[Federal Register Volume 59, Number 240 (Thursday, December 15, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-30771]


[[Page Unknown]]

[Federal Register: December 15, 1994]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket No. 94-22]
RIN 1557-AB14

FEDERAL RESERVE SYSTEM

12 CFR Part 208

[Regulation H; Docket No. R-0764]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325

RIN 3064-AB15

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 567

[No. 94-152]
RIN 1550-AA59

 

Risk-Based Capital Standards; Concentration of Credit Risk and 
Risks of Nontraditional Activities

AGENCIES: Office of the Comptroller of the Currency (OCC), Treasury; 
Board of Governors of the Federal Reserve System (Board); Federal 
Deposit Insurance Corporation (FDIC); and Office of Thrift Supervision 
(OTS), Treasury.

ACTION: Final rule.

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

EFFECTIVE DATE: January 17, 1995.

FOR FURTHER INFORMATION CONTACT: OCC: For issues relating to 
concentration of credit risk and the risks of nontraditional 
activities, Roger Tufts, Senior Economic Advisor (202/874-5070), Office 
of the Chief National Bank Examiner. For legal issues, Ronald 
Shimabukuro, Senior Attorney, Bank Operations and Assets Division (202/
874-4460), Office of the Comptroller of the Currency, 250 E Street, 
S.W., Washington, DC 20219.
    Board: For issues related to concentration of credit risk, David 
Wright, Supervisory Financial Analyst, (202/728-5854) and for issues 
related to the risks of nontraditional activities, William Treacy, 
Supervisory Financial Analyst, (202/452-3859), Division of Banking 
Supervision and Regulation; Scott G. Alvarez, Associate General Counsel 
(202/452-3583), Gregory A. Baer, Managing Senior Counsel (202/452-
3236), Legal Division, Board of Governors of the Federal Reserve 
System. For the hearing impaired only, Telecommunication Device for the 
Deaf (TDD), Dorothea Thompson (202/452-3544), Board of Governors of the 
Federal Reserve System, 20th and C Streets, NW., Washington, DC 20551.
    FDIC: Daniel M. Gautsch, Examination Specialist (202/898-6912), 
Stephen G. Pfeifer, Examination Specialist (202/898-8904), Division of 
Supervision, or Fred S. Carns, Chief, Financial Markets Section, 
Division of Research and Statistics (202/898-3930). For legal issues, 
Pamela E. F. LeCren, Senior Counsel (202/898-3730) or Claude A. Rollin, 
Senior Counsel (202/898-3985), Legal Division, Federal Deposit 
Insurance Corporation, 550 17th Street, NW., Washington, DC 20429.
    OTS: John Connolly, Senior Program Manager, Capital Policy (202) 
906-6465; Dorene Rosenthal, Senior Attorney, Regulations, Legislation 
and Opinions Division (202) 906-7268, Office of Thrift Supervision, 
1700 G Street, NW., Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

I. Background

    The risk-based capital standards adopted by the agencies tailor an 
institution's minimum capital requirement to broad categories of credit 
risk embodied in its assets and off-balance-sheet instruments. These 
standards require institutions to have total capital equal to at least 
8 percent of their risk-weighted assets.1 Institutions with high 
or inordinate levels of risk are expected to operate above minimum 
capital standards. Currently, each agency addresses capital adequacy 
through a variety of supervisory actions and considers the risks of 
credit concentrations and nontraditional activities in taking those 
varied supervisory actions.
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    \1\As defined, risk-weighted assets include credit exposures 
contained in off-balance-sheet instruments.
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    Section 305(b) of FDICIA, Pub. L. 102-242 (12 U.S.C. 1828 note), 
requires the agencies to revise their risk-based capital standards for 
insured depository institutions to ensure that those standards take 
adequate account of interest rate risk, concentration of credit risk 
and the risks of nontraditional activities. This final rule addresses 
concentration of credit risk and the risks of nontraditional 
activities. The agencies are addressing interest rate risk through 
separate rulemakings. See OCC, Board and FDIC joint notice of proposed 
rulemaking, 58 FR 48206 (September 14, 1993) and OTS final rulemaking, 
58 FR 45799 (August 31, 1993). In addition, the agencies issued 
separate final rules to implement the section 305 requirement that 
risk-based capital standards reflect the actual performance and 
expected risk of loss of multifamily mortgages.
    For the risks related to concentration of credit and nontraditional 
activities, the agencies published a joint notice of proposed 
rulemaking on February 22, 1994. See 59 FR 8420. The agencies received 
54 comments, including duplicate comments among the agencies. A 
description of the joint proposed rule along with a discussion of the 
comments follows.

