[Code of Federal Regulations]
[Title 12, Volume 4]
[Revised as of January 1, 2005]
From the U.S. Government Printing Office via GPO Access
[CITE: 12CFR325.105]
[Page 197-237]
TITLE 12--BANKS AND BANKING
CHAPTER III--FEDERAL DEPOSIT INSURANCE CORPORATION
PART 325_CAPITAL MAINTENANCE--Table of Contents
Subpart B_Prompt Corrective Action
Sec. 325.105 Mandatory and discretionary supervisory actions under
section 38.
(a) Mandatory supervisory actions--(1) Provisions applicable to all
banks. All banks are subject to the restrictions contained in section
38(d) of the FDI Act on payment of capital distributions and management
fees.
(2) Provisions applicable to undercapitalized, significantly
undercapitalized, and critically undercapitalized banks. Immediately
upon receiving notice or being deemed to have notice, as provided in
Sec. 325.102 of this subpart, that the bank is undercapitalized,
significantly undercapitalized, or critically undercapitalized, the bank
shall become subject to the provisions of section 38 of the FDI Act:
(i) Restricting payment of capital distributions and management fees
(section 38(d));
[[Page 198]]
(ii) Requiring that the FDIC monitor the condition of the bank
(section 38(e)(1));
(iii) Requiring submission of a capital restoration plan within the
schedule established in this subpart (section 38(e)(2));
(iv) Restricting the growth of the bank's assets (section 38(e)(3));
and
(v) Requiring prior approval of certain expansion proposals (section
38(e)(4)).
(3) Additional provisions applicable to significantly
undercapitalized, and critically undercapitalized banks. In addition to
the provisions of section 38 of the FDI Act described in paragraph
(a)(2) of this section, immediately upon receiving notice or being
deemed to have notice, as provided in Sec. 325.102 of this subpart,
that the bank is significantly undercapitalized, or critically
undercapitalized, or that the bank is subject to the provisions
applicable to institutions that are significantly undercapitalized
because the bank failed to submit or implement in any material respect
an acceptable capital restoration plan, the bank shall become subject to
the provisions of section 38 of the FDI Act that restrict compensation
paid to senior executive officers of the institution (section 38(f)(4)).
(4) Additional provisions applicable to critically undercapitalized
institutions. (i) In addition to the provisions of section 38 of the FDI
Act described in paragraphs (a)(2) and (a)(3) of this section,
immediately upon receiving notice or being deemed to have notice, as
provided in Sec. 325.102 of this subpart, that the insured depository
institution is critically undercapitalized, the institution is
prohibited from doing any of the following without the FDIC's prior
written approval:
(A) Entering into any material transaction other than in the usual
course of business, including any investment, expansion, acquisition,
sale of assets, or other similar action with respect to which the
depository institution is required to provide notice to the appropriate
Federal banking agency;
(B) Extending credit for any highly leveraged transaction;
(C) Amending the institution's charter or bylaws, except to the
extent necessary to carry out any other requirement of any law,
regulation, or order;
(D) Making any material change in accounting methods;
(E) Engaging in any covered transaction (as defined in section
23A(b) of the Federal Reserve Act (12 U.S.C. 371c(b));
(F) Paying excessive compensation or bonuses;
(G) Paying interest on new or renewed liabilities at a rate that
would increase the institution's weighted average cost of funds to a
level significantly exceeding the prevailing rates of interest on
insured deposits in the institution's normal market areas; and
(H) Making any principal or interest payment on subordinated debt
beginning 60 days after becoming critically undercapitalized except that
this restriction shall not apply, until July 15, 1996, with respect to
any subordinated debt outstanding on July 15, 1991, and not extended or
otherwise renegotiated after July 15, 1991.
(ii) In addition, the FDIC may further restrict the activities of
any critically undercapitalized institution to carry out the purposes of
section 38 of the FDI Act.
(5) Exception for certain savings associations. The restrictions in
paragraph (a)(4) of this section shall not apply, before July 1, 1994,
to any insured savings association if:
(i) The savings association had submitted a plan meeting the
requirements of section 5(t)(6)(A)(ii) of the Home Owners' Loan Act (12
U.S.C. 1464(t)(6)(A)(ii)) prior to December 19, 1991;
(ii) The Director of OTS had accepted the plan prior to December 19,
1991; and
(iii) The savings association remains in compliance with the plan or
is operating under a written agreement with the appropriate federal
banking agency.
(b) Discretionary supervisory actions. In taking any action under
section 38 that is within the FDIC's discretion to take in connection
with:
(1) An insured depository institution that is deemed to be
undercapitalized, significantly undercapitalized, or critically
undercapitalized, or has been reclassified as undercapitalized, or
significantly undercapitalized; or
[[Page 199]]
(2) An officer or director of such institution, the FDIC shall
follow the procedures for issuing directives under Sec. Sec. 308.201
and 308.203 of this chapter, unless otherwise provided in section 38 or
this subpart.
Appendix A to Part 325--Statement of Policy on Risk-Based Capital
Capital adequacy is one of the critical factors that the FDIC is
required to analyze when taking action on various types of applications
and when conducting supervisory activities related to the safety and
soundness of individual banks and the banking system. In view of this,
the FDIC's Board of Directors has adopted part 325 of its regulations,
which sets forth (1) minimum standards of capital adequacy for insured
state nonmember banks and (2) standards for determining when an insured
bank is in an unsafe or unsound condition by reason of the amount of its
capital.
This capital maintenance regulation was designed to establish, in
conjunction with other Federal bank regulatory agencies, uniform capital
standards for all federally-regulated banking organizations, regardless
of size. The uniform capital standards were based on ratios of capital
to total assets. While those leverage ratios have served as a useful
tool for assessing capital adequacy, the FDIC believes there is a need
for a capital measure that is more explicitly and systematically
sensitive to the risk profiles of individual banks. As a result, the
FDIC's Board of Directors has adopted this Statement of Policy on Risk-
Based Capital to supplement the part 325 regulation. This statement of
policy does not replace or eliminate the existing part 325 capital-to-
total assets leverage ratios.
The framework set forth in this statement of policy consists of (1)
a definition of capital for risk-based capital purposes, and (2) a
system for calculating risk-weighted assets by assigning assets and off
balance sheet items to broad risk categories. A bank's risk-based
capital ratio is calculated by dividing its qualifying total capital
base (the numerator of the ratio) by its risk-weighted assets (the
denominator).\1\ Table I outlines the definition of capital and provides
a general explanation of how the risk-based capital ratio is calculated,
Table II summarizes the risk weights and risk categories, and Table III
sets forth the credit conversation factors for off-balance sheet items.
Additional explanations of the capital definitions, the risk-weighted
asset calculations, and the minimum risk-based capital ratio guidelines
are provided in Sections I, II and III of this statement of policy.
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\1\ Period-end amounts, rather than average balances, normally will
be used when calculating risk-based capital ratios. However, on a case-
by-case basis, ratios based on average balances may also be required if
supervisory concerns render it appropriate.
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In addition, when certain banks that engage in trading activities
calculate their risk-based capital ratio under this appendix A, they
must also refer to appendix C of this part, which incorporates capital
charges for certain market risks into the risk-based capital ratio. When
calculating their risk-based capital ratio under this appendix A, such
banks are required to refer to appendix C of this part for supplemental
rules to determine qualifying and excess capital, calculate risk-
weighted assets, calculate market risk equivalent assets and add them to
risk-weighted assets, and calculate risk-based capital ratios as
adjusted for market risk.
This statement of policy applies to all FDIC-insured state-chartered
banks (excluding insured branches of foreign banks) that are not members
of the Federal Reserve System, hereafter referred to as state nonmember
banks, regardless of size, and to all circumstances in which the FDIC is
required to evaluate the capital of a banking organization. Therefore,
the risk-based capital framework set forth in this statement of policy
will be used in the examination and supervisory process as well as in
the analysis of applications that the FDIC is required to act upon.
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 rate risk exposure, liquidity, funding and
market risks; the quality and level of earnings; investment, loan
portfolio, and other concentrations 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 as well as a bank's
interest rate risk as measured by the bank's exposure to declines in the
economic value of its capital due to changes in interest rates. 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.
In light of these other considerations, banks generally are expected
to operate above the minimum risk-based capital ratio.
[[Page 200]]
Banks contemplating significant expansion plans, as well as those
institutions with high or inordinate levels of risk, should hold capital
commensurate with the level and nature of the risks to which they are
exposed.
I. Definition of Capital for the Risk-Based Capital Ratio
A bank's qualifying total capital base consists of two types of
capital elements: core capital elements (Tier 1) and supplementary
capital elements (Tier 2). To qualify as an element of Tier 1 or Tier 2
capital, a capital instrument should not contain or be subject to any
conditions, covenants, terms, restrictions, or provisions that are
inconsistent with safe and sound banking practices.
A. The Components of Qualifying Capital (see Table I)
1. Core capital elements (Tier 1) consists of:
i. Common stockholders' equity capital (includes common stock and
related surplus, undivided profits, disclosed capital reserves that
represent a segregation of undivided profits, and foreign currency
translation adjustments, less net unrealized holding losses on
available-for-sale equity securities with readily determinable fair
values);
ii. Noncumulative perpetual preferred stock,\2\ including any
related surplus; and
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\2\ Preferred stock issues where the dividend is reset periodically
based, in whole or in part, upon the bank's current credit standing,
including but not limited to, auction rate, money market or remarketable
preferred stock, are assigned to Tier 2 capital, regardless of whether
the dividends are cumultive or noncumulative.
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iii. Minority interests in the equity capital accounts of
consolidated subsidiaries.
(a) At least 50 percent of the qualifying total capital base should
consist of Tier 1 capital. Core (Tier 1) capital is defined as the sum
of core capital elements minus all intangible assets (other than
mortgage servicing assets, nonmortgage servicing assets and purchased
credit card relationships eligible for inclusion in core capital
pursuant to Sec. 325.5(f)),\3\ minus credit-enhancing interest-only
strips that are not eligible for inclusion in core capital pursuant to
Sec. 325.5(f), minus any disallowed deferred tax assets, and minus any
amount of nonfinancial equity investments required to be deducted
pursuant to section II.B.(6) of this Appendix.
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\3\ An exception is allowed for intanglble assets that are
explicitly approved by the FDIC as part of the bank's regulatory capital
on a specific case basis. These intangibles will be included in capital
for risk-based capital purposes under the terms and conditions that are
specifically approved by the FDIC.
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(b) Although nonvoting common stock, noncumulative perpetual
preferred stock, and minority interests in the equity capital accounts
of consolidated subsidiaries are normally included in Tier 1 capital,
voting common stockholders' equity generally will be expected to be the
dominant form of Tier 1 capital. Thus, banks should avoid undue reliance
on nonvoting equity, preferred stock and minority interests.
(c) Although minority interests in consolidated subsidiaries are
generally included in regulatory capital, exceptions to this general
rule will be made if the minority interests fail to provide meaningful
capital support to the consolidated bank. Such a situation could arise
if the minority interests are entitled to a preferred claim on
essentially low risk assets of the subsidiary. Similarly, although
credit-enhancing interest-only strips and intangible assets in the form
of mortgage servicing assets, nonmortgage servicing assets and purchased
credit card relationships are generally recognized for risk-based
capital purposes, the deduction of part or all of the credit-enhancing
interest-only strips, mortgage servicing assets, nonmortgage servicing
assets and purchased credit card relationships may be required if the
carrying amounts of these assets are excessive in relation to their
market value or the level of the bank's capital accounts. Credit-
enhancing interest-only strips, mortgage servicing assets, nonmortgage
servicing assets, purchased credit card relationships and deferred tax
assets that do not meet the conditions, limitations and restrictions
described in Sec. 325.5(f) and (g) of this part will not be recognized
for risk-based capital purposes.
(d) Minority interests in small business investment companies,
investment funds that hold nonfinancial equity investments (as defined
in section II.B.(6)(ii) of this appendix A), and subsidiaries that are
engaged in nonfinancial activities are not included in the bank's Tier 1
or total capital base if the bank's interest in the company or fund is
held under one of the legal authorities listed in section II.B.(6)(ii)
of this appendix A. In addition, minority interests in consolidated
asset-backed commercial paper programs (ABCP) that are sponsored by a
bank are not to be included in the bank's Tier 1 or total capital base
if the bank excludes the consolidated assets of such programs from risk-
weighted assets pursuant to section II.B.6. of this appendix.
2. Supplementary capital elements (Tier 2) consist of:
i. Allowance for loan and lease losses, up to a maximum of 1.25
percent of risk-weighted assets;
ii. Cumulative perpetual preferred stock, long-term preferred stock
(original maturity of at least 20 years), and any related surplus;
iii. Perpetual preferred stock (and any related surplus) where the
dividend is reset periodically based, in whole or part, on the bank's
current credit standing, regardless of
[[Page 201]]
whether the dividends are cumulative or noncumulative;
iv. Hybrid capital instruments, including mandatory convertible debt
securities;
v. Term subordinated debt and intermediate-term preferred stock
(original average maturity of five years or more) and any related
surplus; and
vi. Net unrealized holding gains on equity securities (subject to
the limitations discussed in paragraph I.A.2.(f) of this section).
The maximum amount of Tier 2 capital that may be recognized for
risk-based capital purposes is limited to 100 percent of Tier 1 capital
(after any deductions for disallowed intangibles and disallowed deferred
tax assets). In addition, the combined amount of term subordinated debt
and intermediate-term preferred stock that may be treated as part of
Tier 2 capital for risk-based capital purposes is limited to 50 percent
of Tier 1 capital. Amounts in excess of these limits may be issued but
are not included in the calculation of the risk-based capital ratio.
(a) Allowance for loan and lease losses. Allowances for loan and
lease losses are reserves that have been established through a charge
against earnings to absorb future losses on loans or lease financing
receivables. Allowances for loan and lease losses exclude allocated
transfer risk reserves, \4\ and reserves created against identified
losses.
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\4\ Allocated transfer risk reserves are reserves that have been
established in accordance with section 905(a) of the International
Lending Supervision Act of 1983 against certain assets whose value has
been found by the U.S. supervisory authorities to have been
significantly impaired by protracted transfer risk problems.
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This risk-based capital framework provides a phasedown during the
transition period of the extent to which the allowance for loan and
lease losses may be included in an institution's capital base. By year-
end 1990, the allowance for loan and lease losses, as an element of
supplementary capital, may constitute no more than 1.5 percent of risk-
weighted assets and, by year-end 1992, no more than 1.25 percent of
risk-weighted assets.\5\
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\5\ The amount of the allowance for loan and lease losses that may
be included as a supplementary capital element is based on a percentage
of gross risk-weighted assets. A bank may deduct reserves for loan and
lease losses that are in excess of the amount permitted to be included
in capital, as well as allocated transfer risk reserves, from gross
risk-weighted assets when computing the denominator of the risk-based
capital ratio.
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(b) Preferred stock. Perpetual preferred stock is defined as
preferred stock that does not have a maturity date, that cannot be
redeemed at the option of the holder, and that has no other provisions
that will require future redemption of the issue. Long-term preferred
stock includes limited-life preferred stock with an original maturity of
20 years or more, provided that the stock cannot be redeemed at the
option of the holder prior to maturity, except with the prior approval
of the FDIC.
Cumulative perpetual preferred stock and long-term preferred stock
qualify for inclusion in supplementary capital provided that the
instruments can absorb losses while the issuer operates as a going
concern (a fundamental characteristic of equity capital) and provided
the issuer has the option to defer payment of dividends on these
instruments. Given these conditions, and the perpetual or long-term
nature of the intruments, there is no limit on the amount of these
preferred stock instruments that may be included with Tier 2 capital.
Noncumulative perpetual preferred stock where the dividend is reset
periodically based, in whole or in part, on the bank's current credit
standing, including auction rate, money market, or remarketable
preferred stock, are also assigned to Tier 2 capital without limit,
provided the above conditions are met.
(c) Hybrid capital instruments. Hybrid capital instruments include
instruments that have certain characteristics of both debt and equity.
In order to be included as supplementary capital elements, these
instruments should meet the following criteria:
(1) The instrument should be unsecured, subordinated to the claims
of depositors and general creditors, and fully paid-up.
(2) The instrument should not be redeemable at the option of the
holder prior to maturity, except with the prior approval of the FDIC.
This requirement implies that holders of such instruments may not
accelerate the payment of principal except in the event of bankruptcy,
insolvency, or reorganization.
(3) The instrument should be available to participate in losses
while the issuer is operating as a going concern. (Term subordinated
debt would not meet this requirement.) To satisfy this requirement, the
instrument should convert to common or perpetual preferred stock in the
event that the sum of the undivided profits and capital surplus accounts
of the issuer results in a negative balance.
(4) The instrument should provide the option for the issuer to defer
principal and interest payments if: (a) The issuer does not report a
profit in the preceding annual period, defined as combined profits
(i.e., net income) for the most recent four quarters, and (b) the issuer
eliminates cash dividends on its common and preferred stock.
Mandatory convertible debt securities, which are subordinated debt
instruments
[[Page 202]]
that require the issuer to convert such instruments into common or
perpetual preferred stock by a date at or before the maturity of the
debt instruments, will qualify as hybrid capital instruments provided
the maturity of these instruments is 12 years or less and the
instruments meet the criteria set forth below for ``term subordinated
debt.'' There is no limit on the amount of hybrid capital instruments
that may be included within Tier 2 capital.
(d) Term subordinated debt and intermediate-term preferred stock.
The aggregate amount of term subordinated debt (excluding mandatory
convertible debt securities) and intermediate-term preferred stock
(including any related surplus) that may be treated as Tier 2 capital
for risk-based capital purposes is limited to 50 percent of Tier 1
capital. Term subordinated debt and intermediate-term preferred stock
should have an original average maturity of at least five years to
qualify as supplementary capital and should not be redeemable at the
option of the holder prior to maturity, except with the prior approval
of the FDIC. For state nonmember banks, a term subordinated debt
instrument is an obligation other than a deposit obligation that:
(1) Bears on its face, in boldface type, the following: This
obligation is not a deposit and is not insured by the Federal Deposit
Insurance Corporation;
(2)(i) Has a maturity of at least five years; or
(ii) In the case of an obligation or issue that provides for
scheduled repayments of principal, has an average maturity of at least
five years; provided that the Director of the Division of Supervision
and Consumer Protection (DSC) may permit the issuance of an obligation
or issue with a shorter maturity or average maturity if the Director has
determined that exigent circumstances require the issuance of such
obligation or issue; provided further that the provisions of this
paragraph I.A.2.(d)(2) shall not apply to mandatory convertible debt
obligations or issues;
(3) States express that the obligation:
(i) Is subordinated and junior in right of payment to the issuing
bank's obligations to its depositors and to the bank's other obligations
to its general and secured creditors; and
(ii) Is ineligible as collateral for a loan by the issuing bank;
(4) Is unsecured;
(5) States expressly that the issuing bank may not retire any part
of its obligation without the prior written consent of the FDIC or other
primary federal regulator; and
(6) Includes, if the obligation is issued to a depository
institution, a specific waiver of the right of offset by the lending
depository institution.
Subordinated debt obligations issued prior to December 2, 1987 that
satisfied the definition of the term ``subordinated note and debenture''
that was in effect prior to that date also will be deemed to be term
subordinated debt for risk-based capital purposes. An optional
redemption (``call'') provision in a subordinated debt instrument that
is exercisable by the issuing bank in less than five years will not be
deemed to constitute a maturity of less than five years, provided that
the obligation otherwise has a stated contractual maturity of at least
five years; the call is exercisable solely at the discretion or option
of the issuing bank, and not at the discretion or option of the holder
of the obligation; and the call is exercisable only with the express
prior written consent of the FDIC under 12 U.S.C. 1828(i)(1) at the time
early redemption or retirement is sought, and such consent has not been
given in advance at the time of issuance of the obligation. Optional
redemption provisions will be accorded similar treatment when
determining the perpetual nature and/or maturity of preferred stock and
other capital instruments.
(e) Discount of limited-life supplementary capital instruments. As a
limited-life capital instrument approaches maturity, the instrument
begins to take on charcteristics of a short-term obligation and becomes
less like a component of capital. Therefore, for risk-based capital
purposes, the outstanding amount of term subordinated debt and limited-
life preferred stock eligible for inclusion in capital will be adjusted
downward, or discounted, as the instruments approach maturity. Each
limited-life capital instrument will be discounted by reducing the
outstanding amount of the capital instrument eligible for inclusion as
supplementary capital by a fifth of the original amount (less
redemptions) each year during the instrument's last five years before
maturity. Such instruments, therefore, will have no capital value when
they have a remaining maturity of less than a year.
