[Federal Register Volume 63, Number 17 (Tuesday, January 27, 1998)]
[Notices]
[Pages 3897-3901]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-1812]
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FEDERAL RESERVE SYSTEM
Differences in Capital and Accounting Standards Among the Federal
Banking and Thrift Agencies; Report to Congressional Committees
AGENCY: Board of Governors of the Federal Reserve System (FRB).
ACTION: Notice of 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.
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SUMMARY: This report was prepared by the FRB pursuant to section 121 of
the Federal Deposit Insurance Corporation Improvement Act of 1991 (12
U.S.C. 1831n(c)). Section 121 requires each Federal banking and thrift
agency to report annually to the above specified Congressional
Committees regarding any differences between the accounting or capital
standards used by such agency and the accounting or capital standards
used by other banking and thrift agencies. The report must be published
in the Federal Register.
FOR FURTHER INFORMATION CONTACT: Gerald A. Edwards, Deputy Associate
Director (202/452-2741), Norah Barger, Assistant Director (202/452-
2402),
[[Page 3898]]
Barbara Bouchard, Manager (202/452-3072), or Arthur Lindo, Supervisory
Financial Analyst (202/452-2695), Division of Banking Supervision and
Regulation. For the hearing impaired only, Telecommunication Device for
the Deaf (TDD), Diane Jenkins (202/452-3544), Board of Governors of the
Federal Reserve System, 20th & C Street, NW, Washington, DC 20551.
SUPPLEMENTARY INFORMATION: The text of the report follows:
Report to the Congressional Committees Regarding Differences in Capital
and Accounting Standards Among the Federal Banking and Thrift Agencies
Introduction and Overview
This is the eighth annual report \1\ on the differences in capital
standards and accounting practices that currently exist among the three
banking agencies (the Board of Governors of the Federal Reserve System
(FRB), the Office of the Comptroller of the Currency (OCC), and the
Federal Deposit Insurance Corporation (FDIC) and the Office of Thrift
Supervision (OTS).\2\
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\1\ The first two reports prepared by the Federal Reserve Board
were made pursuant to section 1215 of the Financial Institutions
Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The
subsequent reports were made pursuant to section 121 of the Federal
Deposit Insurance Corporation Improvement Act of 1991 (FDICIA),
which superseded section 1215 of FIRREA.
\2\ At the federal level, the Federal Reserve System has primary
supervisory responsibility for state-chartered banks that are
members of the Federal Reserve System, as well as for all bank
holding companies and certain operations of foreign banking
organizations. The FDIC has primary responsibility for state
nonmember banks and FDIC-supervised savings banks. National banks
are supervised by the OCC. The OTS has primary responsibility for
savings and loan associations.
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Overview
As stated in the previous reports to Congress, the three bank
regulatory agencies have, for a number of years, employed a common
regulatory framework that establishes minimum capital adequacy ratios
for commercial banking organizations. In 1989, all three banking
agencies and the OTS adopted a risk-based capital framework that was
based upon the international capital accord (Basle Accord) developed by
the Basle Committee on Banking Regulations and Supervisory Practices
(Basle Supervisors Committee) and endorsed by the central bank
governors of the G-10 countries.
The risk-based capital framework establishes minimum ratios of
capital to risk-weighted assets. The Basle Accord requires banking
organizations to have total capital (Tier 1 plus Tier 2) equal to at
least 8 percent and Tier 1 capital equal to at least 4 percent of risk-
weighted assets. Tier 1 capital includes common stock and surplus,
retained earnings, qualifying perpetual preferred stock and surplus,
and minority interest in consolidated subsidiaries, less disallowed
intangibles such as goodwill. Tier 2 capital includes certain
supplementary capital items such as general loan loss reserves,
subordinated debt, and certain other preferred stock and convertible
debt capital instruments, subject to appropriate limitations and
conditions. The amount of Tier 2 includable in regulatory capital is
limited to 100 percent of Tier 1. In addition, institutions that
incorporate market risk exposure into their risk-based capital
requirements may use ``Tier 3'' capital (i.e., short-term subordinated
debt with certain restrictions on repayment provisions) to support
their exposure to market risk. Tier 3 capital is limited to
approximately 70 percent of an institution's measure for market risk.
