[Federal Register Volume 61, Number 167 (Tuesday, August 27, 1996)]
[Rules and Regulations]
[Pages 43948-43952]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-21590]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 30

[Docket No. 96-19]
RIN 1557-AB17

FEDERAL RESERVE SYSTEM

12 CFR Part 208

[Docket No. R-0766]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 364

RIN 3064-AB13

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 570

[No. 96-53]
RIN 1550-AA97


Interagency Guidelines Establishing Standards for Safety and 
Soundness

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

ACTION: Final guidelines.

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SUMMARY: The Office of the Comptroller of the Currency (OCC), the Board 
of Governors of the Federal Reserve System (Board of Governors), the 
Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift 
Supervision (OTS) (collectively, the agencies) are amending the 
Interagency Guidelines Establishing Standards for Safety and Soundness 
(Guidelines) to include asset quality and earnings standards. The 
Guidelines were adopted pursuant to section 39 of the Federal Deposit 
Insurance Act (FDI Act).

EFFECTIVE DATE: October 1, 1996.

FOR FURTHER INFORMATION CONTACT: OCC: Emily R. McNaughton, National 
Bank Examiner (202/874-5170), Office of the Chief National Bank 
Examiner; David Thede, Senior Attorney (202/874-5210), Securities and 
Corporate Practices Division; or Mark Tenhundfeld, Senior Attorney 
(202/874-5090), Legislative and Regulatory Activities Division, Office 
of the Comptroller of the Currency, 250 E Street, SW, Washington, DC 
20219.
    Board of Governors: David Wright, Project Manager (202/728-5854), 
Division of Banking Supervision and Regulation; 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: Robert W. Walsh, Manager, Planning and Program Development 
(202/898-6911) or Michael D. Jenkins, Examination Specialist (202/898-
6896), Division of Supervision; or Susan vandenToorn, Counsel (202/898-
8707), or Nancy L. Alper, Counsel (202/736-0828), Legal Division, 
Federal Deposit Insurance Corporation, 550 17th Street, NW, Washington, 
DC 20429.
    OTS: William Magrini, Senior Project Manager (202/906-5744), 
Supervision Policy; or Kevin Corcoran, Assistant Chief Counsel (202/
906-6962), or Teri M. Valocchi, Counsel (Banking and Finance) (202/906-
7299), Chief Counsel's Office, Office of Thrift Supervision, 1700 G 
Street, NW, Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

I. Background

A. Statutory Framework

    Section 132 of the Federal Deposit Insurance Corporation 
Improvement Act of 1991 (FDICIA), Pub. L. 102-242, amended the Federal 
Deposit Insurance Act (FDI Act) by adding a new section (section 39, 
codified at 12 U.S.C. 1831p-1) that requires each Federal banking 
agency to establish by regulation certain safety and soundness 
standards for the insured depository institutions and depository 
institution holding companies for which it is the primary Federal 
regulator. As enacted in FDICIA, section 39(b) of the FDI Act required 
the agencies to establish standards by regulation specifying a maximum 
ratio of classified assets to capital and minimum earnings sufficient 
to absorb losses without impairing capital.
    Section 318(a) of the Riegle Community Development and Regulatory 
Improvement Act of 1994

[[Page 43949]]

(CDRIA), Pub. L. 103-325, which was enacted on September 23, 1994, 
eliminated the application of section 39 to depository institution 
holding companies and replaced the requirement that the agencies 
``specify'' quantitative asset quality and earnings standards with a 
requirement that the agencies prescribe standards, by regulation or by 
guideline, relating to asset quality and earnings that the agencies 
determine to be appropriate.

