[Federal Register Volume 62, Number 92 (Tuesday, May 13, 1997)]
[Notices]
[Pages 26355-26362]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-12515]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency
[Docket Number 97-12]


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

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

ACTION: Report to the Committee on Banking, Housing, and Urban Affairs 
of the United States Senate and to the Committee on Banking and 
Financial Services of the United States House of Representatives 
regarding differences in capital and accounting standards among the 
federal banking and thrift agencies.

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SUMMARY: The Office of the Comptroller of the Currency (OCC) has 
prepared this report as required by the Federal Deposit Insurance 
Corporation Improvement Act of 1991 (FDICIA). FDICIA requires the OCC 
to provide a report to Congress on any differences in capital standards 
among the federal financial regulatory agencies. This notice is 
intended to satisfy the FDICIA requirement that the report be published 
in the Federal Register.

FOR FURTHER INFORMATION CONTACT: Roger Tufts, Senior Economic Advisor, 
Office of the Chief National Bank Examiner (202) 874-5070, Eugene 
Green, Deputy Chief Accountant, Office of the Chief Accountant (202) 
874-4933, or Ronald Shimabukuro, Senior Attorney, Legislative and 
Regulatory Activities Division, (202) 874-5090, Office of the 
Comptroller of the Currency, 250 E Street, S.W., Washington, DC 20219.

SUPPLEMENTARY INFORMATION:

Differences in Capital and Accounting Standards Among the Federal 
Banking and Thrift Agencies

Report to the Committee on Banking, Housing, and Urban Affairs of the 
United States Senate and to the Committee on Banking and Financial 
Services of the United States House of Representatives

Submitted by the Office of the Comptroller of the Currency
    This report 1 describes the differences among the 
capital requirements of the Office of the Comptroller of the Currency 
(OCC) and those of the Board of Governors of the Federal Reserve System 
(FRB), the Federal Deposit Insurance Corporation (FDIC) and the Office 
of Thrift Supervision (OTS).2 The report is divided into 
four sections. The first section provides a short overview of the 
current capital requirements; the second section discusses the 
differences in the capital standards; the third section briefly 
discusses recent efforts of the Agencies to promote more consistent 
capital standards; and the fourth section discusses the differences in 
accounting standards related to capital. The report covers developments 
through December 31, 1996.
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    \1\ This report is made pursuant to section 121 of the Federal 
Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), Pub. 
L. 102-242, 105 Stat. 2236 (December 19, 1991), 12 U.S.C. 1831n(c). 
Section 121 of FDICIA supersedes section 1215 of the Financial 
Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), 
Pub. L. 101-73, 103 Stat. 183 (August 9, 1989), which imposed 
similar reporting requirement and was repealed.
    \2\ The OCC is the primary supervisor of national banks. Bank 
holding companies and state-chartered banks that are members of the 
Federal Reserve System are supervised by the FRB. State-chartered 
nonmember banks are supervised by the FDIC. The OTS supervises 
savings associations and savings and loan holding companies. In this 
report, the term ``Banking Agencies'' refers to the OCC, FRB and the 
FDIC; the term ``Agencies'' refers to all four of the agencies, 
including the OTS.
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A. Overview of the Risk-Based Capital Standards

    Since the adoption of the risk-based capital guidelines in 1989, 
all of the Agencies have applied similar capital standards to the 
institutions they supervise. The risk-based capital guidelines 
implement the Accord on International Convergence of Capital 
Measurement and Capital Standards adopted in July, 1988, by the Basle 
Committee on Banking Regulations and Supervisory Practices (Basle 
Accord).
    The risk-based capital guidelines establish a framework for 
imposing capital requirements generally based on credit risk. Under the 
risk-based capital guidelines, balance sheet assets and off-balance 
sheet items are categorized, or ``risk-weighted,'' according to the 
relative degree of credit risk inherent in the asset or off-balance 
sheet item. The risk-based capital guidelines specify four risk-weight 
categories--zero percent, 20 percent, 50 percent, and 100 percent. 
Assets or off-balance sheet items with the lowest levels of credit risk 
are risk-weighted in the lowest risk weight category; those presenting 
greater levels of credit risk receive a higher risk weight. Thus, for 
example, securities issued by the U.S. government are risk-weighted at 
zero percent; one- to four-family home mortgages are risk-weighted at 
50 percent; unsecured commercial loans are risk-weighted at 100 
percent.
    Off-balance sheet items must first be translated into an on-
balance-sheet credit equivalent amount by applying the conversion 
factors, or multipliers, that are specified in the risk-based capital 
guidelines of the Agencies. This credit equivalent amount is then 
assigned to one of the four risk-weight categories. For example, a bank 
may extend to its customer a line of credit that the customer may 
borrow against for up to two years. The unused portion of this two year 
line of credit--that is, the amount of available credit that the 
customer has not borrowed--is carried as an off-balance sheet item. 
Under the agencies' risk-based capital guidelines, this unused portion 
is translated to an on-balance-sheet credit equivalent amount by 
applying a 50 percent conversion factor, and the resulting amount is 
then assigned to the 100 percent risk-weight category based on the 
credit risk of the counterparty.
    Once all the assets and off-balance sheet items have been risk-
weighted, the