(f) Unrealized gains on equity securities and unrealized gains
(losses) on other assets. Up to 45 percent of pretax net unrealized
holding gains (that is, the excess, if any, of the fair value over
historical cost) on available-for-sale equity securities with readily
determinable fair values may be included in supplementary capital.
However, the FDIC may exclude all or a portion of these unrealized gains
from Tier 2 capital if the FDIC determines that the equity securities
are not prudently valued. Unrealized gains (losses) on other types of
assets, such as bank premises and available-for-sale debt securities,
are not included in supplementary capital, but the FDIC may take these
unrealized gains (losses) into account as additional factors when
assessing a bank's overall capital adequacy.
[[Page 203]]
B. Deductions from Capital and Other Adjustments
Certain assets are deducted from a bank's capital base for the
purpose of calculating the numerator of the risk-based capital ratio.\6\
These assets include:
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\6\ Any assets deducted from capital when computing the numerator of
the risk-based capital ratio will also be excluded from risk-weighted
assets when computing the denominator of the ratio.
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(1) All intangible assets other than mortgage servicing assets,
nonmortgage servicing assets and purchased credit card relationships.\7\
These disallowed intangibles are deducted from the core capital (Tier 1)
elements.
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\7\ In addition to mortgage servicing assets, nonmortgage servicing
assets and purchased credit card relationships, certain other
intangibles may be allowed if explicitly approved by the FDIC as part of
the bank's regulatory capital on a specific case basis. In evaluating
whether other types of intangibles should be recognized for regulatory
capital purposes on a specific case basis, the FDIC will accord special
attention to the general characteristics of the intangibles, including:
(1) The separability of the intangible asset and the ability to sell it
separate and apart from the bank or the bulk of the bank's assets, (2)
the certainty that a readily identifiable stream of cash flows
associated with the intangible asset can hold its value notwithstanding
the future prospects of the bank, and (3) the existence of a market of
sufficient depth to provide liquidity for the intangible asset.
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(2) Investments in unconsolidated banking and finance
subsidiaries.\8\ This includes any equity or debt capital investments in
banking or finance subsidaries if the subsidiaries are not consolidated
for regulatory capital requirements.\9\ Generally, these investments
include equity and debt capital securities and any other instruments or
commitments that are deemed to be capital of the subsidiary. These
investments are deducted from the bank's total (Tier 1 plus Tier 2)
capital base.
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\8\ For risk-based capital purposes, these subsidiaries are
generally defined as any company that is primarily engaged in banking or
finance and in which the bank, either directly or indirectly, owns more
than 50 percent of the outstanding voting stock but does not consolidate
the company for regulatory capital purposes. In addition to investments
in unconsolidated banking and finance subsidiaries, the FDIC may, on a
case-by-case basis, deduct investments in associated companies or joint
ventures, which are generally defined as any companies in which the
bank, either directly or indirectly, owns 20 to 50 percent of the
outstanding voting stock. Alternatively, the FDIC may, in certain cases,
apply an appropriate risk-weighted capital charge against a bank's
proportionate interest in the assets of associated companies and joint
ventures. The definitions for subsidiaries, associated companies and
joint ventures are contained in the instructions for the preparation of
the Consolidated Reports of Condition and Income.
\9\ Consolidation requirements for regulatory capital purposes
generally follow the consolidation requirements set forth in the
instructions for preparation of the consolidated Reports of Condition
and Income. However, although investments in subsidiaries representing
majority ownership in another Federally-insured depository institution
are not consolidated for purposes of the consolidated Reports of
Condition and Income that are filed by the parent bank, they are
generally consolidated for purposes of determining FDIC regulatory
capital requirements. Therefore, investments in these depository
institution subsidiaries generally will not be deducted for risk-based
capital purposes; rather, assets and liabilities of such subsidiaries
will be consolidated with those of the parent bank when calculating the
risk-based capital ratio. In addition, although securities subsidiaries
established pursuant to 12 CFR 337.4 are consolidated for Report of
Condition and Income purposes, they are not consolidated for regulatory
capital purposes.
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(3) Investments in securities subsidiaries established pursuant to
12 CFR 337.4. The FDIC may also consider deducting investments in other
subsidiaries, either on a case-by-case basis or, as with securities
subsidiaries, based on the general characteristics or functional nature
of the subsidiaries.
(4) Reciprocal holdings of capital instruments of banks that
represent intentional cross-holdings by the banks. These holdings are
deducted from the bank's total capital base.
(5) Deferred tax assets in excess of the limit set forth in Sec.
325.5(g). These disallowed deferred tax assets are deducted from the
core capital (Tier 1) elements.
On a case-by-case basis, and in conjunction with supervisory
examinations, other deductions from capital may also be required,
including any adjustments deemed appropriate for assets classified as
loss.
II. Procedures For Computing Risk-Weighted Assets
A. General Procedures
1. Under the risk-based capital framework, a bank's balance sheet
assets and credit equivalent amounts of off-balance sheet items are
assigned to one of four broad risk categories according to the obligor
or, if
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relevent, the guarantor or the nature of the collateral. The aggregate
dollar amount in each category is then multiplied by the risk weight
assigned to that category. The resulting weighted values from each of
the four risk categories are added together and this sum is the risk-
weighted assets total that, as adjusted.\10\ comprises the denominator
of the risk-based capital ratio.
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\10\ Any asset deducted from a bank's capital accounts when
computing the numerator of the risk-based capital ratio will also be
excluded from risk-weighted assets when calculating the denominator for
the ratio.
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2. The risk-weighted amounts for all off-balance sheet items are
determined by a two-step process. First, the notional principal, or face
value, amount of each off-balance sheet item generally is multiplied by
a credit conversion factor to arrive at a balance sheet credit
equivalent amount. Second, the credit equivalent amount generally is
assigned to the appropriate risk category, like any balance sheet asset,
according to the obligor or, if relevant, the guarantor or the nature of
the collateral.
3. The Director of the Division of Supervision and Consumer
Protection (DSC) may, on a case-by-case basis, determine the appropriate
risk weight for any asset or credit equivalent amount that does not fit
wholly within one of the risk categories set forth in this Appendix A or
that imposes risks on a bank that are not commensurate with the risk
weight otherwise specified in this Appendix A for the asset or credit
equivalent amount. In addition, the Director of the Division of
Supervision and Consumer Protection (DSC) may, on a case-by-case basis,
determine the appropriate credit conversion factor for any off-balance
sheet item that does not fit wholly within one of the credit conversion
factors set forth in this Appendix A or that imposes risks on a bank
that are not commensurate with the credit conversion factor otherwise
specified in this Appendix A for the off-balance sheet item. In making
such a determination, the Director of the Division of Supervision and
Consumer Protection (DSC) will consider the similarity of the asset or
off-balance sheet item to assets or off-balance sheet items explicitly
treated in sections II.B and II.C of this appendix A, as well as other
relevant factors.
B. Other Considerations
1. Indirect Holdings of Assets. Some of the assets on a bank's
balance sheet may represent an indirect holding of a pool of assets; for
example, mutual funds. An investment in shares of a mutual fund whose
portfolio consists solely of various securities or money market
instruments that, if held separately, would be assigned to different
risk categories, generally is assigned to the risk category appropriate
to the highest risk-weighted asset that the fund is permitted to hold in
accordance with the stated investment objectives set forth in its
prospectus. The bank may, at its option, assign the investment on a pro
rata basis to different risk categories according to the investment
limits in the fund's prospectus, but in no case will indirect holdings
through shares in any mutual fund be assigned to a risk weight less than
20 percent. If the bank chooses to assign its investment on a pro rata
basis, and the sum of the investment limits in the fund's prospectus
exceeds 100 percent, the bank must assign risk weights in descending
order. If, in order to maintain a necessary degree of short-term
liquidity, a fund is permitted to hold an insignificant amount of its
assets in short-term, highly liquid securities of superior credit
quality that do not qualify for a preferential risk weight, such
securities will generally be disregarded in determining the risk
category to which the bank's holdings in the overall fund should be
assigned. The prudent use of hedging instruments by a mutual fund to
reduce the risk of its assets will not increase the risk weighting of
the mutual fund investment. For example, the use of hedging instruments
by a mutual fund to reduce the interest rate risk of its government bond
portfolio will not increase the risk weight of that fund above the 20
percent category. Nonetheless, if the fund engages in any activities
that appear speculative in nature or has any other characteristics that
are inconsistent with the preferential risk weighting assigned to the
fund's assets, holdings in the fund will be assigned to the 100 percent
risk category.
2. Collateral. In determining risk weights of various assets, the
only forms of collateral that are formally recognized by the risk-based
capital framework are cash on deposit in the lending bank; securities
issued or guaranteed by the central governments of the OECD-based group
of countries,\11\ U.S.
[[Page 205]]
Government agencies, or U.S. Government-sponsored agencies; and
securities issued or guaranteed by multilateral lending institutions or
regional development banks. Claims fully secured by such collateral are
assigned to the 20 percent risk category. The extent to which these
securities are recognized as collateral for risk-based capital purposes
is determined by their current market value. If a claim is partially
secured, the portion of the claim that is not covered by the collateral
is assigned to the risk category appropriate to the obligor or, if
relevant, the guarantor.
---------------------------------------------------------------------------
\11\ The OECD-based group of countries comprises all full members of
the Organization for Economic Cooperation and Development (OECD)
regardless of entry date, as well as countries that have concluded
special lending arrangements with the International Monetary Fund (IMF)
associated with the IMF's General Arrangements to Borrow, but excludes
any country that has rescheduled its external sovereign debt within the
previous five years. As of November 1995, the OECD included the
following countries: Australia, Austria, Belgium, Canada, Denmark,
Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan,
Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Portugal,
Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United
States; and Saudi Arabia had concluded special lending arrangements with
the IMF associated with the IMF's General Arrangements to Borrow. A
rescheduling of external sovereign debt generally would include any
renegotiation of terms arising from a country's inability or
unwillingness to meet its external debt service obligations, but
generally would not include renegotiations of debt in the normal course
of business, such as a renegotiation to allow the borrower to take
advantage of a decline in interest rates or other change in market
conditions.
---------------------------------------------------------------------------
3. Guarantees. Guarantees of the OECD and non-OECD central
governments, U.S. Government agencies, U.S. Government-sponsored
agencies, state and local governments of the OECD-based group of
countries, multilateral lending institutions and regional development
banks, U.S. depository institutions, foreign banks, and qualifying OECD-
based securities firms are also recognized. If a claim is partially
guaranteed, the portion of the claim that is not fully covered by the
guarantee is assigned to the risk category appropriate to the obligor
or, if relevant, the collateral.
4. Maturity. Maturity is generally not a factor in assigning items
to risk categories with the exceptions of claims on non-OECD banks,
commitments, and interest rate and foreign exchange rate related
contracts. Except for commitments, short-term is defined as one year or
less remaining maturity and long-term is defined as over one year
remaining maturity. In the case of commitments, short-term is defined as
one year or less original maturity and long-term is defined as over one
year original maturity.\12\
---------------------------------------------------------------------------
\12\ Through year-end 1992, remaining rather than original maturity
may be used for determining term to maturity for commitments.
---------------------------------------------------------------------------
5. Recourse, Direct Credit Substitutes, Residual Interests and
Mortgage- and Asset-Backed Securities. For purposes of this section
II.B.5 of this appendix A, the following definitions will apply.
a. Definitions--(1) Credit derivative means a contract that allows
one party (the ``protection purchaser'') to transfer the credit risk of
an asset or off-balance sheet credit exposure to another party (the
``protection provider''). The value of a credit derivative is dependent,
at least in part, on the credit performance of the ``reference asset.''
(2) Credit-enhancing interest only strip is defined in Sec.
325.2(g).
(3) Credit-enhancing representations and warranties means
representations and warranties that are made or assumed in connection
with a transfer of assets (including loan servicing assets) and that
obligate the bank to protect investors from losses arising from credit
risk in the assets transferred or the loans serviced. Credit-enhancing
representations and warranties include promises to protect a party from
losses resulting from the default or nonperformance of another party or
from an insufficiency in the value of the collateral. Credit-enhancing
representations and warranties do not include:
(i) Early default clauses and similar warranties that permit the
return of, or premium refund clauses covering, 1-4 family residential
first mortgage loans that qualify for a 50 percent risk weight for a
period not to exceed 120 days from the date of transfer. These
warranties may cover only those loans that were originated within 1 year
of the date of transfer;
(ii) Premium refund clauses that cover assets guaranteed, in whole
or in part, by the U.S. Government, a U.S. Government agency or a
government-sponsored enterprise, provided the premium refund clauses are
for a period not to exceed 120 days from the date of transfer; or
(iii) Warranties that permit the return of assets in instances of
misrepresentation, fraud or incomplete documentation.
(4) Direct credit substitute means an arrangement in which a bank
assumes, in form or in substance, credit risk associated with an on-or
off-balance sheet credit exposure that was not previously owned by the
bank (third-party asset) and the risk assumed by the bank exceeds the
pro rata share of the bank's interest in the third-party asset. If the
bank has no claim on the third-party asset, then the bank's assumption
of any credit risk with respect to the third party asset is a direct
credit substitute. Direct credit substitutes include, but are not
limited to:
(i) Financial standby letters of credit, which includes any letter
of credit or similar arrangement, however named or described, that
support financial claims on a third party that exceed a bank's pro rata
share of losses in the financial claim;
(ii) Guarantees, surety arrangements, credit derivatives, and
similar instruments backing financial claims;
(iii) Purchased subordinated interests or securities that absorb
more than their pro rata share of credit losses from the underlying
assets;
[[Page 206]]
(iv) Credit derivative contracts under which the bank assumes more
than its pro rata share of credit risk on a third party asset or
exposure;
(v) Loans or lines of credit that provide credit enhancement for the
financial obligations of an account party;
(vi) Purchased loan servicing assets if the servicer:
(A) Is responsible for credit losses with the loans being serviced,
(B) Is responsible for making servicer cash advances (unless the
advances are not direct credit substitutes because they meet the
conditions specified in section II.B.5(a)(9) of this Appendix A), or
(C) Makes or assumes credit-enhancing representations and warranties
with respect to the loans serviced;
(vii) Clean-up calls on third party assets. Clean-up calls that are
exercisable at the option of the bank (as servicer or as an affiliate of
the servicer) when the pool balance is 10 percent or less of the
original pool balance are not direct credit substitutes; and
(viii) Liquidity facilities that provide liquidity support to ABCP
(other than eligible ABCP liquidity facilities).
(5) Eligible ABCP liquidity facility means a liquidity facility
supporting ABCP, in form or in substance, that is subject to an asset
quality test at the time of draw that precludes funding against assets
that are 90 days or more past due or in default. In addition, if the
assets that an eligible ABCP liquidity facility is required to fund
against are externally rated assets or exposures at the inception of the
facility, the facility can be used to fund only those assets or
exposures that are externally rated investment grade at the time of
funding. Notwithstanding the eligibility requirements set forth in the
two preceding sentences, a liquidity facility will be considered an
eligible ABCP liquidity facility if the assets that are funded under the
liquidity facility and which do not meet the eligibility requirements
are guaranteed, either conditionally or unconditionally, by the U.S.
government or its agencies, or by the central government of an OECD
country.
(6) Externally rated means that an instrument or obligation has
received a credit rating from a nationally recognized statistical rating
organization.
(7) Face amount means the notional principal, or face value, amount
of an off-balance sheet item; the amortized cost of an asset not held
for trading purposes; and the fair value of a trading asset.
(8) Financial asset means cash or other monetary instrument,
evidence of debt, evidence of an ownership interest in an entity, or a
contract that conveys a right to receive or exchange cash or another
financial instrument from another party.
(9) Financial standby letter of credit means a letter of credit or
similar arrangement that represents an irrevocable obligation to a
third-party beneficiary:
(i) To receive money borrowed by, or advanced to, or advanced to, or
for the account of, a second party (the account party), or
(ii) To make payment on behalf of the account party, in the event
that the account party fails to fulfill its obligation to the
beneficiary.
(10) Liquidity facility means a legally binding commitment to
provide liquidity support to ABCP by lending to, or purchasing assets
from, any structure, program, or conduit in the event that funds are
required to repay maturing ABCP.
(11) Mortgage servicer cash advance means funds that a residential
mortgage servicer advances to ensure an uninterrupted flow of payments,
including advances made to cover foreclosure costs or other expenses to
facilitate the timely collection of the loan. A mortgage servicer cash
advance is not a recourse obligation or a direct credit substitute if:
(i) The mortgage servicer is entitled to full reimbursement and this
right is not subordinated to other claims on the cash flows from the
underlying asset pool; or
(ii) For any one loan, the servicer's obligation to make
nonreimbursable advances is contractually limited to an insignificant
amount of the outstanding principal of that loan.
(12) Nationally recognized statistical rating organization (NRSRO)
means an entity recognized by the Division of Market Regulation of the
Securities and Exchange Commission (or any successor Division)
(Commission) as a nationally recognized statistical rating organization
for various purposes, including the Commission's uniform net capital
requirements for brokers and dealers (17 CFR 240.15c3-1).
(13) Recourse means an arrangement in which a bank retains, in form
or in substance, of any credit risk directly or indirectly associated
with an asset it has sold (in accordance with generally accepted
accounting principles) that exceeds a pro rata share of the bank's claim
on the asset. If a bank has no claim on an asset it has sold, then the
retention of any credit risk is recourse. A recourse obligation
typically arises when an institution transfers assets in a sale and
retains an obligation to repurchase the assets or absorb losses due to a
default of principal or interest or any other deficiency in the
performance of the underlying obligor or some other party. Recourse may
exist implicitly where a bank provides credit enhancement beyond any
contractual obligation to support assets it has sold. The following are
examples of recourse arrangements:
[[Page 207]]
(i) Credit-enhancing representations and warranties made on the
transferred assets;
(ii) Loan servicing assets retained pursuant to an agreement under
which the bank:
(A) Is responsible for losses associated with the loans being
serviced, or
(B) Is responsible for making mortgage servicer cash advances
(unless the advances are not a recourse obligation because they meet the
conditions specified in section II.B.5(a)(11) of this Appendix A).
(iii) Retained subordinated interests that absorb more than their
pro rata share of losses from the underlying assets;
(iv) Assets sold under an agreement to repurchase, if the assets are
not already included on the balance sheet;
(v) Loan strips sold without contractual recourse where the maturity
of the transferred portion of the loan is shorter than the maturity of
the commitment under which the loan is drawn;
(vi) Credit derivative contracts under which the bank retains more
than its pro rata share of credit risk on transferred assets;
(vii) Clean-up calls at inception that are greater than 10 percent
of the balance of the original pool of transferred loans. Clean-up calls
that are 10 percent or less of the original pool balance that are
exercisable at the option of the bank are not recourse arrangements; and
(viii.) Liquidity facilities that provide liquidity support to ABCP
(other than eligible ABCP liquidity facilities).
(14) Residual interest means any on-balance sheet asset that
represents an interest (including a beneficial interest) created by a
transfer that qualifies as a sale (in accordance with generally accepted
accounting principles (GAAP)) of financial assets, whether through a
securitization or otherwise, and that exposes a bank to credit risk
directly or indirectly associated with the transferred assets that
exceeds a pro rata share of the bank's claim on the assets, whether
through subordination provisions or other credit enhancement techniques.
Residual interests generally include credit-enhancing I/Os, spread
accounts, cash collateral accounts, retained subordinated interests,
other forms of over-collateralization, and similar assets that function
as a credit enhancement. Residual interests further include those
exposures that, in substance, cause the bank to retain the credit risk
of an asset or exposure that had qualified as a residual interest before
it was sold. Residual interests generally do not include interests
purchased from a third party, except that purchased credit-enhancing I/
Os are residual interests for purposes of the risk-based capital
treatment in this appendix.
(15) Risk participation means a participation in which the
originating party remains liable to the beneficiary for the full amount
of an obligation (e.g., a direct credit substitute) notwithstanding that
another party has acquired a participation in that obligation.
(16) Securitization means the pooling and repackaging by a special
purpose entity of assets or other credit exposures into securities that
can be sold to investors. Securitization includes transactions that
create stratified credit risk positions whose performance is dependent
upon an underlying pool of credit exposures, including loans and
commitments.
(17) Sponsor means a bank that establishes an ABCP program; approves
the sellers permitted to participate in the program; approves the asset
pools to be purchased by the program; or administers the ABCP program by
monitoring the assets, arranging for debt placement, compiling monthly
reports, or ensuring compliance with the program documents and with the
program's credit and investment policy.
(18) Structured finance program means a program where receivable
interests and asset-backed securities issued by multiple participants
are purchased by a special purpose entity that repackages those
exposures into securities that can be sold to investors. Structured
finance programs allocate credit risks, generally, between the
participants and credit enhancement provided to the program.
