[Federal Register Volume 59, Number 248 (Wednesday, December 28, 1994)]
[Unknown Section]
[Page ]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-31729]


[Federal Register: December 28, 1994]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket No. 94-25]
RIN 1557-AB14


Risk-Based Capital Guidelines: Collateralized Transactions

AGENCY: Office of the Comptroller of the Currency, Treasury.

ACTION: Final rule.

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SUMMARY: The Office of the Comptroller of the Currency (OCC) is issuing 
this final rule to amend the risk-based capital guidelines to lower the 
risk weight from 20 percent to zero percent for securities lending, 
repurchase agreement transactions, certain collateralized letters of 
credit, and other collateralized on- and off-balance sheet credit 
exposures. This final rule is needed to ensure that the risk weight 
assigned to transactions collateralized with cash or government 
securities more accurately reflects the minimal operational risk and 
the near absence of credit risk those transactions present. In 
addition, this amendment is intended to eliminate the disparity in the 
risk-based capital treatment of collateralized transactions in 
international markets, enabling national banks to compete more 
effectively with foreign banks, and achieves consistency with the 
capital rules applied to state-chartered banks that are members of the 
Federal Reserve System, and their holding companies.

EFFECTIVE DATE: December 31, 1994.

FOR FURTHER INFORMATION CONTACT: Roger Tufts, Senior Economic Advisor, 
Office of the Chief National Bank Examiner, (202) 874-5070; Tom Rollo, 
National Bank Examiner, Office of the Chief National Bank Examiner, 
(202) 874-5070; Ronald Shimabukuro, Senior Attorney, Legislative and 
Regulatory Activities, (202) 874-4460; or Elizabeth Milor, Financial 
Economist, Economic and Regulatory Policy Analysis (202) 874-5220; 
Office of the Comptroller of the Currency, Washington, DC 20219.

SUPPLEMENTARY INFORMATION:

Background and Purpose

    The OCC adopted its risk-based capital guidelines in 1989 to 
implement the International Convergence of Capital Measurement and 
Capital Standards of July 1988, as reported by the Basle Committee on 
Banking Supervision (Basle Accord). See 54 FR 4168 (January 27, 1989). 
These guidelines, developed in cooperation with the Federal Deposit 
Insurance Corporation (FDIC) and the Federal Reserve Board (FRB), 
provide minimum capital requirements that vary primarily on the basis 
of the credit risk profiles of the assets and off-balance sheet 
activities of banks.
    Under the present OCC risk-based capital guidelines, all 
transactions collateralized by cash or government securities issued by 
OECD\1\ countries are risk weighted at 20 percent.\2\ However, some 
transactions collateralized with cash or near-cash assets expose banks 
to significantly less credit risk than other similar transactions. The 
purpose of this final rule is to amend the risk-based capital 
guidelines to lower the risk weight from 20 percent to zero percent for 
certain collateralized transactions that have little or no credit risk 
and only minimal operational risk. This will have a beneficial effect 
on banks by lowering the required capital on certain low-risk 
transactions.
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    \1\Organization for Economic Cooperation and Development (OECD). 
Under the risk-based capital guidelines, OECD countries include 
countries that are full members of the OECD plus countries that have 
concluded special lending arrangements with the International 
Monetary Fund (IMF) associated with the IMF's General Arrangements 
to Borrow. 12 CFR part 3, appendix A, section 1(c)(16).
    \2\Specifically, 12 CFR part 3, appendix A, section 3(a)(2) 
assigns a 20 percent risk weight for:
    (1) That portion of assets collateralized by the current market 
value of securities issued or guaranteed by the United States 
Government or its agencies, or the central government of an OECD 
country;
    (2) That portion of assets collateralized by the current market 
value of securities issued or guaranteed by United States 
Government-sponsored agencies;
    (3) That portion of assets collateralized by the current market 
value of securities issued by official multilateral lending 
institutions of regional development institutions in which the 
United States is a shareholder or contributing member; and
    (4) Assets collateralized by cash held in a segregated deposit 
account by the reporting national bank.
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Proposal

    The OCC published a notice of proposed rulemaking (NPRM) on August 
18, 1993 (58 FR 43822) soliciting comment on whether to permit certain 
transactions collateralized by cash or OECD government securities to 
qualify for the zero percent risk-weight category. Specifically, the 
OCC proposed that securities lending and repurchase agreement 
transactions, and certain collateralized letters of credit be included 
in the zero percent risk-weight category. After carefully considering 
the comments received, the OCC is issuing this final rule adopting the 
NPRM and including additional collateralized on- and off-balance sheet 
exposures in the zero percent risk-weight category.