[[Page 26356]]

total amount of all risk-weighted assets and off-balance sheet items is 
used to determine the total amount of capital required for that 
institution. Specifically, the risk-based capital guidelines of the 
Agencies require each institution to maintain a ratio of total capital 
to risk-weighted assets of 8 percent.
    Total capital is comprised of two components--Tier 1 capital (core 
capital) and Tier 2 capital (supplementary capital).3 Tier 1 
capital includes common stockholders' equity, noncumulative perpetual 
preferred stock and related surplus, and minority interests in 
consolidated subsidiaries. Tier 2 capital includes the allowance for 
loan and lease losses, certain types of preferred stock, some hybrid 
capital instruments, and certain subordinated debt. These Tier 2 
capital instruments, as well as the total amount of Tier 2 capital, are 
subject to limitations and conditions provided by the risk-based 
capital guidelines of the Agencies. In addition, the risk-based capital 
guidelines also require the deduction of certain assets from either 
Tier 1 capital or total capital. For example, as described in section 
B(6), all goodwill must be deducted from Tier 1 capital.
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    \3\ In addition to Tier 1 and Tier 2 capital, the risk-based 
capital guidelines of the Banking Agencies also permit certain banks 
to hold limited amounts of Tier 3 capital to satisfy market risk 
requirements. See section C(2) for further discussion.
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    Institutions generally are expected to hold capital above the 
required minimum level, and most institutions usually do exceed minimum 
risk-based capital requirement. For example, most national banks 
currently hold capital in excess of 10 percent of risk-weighted 
assets.4 However, in addition to the risk-based capital 
requirement, the Agencies also impose a leverage capital requirement, 
expressed as the percentage of Tier 1 capital to total assets. Unlike 
the risk-based capital ratio, the leverage capital ratio is based on 
total assets, not total risk-weighted assets. This means that the 
leverage capital ratio is computed without regard to the risk-weight 
categories assigned to the assets and without including off-balance 
sheet items.
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    \4\ In addition to the risk-based capital guidelines, the 
Agencies have issued regulations implementing the prompt corrective 
action (PCA) provisions of the Federal Deposit Insurance Corporation 
Improvement Act of 1991 (FDICIA). FDICIA requires that the Agencies 
take certain supervisory actions if an institution's capital 
declines to unacceptable levels. See 12 U.S.C. 1831o. As required by 
the statute, the PCA regulations establish four capital categories 
that are defined in terms of three separate capital measures (the 
risk-based capital ratio, the leverage ratio, and the ratio of Tier 
1 capital to risk-weighted assets). These four categories are: well 
capitalized, adequately capitalized, undercapitalized, and 
significantly undercapitalized. By way of illustration, an 
institution is well capitalized if its risk-based capital ratio is 
10 percent or greater; its leverage ratio is 5 percent or greater; 
and its ratio of Tier 1 capital to risk-weighted assets is 6 percent 
or greater. A fifth PCA category--critically undercapitalized--is 
defined, as the statute requires, as a 2 percent ratio of tangible 
equity to total assets. See 12 CFR Part 6 (1996) (the OCC's prompt 
corrective action regulations).
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B. Remaining Differences in Capital Standards of the Agencies

    Although the Agencies have adopted common leverage capital 
requirements and risk-based capital guidelines, there remain some 
technical differences in language and interpretation of the capital 
standards. These differences are described in this section. Some of 
these differences, however, may be eliminated through an interagency 
rulemaking conducted pursuant to section 303 of the Riegle Community 
Development and Regulatory Improvement Act of 1994 (CDRI 
Act).5 The items in this section for which the Agencies have 
agreed to propose uniform treatment are marked with an asterisk (*) and 
further discussed in section C(1)(i) of this report.
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    \5\ Pub. L. 103-325, section 303, 108 Stat. 2160, 2215 (1994) 
(codified at 12 U.S.C. 1835). Section 303(a)(2) required that the 
Agencies ``work jointly * * * to make uniform all regulations and 
guidelines implementing common statutory or supervisory policies.'' 
See also Board of Governors of the Federal Reserve System, Federal 
Deposit Insurance Corporation, Office of the Comptroller of the 
Currency, and the Office of Thrift Supervision, Joint Report: 
Streamlining of Regulatory Requirements (September 23, 1996) 
(Progress report submitted by the Agencies to the Congress pursuant 
to section 303(a)(3) of the CDRI Act).
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1. Leverage Capital Requirements*

    Under the OCC leverage capital requirement, highly-rated banks 
(composite CAMELS 6 rating of 1) must maintain a minimum 
leverage capital ratio of at least 3 percent of Tier 1 capital to total 
assets. All other banks must maintain an additional 100 to 200 basis 
points of Tier 1 capital to total assets. The OCC leverage capital 
requirement is the same as the rules of the other Banking Agencies.
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    \6\ On December 9, 1996, the Federal Financial Institutions 
Examination Council (FFIEC) adopted the revised Uniform Financial 
Institutions Rating System (UFIRS or CAMELS rating system). The 
UFIRS is an internal rating system used by the federal and state 
banking regulators for assessing the soundness of financial 
institutions on a uniform basis and for identifying those insured 
institutions requiring special supervisory attention. Among other 
things, the revised UFIRS added a sixth ``S'' component called 
``Sensitivity to Market Risk'' to the CAMELS rating system. This 
change reflects an increased emphasis by the Agencies on the quality 
of risk management practices. A final notice was published in the 
Federal Register on December 19, 1996, effective January 1, 1997. 
See 61 FR 67021 (December 19, 1996).
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    Saving associations are subject to a leverage ratio requirement of 
3 percent of core capital 7 to adjusted total assets and a 
tangible capital requirement of 1.5 percent of total assets. The OTS 
has not yet adopted a final rule to amend its leverage ratio 
requirement to be consistent with the leverage ratio requirements of 
the other Banking Agencies. See 56 FR 16238 (April 22, 1991). OTS 
regulated institutions, however, must satisfy the same percentage 
requirements for leverage capital as banks in order to be considered 
adequately capitalized for purposes of the PCA standards applicable to 
all insured depository institutions. See 12 U.S.C. 1831o.
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    \7\ While the definition of core capital is generally consistent 
with the definition of Tier 1 capital, there are some differences. 
Mutual savings associations may include certain nonwithdrawable 
accounts and pledged deposits as core capital. In addition, under 
section 221 of FIRREA, 12 U.S.C. 1828(n), qualifying supervisory 
goodwill was permitted to be included in core capital for savings 
associations; however, supervisory goodwill was phased out of core 
capital at the end of 1994.
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2. Equity Investments

    To the extent that a bank is permitted to hold equity securities 
(such as securities obtained in connection with debts previously 
contracted), the OCC risk-based capital guidelines generally require 
these investments to be risk weighted at 100 percent. However, on a 
case-by-case basis, the OCC may require deduction of equity investments 
from the capital of the parent bank or impose other requirements in 
order to assess an appropriate capital charge above the minimum capital 
requirements. The other Banking Agencies have similar rules. The 
capital treatment of equity investments is also discussed in section 
B(5) of this report.
    After the enactment of FIRREA, savings associations were required 
to deduct equity investments that are impermissible for national banks 
from capital gradually during a phase-in period. The phase-in period 
ended July 1, 1996.

