[Federal Register Volume 59, Number 235 (Thursday, December 8, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-30156]


  Federal Register / Vol. 59, No. 235 / Thursday, December 8, 1994 /
  
[[Page Unknown]]

[Federal Register: December 8, 1994]


                                                   VOL. 59, NO. 235

                                         Thursday, December 8, 1994

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R-0823]

 

Capital; Capital Adequacy Guidelines

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Board of Governors of the Federal Reserve System is 
amending its risk-based capital guidelines for state member banks and 
bank holding companies. Under this final rule, institutions are 
generally directed to not include in regulatory capital the ``net 
unrealized holding gains (losses) on securities available for sale,'' 
the new common stockholders' equity account created by Statement of 
Financial Accounting Standards Number 115 (FAS 115), Accounting for 
Certain Investments in Debt and Equity Securities. Net unrealized 
losses on marketable equity securities (i.e., equity securities with 
readily determinable fair values), however, will continue to be 
deducted from Tier 1 capital. This rule has the general effect of 
valuing available-for-sale securities at amortized cost (i.e., based on 
historical cost), rather than at fair value (i.e., generally at market 
value), for purposes of calculating the risk-based and leverage capital 
ratios.

EFFECTIVE DATE: December 31, 1994.

FOR FURTHER INFORMATION CONTACT: Rhoger H Pugh, Assistant Director 
(202/728-5883), Norah M. Barger, Manager (202/452-2402), Arleen E. 
Lustig, Supervisory Financial Analyst (202/452-2987), and John M. 
Frech, Supervisory Financial Analyst (202/452-2275), Division of 
Banking Supervision and Regulation, Board of Governors of the Federal 
Reserve System. For the hearing impaired only, Telecommunication Device 
for the Deaf (TDD), Dorothea Thompson (202/452-3544), Board of 
Governors of the Federal Reserve System, 20th and C Streets NW, 
Washington, DC 20551.

SUPPLEMENTARY INFORMATION:

Background

    On December 28, 1993, the Board of Governors issued for public 
comment a proposal to amend its risk-based capital guidelines1 for 
state member banks and bank holding companies to include in Tier 1 
capital the ``net unrealized holding gains and losses on securities 
available for sale'' (58 FR 68563, December 28, 1993). The proposal 
would have had the effect of valuing securities available for sale at 
market value for purposes of calculating the risk-based and leverage 
capital ratios. In its proposal, the Board offered several alternative 
treatments, one of which was to not include such net unrealized gains 
and losses in the calculation of regulatory capital. It is this 
alternative treatment that the Board is adopting as a final rule. The 
comment period ended on January 21, 1994.
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    \1\The Board's risk-based capital guidelines implement, for 
state member banks and bank holding companies, the international 
bank capital standards as set forth in the Basle Accord. The Basle 
Accord is a risk-based capital framework that was proposed by the 
Basle Committee on Banking Regulations and Supervisory Practices and 
endorsed by the central bank governors of the Group of Ten (G-10) 
countries in July 1988. The Committee is comprised of 
representatives of the central banks and supervisory authorities 
from the G-10 countries (Belgium, Canada, France, Germany, Italy, 
Japan, Netherlands, Sweden, Switzerland, the United Kingdom, and the 
United States) and Luxembourg.
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    The proposal was in response to the issuance of FAS 115 on May 31, 
1993, which established ``net unrealized holding gains (losses) on 
securities available for sale'' as a new element of common 
stockholders' equity. All banking organizations were required to adopt 
FAS 115, for both generally accepted accounting principles (GAAP) and 
regulatory reporting purposes, as of January 1, 1994, or the beginning 
of their first fiscal year thereafter, if later. Earlier adoption was 
permitted.
    Since the final capital treatment of such net unrealized gains and 
losses on available-for-sale securities was not in effect by year-end 
1993, the Board directed state member banks and bank holding companies 
to continue calculating the risk-based and leverage capital ratios on a 
pre-FAS 115 basis. Accordingly, the net unrealized holding gains and 
losses on available-for-sale debt securities were not included in 
regulatory capital, and the amortized cost rather than the fair value 
of available-for-sale debt securities generally continued to be used in 
the calculation of both capital ratios. Moreover, equity securities 
with readily determinable fair values continued to be valued at the 
lower of cost or fair value for regulatory capital purposes. Both the 
Federal Deposit Insurance Corporation (FDIC) and the Office of the 
Comptroller of the Currency (OCC) followed this interim capital 
treatment.

