[Federal Register Volume 62, Number 207 (Monday, October 27, 1997)]
[Proposed Rules]
[Pages 55692-55694]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-28271]


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FEDERAL RESERVE SYSTEM

12 CFR Part 225

[Regulation Y; Docket No. R-0948]


Risk-Based Capital Standards: Construction Loans on Presold 
Residential Properties; Junior Liens on 1- to 4-Family Residential 
Properties; and Mutual Funds and Leverage Capital Standards: Tier 1 
Leverage Ratio

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Board of Governors of the Federal Reserve System is 
proposing to amend its risk-based capital guidelines for bank holding 
companies by revising the treatment for junior liens on 1- to 4-family 
residential properties and mutual funds and the language for 
construction loans on presold residential properties, and to simplify 
the leverage capital guidelines for bank holding companies. The 
proposal, which was developed on an interagency basis, would implement 
part of section 303 of the Riegle Community Development and Regulatory 
Improvement Act of 1994, which requires the Federal banking agencies to 
work jointly to make uniform their regulations and guidelines 
implementing common statutory or supervisory policies. The effect of 
the proposal would be that the bank holding company risk-based capital 
treatment for construction loans on presold residential properties, 
real estate loans secured by junior liens on 1- to 4-family residential 
properties, and investments in mutual funds would be consistent with 
the risk-based capital treatment of the other Federal banking and 
thrift regulatory agencies, and the bank holding company Tier 1 
leverage standards would be simplified and revised to take into account 
the market risk capital rule.

DATES: Comments must be received on or before December 26, 1997.

ADDRESSES: Comments should refer to Docket No. R-0948 and may be mailed 
to William W. Wiles, Secretary, Board of Governors of the Federal 
Reserve System, 20th Street and Constitution Avenue, N.W., Washington 
D.C., 20551. Comments may also be delivered to Room B-2222 of the 
Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays, or the guard 
station in the Eccles Building courtyard on 20th Street, N.W. (between 
Constitution Avenue and C Street) at any time. Comments may be 
inspected in Room MP-500 of the Martin Building between 9 a.m. and 5 
p.m. weekdays, except as provided in 12 CFR 261.8 of the Board's Rules 
Regarding Availability of Information.

FOR FURTHER INFORMATION CONTACT: Roger Cole, Associate Director (202/
452-2618); Norah Barger, Assistant Director (202/452-2402); or Barbara 
Bouchard, Senior Supervisory Financial Analyst (202/452-3072), Division 
of Banking Supervision and Regulation. For the hearing impaired only, 
Telecommunication Device for the Deaf (TDD), Diane Jenkins (202/452-
3544).

SUPPLEMENTARY INFORMATION: The Federal Reserve, along with the other 
bank and thrift regulatory agencies (that is, the Office of the 
Comptroller of the Currency (OCC), the Federal Deposit Insurance 
Corporation (FDIC), and the Office of Thrift Supervision (OTS) 
(collectively, the Agencies)), issued a joint notice of proposed 
rulemaking, published elsewhere in today's Federal Register, under 
Docket No. R-0947. In that joint notice, the Agencies have proposed 
several amendments to their risk-based capital standards that would 
eliminate inconsistencies among the capital rules for banks and 
thrifts. In particular, the Agencies have proposed amendments to the 
risk-based capital treatment of construction loans on presold 
residential properties, loans secured by junior liens on 1- to 4-family 
residential property, and investments in mutual funds. The agencies 
also have proposed a streamlining revision to their leverage capital 
rules. The Federal Reserve, in this notice, is proposing conforming 
amendments to its risk-based capital guidelines for bank holding 
companies, as well as a streamlining revision to its leverage capital 
guidelines for such organizations, that takes into account the market 
risk capital rule (12 CFR part 225, appendix E).