3. Assets subject to Guarantee Arrangements by the Federal Savings and 
Loan Insurance Corporation (FSLIC)/Federal Deposit Insurance 
Corporation

    The OCC risk-based capital guidelines assign assets with FSLIC or 
FDIC guarantees to the 20 percent risk-weight category, the same 
category to which claims on depository institutions and government-
sponsored agencies are assigned. The other Banking Agencies also assign 
these assets to the 20 percent weight category. The OTS assigns these

[[Page 26357]]

assets to the zero percent risk-weight category.

4. Limitation on Subordinated Debt and Limited-Life Preferred Stock

    The OCC limits the amount of Tier 2 capital that may be included in 
total capital to no more than 100 percent of Tier 1 capital. Consistent 
with the Basle Accord, the OCC further limits the amount of 
subordinated debt and limited-life preferred stock that may be included 
in Tier 2 capital to 50 percent of Tier 1 capital. In addition, the OCC 
risk-based capital guidelines require that subordinated debt and 
limited-life preferred stock be discounted 20 percent in each of the 
five years prior to maturity. The other Banking Agencies have similar 
rules.
    The OTS risk-based capital rules also limit Tier 2 capital to 100 
percent of Tier 1 capital, but do not contain any sublimit on the total 
amount of limited-life instruments that may be included within Tier 2 
capital. In addition, the OTS allows savings associations the option of 
either (1) discounting maturing capital instruments (issued on or after 
November 7, 1989) by 20 percent a year over the last five years of 
their term, 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 total capital of the savings association.

5. Subsidiaries*

    Consistent with the Basle Accord, the Banking Agencies generally 
require that significant 8 majority-owned subsidiaries be 
consolidated with the parent institution for both regulatory reporting 
and capital purposes. If a subsidiary is not consolidated, the bank's 
investment in the subsidiary constitutes a capital investment in the 
subsidiary. The OCC risk-based capital guidelines specifically provide 
that capital investments in an unconsolidated banking or financial 
subsidiary must be deducted from the total capital of the bank. The OCC 
risk-based capital guidelines also permit the OCC to require the 
deduction of investments in other subsidiaries and associated companies 
on a case-by-case basis. In addition, Part 5 of the OCC's regulations 
requires deconsolidation of any subsidiary that engages as principal in 
activities not permitted to be conducted in the bank directly, and 
requires the bank's equity investment in that subsidiary to be deducted 
from the capital of the bank. See 61 FR 60342 (November 27, 1996).
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    \8\ A significant majority-owned subsidiary is a subsidiary in 
which the investment by the parent bank represents a significant 
financial interest of the parent bank as evidenced by (1) the bank 
investment or advances to the subsidiary equals 5 percent or more of 
the total equity capital of the bank, (2) the bank's proportional 
share of the gross income or revenue of the subsidiary equals 5 
percent or more of the gross income or revenue of the bank, (3) the 
income (or loss before taxes) of the subsidiary amount to 5 percent 
or more of the income (or loss before taxes) of the bank, or (4) the 
subsidiary is the parent of a subsidiary that is considered a 
significant subsidiary.
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    The FRB risk-based capital guidelines for state member banks 
generally require the deduction of investments in unconsolidated 
banking and finance subsidiaries. The FRB may require an investment in 
unconsolidated subsidiaries other than banking and finance subsidiaries 
or joint ventures and associated companies, (1) to be deducted, (2) to 
be appropriately risk-weighted against the proportionate share of the 
assets of the entity, or (3) to be consolidated line-by-line with the 
entity. In addition, the FRB may require the parent organization to 
maintain capital above the minimum standard sufficient to compensate 
for any risks associated with the investment.
    The FRB risk-based capital guidelines also explicitly permit the 
deduction of investments in certain subsidiaries that, while 
consolidated for accounting purposes, are not consolidated for certain 
specified supervisory or regulatory purposes. For example, the FRB 
deducts investments in, and unsecured advances to, ``Section 20'' 
securities subsidiaries from the capital of the parent bank holding 
company.
    The FDIC accords similar treatment to certain type of securities 
subsidiaries of state-chartered nonmember banks. Moreover, under the 
FDIC rules, investments in, and extensions of credit to, certain 
mortgage banking subsidiaries are also deducted in computing the 
capital of the parent bank. Neither the OCC nor the FRB has a similar 
requirement with regard to mortgage banking subsidiaries.
    Under OTS risk-based capital guidelines, a distinction is made 
between saving associations subsidiaries engaged in activities 
permissible for national banks and their subsidiaries and saving 
association subsidiaries engaged in activities ``impermissible'' for 
national banks. This distinction is mandated by FIRREA. Subsidiaries of 
savings associations that engage only in activities permissible for 
national banks are consolidated on a line-for-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 national bank-impermissible activities are 
deducted in computing tangible and core capital of the parent 
association. The remaining assets (the percent of assets corresponding 
to the nondeducted portion of the investment in the subsidiary) are 
consolidated with the assets of the parent association. However, 
investments, including loans outstanding as of April 12, 1989, to 
subsidiaries that were engaged in impermissible activities prior to 
that date, are grandfathered. These investments were required to be 
phased-out of capital by July 1, 1994; however, the transition period 
for investments made prior to April 12, 1989, in nonincludable real 
estate subsidiaries could be extended, in certain circumstances, to 
July 1, 1996. See 12 U.S.C. 1464(t)(5)(D). During this transition 
period, investments in subsidiaries engaged in impermissible activities 
that had not been phased out of capital were consolidated on a pro rata 
basis.