Discussion

    In developing the risk-based capital guidelines, the FRB, FDIC and 
OCC (banking agencies) initially proposed assigning transactions 
collateralized by cash or OECD government securities to a 10 percent 
risk-weight category. See 53 FR 8550, 8553 (March 15, 1988). Under the 
Basle Accord, signatory countries have some latitude in assigning risk 
weights to claims collateralized by cash or OECD government securities. 
Specifically, paragraph 39 of the Basle Accord provides:

    In view of the varying practices among banks in different 
countries for taking collateral and different experiences of the 
stability of physical or financial collateral values, it has not 
been found possible to develop a basis for recognising collateral 
generally in the weighting system. The more limited recognition of 
collateral will apply only to loans secured against cash or against 
securities issued by OECD central governments and specified 
multilateral development banks. These will attract the weight given 
to the collateral (i.e. a zero or a low weight).

    When the banking agencies adopted the final risk-based capital 
guidelines, they eliminated the 10 percent risk-weight category in the 
interest of simplicity. See 54 FR 4168 (January 27, 1989). To limit the 
types of claims qualifying for the zero percent risk-weight category, 
the banking agencies assigned claims collateralized by cash and OECD 
central government securities, including securities unconditionally 
guaranteed by the U.S. government, to the lowest non-zero risk weight, 
which is 20 percent. See 54 FR 4173, 4174 (January 27, 1989).