Proposed Amendments to the Risk-Based Capital Guidelines

    With regard to construction loans on presold residential 
properties, the Board is not proposing any substantive change to its 
rule, but is proposing a revision to the regulatory language to provide 
guidance on the characteristics of loans to builders that will be 
considered prudently underwritten. This change would conform the 
discussion of qualifying construction loans to builders to the existing 
language of the FDIC. For junior liens on 1-to 4-family properties, the 
Board is proposing to treat all first and second liens separately, even 
if the lending institution holds both liens and no party holds an 
intervening lien. Under the proposed treatment, qualifying first liens 
would be risk weighted at 50 percent, and non-qualifying first liens 
and all junior liens would be risk weighted at 100 percent. The Federal 
Reserve is proposing to retain its general treatment for investments in 
mutual funds, that is, generally assigning an institution's investment 
in a mutual fund to the highest risk-weight category applicable to any 
asset the fund is authorized to hold in accordance with its prospectus. 
The Federal Reserve is also proposing to allow an institution, at its 
option, to allocate its investment in a mutual fund among the risk-
weight categories based on the maximum percentage of the mutual fund's 
portfolio that may consist of higher risk-weighted assets under its 
prospectus. These proposed revisions are consistent with the Federal 
Reserve's proposed amendments for state member banks that are set forth 
in the earlier referenced interagency notice of proposed rulemaking.

Proposed Amendment to the Tier 1 Leverage Guidelines

    The Federal Reserve's capital adequacy guidelines for bank holding 
companies set forth the following minimum levels of Tier 1 capital to 
total assets (leverage ratio): a 3 percent minimum for organizations 
rated a composite 1 under the BOPEC 1 rating system for bank 
holding companies and a minimum of 3 percent plus 100 to 200 basis 
points for all other organizations. The Federal Reserve is proposing to 
amend its guidelines to set forth a minimum 3 percent leverage ratio 
for bank holding companies that are BOPEC 1-rated or have implemented 
the risk-based capital market risk measure set forth in the Board's 
capital adequacy guidelines (12 CFR part 225, appendix E). All other 
bank holding companies would be subject to a 4 percent minimum Tier 1 
leverage ratio. Higher

[[Page 55693]]

capital ratios could be required if warranted by the particular 
circumstances or risk profiles of individual banking organizations. 
Institutions with supervisory, financial, or operational weaknesses 
would continue to be expected to operate well above minimum capital 
levels. Organizations experiencing or anticipating significant growth 
also would be expected to maintain capital ratios, including tangible 
capital positions, well above the minimum.
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    \1\ The BOPEC rating system is used by supervisors to summarize 
their evaluations of the strength and soundness of bank holding 
companies in a comprehensive and uniform manner.
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    The Federal Reserve notes that this proposed amendment would lower 
the minimum Tier 1 leverage ratio for institutions that have 
implemented the market risk capital rule. While the Federal Reserve 
believes it is desirable for bank holding companies to maintain a 
minimum base of capital to total assets, it also recognizes that the 
leverage ratio can be an inexact measure of capital adequacy for many 
bank holding companies, particularly for very large organizations that 
have significant trading portfolios and are extensively engaged in fee-
generating off-balance-sheet activity. Accordingly, in light of the 
revisions to the risk-based capital measure to capture market risk as 
well as credit risk, the Federal Reserve believes it is appropriate to 
lower the minimum Tier 1 leverage ratio to 3 percent for bank holding 
companies that have implemented the market risk rule.
    The Federal Reserve requests comment on all aspects of this 
proposal. With regard to the proposed treatment for first and second 
liens, the Board notes that it continues to believe its current 
approach of merging first and second liens more appropriately reflects 
the risk of those transactions. This is because, in terms of an 
institution's collateral position, funds advanced on both the first and 
second note are effectively secured by a first lien and timely payment 
in accordance with the terms of both loans depends on the same 
borrower's financial ability to pay. Furthermore, the Board believes 
that merging these liens is consistent with general industry practice. 
Thus, the Board requests, in particular, comment on the proposed 
treatment for first and second liens.

Regulatory Flexibility Act Analysis

    Pursuant to section 605(b) of the Regulatory Flexibility Act, the 
Board does not believe the proposed rule would have a significant 
impact on a substantial number of small business entities in accord 
with the spirit and purposes of the Regulatory Flexibility Act (5 
U.S.C. 601 et seq.). Accordingly, a regulatory flexibility analysis is 
not required. In addition, because the risk-based capital guidelines 
generally do not apply to bank holding companies with consolidated 
assets of less than $150 million, the proposed rule would not affect 
such companies. The effect of the proposed rule would be to reduce 
regulatory burden on bank holding companies by unifying the Agencies' 
risk-based capital treatment for presold construction loans, junior 
liens, and investments in mutual funds, and simplifying the Tier 1 
leverage standards.

Paperwork Reduction Act

    The Board has determined that the proposed rule does not involve a 
collection of information pursuant to the provisions of the Paperwork 
Reduction Act of 1995 (44 U.S.C. 3501 et seq.).