6. Nonresidential Construction and Land Loans

    Under the OCC risk-based capital guidelines, loans for real estate 
development and construction are assigned to the 100 percent risk-
weight category. Reserves or charge-offs are required for such loans 
when weaknesses or losses develop. The OCC has 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 other Banking 
Agencies have similar rules.
    OTS generally also assigns these loans to the 100 percent risk-
weight category. However, if the amount of the loan exceeds 80 percent 
of the fair value of the property, savings associations must deduct the 
full amount of the excess portion from total capital.9
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    \9\ Prior to July 1, 1994, only a percentage (as provided by a 
phase-in schedule) of the excess portion was required to be deducted 
from total capital.
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7. Mortgage-Backed Securities (MBS)

    The OCC risk-based capital guidelines generally assign a risk 
weight to privately-issued MBSs according to the underlying assets, but 
in no case is a privately-issued MBS assigned to the zero percent risk-
weight category. Privately-issued MBSs, where the direct underlying 
assets are mortgages, are generally assigned 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-weight 
category. The other Banking Agencies have similar rules.

[[Page 26358]]

    Similarly, the OTS assigns privately issued MBSs backed by 
securities issued or guaranteed by government agencies or government-
sponsored enterprises to the 20 percent risk-weight category. However, 
unlike the Banking Agencies, the OTS also assigns certain privately-
issued high quality mortgage-related securities with AA or better 
investment ratings to the 20 percent risk-weight category. Like the 
Banking Agencies, the OTS does not assign any privately issued MBS to 
the zero percent category.
    With respect to other MBSs, the Agencies 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.

8. Agricultural Loan Loss Amortization

    In determining 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, 1991.10 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 and 
agricultural personal property. These losses must be fully amortized 
over a period not to exceed seven years and, in any case, must be fully 
amortized by year-end 1998. Savings associations are not eligible to 
participate in the agricultural loan loss amortization program 
established by this statute.
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    \10\ This program will sunset January 1, 1999. See 60 FR 27401 
(May 24, 1995).
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9. Treatment of Junior Liens on One- to Four-Family Properties*

    In some cases, a banking organization may make two loans secured by 
the same residential property; one loan is secured by a first lien, the 
other by a second lien. The OCC and the FDIC generally assign first 
liens on one-to four-family properties to the 50 percent risk-weight 
category. The assignment of first lien mortgages to the 50 percent 
risk-weight category is based upon the expectation that banks will 
adhere to the requirement for prudent underwriting standards with 
respect to the maximum loan-to-value ratio, the borrower's paying 
capacity and the long-term expectations for the real estate market in 
which the bank is lending.
    The OCC assigns all second liens on residential property to the 100 
percent risk-weight category, regardless of whether the institution 
also holds the first lien. The FDIC similarly assigns all second liens 
to the 100 percent risk-weight category. However, in determining the 
risk-weight of the first lien, the FDIC considers the first and second 
liens together to assess whether the first lien satisfies prudent 
underwriting standards. When evaluated together, if the first and 
second liens are within the prudent loan-to-value ratio and satisfy all 
other underwriting standards, then the first lien will be assigned to 
the 50 percent risk-weight category; otherwise, it will be assigned to 
the 100 percent risk-weight category.
    The FRB and OTS consider the first and second liens as a single 
loan, provided there are no intervening liens. Therefore, the total 
amount of these transactions may be assigned to the 100 percent risk-
weight category, if, in the aggregate, the two loans exceed a prudent 
loan-to-value ratio and, therefore, do not qualify for the 50 percent 
risk-weight category. This approach is intended to avoid possible 
circumvention of the capital requirements and capture the risks 
associated with the combined transactions. However, if the total amount 
of the transaction does satisfy a prudent loan-to-value ratio and other 
underwriting standards, then both the first and second liens may be 
assigned to the 50 percent risk-weight category.

10. Pledged Deposits and Nonwithdrawable Accounts

    Pledged deposits and nonwithdrawable accounts that satisfy 
specified OTS criteria may be included in core capital by mutual 
savings associations. Pledged deposits and nonwithdrawable accounts 
generally represent capital investments in mutual saving associations 
under the same terms as perpetual noncumulative preferred stock. These 
mutual saving associations accept capital investments in the form of 
pledged deposits and nonwithdrawable accounts because mutual 
associations are not legally authorized to issue common or preferred 
stock. Income capital certificates and mutual capital certificates that 
were issued by savings associations under applicable statutory 
authority and regulations and held by the FDIC may be included in Tier 
2 capital by savings associations.
    These instruments are unique to savings associations and are not 
held by commercial banks. Consequently, these instruments are not 
addressed in the OCC risk-based capital guidelines.

11. Mutual Funds*

    The OCC and the other Banking Agencies generally assign all of the 
holdings of a bank in a mutual fund to the risk category appropriate to 
the asset with the highest risk that a particular mutual fund is 
permitted to hold under its operating rules. This approach takes into 
account the maximum degree of risk to which a bank may be exposed when 
investing in a mutual fund. On a case-by-case basis, however, the OCC 
may permit a bank to risk weight the investments in a mutual fund on a 
pro rata basis relative to the maximum risk weights of the assets the 
mutual fund is permitted to hold but limited to no lower than a 20 
percent risk weight.
    The OTS applies a capital charge based on the riskiest asset that 
is actually held by the mutual fund at a particular time. In addition, 
the OTS and OCC guidelines also permit, on a case-by-case basis, 
investments in mutual funds to be risk weighted on a pro rata basis 
dependent on the actual composition of the fund.