(19) Traded position means a position that is externally rated and
is retained, assumed or issued in connection with an asset
securitization, where there is a reasonable expectation that, in the
near future, the rating will be relied upon by unaffiliated investors to
purchase the position; or an unaffiliated third party to enter into a
transaction involving the position, such as a purchase, loan, or
repurchase agreement.
(b) Credit equivalent amounts and risk weights of recourse
obligations and direct credit substitutes--(1) General rule for
determining the credit-equivalent amount. Except as otherwise provided,
the credit-equivalent amount for a recourse obligation or direct credit
substitute is the full amount of the credit-enhanced assets for which
the bank directly or indirectly retains or assumes credit risk
multiplied by a 100% conversion factor. Thus, a bank that extends a
partial direct credit substitute, e.g., a financial standby letter of
credit that absorbs the first 10 percent of loss on a transaction, must
maintain capital against the full amount of the assets being supported.
(2) Risk-weight factor. To determine the bank's risk-weighted assets
for an off-balance sheet recourse obligation or a direct credit
substitute, the credit equivalent amount is assigned to the risk
category appropriate to the obligor in the underlying transaction, after
considering any associated guarantees or collateral. For a direct credit
substitute that is an on-balance sheet asset, e.g., a purchased
subordinated security, a
[[Page 208]]
bank must calculate risk-weighted assets using the amount of the direct
credit substitute and the full amount of the assets it supports, i.e.,
all the more senior positions in the structure. The treatment covered in
this paragraph (b) is subject to the low-level exposure rule provided in
section II.B.5(h)(1) of this appendix A.
(c) Credit equivalent amount and risk weight of participations in,
and syndications of, direct credit substitutes. Subject to the low-level
exposure rule provided in section II.B.5(h)(1) of this appendix A, the
credit equivalent amount for a participation interest in, or syndication
of, a direct credit substitute (excluding purchased credit-enhancing
interest-only strips) is calculated and risk weighted as follows:
(1) Treatment for direct credit substitutes for which a bank has
conveyed a risk participation. In the case of a direct credit substitute
in which a bank has conveyed a risk participation, the full amount of
the assets that are supported by the direct credit substitute is
converted to a credit equivalent amount using a 100% conversion factor.
However, the pro rata share of the credit equivalent amount that has
been conveyed through a risk participation is then assigned to whichever
risk-weight category is lower: the risk-weight category appropriate to
the obligor in the underlying transaction, after considering any
associated guarantees or collateral, or the risk-weight category
appropriate to the party acquiring the participation. The pro rata share
of the credit equivalent amount that has not been participated out is
assigned to the risk-weight category appropriate to the obligor,
guarantor, or collateral. For example, the pro rata share of the full
amount of the assets supported, in whole or in part, by a direct credit
substitute conveyed as a risk participation to a U.S. domestic
depository institution or an OECD bank is assigned to the 20 percent
risk category.\13\
---------------------------------------------------------------------------
\13\ A risk participation with a remaining maturity of one year or
less that is conveyed to a non-OECD bank is also assigned to the 20
percent risk category.
---------------------------------------------------------------------------
(2) Treatment for direct credit substitutes in which the bank has
acquired a risk participation. In the case of a direct credit substitute
in which the bank has acquired a risk participation, the acquiring
bank's pro rata share of the direct credit substitute is multiplied by
the full amount of the assets that are supported by the direct credit
substitute and converted using a 100% credit conversion factor. The
resulting credit equivalent amount is then assigned to the risk-weight
category appropriate to the obligor in the underlying transaction, after
considering any associated guarantees or collateral.
(3) Treatment for direct credit substitutes related to syndications.
In the case of a direct credit substitute that takes the form of a
syndication where each party is obligated only for its pro rata share of
the risk and there is no recourse to the originating entity, each bank's
credit equivalent amount will be calculated by multiplying only its pro
rata share of the assets supported by the direct credit substitute by a
100% conversion factor. The resulting credit equivalent amount is then
assigned to the risk-weight category appropriate to the obligor in the
underlying transaction, after considering any associated guarantees or
collateral.
(d) Externally rated positions: credit-equivalent amounts and risk
weights.--(1) Traded positions. With respect to a recourse obligation,
direct credit substitute, residual interest (other than a credit-
enhancing interest-only strip) or mortgage- or asset-backed security
that is a ``traded position'' and that has received an external rating
on a long-term position that is one grade below investment grade or
better or a short-term position that is investment grade, the bank may
multiply the face amount of the position by the appropriate risk weight,
determined in accordance with Table A or B of this appendix A, as
appropriate.\14\ If a traded position receives more than one external
rating, the lowest rating will apply.
---------------------------------------------------------------------------
\14\ Stripped mortgage-backed securities and similar instruments,
such as interest-only strips that are not credit-enhancing and
principal-only strips, must be assigned to the 100% risk category.
Table A
------------------------------------------------------------------------
Risk weight
Long-term rating category Examples (In percent)
------------------------------------------------------------------------
Highest or second highest AAA, AA............. 20
investment grade.
Third highest investment grade.... A................... 50
Lowest investment grade........... BBB................. 100
One category below investment BB.................. 200
grade.
------------------------------------------------------------------------
[[Page 209]]
Table B
------------------------------------------------------------------------
Risk weight
Short-term rating category Examples (In percent)
------------------------------------------------------------------------
Highest investment grade.......... A-1, P-1............ 20
Second highest investment grade... A-2, P-2............ 50
Lowest investment grade........... A-3, P-3............ 100
------------------------------------------------------------------------
(2) Non-traded positions. A recourse obligation, direct credit
substitute, residual interest (but not a credit-enhancing interest-only
strip) or mortgage- or asset-backed security extended in connection with
a securitization that is not a ``traded position'' may be assigned a
risk weight in accordance with section II.B.5(d)(1) of this appendix A
if:
(i) It has been externally rated by more than one NRSRO;
(ii) It has received an external rating on a long-term position that
is one category below investment grade or better or a short-term
position that is investment grade by all NRSROs providing a rating;
(iii) The ratings are publicly available; and
(iv) The ratings are based on the same criteria used to rate traded
positions. If the ratings are different, the lowest rating will
determine the risk category to which the recourse obligation, direct
credit substitute, residual interest, or mortgage- or asset-backed
security will be assigned.
(e) Senior positions not externally rated. For a recourse
obligation, direct credit substitute, residual interest or mortgage- or
asset-backed security that is not externally rated but is senior in all
features to a traded position (including collateralization and
maturity), a bank may apply a risk weight to the face amount of the
senior position in accordance with section II.B.5(d)(1) of this appendix
A, based upon the risk weight of the traded position, subject to any
current or prospective supervisory guidance and the bank satisfying the
FDIC that this treatment is appropriate. This section will apply only if
the traded position provides substantial credit support for the entire
life of the unrated position.
(f) Residual interests--(1) Concentration limit on credit-enhancing
interest-only strips. In addition to the capital requirement provided by
section II.B.5(f)(2) of this appendix A, a bank must deduct from Tier 1
capital the face amount of all credit-enhancing interest-only strips in
excess of 25 percent of Tier 1 capital in accordance with Sec.
325.5(f)(3).
(2) Credit-enhancing interest-only strip capital requirement. After
applying the concentration limit to credit-enhancing interest-only
strips in accordance with Sec. 325.5(f)(3), a bank must maintain risk-
based capital for a credit-enhancing interest-only strip, equal to the
remaining face amount of the credit-enhancing interest-only strip (net
of the remaining proportional amount of any existing associated deferred
tax liability recorded on the balance sheet), even if the amount of
risk-based capital required to be maintained exceeds the full risk-based
capital requirement for the assets transferred. Transactions that, in
substance, result in the retention of credit risk associated with a
transferred credit-enhancing interest-only strip will be treated as if
the credit-enhancing interest-only strip was retained by the bank and
not transferred.
(3) Other residual interests capital requirement. Except as
otherwise provided in section II.B.5(d) or (e) of this appendix A, a
bank must maintain risk-based capital for a residual interest (excluding
a credit-enhancing interest-only strip) equal to the face amount of the
residual interest (net of any existing associated deferred tax liability
recorded on the balance sheet), even if the amount of risk-based capital
required to be maintained exceeds the full risk-based capital
requirement for the assets transferred. Transactions that, in substance,
result in the retention of credit risk associated with a transferred
residual interest will be treated as if the residual interest was
retained by the bank and not transferred.
(4) Residual interests and other recourse obligations. Where the
aggregate capital requirement for residual interests (including credit-
enhancing interest-only strips) and recourse obligations arising from
the same transfer of assets exceed the full risk-based capital
requirement for assets transferred, a bank must maintain risk-based
capital equal to the greater of the risk-based capital requirement for
the residual interest as calculated under sections II.B.5(f)(2) through
(3) of this appendix A or the full risk-based capital requirement for
the assets transferred.
(g) Positions that are not rated by an NRSRO. A bank's position
(other than a residual interest) in a securitization or structured
finance program that is not rated by an NRSRO may be risk-weighted based
on the bank's determination of the credit rating of the position, as
specified in Table C of this appendix A, multiplied by the face amount
of the position. In order to qualify for this treatment, the bank's
system for determining the credit rating of the position must meet one
of the three alternative standards set out in section II.B.5(g)(1)
through (3) of this appendix A.
[[Page 210]]
Table C
------------------------------------------------------------------------
Risk Weight
Rating category Examples (In percent)
------------------------------------------------------------------------
Investment grade.................. BBB or better....... 100
One category below investment BB.................. 200
grade.
------------------------------------------------------------------------
(1) Internal risk rating used for asset-backed programs. A bank
extends a direct credit substitute (but not a purchased credit-enhancing
interest-only strip) to an asset-backed commercial paper program
sponsored by the bank and the bank is able to demonstrate to the
satisfaction of the FDIC, prior to relying upon its use, that the bank's
internal credit risk rating system is adequate. Adequate internal credit
risk rating systems usually contain the following criteria:\15\
---------------------------------------------------------------------------
\15\ The adequacy of a bank's use of its internal credit risk rating
system must be demonstrated to the FDIC considering the criteria listed
in this section and the size and complexity of the credit exposures
assumed by the bank.
---------------------------------------------------------------------------
(i) The internal credit risk rating system is an integral part of
the bank's risk management system that explicitly incorporates the full
range of risks arising from a bank's participation in securitization
activities;
(ii) Internal credit ratings are linked to measurable outcomes, such
as the probability that the position will experience any loss, the
position's expected loss given default, and the degree of variance in
losses given default on that position;
(iii) The internal credit risk rating system must separately
consider the risk associated with the underlying loans or borrowers, and
the risk associated with the structure of a particular securitization
transaction;
(iv) The internal credit risk rating system identifies gradations of
risk among ``pass'' assets and other risk positions;
(v) The internal credit risk rating system must have clear, explicit
criteria (including for subjective factors), that are used to classify
assets into each internal risk grade;
(vi) The bank must have independent credit risk management or loan
review personnel assigning or reviewing the credit risk ratings;
(vii) An internal audit procedure should periodically verify that
internal risk ratings are assigned in accordance with the bank's
established criteria;
(viii) The bank must monitor the performance of the internal credit
risk ratings assigned to nonrated, nontraded direct credit substitutes
over time to determine the appropriateness of the initial credit risk
rating assignment and adjust individual credit risk ratings, or the
overall internal credit risk ratings system, as needed; and
(ix) The internal credit risk rating system must make credit risk
rating assumptions that are consistent with, or more conservative than,
the credit risk rating assumptions and methodologies of NRSROs.
(2) Program Ratings. A bank extends a direct credit substitute or
retains a recourse obligation (but not a residual interest) in
connection with a structured finance program and an NRSRO has reviewed
the terms of the program and stated a rating for positions associated
with the program. If the program has options for different combinations
of assets, standards, internal credit enhancements and other relevant
factors, and the NRSRO specifies ranges of rating categories to them,
the bank may apply the rating category applicable to the option that
corresponds to the bank's position. In order to rely on a program
rating, the bank must demonstrate to the FDIC's satisfaction that the
credit risk rating assigned to the program meets the same standards
generally used by NRSROs for rating traded positions. The bank must also
demonstrate to the FDIC's satisfaction that the criteria underlying the
NRSRO's assignment of ratings for the program are satisfied for the
particular position issued by the bank. If a bank participates in a
securitization sponsored by another party, the FDIC may authorize the
bank to use this approach based on a program rating obtained by the
sponsor of the program.
(3) Computer Program. A bank is using an acceptable credit
assessment computer program that has been developed by an NRSRO to
determine the rating of a direct credit substitute or recourse
obligation (but not a residual interest) extended in connection with a
structured finance program. In order to rely on the rating determined by
the computer program, the bank must demonstrate to the FDIC's
satisfaction that ratings under the program correspond credibly and
reliably with the ratings of traded positions. The bank must also
demonstrate to the FDIC's satisfaction the credibility of the program in
financial markets, the reliability of the program in assessing credit
risk, the applicability of the program to the bank's position, and the
proper implementation of the program.
(h) Limitations on risk-based capital requirements--(1) Low-level
exposure rule. If the maximum exposure to loss retained or assumed
[[Page 211]]
by a bank in connection with a recourse obligation, a direct credit
substitute, or a residual interest is less than the effective risk-based
capital requirement for the credit-enhanced assets, the risk-based
capital required under this appendix A is limited to the bank's maximum
contractual exposure, less any recourse liability account established in
accordance with generally accepted accounting principles. This
limitation does not apply when a bank provides credit enhancement beyond
any contractual obligation to support assets it has sold.
(2) Mortgage-related securities or participation certificates
retained in a mortgage loan swap. If a bank holds a mortgage-related
security or a participation certificate as a result of a mortgage loan
swap with recourse, capital is required to support the recourse
obligation plus the percentage of the mortgage-related security or
participation certificate that is not covered by the recourse
obligation. The total amount of capital required for the on-balance
sheet asset and the recourse obligation, however, is limited to the
capital requirement for the underlying loans, calculated as if the bank
continued to hold these loans as an on-balance sheet asset.
(3) Related on-balance sheet assets. If a recourse obligation or
direct credit substitute also appears as a balance sheet asset, the
asset is risk-weighted only under this section II.B.5 of this appendix
A, except in the case of loan servicing assets and similar arrangements
with embedded recourse obligations or direct credit substitutes. In that
case, the on-balance sheet servicing assets and the related recourse
obligations or direct credit substitutes must both be separately risk
weighted and incorporated into the risk-based capital calculation.
(i) Alternative Capital Calculation for Small Business Obligations.
(1) Definitions. For purposes of this section II.B. 5(i):
(i) Qualified bank means a bank that:
(A) Is well capitalized as defined in Sec. 325.103(b)(1) without
applying the capital treatment described in this section II.B.5(i), or
(B) Is adequately capitalized as defined in Sec. 325.103(b)(2)
without applying the capital treatment described in this section
II.B.5(i) and has received written permission by order of the FDIC to
apply the capital treatment described in this section II.B.5(i).
(iii) Small business means a business that meets the criteria for a
small business concern established by the Small Business Administration
in 13 CFR part 121 pursuant to 15 U.S.C. 632.
(2) Capital and reserve requirements. Notwithstanding the risk-based
capital treatment outlined in any other paragraph (other than paragraph
(i) of this section II.B.5), with respect to a transfer with recourse of
a small business loan or a lease to a small business of personal
property that is a sale under generally accepted accounting principles,
and for which the bank establishes and maintains a non-capital reserve
under generally accepted accounting principles sufficient to meet the
reasonable estimated liability of the bank under the recourse
arrangement; a qualified bank may elect to include only the face amount
of its recourse in its risk-weighted assets for purposes of calculating
the bank's risk-based capital ratio.
(3) Limit on aggregate amount of recourse. The total outstanding
amount of recourse retained by a qualified bank with respect to
transfers of small business loans and leases to small businesses of
personal property and included in the risk-weighted assets of the bank
as described in section II.B.5(i)(2) of this appendix A may not exceed
15 percent of the bank's total risk-based capital, unless the FDIC
specifies a greater amount by order.
(4) Bank that ceases to be qualified or that exceeds aggregate
limit. If a bank ceases to be a qualified bank or exceeds the aggregate
limit in section II.B.5(i)(3) of this appendix A, the bank may continue
to apply the capital treatment described in section II.B.5(i)(2) of this
appendix A to transfers of small business loans and leases to small
businesses of personal property that occurred when the bank was
qualified and did not exceed the limit.
(5) Prompt correction action not affected. (i) A bank shall compute
its capital without regard to this section II.B.5(i) for purposes of
prompt corrective action (12 U.S.C. 1831o) unless the bank is a well
capitalized bank (without applying the capital treatment described in
this section II.B.5(i)) and, after applying the capital treatment
described in this section II.B.5(i), the bank would be well capitalized.
(ii) A bank shall compute its capital without regard to this section
II.B.5(i) for purposes of 12 U.S.C. 1831o(g) regardless of the bank's
capital level.
(6) Nonfinancial equity investments. (i) General. A bank must deduct
from its Tier 1 capital the sum of the appropriate percentage (as
determined below) of the adjusted carrying value of all nonfinancial
equity investments held by the bank or by its direct or indirect
subsidiaries. For purposes of this section II.B.(6), investments held by
a bank include all investments held directly or indirectly by the bank
or any of its subsidiaries.
(ii) Scope of nonfinancial equity investments. A nonfinancial equity
investment means any equity investment held by the bank in a
nonfinancial company: through a small business investment company (SBIC)
under section 302(b) of the Small Business Investment Act
[[Page 212]]
of 1958 (15 U.S.C. 682(b));\16\ under the portfolio investment
provisions of Regulation K issued by the Board of Governors of the
Federal Reserve System (12 CFR 211.8(c)(3)); or under section 24 of the
Federal Deposit Insurance Act (12 U.S.C. 1831a), other than an
investment held in accordance with section 24(f) of that Act.\17\ A
nonfinancial company is an entity that engages in any activity that has
not been determined to be permissible for the bank to conduct directly,
or to be financial in nature or incidental to financial activities under
section 4(k) of the Bank Holding Company Act (12 U.S.C. 1843(k)).
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\16\ An equity investment made under section 302(b) of the Small
Business Investment Act of 1958 in a SBIC that is not consolidated with
the bank is treated as a nonfinancial equity investment.
\17\ The Board of Directors of the FDIC, acting directly, may, in
exceptional cases and after a review of the proposed activity, permit a
lower capital deduction for investments approved by the Board of
Directors under section 24 of the FDI Act so long as the bank's
investments under section 24 and SBIC investments represent, in the
aggregate, less than 15 percent of the Tier 1 capital of the bank. The
FDIC reserves the authority to impose higher capital charges on any
investment where appropriate.
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(iii) Amount of deduction from core capital. (A) The bank must
deduct from its Tier 1 capital the sum of the appropriate percentages,
as set forth in the table following this paragraph, of the adjusted
carrying value of all nonfinancial equity investments held by the bank.
The amount of the percentage deduction increases as the aggregate amount
of nonfinancial equity investments held by the bank increases as a
percentage of the bank's Tier 1 capital.
Deduction for Nonfinancial Equity Investments
------------------------------------------------------------------------
Aggregate adjusted carrying value
of all nonfinancial equity
investments held directly or Deduction from Tier 1 Capital (as a
indirectly by the bank (as a percentage of the adjusted carrying
percentage of the Tier 1 capital of value of the investment)
the bank) \1\
------------------------------------------------------------------------
Less than 15 percent............... 8 percent.
15 percent to 24.99 percent........ 12 percent.
25 percent and above............... 25 percent.
------------------------------------------------------------------------
\1\ For purposes of calculating the adjusted carrying value of
nonfinancial equity investments as a percentage of Tier 1 capital,
Tier 1 capital is defined as the sum of core capital elements net of
goodwill and net of all identifiable intangible assets other than
mortgage servicing assets, nonmortgage servicing assets and purchased
credit card relationships, but prior to the deduction for any
disallowed mortgage servicing assets, any disallowed nonmortgage
servicing assets, any disallowed purchased credit card relationships,
any disallowed credit-enhancing interest-only strips (both purchased
and retained), any disallowed deferred tax assets, and any
nonfinancial equity investments.
(B) These deductions are applied on a marginal basis to the portions
of the adjusted carrying value of nonfinancial equity investments that
fall within the specified ranges of the parent bank's Tier 1 capital.
For example, if the adjusted carrying value of all nonfinancial equity
investments held by a bank equals 20 percent of the Tier 1 capital of
the bank, then the amount of the deduction would be 8 percent of the
adjusted carrying value of all investments up to 15 percent of the
bank's Tier 1 capital, and 12 percent of the adjusted carrying value of
all investments in excess of 15 percent of the bank's Tier 1 capital.