Comments

    The comment period for the NPRM closed on September 17, 1993. 
Twenty-four comments were received. The commenters represented a 
diverse group of banking interests consisting of 14 banks and bank 
holding companies, one banking subsidiary, four bankers' associations 
or trade groups, one federally sponsored agency, and four other 
interested parties. All commenters generally supported reducing both 
the risk weight applied to the transactions included in the NPRM and 
the proposed collateral margin requirement. Most commenters also 
supported extending the zero percent risk weight to a broader range of 
transactions.
    The OCC invited comment on all aspects of the NPRM and posed four 
specific questions. The questions and the responses follow.
    Question 1: Should additional requirements be established to ensure 
that only very low-risk transactions are assigned to the zero percent 
risk-weight category? For example, should the zero percent risk weight 
be available only to institutions that have appropriate management and 
operating systems in place?
    Eleven commenters addressed this question, all indicating that they 
consider additional regulatory requirements unnecessary. Most 
commenters expressed the view that operating systems are best 
supervised through the examination process. One commenter thought that 
new requirements were not needed, because of the new annual audit 
requirement established under the Federal Deposit Insurance Corporation 
Improvement Act of 1991 (FDICIA) (Pub. L. 102-242).
    Question 2: Should the OCC establish a specific minimum positive 
margin required for collateralized transactions to qualify for the zero 
percent risk weight for those credit exposures with market values that 
experience normal volatility? Should the OCC require that national 
banks maintain margins in excess of this minimum for those exposures 
with more volatile market values?
    A number of commenters indicated that the OCC should not establish 
a specific margin requirement under the risk-based capital guidelines. 
Eleven commenters cited the proposed daily mark-to-market and positive 
collateral margin requirements as sufficient for ensuring safety and 
soundness. The majority of these commenters stated that specific 
regulatory requirements could disrupt normal market operations, because 
the collateral margins are negotiated as part of the contract for many 
collateralized transactions. Two commenters stated that the Federal 
Financial Institutions Examination Council (FFIEC) guidelines provide 
adequate guidance for banks participating in the securities lending 
markets.\3\ Four commenters suggested that, instead of establishing a 
collateral margin requirement, the OCC should use pro rata risk 
weighting, assigning only that portion of a transaction that has 
sufficient collateral to the zero percent risk-weight category.
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    \3\These guidelines were issued to national banks by the OCC in 
Banking Circular 196, dated May 7, 1985.
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    Question 3: For some securities lending transactions, banks 
indemnify their clients against losses that could occur if the market 
value of the lent security exceeds that of the collateral provided. 
Should the OCC permit transactions with indemnification agreements that 
cover additional losses to qualify for the zero percent risk weight?
    Four commenters supported excluding from the zero percent risk 
weight those collateralized transactions where a bank indemnifies a 
client against losses other than those arising from collateral 
shortages caused by changes in market values. However, most commenters 
suggested that indemnification agreements that cover additional losses 
should not exclude a collateralized transaction from the zero percent 
risk-weight category. Four commenters supported allowing the zero 
percent risk weight for transactions in which a bank indemnifies its 
client against all losses, if the client continuously maintains a 
positive collateral margin with the bank or its agent, or if a bank 
acts only as agent in a transaction.
    Question 4: At this time, the OCC believes that this proposal would 
apply only to securities lending transactions, repurchase agreements, 
and certain collateralized financial guarantees. The OCC invites 
comment as to whether, in the current market place, there are other 
collateralized transactions that expose banks to minimal risk that have 
contracts structured to meet the collateral requirements of this 
proposal. The OCC is specifically interested in comments concerning (a) 
bank participation in collateralized markets for swap agreements and 
(b) bank issued collateralized letters of credit other than financial 
guarantees.
    Eighteen commenters supported including all transactions 
collateralized with Treasury securities in the zero percent risk-weight 
category. Seven commenters supported including collateralized swap 
agreements, and three commenters supported extending the zero percent 
risk weight to all collateralized letters of credit. One commenter 
suggested that the OCC should assign all affiliate transactions, 
regardless of collateral, to the zero percent risk weight, because such 
transactions expose banks to the same insignificant credit risk as the 
collateralized transactions mentioned in the NPRM.
    In addition to the questions presented in the NPRM, the commenters 
raised other significant issues. Two commenters mentioned that some 
otherwise qualifying collateralized transactions involving foreign 
jurisdictions would not qualify for the zero percent risk weight under 
the NPRM. For example, the NPRM discussed a requirement that a bank 
receiving collateral in the form of OECD government securities must 
have a perfected interest in those securities. If a bank counterparty 
operates in a foreign jurisdiction, these commenters noted that it may 
not be possible to obtain a perfected security interest for that 
transaction.
    Two commenters recommended that transactions collateralized with 
either irrevocable letters of credit or government agency securities 
should be eligible for the zero percent risk-weight category, because 
these types of collateral provide the same degree of protection as 
government securities.
    Twelve commenters urged the OCC to modify the NPRM to parallel that 
of the FRB, in order to maintain parity of capital treatment for 
collateralized transactions.
    After careful consideration of all the comments received, the OCC 
adopts this final rule to permit national banks to assign to the zero 
percent risk-weight category the off-balance sheet transactions 
proposed in the NPRM. These off-balance sheet transactions include 
securities lending and repurchase agreement transactions, 
collateralized letters of credit that serve as financial guarantees, 
and certain collateralized credit exposures arising from off-balance 
sheet transactions. In addition, based on the comments received, the 
final rule allows national banks to include in the zero percent risk-
weight category certain loans and other on-balance sheet credit 
exposures that are collateralized fully by cash or OECD government 
securities.
    To qualify for a zero percent risk weight, the credit exposure must 
satisfy the following criteria:
    (1) The bank's counterparty must maintain a positive collateral 
margin relative to the amount of the bank's exposure to that 
counterparty;
    (2) The collateral either must be cash or securities issued or 
guaranteed by OECD central governments or U.S. government agencies;
    (3) The bank must maintain control over the collateral. Cash 
collateral must be held on deposit by the bank or by a third-party for 
the account of the bank. OECD government securities posted by a 
counterparty must be held by the bank or by a third-party acting on 
behalf of the bank; and
    (4) Where the bank is acting as agent for a customer in a 
transaction involving the lending or sale of securities, and the 
transaction is collateralized by cash or OECD government securities 
delivered to the bank, then (a) any bank indemnification is limited to 
no more than the difference between the market value of the securities 
and the collateral received, and (b) any reinvestment risk associated 
with that collateral is borne by the customer.