FAS 115

    FAS 115 divides securities held by banking organizations among 
three categories: (1) Securities held to maturity; (2) trading account 
securities; and (3) securities available for sale.
    Under FAS 115, trading securities are defined as those securities 
that an institution buys and holds principally for the purpose of 
selling in the near term. As under earlier accounting standards, these 
securities are to be reported at fair value (i.e., generally at market 
value), with net unrealized changes in their value reported directly in 
the income statement as part of an institution's earnings.
    Under FAS 115, securities held to maturity are to be recorded at 
amortized cost. However, FAS 115 states that a banking organization may 
include a security in the held-to-maturity category only if management 
has ``the positive intent and ability to hold the security to 
maturity.''
    Securities meeting the definition of the available-for-sale 
category (i.e., all securities not held for trading that an institution 
cannot justify categorizing as held-to-maturity) are to be reported at 
fair value. Changes in the fair value of securities available for sale 
are to be reported, net of tax effects, directly in a separate 
component of common stockholders' equity. Consequently, any unrealized 
appreciation or depreciation in the value of securities in the 
available-for-sale category has no impact on the reported earnings of 
an institution, but affects its GAAP equity capital position.

Initial Proposal

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

Comments Received

    The Federal Reserve received letters from 59 public commenters. 
Comments were received from 17 multinational and large regional banking 
organizations, 24 community banking organizations, seven foreign banks, 
six banking trade associations, two state banking supervisors, two 
consultants, and one law firm. Twenty-one of the public commenters 
supported the proposal to include ``net unrealized holding gains 
(losses) on securities available for sale,'' in Tier 1 capital, while 
38 opposed the proposal, including all seven foreign banks.
    Public commenters opposed to the proposal included 18 out of the 24 
community banks, 5 out of the 17 multinational and large regional 
banking organizations, all seven foreign banking organizations, three 
banking trade associations, two state banking supervisory 
organizations, two consultants, and one law firm. Some of the common 
reasons cited for opposing the proposal included:
    (1) The additional volatility to capital resulting from marking-to-
market the available-for-sale securities and consequent fluctuations 
for some institutions in their single borrower lender limits;
    (2) The potential for temporary changes in interest rates to have 
an adverse effect on the risk-based and leverage capital ratios that 
would result in a lower prompt corrective action category or higher 
FDIC risk-based insurance premiums;
    (3) The distorting effect of applying market value accounting to 
some items on only one side of the institution's balance sheet, 
particularly since interest rate changes that cause changes in asset 
values often give rise to offsetting changes to the value of the 
deposit base, which existing accounting standards do not recognize; and
    (4) The potential for organizations to become critically 
undercapitalized and subject to closure as a result of temporary 
changes in the market values of securities that the banking 
organization has no intention of selling.
    All seven foreign banks that commented on the proposal opposed the 
inclusion of the net unrealized gains and losses on available-for-sale 
securities in Tier 1 on the grounds that such treatment for the new 
equity account is inconsistent with the Basle Accord. In their view, 
this account is more comparable to securities revaluation reserves, 
which, under the Accord, are substantially discounted and accorded Tier 
2 status, rather than disclosed reserves, which receive an unlimited 
Tier 1 treatment under the Accord.
    Twelve of the 17 multinational and large regional banking 
organizations commented favorably on the proposal, as did three banking 
trade associations. However, five multinational and large regional 
banking organizations opposed the proposal citing concerns similar to 
those given by smaller institutions. The 21 commenters favoring the 
proposal gave two main reasons for their support:
    (1) The proposed Tier 1 treatment of the new account would parallel 
the GAAP equity treatment for unrealized gains and losses and, thus, 
institutions could avoid having to maintain two sets of accounting 
records for available-for-sale securities; and
    (2) Tier 1 treatment would be consistent with the intent of section 
121 of the Federal Deposit Insurance Corporation Improvement Act of 
1991 (FDICIA), which stipulates that regulatory accounting standards be 
no less stringent than GAAP.
    In its proposal, the Board asked for specific comment on six 
issues. Ten public commenters commented on the first issue, which 
concerned the extent to which FAS 115 may permit an institution to sell 
securities from the held-to-maturity account without calling into 
question the institution's intent or ability to continue to hold other 
securities reported in that account. All 10 commenters stated that FAS 
115 provides a specific set of circumstances under which banking 
organizations can sell securities from the held-to-maturity account 
without tainting the remaining securities in that account.
    Seven banking institutions commented on the second issue, which 
concerned requests for examples of isolated, nonrecurring, and unusual 
events involving demands for liquidity that would permit the sale or 
transfer of held-to-maturity securities under FAS 115. The most common 
examples cited were changes in tax law, deterioration in the credit-
worthiness of a security issuer, and natural disasters.
    The third issue concerned alternatives to the proposed Tier 1 
capital treatment. Twenty-three organizations commented on the 
alternatives included in the Board's request for public comment. These 
alternatives included: Excluding all such changes from capital; 
deducting losses from Tier 1 capital, and either not recognizing any 
gains for capital purposes or including them in Tier 2 capital; and 
including both the gains and losses in Tier 2 capital.
    Of the 23 commenters, six were multinational or large regional 
banking organizations that supported the proposal. Generally, these 
organizations did not favor any of the alternatives. However, 13 
commenters, including the seven foreign banks that opposed the 
proposal, stated that they preferred Tier 2 treatment for net 
unrealized gains and losses on available-for sale securities over Tier 
1 treatment. Four commenters preferred not including the net unrealized 
gains and losses on available-for-sale securities in regulatory 
capital.
    The fourth issue concerned the extent to which the above 
alternatives might create an incentive for banking organizations to 
sell securities that have appreciated to realize the gains in Tier 1 
capital, while holding securities that have depreciated to avoid 
reductions in Tier 1 capital. Six commenters offered views on this 
issue. Most of these commenters felt that including unrealized gains 
and losses in regulatory capital would provide some disincentive for 
banks not to pursue such a strategy. Another commenter stated that 
while the exclusion of the net unrealized gains and losses could lead a 
company to selectively sell only securities in which it had a gain, the 
Securities and Exchange Commission (SEC) would question such a 
practice.
    In setting forth the fifth issue, the Board asked commenters to 
suggest the appropriate manner for maintaining an Allocated Transfer 
Risk Reserve (ATRR) for certain foreign debt securities (e.g., ``Brady 
Bonds'') held as securities available for sale. Three multinational 
banking institutions responded to this issue. All three organizations 
stated that the ATRR should not be applied to such foreign securities 
since such securities are reflected on banks' financial statements at 
market value.
    The last issue concerned the importance of maintaining consistent 
application of the Basle capital standards. Fourteen banking 
organizations and associations commented on this issue. Seven 
commenters, all of which were foreign banks, stated that the proposal 
to include the new common equity component in Tier 1 was inconsistent 
with the provisions of the Basle Accord. They stated that Tier 1 
treatment could create competitive inequality with international banks. 
Moreover, they stated that Tier 1 treatment could cause inconsistency 
between the Tier 1 measure applied to U.S. banks and the Tier 1 measure 
applied by other banks regulated by different accounting rules, 
reducing the meaningfulness of the capital adequacy comparisons. 
However, three banking organizations, all of which supported the Tier 1 
proposal, stated that the proposal was consistent with the Basle Accord 
and, therefore, would not reduce the meaningfulness of comparisons.