12. Collateralized Transactions*

    Both the OCC and FRB permit certain loans and transactions 
collateralized by cash and OECD government securities to qualify for a 
zero percent risk weight. The FDIC and OTS risk weight loans and 
transactions collateralized by cash and OECD government securities at 
20 percent. See discussion in section C(1)(i) of this report.

C. Recent Interagency Rulemaking Projects

    The three Banking Agencies have amended their capital adequacy 
rules in several significant ways since they were originally adopted. 
First, the credit risk framework of the risk-based capital guidelines 
has been expanded to cover derivative contracts. Second, the risk-based 
capital guidelines have been amended to incorporate a market risk 
component which serves to supplement credit risk. Third, all four 
Agencies have added an interest rate risk component to their capital 
adequacy rules. In amending the capital adequacy rules, the practice of 
the Agencies is to consult closely with one another even in instances 
where joint rulemaking is not statutorily required. This ensures that 
all insured depository institutions are subject to the same standards 
to the maximum extent feasible. The following describes the most 
significant rulemaking projects undertaken during the period covered by 
this report.

[[Page 26359]]

1. Amendments to the Risk-Based Capital Credit Risk Framework

    This section discusses regulatory efforts of the Agencies to amend 
the credit risk framework of the risk-based capital guidelines.
a. Expanded Matrix for Derivative Contracts
    On September 5, 1995, the OCC and the other Banking Agencies issued 
a joint final rule on derivative contracts which amended the risk-based 
capital guidelines to cover derivative contracts. See 60 FR 46170 
(September 5, 1995); see also 59 FR 45243 (September 1, 1994) (OCC 
proposed rule). Specifically, the rule expanded and revised the set of 
off-balance sheet credit conversion factors used to calculate the 
potential future credit exposure on derivative contracts and permitted 
banks to net multiple derivative contracts executed with a single 
counterparty that are subject to a qualifying bilateral netting 
contract when calculating the potential future credit exposure.
b. Membership in the Organization for Economic Cooperation and 
Development (OECD)
    Under the risk-based capital guidelines, claims on, or guarantees 
by, certain entities in OECD-based countries generally are subject to a 
lower capital charge. See 12 CFR Part 3, Appendix A 3(a)(1)(iii) 
(securities issued by the United States or the central government of an 
OECD country subject to zero percent risk weight). On December 20, 
1995, the OCC and the other Banking Agencies amended the definition of 
``OECD-based country'' to exclude any country that has rescheduled its 
external sovereign debt within the previous five years. See 60 FR 66042 
(December 20, 1995). This rule was issued in response to a change by 
the Basle Committee on Banking Regulations and Supervisory Practices to 
the Basle Accord.
c. Unrealized Gains and Losses on Securities Available for Sale
    The Agencies have all issued final rules on unrealized gains and 
losses on securities available for sale. The final rules were developed 
jointly by the OCC and the other Agencies in response to Financial 
Accounting Standard (FAS) 115, which generally requires net unrealized 
gains and losses on securities available for sale to be included in 
capital. See Financial Accounting Standards Board, Statement of 
Financial Accounting Standards Number 115 (Accounting for Certain 
Investments in Debt and Equity Securities), No. 126-D (May 1993). The 
Federal Financial Institutions Examination Council adopted FAS 115 for 
regulatory reporting purposes beginning December 15, 1993.
    The proposed rules of the Agencies would have adopted FAS 115 for 
regulatory capital purposes by amending the definition of ``common 
stockholders' equity'' in the capital guidelines to include both 
unrealized gains and losses on securities available for sale. However, 
after careful consideration of the comments received, the OCC, along 
with the other Agencies, decided not to adopt the proposed rule because 
of the potential volatility that could result if FAS 115 unrealized 
gains and losses are required to be included in regulatory capital. 
Consequently, the OCC final rule does not require national banks to use 
FAS 115 for the purposes of computing regulatory capital. See 59 FR 
60552 (November 25, 1994). The FDIC, the OTS and the FRB issued similar 
final rules. See 59 FR 66662 (December 28, 1994) (FDIC final rule); 60 
FR 42025 (August 15, 1995) (OTS final rule); and 59 FR 63641 (December 
8, 1994) (FRB final rule).
d. Concentrations of Credit and Nontraditional Activities
    The Agencies have implemented section 305 of FDICIA by amending 
their capital adequacy rules to explicitly identify concentrations of 
credit risk and certain risks arising from nontraditional activities as 
important factors in assessing each institution's overall capital 
adequacy. The four Agencies issued a joint final rule on the risks from 
concentrations of credit and nontraditional activities. The final rule 
was published in the Federal Register on December 15, 1994. See 59 FR 
64561 (December 15, 1994).
e. Bilateral Netting Contracts
    On December 28, 1994, the OCC and the OTS issued a joint final rule 
on bilateral netting contracts. This final rule amended the risk-based 
capital guidelines to permit netting of certain interest rate and 
foreign exchange rate contracts in calculating the current exposure 
portion of the credit equivalent amount of these contracts for risk-
based capital purposes. See 59 FR 66645 (December 28, 1994). The FRB 
and the FDIC issued similar final rules. See 59 FR 62987 (December 7, 
1994) (FRB final rule); and 59 FR 66656 (December 28, 1994) (FDIC final 
rule).
f. Collateralized Transactions
    The rule on collateralized transactions amended the OCC risk-based 
capital guidelines to lower the risk weight from 20 percent to zero 
percent on certain loans and transactions collateralized by cash or 
government securities. The OCC issued its final rule on collateralized 
transactions on December 28, 1994. See 59 FR 66642 (December 28, 1994). 
See section C(1)(i) for a description of the plan of the Agencies to 
issue uniform rules with respect to collateralized transactions.
g. Deferred Tax Assets
    The OCC final rule on deferred tax assets amended the risk-based 
capital guidelines to limit the amount of certain deferred tax assets 
that may be included in an institution's Tier 1 capital to the lesser 
of (1) the amount of deferred tax assets the institution expects to 
realize within one year or (2) 10 percent of Tier 1 capital. This final 
rule was developed jointly by the Agencies in response to FAS 109, 
which was adopted for regulatory reporting purposes beginning January 
1, 1993. See Financial Accounting Standards Board, Statement of 
Financial Accounting Standards Number 109 (Accounting for Income 
Taxes), No. 112-A (February 1992). FAS 109 provides guidance on the 
accounting treatment of income taxes and generally allows banks to 
report certain deferred tax assets they could not previously recognize. 
The OCC issued its final rule on February 10, 1994. See 60 FR 7903 
(February 10, 1994). The FRB and the FDIC issued similar final rules. 
See 59 FR 65920 (December 22, 1994) (FRB); and 60 FR 8182 (February 13, 
1995) (FDIC). The OTS had adopted this general approach through the 
issuance of a Thrift Bulletin. See TB-56 (January 1993).
h. Mortgage Servicing Rights
    On August 1, 1995, the OCC, the other Banking Agencies, and the OTS 
issued a joint interim rule with request for comment on the capital 
treatment of originated mortgage servicing rights (OMSR). See 60 FR 
39266 (August 1, 1995). The interim rule was developed in response to 
FAS 122 on mortgage servicing rights which eliminates the accounting 
distinction between OMSRs and purchased mortgage servicing rights 
(PMSR). See Financial Accounting Standards Board, Statement of 
Financial Accounting Standards Number 122 (Accounting for Mortgage 
Servicing Rights). Specifically, the interim rule amends the capital 
adequacy rules to treat OMSRs the same as PMSRs for regulatory capital 
purposes. Therefore, subject to an overall 50 percent limit of Tier 1 
capital, both OMSRs and PMSRs may be included in capital for regulatory 
capital and PCA purposes.