Collateral

    Collateralized transactions differ from other types of transactions 
in that the bank's credit exposure is supported by a pledge of 
collateral. The degree of protection afforded by the collateral depends 
on the quality of the collateral and the legal effectiveness of the 
pledge.
    This final rule limits the types of qualifying collateral to cash 
(both domestic and foreign currency) and OECD government securities. 
This limitation preserves the quality of the collateral because both 
cash and OECD government securities are liquid and readily marketable. 
With respect to the legal effectiveness of the pledge of collateral, 
this final rule requires that the bank must maintain control over the 
collateral. This requirement is different from the NPRM. First, this 
final rule does not require a bank to obtain a perfected security 
interest for OECD government securities pledged as collateral. This 
change was made in response to the comment that the perfection of a 
security interest may not be possible in certain transactions involving 
foreign jurisdictions. While the OCC believes that a perfected security 
interest generally should be obtained when possible, the OCC has 
considered this issue and shares the commenter's concern. As a result 
this final rule does not require the bank to obtain a perfected 
security interest in the collateral.
    Second, the OCC believes that safe and sound banking practice 
requires that a bank exercise control over the collateral in order to 
protect the interest of the bank. If the collateral consists of cash, 
then the cash must be held on deposit by the bank or by a third-party 
for the account of the bank. To qualify for a zero percent risk weight, 
a third-party collateral arrangement must adequately insulate the bank 
from the credit exposure, and not introduce other significant risks.
    Similarly, if the collateral consists of OECD government 
securities, then the bank must maintain control of the OECD government 
securities. In some instances, a bank may want to maintain actual 
possession over the OECD government securities. This final rule, 
however, makes clear that a third party, acting on behalf of the bank, 
may hold and administer the collateral for the bank.
    A national bank may assign to the zero percent risk-weight category 
only those credit exposures for which the bank's counterparty maintains 
a positive collateral margin. In addition, if any component of a 
collateralized transaction is denominated in foreign exchange, then 
fluctuations in exchange rates also could result in changes in market 
value. Therefore, to qualify for the zero percent risk-weight category, 
a bank must ensure that its counterparty maintains a positive 
collateral margin with respect to fluctuations in interest rates, 
foreign exchange rates, or other market factors.

Bank Indemnification

    This final rule clarifies an issue raised by the commenters. Where 
a bank is acting as agent for a customer in a securities lending 
transaction, the transaction qualifies for the zero percent risk-weight 
category provided that the bank's indemnification is limited. Under 
this final rule, any indemnification extended by a bank must be limited 
to no more than the difference between the market value of the 
securities lent and the market value of the collateral received, and 
any reinvestment risk associated with the collateral (either cash or 
OECD government securities) must be borne by the customer.

International Comparability of Capital Standards

    In re-examining the capital treatment of transactions 
collateralized with cash and OECD government securities, the OCC noted 
that most foreign supervisors subscribing to the Basle Agreement assign 
the zero percent risk weight to transactions collateralized with cash 
or OECD government securities. Reassigning these transactions to the 
zero percent risk-weight category under U.S. standards eliminates the 
disparate capital treatment.

Effective Date

    Section 302 of the Riegle Community Development and Regulatory 
Improvement Act of 1994 (RCDRIA) (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. Similarly, the Administrative Procedure Act requires a 30-
day delayed effective date, unless the rule either relieves a 
restriction or the agency finds good cause. 5 U.S.C. 553(d)(1) and (3).
    This final rule amend the risk-based capital guidelines to lower 
the risk weight from 20 percent to zero percent for certain 
transactions collateralized with cash or government securities. This 
final rule revises the risk weights to more accurately reflect the 
minimal operational risks of these transactions, corrects the disparity 
in the risk-based capital treatment of collateralized transactions in 
international markets, and provides consistency with the capital rules 
applied to state-chartered banks that are members of the Federal 
Reserve System, and their holding companies. The OCC believes that 
these benefits far outweigh any burden of complying with the 
requirements of this final rule. For these reasons, the OCC determines 
that, pursuant to section 302 of RCDRIA and 5 U.S.C. 553(d)(1) and (3), 
there is sufficient good cause to provide for an effective date of 
December 31, 1994. A year-end effective date allows banks to take 
advantage of this final rule for the first quarter of the new calendar 
year. Delay in implementation of this final rule, to the next calendar 
quarter would be unnecessary and contrary to the public interest 
because compliance would be more difficult and costly, and could 
require additional accounting adjustments and disclosures.

