[Federal Register Volume 60, Number 9 (Friday, January 13, 1995)]
[Notices]
[Pages 3227-3235]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-900]



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FEDERAL RESERVE SYSTEM


Report to Congressional Committees Regarding Differences in 
Capital and Accounting Standards Among the Federal Banking and Thrift 
Agencies

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice.

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SUMMARY: This report to the Committee on Banking, Housing, and Urban 
Affairs of the United States Senate and to the Committee on Banking, 
Finance and Urban Affairs of the United States House of Representatives 
has been prepared by the Federal Reserve Board pursuant to section 121 
of the Federal Deposit Insurance Corporation Improvement Act of 1991. 
Section 121 requires each Federal banking and thrift agency to report 
annually to the above specified Congressional Committees regarding any 
differences between the accounting or capital standards used by such 
agency and the accounting or capital standards used by other banking 
and thrift agencies. The report must also contain an explanation of the 
reasons for any discrepancy in such accounting or capital standards.

FOR FURTHER INFORMATION CONTACT: Rhoger H Pugh, Assistant Director 
(202)/728-5883), Norah M. Barger, Manager (202/452-2402), Gerald A. 
Edwards, Jr., Assistant Director (202/452-2741), Robert Motyka, 
Supervisory Financial Analyst (202/452-3621), Nancy J. Rawlings, Senior 
Financial Analyst (202/452-3059), 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 & C Street, N.W., Washington, D.C. 20551.

Introduction and Overview

    This is the fifth annual report1 on the differences in capital 
standards and accounting practices that currently exist among the three 
banking agencies (the Board of Governors of the Federal Reserve System 
(FRB), the Office of the Comptroller of the Currency (OCC), and the 
Federal Deposit Insurance Corporation (FDIC)) and the Office of Thrift 
Supervision (OTS).2 Section One of the report focuses on 
differences in the agencies' capital standards; Section Two discusses 
differences in accounting standards. The remainder of this introduction 
provides an overview of the discussion contained in these sections.

    \1\The first two reports prepared by the Federal Reserve Board 
were made pursuant to section 1215 of the Financial Institutions 
Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The third 
and fourth reports were made pursuant to section 121 of the Federal 
Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), 
which superseded section 1215 of FIRREA.
    \2\At the federal level, the Federal Reserve System has primary 
supervisory responsibility for state-chartered banks that are 
members of the Federal Reserve System as well as all bank holding 
companies. The FDIC has primary responsibility for state nonmember 
banks and FDIC-supervised savings banks. National banks are 
supervised by the OCC. The OTS has primary responsibility for 
savings and loan associations.
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Capital Standards

    As stated in the previous reports to the Congress, the three bank 
regulatory agencies have, for a number of years, employed a common 
regulatory framework that establishes minimum capital adequacy ratios 
for commercial banking organizations. In 1989, all three banking 
agencies and the OTS adopted a risk-based capital framework that was 
based upon the international capital accord (Basle Accord) developed by 
the Basle Committee on Banking Regulations and Supervisory Practices 
(referred to as the Basle Supervisors' Committee) and endorsed by the 
central bank governors of the G-10 countries.
    The risk-based capital framework establishes minimum ratios of 
total and [[Page 3228]] Tier 1 (core) capital to risk-weighted assets. 
The Basle Accord requires banking organizations to have total capital 
equal to at least 8 percent, and Tier 1 capital equal to at least 4 
percent, of risk-weighted assets after a phase-in period that ended on 
December 31, 1992. Tier 1 capital is principally comprised of common 
shareholders' equity and qualifying perpetual preferred stock, less 
disallowed intangibles, such as goodwill. The other component of total 
capital, Tier 2, may include certain supplementary capital items, such 
as general loan loss reserves and subordinated debt. The risk-based 
capital requirements are viewed by the three banking agencies and the 
OTS as minimum standards, and most institutions are expected to, and 
generally do, maintain capital levels well above the minimums.
    In addition to specifying identical ratios, the risk-based capital 
framework implemented by the three banking agencies includes a common 
definition of regulatory capital and a uniform system of risk weights 
and categories. While the minimum standards and risk weighting 
framework are common to all the banking agencies, there are some 
technical differences in language and interpretation among the 
agencies. The OTS employs a similar risk-based capital framework, 
although it differs in some respects from that adopted by the three 
banking agencies. These differences, as well as other technical 
differences in the agencies' capital standards, are discussed in 
Section One of this report.
    In addition to the risk-based capital requirements, the agencies 
also have established leverage standards setting forth minimum ratios 
of capital to total assets. As discussed in Section One, the three 
banking agencies employ uniform leverage standards, while the OTS has 
established, pursuant to FIRREA, somewhat different standards.
    The staffs of the agencies meet regularly to identify and address 
differences and inconsistencies in their capital standards. The 
agencies are committed to continuing this process in an effort to 
achieve full uniformity in their capital standards. In this regard, 
Section One contains discussions of the banking agencies' efforts 
during the past year to achieve uniformity with respect to the capital 
treatment of the sale of assets with recourse, implementation of 
proposed amendments made by the Basle Supervisors' Committee to the 
Basle Accord, and the capital treatment of assets to address recent 
accounting changes issued by the Financial Accounting Standards Board 
(FASB).
    In addition, the agencies have continued to coordinate efforts in 
revising the risk-based capital requirements as required by provisions 
of section 305 of FDICIA to take into account interest rate risk and 
risks arising from concentrations of credit and nontraditional 
activities. With regard to interest rate risk, the agencies, on the 
basis of public comments received, are considering a revision to their 
notice of proposed rulemaking issued on September 14, 1993, that is 
expected to be issued sometime in the near future. With regard to the 
risks arising from concentrations of credit and nontraditional 
activities, in 1994 the Federal Reserve, FDIC, and OTS approved uniform 
final rules. These rules will become effective once the OCC's final 
rule has been approved, as it is expected to be in the near future.
    During 1994, one difference between the risk-based capital 
guidelines of the three banking agencies and the OTS was eliminated. 
The difference concerned the treatment of multifamily mortgages. The 
three banking agencies had placed such mortgages in the 100 percent 
risk category, while the OTS had permitted a 50 percent risk weight for 
multifamily mortgage loans secured by buildings with 5-36 units with at 
least an 80 percent loan-to-value ratio and 80 percent occupancy rate. 
Late last year and early this year, the three banking agencies and OTS 
adopted uniform amendments to their rules to implement section 618(b) 
of the Resolution Trust Corporation Refinancing, Restructuring, and 
Improvement Act of 1991. This Act mandated the lowering under the risk-
based capital framework of the risk category for multifamily loans 
meeting certain criteria to 50 percent.