[[Page 26360]]

i. CDRI Act Section 303(a)(2) Capital Amendments
    In addition to the general ongoing efforts of the Agencies to 
achieve uniform capital and accounting standards, as part of the 
interagency review of regulations under section 303(a)(2) of the 
RCDRIA, the Agencies currently are evaluating the capital and 
accounting differences in this report in contemplation of changes to 
achieve greater uniformity. The Agencies already have issued a joint 
proposed rule on collateralized transactions as part of their efforts 
under section 303(a)(2) of the CDRI Act. See 61 FR 42565 (August 16, 
1996). Under this joint proposed rule, the FDIC and OTS would adopt a 
collateralized transactions rule lowering the risk weight from 20 
percent to zero percent on certain loans and transactions 
collateralized by cash or government securities; the OCC and FRB would 
revise their current collateralized transactions rule to use more 
uniform language.
    In addition to collateralized transactions, the Agencies have 
identified several other provisions as appropriate for revision under 
section 303(a)(2) of the CDRI Act. These provisions include the capital 
treatment of presold residential construction loans, junior liens on 
one to four-family residential properties, and mutual funds, 
investments in subsidiaries and the minimum leverage capital 
requirement. See Joint Report: Streamlining of Regulatory Requirements, 
pages I-6 through I-9.

2. Market Risk Component

    The joint final rule issued by the Banking Agencies on market risk 
amended the risk-based capital guidelines to incorporate a measure for 
market risk in foreign exchange and commodity activities and in the 
trading of debt and equity instruments. Market risk generally 
represents the risk of loss attributable to on and off-balance sheet 
positions caused by movements in market prices. The effect of the final 
rule is to require certain banks with relatively large amounts of 
trading activities to hold additional capital based on the measure of 
their market risk exposure as determined by the banks own internal 
value-at-risk model. The final rule also establishes a third capital 
category, Tier 3 capital, which generally consists of certain short 
term subordinated debt subject to a lock-in clause that prevent the 
issuer from repayment if the bank's risk-based capital ratio falls 
below 8 percent. Tier 3 capital can only be used to satisfy market risk 
capital requirements. The joint final rule was issued by the Banking 
Agencies on September 6, 1996. See 61 FR 47358 (September 6, 1996).

3. Interest Rate Risk Component

    The joint final rule issued by the Banking Agencies on interest 
rate risk amended the capital adequacy rules to clarify the authority 
of the Banking Agencies to specifically include in their evaluation of 
bank capital an assessment of the exposure to declines to bank's 
capital due to changes in interest rates. The final rule on interest 
rate risk was issued jointly by the OCC and the other Banking Agencies 
on August 2, 1995. See 60 FR 39490 (August 2, 1995). The Banking 
Agencies also have issued a joint policy statement on interest rate 
risk on June 26, 1996. See 61 FR 33166 (June 26, 1996). The joint 
policy statement provides guidance to banks on measuring and managing 
their interest rate risk exposure.
    The OTS has adopted an interest rate risk component to its risk-
based capital guidelines, which became effective on January 1, 1994. 
Once fully implemented, under the OTS rule thrift institutions with an 
above normal level of interest rate risk will be subject to a capital 
charge commensurate to their risk exposure. Unlike the interest rate 
risk rules of the Banking Agencies, the OTS rule, when implemented, 
would impose an automatic capital charge for interest rate risk over a 
specified level. In addition, under the OTS rule, the OTS collects data 
and computes the interest rate risk exposure and corresponding capital 
charge for all thrift institutions required to report.