Risk-weighted assets are calculated by assigning risk weights of zero,
20, 50, and 100 percent to broad categories of assets and off-balance
sheet items based upon their relative credit risk. The OTS has adopted
a risk-based capital standard that in most respects is similar to the
framework adopted by the banking agencies. Differences between the OTS
capital rules and those of the banking agencies are noted elsewhere in
this report.
The measurement of capital adequacy in the present framework is
mainly directed toward assessing capital in relation to credit risk. In
December 1995, the G-10 Governors endorsed an amendment to the Basle
Accord that will, beginning in January 1998, require internationally-
active banks to measure and hold capital to support their market risk
exposure. Specifically, banks will be required to hold capital against
their exposure to general market risk associated with changes in
interest rates, equity prices, exchange rates, and commodity prices, as
well as for exposure to specific risk associated with equity positions
and certain debt positions in the trading portfolio. The FRB, FDIC, and
OCC issued in August 1996 amendments to their respective risk-based
capital standards that implemented the market risk amendment to the
Accord. The banking agencies' amendments contain a threshold amount of
trading activity: institutions with trading assets and liabilities
greater than or equal to 10 percent of assets or trading assets and
liabilities greater than or equal to $1 billion are required to apply
the market risk rules. The OTS did not amend its capital rules in this
regard since savings institutions do not have such significant levels
of trading activity.
In addition to the risk-based capital requirements, the agencies
also have established leverage standards setting forth minimum ratios
of capital to total assets. The three banking agencies employ uniform
leverage standards, while the OTS has established, pursuant to FIRREA,
a somewhat different standard. On October 27, 1997, the agencies issued
for public comment a proposal that would eliminate these differences.
All of the agencies view the risk-based capital standards as a
minimum supervisory benchmark. In part, this is because the risk-based
capital framework focuses primarily on credit risk; it does not take
full or explicit account of certain other banking risks, such as
exposure to changes in interest rates. The full range of risks to which
depository institutions are exposed are reviewed and evaluated
carefully during on-site examinations. In view of these risks, most
banking organizations are expected to, and generally do, maintain
capital levels well above the minimum risk-based and leverage capital
requirements.
The staffs of the agencies meet regularly to identify and address
differences and inconsistencies in their capital standards. The
agencies are committed to continuing this process in an effort to
achieve full uniformity in their capital standards. In addition, the
agencies have considered the remaining differences as part of a
regulatory review undertaken to comply with Section 303 of the Riegle
Community Development and Regulatory Improvement Act of 1994 (Riegle
Act), which specifies that the agencies ``make uniform all regulations
and guidelines implementing common statutory or supervisory policies.''
Efforts To Achieve Uniformity
Leverage Capital Ratios
The three banking agencies employ a leverage standard based upon
the common definition of Tier 1 capital contained in their risk-based
capital guidelines. These standards, established in the second half of
1990 and in early 1991, require the most highly-rated institutions to
meet a minimum Tier 1 capital ratio of 3 percent. For all other
institutions, these standards generally require an additional cushion
of at least 100 to 200 basis points, i.e., a minimum leverage ratio of
at least 4 to 5 percent, depending upon an organization's financial
condition. As required by FIRREA, the OTS has established a 3
[[Page 3899]]
percent core capital ratio and a 1.5 percent tangible capital leverage
requirement for thrift institutions. Certain adjustments discussed in
this report apply to the core capital definition used by savings
associations.