Accounting Standards

    Over the years, the three banking agencies, under the auspices of 
the Federal Financial Institutions Examination Council (FFIEC), have 
developed Uniform Reports of Condition and Income (Call Reports) for 
all commercial banks and FDIC-supervised savings banks. The reporting 
standards followed by the three banking agencies are substantially 
consistent, aside from a few limited exceptions, with generally 
accepted accounting principles (GAAP) as they are applied by commercial 
banks.3 The uniform bank Call Report serves as the basis for 
calculating risk-based capital and leverage ratios, as well as for 
other regulatory purposes. Thus, material differences in regulatory 
accounting and reporting standards among commercial banks and FDIC-
supervised savings banks do not exist.

    \3\In those cases where bank Call Report standards are different 
from GAAP, the regulatory reporting requirements are intended to be 
more conservative than GAAP.
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    The OTS requires each thrift institution to file the Thrift 
Financial Report (TFR), which is generally consistent with GAAP. The 
TFR differs in some respects from the bank Call Report in that, as 
previously mentioned, there are a few areas in which the bank Call 
Report departs from GAAP. A summary of the differences between the bank 
Call Report and the TFR is presented in Section Two.
    As in the past, the agencies are continuing interagency efforts to 
reduce paperwork and regulatory burdens. The Federal Reserve has taken 
a leadership role in coordinating these efforts in developing 
supervisory guidance to further improve regulatory reporting 
requirements. For example, during 1994 Federal Reserve and FASB 
officials have met to discuss major accounting issues affecting the 
banking industry, as well as the remaining few differences between GAAP 
and regulatory reporting standards. The agencies are also working on 
projects that are intended to refine and improve policies and address 
the few reporting differences that currently exist between the banking 
agencies and the OTS. On December 21, 1993, the three banking agencies 
and the OTS, under the auspices of the FFIEC, issued an interagency 
policy statement on the allowance for loan and lease losses (ALLL). The 
policy statement, which was developed on an interagency basis to 
provide comprehensive guidance on the ALLL, is consistent with GAAP. 
The agencies are also coordinating actions to reduce the possibility 
that new differences in accounting and reporting policies may arise. In 
this regard, the agencies recently adopted the same regulatory 
reporting requirements for FAS 114, a new accounting standard covering 
loan impairment that becomes effective in 1995.

Section One

Differences in Capital Standards Among Federal Banking and Thrift 
Supervisory Agencies

Overview

Leverage Capital Ratios

    The three banking agencies employ a leverage standard based upon 
the common definition of Tier 1 capital contained in their risk-based 
capital guidelines. These standards, established in the second half of 
1990 and in early 1991, require the most highly-rated 
[[Page 3229]] institutions to meet a minimum Tier 1 capital ratio of 3 
percent. For all other institutions, these standards generally require 
an additional cushion of at least 100 to 200 basis points, i.e., a 
minimum leverage ratio of at least 4 to 5 percent, depending upon an 
organization's financial condition.
    As required by FIRREA, the OTS has established a 3 percent core 
capital ratio and a 1.5 percent tangible capital leverage requirement 
for thrift institutions. However, the OTS has not yet finalized a new 
leverage rule, which has been under consideration for some time. This 
leverage rule is intended to conform to the leverage rules of the three 
banking agencies. The differences that will exist after the OTS has 
adopted its new standard pertain to the definition of core capital. 
While this definition generally conforms to Tier 1 bank capital, 
certain adjustments discussed in this report apply to the core capital 
definition used by savings associations. In addition, core capital as 
currently defined by the OTS includes qualifying supervisory goodwill. 
By the end of 1994, such goodwill will be phased out of thrift core 
capital. Therefore, beginning with the first quarter of 1995, the 
treatment of goodwill for thrift institutions will be consistent with 
that of the banking agencies.

Risk-Based Capital Ratios

    The three banking agencies have adopted risk-based capital 
standards consistent with the Basle Accord. These standards, which were 
fully phased in at the end of 1992, require all commercial banking 
organizations to maintain a minimum ratio of total capital (Tier 1 plus 
Tier 2) to risk-weighted assets of 8 percent. Tier 1 capital includes 
common stock and surplus, retained earnings, qualifying perpetual 
preferred stock and surplus, and minority interests in consolidated 
subsidiaries, less goodwill. Tier 1 capital must comprise at least 50 
percent of the total risk-based capital requirement. Tier 2 capital 
includes such components as general loan loss reserves, subordinated 
term debt, and certain other preferred stock and convertible debt 
capital instruments, subject to appropriate limitations and conditions. 
Risk-weighted assets are calculated by assigning risk weights of 0, 20, 
50, and 100 percent to broad categories of assets and off-balance sheet 
items based upon their relative credit risks. The OTS has adopted a 
risk-based capital standard that in most respects is similar to the 
framework adopted by the banking agencies.
    All the banking agencies view the risk-based capital standard as a 
minimum supervisory benchmark. In part, this is because the risk-based 
capital standard focuses primarily on credit risk; it does not take 
full or explicit account of certain other banking risks, such as 
exposure to changes in interest rates. The full range of risks to which 
depository institutions are exposed are reviewed and evaluated 
carefully during on-site examinations. In view of these risks, most 
banking organizations are expected to operate with capital levels well 
above the minimum risk-based and leverage capital requirements.