(C) The total adjusted carrying value of any nonfinancial equity
investment that is subject to deduction under this paragraph is excluded
from the bank's risk-weighted assets for purposes of computing the
denominator of the bank's risk-based capital ratio and from total assets
for purposes of calculating the denominator of the leverage ratio.\18\
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\18\ For example, if 8 percent of the adjusted carrying value of a
nonfinancial equity investment is deducted from Tier 1 capital, the
entire adjusted carrying value of the investment will be excluded from
both risk-weighted assets and total assets in calculating the respective
denominators for the risk-based capital and leverage ratios.
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(D) This Appendix establishes minimum risk-based capital ratios and
banks are at all times expected to maintain capital commensurate with
the level and nature of the risks to which they are exposed. The risk to
a bank from nonfinancial equity investments increases with its
concentration in such investments and strong capital levels above the
minimum requirements are particularly important when a bank has a high
degree of concentration in nonfinancial equity investments (e.g., in
excess of 50 percent of Tier 1 capital). The FDIC intends to monitor
banks and apply heightened supervision to equity investment activities
as appropriate, including where the bank has a high degree of
concentration in nonfinancial equity investments, to ensure that each
bank maintains capital levels that are appropriate in light of its
equity investment activities. The FDIC
[[Page 213]]
also reserves authority to impose a higher capital charge in any case
where the circumstances, such as the level of risk of the particular
investment or portfolio of investments, the risk management systems of
the bank, or other information, indicate that a higher minimum capital
requirement is appropriate.
(iv) SBIC investments. (A) No deduction is required for nonfinancial
equity investments that are held by a bank through one or more SBICs
that are consolidated with the bank or in one or more SBICs that are not
consolidated with the bank to the extent that all such investments, in
the aggregate, do not exceed 15 percent of the bank's Tier 1 capital.
Any nonfinancial equity investment that is held through an SBIC or in an
SBIC and that is not required to be deducted from Tier 1 capital under
this section II.B.(6)(iv) will be assigned a 100 percent risk-weight and
included in the bank's consolidated risk-weighted assets.\19\
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\19\ If a bank has an investment in a SBIC that is consolidated for
accounting purposes but that is not wholly owned by the bank, the
adjusted carrying value of the bank's nonfinancial equity investments
through the SBIC is equal to the bank's proportionate share of the
adjusted carrying value of the SBIC's investments in nonfinancial
companies. The remainder of the SBIC's adjusted carrying value (i.e.,
the minority interest holders' proportionate share) is excluded from the
risk-weighted assets of the bank. If a bank has an investment in a SBIC
that is not consolidated for accounting purposes and has current
information that identifies the percentage of the SBIC's assets that are
equity investments in nonfinancial companies, the bank may reduce the
adjusted carrying value of its investment in the SBIC proportionately to
reflect the percentage of the adjusted carrying value of the SBIC's
assets that are not equity investments in nonfinancial companies. If a
bank reduces the adjusted carrying value of its investment in a non-
consolidated SBIC to reflect financial investments of the SBIC, the
amount of the adjustment will be risk weighted at 100 percent and
included in the bank's risk-weighted assets.
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(B) To the extent the adjusted carrying value of all nonfinancial
equity investments that a bank holds through one or more SBICs that are
consolidated with the bank or in one or more SBICs that are not
consolidated with the bank exceeds, in the aggregate, 15 percent of the
bank's Tier 1 capital, the appropriate percentage of such amounts (as
set forth in the table in section II.B.(6)(iii)(A)) must be deducted
from the bank's common stockholders' equity in determining the bank's
Tier 1 capital. In addition, the aggregate adjusted carrying value of
all nonfinancial equity investments held by a bank through a
consolidated SBIC and in a non-consolidated SBIC (including any
investments for which no deduction is required) must be included in
determining, for purposes of the table in section II.B.(6)(iii)(A), the
total amount of nonfinancial equity investments held by the bank in
relation to its Tier 1 capital.
(v) Transition provisions. No deduction under this section II.B.(6)
is required to be made with respect to the adjusted carrying value of
any nonfinancial equity investment (or portion of such an investment)
that was made by the bank prior to March 13, 2000, or that was made by
the bank after such date pursuant to a binding written commitment \20\
entered into prior to March 13, 2000, provided that in either case the
bank has continuously held the investment since the relevant investment
date.\21\ For purposes of this section II.B.(6)(v) a nonfinancial equity
investment made prior to March 13, 2000, includes any shares or other
interests received by the bank through a stock split or stock dividend
on an investment made prior to March 13, 2000, provided the bank
provides no consideration for the shares or interests received and the
transaction does not materially increase
[[Page 214]]
the bank's proportional interest in the company. The exercise on or
after March 13, 2000, of options or warrants acquired prior to March 13,
2000, is not considered to be an investment made prior to March 13,
2000, if the bank provides any consideration for the shares or interests
received upon exercise of the options or warrants. Any nonfinancial
equity investment (or portion thereof) that is not required to be
deducted from Tier 1 capital under this section II.B.(6)(v) must be
included in determining the total amount of nonfinancial equity
investments held by the bank in relation to its Tier 1 capital for
purposes of the table in section II.B.(6)(iii)(A). In addition, any
nonfinancial equity investment (or portion thereof) that is not required
to be deducted from Tier 1 capital under this section II.B.(6)(v) will
be assigned a 100-percent risk weight and included in the bank's
consolidated risk-weighted assets.
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\20\ A ``binding written commitment'' means a legally binding
written agreement that requires the bank to acquire shares or other
equity of the company, or make a capital contribution to the company,
under terms and conditions set forth in the agreement. Options,
warrants, and other agreements that give a bank the right to acquire
equity or make an investment, but do not require the bank to take such
actions, are not considered a binding written commitment for purposes of
this section II.B.(6)(v).
\21\ For example, if a bank made an equity investment in 100 shares
of a nonfinancial company prior to March 13, 2000, the adjusted carrying
value of that investment would not be subject to a deduction under this
section II.B.(6). However, if the bank made any additional equity
investment in the company after March 13, 2000, such as by purchasing
additional shares of the company (including through the exercise of
options or warrants acquired before or after March 13, 2000) or by
making a capital contribution to the company and such investment was not
made pursuant to a binding written commitment entered into before March
13, 2000, the adjusted carrying value of the additional investment would
be subject to a deduction under this section II.B.(6). In addition, if
the bank sold and repurchased, after March 13, 2000, 40 shares of the
company, the adjusted carrying value of those 40 shares would be subject
to a deduction under this section II.B.(6).
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(vi) Adjusted carrying value. (A) For purposes of this section
II.B.(6), the ``adjusted carrying value'' of investments is the
aggregate value at which the investments are carried on the balance
sheet of the bank reduced by any unrealized gains on those investments
that are reflected in such carrying value but excluded from the bank's
Tier 1 capital and associated deferred tax liabilities. For example, for
equity investments held as available-for-sale (AFS), the adjusted
carrying value of the investments would be the aggregate carrying value
of those investments (as reflected on the consolidated balance sheet of
the bank) less any unrealized gains on those investments that are
included in other comprehensive income and not reflected in Tier 1
capital, and associated deferred tax liabilities.\22\
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\22\ Unrealized gains on available-for-sale equity investments may
be included in Tier 2 capital to the extent permitted under section
I.A.(2)(f) of this appendix A. In addition, the net unrealized losses on
available-for-sale equity investments are deducted from Tier 1 capital
in accordance with section I.A.(1) of this appendix A.
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(B) As discussed above with respect to consolidated SBICs, some
equity investments may be in companies that are consolidated for
accounting purposes. For investments in a nonfinancial company that is
consolidated for accounting purposes under generally accepted accounting
principles, the bank's adjusted carrying value of the investment is
determined under the equity method of accounting (net of any intangibles
associated with the investment that are deducted from the bank's core
capital in accordance with section I.A.(1) of this appendix A). Even
though the assets of the nonfinancial company are consolidated for
accounting purposes, these assets (as well as the credit equivalent
amounts of the company's off-balance sheet items) should be excluded
from the bank's risk-weighted assets for regulatory capital purposes.
(vii) Equity investments. For purposes of this section II.B.(6), an
equity investment means any equity instrument (including common stock,
preferred stock, partnership interests, interests in limited liability
companies, trust certificates and warrants and call options that give
the holder the right to purchase an equity instrument), any equity
feature of a debt instrument (such as a warrant or call option), and any
debt instrument that is convertible into equity where the instrument or
feature is held under one of the legal authorities listed in section
II.B.(6)(ii) of this appendix A. An investment in any other instrument
(including subordinated debt) may be treated as an equity investment if,
in the judgment of the FDIC, the instrument is the functional equivalent
of equity or exposes the bank to essentially the same risks as an equity
instrument.
6. Asset-backed commercial paper programs. a. An asset-backed
commercial paper (ABCP) program means a program that primarily issues
externally rated commercial paper backed by assets or other exposures
held in a bankruptcy-remote, special purpose entity.
b. A bank that qualifies as a primary beneficiary and must
consolidate an ABCP program that is defined as a variable interest
entity under GAAP may exclude the consolidated ABCP program assets from
risk-weighted assets provided that the bank is the sponsor of the ABCP
program. If a bank excludes such consolidated ABCP program assets, the
bank must assess the appropriate risk-based capital charge against any
exposures of the bank arising in connection with such ABCP programs,
including direct credit substitutes, recourse obligations, residual
interests, liquidity facilities, and loans, in accordance with sections
II.B.5., II.C. and II.D. of this appendix.
c. If a bank has multiple overlapping exposures (such as a program-
wide credit enhancement and multiple pool-specific liquidity facilities)
to an ABCP program that is not consolidated for risk-based capital
purposes, the bank is not required to hold capital under duplicative
risk-based capital requirements under this appendix against the
overlapping position. Instead, the bank should apply to the overlapping
position the applicable risk-based capital treatment that results in the
highest capital charge.
C. Risk Weights for Balance Sheet Assets (see Table II)
The risk-based capital framework contains four risk weight
categories--0 percent, 20 percent, 50 percent and 100 percent. In
general, if a particular item can be placed in more than one risk
category, it is assigned to the category that has the lowest risk
[[Page 215]]
weight. An explanation of the components of each category follows:
Category 1--Zero Percent Risk Weight. a. This category includes cash
(domestic and foreign) owned and held in all offices of the bank or in
transit; balances due from Federal Reserve Banks and central banks in
other OECD countries; the portions of local currency claims on or
unconditionally guaranteed by non-OECD central governments to the extent
that the bank has liabilities booked in that currency; and gold bullion
held in the bank's own vaults or in another bank's vaults on an
allocated basis, to the extent it is offset by gold bullion
liabilities.\23\
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\23\ All other bullion holdings are to be assigned to the 100
percent risk weight category.
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b. The zero percent risk category also includes direct claims \24\
(including securities, loans, and leases) on, and the portions of claims
that are unconditionally guaranteed by, OECD central governments \25\
and U.S. Government agencies.\26\ Federal Reserve Bank stock also is
included in this category.
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\24\ For purposes of determining the appropriate risk weights for
this risk-based capital framework, the terms claims and securities refer
to loans or other debt obligations of the entity on whom the claim is
held. Investments in the form of stock or equity holdings in commercial
or financial firms are generally assigned to the 100 percent risk
category.
\25\ A central government is defined to include departments and
ministries, including the central bank, of the central government. The
U.S. central bank includes the 12 Federal Reserve Banks. The definition
of central government does not include state, provincial or local
governments or commercial enterprises owned by the central government.
In addition, it does not include local government entities or commercial
enterprises whose obligations are guaranteed by the central government.
OECD central governments are defined as central governments of the OECD-
based group of countries. Non-OECD central governments are defined as
central governments of countries that do not belong to the OECD-based
group of countries.
\26\ For risk-based capital purposes U.S. Government agency is
defined as an instrumentality of the U.S. Government whose debt
obligations are fully and explicitly guaranteed as to the timely payment
of principal and interest by the full faith and credit of the U.S.
Government. These agencies include the Government National Mortgage
Association (GNMA), the Veterans Administration (VA), the Federal
Housing Administration (FHA), the Farmers Home Administration (FHA), the
Export-Import Bank (Exim Bank), the Overseas Private Investment
Corporation (OPIC), the Commodity Credit Corporation (CCC), and the
Small Business Administration (SBA). U.S. Government agencies generally
do not directly issue securities to the public; however, a number of
U.S. Government agencies, such as GNMA, guarantee securities that are
publicly held.
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c. This category also includes claims on, and claims guaranteed by,
qualifying securities firms incorporated in the United States or other
members of the OECD-based group of countries that are collateralized by
cash on deposit in the lending bank or by securities issued or
guaranteed by the United States or OECD central governments (including
U.S. government agencies), provided that a positive margin of collateral
is required to be maintained on such a claim on a daily basis, taking
into account any change in a bank's exposure to the obligor or
counterparty under the claim in relation to the market value of the
collateral held in support of the claim.
Category 2--20 Percent Risk Weight. a. This category includes short-
term claims (including demand deposits) on, and portions of short-term
claims that are guaranteed \27\ by, U.S. depository institutions \28\
and foreign banks;\29\ portions of claims collateralized by
[[Page 216]]
cash held in a segregated deposit account of the lending bank; cash
items in process of collection, both foreign and domestic; and long-term
claims on, and portions of long-term claims guaranteed by, U.S.
depository institutions and OECD banks.\30\This category also includes a
claim \31\ on, or guaranteed by, qualifying securities firms
incorporated in the United States or other member of the OECD-based
group of countries \32\ provided that: the qualifying securities firm
has a long-term issuer credit rating, or a rating on at least one issue
of long-term debt, in one of the three highest investment grade rating
categories from a nationally recognized statistical rating organization;
or the claim is guaranteed by the firm's parent company and the parent
company has such a rating. If ratings are available from more than one
rating agency, the lowest rating will be used to determine whether the
rating requirement has been met. This category also includes a
collateralized claim on a qualifying securities firm in such a country,
without regard to satisfaction of the rating standard, provided that the
claim arises under a contract that:
(1) Is a reverse repurchase/repurchase agreement or securities
lending/borrowing transaction executed using standard industry
documentation;
(2) Is collateralized by debt or equity securities that are liquid
and readily marketable;
(3) Is marked-to-market daily;
(4) Is subject to a daily margin maintenance requirement under the
standardized documentation; and
(5) Can be liquidated, terminated, or accelerated immediately in
bankruptcy or similar proceeding, and the security or collateral
agreement will not be stayed or avoided, under applicable law of the
relevant jurisdiction.\33\
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\27\ Claims guaranteed by U.S. depository institutions and foreign
banks include risk participations in both bankers acceptances and
standby letters of credit, as well as participations in commitments,
that are conveyed to other U.S. depository institutions or foreign
banks.
\28\ U.S. depository institutions are defined to include branches
(foreign and domestic) of federally-insured banks and depository
institutions chartered and headquartered in the 50 states of the United
States, the District of Columbia, Puerto Rico, and U.S. territories and
possessions. The definition encompasses banks, mutual or stock savings
banks, savings or building and loan associations, cooperative banks,
credit unions, international banking facilities of domestic depository
institutions, and U.S.-chartered depository institutions owned by
foreigners. However, this definition excludes branches and agencies of
foreign banks located in the U.S. and bank holding companies.
\29\ Foreign banks are distinguished as either OECD banks or non-
OECD banks. OECD banks include banks and their branches (foreign and
domestic) organized under the laws of countries (other than the U.S.)
that belong to the OECD-based group of countries. Non-OECD banks include
banks and their branches (foreign and domestic) organized under the laws
of countries that do not belong to the OECD-based group of countries.
For risk-based capital purposes, a bank is defined as an institution
that engages in the business of banking; is recognized as a bank by the
bank supervisory or monetary authorities of the country of its
organization or principal banking operations; receives deposits to a
substantial extent in the regular course of business; and has the power
to accept demand deposits.
\30\ Long-term claims on, or guaranteed by, non-OECD banks and all
claims on bank holding companies are assigned to the 100 percent risk
weight category, as are holdings of bank-issued securities that qualify
as capital of the issuing banks for risk-based capital purposes.
\31\ Claims on a qualifying securities firm that are instruments the
firm, or its parent company, uses to satisfy its applicable capital
requirements are not eligible for this risk weight.
\32\ With regard to securities firms incorporated in the United
States, qualifying securities firms are those securities firms that are
broker-dealers registered with the Securities and Exchange Commission
(SEC) and are in compliance with the SEC's net capital rule, 17 CFR
240.15c3-1. With regard to securities firms incorporated in any other
country in the OECD-based group of countries, qualifying securities
firms are those securities firms that a bank is able to demonstrate are
subject to consolidated supervision and regulation (covering their
direct and indirect subsidiaries, but not necessarily their parent
organizations) comparable to that imposed on banks in OECD countries.
Such regulation must include risk-based capital requirements comparable
to those applied to banks under the Accord on International Convergence
of Capital Measurement and Capital Standards (1988, as amended in 1998)
(Basel Accord). Claims on a qualifying securities firm that are
instruments the firm, or its parent company, uses to satisfy its
applicable capital requirements are not eligible for this risk weight
and are generally assigned to at least a 100 percent risk weight. In
addition, certain claims on qualifying securities firms are eligible for
a zero percent risk weight if the claims are collateralized by cash on
deposit in the lending bank or by securities issued or guaranteed by the
United States or OECD central governments (including U.S. government
agencies), provided that a positive margin of collateral is required to
be maintained on such a claim on a daily basis, taking into account any
change in a bank's exposure to the obligor or counterparty under the
claim in relation to the market value of the collateral held in support
of the claim.
\33\ For example, a claim is exempt from the automatic stay in
bankruptcy in the United States if it arises under a securities contract
or a repurchase agreement subject to section 555 or 559 of the
Bankruptcy Code, respectively (11 U.S.C. 555 or 559), a qualified
financial contract under section 11(e)(8) of the Federal Deposit
Insurance Act (12 U.S.C. 1821(e)(8)), or a netting contract between
financial institutions under sections 401-407 of the Federal Deposit
Insurance Corporation Improvement Act of 1991 (12 U.S.C. 4401-4407), or
the Board's Regulation EE (12 CFR part 231).
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[[Page 217]]
b. This category also includes claims on, or portions of claims
guaranteed by, U.S. Government-sponsored agencies;\34\ and portions of
claims (including repurchase agreements) collateralized by securities
issued or guaranteed by OECD central governments, U.S. Government
agencies, or U.S. Government-sponsored agencies. Also included in the 20
percent risk category are portions of claims that are conditionally
guaranteed by OECD central governments and U.S. Government agencies,\35\
as well as portions of local currency claims that are conditionally
guaranteed by non-OECD central governments to the extent that the bank
has liabilities booked in that currency.
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\34\ For risk-based capital purposes, U.S. Government-sponsored
agencies are defined as agencies originally established or chartered by
the U.S. Government to serve public purposes specified by the U.S.
Congress but whose debt obligations are not explicitly guaranteed by the
full faith and credit of the U.S. Government. These agencies include the
Federal Home Loan Mortgage Corporation (FHLMC), the Federal National
Mortgage Association (FNMA), the Farm Credit System, the Federal Home
Loan Bank System, and the Student Loan Marketing Association (SLMA). For
risk-based capital purposes, claims on U.S. Government-sponsored
agencies also include capital stock in a Federal Home Loan Bank that is
held as a condition of membership in that Bank.
\35\ For risk-based capital purposes, a conditional guarantee is
deemed to exist if the validity of the guarantee by the OECD central
government or the U.S. Government agency is dependent upon some
affirmative action (e.g., servicing requirements on the part of the
beneficiary of the guarantee). Portions of claims that are
unconditionally guaranteed by OECD central governments or U.S.
Government agencies are assigned to the zero percent risk category.
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c. General obligation claims on, or portions of claims guaranteed
by, the full faith and credit of states or other political subdivisions
of the United States or other countries of the OECD-based group are also
assigned to this 20 percent risk category.\36\ In addition, this
category includes claims on the International Bank for Reconstruction
and Development (World Bank), International Finance Corporation the
Inter-American Development Bank, the Asian Development Bank, the African
Development Bank, the European Investment Bank, the European Bank for
Reconstruction and Development, the Nordic Investment Bank, and other
multilateral lending institutions or regional development institutions
in which the U.S. Government is a shareholder or contributing member, as
well as portions of claims guaranteed by such organizations or
collateralized by their securities.
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\36\ Claims on, or guaranteed by, states or other political
subdivisions of countries that do not belong to the OECD-based group of
countries are to be placed in the 100 percent risk weight category.