B. Agencies' Proposals

    The agencies published a joint notice of proposed rulemaking in the 
Federal Register on November 18, 1993 (59 FR 60802) that solicited 
comment on specific standards that would govern numerous facets of a 
depository institution's operations, including quantitative standards 
governing a depository institution's asset quality and earnings. On 
July 10, 1995 (60 FR 35674), the agencies adopted: (1) final guidelines 
in all areas except asset quality and earnings; and (2) a final rule 
establishing deadlines for submission and review of safety and 
soundness compliance plans which may be required for failure to meet 
one or more of the safety and soundness standards adopted in the 
Guidelines.1 On the same day (60 FR 35688), the agencies also 
proposed revised guidelines concerning asset quality and earnings 
standards to address problems noted by many commenters with the 
quantitative standards. The primary concern of these commenters was 
that it was impossible to design quantitative standards that would be 
appropriate for every regulated institution. Because the CDRIA 
clarified that quantitative standards were not required, the agencies 
proposed to replace the quantitative standards with more comprehensive 
qualitative standards that emphasize monitoring, reporting, and 
preventive or corrective action appropriate to the size of the 
institution and the nature and scope of its activities.
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    \1\ For the OCC, these Guidelines appear as Appendix A to part 
30; for the Board of Governors, these Guidelines appear as Appendix 
D to part 208; for the FDIC, these Guidelines appear as Appendix A 
to part 364; and for the OTS, these Guidelines appear as Appendix A 
to part 570.
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    The proposed asset quality standards required an institution to 
identify problem assets and estimate inherent losses. The proposal also 
required an institution to: (1) consider the size and potential risks 
of material concentrations of credit risk; (2) compare the level of 
problem assets to the level of capital and establish reserves 
sufficient to absorb anticipated losses on those and other assets; (3) 
take appropriate corrective action to resolve problem assets; and (4) 
provide periodic asset quality reports to the board of directors to 
assess the level of asset risk. The proposal noted that the complexity 
and sophistication of an institution's monitoring, reporting systems, 
and corrective actions should be commensurate with the size, nature, 
and scope of the institution's operations.
    The agencies proposed earnings standards requiring monitoring and 
reporting systems similar to those required in the standards for asset 
quality. The proposed earnings standards were intended to enhance early 
identification and resolution of problems. The standards required an 
institution to compare its earnings trends, relative to equity, assets, 
and other common benchmarks, with its historical experience and with 
the earnings trends of its peers. The proposed standards also provided 
that an institution should: (1) evaluate the adequacy of earnings given 
the institution's size, and complexity, and the risk profile of the 
institution's assets and operations; (2) assess the source, volatility, 
and sustainability of earnings; (3) evaluate the effect of nonrecurring 
or extraordinary income or expense; (4) take steps to ensure that 
earnings are sufficient to maintain adequate capital and reserves after 
considering asset quality and the institution's rate of growth; and (5) 
provide periodic reports with adequate information for management and 
the board of directors to assess earnings performance.

II. Discussion of Comments

    The agencies received a total of 31 2 comments, some of which 
were sent to more than one agency. Commenters were overwhelmingly 
supportive of the proposal, particularly its reliance on qualitative 
and flexible standards in lieu of the quantitative standards originally 
proposed. Commenters noted that the more flexible guidelines embodied 
in the second proposed rule built upon a depository institution's own 
procedures for monitoring, reporting, and taking action with respect to 
asset quality and earnings conditions. Commenters agreed that well run 
institutions would not have to alter their practices in order to comply 
with the proposed standards.
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    \2\ The Board of Governors received 14 comments, while the OCC, 
FDIC, and OTS received 8, 6, and 3, respectively.
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    Some commenters suggested amendments to the proposal. One commenter 
asked the agencies to clarify how the proposed standards interact with 
the examination process and the determination of CAMEL ratings. Another 
commenter emphasized that institutions need flexibility in determining 
earnings benchmarks and defining the appropriate peer group. A third 
commenter suggested that the agencies eliminate the earnings standard 
directing each institution to evaluate the effect of nonrecurring or 
extraordinary income or expense. This commenter believed such an 
evaluation was effectively required by the separate standard requiring 
the institution to assess the source, volatility, and sustainability of 
earnings. Finally, one commenter asked that institutions be given the 
option of complying with quantitative standards.

