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2000 - Rules and Regulations
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Appendix B to Part 325Statement 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
§ 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 § 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
{{12-31-01 p.2262.08}}with a Composite rating
of 1 or 2 under the Uniform Financial Institutions Rating System. Banks
meeting this 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
§ 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
{{12-31-01 p.2262.09}}applications as provided
for in § 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.
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, § 325.2(t) 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 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
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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 § 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
preferred stock. (This prior consent is also 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
{{2-28-93 p.2262.11}}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
§ 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 the
bank's consolidated statements as defined in the instructions for the
preparation of Consolidated Reports of Condition and Income.
{{2-28-93 p.2262.12}}
The first exception relates to securities subsidiaries of state
nonmember banks which are subject to § 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, § 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
§ 325.3(b).
Also, § 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
{{2-28-06 p.2262.13}}
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 capital
treatment for investments in subsidiaries and for certain intangible
assets.
In determining whether a savings association's application should be
approved pursuant to § 325.3(c), or whether an unsafe or unsound
practice or condition exists pursuant to §§ 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.
[Codified to 12 C.F.R. Part 325, Appendix B]
[Source: 50 Fed. Reg. 11139, March 19, 1985, effective
April 18, 1985; 56 Fed. Reg. 10166, March 11, 1991, effective April 10,
1991; 58 Fed. Reg. 6369, January 28, 1993, effective March 1, 1993; 58
Fed. Reg. 8219, February 12, 1993, effective March 15, 1993; 58 Fed.
Reg. 60103, November 15, 1993; 60 Fed. Reg 39232, August 1, 1995; 63
Fed. Reg. 42678, August 10, 1998, effective October 1, 1998; 66 Fed.
Reg. 59661, November 29, 2001, effective January 1,
2002]
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
§ 325.5(f). Go Back to Text
2 This specific approval must be received in accordance with
§ 325.5(b). In evluating
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'sassets; (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. Go Back to Text
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