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d. This category also includes recourse obligations, direct credit
substitutes, residual interests (other than a credit-enhancing interest-
only strip) and asset- or mortgage-backed securities rated in the
highest or second highest investment grade category, e.g., AAA, AA, in
the case of long-term ratings, or the highest rating category, e.g., A-
1, P-1, in the case of short-term ratings.
a. Category 3--50 Percent Risk Weight. This category includes loans
fully secured by first liens \37\ on one-to-four family residential
properties, provided that such loans have been approved in accordance
with prudent underwriting standards, including standards relating to the
loan amount as a percent of the appraised value of the property,\38\ and
provided that the loans are not past due 90 days or more or carried in
nonaccrual status.\39\ The types of loans that qualify as loans secured
by one-to-four family residential properties are listed in the
instructions for preparation of the Consolidated Reports of Condition
and Income. These properties may be either owner-occupied or rented. In
addition, for risk-based capital purposes, loans secured by one-to-four
family residential properties include loans to builders with substantial
project equity for the construction of one-to-four family residences
that have been presold under firm contracts to purchasers who have
obtained firm commitments for permanent qualifying mortgage loans and
have made substantial earnest money deposits. Such loans to builders
will be considered prudently underwritten only if the bank has obtained
sufficient documentation that the buyer of the home intends to purchase
the home (i.e., has a legally binding written sales contract) and has
the ability to obtain a mortgage loan sufficient to purchase the
[[Page 218]]
home (i.e., has a firm written commitment for permanent financing of the
home upon completion), provided the following criteria are met:
(1) The purchaser is an individual(s) who intends to occupy the
residence and is not a partnership, joint venture, trust, corporation,
or any other entity (including an entity acting as a sole
proprietorship) that is purchasing one or more of the homes for
speculative purposes;
(2) The builder must incur at least the first ten percent of the
direct costs (i.e., actual costs of the land, labor, and material)
before any drawdown is made under the construction loan and the
construction loan may not exceed 80 percent of the sales price of the
presold home;
(3) The purchaser has made a substantial ``earnest money deposit''
of no less than three percent of the sales price of the home and the
deposit must be subject to forfeiture if the purchaser terminates the
sales contract; and
(4) The earnest money deposit must be held in escrow by the bank
financing the builder or by an independent party in a fiduciary capacity
and the escrow agreement must provide that, in the event of default
arising from the cancellation of the sales contract by the buyer, the
escrow funds must first be used to defray any costs incurred by the
bank.
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\37\ If a bank holds the first and junior lien(s) on a residential
property and no other party holds an intervening lien, the transactions
are treated as a single loan secured by a first lien for purposes of
determining the loan-to-value ratio and assigning a risk weight.
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By order of the Board of Directors.
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\38\ For risk-based capital purposes, the loan-to-value ratio
generally is based upon the most current appraised value of the
property. The appraisal should be performed in a manner consistent with
the Federal banking agencies' real estate appraisal guidelines and with
the bank's own appraisal guidelines.
\39\ Real estate loans that do not meet all of the specified
criteria or that are made for the purpose of property development are
placed in the 100 percent risk category.
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b. This category also includes loans fully secured by first liens on
multifamily residential properties,\40\ provided that:
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\40\ The types of loans that qualify as loans secured by multifamily
residential properties are listed in the instructions for preparation of
the Consolidated Reports of Condition and Income. In addition, from the
standpoint of the selling bank, when a multifamily residential property
loan is sold subject to a pro rata loss sharing arrangement which
provides for the purchaser of the loan to share in any loss incurred on
the loan on a pro rata basis with the selling bank, that portion of the
loan is not subject to the risk-based capital standards. In connection
with sales of multifamily residential property loans in which the
purchaser of the loan shares in any loss incurred on the loan with the
selling bank on other than a pro rata basis, the selling bank must treat
these other loss sharing arrangements in accordance with section II.B.5
of this appendix A.
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(1) The loan amount does not exceed 80 percent of the value \41\ of
the property securing the loan as determined by the most current
appraisal or evaluation, whichever may be appropriate (75 percent if the
interest rate on the loan changes over the term of the loan);
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\41\ At the origination of a loan to purchase an existing property,
the term ``value'' means the lesser of the actual acquisition cost or
the estimate of value set forth in an appraisal or evaluation, whichever
may be appropriate.
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(2) For the property's most recent fiscal year, the ratio of annual
net operating income generated by the property (before payment of any
debt service on the loan) to annual debt service on the loan is not less
than 120 percent (115 percent if the interest rate on the loan changes
over the term of the loan) or, in the case of a property owned by a
cooperative housing corporation or nonprofit organization, the property
generates sufficient cash flow to provide comparable protection to the
bank;
(3) Amortization of principal and interest on the loan occurs over a
period of not more than 30 years;
(4) The minimum original maturity for repayment of principal on the
loan is not less than seven years;
(5) All principal and interest payments have been made on a timely
basis in accordance with the terms of the loan for at least one year
before the loan is placed in this category; \42\
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\42\ In the case where the existing owner of a multifamily
residential property refinances a loan on that property, all principal
and interest payments on the loan being refinanced must have been made
on a timely basis in accordance with the terms of that loan for at least
the preceding year. The new loan must meet all of the other eligibility
criteria in order to qualify for a 50 percent risk weight.
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(6) The loan is not 90 days or more past due or carried in
nonaccrual status; and
(7) The loan has been made in accordance with prudent underwriting
standards.
c. This category also includes revenue (non-general obligation)
bonds or similar obligations, including loans and leases, that are
obligations of states or political subdivisions of the United States or
other OECD countries, but for which the government entity is committed
to repay the debt with revenues from the specific projects financed,
rather than from general tax funds (e.g., municipal revenue bonds). In
addition, the credit equivalent amount of derivative contracts that do
not qualify for a lower risk weight are assigned to the 50 percent risk
category.
d. This category also includes recourse obligations, direct credit
substitutes, residual interests (other than a credit-enhancing interest-
only strip) and asset- or mortgage-backed securities rated in the third
highest investment grade category, e.g., A, in the case of long-term
ratings, or the second highest rating category, e.g., A-2, P-2, in the
case of short-term ratings.
Category 4--100 Percent Risk Weight. (a) All assets not included in
the categories above in section II.C of this appendix A, except the
[[Page 219]]
assets specifically included in the 200 percent category below in
section II.C of this appendix A and assets that are otherwise risk
weighted in accordance with section II.B.5 of this appendix A, are
assigned to this category, which comprises standard risk assets. The
bulk of the assets typically found in a loan portfolio would be assigned
to the 100 percent category.
(b) This category includes:
(1) Long-term claims on, and the portions of long-term claims that
are guaranteed by, non-OECD banks, and all claims on non-OECD central
governments that entail some degree of transfer risk; \43\
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\43\ Such assets include all non-local currency claims on, and the
portions of claims that are guaranteed by, non-OECD central governments
and those portions of local currency claims on, or guaranteed by, non-
OECD central governments that exceed the local currency liabilities held
by the bank.
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(2) All claims on foreign and domestic private-sector obligors not
included in the categories above in section II.C of this appendix A
(including loans to nondepository financial institutions and bank
holding companies);
(3) Claims on commercial firms owned by the public sector;
(4) Customer liabilities to the bank on acceptances outstanding
involving standard risk claims; \44\
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\44\ Customer liabilities on acceptances outstanding involving
nonstandard risk claims, such as claims on U.S. depository institutions,
are assigned to the risk category appropriate to the identity of the
obligor or, if relevant, the nature of the collateral or guarantees
backing the claims. Portions of acceptances conveyed as risk
participations to U.S. depository institutions or foreign banks are
assigned to the 20 percent risk category appropriate to short-term
claims guaranteed by U.S. depository institutions and foreign banks.
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(5) Investments in fixed assets, premises, and other real estate
owned;
(6) Common and preferred stock of corporations, including stock
acquired for debts previously contracted;
(7) Commercial and consumer loans (except those assigned to lower
risk categories due to recognized guarantees or collateral and loans
secured by residential property that qualify for a lower risk weight);
(8) Recourse obligations, direct credit substitutes, residual
interests (other than a credit-enhancing interest-only strip) and asset-
or mortgage-backed securities rated in the lowest investment grade
category, e.g., BBB, as well as certain positions (but not residual
interests) which the bank rates pursuant to section section II.B.5(g) of
this appendix A.;
(9) Industrial-development bonds and similar obligations issued
under the auspices of states or political subdivisions of the OECD-based
group of countries for the benefit of a private party or enterprise
where that party or enterprise, not the government entity, is obligated
to pay the principal and interest;
(10) All obligations of states or political subdivisions of
countries that do not belong to the OECD-based group; and
(11) Stripped mortgage-backed securities and similar instruments,
such as interest-only strips that are not credit-enhancing and
principal-only strips.
(12) Claims representing capital of a qualifying securities firm.
(c) The following assets also are assigned a risk weight of 100
percent if they have not already been deducted from capital: investments
in unconsolidated companies, joint ventures, or associated companies;
instruments that qualify as capital issued by other banks; deferred tax
assets; and mortgage servicing assets, nonmortgage servicing assets, and
purchased credit card relationships.
Category 5--200 Percent Risk Weight. This category includes:
(a) Externally rated recourse obligations, direct credit
substitutes, residual interests (other than a credit-enhancing interest-
only strip), and asset- and mortgage-backed securities that are rated
one category below the lowest investment grade category, e.g., BB, to
the extent permitted in section II.B.5(d) of this appendix A; and
(b) A position (but not a residual interest) in a securitization or
structured finance program that is not rated by an NRSRO for which the
bank determines that the credit risk is equivalent to one category below
investment grade, e.g., BB, to the extent permitted in section
II.B.5.(g) of this appendix A.
D. Conversion Factors for Off-Balance Sheet Items (see Table III)
The face amount of an off-balance sheet item is generally
incorporated into the risk-weighted assets in two steps. The face amount
is first multiplied by a credit conversion factor, except as otherwise
specified in section II.B.5 of this appendix A for direct credit
substitutes and recourse obligations. The resultant credit equivalent
amount is assigned to the appropriate risk category according to the
obligor or, if relevant, the guarantor, the nature of any collateral, or
external credit ratings.\45\
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\45\ The sufficiency of collateral and guarantees for off-balance-
sheet items is determined by the market value of the collateral or the
amount of the guarantee in relation to the face amount of the item,
except for derivative contracts, for which this determination is
generally made in relation to the credit equivalent amount. Collateral
and guarantees are subject to the same provisions noted under section
II.B of this appendix A.
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[[Page 220]]
1. Items With a 100 Percent Conversion Factor. (a) Except as
otherwise provided in section II.B.5. of this appendix A, the full
amount of an asset or transaction supported, in whole or in part, by a
direct credit substitute or a recourse obligation. Direct credit
substitutes and recourse obligations are defined in section II.B.5. of
this appendix A.
(b) Sale and repurchase agreements, if not already included on the
balance sheet, and forward agreements. Forward agreements are legally
binding contractual obligations to purchase assets with drawdown which
is certain at a specified future date. Such obligations include forward
purchases, forward forward deposits placed,\46\ and partly-paid shares
and securities; they do not include commitments to make residential
mortgage loans or forward foreign exchange contracts.
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\46\ Forward forward deposits accepted are treated as interest rate
contracts.
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(c) Securities lent by a bank are treated in one of two ways,
depending upon whether the lender is exposed to risk of loss. If a bank,
as agent for a customer, lends the customer's securities and does not
indemnify the customer against loss, then the securities transaction is
excluded from the risk-based capital calculation. On the other hand, if
a bank lends its own securities or, acting as agent for a customer,
lends the customer's securities and indemnifies the customer against
loss, the transaction is converted at 100 percent and assigned to the
risk weight category appropriate to the obligor or, if applicable, to
the collateral delivered to the lending bank or the independent
custodian acting on the lending bank's behalf.
2. Items With a 50 Percent Conversion Factor. a. Transaction-related
contingencies are to be converted at 50 percent. Such contingencies
include bid bonds, performance bonds, warranties, and performance
standby letters of credit related to particular transactions, as well as
acquisitions of risk participations in performance standby letters of
credits. Performance standby letters of credit (performance bonds) are
irrevocable obligations of the bank to pay a third-party beneficiary
when a customer (account party) fails to perform on some contractual
nonfinancial obligation. Thus, performance standby letters of credit
represent obligations backing the performance of nonfinancial or
commercial contracts or undertakings. To the extent permitted by law or
regulation, performance standby letters of credit include arrangements
backing, among other things, subcontractors' and suppliers' performance,
labor and materials contracts, and construction bids.
b. The unused portion of commitments with an original maturity
exceeding one year, including underwriting commitments and commercial
and consumer credit commitments, also are to be converted at 50 percent.
Original maturity is defined as the length of time between the date the
commitment is issued and the earliest date on which: (1) The bank can at
its option, unconditionally (without cause) cancel the commitment,\47\
and (2) the bank is scheduled to (and as a normal practice actually
does) review the facility to determine whether or not it should be
extended and, on at least an annual basis, continues to regularly review
the facility. Facilities that are unconditionally cancelable (without
cause) at any time by the bank are not deemed to be commitments,
provided the bank makes a separate credit decision before each drawing
under the facility.
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\47\ In the case of home equity or mortgage lines of credit secured
by liens on one-to-four family residential properties, a bank is deemed
able to unconditionally cancel the commitment if, at its option, it can
prohibit additional extensions of credit, reduce the credit line, and
terminate the commitment to the full extent permitted by relevant
Federal law.
---------------------------------------------------------------------------
c.i. Commitments are defined as any legally binding arrangements
that obligate a bank to extend credit in the form of loans or lease
financing receivables; to purchase loans, securities, or other assets;
or to participate in loans and leases. Commitments also include
overdraft facilities, revolving credit, home equity and mortgage lines
of credit, eligible ABCP liquidity facilities, and similar transactions.
Normally, commitments involve a written contract or agreement and a
commitment fee, or some other form of consideration. Commitments are
included in weighted-risk assets regardless of whether they contain
material adverse change clauses or other provisions that are intended to
relieve the issuer of its funding obligation under certain conditions.
In the case of commitments structured as syndications, where the bank is
obligated solely for its pro rata share, only the bank's proportional
share of the syndicated commitment is taken into account in calculating
the risk-based capital ratio.
ii. Banks that are subject to the market risk rules in appendix C to
part 325 are required to convert the notional amount of eligible ABCP
liquidity facilities, in form or in substance, with an original maturity
of over one year that are carried in the trading account at 50 percent
to determine the appropriate credit equivalent amount even though those
facilities are structured or characterized as derivatives or other
trading book assets. Liquidity facilities that support ABCP,
[[Page 221]]
in form or in substance, (including those positions to which the market
risk rules may not be applied as set forth in section 2(a) of appendix C
of this part) that are not eligible ABCP liquidity facilities are to be
considered recourse obligations or direct credit substitutes, and
assessed the appropriate risk-based capital treatment in accordance with
section II.B.5. of this appendix.
d. In the case of commitments structured as syndications where the
bank is obligated only for its pro rata share, the risk-based capital
framework includes only the bank's proportional share of such
commitments. Thus, after a commitment has been converted at 50 percent,
portions of commitments that have been conveyed to other U.S. depository
institutions or OECD banks, but for which the originating bank retains
the full obligation to the borrower if the participating bank fails to
pay when the commitment is drawn upon, will be assigned to the 20
percent risk category. The acquisition of such a participation in a
commitment would be converted at 50 percent and the credit equivalent
amount would be assigned to the risk category that is appropriate for
the account party obligor or, if relevant, to the nature of the
collateral or guarantees.
e. Revolving underwriting facilities (RUFs), note issuance
facilities (NIFs), and other similar arrangements also are converted at
50 percent. These are facilities under which a borrower can issue on a
revolving basis short-term notes in its own name, but for which the
underwriting banks have a legally binding commitment either to purchase
any notes the borrower is unable to sell by the rollover date or to
advance funds to the borrower.
3. Items With a 20 Percent Conversion Factor. Short-term, self-
liquidating, trade-related contingencies which arise from the movement
of goods are converted at 20 percent. Such contingencies include
commercial letters of credit and other documentary letters of credit
collateralized by the underlying shipments.
4. Items With a 10 Percent Conversion Factor. a. Unused portions of
eligible ABCP liquidity facilities with an original maturity of one year
or less that provide liquidity support to ABCP also are converted at 10
percent.
b. Banks that are subject to the market risk rules in appendix C to
part 325 are required to convert the notional amount of eligible ABCP
liquidity facilities, in form or in substance, with an original maturity
of one year or less that are carried in the trading account at 10
percent to determine the appropriate credit equivalent amount even
though those facilities are structured or characterized as derivatives
or other trading book assets. Liquidity facilities that provide
liquidity support to ABCP, in form or in substance, (including those
positions to which the market risk rules may not be applied as set forth
in section 2(a) of appendix C of this part) that are not eligible ABCP
liquidity facilities are to be considered recourse obligations or direct
credit substitutes and assessed the appropriate risk-based capital
requirement in accordance with section II.B.5. of this appendix.
5. Items With a Zero Percent Conversion Factor. These include unused
portions of commitments, with the exception of eligible ABCP liquidity
facilities, with an original maturity of one year or less, or which are
unconditionally cancelable at any time, provided a separate credit
decision is made before each drawing under the facility. Unused portions
of retail credit card lines and related plans are deemed to be short-
term commitments if the bank, in accordance with applicable law, has the
unconditional option to cancel the credit line at any time.
E. Derivative Contracts (Interest Rate, Exchange Rate, Commodity
(including precious metal) and Equity Derivative Contracts)
1. Credit equivalent amounts are computed for each of the following
off-balance-sheet derivative contracts:
(a) Interest Rate Contracts
(i) Single currency interest rate swaps.
(ii) Basis swaps.
(iii) Forward rate agreements.
(iv) Interest rate options purchased (including caps, collars, and
floors purchased).
(v) Any other instrument linked to interest rates that gives rise to
similar credit risks (including when-issued securities and forward
deposits accepted).
(b) Exchange Rate Contracts
(i) Cross-currency interest rate swaps.
(ii) Forward foreign exchange contracts.
(iii) Currency options purchased.
(iv) Any other instrument linked to exchange rates that gives rise
to similar credit risks.
(c) Commodity (including precious metal) or Equity Derivative
Contracts
(i) Commodity- or equity-linked swaps.
(ii) Commodity- or equity-linked options purchased.
(iii) Forward commodity- or equity-linked contracts.
(iv) Any other instrument linked to commodities or equities that
gives rise to similar credit risks.
2. Exchange rate contracts with an original maturity of 14 calendar
days or less and derivative contracts traded on exchanges that require
daily receipt and payment of cash variation margin may be excluded from
the risk-based ratio calculation. Gold contracts are accorded the same
treatment as exchange rate contracts except gold contracts with an
original maturity of 14 calendar days or less are included in the risk-
based calculation. Over-the-counter options purchased are included and
treated in the same way as other derivative contracts.
[[Page 222]]
3. Credit Equivalent Amounts for Derivative Contracts. (a) The
credit equivalent amount of a derivative contract that is not subject to
a qualifying bilateral netting contract in accordance with section
II.E.5. of this appendix A is equal to the sum of:
(i) The current exposure (which is equal to the mark-to-market
value,\48\ if positive, and is sometimes referred to as the replacement
cost) of the contract; and
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\48\ Mark-to-market values are measured in dollars, regardless of
the currency or currencies specified in the contract and should reflect
changes in both underlying rates, prices and indices, and counterparty
credit quality.
---------------------------------------------------------------------------
(ii) An estimate of the potential future credit exposure.
(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 equal to that mark-to-market value. If the mark-to-
market value is zero or negative, then the current exposure is zero.
(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 credit conversion factors are:
Conversion Factor Matrix
----------------------------------------------------------------------------------------------------------------
Exchange Precious
Remaining maturity Interest rate and Equity metals, Other
rate gold except gold commodities
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0% 1.0% 6.0% 7.0% 10.0%
More than one year to five years............... 0.5% 5.0% 8.0% 7.0% 12.0%
More than five years........................... 1.5% 7.5% 10.0% 8.0% 15.0%
----------------------------------------------------------------------------------------------------------------
(d) For contracts that are structured to settle outstanding exposure
on specified dates and where the terms are reset such that the market
value of the contract is zero on these specified dates, the remaining
maturity is equal to the time until the next reset date. For interest
rate contracts with remaining maturities of more than one year and that
meet these criteria, the conversion factor is subject to a minimum value
of 0.5 percent.
(e) For contracts with multiple exchanges of principal, the
conversion factors are to be multiplied by the number of remaining
payments in the contract. Derivative contracts not explicitly covered by
any of the columns of the conversion factor matrix are to be treated as
``other commodities.''
(f) No potential future exposure is calculated for single currency
interest rate swaps in which payments are made based upon two floating
rate indices (so called floating/floating or basis swaps); the credit
exposure on these contracts is evaluated solely on the basis of their
mark-to-market values.