III. Final Guidelines

    The agencies are adopting the asset quality and earnings standards 
substantially as proposed. These qualitative standards are sufficiently 
flexible to permit an institution to adopt practices that are 
consistent with safe and sound banking practices and that are 
appropriate for the institution. Moreover, the standards are designed 
to prompt a depository institution to take steps that will help 
identify emerging problems in the institution.
    The final rule makes two minor changes to the asset quality 
standards. First, the order of the steps a depository institution is to 
take is rearranged to reflect more accurately the appropriate sequence 
of these steps. Second, the final rule deletes the word ``quality'' in 
the standard requiring periodic asset reports (asset quality standard 6 
in the final guidelines). This change was made to emphasize that the 
report is to address each of the asset quality standards, as 
appropriate, and not focus solely on problem assets. In response to the 
comment about the redundant earnings standards, the final rule combines 
the two standards concerning the nonrecurring income and sustainability 
of income. The agencies agree that these standards need not be listed 
separately, given the significant overlap in what they address. A 
discussion of the remaining comments follows.
    Impact on examinations and ratings. The guidelines will not change 
the examination process or the determination of CAMEL ratings. These 
guidelines represent the agencies' longstanding expectation regarding 
an institution's management of asset quality and earnings, and, as 
such, will not require a change in the agencies' examination procedures 
or the determination of an institution's rating.
    Definition of peer group. The agencies recognize that defining a 
peer group

[[Page 43950]]

necessarily entails making decisions about which criteria to use. The 
guidelines identify equity and asset data as two commonly used 
benchmarks in defining a peer group and expressly state that an 
institution may use other commonly used benchmarks. The agencies will 
be flexible in permitting institutions to select criteria reasonably 
designed to provide a meaningful peer group comparison.
    Quantitative standards. The agencies have decided against returning 
to quantitative standards in lieu of, or in addition to, the standards 
proposed. The agencies believe the standards contained in the final 
guidelines will encourage the adoption of practices that are consistent 
with safe and sound banking practices and that are appropriate for a 
given institution. Moreover, the agencies believe that these standards 
will be more effective than quantitative standards would be in helping 
identify emerging problems in a financial institution. However, even 
though the agencies are not adopting quantitative standards, the 
agencies will continue to analyze asset quality ratios and earnings 
levels, and trends thereof, in assessing an institution.

IV. Regulatory Flexibility Act

    Pursuant to section 605(b) of the Regulatory Flexibility Act, 5 
U.S.C. 605(b), the agencies hereby certify that these guidelines will 
not have a significant economic impact on a substantial number of small 
entities. Accordingly, a regulatory flexibility analysis is not 
required. As is explained more fully in the preamble to these 
guidelines, the guidelines are designed to illustrate what the agencies 
consider to be steps that are consistent with safe and sound banking 
practices while preserving flexibility for an institution to adopt a 
system that is appropriate for its circumstances.

V. Executive Order 12866

    The OCC and OTS have determined that these final guidelines are not 
significant regulatory actions for purposes of Executive Order 12866.

VI. OCC and OTS: Unfunded Mandates Reform Act of 1995 Statement

    Section 202 of the Unfunded Mandates Reform Act of 1995, Pub. L. 
104-4 (Unfunded Mandates Act) requires that an agency prepare a 
budgetary impact statement before promulgating any rule likely to 
result in a Federal mandate that may result in the expenditure by 
State, local, and tribal governments, in the aggregate, or by the 
private sector of $100 million or more in any one year. If a budgetary 
impact statement is required, section 205 of the Unfunded Mandates Act 
also requires an agency to identify and consider a reasonable number of 
regulatory alternatives before promulgating a rule. The OCC and OTS 
have determined that the final guidelines will not result in 
expenditures by State, local, and tribal governments, or by the private 
sector, of $100 million or more in any one year. Accordingly, the OCC 
and the OTS have not prepared a budgetary impact statement or 
specifically addressed any regulatory alternatives. As discussed in the 
preamble, the final guidelines represent the standards applied by the 
agencies in examining insured depository institutions, and, therefore, 
represent no change in the agencies' policies and impose minimal new 
Federal requirements.