On October 27, 1997, the four agencies issued a proposal for public
comment addressing the leverage standards (62 FR 55686). Under the
proposal, institutions rated a composite 1 under the Uniform Financial
Institutions Rating System (UFIRS) \3\ would be subject to a minimum
3.0 percent leverage ratio and all other institutions would be subject
to a minimum 4.0 percent leverage ratio. This change would simplify and
streamline the Board's, FDIC's, and OCC's leverage rules. In addition,
changes proposed by the OTS, if adopted, would make all the agencies'
rules uniform. The comment period for the proposal ended on December
26, 1997. Agency staffs intend to issue a final amendment in early
1998.
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\3\ The UFIRS is used by supervisors to summarize their
evaluations of the strength and soundness of financial institutions
in a comprehensive and uniform manner.
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Efforts to Incorporate Non-Credit Risks
The Federal Reserve has been working with the other U.S. banking
agencies and with regulatory authorities abroad to develop methods of
measuring certain market and price risks and determining appropriate
capital standards for these risks. These efforts have related to
interest rate risk arising from all activities of a bank and to market
risk associated principally with an institution's trading activities.
Regarding domestic efforts, the banking agencies have, for several
years, been working to develop capital standards pertaining to interest
rate risk. In June 1996, the U.S. banking agencies issued a joint
policy statement describing a common framework for the supervision of
interest rate risk in banking organizations. It calls for a review of
the qualitative characteristics and adequacy of an institution's
interest rate risk management, as well as an assessment of risk
relative to its earnings and the economic value of its capital. The
framework is consistent with 1995 revisions to the U.S. risk-based
capital rules that incorporated the exposure of that economic value to
changes in interest rates as an important element in the evaluation of
capital adequacy. In September 1997, the Basle Supervisors Committee,
with the agreement of the G-10 governors, released a paper, based on
the U.S. joint policy statement, that contains a set of principles for
the management of interest rate risk.
In 1995 the Basle Supervisors Committee issued an amendment to the
Basle Accord that requires internationally-active banks to hold capital
against market risk exposure. The FRB, FDIC and OCC amended their
respective risk-based capital guidelines in 1996 to implement the
amendment to the Accord. Under the agencies' guidelines, affected
institutions must use an internal value-at-risk model to measure market
risk and calculate corresponding capital requirements. The market risk
rules become mandatory for certain institutions in January 1998. The
OTS does not intend, at this time, to issue a rule on market risk since
the savings institutions they supervise do not have significant levels
of trading activity.
As mentioned in the introduction, the agencies have been meeting to
fulfill the requirements of Section 303 of the Riegle Act that calls
for uniform rules and guidelines. In this regard, in October 1997, the
agencies issued for public comment a proposal that would eliminate
existing minor differences among the agencies' risk-based capital
treatment for the following assets: presold residential properties,
junior liens on 1- to 4-family residential properties, and banks'
holdings of mutual funds. In addition, the agencies worked together on
the following capital issues.
Recourse
The agencies published in the Federal Register on November 5, 1997,
(62 FR 5994), uniform, proposed rules that would use credit ratings to
match the risk-based capital assessment more closely to an
institution's relative risk of loss in certain asset securitizations.
Unrealized Gains on Certain Equity Securities
In October 1997 the agencies issued for public comment an
interagency proposal that would permit institutions to include in Tier
2 capital up to 45 percent of unrealized gains on certain available-
for-sale equity securities (62 FR 55682).
Capital Impact of Recent Changes to Accounting Standards
From time to time, the Financial Accounting Standards Board (FASB)
issues new and modified financial accounting standards. The adoption of
some of these standards for regulatory reporting purposes has the
potential of affecting the definition and calculation of regulatory
capital. Accordingly, the staffs of the agencies work together to
propose uniform regulatory capital responses to such accounting
changes. Over this past year, the agencies have dealt with certain
capital effects of Statement of Financial Accounting Standard (FAS) No.
125, ``Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities'' which supersedes FAS No. 122,
``Accounting for Mortgages Servicing Rights.'' FAS 125, ``Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities.''