Efforts to Incorporate Non-Credit Risks

    The Federal Reserve has for some time been working with the other 
U.S. banking agencies and the regulatory authorities on the Basle 
Supervisors' Committee to develop possible methods to measure and 
address certain market and price risks. In April, 1993, the Basle 
Supervisors' Committee issued a consultative paper that addresses, 
among other items, proposals to include certain risks into the 
framework of the Basle Accord. These include interest rate risk arising 
from imbalances between the maturity of debt instruments held as assets 
and issued as liabilities and market risk associated with holdings of 
traded debt and equity securities. One important reason for addressing 
these risks on an international level is to develop supervisory 
approaches that do not undermine the competitiveness of U.S. banking 
organizations.
    Aside from this initial international effort, the OTS capital 
standards for some time have taken into account interest rate risk, 
and, in August, 1992, the FRB, OCC, and FDIC sought public comment on a 
proposed framework for incorporating into their capital standards 
interest rate risk, as required under section 305 of FDICIA. In 
response to concerns raised and recommendations made by commenters, on 
September 14, 1993, the three banking agencies issued for public 
comment a substantially modified proposal on interest rate risk. 
Throughout 1994, the agencies have been meeting to review the public 
comments and consider the alternative approaches offered by the 
commenters. It is anticipated that the banking agencies will issue a 
revised notice of proposed rulemaking in early 1995 that will provide 
certain modifications and enhancements to the proposal to address 
concerns expressed by public commenters. The approach ultimately 
adopted by the banking agencies could differ from that already taken by 
the OTS.
    Section 305 of FDICIA also requires the banking agencies to amend 
their risk-based capital rules to take into account concentrations of 
credit risk and nontraditional activities. The agencies proposed an 
amendment implementing this requirement in February, 1994. On August 3, 
1994, the Federal Reserve approved an amendment to its risk-based 
capital guidelines to identify explicitly concentrations of credit risk 
and an institution's ability to manage them as important factors in 
assessing an institution's overall capital adequacy. The amendments 
also indicate that an institution's ability to adequately manage the 
risks posed by nontraditional activities affects its risk exposure.

Recent Interagency Efforts

    In addition to coordinating efforts to incorporate noncredit risks, 
the agencies worked together during 1994 to issue proposals for public 
comment that would amend the agencies' respective risk-based capital 
standards with respect to: (1) The sale of assets with recourse; (2) 
the recognition of bilateral netting arrangements for derivative 
contracts; (3) higher capital charges for long-dated derivative 
contracts and reduced capital charges for the potential future exposure 
of contracts that are affected by netting arrangements; and (4) the 
definition of the OECD-based group of countries for the purpose of 
specifying country transfer risk. The agencies also coordinated efforts 
to make modifications in their capital guidelines in light of recent 
changes in accounting standards.

Recourse

    The agencies issued a joint proposal on May 24, 1994, that would 
amend their respective risk-based capital guidelines with regard to 
assets sold with recourse and direct credit substitutes. This 
publication, which included a notice and an advanced notice of proposed 
rulemakings, was a culmination of several attempts by the agencies to 
resolve important differences on this issue. The notice of proposed 
rulemaking is intended to allow banking organizations to maintain lower 
amounts of capital against low-level recourse transactions. The 
advanced notice of proposed rulemaking is a preliminary proposal to use 
credit ratings to match the risk-based capital assessment more closely 
to an institution's relative risk of loss in certain asset 
securitizations. The comment period for these proposals 
[[Page 3230]] ended on July 25, 1994. The agencies are reviewing the 
comments received.

Bilateral Netting Arrangements

    In response to industry recommendations, and pursuant to the 
consultative paper the Basle Supervisors' Committee issued in April, 
1993, the staffs of the four agencies in 1994 made uniform proposals to 
amend their risk-based capital standards to recognize bilateral netting 
arrangements associated with interest and exchange rate contracts. To 
qualify for netting treatment, netting arrangements would have to 
genuinely reduce credit risk and be legally enforceable in all relevant 
jurisdictions as evidenced by well-founded and reasoned legal opinions. 
A final rule on this matter was adopted by the Board on December 2, 
1994, and the other agencies are expected to issue final rules in the 
near future.

Derivative Contracts and Recognizing the Effects of Netting on 
Potential Future Exposure

    The agencies worked together on proposing amendments to their 
respective risk-based capital guidelines that are based on proposed 
revisions to the Basle Accord that the Basle Supervisors' Committee 
initiated in July 1994. The Board issued for public comment, on August 
22, 1994, a proposed rulemaking that would: (1) increase the capital 
charge for the potential future counterparty exposure of interest and 
exchange rate contracts that are over five years in remaining maturity, 
as well as of equity, precious metals, and other commodity-related 
contracts; and (2) recognize the effects of bilateral netting 
arrangements in calculating the potential future exposure for contracts 
subject to qualifying netting arrangements. The agencies have been 
coordinating their efforts to review the public comments and to draft 
final rules on these proposals. The final amendments to the agencies' 
risk-based capital standards are contingent upon an endorsement by the 
G-10 Governors of a final revision to the Basle Accord.

Country Transfer Risk

    In July 1994, the G-10 Governors announced their intention to 
modify the Basle Accord in 1995 with regard to country transfer risk. 
Specifically, it was agreed to revise the definition of the OECD-based 
group of countries\4\ that are accorded a preferential risk weight. The 
revision would retain the OECD-based group of countries as the 
principle criterion for preferential risk weight status, but exclude 
for five years any country that reschedules its external sovereign 
debt. The Board and the OCC issued a joint notice of proposed 
rulemaking on October 14, 1994, that seeks public comment on an 
amendment to their respective risk-based capital guidelines. The FDIC 
and OTS expect to issue similar proposals in 1995.