List of Subjects

12 CFR Part 30

    Administrative practice and procedure, National banks, Reporting 
and recordkeeping requirements, Safety and soundness.

12 CFR Part 208

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

12 CFR Part 364

    Administrative practice and procedure, Bank deposit insurance, 
Banks, banking, Reporting and recordkeeping requirements, Safety and 
soundness.

12 CFR Part 570

    Accounting, Administrative practices and procedures, Bank deposit 
insurance, Holding companies, Reporting and recordkeeping requirements, 
Savings associations, Safety and soundness.

Office of the Comptroller of the Currency

12 CFR CHAPTER I

Authority and Issuance

    For the reasons set forth in the joint preamble, part 30 of chapter 
I of title 12 of the Code of Federal Regulations is amended as follows:

PART 30--SAFETY AND SOUNDNESS STANDARDS

    1. The authority citation for part 30 is revised to read as 
follows:

    Authority: 12 U.S.C. 93a, 1831p-1.

    2. The table of contents of appendix A to part 30 is amended by 
adding entries for II.G. and II.H. to read as follows:

Appendix A to Part 30--Interagency Guidelines Establishing 
Standards for Safety and Soundness

Table of Contents

* * * * *
    II. * * *
    G. Asset quality.
    H. Earnings.
* * * * *
    3. Item II of appendix A to part 30 is amended by adding paragraphs 
G and H to read as follows:
* * * * *

II. Operational and Managerial Standards

* * * * *
    G. Asset quality. An insured depository institution should 
establish and maintain a system that is commensurate with the 
institution's size and the nature and scope of its operations to 
identify problem assets and prevent deterioration in those assets. The 
institution should:
    1. Conduct periodic asset quality reviews to identify problem 
assets;
    2. Estimate the inherent losses in those assets and establish 
reserves that are sufficient to absorb estimated losses;
    3. Compare problem asset totals to capital;
    4. Take appropriate corrective action to resolve problem assets;
    5. Consider the size and potential risks of material asset 
concentrations; and
    6. Provide periodic asset reports with adequate information for 
management and the board of directors to assess the level of asset 
risk.
    H. Earnings. An insured depository institution should establish and 
maintain a system that is commensurate with the institution's size and 
the nature and scope of its operations to evaluate and monitor earnings 
and ensure that earnings are sufficient to maintain adequate capital 
and reserves. The institution should:
    1. Compare recent earnings trends relative to equity, assets, or 
other commonly used benchmarks to the institution's historical results 
and those of its peers;
    2. Evaluate the adequacy of earnings given the size, complexity, 
and risk profile of the institution's assets and operations;
    3. Assess the source, volatility, and sustainability of earnings, 
including the effect of nonrecurring or extraordinary income or 
expense;
    4. Take steps to ensure that earnings are sufficient to maintain 
adequate

[[Page 43951]]

capital and reserves after considering the institution's asset quality 
and growth rate; and
    5. Provide periodic earnings reports with adequate information for 
management and the board of directors to assess earnings performance.
* * * * *
    Dated: May 21, 1996.
Eugene A. Ludwig,
Comptroller of the Currency.

Federal Reserve System

12 CFR CHAPTER II

Authority and Issuance

    For the reasons set forth in the joint preamble, part 208 of 
chapter II of title 12 of the Code of Federal Regulations is amended as 
follows:

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) and (c), 321-338, 461, 481, 
486, 601, 611, 1814, 1823(j), 1831o, 1831p-1, 3906, 3909, 3310, 
3331-3351, 15 U.S.C. 78b, 78o-4(c)(5), 78q, 78q-1, 78w, 781(b), 
781(i), and 1781(g).