II. Concentration of Credit Risk

A. Proposed Approach

    In the joint proposed rule, the agencies stated that it was not 
currently feasible to quantify the risk related to concentrations of 
credit for use in a formula-based capital calculation. Although most 
institutions can identify and track large concentrations of credit risk 
by individual or related groups of borrowers, and some can identify 
concentrations by industry, geographic area, country, loan type or 
other relevant factors, there is no generally accepted approach to 
identifying and quantifying the magnitude of risk associated with 
concentrations of credit. In particular, definitions and analyses of 
concentrations are not uniform within the industry and are based in 
part on the subjective judgments of each institution using its 
experience and knowledge of its specific borrowers, market areas and 
products.
    Nonetheless, techniques do exist to identify broad classes of 
concentrations and to recognize significant exposures. The effective 
tracking and management of such risk is important to ensuring the 
safety and soundness of financial institutions. Institutions with 
significant concentrations of credit risk require capital above the 
regulatory minimums. As new developments in identifying and measuring 
concentration of credit risk emerge, the agencies will consider 
potential refinements to the risk-based capital standards.
    Accordingly, the agencies proposed to take account of concentration 
of credit risk in their risk-based capital guidelines or regulations by 
amending the standards to explicitly cite concentrations of credit risk 
and an institution's ability to monitor and control them as important 
factors in assessing an institution's overall capital adequacy. The 
joint proposed rule contemplated that in addition to reviewing 
concentrations of credit risk pursuant to section 305, the agencies 
also may review an institution's management of concentrations of credit 
risk for adequacy and consistency with safety and soundness standards 
regarding internal controls, credit underwriting or other relevant 
operational and managerial areas to be promulgated pursuant to section 
132 of FDICIA.

B. Comments

    The vast majority of commenters supported the agencies' decision 
not to propose any quantitative formula or standard. Many commenters, 
however, expressed a general concern as to how the agencies would 
implement and interpret the joint proposed rule. Commenters noted with 
approval the agencies' observation that rulemaking in this area could 
inadvertently create false incentives or unintended consequences that 
might decrease the safety and soundness of the banking and thrift 
industries or unnecessarily reduce the availability of credit to 
potential borrowers. Several commenters, particularly smaller banks, 
agreed with the agencies that, while portfolio diversification is a 
desirable goal, it may also increase an institution's overall risk if 
accomplished by lending in unfamiliar market areas to out-of-territory 
borrowers or by rapid expansion of new loan products for which the 
institution does not have adequate expertise.
    A significant number of commenters went further, however, 
suggesting that any requirement for institutions to hold additional 
capital for significant concentrations of credit risk, including the 
case-by-case approach proposed by the agencies, would hurt small banks 
with limited portfolios and would encourage unhealthy diversification. 
Under the ``Qualified Thrift Lender'' test, for example, thrifts must 
hold 65 percent of their assets in qualifying categories. This 
requirement necessarily ``concentrates'' a thrift's portfolio in 
certain types of assets. Agricultural banks described their position as 
similar, and therefore opposed any requirement of additional capital in 
order to compensate for exposures to concentrations of credit.
    One commenter felt that the potential risk of loss from 
concentrations of credit should be reflected in the allowance for loan 
and lease losses (ALLL). As described in the December 21, 1993 
Interagency Policy Statement regarding the ALLL, the current amount of 
the loan and lease portfolio that is not likely to be collected should 
be reflected in the ALLL. In making a determination as to the 
appropriate level for the ALLL, the policy statement identifies 
concentrations of credit risk as one of several factors to be taken 
into account by an institution. While both the ALLL and capital serve 
as a cushion against losses, the difference between the ALLL and 
capital is that the ALLL should be maintained at a level that is 
adequate to absorb estimated losses, while capital is meant to provide 
an additional cushion for unexpected future losses. Because the 
magnitude and timing of losses from concentrations are hard to predict 
and therefore come unexpectedly, institutions with significant levels 
of concentrations of credit risk should hold capital above the 
regulatory minimums. At the same time, institutions with concentrations 
of credit that are experiencing a deterioration in credit quality and 
collectability should reflect the increased risk in those 
concentrations in the ALLL. Any identifiable loan and lease losses 
should be recognized immediately by reducing the asset's value and the 
ALLL.