    \4\The OECD-based group of countries currently includes members 
of the Organization of Economic Cooperation and Development and 
countries that have concluded special lending arrangements with the 
International Monetary Fund (IMF) associated with the Fund's General 
Arrangements to Borrow. Saudi Arabia is the only non-OECD country 
that has concluded such arrangements.
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Capital Impact of Recent Changes to Accounting Standards

    Recently, FASB issued pronouncements concerning new and modified 
financial accounting standards. The adoption of some of these standards 
for regulatory reporting purposes had the potential of affecting the 
definition and calculation of regulatory capital. Accordingly, the 
staffs of the agencies worked together to propose uniform regulatory 
capital responses to such accounting changes. Over this past year, the 
agencies dealt with the accounting issues, described below.
    FAS 115, ``Accounting for Certain Investments in Debt and Equity 
Securities.''
    The staffs of the four agencies met this year to discuss the public 
comments received in response to proposed amendments, issued in 1993 
and early 1994, to their respective risk-based capital standards that 
would include in Tier 1 capital the net unrealized changes in value of 
securities available for sale for purposes of calculating the risk-
based and leverage capital ratios of banking organizations. The 
proposals, which were in response to the recently adopted FAS 115, also 
requested comment on several alternative approaches, one of which was 
to not adopt FAS 115 for capital purposes. On November 10, 1994, the 
FFIEC recommended to the agencies that they not adopt FAS 115 for 
capital purposes. Acting on this recommendation, the Board, on November 
30, 1994, adopted a final rule effective December 31, 1994. Under the 
final rule, institutions are generally directed not to include in Tier 
1 capital the component of common stockholders' equity, net unrealized 
holding gains and losses on securities available for sale that was 
created by FAS 115. The other agencies are expected to issue similar 
rules in the near future.
    FAS 109, ``Accounting for Income Taxes.''
    The agencies issued in 1993 proposals to limit the amount of 
deferred tax assets includable in calculating Tier 1 capital. Under the 
proposals, certain deferred tax assets are limited to the lesser of 10 
percent of Tier 1 capital or the amount of such assets the institution 
expects to realize in the subsequent year. On November 18, 1994, the 
FFIEC recommended that the agencies finalize these proposals. The 
agencies are preparing to issue final rules that will be made effective 
early in 1995.
    FAS 114, ``Accounting by Creditors for Impairment of a Loan.''
    On May 17, 1994, the agencies issued a joint request for comment 
regarding certain implementation issues arising from the agencies' 
recent adoption for regulatory reporting purposes of FAS 114. FAS 114 
presents a methodology for calculating the loan loss reserve for 
certain loans that is based on present value considerations. Through 
the FFIEC, the agencies, on November 18, 1994, announced a decision 
that the current reporting of nonaccrual loans would be maintained and 
the allowances calculated under FAS 114 are to be reported as part of 
the general allowance.

Specific Capital Differences

    Differences among the risk-based capital standards of the OTS and 
the three banking agencies are discussed below.

Certain collateralized transactions

    On December 23, 1992, the Federal Reserve Board issued an amendment 
to its risk-based and leverage capital guidelines that lowers from 20 
to 0 percent the risk category for collateralized transactions meeting 
certain criteria. This preferential treatment is only available for 
claims collateralized by cash on deposit in the bank or by securities 
issued or guaranteed by OECD central governments or U.S. government 
agencies. In addition, a positive margin of collateral must be 
maintained on a daily basis fully taking into account any change in the 
banking organization's exposure to the obligor or counterparty under a 
claim in relation to the market value of the collateral held in support 
of that claim.
    As reported in last year's report, the OCC, on August 18, 1993, 
issued a proposal for public comment that would also lower the risk 
weight for certain collateralized transactions. At the time of this 
report, a final rule has not been approved. The FDIC and OTS are 
considering similar proposals.

Equity Investments

    In general, commercial banks that are members of the Federal 
Reserve System [[Page 3231]] are not permitted to invest in equity 
securities, nor are they generally permitted to engage in real estate 
investment or development activities. To the extent that commercial 
banks are permitted to hold equity securities (for example, in 
connection with debts previously contracted), the three banking 
agencies generally assign such investments to the 100 percent risk 
category for risk-based capital purposes.
    Under the three banking agencies' rules, the agencies may, on a 
case-by-case basis, deduct equity investments from the parent bank's 
capital or make other adjustments, if necessary, to assess an 
appropriate capital charge above the minimum requirement. The banking 
agencies' treatment of investments in subsidiaries is discussed below.
    The OTS risk-based capital standards require that thrift 
institutions deduct certain equity investments from capital over a 
phase-in period, which ended on July 1, 1994, as explained more fully 
below in the section on subsidiaries.

FSLIC/FDIC-covered assets (assets subject to guarantee arrangements by 
the FSLIC or FDIC)

    The three banking agencies generally place these assets in the 20 
percent risk category, the same category to which claims on depository 
institutions and government-sponsored agencies are assigned.
    The OTS places these assets in the zero percent risk category.

Repossessed assets and assets more than 90 days past due

    The three banking agencies require that foreclosed real estate be 
written down to fair value (see Section Two of this report, ``Specific 
Valuation Allowances for, and Charge-Offs of, Troubled Real Estate 
Loans not in Foreclosure'' for further details) with the resulting 
asset assigned to the 100 percent risk category. The write-down 
effectively results in a reduction of capital. Assets 90 days or more 
past due, including 1- to 4-family residential mortgages, are assigned 
to the 100 percent risk category. If and when such assets are 
eventually charged off, capital is effectively adjusted for any 
resulting loss.
    Consistent with the Basle Accord, the 100 percent risk category is 
the highest risk category under the risk-based capital guidelines of 
the three banking agencies. As noted above, however, the bank risk-
based capital standards represent minimum ratios. Organizations with 
high levels of risk, including a significant volume of nonperforming or 
past due assets, are expected to maintain capital ratios above minimum 
levels. Thus, the risk-based capital framework of the banking agencies 
provides the flexibility to require higher levels of capital against 
assets of this type.
    The OTS risk-based capital framework assigns a 200 percent risk 
weight to repossessed assets (generally referred to as real estate 
owned or REO) and assets more than 90 days past due. An exception 
exists for 1- to 4-family residential mortgages more than 90 days past 
due, which are assigned to the 100 percent risk category. The OTS 
intends to change the risk weight for all REO to 100 percent in 
conjunction with recent changes in the accounting for REO.