    2. The table of contents of appendix D to part 208 is amended by 
adding entries for II.G. and II.H. to read as follows:

Appendix D to Part 208--Interagency Guidelines Establishing Standards 
for Safety and Soundness

Table of Contents

* * * * *
    II. * * *
    G. Asset quality.
    H. Earnings.
* * * * *
    3. Item II of appendix D to part 208 is amended by adding 
paragraphs G and H to read as follows:
* * * * *

II. Operational and Managerial Standards

* * * * *
    G. Asset quality. An insured depository institution should 
establish and maintain a system that is commensurate with the 
institution's size and the nature and scope of its operations to 
identify problem assets and prevent deterioration in those assets. The 
institution should:
    1. Conduct periodic asset quality reviews to identify problem 
assets;
    2. Estimate the inherent losses in those assets and establish 
reserves that are sufficient to absorb estimated losses;
    3. Compare problem asset totals to capital;
    4. Take appropriate corrective action to resolve problem assets;
    5. Consider the size and potential risks of material asset 
concentrations; and
    6. Provide periodic asset reports with adequate information for 
management and the board of directors to assess the level of asset 
risk.
    H. Earnings. An insured depository institution should establish and 
maintain a system that is commensurate with the institution's size and 
the nature and scope of its operations to evaluate and monitor earnings 
and ensure that earnings are sufficient to maintain adequate capital 
and reserves. The institution should:
    1. Compare recent earnings trends relative to equity, assets, or 
other commonly used benchmarks to the institution's historical results 
and those of its peers;
    2. Evaluate the adequacy of earnings given the size, complexity, 
and risk profile of the institution's assets and operations;
    3. Assess the source, volatility, and sustainability of earnings, 
including the effect of nonrecurring or extraordinary income or 
expense;
    4. Take steps to ensure that earnings are sufficient to maintain 
adequate capital and reserves after considering the institution's asset 
quality and growth rate; and
    5. Provide periodic earnings reports with adequate information for 
management and the board of directors to assess earnings performance.
* * * * *
    By order of the Board of Governors of the Federal Reserve 
System, June 14th, 1996.
William W. Wiles,
Secretary of the Board.

Federal Deposit Insurance Corporation

12 CFR CHAPTER III

Authority and Issuance

    For the reasons set forth in the joint preamble, part 364 of 
chapter III of title 12 of the Code of Federal Regulations is amended 
as follows:

PART 364--STANDARDS FOR SAFETY AND SOUNDNESS

    1. The authority citation for part 364 continues to read as 
follows:

    Authority: 12 U.S.C. 1819 (Tenth), 1831p-1.

    2. The table of contents of appendix A to part 364 is amended by 
adding entries for II.G. and II.H. to read as follows:

Appendix A to Part 364--Interagency Guidelines Establishing Standards 
for Safety and Soundness

Table of Contents

* * * * *
    II. * * *
    G. Asset quality.
    H. Earnings.
* * * * *
    3. Item II of appendix A to part 364 is amended by adding 
paragraphs G and H to read as follows:
 * * * * *

II. Operational and Managerial Standards

* * * * *
    G. Asset quality. An insured depository institution should 
establish and maintain a system that is commensurate with the 
institution's size and the nature and scope of its operations to 
identify problem assets and prevent deterioration in those assets. The 
institution should:
    1. Conduct periodic asset quality reviews to identify problem 
assets;
    2. Estimate the inherent losses in those assets and establish 
reserves that are sufficient to absorb estimated losses;
    3. Compare problem asset totals to capital;
    4. Take appropriate corrective action to resolve problem assets;
    5. Consider the size and potential risks of material asset 
concentrations; and
    6. Provide periodic asset reports with adequate information for 
management and the board of directors to assess the level of asset 
risk.
    H. Earnings. An insured depository institution should establish and 
maintain a system that is commensurate with the institution's size and 
the nature and scope of its operations to evaluate and monitor earnings 
and ensure that earnings are sufficient to maintain adequate capital 
and reserves. The institution should:
    1. Compare recent earnings trends relative to equity, assets, or 
other commonly used benchmarks to the institution's historical results 
and those of its peers;
    2. Evaluate the adequacy of earnings given the size, complexity, 
and risk profile of the institution's assets and operations;
    3. Assess the source, volatility, and sustainability of earnings, 
including the effect of nonrecurring or extraordinary income or 
expense;
    4. Take steps to ensure that earnings are sufficient to maintain 
adequate capital and reserves after considering the institution's asset 
quality and growth rate; and