C. Final Rules

    After careful consideration of all the comments, the agencies have 
decided to adopt the proposed rules on concentration of credit risk 
without modification. The agencies believe that there is not currently 
an acceptable method to add a quantitative formula to the risk-based 
capital standards in order to measure concentration of credit risk. 
However, the agencies also believe that institutions identified through 
the examination process as having significant exposure to concentration 
of credit risk or as not adequately managing concentration risk, should 
hold capital in excess of the regulatory minimums.
    The agencies have reached this conclusion for two reasons. First, 
although the agencies recognize that in some cases concentrations of 
credit are inevitable, they nonetheless can pose important risks. Other 
things being equal, an institution that is not diversified faces risks 
that a diversified institution does not, and accordingly presents risks 
to the deposit insurance fund that a diversified institution does not. 
Second, Congress in section 305 of FDICIA clearly mandated that these 
risks be taken into account in determining an institution's capital 
adequacy. OTS, however, does not believe it is appropriate to, and will 
not, implement section 305 in a way that penalizes thrift institutions 
for complying with the statutory Qualified Thrift Lender test. In 
addition, the agencies are not encouraging out-of-territory lending as 
a response to diversification concerns.

III. Risks of Nontraditional Activities

A. Proposed Approach

    The agencies proposed to take account of the risks posed by 
nontraditional activities by ensuring that, as members of the industry 
began to engage in, or significantly expand their participation in, a 
nontraditional activity, the risks of that activity would be promptly 
analyzed and the activity given appropriate capital treatment. The 
agencies also proposed to amend their risk-based capital standards to 
explicitly cite the risks arising from nontraditional activities, and 
management's ability to monitor and control these risks, as important 
factors to consider in assessing an institution's overall capital 
adequacy.
    New developments in technology and financial markets have 
introduced significant changes to the banking industry, and in some 
cases have led institutions to engage in activities not traditionally 
considered part of their business. Both in the risk-based capital 
regulations and guidelines adopted by the agencies in 1989 and in 
subsequent revisions and interpretations, the agencies have adopted 
measures to take adequate account of the risks of nontraditional 
activities under the risk-based capital standards. For example, the 
FRB, FDIC and the OCC have recently published for comment a proposal to 
change the way that the counterparty credit risks are measured and 
incorporated into a risk-based capital ratio for equity index, 
commodity, and precious metals off-balance sheet instruments. These 
proposed changes were unique for each of the distinct products. The OTS 
intends to issue a parallel proposal in the near future. As 
nontraditional activities develop in the future, the agencies will 
address each activity on a case-by-case basis. Thus, to the extent that 
section 305 constitutes a mandate to the agencies to make certain that 
risk-based capital standards are kept current with industry practices, 
the agencies have been acting consistently with the intent of section 
305.

B. Comments and Final Rules

    While most comments focused on concentration of credit risk rather 
than nontraditional activities, some commenters noted their approval of 
the agencies' approach with regard to both parts of the rulemaking. 
Only a few commenters criticized the agencies' proposal on 
nontraditional activities, expressing concern that the agencies' 
proposals were too vague for examiners to apply or that the proposals 
were too inflexible.
    After careful consideration of all the comments, the agencies are 
adopting the joint proposed rule on nontraditional activities without 
modification. The agencies believe that this final rule appropriately 
recognizes that the effect of a nontraditional activity on an 
institution's capital adequacy depends on the activity, the profile of 
the institution, and the institution's ability to monitor and control 
the risks arising from that activity. The agencies will continue their 
efforts to incorporate nontraditional activities into risk-based 
capital. In addition, to the extent appropriate, the agencies will 
issue examination guidelines on new developments in nontraditional 
activities or concentrations of credit to ensure that adequate account 
is taken of the risks of these activities.

IV. Paperwork Reduction Act

    No collections of information pursuant to section 3504(h) of the 
Paperwork Reduction Act (44 U.S.C. 3501 et seq.) are contained in this 
final rule. Consequently, no information has been submitted to the 
Office of Management and Budget for review.

V. Regulatory Flexibility Act Statement

    Each agency hereby certifies pursuant to section 605b of the 
Regulatory Flexibility Act (5 U.S.C. 605(b)) that the final rule will 
not have a significant economic impact on a substantial number of small 
entities within the meaning of the Regulatory Flexibility Act (5 U.S.C. 
601 et seq.). This final rule does not necessitate the development of 
sophisticated recordkeeping or reporting systems by small institutions; 
nor will small institutions need to seek out the expertise of 
specialized accountants, lawyers, or managers in order to comply with 
the regulation.

VI. Executive Order 12866

    The OCC and OTS have determined that this final rule does not 
constitute ``significant regulatory action'' for purposes of Executive 
Order 12866.

List of Subjects

12 CFR Part 3

    Administrative practice and procedure, Capital risk, National 
banks, Reporting and recordkeeping requirements.

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 325

    Bank deposit insurance, Banks, Banking, Capital adequacy, Reporting 
and recordkeeping requirements, Savings associations, State nonmember 
banks.