4. Risk Weights and Avoidance of Double Counting. (a) Once the
credit equivalent amount for a derivative contract, or a group of
derivative contracts subject to a qualifying bilateral netting
agreement, has been determined, that amount is assigned to the risk
category appropriate to the counterparty, or, if relevant, the guarantor
or the nature of any collateral. However, the maximum weight that will
be applied to the credit equivalent amount of such contracts is 50
percent.
(b) In certain cases, credit exposures arising from the derivative
contracts covered by these guidelines may already be reflected, in part,
on the balance sheet. To avoid double counting such exposures in the
assessment of capital adequacy and, perhaps, assigning inappropriate
risk weights, counterparty credit exposures arising from the types of
instruments covered by these guidelines may need to be excluded from
balance sheet assets in calculating a bank's risk-based capital ratio.
(c) The FDIC notes that the conversion factors set forth in section
II.E.3. of appendix A, which are based on observed volatilities of the
particular types of instruments, are subject to review and modification
in light of changing volatilities or market conditions.
(d) Examples of the calculation of credit equivalent amounts for
these types of contracts are contained in Table IV of this appendix A.
5. Netting. (a) For purposes of this appendix A, netting refers to
the offsetting of positive and negative mark-to-market values when
determining a current exposure to be used in the calculation of a credit
equivalent amount. Any legally enforceable form of bilateral netting
(that is, netting with a single counterparty) of derivative contracts is
recognized for purposes of calculating the credit equivalent amount
provided that:
(i) The netting is accomplished under a written netting contract
that creates a single legal obligation, covering all included individual
contracts, with the effect that the
[[Page 223]]
bank would have a claim or obligation to receive or pay, respectively,
only the net amount of the sum 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 default, bankruptcy, liquidation, or
similar circumstances;
(ii) The bank obtains a written and reasoned legal opinion(s)
representing that in the event of a legal challenge, including one
resulting from default, insolvency, bankruptcy or similar circumstances,
the relevant court and administrative authorities would find the bank's
exposure to be such a net amount under:
(1) 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, then also
under the law of the jurisdiction in which the branch is located;
(2) The law that governs the individual contracts covered by the
netting contract; and
(3) The law that governs the netting contract.
(iii) The bank establishes and maintains procedures to ensure that
the legal characteristics of netting contracts are kept under review in
the light of possible changes in relevant law; and
(iv) The bank maintains in its file documentation adequate to
support the netting of derivative contracts, including a copy of the
bilateral netting contract and necessary legal opinions.
(b) A contract containing a walkaway clause is not eligible for
netting for purposes of calculating the credit equivalent amount.\49\
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\49\ For purposes of this section, a walkaway clause means 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 a defaulter or the estate of a defaulter is a net
creditor under the contract.
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(c) By netting individual contracts for the purpose of calculating
its credit equivalent amount, a bank represents that it has met the
requirements of this appendix A and all the appropriate documents are in
the bank's files and available for inspection by the FDIC. Upon
determination by the FDIC that a bank's files are inadequate or that a
netting contract may not be legally enforceable under any one of the
bodies of law described in paragraphs (ii)(1) through (3) of section
II.E.5.(a) of this appendix A, underlying individual contracts may be
treated as though they were not subject to the netting contract.
(d) The credit equivalent amount of derivative contracts that are
subject to a qualifying bilateral netting contract is calculated by
adding:
(i) The net current exposure of the netting contract; and
(ii) The sum of the estimates of potential future exposure for all
individual contracts subject to the netting contract, adjusted to take
into account the effects of the netting contract.\50\
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\50\ For purposes of calculating potential future credit exposure
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 to each party falling due on each value
date in each currency.
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(e) The net current exposure is the sum of all positive and negative
mark-to-market values of the individual contracts subject to the netting
contract. If the net sum of the mark-to-market values is positive, then
the net current exposure is equal to that sum. If the net sum of the
mark-to-market values is zero or negative, then the net current exposure
is zero.
(f) The effects of the bilateral netting contract on the gross
potential future exposure are recognized through application of a
formula, resulting in an adjusted add-on amount (Anet). The
formula, which employs the ratio of net current exposure to gross
current exposure (NGR) is expressed as:
Anet = (0.4 x Agross) + 0.6(NGR x
Agross)
The effect of this formula is that Anet is the weighted
average of Agross, and Agross adjusted by the NGR.
(g) The NGR may be calculated in either one of two ways--referred to
as the counterparty-by-counterparty approach and the aggregate approach.
(i) Under the counterparty-by-counterparty approach, the NGR is the
ratio of the net current exposure of the netting contract to the gross
current exposure of the netting contract. The gross current exposure is
the sum of the current exposures of all individual contracts subject to
the netting contract calculated in accordance with section II.E. of this
appendix A.
(ii) Under the aggregate approach, the NGR is the ratio of the sum
of all of the net current exposures for qualifying bilateral netting
contracts to the sum of all of the gross current exposures for those
netting contracts (each gross current exposure is calculated in the same
manner as in section II.E.5.(g)(i) of this appendix A). Net negative
mark-to-market values to individual counterparties cannot be used to
offset net
[[Page 224]]
positive current exposures to other counterparties.
(iii) A bank must use consistently either the counterparty-by-
counterparty approach or the aggregate approach to calculate the NGR.
Regardless of the approach used, the NGR should be applied individually
to each qualifying bilateral netting contract to determine the adjusted
add-on for that netting contract.
III. Minimum Risk-Based Capital Ratio
Subject to section II.B.5. of this appendix A, banks generally will
be expected to meet a minimum ratio of qualifying total capital to risk-
weighted assets of 8 percent, of which at least 4 percentage points
should be in the form of core capital (Tier 1). Any bank that does not
meet the minimum risk-based capital ratio, or whose capital is otherwise
considered inadequate, generally will be expected to develop and
implement a capital plan for achieving an adequate level of capital,
consistent with the provisions of this risk-based capital framework and
Sec. 325.104, the specific circumstances affecting the individual bank,
and the requirements of any related agreements between the bank and the
FDIC.
Table I--Definition of Qualifying Capital
------------------------------------------------------------------------
Components Minimum requirements
------------------------------------------------------------------------
(1) CORE CAPITAL (Tier 1).............. Must equal or exceed 4% of
weighted-risk assets.
(a) Common stockholders' equity.... No limit.\1\
(b) Noncumulative perpetual No limit.\1\
preferred stock and any related
surplus.
(c) Minority interest in equity No limit.\1\
accounts of consolidated.
(d) Less: All intangible assets (\2\).
other than certain mortgage
servicing assets, nonmortgage
servicing assets and purchased
credit card relationships.
(e) Less: Certain credit-enhancing (\3\).
interest-only strips and
nonfinancial equity investments
required to be deducted from
capital.
(f) Less: Certain deferred tax (\4\).
assets.
(2) SUPPLEMENTARY CAPITAL (Tier 2)..... Total of tier 2 is limited to
100% of tier 1.\5\
(a) Allowance for loan and lease Limited to 1.25% of weighted-
losses. risk assets.\5\
(b) Unrealized gains on certain Limited to 45% of pretax net
equity securities.\6\. unrealized gains.\6\
(c) Cumulative perpetual and long- No limit within tier 2; long-
term preferred stock (original term preferred is amortized
maturity of 20 years or more) and for capital purposes as it
any related surplus. approaches maturity.
(d) Auction rate and similar No limit within Tier 2.
preferred stock (both cumulative
and non-cumulative).
(e) Hybrid capital instruments No limit within Tier 2.
(including mandatory convertible
debt securities).
(f) Term subordinated debt and Term subordinated debt and
intermediate-term preferred stock intermediate-term preferred
(original weighted average stock are limited to 50% of
maturity of five years or more). Tier 1 \5\ and amortized for
capital purposes as they
approach maturity.
(3) DEDUCTIONS (from sum of tier 1 and
tier 2)
(a) Investments in banking and
finance subsidiaries that are not
consolidated for regulatory
capital purposes
(b) Intentional, reciprocal cross-
holdings of capital securities
issued by banks
(c) Other deductions (such as On a case-by-case basis or as a
investment in other subsidiaries matter of policy after formal
or joint ventures) as determined consideration of relevant
by supervisory authority. issues.
(4) TOTAL CAPITAL...................... Must equal or exceed 8% of
weighted-risk assets.
------------------------------------------------------------------------
\1\ No express limits are placed on the amounts of nonvoting common,
noncumulative perpetual preferred stock, and minority interests that
may be recognized as part of Tier 1 capital. However, voting common
stockholders' equity capital generally will be expected to be the
dominant form of Tier 1 capital and banks should avoid undue reliance
on other Tier 1 capital elements.
\2\ The amounts of mortgage servicing assets, nonmortgage servicing
assets and purchased credit card relationships that can be recognized
for purposes of calculating Tier 1 capital are subject to the
limitations set forth in Sec. 325.5(f). All deductions are for
capital purposes only; deductions would not affect accounting
treatment.
\3\ The amounts of credit-enhancing interest-only strips that can be
recognized for purposes of calculating Tier 1 capital are subject to
the limitations set forth in Sec. 325.5(f). The amounts of
nonfinancial equity investments that must be deducted for purposes of
calculating Tier 1 capital are set forth in section II.B.(6) of
appendix A to part 325.
\4\ Deferred tax assets are subject to the capital limitations set forth
in Sec. 325.5(g).
\5\ Amounts in excess of limitations are permitted but do not qualify as
capital.
\6\ Unrealized gains on equity securities are subject to the capital
limitations set forth in paragraph I.A(2)(f) of appendix A to part
325.
Calculation of the Risk-Based Capital Ratio
When calculating the risk-based capital ratio under the framework
set forth in this statement of policy, qualifying total capital (the
numerator) is divided by risk-weighted assets (the denominator). The
process of determining the numerator for the ratio is
[[Page 225]]
summarized in Table I. The calculation of the denominator is based on
the risk weights and conversion factors that are summarized in Tables II
and III.
When determining the amount of risk-weighted assets, balance sheet
assets are assigned an appropriate risk weight (see Table II) and off-
balance sheet items are first converted to a credit equivalent amount
(see Table III) and then assigned to one of the risk weight categories
set forth in Table II.
The balance sheet assets and the credit equivalent amount of off-
balance sheet items are then multiplied by the appropriate risk weight
percentages and the sum of these risk-weighted amounts is the gross
risk-weighted asset figure used in determining the denominator of the
risk-based capital ratio. Any items deducted from capital when computing
the amount of qualifying capital may also be excluded from risk-weighted
assets when calculating the denominator for the risk-based capital
ratio.
Table II--Summary of Risk Weights and Risk Categories
Category 1--Zero Percent Risk Weight
(1) Cash (domestic and foreign).
(2) Balances due from Federal Reserve Banks and central banks in
other OECD countries.
(3) Direct claims on, and portions of claims unconditionally
guaranteed by, the U.S. Treasury, U.S. Government agencies,\1\ or
central governments in other OECD countries.
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\1\ For the purpose of calculating the risk-based capital ratio, a
U.S. Government agency is defined as an instrumentality of the U.S.
Government whose obligations are fully and explicitly guaranteed as to
the timely repayment of principal and interest by the full faith and
credit of the U.S. Government.
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(4) Portions of local currency claims on, or unconditionally
guaranteed by, non-OECD central governments (including non-OECD central
banks), to the extent the bank has liabilities booked in that currency.
(5) Gold bullion held in the bank's own vaults or in another bank's
vaults on an allocated basis, to the extent that it is offset by gold
bullion liabilities
(6) Federal Reserve Bank stock.
(7) Claims on, or guaranteed by, qualifying securities firms
incorporated in the United States or other members of the OECD-based
group of countries that are collateralized by cash on deposit in the
lending bank or by securities issued or guaranteed by the United States
or OECD central governments (including U.S. government agencies),
provided that a positive margin of collateral is required to be
maintained on such a claim on a daily basis, taking into account any
change in a bank's exposure to the obligor or counterparty under the
claim in relation to the market value of the collateral held in support
of the claim.
Category 2--20 Percent Risk Weight
(1) Cash items in the process of collection.
(2) All claims (long- and short-term) on, and portions of claims
(long- and short-term) guaranteed by, U.S. depository institutions and
OECD banks.
(3) Short-term (remaining maturity of one year or less) claims on,
and portions of short-term claims guaranteed by, non-OECD banks.
(4) Portions of loans and other claims conditionally guaranteed by
the U.S. Treasury, U.S. Government agencies,\1\ or central governments
in other OECD countries and portions of local currency claims
conditionally guaranteed by non-OECD central governments to the extent
that the bank has liabilities booked in that currency.
(5) Securities and other claims on, and portions of claims
guaranteed by, U.S. Government-sponsored agencies.\2\
---------------------------------------------------------------------------
\2\ For the purpose of calculating the risk-based capital ratio, a
U.S. Government-sponsored agency is defined as an agency originally
established or chartered to serve public purposes specified by the U.S.
Congress but whose obligations are not explicitly guaranteed by the full
faith and credit of the U.S. Government.
---------------------------------------------------------------------------
(6) Portions of loans and other claims (including repurchase
agreements) collateralized \3\ by securities issued or guaranteed by the
U.S. Treasury, U.S. Government agencies, U.S. Government-sponsored
agencies or central governments in other OECD countries.
---------------------------------------------------------------------------
\3\ Degree of collateralization is determined by current market
value.
---------------------------------------------------------------------------
(7) Portions of loans and other claims collateralized \3\ by cash on
deposit in the lending bank.
(8) General obligation claims on, and portions of claims guaranteed
by, the full faith and credit of states or other political subdivisions
of OECD countries, including U.S. state and local governments.
(9) Claims on, and portions of claims guaranteed by, official
multilateral lending institutions or regional development institutions
in which the U.S. Government is a shareholder or a contributing member.
(10) Portions of claims collateralized \3\ by securities issued by
official multilateral lending institutions or regional development
institutions in which the U.S. Government is a shareholder or
contributing member.
(11) Investments in shares of mutual funds whose portfolios are
permitted to hold only assets that qualify for the zero or 20 percent
risk categories.
[[Page 226]]
(12) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips) and asset-
or mortgage-backed securities rated in either of the two highest
investment grade categories, e.g., AAA or AA, in the case of long-term
ratings, or the highest rating category, e.g., A-1, P-1, in the case of
short-term ratings.
(13) Claims on, and claims guaranteed by, qualifying securities
firms incorporated in the United States or other member of the OECD-
based group of countries provided that:
a. The qualifying securities firm has a rating in one of the top
three investment grade rating categories from a nationally recognized
statistical rating organization; or
b. The claim is guaranteed by a qualifying securities firm's parent
company with such a rating.
(14) Certain collateralized claims on qualifying securities firms in
the United States or other member of the OECD-based group of countries,
without regard to satisfaction of the rating standard, provided that the
claim arises under a contract that:
a. Is a reverse repurchase/repurchase agreement or securities
lending/borrowing transaction executed under standard industry
documentation;
b. Is collateralized by liquid and readily marketable debt or equity
securities;
c. Is marked to market daily;
d. Is subject to a daily margin maintenance requirement under the
standard documentation; and
e. Can be liquidated, terminated, or accelerated immediately in
bankruptcy or similar proceeding, and the security or collateral
agreement will not be stayed or avoided, under applicable law of the
relevant country.
Category 3--50 Percent Risk Weight
(1) Loans fully secured by first liens on one-to-four family
residential properties (including certain presold residential
construction loans), provided that the loans were approved in accordance
with prudent underwriting standards and are not past due 90 days or more
or carried in nonaccrual status.
(2) Loans fully secured by first liens on multifamily residential
properties that have been prudently underwritten and meet specified
requirements with respect to loan-to-value ratio, level of annual net
operating income to required debt service, maximum amortization period,
minimum original maturity, and demonstrated timely repayment
performance.
(3) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips) and asset-
or mortgage-backed securities rated in the third-highest investment
grade category, e.g., A, in the case of long-term ratings, or the second
highest rating category, e.g., A-2, P-2, in the case of short-term
ratings.
(4) Revenue bonds or similar obligations, including loans and
leases, that are obligations of U.S. state or political subdivisions of
the United States or other OECD countries but for which the government
entity is committed to repay the debt only out of revenues from the
specific projects financed.
(5) Credit equivalent amounts of interest rate and foreign exchange
rate related contracts, except for those assigned to a lower risk
category.
Category 4--100 Percent Risk Weight
(1) All other claims on private obligors.
(2) Claims on, or guaranteed by, non-OECD banks with a remaining
maturity exceeding one year.
(3) Claims on non-OECD central governments that are not included in
item 4 of Category 1 or item 3 of Category 2, and all claims on non-OECD
state and local governments.
(4) Obligations issued by U.S. state or local governments or other
OECD local governments (including industrial development authorities and
similar entities) that are repayable solely by a private party or
enterprise.
(5) Premises, plant, and equipment; other fixed assets; and other
real estate owned.
(6) Investments in any unconsolidated subsidiaries, joint ventures,
or associated companies--if not deducted from capital.
(7) Instruments issued by other banking organizations that qualify
as capital.
(8) Claims on commercial firms owned by the U.S. Government or
foreign governments.
(9) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips) and asset-
or mortgage-backed securities rated in the lowest investment grade
category, e.g., BBB, as well as certain positions (but not residual
interests) which the bank rates pursuant to section II.B.5(g) of this
appendix A.
(10) All other assets, including any intangible assets that are not
deducted from capital, and the credit equivalent amounts \4\ of off-
balance sheet items not assigned to a different risk category.
---------------------------------------------------------------------------
\4\ In general, for each off-balance sheet item, a conversion factor
(see Table III) must be applied to determine the ``credit equivalent
amount'' prior to assigning the off-balance sheet item to a risk weight
category.
---------------------------------------------------------------------------
Category 5--200 Percent Risk Weight.
(1) Externally rated recourse obligations, direct credit
substitutes, residual interests (other than credit-enhancing interest-
only
[[Page 227]]
strips), and asset- and mortgage-backed securities that are rated one
category below the lowest investment grade category, e.g., BB, to the
extent permitted in section II.B.5(d) of this appendix A; and
(2) A position (but not a residual interest) extended in connection
with a securitization or structured financing program that is not rated
by an NRSRO for which the bank determines that the credit risk is
equivalent to one category below investment grade, e.g., BB, to the
extent permitted in section II.B.5.(g) of this appendix A.
[54 FR 11509, Mar. 21, 1989]
Editorial Note: For Federal Register citations affecting Appendix A
of part 325, see the List of CFR Sections Affected, which appears in the
Finding Aids section of the printed volume and on GPO Access.
Appendix B to Part 325--Statement of Policy on Capital Adequacy
Part 325 of the Federal Deposit Insurance Corporation rules and
regulations (12 CFR part 325) sets forth minimum leverage capital
requirements for fundamentally sound, well-managed banks having no
material or significant financial weaknesses. It also defines capital
and sets forth sanctions which will be used against banks which are in
violation of the part 325 regulation. This statement of policy on
capital adequacy provides some interpretational and definitional
guidance as to how this part 325 regulation will be administered and
enforced by the FDIC. This statement of policy also addresses certain
aspects of the FDIC's minimum risk-based capital guidelines that are set
forth in appendix A to part 325. This statement of policy does not
address the prompt corrective action provisions mandated by the Federal
Deposit Insurance Corporation Improvement Act of 1991. However, section
38 of the Federal Deposit Insurance Act and subpart B of part 325
provide guidance on the prompt corrective action provisions, which
generally apply to institutions with inadequate levels of capital.
I. Enforcement of Minimum Capital Requirements
Section 325.3(b)(1) specifies that FDIC-supervised, state-chartered
nonmember commercial and savings banks (or other insured depository
institutions making applications to the FDIC that require the FDIC to
consider the adequacy of the institutions' capital structure) must
maintain a minimum leverage ratio of Tier 1 (or core) capital to total
assets of at least 3 percent; however, this minimum only applies to the
most highly-rated banks (i.e., those with a composite CAMELS rating of 1
under the Uniform Financial Institutions Rating System established by
the Federal Financial Institutions Examination Council) that are not
anticipating or experiencing any significant growth. All other state
nonmember banks would need to meet a minimum leverage ratio that is at
least 100 to 200 basis points above this minimum. That is, in accordance
with Sec. 325.3(b)(2), an absolute minimum leverage ratio of not less
than 4 percent must be maintained by those banks that are not highly-
rated or that are anticipating or experiencing significant growth.
In addition to the minimum leverage capital standards, section III
of appendix A to part 325 indicates that state nonmember banks generally
are expected to maintain a minimum risk-based capital ratio of
qualifying total capital to risk-weighted assets of 8 percent, with at
least one-half of that total capital amount consisting of Tier 1
capital.