[[Page 43952]]

    5. Provide periodic earnings reports with adequate information for 
management and the board of directors to assess earnings performance.
* * * * *
    By order of the Board of Directors.

    Dated at Washington, D.C. this 13th day of August 1996.

Federal Deposit Insurance Corporation.
Jerry L. Langley,
Executive Secretary.

Office of Thrift Supervision

12 CFR CHAPTER V

Authority and Issuance

    For the reasons set forth in the joint preamble, part 570 of 
chapter V of title 12 of the Code of Federal Regulations is amended as 
follows:

PART 570--SUBMISSION AND REVIEW OF SAFETY AND SOUNDNESS COMPLIANCE 
PLANS AND ISSUANCE OF ORDERS TO CORRECT SAFETY AND SOUNDNESS 
DEFICIENCIES

    1. The authority citation for part 570 continues to read as 
follows:

    Authority: 12 U.S.C. 1831p-1.

    2. The table of contents of appendix A to part 570 is amended by 
adding entries for II.G. and II.H. to read as follows:

Appendix A to Part 570--Interagency Guidelines Establishing 
Standards for Safety and Soundness

Table of Contents

* * * * *
    II. * * *
    G. Asset quality.
    H. Earnings.
* * * * *
    3. Item II of appendix A to part 570 is amended by adding 
paragraphs G and H to read as follows:
 * * * * *

II. Operational and Managerial Standards

* * * * *
    G. Asset quality. An insured depository institution should 
establish and maintain a system that is commensurate with the 
institution's size and the nature and scope of its operations to 
identify problem assets and prevent deterioration in those assets. The 
institution should:
    1. Conduct periodic asset quality reviews to identify problem 
assets;
    2. Estimate the inherent losses in those assets and establish 
reserves that are sufficient to absorb estimated losses;
    3. Compare problem asset totals to capital;
    4. Take appropriate corrective action to resolve problem assets;
    5. Consider the size and potential risks of material asset 
concentrations; and
    6. Provide periodic asset reports with adequate information for 
management and the board of directors to assess the level of asset 
risk.
    H. Earnings. An insured depository institution should establish and 
maintain a system that is commensurate with the institution's size and 
the nature and scope of its operations to evaluate and monitor earnings 
and ensure that earnings are sufficient to maintain adequate capital 
and reserves. The institution should:
    1. Compare recent earnings trends relative to equity, assets, or 
other commonly used benchmarks to the institution's historical results 
and those of its peers;
    2. Evaluate the adequacy of earnings given the size, complexity, 
and risk profile of the institution's assets and operations;
    3. Assess the source, volatility, and sustainability of earnings, 
including the effect of nonrecurring or extraordinary income or 
expense;
    4. Take steps to ensure that earnings are sufficient to maintain 
adequate capital and reserves after considering the institution's asset 
quality and growth rate; and
    5. Provide periodic earnings reports with adequate information for 
management and the board of directors to assess earnings performance.
* * * * *
    Dated: June 3, 1996.
John F. Downey,
Executive Director, Supervision.
[FR Doc. 96-21590 Filed 8-26-96; 8:45 am]
BILLING CODE 4810-33-P, 6210-01-P, 6714-01-P, 6720-01-P