Limitation on subordinated debt and limited-life preferred stock

    Consistent with the Basle Accord, the three banking agencies limit 
the amount of subordinated debt and limited-life preferred stock that 
may be included in Tier 2 capital. This limit, in effect, states that 
these components together may not exceed 50 percent of Tier 1 capital. 
In addition, maturing capital instruments must be discounted by 20 
percent in each of the last five years prior to maturity.
    Neither subordinated debt nor limited-life preferred stock is a 
permanent source of funds, and subordinated debt cannot absorb losses 
while the bank continues to operate as a going-concern. On the other 
hand, both capital components can provide a cushion of protection to 
the FDIC insurance fund. Thus, the 50 percent limitation permits the 
inclusion of some subordinated debt in capital, while assuring that 
permanent stockholders' equity capital remains the predominant element 
in bank regulatory capital.
    The OTS has no limitation on the total amount of limited-life 
preferred stock or maturing capital instruments that may be included 
within Tier 2 capital. In addition, the OTS allows thrifts the option 
of: (1) Discounting maturing capital instruments issued on or after 
November 7, 1989, by 20 percent a year over the last 5 years of their 
term--the approach required by the banking agencies; or (2) including 
the full amount of such instruments provided that the amount maturing 
in any of the next seven years does not exceed 20 percent of the 
thrift's total capital.

Subsidiaries

    Consistent with the Basle Accord and long-standing supervisory 
practices, the three banking agencies generally consolidate all 
significant majority-owned subsidiaries of the parent organization for 
capital purposes. This consolidation assures that the capital 
requirements are related to all of the risks to which the banking 
organization is exposed.
    As with most other bank subsidiaries, banking and finance 
subsidiaries generally are consolidated for regulatory capital 
purposes. However, in cases where banking and finance subsidiaries are 
not consolidated, the Federal Reserve, consistent with the Basle 
Accord, generally deducts investments in such subsidiaries in 
determining the adequacy of the parent bank's capital.
    The Federal Reserve's risk-based capital guidelines provide a 
degree of flexibility in the capital treatment of unconsolidated 
subsidiaries (other than banking and finance subsidiaries) and 
investments in joint ventures and associated companies. For example, 
the Federal Reserve may deduct investments in such subsidiaries from an 
organization's capital, may apply an appropriate risk-weighted capital 
charge against the proportionate share of the assets of the entity, may 
require a line-by-line consolidation of the entity, or otherwise may 
require that the parent organization maintain a level of capital above 
the minimum standard that is sufficient to compensate for any risks 
associated with the investment.
    The guidelines also permit the deduction of investments in 
subsidiaries that, while consolidated for accounting purposes, are not 
consolidated for certain specified supervisory or regulatory purposes. 
For example, the Federal Reserve deducts investments in, and unsecured 
advances to, Section 20 securities subsidiaries from the parent bank 
holding company's capital. The FDIC accords similar treatment to 
securities subsidiaries of state nonmember banks established pursuant 
to Section 337.4 of the FDIC regulations.
    Similarly, in accordance with Section 325.5(f) of the FDIC 
regulations, a state nonmember bank must deduct investments in, and 
extensions of credit to, certain mortgage banking subsidiaries in 
computing the parent bank's capital. (The Federal Reserve does not have 
a similar requirement with regard to mortgage banking subsidiaries. The 
OCC does not have requirements dealing specifically with the capital 
treatment of either mortgage banking or securities subsidiaries. The 
OCC, however, does reserve the right to require a national bank, on a 
case-by-case basis, to deduct from capital investments in, and 
extensions of credit to, any nonbanking subsidiary.)
    The deduction of investments in subsidiaries from the parent's 
capital is designed to ensure that the capital supporting the 
subsidiary is not also [[Page 3232]] used as the basis of further 
leveraging and risk-taking by the parent banking organization. In 
deducting investments in, and advances to, certain subsidiaries from 
the parent's capital, the Federal Reserve expects the parent banking 
organization to meet or exceed minimum regulatory capital standards 
without reliance on the capital invested in the particular subsidiary. 
In assessing the overall capital adequacy of banking organizations, the 
Federal Reserve may also consider the organization's fully consolidated 
capital position.
    Under the OTS capital guidelines, a distinction, mandated by 
FIRREA, is drawn between subsidiaries that are engaged in activities 
that are permissible for national banks and subsidiaries that are 
engaged in ``impermissible'' activities for national banks. 
Subsidiaries of thrift institutions that engage only in permissible 
activities are consolidated on a line-by-line basis if majority-owned 
and on a pro rata basis if ownership is between 5 percent and 50 
percent. As a general rule, investments, including loans, in 
subsidiaries that engage in impermissible activities are deducted in 
determining the capital adequacy of the parent. However, investments, 
including loans, outstanding as of April 12, 1989, to subsidiaries that 
were engaged in impermissible activities prior to that date are 
grandfathered and were phased-out of capital over a transition period 
that expired on July 1, 1994. During this transition period, 
investments in subsidiaries engaged in impermissible activities that 
have not been phased-out of capital were consolidated on a pro rata 
basis.

Nonresidential Construction and Land Loans

    The three banking agencies assign loans for real estate development 
and construction purposes to the 100 percent risk category. Reserves or 
charge-offs are required, in accordance with examiner judgment, when 
weaknesses or losses develop in such loans. The banking agencies have 
no requirement for an automatic charge-off when the amount of a loan 
exceeds the fair value of the property pledged as collateral for the 
loan.
    The OTS generally assigns these loans to the 100 percent risk 
category. However, if the amount of the loan exceeds 80 percent of the 
fair value of the property, that excess portion must be deducted from 
capital in accordance with a phase-in arrangement, which ended on July 
1, 1994.