State nonmember banks (hereinafter referred to as ``banks'')
operating with leverage capital ratios below the minimums set forth in
part 325 will be deemed to have inadequate capital and will be in
violation of the part 325 regulation. Furthermore, banks operating with
risk-based capital ratios below the minimums set forth in appendix A to
part 325 generally will be deemed to have inadequate capital. Banks
failing to meet the minimum leverage and/or risk-based capital ratios
normally can expect to have any application submitted to the FDIC denied
(if such application requires the FDIC to evaluate the adequacy of the
institution's capital structure) and also can expect to be subject to
the use of capital directives or other formal enforcement action by the
FDIC to increase capital.
Capital adequacy in banks which have capital ratios at or above the
minimums will be assessed and enforced based on the following factors
(these same criteria will apply to any insured depository institutions
making applications to the FDIC and to any other circumstances in which
the FDIC is requested or required to evaluate the adequacy of a
depository institution's capital structure):
A. Banks Which Are Fundamentally Sound and Well-Managed
The minimum leverage capital ratios set forth in Sec. 325.3(b)(2)
and the minimum risk-based capital ratios set forth in section III of
appendix A to part 325 generally will be viewed as the minimum
acceptable capital standards for banks whose overall financial condition
is fundamentally sound, which are well-managed and which have no
material or significant financial weaknesses. While the FDIC will make
this determination in each bank based upon its own condition and
specific circumstances, this definition will generally apply to those
banks evidencing a level of risk which is no greater than that normally
associated with a Composite rating of 1 or 2 under the Uniform Financial
Institutions Rating System. Banks meeting this
[[Page 228]]
definition which are in compliance with the minimum leverage and risk-
based capital ratio standards will not generally be required by the FDIC
to raise new capital from external sources.
The FDIC does, however, encourage such banks to maintain capital
well above the minimums, particularly those institutions that are
anticipating or experiencing significant growth, and will carefully
evaluate their earnings and growth trends, dividend policies, capital
planning procedures and other factors important to the continuous
maintenance of adequate capital. Adverse trends or deficiencies in these
areas will be subject to criticism at regular examinations and may be an
important factor in the FDIC's action on applications submitted by such
banks. In addition, the FDIC's consideration of capital adequacy in
banks making applications to the FDIC will also fully examine the
expected impact of those applications on the bank's ability to maintain
its capital adequacy. In all cases, banks should maintain capital
commensurate with the level and nature of risks, including the volume
and severity of adversely classified assets, to which they are exposed.
B. All Other Banks
Banks not meeting the definition set forth in I.A. of this appendix,
that is, banks evidencing a level of risk which is at least as great as
that normally associated with a Composite rating of 3, 4, or 5 under the
Uniform Financial Institutions Rating System, will be required to
maintain capital higher than the minimum regulatory requirement and at a
level deemed appropriate in relation to the degree of risk within the
institution. These higher capital levels will normally be addressed
through memorandums of understanding between the FDIC and the bank or,
in cases of more pronounced risk, through the use of formal enforcement
actions under section 8 of the Federal Deposit Insurance Act (12 U.S.C.
1818).
C. Capital Requirements of Primary Regulator
Notwithstanding I.A. and B. of this appendix, all banks (or other
depository institutions making applications to the FDIC that require the
FDIC to consider the adequacy of the institutions' capital structure)
will be expected to meet any capital requirements established by their
primary state or federal regulator which exceed the minimum capital
requirement set forth in the FDIC's part 325 regulation. In addition,
the FDIC will, when establishing capital requirements higher than the
minimum set forth in the regulation, consult with an institution's
primary state or federal regulator.
II. Capital Plans
Section 325.4(b) specifies that any bank which has less than its
minimum leverage capital requirement is deemed to be engaging in an
unsafe or unsound banking practice unless it has submitted, and is in
compliance with, a plan approved by the FDIC to increase its Tier 1
leverage capital ratio to such level as the FDIC deems appropriate.
As required under Sec. 325.104(a)(1) of this part, a bank must file
a written capital restoration plan with the appropriate FDIC regional
director within 45 days of the date that the bank receives notice or is
deemed to have notice that the bank is undercapitalized, significantly
undercapitalized or critically undercapitalized, unless the FDIC
notifies the bank in writing that the plan is to be filed within a
different period. The amount of time allowed to achieve the minimum
leverage capital requirement will be evaluated by the FDIC on a case-by-
case basis and will depend on a number of factors, including the
viability of the bank and whether it is fundamentally sound and well-
managed.
Banks evidencing more than normal levels of risk will normally have
their minimum capital requirements established in a formal or informal
enforcement proceeding. The time frames for meeting these requirements
will be set forth in such actions and will generally require some
immediate action on the bank's part to meet its minimum capital
requirement. The reasonableness of capital plans submitted by depository
institutions in connection with applications as provided for in Sec.
325.3(d)(2) will be determined in conjunction with the FDIC's
consideration of the application.
III. Written Agreements
Section 325.4(c) provides that any insured depository institution
with a Tier 1 capital to total assets (leverage) ratio of less than 2
percent must enter into and be in compliance with a written agreement
with the FDIC (or with its primary federal regulator with FDIC as a
party to the agreement) to increase its Tier 1 leverage capital ratio to
such level as the FDIC deems appropriate or may be subject to a section
8(a) termination of insurance action by the FDIC. Except in the very
rarest of circumstances, the FDIC will require that such agreements
contemplate immediate efforts by the depository institution to acquire
the required capital.
The guidance in this section III is not intended to preclude the
FDIC from taking section 8(a) or other enforcement action against any
institution, regardless of its capital level, if the specific
circumstances deem such action to be appropriate.
[[Page 229]]
IV. Capital Components
Section 325.2 sets forth the definition of Tier 1 capital for the
leverage standard as well as the definitions for the various instruments
and accounts which are included therein. Although nonvoting common
stock, noncumulative perpetual preferred stock, and minority interests
in consolidated subsidiaries are normally included in Tier 1 capital,
voting common stockholders' equity generally will be expected to be the
dominant form of Tier 1 capital. Thus, banks should avoid undue reliance
on nonvoting equity, preferred stock and minority interests. The
following provides some additional guidance with respect to some of the
items that affect the calculation of Tier 1 capital.
A. Intangible Assets
The FDIC permits state nonmember banks to record intangible assets
on their books and to report the value of such assets in the
Consolidated Reports of Condition and Income (``Call Report''). As noted
in the instructions for preparation of the Consolidated Reports of
Condition and Income (published by the Federal Financial Institutions
Examination Council), intangible assets may arise from business
combinations accounted for under the purchase method and acquisitions of
portions or segments of another institution's business, such as branch
offices, mortgage servicing portfolios, and credit card portfolios.
Notwithstanding the authority to report all intangible assets in the
Consolidated Reports of Condition and Income, Sec. 325.2(v) of the
regulation specifies that mortgage servicing assets, nonmortgage
servicing assets and purchased credit card relationships are the only
intangible assets which will be allowed as Tier 1 capital.\1\ The
portion of equity capital represented by other types of intangible
assets will be deducted from equity capital and assets in the
computation of a bank's Tier 1 capital. Certain of these intangible
assets may, however, be recognized for regulatory capital purposes if
explicitly approved by the Director of the Division of Supervision and
Consumer Protection (DSC) as part of the bank's regulatory capital on a
specific case basis. These intangibles will be included in regulatory
capital under the terms and conditions that are specifically approved by
the FDIC.\2\
---------------------------------------------------------------------------
\1\ Although intangible assets in the form of mortgage servicing
assets, nonmortgage servicing assets and purchased credit card
relationships are generally recognized for regulatory capital purposes,
the --deduction of part or all of the mortgage servicing assets,
nonmortgage servicing assets and purchased credit card relationships may
be required if the carrying amounts of these rights are excessive in
relation to their market value or the level of the bank's capital
accounts. In this regard, mortgage servicing assets, nonmortgage
servicing assets and purchased credit card relationships will be
recognized for regulatory capital purposes only to the extent the rights
meet the conditions, limitations and restrictions described in Sec.
325.5(f).
\2\ This specific approval must be received in accordance with Sec.
325.5(b). In evaluating whether other types of intangibles should be
recognized for regulatory capital purposes, the FDIC will accord special
attention to the general characteristics of the intangibles, including:
(1) The separability of the intangible asset and the ability to sell it
separate and apart from the bank or the bulk of the bank's assets, (2)
the certainty that a readily identifiable stream of cash flows
associated with the intangible asset can hold its value notwithstanding
the future prospects of the bank, and (3) the existence of a market of
sufficient depth to provide liquidity for the intangible asset. However,
pursuant to section 18(n) of the Federal Deposit Insurance Act (12
U.S.C. 1828(n)), specific approval cannot be given for an unidentifiable
intangible asset, such as goodwill, if acquired after April 12, 1989.
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In certain instances banks may have investments in unconsolidated
subsidiaries or joint ventures that have large volumes of intangible
assets. In such instances the bank's consolidated statements will
reflect an investment in a tangible asset even though such investment
will, in fact, be represented by a large volume of intangible assets. In
any such situation where this is material, the bank's investment in the
unconsolidated subsidiary will be divided into a tangible and an
intangible portion based on the percentage of intangible assets to total
assets in the subsidiary. The intangible portion of the investment will
be treated as if it were an intangible asset on the bank's books in the
calculation of Tier 1 capital. However, intangible assets in the form of
mortgage servicing assets, nonmortgage servicing assets and purchased
credit card relationships, including servicing intangibles held by
mortgage banking subsidiaries, are subject to the specific criteria set
forth in Sec. 325.5(f).
B. Perpetual Preferred Stock
Perpetual preferred stock is defined as preferred stock that does
not have a maturity date, that cannot be redeemed at the option of the
holder, and that has no other provisions that will require future
redemption of the issue. Also, pursuant to section 18(i)(1) of the
Federal Deposit Insurance Act (12 U.S.C. 1828(i)(1)), a state nonmember
bank cannot, without the prior consent of the FDIC, reduce the amount or
retire any part of its perferred stock. (This prior consent is also
[[Page 230]]
required for the reduction or retirement of any part of a state
nonmember bank's common stock or capital notes and debentures.)
Noncumulative perpetual preferred stock is generally included in
Tier 1 capital. Nonetheless, it is possible for banks to issue preferred
stock with a dividend rate which escalates to such a high rate that the
terms become so onerous as to effectively force the bank to call the
issue (for example, an issue with a low initial rate that is scheduled
to escalate to much higher rates in subsequent periods). Preferred stock
issues with such onerous terms have much the same characteristics as
limited life preferred stock in that the bank would be effectively
forced to redeem the issue to avoid performance of the onerous terms.
Such instruments may be disallowed as Tier 1 capital and, for risk-based
capital purposes, would be included in Tier 2 capital only to the extent
that the instruments fall within the limitations applicable to
intermediate-term preferred stock. Banks which are contemplating issues
bearing terms which may be so characterized are encouraged to submit
them to the appropriate FDIC regional office for review prior to
issuance. Nothing herein shall prohibit banks from issuing floating rate
preferred stock issues where the rate is constant in relation to some
outside market or index rate. However, noncumulative floating rate
instruments where the rate paid is based in some part on the current
credit standing of the bank, and all cumulative preferred stock
instruments, are excluded from Tier 1 capital. These instruments are
included in Tier 2 capital for risk-based capital purposes in accordance
with the limitations set forth in appendix A to part 325.
The FDIC will also require that issues of perpetual preferred stock
be consistent with safe and sound banking practices. Issues which would
unduly enrich insiders or which contain dividend rates or other terms
which are inconsistent with safe and sound banking practices will likely
be the subject of appropriate supervisory response from the FDIC. Banks
contemplating preferred stock issues which may pose safety and soundness
concerns are encouraged to submit such issues to the appropriate FDIC
regional office for review prior to sale. Pursuant to Sec. 325.5(e),
capital instruments that contain or that are subject to any conditions,
covenants, terms, restrictions or provisions that are inconsistent with
safe and sound banking practices will not qualify as capital under part
325.
C. Other Instruments or Transactions Which Fail to Provide Capital
Support
Section 325.5(b) specifies that any capital component or balance
sheet entry or account which has characteristics or terms that diminish
its contribution to an insured depository institution's ability to
absorb losses shall be deducted from capital. An example involves
certain types of minority interests in consolidated subsidiaries.
Minority interests in consolidated subsidiaries have been included in
capital based on the fact that they provide capital support to the risk
in the consolidated subsidiaries. Certain transactions have been
structured where a bank forms a subsidiary by transferring essentially
risk-free or low-risk assets to the subsidiary in exchange for common
stock of the subsidiary. The subsidiary then sells preferred stock to
third parties.
The preferred stock becomes a minority interest in a consolidated
subsidiary but, in effect, represents an essentially risk-free or low-
risk investment for the preferred stockholders. This type of minority
interest fails to provide any meaningful capital support to the
consolidated entity inasmuch as it has a preferred claim on the
essentially risk-free or low-risk assets of the subsidiary. In addition,
certain minority interests are not substantially equivalent to permanent
equity in that the interests must be paid off on specified future dates,
or at the option of the holders of the minority interests, or contain
other provisions or features that limit the ability of the minority
interests to effectively absorb losses. Capital instruments or
transactions of this nature which fail to absorb losses or provide
meaningful capital support will be deducted from Tier 1 capital.
D. Mandatory Convertible Debt
Mandatory convertible debt securities are subordinated debt
instruments that require the issuer to convert such instruments into
common or perpetual preferred stock by a date at or before the maturity
of the debt instruments. The maturity of these instruments must be 12
years or less and the instruments must also meet the other criteria set
forth in appendix A to part 325. Mandatory convertible debt is excluded
from Tier 1 capital but, for risk-based capital purposes, is included in
Tier 2 capital as a ``hybrid capital instrument.''
So-called ``equity commitment notes,'' which merely require a bank
to sell common or perpetual preferred stock during the life of the
subordinated debt obligation, are specifically excluded from the
definition of mandatory convertible debt securities and are only
included in Tier 2 capital under the risk-based capital framework to the
extent that they satisfy the requirements and limitations for ``term
subordinated debt'' set forth in appendix A to part 325.
V. Analysis of Consolidated Companies
In determining a bank's compliance with its minimum capital
requirements the FDIC will, with two exceptions, generally utilize
[[Page 231]]
the bank's consolidated statements as defined in the instructions for
the preparation of Consolidated Reports of Condition and Income.
The first exception relates to securities subsidiaries of state
nonmember banks which are subject to Sec. 337.4 of the FDIC's rules and
regulations (12 CFR 337.4). Any subsidiary subject to this section must
be a bona fide subsidiary which is adequately capitalized. In addition,
Sec. 337.4(b)(3) requires that any insured state nonmember bank's
investment in such a subsidiary shall not be counted towards the bank's
capital. In those instances where the securities subsidiary is
consolidated in the bank's Consolidated Report of Condition it will be
necessary, for the purpose of calculating the bank's Tier 1 capital, to
adjust the Consolidated Report of Condition in such a manner as to
reflect the bank's investment in the securities subsidiary on the equity
method. In this case, and in those cases where the securities subsidiary
has not been consolidated, the investment in the subsidiary will then be
deducted from the bank's capital and assets prior to calculation of the
bank's Tier 1 capital ratio. (Where deemed appropriate, the FDIC may
also consider deducting investments in other subsidiaries, either on a
case-by-case basis or, as with securities subsidiaries, based on the
general characteristics or functional nature of the subsidiaries.)
The second exception relates to the treatment of subsidiaries of
insured banks that are domestic depository institutions such as
commercial banks, savings banks, or savings associations. These
subsidiaries are not consolidated on a line-by-line basis with the
insured bank parent in the bank parent's Consolidated Reports of
Condition and Income. Rather, the instructions for these reports provide
that bank investments in such depository institution subsidiaries are to
be reported on an unconsolidated basis in accordance with the equity
method. Since the FDIC believes that the minimum capital requirements
should apply to a bank's depository activities in their entirety,
regardless of the form that the organization's corporate structure
takes, it will be necessary, for the purpose of calculating the bank's
Tier 1 leverage and total risk-based capital ratios, to adjust a bank
parent's Consolidated Report of Condition to consolidate its domestic
depository institution subsidiaries on a line-by-line basis. The
financial statements of the subsidiary that are used for this
consolidation must be prepared in the same manner as the Consolidated
Report of Condition.
The FDIC will, in determining the capital adequacy of a bank which
is a member of a bank holding company or chain banking group, consider
the degree of leverage and risks undertaken by the parent company or
other affiliates. Where the level of risk in a holding company system is
no more than normal and the consolidated company is adequately
capitalized at all appropriate levels, the FDIC generally will not
require additional capital in subsidiary banks under its supervision
over and above that which would be required for the subsidiary bank on
its own merit. In cases where a holding company or other affiliated
banks (or other companies) evidence more than a normal degree of risk
(either by virtue of the quality of their assets, the nature of the
activities conducted, or other factors) or where the affiliated
organizations are inadequately capitalized, the FDIC will consider the
potential impact of the additional risk or excess leverage upon an
individual bank to determine if such factors will likely result in
excessive requirements for dividends, management fees, or other support
to the holding company or affiliated organizations which would be
detrimental to the bank. Where the excessive risk or leverage in such
organizations is determined to be potentially detrimental to the bank's
condition or its ability to maintain adequate capital, the FDIC may
initiate appropriate supervisory action to limit the bank's ability to
support its weaker affiliates and/or require higher than minimum capital
ratios in the bank.
VI. Applicability of Part 325 to Savings Associations
Section 325.3(c) indicates that, where the FDIC is required to
evaluate the adequacy of any depository institution's (including any
savings association's) capital structure in conjunction with an
application filed by the institution, the FDIC will not approve the
application if the depository institution does not meet the minimum
leverage capital requirement set forth in Sec. 325.3(b).
Also, Sec. 325.4(b) states that, under certain conditions specified
in section 8(t) of the Federal Deposit Insurance Act, the FDIC may take
section 8(b)(1) and/or 8(c) enforcement action against a savings
association that is deemed to be engaged in an unsafe or unsound
practice on account of its inadequate capital structure. Section
325.4(c) further specifies that any insured depository institution with
a Tier 1 leverage ratio (as defined in part 325) of less than 2 percent
is deemed to be operating in an unsafe or unsound condition pursuant to
section 8(a) of the Federal Deposit Insurance Act.
In addition, the Office of Thrift Supervision (OTS), as the primary
federal regulator of savings associations, has established minimum core
capital leverage, tangible capital and risk-based capital requirements
for savings associations (12 CFR part 567). In this regard, certain
differences exist between the methods used by the OTS to calculate a
savings association's capital and the methods set forth by the FDIC in
part 325. These differences include, among others, the core
[[Page 232]]
capital treatment for investments in subsidiaries and for certain
intangible assets.
In determining whether a savings association's application should be
approved pursuant to Sec. 325.3(c), or whether an unsafe or unsound
practice or condition exists pursuant to Sec. Sec. 325.4(b) and
325.4(c), the FDIC will consider the extent of the savings association's
capital as determined in accordance with part 325. However, the FDIC
will also consider the extent to which a savings association is in
compliance with (a) the minimum capital requirements set forth by the
OTS, (b) any related capital plans for meeting the minimum capital
requirements approved by the OTS, and/or (c) any other criteria deemed
by the FDIC as appropriate based on the association's specific
circumstances.
[56 FR 10166, Mar. 11, 1991, as amended at 58 FR 6369, Jan. 28, 1993; 58
FR 8219, Feb. 12, 1993; 58 FR 60103, Nov. 15, 1993; 60 FR 39232, Aug. 1,
1995; 63 FR 42678, Aug. 10, 1998; 66 FR 59661, Nov. 29, 2001]
Appendix C to Part 325--Risk-Based Capital for State Non-Member Banks:
Market Risk
Section 1. Purpose, Applicability, Scope, and Effective Date
(a) Purpose. The purpose of this appendix is to ensure that banks
with significant exposure to market risk maintain adequate capital to
support that exposure.\1\ This appendix supplements and adjusts the
risk-based capital ratio calculations under appendix A of this part with
respect to those banks.
---------------------------------------------------------------------------
\1\ This appendix is based on a framework developed jointly by
supervisory authorities from the countries represented on the Basle
Committee on Banking Supervision and endorsed by the Group of Ten
Central Bank Governors. The framework is described in a Basle Committee
paper entitled ``Amendment to the Capital Accord to Incorporate Market
Risks,'' January 1996. Also see modifications issued in September 1997.
---------------------------------------------------------------------------
(b) Applicability. (1) This appendix applies to any insured state
nonmember bank whose trading activity \2\ (on a worldwide consolidated
basis) equals:
---------------------------------------------------------------------------
\2\ Trading activity means the gross sum of trading assets and
liabilities as reported in the bank's most recent quarterly Consolidated
Report of Condition and Income (Call Report).
---------------------------------------------------------------------------
(i) 10 percent or more of total assets; \3\ or
---------------------------------------------------------------------------
\3\ Total assets means quarter-end total assets as reported in the
bank's most recent Call Report.