Final Rule

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

Regulatory Flexibility Act Analysis

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

Paperwork Reduction Act and Regulatory Burden

    The Board has determined that this final rule will not increase the 
regulatory paperwork burden of banking organizations pursuant to the 
provisions of the Paperwork Reduction Act (44 U.S.C. 3501 et seq.).
    Section 302 of the Riegle Community Development and Regulatory 
Improvement Act of 1994 (Pub. L. 103-325, 108 Stat. 2160) provides that 
the federal banking agencies must consider the administrative burdens 
and benefits of any new regulations that impose additional requirements 
on insured depository institutions. Section 302 also requires such a 
rule to take effect on the first day of the calendar quarter following 
final publication of the rule, unless the agency, for good cause, 
determines an earlier effective date is appropriate.
    The new capital rule does not impose any new requirements on 
depository institutions of bank holding companies for purposes of 
calculating their risk-based and leverage capital ratios. The amended 
rule clarifies the capital treatment of a common stockholders' equity 
component, ``net unrealized holding gains (losses) on securities 
available for sale,'' created by FAS 115, but does not change current 
treatment. For these reasons, the Board has determined that an 
effective date of December 31, 1994, is appropriate. For these same 
reasons, in accordance with 5 U.S.C. 553(d)(3), the Board finds there 
is good cause not to follow the 30-day notice requirements of 5 U.S.C. 
553(d) and to make the rule effective on December 31, 1994.