Mortgage-Backed Securities (MBS)

    The three banking agencies, in general, place privately-issued MBSs 
in a risk category appropriate to the underlying assets but in no case 
to the zero percent risk category. In the case of privately-issued MBSs 
where the direct underlying assets are mortgages, this treatment 
generally results in a risk weight of 50 percent or 100 percent. 
Privately-issued MBSs that have government agency or government-
sponsored agency securities as their direct underlying assets are 
generally assigned to the 20 percent risk category.
    The OTS assigns privately-issued high quality mortgage-related 
securities to the 20 percent risk category. These are, generally, 
privately-issued MBSs with AA or better investment ratings.
    At the same time, both the banking and thrift agencies 
automatically assign to the 100 percent risk weight category certain 
MBSs, including interest-only strips, residuals, and similar 
instruments that can absorb more than their pro rata share of loss. The 
Federal Reserve, in conjunction with the other banking agencies and the 
OTS, issued, on January 10, 1992, more specific guidance as to the 
types of ``high risk'' MBSs that will qualify for a 100 percent risk 
weight.

Assets Sold With Recourse

    In general, recourse arrangements allow the purchaser of an asset 
to ``put'' the asset back to the originating institution under certain 
circumstances, for example if the asset ceases to perform 
satisfactorily. This, in turn, can expose the originating institution 
to any loss associated with the asset. As a general rule, the three 
banking agencies require that sales of assets involving any recourse be 
reported as financings and that the assets be retained on the balance 
sheet. This effectively requires a full leverage and risk-based capital 
charge whenever assets are sold with recourse, including limited 
recourse. The Federal Reserve generally applies a capital charge to any 
off-balance sheet recourse arrangement that is the equivalent of a 
guarantee, regardless of the nature of the transaction that gives rise 
to the recourse obligation.
    An exception to this general rule for the three banking 
organizations involves pools of 1- to 4-family residential mortgages 
and to certain farm mortgage loans. Certain recourse transactions 
involving these assets are reported in the bank Call Report as sales, 
and, thus, are not included in the asset base used in calculating the 
Tier 1 leverage ratio. For risk-based capital purposes, however, the 
amount of such mortgages sold with recourse is generally treated as an 
off-balance sheet guarantee, and assessed a capital charge.
    In general, the OTS also requires a full risk-based capital charge 
against assets sold with recourse. However, in the case of assets sold 
with recourse, the OTS limits the capital charge to the lesser of the 
amount of recourse or the actual amount of capital that would otherwise 
be required against that asset, that is, the normal full capital 
charge.
    Some securitized asset arrangements involve the issuance of senior 
and subordinated classes of securities against pools of assets. When a 
bank originates such a transaction by placing loans that it owns in a 
trust and retaining any portion of the subordinated securities, the 
banking agencies require that capital be maintained against the entire 
amount of the asset pool. When a bank acquires a subordinated security 
in a pool of assets that it did not originate, the banking agencies 
assign the investment in the subordinated piece to the 100 percent 
risk-weight category. The Federal Reserve carefully reviews these 
instruments to determine if additional reserves, asset write-downs, or 
capital are necessary to protect the bank.
    The OTS requires that risk-based capital be maintained against the 
entire amount of the asset pool in both of the situations described in 
the preceding paragraph. Additionally, the OTS applies a capital charge 
to the full amount of assets being serviced when the servicer is 
required to absorb credit losses on the assets being serviced.
    On May 25, 1994, the three banking agencies and the OTS, under the 
auspices of the FFIEC, sought public comment on various aspects of the 
capital treatment of recourse transactions by publishing a Notice of 
Proposed Rulemaking (NPR) and an Advance Notice of Proposed Rulemaking 
(ANPR), which is a more preliminary step in the formal rulemaking 
process. The comment period ended July 25, 1994.
    The NPR proposed to amend the banking agencies' risk-based capital 
guidelines by:
    (1) Reducing the risk-based capital charge for ``low level'' 
recourse arrangements to an amount equal to the maximum contractual 
recourse obligation;
    (2) Requiring equivalent capital treatment of recourse arrangements 
and direct credit substitutes that provide first dollar loss 
protection. This would increase the capital assessment for first loss 
standby letters of credit and purchased subordinated interests that 
[[Page 3233]] only provide partial credit enhancement; and
    (3) Defining ``recourse'' and associated terms such as ``standard 
representations and warranties.''
    The ANPR proposed incorporating into the risk-based capital 
guidelines a framework based on formal credit ratings for assessing 
capital against exposures with different levels of risk in certain 
asset securitizations. Thus, the more risky a particular risk position 
with a securitized transaction, the higher the capital charge.
    Staffs of the agencies are reviewing public comments, particularly 
in light of the Reigle Community Development and Regulatory Improvement 
Act of 1994 (Act), which was signed into law on September 23, 1994. 
Section 350 of the Act requires the banking agencies, by the end of 
March 1995, to promulgate regulations that better reflect the exposure 
of an insured depository institution to credit risk from transfers of 
assets with recourse. At a minimum, these regulations must limit the 
amount of required capital to be held against assets sold with recourse 
to the maximum amount of recourse for which the ``selling'' institution 
is contractually liable. The staffs of the agencies are working to 
issue by the end of March 1994 a final rule incorporating the proposed 
``low level'' recourse treatment in order to meet the legislative 
requirements of section 350. Staffs of the agencies are also continuing 
their work on developing proposals to make the capital requirements for 
recourse transactions more commensurate with the actual risk inherent 
in the transactions.

Agricultural Loan Loss Amortization

    In the computation of regulatory capital, those banks accepted into 
the agricultural loan loss amortization program pursuant to Title VIII 
of the Competitive Equality Banking Act of 1987 are permitted to defer 
and amortize losses incurred on agricultural loans between January 1, 
1984 and December 31, 1991. The program also applies to losses incurred 
between January 1, 1983 and December 31, 1991, as a result of 
reappraisals and sales of agricultural Other Real Estate Owned (OREO) 
and agricultural personal property. These loans must be fully amortized 
over a period not to exceed seven years and, in any case, must be fully 
amortized by year-end 1998. Thrifts are not eligible to participate in 
the agricultural loan loss amortization program established by this 
statute.