---------------------------------------------------------------------------
(ii) $1 billion or more.
(2) The FDIC may additionally apply this appendix to any insured
state nonmember bank if the FDIC deems it necessary or appropriate for
safe and sound banking practices.
(3) The FDIC may exclude an insured state nonmember bank otherwise
meeting the criteria of paragraph (b)(1) of this section from coverage
under this appendix if it determines the bank meets such criteria as a
consequence of accounting, operational, or similar considerations, and
the FDIC deems it consistent with safe and sound banking practices.
(c) Scope. The capital requirements of this appendix support market
risk associated with a bank's covered positions.
(d) Effective date. This appendix is effective as of January 1,
1997. Compliance is not mandatory until January 1, 1998. Subject to
supervisory approval, a bank may opt to comply with this appendix as
early as January 1, 1997.\4\
---------------------------------------------------------------------------
\4\ A bank that voluntarily complies with the final rule prior to
January 1, 1998, must comply with all of its provisions.
---------------------------------------------------------------------------
Section 2. Definitions
For purposes of this appendix, the following definitions apply:
(a) Covered positions means all positions in a bank's trading
account, and all foreign exchange \5\ and commodity positions, whether
or not in the trading account.\6\ Positions include on-balance-sheet
assets and liabilities and off-balance-sheet items. Securities subject
to repurchase and lending agreements are included as if they are still
owned by the lender. Covered positions exclude all positions in a bank's
trading account that, in form or in substance, act as liquidity
facilities that provide liquidity support to asset-backed commercial
paper. Such excluded positions are subject to the risk-based capital
requirements set forth in appendix A of this part.
---------------------------------------------------------------------------
\5\ Subject to FDIC review, a bank may exclude structural positions
in foreign currencies from its covered positions.
\6\ The term trading account is defined in the instructions to the
Call Report.
---------------------------------------------------------------------------
(b) Market risk means the risk of loss resulting from movements in
market prices. Market risk consists of general market risk and specific
risk components.
(1) General market risk means changes in the market value of covered
positions resulting from broad market movements, such as changes in the
general level of interest rates, equity prices, foreign exchange rates,
or commodity prices.
(2) Specific risk means changes in the market value of specific
positions due to factors other than broad market movements and includes
event and default risk as well as idiosyncratic variations.
(c) Tier 1 and Tier 2 capital are defined in appendix A of this
part.
[[Page 233]]
(d) Tier 3 capital is subordinated debt that is unsecured; is fully
paid up; has an original maturity of at least two years; is not
redeemable before maturity without prior approval by the FDIC; includes
a lock-in clause precluding payment of either interest or principal
(even at maturity) if the payment would cause the issuing bank's risk-
based capital ratio to fall or remain below the minimum required under
appendix A of this part; and does not contain and is not covered by any
covenants, terms, or restrictions that are inconsistent with safe and
sound banking practices.
(e) Value-at-risk (VAR) means the estimate of the maximum amount
that the value of covered positions could decline during a fixed holding
period within a stated confidence level, measured in accordance with
section 4 of this appendix.
Section 3. Adjustments to the Risk-Based Capital Ratio Calculations.
(a) Risk-based capital ratio denominator. A bank subject to this
appendix shall calculate its risk-based capital ratio denominator as
follows:
(1) Adjusted risk-weighted assets. Calculate adjusted risk-weighted
assets, which equals risk-weighted assets (as determined in accordance
with appendix A of this part), excluding the risk-weighted amounts of
all covered positions (except foreign exchange positions outside the
trading account and over-the-counter derivative positions) \7\ and
receivables arising from the posting of cash collateral that is
associated with securities borrowing transactions to the extent the
receivables are collateralized by the market value of the borrowed
securities, provided that the following conditions are met:
(i) The transaction is based on securities includable in the trading
book that are liquid and readily marketable,
(ii) The transaction is marked to market daily,
(iii) The transaction is subject to daily margin maintenance
requirements,
(iv) The transaction is a securities contract for the purposes of
section 555 of the Bankruptcy Code (11 U.S.C. 555), a qualified
financial contract for the purposes of section 11(e)(8) of the Federal
Deposit Insurance Act (12 U.S.C. 1821(e)(8)), or a netting contract
between or among financial institutions for the purposes of sections
401-407 of the Federal Deposit Insurance Corporation Improvement Act of
1991 (12 U.S.C. 4401-4407), or the Board's Regulation EE (12 CFR Part
231).
---------------------------------------------------------------------------
\7\ Foreign exchange positions outside the trading account and all
over-the-counter derivative positions, whether or not in the trading
account, must be included in the adjusted risk weighted assets as
determined in appendix A of this part.
---------------------------------------------------------------------------
(2) Measure for market risk. Calculate the measure for market risk,
which equals the sum of the VAR-based capital charge, the specific risk
add-on (if any), and the capital charge for de minimis exposures (if
any).
(i) VAR-based capital charge. The VAR-based capital charge equals
the higher of:
(A) The previous day's VAR measure; or
(B) The average of the daily VAR measures for each of the preceding
60 business days multiplied by three, except as provided in section 4(e)
of this appendix;
(ii) Specific risk add-on. The specific risk add-on is calculated in
accordance with section 5 of this appendix; and
(iii) Capital charge for de minimis exposure. The capital charge for
de minimis exposure is calculated in accordance with section 4(a) of
this appendix.
(3) Market risk equivalent assets. Calculate market risk equivalent
assets by multiplying the measure for market risk (as calculated in
paragraph (a)(2) of this section) by 12.5.
(4) Denominator calculation. Add market risk equivalent assets (as
calculated in paragraph (a)(3) of this section) to adjusted risk-
weighted assets (as calculated in paragraph (a)(1) of this section). The
resulting sum is the bank's risk-based capital ratio denominator.
(b) Risk-based capital ratio numerator. A bank subject to this
appendix shall calculate its risk-based capital ratio numerator by
allocating capital as follows:
(1) Credit risk allocation. Allocate Tier 1 and Tier 2 capital equal
to 8.0 percent of adjusted risk-weighted assets (as calculated in
paragraph (a)(1) of this section).\8\
---------------------------------------------------------------------------
\8\ A bank may not allocate Tier 3 capital to support credit risk
(as calculated under appendix A of this part).
---------------------------------------------------------------------------
(2) Market risk allocation. Allocate Tier 1, Tier 2, and Tier 3
capital equal to the measure for market risk as calculated in paragraph
(a)(2) of this section. The sum of Tier 2 and Tier 3 capital allocated
for market risk must not exceed 250 percent of Tier 1 capital allocated
for market risk. (This requirement means that Tier 1 capital allocated
in this paragraph (b)(2) must equal at least 28.6 percent of the measure
for market risk.)
(3) Restrictions. (i) The sum of Tier 2 capital (both allocated and
excess) and Tier 3 capital (allocated in paragraph (b)(2) of this
section) may not exceed 100 percent of Tier 1 capital (both allocated
and excess).\9\
---------------------------------------------------------------------------
\9\ Excess Tier 1 capital means Tier 1 capital that has not been
allocated in paragraphs (b)(1) and (b)(2) of this section. Excess Tier 2
capital means Tier 2 capital that has not been allocated in paragraph
(b)(1) and (b)(2) of this section, subject to the restrictions in
paragraph (b)(3) of this section.
---------------------------------------------------------------------------
[[Page 234]]
(ii) Term subordinated debt (and intermediate-term preferred stock
and related surplus) included in Tier 2 capital (both allocated and
excess) may not exceed 50 percent of Tier 1 capital (both allocated and
excess).
(4) Numerator calculation. Add Tier 1 capital (both allocated and
excess), Tier 2 capital (both allocated and excess), and Tier 3 capital
(allocated under paragraph (b)(2) of this section). The resulting sum is
the bank's risk-based capital ratio numerator.
Section 4. Internal Models
(a) General. For risk-based capital purposes, a bank subject to this
appendix must use its internal model to measure its daily VAR, in
accordance with the requirements of this section.\10\ The FDIC may
permit a bank to use alternative techniques to measure the market risk
of de minimis exposures so long as the techniques adequately measure
associated market risk.
---------------------------------------------------------------------------
\10\ A bank's internal model may use any generally accepted
measurement techniques, such as variance-covariance models, historical
simulations, or Monte Carlo simulations. However, the level of
sophistication and accuracy of a bank's internal model must be
commensurate with the nature and size of its covered positions. A bank
that modifies its existing modeling procedures to comply with the
requirements of this appendix for risk-based capital purposes should,
nonetheless, continue to use the internal model it considers most
appropriate in evaluating risks for other purposes.
---------------------------------------------------------------------------
(b) Qualitative requirements. A bank subject to this appendix must
have a risk management system that meets the following minimum
qualitative requirements:
(1) The bank must have a risk control unit that reports directly to
senior management and is independent from business trading units.
(2) The bank's internal risk measurement model must be integrated
into the daily management process.
(3) The bank's policies and procedures must identify, and the bank
must conduct, appropriate stress tests and backtests.\11\ The bank's
policies and procedures must identify the procedures to follow in
response to the results of such tests.
---------------------------------------------------------------------------
\11\ Stress tests provide information about the impact of adverse
market events on a bank's covered positions. Backtests provide
information about the accuracy of an internal model by comparing a
bank's daily VAR measures to its corresponding daily trading profits and
losses.
---------------------------------------------------------------------------
(4) The bank must conduct independent reviews of its risk
measurement and risk management systems at least annually.
(c) Market risk factors. The bank's internal model must use risk
factors sufficient to measure the market risk inherent in all covered
positions. The risk factors must address interest rate risk,\12\ equity
price risk, foreign exchange rate risk, and commodity price risk.
---------------------------------------------------------------------------
\12\ For material exposures in the major currencies and markets,
modeling techniques must capture spread risk and must incorporate enough
segments of the yield curve--at least six--to capture differences in
volatility and less than perfect correlation of rates along the yield
curve.
---------------------------------------------------------------------------
(d) Quantitative requirements. For regulatory capital purposes, VAR
measures must meet the following quantitative requirements:
(1) The VAR measures must be calculated on a daily basis using a 99
percent, one-tailed confidence level with a price shock equivalent to a
ten-business day movement in rates and prices. In order to calculate VAR
measures based on a ten-day price shock, the bank may either calculate
ten-day figures directly or convert VAR figures based on holding periods
other than ten days to the equivalent of a ten-day holding period (for
instance, by multiplying a one-day VAR measure by the square root of
ten).
(2) The VAR measures must be based on an historical observation
period (or effective observation period for a bank using a weighting
scheme or other similar method) of at least one year. The bank must
update data sets at least once every three months or more frequently as
market conditions warrant.
(3) The VAR measures must include the risks arising from the non-
linear price characteristics of options positions and the sensitivity of
the market value of the positions to changes in the volatility of the
underlying rates or prices. A bank with a large or complex options
portfolio must measure the volatility of options positions by different
maturities.
(4) The VAR measures may incorporate empirical correlations within
and across risk categories, provided that the bank's process for
measuring correlations is sound. In the event that the VAR measures do
not incorporate empirical correlations across risk categories, then the
bank must add the separate VAR measures for the four major risk
categories to determine its aggregate VAR measure.
(e) Backtesting. (1) Beginning one year after a bank starts to
comply with this appendix, a bank must conduct backtesting by comparing
each of its most recent 250 business days' actual net trading profit or
loss \13\ with
[[Page 235]]
the corresponding daily VAR measures generated for internal risk
measurement purposes and calibrated to a one-day holding period and a 99
percent, one-tailed confidence level.
---------------------------------------------------------------------------
\13\ Actual net trading profits and losses typically include such
things as realized and unrealized gains and losses on portfolio
positions as well as fee income and commissions associated with trading
activities.
---------------------------------------------------------------------------
(2) Once each quarter, the bank must identify the number of
exceptions, that is, the number of business days for which the magnitude
of the actual daily net trading loss, if any, exceeds the corresponding
daily VAR measure.
(3) A bank must use the multiplication factor indicated in Table 1
of this appendix in determining its capital charge for market risk under
section 3(a)(2)(i)(B) of this appendix until it obtains the next
quarter's backtesting results, unless the FDIC determines that a
different adjustment or other action is appropriate.
Table 1--Multiplication Factor Based on Results of Backtesting
------------------------------------------------------------------------
Multiplication
Number of exceptions factor
------------------------------------------------------------------------
4 or fewer.............................................. 3.00
5....................................................... 3.40
6....................................................... 3.50
7....................................................... 3.65
8....................................................... 3.75
9....................................................... 3.85
10 or more.............................................. 4.00
------------------------------------------------------------------------
Section 5. Specific Risk
(a) Modeled specific risk. A bank may use its internal model to
measure specific risk. If the bank has demonstrated to the FDIC that its
internal model measures the specific risk, including event and default
risk as well as idiosyncratic variation, of covered debt and equity
positions and includes the specific risk measure in the VAR-based
capital charge in section 3(a)(2)(i) of this appendix, then the bank has
no specific risk add-on for purposes of section 3(a)(2)(ii) of this
appendix. The model should explain the historical price variation in the
trading portfolio and capture concentration, both magnitude and changes
in composition. The model should also be robust to an adverse
environment and have been validated through backtesting which assesses
whether specific risk is being accurately captured.
(b) Add-on charge for modeled specific risk. A bank that
incorporates specific risk in its internal model but fails to
demonstrate to the FDIC that its internal model adequately measures all
aspects of specific risk for covered debt and equity positions,
including event and default risk, as provided by section 5(a) of this
appendix, must calculate the bank's specific risk add-on for purposes of
section 3(a)(2)(ii) of this appendix as follows:
(1) If the model is capable of valid separation of the VAR measure
into a specific risk portion and a general market risk portion, then the
specific risk add-on is equal to the previous day's specific risk
portion.
(2) If the model does not separate the VAR measure into a specific
risk portion and a general market risk portion, then the specific risk
add-on is the sum of the previous day's VAR measures for subportfolios
of covered debt and equity positions.
(c) Add-on charge if specific risk is not modeled. If a bank does
not model specific risk in accordance with paragraph (a) or (b) of this
section, the bank's specific risk add-on charge for purposes of section
3(a)(2)(ii) of this appendix equals the sum of the components for
covered debt and equity positions. If a bank models, in accordance with
paragraph (a) or (b) of this section, the specific risk of covered debt
positions but not covered equity positions (or vice versa), then the
bank's specific risk add-on charge for the positions not modeled is the
component for covered debt or equity positions as appropriate:
(1) Covered debt positions. (i) For purposes of this section 5,
covered debt positions means fixed-rate or floating-rate debt
instruments located in the trading account and instruments located in
the trading account with values that react primarily to changes in
interest rates, including certain non-convertible preferred stock,
convertible bonds, and instruments subject to repurchase and lending
agreements. Also included are derivatives (including written and
purchased options) for which the underlying instrument is a covered debt
instrument that is subject to a non-zero specific risk capital charge.
(A) For covered debt positions that are derivatives, a bank must
risk-weight (as described in paragraph (c)(1)(iii) of this section) the
market value of the effective notional amount of the underlying debt
instrument or index portfolio. Swaps must be included as the notional
position in the underlying debt instrument or index portfolio, with a
receiving side treated as a long position and a paying side treated as a
short position; and
(B) For covered debt positions that are options, whether long or
short, a bank must risk-weight (as described in paragraph (c)(1)(iii) of
this section) the market value of the effective notional amount of the
underlying debt instrument or index multiplied by the option's delta.
(ii) A bank may net long and short covered debt positions (including
derivatives) in identical debt issues or indices.
(iii) A bank must multiply the absolute value of the current market
value of each net long or short covered debt position by
[[Page 236]]
the appropriate specific risk weighting factor indicated in Table 2 of
this appendix. The specific risk capital charge component for covered
debt positions is the sum of the weighted values.
Table 2--Specific Risk Weighting Factors for Covered Debt Positions
------------------------------------------------------------------------
Weighting
Category Remaining maturity factor (in
(contractual) percent)
------------------------------------------------------------------------
Government......................... N/A.................... 0.00
Qualifying......................... 6 months or less....... 0.25
Over 6 months to 24 1.00
months.
Over 24 months......... 1.60
Other.............................. N/A.................... 8.00
------------------------------------------------------------------------
(A) The government category includes all debt instruments of central
governments of OECD-based countries \14\ including bonds, Treasury
bills, and other short-term instruments, as well as local currency
instruments of non-OECD central governments to the extent the bank has
liabilities booked in that currency.
---------------------------------------------------------------------------
\14\ Organization for Economic Cooperation and Development (OECD)-
based countries is defined in appendix A of this part.
---------------------------------------------------------------------------
(B) The qualifying category includes debt instruments of U.S.
government-sponsored agencies, general obligation debt instruments
issued by states and other political subdivisions of OECD-based
countries, multilateral development banks, and debt instruments issued
by U.S. depository institutions or OECD-banks that do not qualify as
capital of the issuing institution.\15\ This category also includes
other debt instruments, including corporate debt and revenue instruments
issued by states and other political subdivisions of OECD countries,
that are:
---------------------------------------------------------------------------
\15\ U.S. government-sponsored agencies, multilateral development
banks, and OECD banks are defined in appendix A of this part.
---------------------------------------------------------------------------
(1) Rated investment-grade by at least two nationally recognized
credit rating services;
(2) Rated investment-grade by one nationally recognized credit
rating agency and not rated less than investment-grade by any other
credit rating agency; or
(3) Unrated, but deemed to be of comparable investment quality by
the reporting bank and the issuer has instruments listed on a recognized
stock exchange, subject to review by the FDIC.
(C) The other category includes debt instruments that are not
included in the government or qualifying categories.
(2) Covered equity positions. (i) For purposes of this section 5,
covered equity positions means equity instruments located in the trading
account and instruments located in the trading account with values that
react primarily to changes in equity prices, including voting or non-
voting common stock, certain convertible bonds, and commitments to buy
or sell equity instruments. Also included are derivatives (including
written and purchased options) for which the underlying is a covered
equity position.
(A) For covered equity positions that are derivatives, a bank must
risk weight (as described in paragraph (c)(2)(iii) of this section) the
market value of the effective notional amount of the underlying equity
instrument or equity portfolio. Swaps must be included as the notional
position in the underlying equity instrument or index portfolio, with a
receiving side treated as a long position and a paying side treated as a
short position; and
(B) For covered equity positions that are options, whether long or
short, a bank must risk weight (as described in paragraph (c)(2)(iii) of
this section) the market value of the effective notional amount of the
underlying equity instrument or index multiplied by the option's delta.
(ii) A bank may net long and short covered equity positions
(including derivatives) in identical equity issues or equity indices in
the same market.\16\
---------------------------------------------------------------------------
\16\ A bank may also net positions in depository receipts against an
opposite position in the underlying equity or identical equity in
different markets, provided that the bank includes the costs of
conversion.
---------------------------------------------------------------------------
(iii)(A) A bank must multiply the absolute value of the current
market value of each net long or short covered equity position by a risk
weighting factor of 8.0 percent, or by 4.0 percent if the equity is held
in a portfolio that is both liquid and well-diversified.\17\ For covered
equity positions that are index contracts comprising a well-diversified
portfolio of equity instruments, the net long or short position is
multiplied by a risk weighting factor of 2.0 percent.
---------------------------------------------------------------------------
\17\ A portfolio is liquid and well-diversified if: (1) it is
characterized by a limited sensitivity to price changes of any single
equity issue or closely related group of equity issues held in the
portfolio; (2) the volatility of the portfolio's value is not dominated
by the volatility of any individual equity issue or by equity issues
from any single industry or economic sector; (3) it contains a large
number of individual equity positions, with no single position
representing a substantial portion of the portfolio's total market
value; and (4) it consists mainly of issues traded on organized
exchanges or in well-established over-the-counter markets.
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(B) For covered equity positions from the following futures-related
arbitrage strategies, a bank may apply a 2.0 percent risk weighting
factor to one side (long or short)
[[Page 237]]
of each position with the opposite side exempt from charge, subject to
review by the FDIC:
(1) Long and short positions in exactly the same index at different
dates or in different market centers; or
(2) Long and short positions in index contracts at the same date in
different but similar indices.
(C) For futures contracts on broadly-based indices that are matched
by offsetting positions in a basket of stocks comprising the index, a
bank may apply a 2.0 percent risk weighting factor to the futures and
stock basket positions (long and short), provided that such trades are
deliberately entered into and separately controlled, and that the basket
of stocks comprises at least 90 percent of the capitalization of the
index.
(iv) The specific risk capital charge component for covered equity
positions is the sum of the weighted values.
[61 FR 47376, Sept. 6, 1996, as amended at 62 FR 68068, Dec. 30, 1997;
64 FR 19038, Apr. 19, 1999; 65 FR 75859, Dec. 5, 2000; 69 FR 44924, July
28, 2004]