List of Subjects in 12 CFR Part 225

    Administrative practice and procedure, Banks, banking, Federal 
Reserve System, Holding companies, Reporting and recordkeeping 
requirements, Securities.

    For the reasons set forth in the preamble, part 225 of chapter II 
of title 12 of the Code of Federal Regulations is proposed to be 
amended as follows:

PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL 
(REGULATION Y)

    1. The authority citation for part 225 is revised to read as 
follows:

    Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-1, 
1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, and 
3909.

    2. In appendix A to part 225, section III.A., footnote 24 is 
revised to read as follows:

APPENDIX A TO PART 225--CAPITAL ADEQUACY GUIDELINES FOR BANK 
HOLDING COMPANIES: RISK-BASED MEASURE

* * * * *
    III. * * *
    A. * * * 24
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    \24\ An investment in shares of a mutual fund whose portfolio 
consists solely of various securities or money market instruments 
that, if held separately, would be assigned to different risk 
categories, generally is assigned to the risk category appropriate 
to the highest risk-weighted asset that the fund is permitted to 
hold in accordance with the stated investment objectives as set 
forth in the prospectus. The organization may, at its option, assign 
the investment on a pro rata basis to different risk categories 
according to the investment limits in the fund's prospectus, but in 
no case will indirect holdings through shares in any mutual fund be 
assigned to a risk weight less than 20 percent. If, in order to 
maintain a necessary degree of short-term liquidity, a fund is 
permitted to hold an insignificant amount of its assets in short-
term, highly liquid securities of superior credit quality that do 
not qualify for a preferential risk weight, such securities 
generally will be disregarded in determining the risk category into 
which the organization's holding in the overall fund should be 
assigned. The prudent use of hedging instruments by a mutual fund to 
reduce the risk of its assets will not increase the risk weighting 
of the mutual fund investment. For example, the use of hedging 
instruments by a mutual fund to reduce the interest rate risk of its 
government bond portfolio will not increase the risk weight of that 
fund above the 20 percent category. Nonetheless, if the fund engages 
in any activities that appear speculative in nature or has any other 
characteristics that are inconsistent with the preferential risk 
weighting assigned to the fund's assets, holdings in the fund will 
be assigned to the 100 percent risk category.
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* * * * *
    3. In appendix A to part 225, section III.C.3. is amended by 
removing and reserving footnote 37 and by adding a new sentence to the 
end of the footnote 38 to read as follows:
* * * * *
    III. * * *
    C. * * *
    3. * * * 38 * * *
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    \38\ * * * Such loans to builders will be considered prudently 
underwritten only if the bank holding company has obtained 
sufficient documentation that the buyer of the home intends to 
purchase the home (i.e., has a legally binding written sales 
contract) and has the ability to obtain a mortgage loan sufficient 
to purchase the home (i.e., has a firm written commitment for 
permanent financing of the home upon completion).
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* * * * *
    4. In appendix D to part 225, section II.a. is revised to read as 
follows:

APPENDIX D TO PART 225--CAPITAL ADEQUACY GUIDELINES FOR BANK 
HOLDING COMPANIES: TIER 1 LEVERAGE MEASURE

* * * * *
    II. * * *
    a. For a strong banking organization (rated composite 1 under 
the BOPEC rating system of bank holding companies or has implemented 
the Board's risk-based capital measure for market risk as set forth 
in appendices A and E of this part) the minimum ratio of Tier 1 
capital to total assets is 3.0 percent. Such organizations must not 
be anticipating or experiencing significant growth, are expected to 
have well diversified risk (including no undue interest rate risk 
exposure), excellent asset quality, high liquidity, good earnings, 
and in general be considered a strong banking organization. In 
addition, organizations are expected to maintain capital ratios, 
including tangible capital positions, well above minimum levels. For 
all other bank holding companies, the minimum ratio is 4.0 percent. 
Higher capital ratios could be required if warranted by the 
particular circumstances or risk profiles of individual banking 
organizations. In all cases, bank holding companies should hold 
capital commensurate with the level and nature of all risks, 
including the volume and severity of problem loans, to which they 
are exposed.
* * * * *

[[Page 55694]]

    By order of the Board of Governors of the Federal Reserve 
System, October 21, 1997.
William W. Wiles,
Secretary of the Board.
[FR Doc. 97-28271 Filed 10-24-97; 8:45 am]
BILLING CODE 6210-01-P