4. Recourse

    In general, recourse is the risk of loss retained by an institution 
when it sells an asset. Recourse arrangements allow the purchaser of an 
asset to seek recovery against the institution that sold the asset 
under the conditions in the agreement. Under the current risk-based 
capital guidelines of the Banking Agencies, sales of assets involving 
recourse generally must be reported as financings which means that the 
assets are retained on the balance sheet of the selling bank. The OTS 
treats sales with recourse as sales for regulatory reporting and 
leverage ratio purposes if they meet the criteria under generally 
accepted accounting principles (GAAP) for sales treatment, including 
the establishment of a recourse liability account for reasonably 
estimated losses from the recourse obligation.
a. Low Level Recourse
    Prior to the adoption of the final rule on low level recourse, the 
risk-based capital guidelines of the Banking Agencies had the effect of 
requiring a full leverage and risk-based capital charge whenever assets 
are sold with recourse, even if the institution's maximum exposure 
under the recourse obligation is less than the capital charge on the 
asset sold. On April 10, 1995, the OCC issued a final rule on low level 
recourse. See 60 FR 17986 (April 10, 1995). This final rule amends the 
risk-based capital guidelines to limit the amount of capital that a 
bank must hold to the maximum contractual loss exposure retained by the 
bank under the recourse obligation if that amount is less than the 
amount of the effective capital requirement for the underlying asset. 
This final rule implements the requirements of section 350 of the CDRI 
Act (12 U.S.C. 4808), which generally limits the risk-based capital 
charge for assets transferred with recourse to the amount of recourse 
the bank is contractually liable under the recourse agreement. The FRB 
and the FDIC issued similar final rules. See 60 FR 8177 (February 13, 
1995) (FRB final rule); and 60 FR 15858 (March 28, 1995) (FDIC final 
rule). The OTS capital rules already reflected this position on low 
level recourse.
b. Recourse and Direct Credit Substitutes
    On May 25, 1994, the Agencies jointly issued an advance notice of 
proposed rulemaking (ANPR) on recourse. See 59 FR 27116 (May 25, 1995). 
The ANPR proposed an approach that would use credit ratings to more 
closely match the risk-based capital assessment to an institution's 
relative risk of loss in certain asset securitizations.
c. Small Business Loan Recourse
    Section 208 of the CDRI Act (12 U.S.C. 1835) generally reduces the 
amount of capital required to be held by certain qualified institutions 
for recourse retained in certain transfers of small business loans and 
leases of personal property. Currently, the Agencies are engaged in 
rulemaking to implement section 208. The FRB issued a final rule on 
August 31, 1995. See 60 FR 45612 (August 31, 1995). The FDIC, OTS, and 
the OCC, have issued interim rules with request for comment. See 60 FR 
45606 (August 31, 1995) (FDIC interim rule); 60 FR 45618 (August 31, 
1995) (OTS interim rule); and 60 FR 47455 (September 13, 1995) (OCC 
interim rule).

[[Page 26361]]

D. Interagency Differences in Accounting Principles

    The regulatory reporting standards for all commercial banks, 
whether regulated by the OCC, the FRB, or the FDIC, are prescribed in 
the instructions to the Call Report. The Call Report instructions are 
prepared by the Federal Financial Institutions Examination Council 
(FFIEC) and require banks to follow generally accepted accounting 
principles (GAAP) for reports of condition and income required to be 
filed with the Banking Agencies except as permitted under section 121 
of FDICIA. Under section 121 of FDICIA, the Banking Agencies must 
require financial institutions to use accounting principles ``no less 
stringent than GAAP'' for reports of condition and income to be filed 
with the Banking Agencies. Reporting in accordance with GAAP generally 
satisfies this statutory requirement.
    Although the accounting and reporting requirements imposed by the 
Banking Agencies were, for the most part, already consistent with GAAP, 
on November 3, 1995, the FFIEC announced the full adoption of GAAP as 
the reporting basis for the Call Report. Proposed Call Report changes 
to further conform the Call Report with GAAP were published for comment 
on September 16, 1996. See 61 FR 48687 (September 16, 1996). The final 
Call Report changes were published on February 21, 1997. See 62 FR 8078 
(February 21, 1997).
    The OTS requires each savings association to file the Thrift 
Financial Report. That report is filed on a basis consistent with GAAP 
as it is applied by savings associations, which differs in a few 
respects from GAAP as GAAP applies to banks. These current differences 
in accounting principles between the banks and thrift institutions 
result in some differences in financial statement presentation and in 
amounts of regulatory capital required to be maintained by these 
institutions. The following summarizes the significant differences 
between the Thrift Financial Report and the Call Report as of year-end 
1996. However, the implementation of the current Call Report changes to 
move toward the full adoption of GAAP by the Banking Agencies will 
essentially eliminate substantive accounting differences among the 
Agencies. As a result most of the accounting differences discussed in 
this section will be eliminated. To the degree, any accounting 
differences remain, the Agencies will continue to work toward 
reconciling those remaining differences.

1. Futures and Forward Contracts

    Differences in this area result because the Banking Agencies 
generally require future and forward contracts to be marked to market, 
whereas under GAAP savings associations may defer gains and losses 
resulting from certain hedging activities.
    The Banking Agencies do not follow GAAP, but require banks to 
report changes in the market value of futures and forward contracts, 
even when used as hedges, in current income. However, futures contracts 
used to hedge mortgage banking operations are reported in accordance 
with GAAP. The accounting for futures and forward contracts is being 
reexamined by the Financial Accounting Standards Board (FASB) as part 
of an ongoing project on accounting for derivatives.
    The OTS requires savings associations to follow GAAP to account for 
futures contracts. Accordingly, when specified hedging criteria are 
satisfied, the accounting for the futures contract is matched with the 
accounting for the hedged item. Changes in the market value of the 
futures contract are recognized in income when the income effects of 
the hedged item are recognized. This reporting can result in the 
deferral of both gains and losses. Although there is no specific GAAP 
for forward contracts, the OTS applies these same principles to forward 
contracts.

2. Push-Down Accounting

    When a depository institution is acquired in a purchase 
transaction, the holding company is required to revalue all of the 
assets and liabilities of the depository institution at fair value at 
the time of acquisition. When push-down accounting is applied, the same 
fair value adjustments recorded by the parent holding company are also 
recorded at the depository institution level.
    All of the agencies require the use of push-down accounting when 
there has been a substantial change in the ownership of the 
institution. However, differing standards have been applied to 
determine when this substantial change has occurred.
    The Banking Agencies require push-down accounting when there is at 
least a 95 percent change in ownership of the institution. This 
approach is consistent with interpretations of the Securities and 
Exchange Commission.
    The OTS requires push-down accounting when there is at least a 90 
percent change of ownership.