12 CFR Part 567

    Capital, Reporting and recordkeeping requirements, Savings 
associations.

Authority and Issuance

OFFICE OF THE COMPTROLLER OF THE CURRENCY

12 CFR Chapter I

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

PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES

    1. The authority citation for part 3 is revised to read as follows:

    Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n 
note, 3907 and 3909.

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


Sec. 3.10  Applicability.

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

    Dated: November 18, 1994.
Eugene A. Ludwig,
Comptroller of the Currency.

FEDERAL RESERVE SYSTEM

12 CFR Chapter II

    For the reasons set forth in the joint preamble, 12 CFR Part 208 is 
amended 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 continues to read as 
follows:

    Authority: 12 U.S.C. 36, 248(a), 248(c), 321-338a, 371d, 461, 
481-486, 601, 611, 1814, 1823(j), 1828(o), 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 the fifth and 
sixth paragraphs under ``I. Overview'' to read as follows:

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

I. Overview

* * * * *
    The risk-based capital ratio focuses principally on broad 
categories of credit risk, although the framework for assigning 
assets and off-balance-sheet items to risk categories does 
incorporate elements of transfer risk, as well as limited instances 
of interest rate and market risk. The framework incorporates risks 
arising from traditional banking activities as well as risks arising 
from nontraditional activities. The risk-based ratio does not, 
however, incorporate other factors that can affect an institution's 
financial condition. These factors include overall interest-rate 
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 risks presented 
by concentrations of credit and nontraditional activities.
    In addition to evaluating capital ratios, an overall assessment 
of capital adequacy must take account of those factors, including, 
in particular, the level and severity of problem and classified 
assets. For this reason, the final supervisory judgement on a bank's 
capital adequacy may differ significantly from conclusions that 
might be drawn solely from the level of its risk-based capital 
ratio.
* * * * *
    By order of the Board of Governors of the Federal Reserve 
System, December 9, 1994.
Barbara R. Lowrey,
Associate Secretary of the Board.

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Chapter III

    For the reasons set forth in the joint preamble, 12 CFR Part 325 is 
amended as follows:

PART 325--CAPITAL MAINTENANCE

    1. The authority citation for part 325 is revised to read as 
follows:

    Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b), 
1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n), 
1828(o), 1828 note, 1831n note, 1831o, 3907, 3909.


Sec. 325.3  [Amended]

    2. Section 325.3(a) is amended in the fourth sentence by adding 
``significant risks from concentrations of credit or nontraditional 
activities,'' immediately after ``funding risks,'' and by adding ``will 
take these other factors into account in analyzing the bank's capital 
adequacy and'' immediately after `FDIC'' and before ``may''.
    3. The fifth paragraph of the introductory text of Appendix A to 
Part 325 is revised to read as follows:

Appendix A to Part 325--Statement of Policy on Risk-Based Capital

* * * * *
    The risk-based capital ratio focuses principally on broad 
categories of credit risk; however, the ratio does not take account 
of many other factors that can affect a bank's financial condition. 
These factors include overall interest 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. 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.
* * * * *
    By order of the Board of Directors.

    Dated at Washington, DC, this 9th day of August 1994.

Federal Deposit Insurance Corporation.
Robert E. Feldman,
Acting Executive Secretary.

OFFICE OF THRIFT SUPERVISION

12 CFR Chapter V

    For the reasons set forth in the joint preamble, 12 CFR Part 567 is 
amended as follows:

SUBCHAPTER D--REGULATIONS APPLICABLE TO ALL SAVINGS ASSOCIATIONS

PART 567--CAPITAL

    1. The authority citation for part 567 continues to read as 
follows:

    Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1467a, 1828 
(note).

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


Sec. 567.3  Individual minimum capital requirements.

* * * * *
    (b) * * *
    (3) A savings association that has a high degree of exposure to 
interest rate risk, prepayment risk, credit risk, concentration of 
credit risk, certain risks arising from nontraditional activities, or 
similar risks; or a high proportion of off-balance sheet risk, 
especially standby letters of credit;
* * * * *
    (9) A savings association that has a record of operational losses 
that exceeds the average of other, similarly situated savings 
associations; has management deficiencies, including failure to 
adequately monitor and control financial and operating risks, 
particularly the risks presented by concentrations of credit and 
nontraditional activities; or has a poor record of supervisory 
compliance.
* * * * *
    Dated: August 12, 1994.

    By the Office of Thrift Supervision.
Jonathan L. Fiechter,
Acting Director.
[FR Doc. 94-30771 Filed 12-14-94; 8:45 am]
BILLING CODES: OCC 4810-33-P; Board 6210-01-P; FDIC 6714-01-P; OTS 
6720-01-P