currency liabilities „ If
not funded by local currency liabilities* such local
currency claims are included in the Standard Risk
category o
**** include customers1 liabilities associated with acceptance
participations purchased.
Participations sold are
included in Money Market Risk if the purchaser is a U=S.
depository institution* Moderate Risk if the purchaser is
a bank in an industrial country* and Standard Risk for
all other purchasers»
***** include loans involved in transactions of the type that
are required to be reported as borrowings (as opposed to
sales) under bank call report instructions. For purposes
of the supplemental adjusted capital measure* bank
holding companies should include the same type of items
in this category even if* under generally accepted
accounting principles* such loans sold with recourse may
be treated as sales and removed from the balance sheet.
41
Table II:
Illustration of Calculation of Supplemental
Adjusted Capital Measure
Risk
Weight
Dollar Amount of
Iterns in Cateqor y
Risk Category
Cash and equivalents
Weighted Risk
Assets and
Of f-BalanceSheet Items
5,000
X
0
0
Money market risk
35,000
X
o30
10,500
Moderate risk
30,000
X
o60
18,000
Standard risk
80,000
X
lo00
.80,000
Total (including
150,000
$100,000 in aggregate
assets and $50,000
in off-balance sheet items))
Aggregate primary capital
Primary capital to total
assets ratio (as defined
under existing Guidelines)
Supplemental adjusted
capital ratio
(as proposed)
108,500
7,000
7,000
100,000
7,000
108,500
s
7.0%
JS
6.5%
Notes This example assumes a bank with total assets (before
deducting the loan loss reserve) of $100,000, off-balance
sheet items of $50,000, and primary capital of $7,000*
SUPERVISORY ACTION
While
the
supplemental
adjusted
capital
ratio
establishes a guideline for assessing the capital adequacy of
individual
certain
manner 0
banking
types
of
organizations,
risk
the
in a general
ratio
and
measures
relatively
only
broad
The Board will continue to make judgments on capital
adequacy in individual cases,
judgments which reflect a broad
mix of qualitative and quantitative considerations that may not
42 -
be
contained
consider,
in
ratioQ
among
other
of
earnings;
variability
liabilities;
quality
the
of
things,
to
assessment
composition
of
capital
are
and
systems
loans
and
especially
These
the loan
sovereign risk concentrations,
the
evaluating
to
and
the
structure
of
rate
changes;
the
and
controls, and
supplemental
risk
investments.
Asset
critical
in
the
include
the
risk
credit
and
and the level and severity of
and criticized
all other
trend
portfolio,
assets0
continue to assess capital adequacy by
assessing
continue
quality,
interest
adequacy,,
and profile of
classified
will
the effectiveness of loan and investment
considerations
examiner
the
management, internal
and the quality of
quality
Board
liquidity
vulnerability
operating procedures;
policies;
The
adjusted
factors
(1)
The Board
calculating
capital
and,
will
ratio,
and
(2)
in particular,
(3)
taking into account the level and severity of classified assets,,
The supplemental adjusted capital ratio is to be used
in tandem with
the primary and total capital-to-total asset
ratios as a guide in determining minimum capital requirements.
Individual banking organizations will continue to be subject to
constraints on total leverage,
with the supplemental adjusted
capital ratio as an additional guideline to encourage banking
organizations
to make appropriate adjustments
in either
the
risk composition of their portfolios or the overall level of
primary
capital0
Banking
organizations,
however,
will
be
required to maintain primary and total capital ratios at least
equal to the minimum levels set forth in these Guidelines»
43
Supplemental
adjusted
capital
ratios
should
be
calculated for all state-member banks and bank holding companies
on
a
consolidated
basis 5 /
The
Board
will
use
the
supplemental adjusted capital measure to evaluate the capital of
all
banking
established
organizations
certain
regardless
objective
of
standards
regional and multinational organizations,
size,
for
but
the
it has
ratios
of
i 0e 0, those with more
than $1 billion in consolidated assets.
For organizations with assets of $1 billion or more,
the tandem operation of the supplemental adjusted capital ratio
and the minimum primary capital ratio
following
zone
descriptions
for
the
is illustrated by the
supplemental
adjusted
capital ratio*,
5/
10
Zone, 1 - organizations with supplemental adjusted
capital ratios in this zone would be presumed to
have adequate capital in relation to risk,
barring significant asset quality or other
financial ©r operating concerns,
including
excessive asset concentrations»
For these
organizations, assets could be increased even if
the primary capital-to-total asset ratio dropped
close to the existing minimum threshold of 5 05
percent„
2°
Zone 2 - Organizations with supplemental adjusted
capital ratios in this zone would be considered
to have acceptable capital in relation to risk,
depending upon where they were within the zone,
The supplemental adjusted capital ratio for bank holding
companies with less than $150 million in consolidated assets
should be calculated on a bank ,onl^ basis unless (1) the
holding company or any nonbank subsidiary is engaged directly
or indirectly in any nonbank activity involving significant
leverage or (2) the holding company or any nonbank subsidiary
has outstanding significant debt held by the general publicQ
44
as well as how the institution fared on the basis
of qualitative and financial considerations»
Particularly for organizations in the upper half
of the zone, there might be scope for asset
growth
and
declines
in
the
primary
capital-to-total asset ratio, barring asset
quality or other financial concerns»
3„
Zone 3 - Supplemental adjusted capital ratios in
tSTis zone would be below the minimum acceptable
levelo
Organizations with such supplemental
adjusted ratios would be presumed to have
inadequate capital in relation to risk even if
their primary capital-to-total assets ratios were
above
the
5„5
percent
minimum.,
Such
organizations would be expected to develop and
submit to their supervisory authorities plans to
bring their supplemental adjusted ratios to an
adequate level, either by raising new capital or
by adjusting the risk profile of their activities,,
Since the supplemental adjusted capital ratio does not
take
explicit
account
of
all
risk
factors,
banking
organizations with financial or operating characteristics that
are cause for supervisory concern,
including significant asset
problems (as reflected in the level and severity of classified
assets),
and undue asset concentrations,
will be expected to
operate above minimum primary and total capital ratios and,
applicable,
above
the minimum
supplemental
adjusted
capital
Reserve
System,
ratio o
Board of Governors
of
the Federal
if
January 24, 19860
( s i g n e d ) W i l l i a m Wa W i l e s
William w„ Wiles
Secretary of the Board
@FedFRASER