Regulatory Flexibility Act

    Pursuant to section 605(b) of the Regulatory Flexibility Act, it is 
hereby certified that this final rule will not have a significant 
economic impact on a substantial number of small entities. Accordingly, 
a regulatory flexibility analysis is not required.
    This final rule benefits all national banks by assigning to the 
zero percent risk-weight category certain collateralized transactions, 
and by promoting competitive equality with other financial 
institutions. While the exact volume of collateralized transactions is 
unknown, the OCC believes that assigning these types of collateralized 
transactions to the zero percent risk-weight category will not 
significantly impact national banks, regardless of size.

Executive Order 12866

    The OCC has determined that this final rule is not a significant 
regulatory action under Executive Order 12866.

List of Subjects in 12 CFR Part 3

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

Authority and Issuance

    For the reasons set out in the preamble, appendix A of title 12, 
chapter I, part 3 of the Code of Federal Regulations is amended as set 
forth below.

PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES

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

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

    2. In appendix A to part 3, section 3 is amended by adding a new 
paragraph (a)(1)(viii), revising paragraph (a)(2)(iv), removing 
(a)(2)(xii), and redesignating paragraph (a)(2)(xiii) as (a)(2)(xii) to 
read as follows:

Appendix A to Part 3--Risk-Based Capital Guidelines

* * * * *

Section 3.  Risk Categories/Weights for On-Balance Sheet Assets and 
Off-Balance Sheet Items.

* * * * *
    (a) * * *
    (1) * * *
    (viii) That portion of assets and off-balance sheet transactions 
collateralized by cash or securities issued or directly and 
unconditionally guaranteed by the United States Government or its 
agencies, or the central government of an OECD country, provided 
that:9a
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    \9\aAssets and off-balance sheet transactions collateralized by 
securities issued or guaranteed by the United States Government or 
its agencies, or the central government of an OECD country include, 
but are not limited to, securities lending transactions, repurchase 
agreements, collateralized letters of credit, such as reinsurance 
letters of credit, and other similar financial guarantees. Swaps, 
forwards, futures, and options transactions are also eligible, if 
they meet the collateral requirements. However, the OCC may at its 
discretion require that certain collateralized transactions be risk 
weighted at 20 percent if they involve more than minimal risk.
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    (A) The bank maintains control over the collateral:
    (1) If the collateral consists of cash, the cash must be held on 
deposit by the bank or by a third-party for the account of the bank;
    (2) If the collateral consists of OECD government securities, 
then the OECD government securities must be held by the bank or by a 
third-party acting on behalf of the bank;
    (B) The bank maintains a daily positive margin of collateral 
fully taking into account any change in the market value of the 
collateral held as security;
    (C) Where the bank is acting as a customer's agent in a 
transaction involving the loan or sale of securities that is 
collateralized by cash or OECD government securities delivered to 
the bank, any obligation by the bank to indemnify the customer is 
limited to no more than the difference between the market value of 
the securities lent and the market value of the collateral received, 
and any reinvestment risk associated with the collateral is borne by 
the customer; and
    (D) The transaction involves no more than minimal risk.
    (2) * * *
    (iv) That portion of assets collateralized by cash or by 
securities issued or directly and unconditionally guaranteed by the 
United States Government or its agencies, or the central government 
of an OECD country, that does not qualify for the zero percent risk-
weight category.
* * * * *
    Dated: December 21, 1994.
Eugene A. Ludwig,
Comptroller of the Currency.
[FR Doc. 94-31729 Filed 12-27-94; 8:45 am]
BILLING CODE 4810-33-P