3. Excess Service Fees

    Excess service fees are created when a bank sells mortgage loans, 
but retains the servicing rights. Excess service fees represent the 
present value of the servicing fees in excess of the normal servicing 
fee. Savings associations consider excess servicing fees in the 
determination of the gain or loss on a loan sale, whereas banks 
generally recognize the excess fee over the life of the loan.
    The Banking Agencies require banks to follow GAAP for residential 
first mortgage loans. This requires that when loans are sold with 
servicing retained and the stated servicing fee is sufficiently higher 
than a normal servicing fee, the sales price is adjusted to determine 
the gain or loss from the sale. This allows additional gain recognition 
for the excess servicing fee at the time of sale and recognizes a 
normal servicing fee in each subsequent year. This gain cannot exceed 
the gain assuming the loans were sold with servicing released. In 
addition, the Banking Agencies allow limited recognition at the time of 
sale of excess servicing fees for SBA loans.
    For all other loans, the Banking Agencies require that excess 
servicing fees retained on loans sold be recognized over the 
contractual life of the transferred assets.
    The OTS follows GAAP in valuing all excess service fees. Therefore, 
the accounting stated above for sales of mortgage loans with excess 
servicing at banking institutions would apply to all loan sales with 
excess servicing at savings associations.

4. In-substance Defeasance of Debt

    The Banking Agencies do not permit banks to defease their 
liabilities in accordance with FAS 76, whereas saving associations may 
eliminate defeased liabilities from the balance sheet. FAS 76 concerns 
the extinguishment of debt. Specifically, FAS 76 specifies that debt is 
to be considered extinguished if the debtor is relieved of primary 
liability for the debt by the creditor and it is probable that the 
debtor will not be required to make future payments as guarantor of the 
debt. In addition, even though the creditor does not relieve the debtor 
of its primary obligation, debt is to be considered extinguished if (1) 
the debtor irrevocably places cash or other essentially risk-free 
monetary assets in a trust solely for satisfying that debt and (2) the 
possibility that the debtor will be required to make further payments 
is remote. The Banking Agencies report in-substance defeased debt as a 
liability and the securities contributed to the trust as assets with no 
recognition of any gain or loss on the transaction.

[[Page 26362]]

    The OTS accounts for debt that has been in-substance defeased in 
accordance with GAAP. Therefore, when a debtor irrevocably places risk-
free monetary assets in a trust solely for satisfying the debt and the 
possibility that the debtor will be required to make further payments 
is remote, the debt is considered extinguished. The transfer can result 
in a gain or loss in the current period.

5. Sales of Assets with Recourse

    Banks generally do not report sales of receivables if any risk of 
loss is retained. Savings associations report sales when the risk of 
loss can be estimated in accordance with FAS 77.
    The Banking Agencies generally allow banks to report transfers of 
receivables 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, assets transferred with recourse are reported 
as financings, not sales.
    However, this rule does not apply to the transfer of mortgage loans 
under certain government programs (GNMA, FNMA, etc.). Transfers of 
mortgages under one of these programs are automatically treated as 
sales. Furthermore, private transfers of pools of mortgages are also 
reported as sales if the transferring institution does not retain more 
than an insignificant risk of loss on the assets transferred.
    The OTS follows GAAP to account for a transfer of all receivables 
with recourse. A transfer of receivables with recourse is recognized as 
a sale if: (1) the seller 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.

6. Negative Goodwill

    The Banking Agencies require that negative goodwill be reported as 
a liability, and not netted against the goodwill asset.
    The OTS permits negative goodwill to offset the goodwill assets 
resulting from other acquisitions.

7. Offsetting of Amounts Related to Certain Contracts

    Financial Accounting Standards Board Interpretation Number (FIN) 39 
became effective in 1994. FIN 39 allows the offsetting of assets and 
liabilities on the balance sheet (e.g., loans, deposits, etc.), as well 
as the netting of assets and liabilities arising from off-balance sheet 
derivatives instruments, when four conditions are met. These conditions 
relate to whether a valid right of offset exists. FIN 41, which also 
became effective in 1994, provides for the netting of repurchase and 
reverse repurchase agreements when certain conditions are met.
    The Banking Agencies have adopted FIN 39 solely for on-balance 
sheet amounts arising from conditional and exchange contracts (e.g., 
interest rate swaps, options, etc.). The Banking Agencies have not 
adopted FIN 41. The Call Report's existing guidance, which generally 
prohibits netting of assets and liabilities, is currently followed in 
all other cases. The OTS policy on netting of assets and liabilities is 
consistent with GAAP.

8. Specific Valuation Allowance for and Charge-offs of Troubled Loans

    The Banking Agencies generally consider real estate loans that lack 
acceptable cash flows or other repayment sources to be ``collateral 
dependent.'' When the fair value of the collateral of such a loan has 
declined below book value, the loan is reduced to fair value. This 
approach is consistent with GAAP applicable to banks and FAS 114.
    The OTS requires a specific valuation allowance against or partial 
charge-off of a loan when its book value exceeds its ``value.'' The 
``value'' is defined as either the present value of the expected future 
cash flows discounted at the loan's effective interest rate, the 
observable market price, or the fair value of the collateral. This 
policy is also consistent with the requirements of FAS 114.
    Effective March 31, 1995, the OTS required that losses on 
collateral dependent loans be measured based on the fair value of the 
collateral. Accordingly, after March 31, 1995, the OTS policy regarding 
the recognition of losses on collateral dependent loans became 
comparable to that of the Bank Agencies.

    Dated: May 6, 1997.
Eugene A. Ludwig,
Comptroller of the Currency.
[FR Doc. 97-12515 Filed 5-12-97; 8:45 am]
BILLING CODE 4810-33-P