Treatment of Junior Liens on 1- to 4-Family Properties

    In some cases, a banking organization may make two loans on a 
single residential property, one loan secured by a first lien, the 
other by a second lien. In such a situation, the Federal Reserve views 
these two transactions as a single loan, provided there are no 
intervening liens. This could result in assigning the total amount of 
these transactions to the 100 percent risk weight category, if, in the 
aggregate, the two loans exceeded a prudent loan-to-value ratio and, 
therefore, did not qualify for the 50 percent risk weight. This 
approach is intended to avoid possible circumvention of the capital 
requirements and capture the risks associated with the combined 
transactions.
    The FDIC, OCC, and the OTS generally assign the loan secured by the 
first lien to the 50 percent risk-weight category and the loan secured 
by the second lien to the 100 percent risk-weight category.

Pledged Deposits and Nonwithdrawable Accounts

    The capital guidelines of the OTS permit thrift institutions to 
include in capital certain pledged deposits and nonwithdrawable 
accounts that meet the criteria of the OTS. Income Capital Certificates 
and Mutual Capital Certificates held by the OTS may also be included in 
capital by thrift institutions. These instruments are not relevant to 
commercial banks, and, therefore, they are not addressed in the three 
banking agencies' capital guidelines.

Mutual Funds

    The three banking agencies generally assign all of a bank's 
holdings in a mutual fund to the risk category appropriate to the 
highest risk asset that a particular mutual fund is permitted to hold 
under its operating rules. The purpose of this is to take into account 
the maximum degree of risk to which a bank may be exposed when 
investing in a mutual fund in view of the fact that the future 
composition and risk characteristics of the fund's holding cannot be 
known in advance.
    The OTS applies a capital charge appropriate to the riskiest asset 
that a mutual fund is actually holding at a particular time. In 
addition, both the OTS and the OCC guidelines also permit, on a case-
by-case basis, investments in mutual funds to be allocated on a pro 
rata basis in a manner consistent with the actual composition of the 
mutual fund.

Section Two

Differences in Accounting Standards Among Federal Banking and 
Thrift Supervisory Agencies

    Under the auspices of the FFIEC, the three banking agencies have 
developed uniform reporting requirements for commercial banks to be 
used in the preparation of the Call Report. The FDIC has also applied 
these uniform reporting requirements to savings banks under its 
supervision. The income statement and balance sheet accounts presented 
in the Call Report are used by the bank supervisory agencies for 
determining the capital adequacy of banks. The data collected in this 
report also are used for other regulatory, supervisory, analytical, and 
statistical purposes, and provide information to the Federal Reserve 
for the conduct of monetary policy.
    Section 121 of FDICIA states that ``accounting principles 
applicable to reports or statements required to be filed by all insured 
depository institutions with federal banking agencies shall be uniform 
and consistent with generally accepted accounting principles (GAAP).'' 
Under section 121, the objectives of accounting principles applicable 
to such reports and statements are to:
    1. Result in financial statements and reports of condition that 
accurately reflect the institution's capital;
    2. Facilitate effective supervision of depository institutions; and
    3. Facilitate prompt corrective action at least cost to the 
insurance funds.
    Section 121 further states that a federal banking agency may 
``prescribe an accounting principle . . . which is no less stringent 
than GAAP'' when the agency determines that ``the application of any 
generally accepted accounting principle is inconsistent with the 
objectives'' of accounting principles noted above.
    Section 121 of FDICIA thus requires the Federal Reserve and the 
other federal banking agencies to set forth reporting requirements in 
the Call Report that are consistent with, or no less stringent than, 
GAAP. The reporting requirements for the Call Report are substantially 
consistent with GAAP as applied by commercial banks, aside from a few 
limited exceptions. As a matter of long-standing policy, the reporting 
requirements for Call Reports depart from GAAP only in those instances 
where statutory requirements or overriding supervisory concerns warrant 
a departure from GAAP. Furthermore, in those cases where the reporting 
requirements for bank Call Reports are different from GAAP, they are 
more conservative than GAAP. [[Page 3234]] Thus, bank regulatory 
reporting requirements are consistent with the objectives and mandate 
of FDICIA Section 121.
    The agencies have been working to limit the number of differences 
between regulatory reporting requirements and GAAP. In some cases, 
however, differences will exist when there is a need to address 
supervisory concerns. In addition, the agencies have been working 
closely to coordinate any new accounting and reporting policies, to 
ensure consistency among the agencies and to reduce or eliminate 
differences with GAAP.
    The OTS has developed and maintains a separate reporting system for 
the thrift institutions under its supervision. The financial report for 
thrifts, or TFR, is based on GAAP as applied by thrifts.
    A summary of the primary differences in regulatory reporting 
requirements between the three bank agencies and the OTS is set forth 
below. The information is based on a study developed on an interagency 
basis.

Futures and Forward Contracts

    The banking agencies, as a general rule, do not permit the deferral 
of losses by banks on futures and forwards regardless of whether they 
are used for hedging purposes. All changes in market value of futures 
and forward contracts are reported in current period income. The 
banking agencies adopted this reporting requirement as a supervisory 
policy prior to the adoption of FASB Statement No. 80, which allows 
hedge or loss deferral accounting, under certain circumstances. Hedge 
accounting in accordance with FASB Statement No. 80 is permitted by the 
banking agencies only in the case of futures and forward contracts used 
in mortgage banking operations.
    The OTS practice is to follow FASB Statement No. 80 for futures 
contracts. In accordance with this statement, when hedging criteria are 
satisfied, the accounting for the futures contract is related to the 
accounting treatment for the hedged item. Changes in the market value 
of the futures contract are recognized in income when the effects of 
related changes in the price or interest rate of the hedged item are 
recognized. Such reporting can result in deferred losses, which would 
be reflected as assets on the thrift's balance sheet in accordance with 
GAAP.
    The Federal Reserve is closely reviewing hedge accounting issues 
with the other federal banking agencies, with the objective of 
encouraging the FASB to develop a comprehensive hedge accounting 
framework that results in consistent accounting treatment for all 
derivative instruments of financial and nonfinancial companies.