List of Subjects

12 CFR Part 208

    Accounting, Agriculture, Banks, Banking, Confidential business 
information, Crime, Currency, Federal Reserve System, Mortgages, 
Reporting and recordkeeping requirements, Securities.

12 CFR Part 225

    Administrative practice and procedure, Banks, Banking, Federal 
Reserve System, Holding companies, Reporting and recordkeeping 
requirements, Securities.

    For the reasons set forth in the preamble, the Board is amending 12 
CFR parts 208 and 225 as set forth below:

PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL 
RESERVE SYSTEM (REGULATION H)

    1. The authority citation for part 208 is revised to read as 
follows:

    Authority: 12 U.S.C. 36, 248(a), 248(c), 321-338a, 371d, 461, 
481-486, 601, 611, 1814, 1823(j), 1828(o), 1831o, 1831p-1, 3105, 
3310, 3331-3351 and 3906-3909; 15 U.S.C. 78b, 78l(b), 78l(g), 
78l(i), 78o-4(c)(5), 78q, 78q-1 and 78w; 31 U.S.C. 5318.

    2. Appendix A to part 208 is amended by revising sections II.A.1.a. 
and II.A.2.f to read as follows:

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

* * * * *
    II. * * *
    A. * * *
    1. * * *
    a. Common stockholders' equity. For purposes of calculating the 
risk-based capital ratio, common stockholders' equity is limited to 
common stock; related surplus; and retained earnings, including 
capital reserves and adjustments for the cumulative effect of 
foreign currency translation, net of any treasury stock; less net 
unrealized holding losses on available-for-sale equity securities 
with readily determinable fair values. For this purpose, net 
unrealized holding gains on such equity securities and net 
unrealized holding gains (losses) on available-for-sale debt 
securities are not included in common stockholders' equity.
* * * * *
    2. * * *
    f. Revaluation reserves. i. Such reserves reflect the formal 
balance sheet restatement or revaluation for capital purposes of 
asset carrying values to reflect current market values. The federal 
banking agencies generally have not included unrealized asset 
appreciation in capital ratio calculations, although they have long 
taken such values into account as a separate factor in assessing the 
overall financial strength of a bank.
    ii. Consistent with long-standing supervisory practice, the 
excess of market values over book values for assets held by state 
member banks will generally not be recognized in supplementary 
capital or in the calculation of the risk-based capital ratio. 
However, all banks are encouraged to disclose their equivalent of 
premises (building) and security revaluation reserves. The Federal 
Reserve will consider any appreciation, as well as any depreciation, 
in specific asset values as additional considerations in assessing 
overall capital strength and financial condition.
* * * * *

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

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

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

    2. Appendix A to part 225 is amended by revising sections II.A.1.a. 
and II.A.2.f to read as follows:

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

* * * * *
    II. * * *
    A. * * *
    1. * * *
    a. Common stockholders' equity. For purposes of calculating the 
risk-based capital ratio, common stockholders' equity is limited to 
common stock; related surplus; and retained earnings, including 
capital reserves and adjustments for the cumulative effect of 
foreign currency translation, net of any treasury stock; less net 
unrealized holding losses on available-for-sale equity securities 
with readily determinable fair values. For this purpose, net 
unrealized holding gains on such equity securities and net 
unrealized holding gains (losses) on available-for-sale debt 
securities are not included in common stockholders' equity.
* * * * *
    2. * * *
    f. Revaluation reserves. i. Such reserves reflect the formal 
balance sheet restatement or revaluation for capital purposes of 
asset carrying values to reflect current market values. The Federal 
Reserve generally has not included unrealized asset appreciation in 
capital ratio calculations, although it has long taken such values 
into account as a separate factor in assessing the overall financial 
strength of a banking organization.
    ii. Consistent with long-standing supervisory practice, the 
excess of market values over book values for assets held by bank 
holding companies will generally not be recognized in supplementary 
capital or in the calculation of the risk-based capital ratio. 
However, all bank holding companies are encouraged to disclose their 
equivalent of premises (building) and security revaluation reserves. 
The Federal Reserve will consider any appreciation, as well as any 
depreciation, in specific asset values as additional considerations 
in assessing overall capital strength and financial condition.
* * * * *
Board of Governors of the Federal Reserve System, December 2, 1994.
Barbara R. Lowrey,
Associate Secretary of the Board.
[FR Doc. 94-30156; Filed 12-7-94; 8:45 am]
BILLING CODE 6210-01-P