Excess Servicing Fees

    As a general rule, the three banking agencies do not follow GAAP 
for excess servicing fees, but require a more conservative treatment. 
Excess servicing results when loans are sold with servicing retained 
and the stated servicing fee rate is greater than the normal servicing 
fee rate. With the exception of sales of pools of first lien one- to 
four-family residential mortgages for which the banking agencies' 
approach is consistent with FASB Statement No. 65, excess servicing fee 
income in banks must be reported as realized over the life of the 
transferred asset, not recognized up front as required by FASB 
Statement No. 65.
    The OTS allows the present value of the future excess servicing fee 
to be treated as an adjustment to the sales price for purposes of 
recognizing gain or loss on the sale. This approach is consistent with 
FASB Statement No. 65.

In-Substance Defeasance of Debt

    The banking agencies do not permit banks to report defeasance of 
their debt obligations in accordance with FASB Statement No. 76. 
Defeasance involves a debtor irrevocably placing risk-free monetary 
assets in a trust solely for satisfying the debt. Under FASB Statement 
No. 76, the assets in the trust and the defeased debt are removed from 
the balance sheet and a gain or loss for the current period can be 
recognized. However, for Call Report purposes, banks may not remove 
assets or defeased liabilities from their balance sheets or recognize 
resulting gains or losses. The banking agencies have not adopted FASB 
Statement No. 76 because of uncertainty regarding the irrevocable 
trusts established for defeasance purposes. Furthermore, defeasance 
would not relieve the bank of its contractual obligation to pay 
depositors or other creditors.
    OTS practice is to follow FASB Statement No. 76.

Sales of Assets With Recourse

    In accordance with FASB Statement No. 77, a transfer of receivables 
with recourse is recognized as a sale if: (1) The transferor surrenders 
control of the future economic benefits; (2) the transferor's 
obligation under the recourse provisions can be reasonably estimated; 
and (3) the transferee cannot require repurchase of the receivables 
except pursuant to the recourse provisions.
    The practice of the three banking agencies is generally to permit 
commercial banks to report transfers of receivables with recourse as 
sales only when the transferring institution (1) retains no risk of 
loss from the assets transferred and (2) has no obligation for the 
payment of principal or interest on the assets transferred. As a 
result, virtually no transfers of assets with recourse can be reported 
as sales. However, this rule does not apply to the transfer of first 
lien 1- to 4-family residential or agricultural mortgage loans under 
certain government-sponsored programs (including the Federal National 
Mortgage Association and the Federal Home Loan Mortgage Corporation). 
Transfers of mortgages under these programs are generally treated as 
sales for Call Report purposes.
    Furthermore, private transfers of first lien 1- to four-family 
residential mortgages are also reported as sales if the transferring 
institution retains only an insignificant risk of loss on the assets 
transferred. However, the seller's obligation under recourse provisions 
related to sales of mortgage loans under the government programs is 
viewed as an off-balance sheet exposure. Thus, for risk-based capital 
purposes, capital is generally expected to be held for recourse 
obligations associated with such transactions.
    The OTS policy is to follow FASB Statement No. 77. However, in the 
calculation of risk-based capital under the OTS guidelines, off-balance 
sheet recourse obligations generally are converted at 100 percent. This 
effectively negates the sale treatment recognized on a GAAP basis for 
risk-based capital purposes, but not for leverage capital purposes. 
Thus, by making this adjustment in the risk-based capital calculation, 
the differences between the OTS and the banking agencies for capital 
adequacy measurement purposes are substantially reduced.
    Over the past few years, the FFIEC has studied transfers of assets 
with recourse (often referred to as the ``recourse study''). In this 
respect, the staff of the Federal Reserve has reviewed the capital and 
regulatory reporting treatment for sales of assets with recourse and on 
May 25, 1994, issued, under the auspices of the FFIEC, a proposal for 
public comment which addresses these issues. If finalized, the proposal 
could reduce the differences between regulatory reporting requirements 
and GAAP in this area by allowing a larger portion of transfers of 
assets with recourse to be treated as sales. In addition, the staff of 
the Federal Reserve has been working with [[Page 3235]] the other 
agencies to implement section 350 of the Riegle Community Development 
and Regulatory Improvement Act of 1994, which deals with the regulatory 
reporting and capital treatment of certain recourse transactions, as 
discussed in greater detail on page 28 of Section One of this report.

Push-Down Accounting

    When a depository institution is acquired in a purchase 
transaction, but retains its separate corporate existence, the 
institution is required to revalue all of the assets and liabilities at 
fair value at the time of acquisition. When push-down accounting is 
applied, the same revaluation made by the parent holding company is 
made at the depository institution level.
    The three banking agencies require push-down accounting when there 
is at least a 95 percent change in ownership. This approach is 
generally consistent with interpretations of the Securities and 
Exchange Commission.
    The OTS requires push-down accounting when there is at least a 90 
percent change in ownership.

Negative Goodwill

    The three banking agencies require that negative goodwill be 
reported as a liability, and not be netted against goodwill assets. 
Such a policy ensures that all goodwill assets are deducted in 
regulatory capital calculations, consistent with the Basle Accord.
    The OTS permits negative goodwill to offset goodwill assets 
reported in the financial statements.

Offsetting

    The three banking agencies generally prohibit netting of assets and 
liabilities in the Call Report. However, FASB Interpretation No. 39 
(FIN 39) netting requirements have been adopted for Call Report 
purposes solely for assets and liabilities that arise from off-balance-
sheet instruments. For example, under FIN 39, the assets and 
liabilities arising from these contracts may be netted when there is a 
legally enforceable bilateral master netting agreement.
    The OTS policy on netting for all assets and liabilities is 
consistent with GAAP, as set forth in FIN 39. FIN 39 allows 
institutions to offset assets and liabilities (e.g., loans and 
deposits) when four conditions are met. Moreover, the OTS permits 
netting for off-balance sheet conditional and exchange contracts to the 
same extent as the banking agencies.

    By order of the Board of Governors of the Federal Reserve 
System, January 9, 1995.
William W. Wiles,
Secretary of the Board.
[FR Doc. 95-900 Filed 1-12-95; 8:45 am]
BILLING CODE 6210-10-P