The agencies issued a proposal on August 4, 1997, to amend their
capital standards to address the treatment of servicing assets on both
mortgage assets and financial assets other than mortgages (62 FR
42006). The public comment period ended on October 3, 1997. The
proposed rule reflects changes in accounting standards for servicing
assets made in FAS 125. FAS 125 extended the accounting treatment for
mortgage servicing to servicing on all financial assets. The proposed
amendment would raise the capital limitation on the sum of all mortgage
servicing assets and purchased credit card relationships from 50
percent of Tier 1 capital to 100 percent of Tier 1 capital.
Furthermore, servicing assets on financial assets other than mortgages
would be deducted from Tier 1 capital. A final rule should be in place
in the first part of 1998.
Capital Differences
Differences among the risk-based capital standards of the OTS and
the three banking agencies are discussed below.
Certain Collateral Transactions
The four agencies, on August 16, 1996, published a joint proposed
rulemaking that would, if implemented, eliminate capital differences
among the agencies' risk-based capital treatment for collateralized
transactions (61 FR 42565).
The Federal Reserve permits certain collateralized transactions to
be risk-weighted at zero percent. This preferential treatment is
available only for claims fully collateralized by cash on deposit in
the bank or by securities issued or guaranteed by OECD central
governments or U.S. government agencies. A positive margin of
collateral must be maintained on a daily basis fully taking into
account any change in the banking organization's exposure to the
obligor or counterparty under a claim in relation to the market value
of the collateral held in support of that claim. Other collateralized
claims, or
[[Page 3900]]
portions thereof, are risk-weighted at 20 percent.
The OCC permits portions of claims collateralized by cash or OECD
government securities to receive a zero percent risk weight, provided
that the collateral is marked to market daily and a positive margin is
maintained. The FDIC's and OTS's rules permit portions of claims
collateralized by cash or OECD government securities to receive a 20
percent risk weight.
Under the agencies' proposed rule, portions of claims
collateralized by cash or OECD government securities could be assigned
a zero percent risk weight, provided the transactions meet certain
criteria, which would be uniform among the agencies. Agency staffs
intend to finalize the outstanding proposal in early 1998.
FSLIC/FDIC--Covered Assets (Assets Subject to Guarantee Arrangements by
the FSLIC or FDIC)
The three banking agencies generally place these assets in the 20
percent risk category, the same category to which claims on depository
institutions and government-sponsored agencies are assigned. The OTS
places these assets in the zero percent risk category.
Limitation of Subordinated Debt and Limited-life Preferred Stock
The three banking agencies limit 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, maturing capital
instruments must be discounted by 20 percent in search of the last five
years prior to maturity. The OTS has no limitation on the total amount
of limited-life preferred stock or maturing capital instruments that
may be included within Tier 2 capital. In addition, the OTS allows
savings institutions the option of: (1) discounting maturing capital
instruments issued on or after November 7, 1989, by 20 percent a year
over the last 5 years of their term; or (2) including the full amount
of such instruments provided that the amount maturing in any of the
next seven years does not exceed 20 percent of the thrift's total
capital.
Subsidiaries
Consistent with the Basle Accord and long-standing supervisory
practices, the three banking agencies generally consolidate all
significant majority-owned subsidiaries of the parent organization for
capital purposes. This consolidation assures that the capital
requirements are related to all of the risks to which the banking
organization is exposed. As with most other bank subsidiaries, banking
and finance subsidiaries generally are consolidated for regulatory
capital purposes. However, in cases where banking and finance
subsidiaries are not consolidated, the Federal Reserve, consistent with
the Basle Accord, generally deducts investments in such subsidiaries in
determining the adequacy of the parent bank's capital.
The Federal Reserve's risk-based capital guidelines provide a
degree of flexibility in the capital treatment of unconsolidated
subsidiaries (other than banking and finance subsidiaries) and
investments in joint ventures and associated companies. For example,
the Federal Reserve may deduct investments in such subsidiaries from an
organization's capital, may apply an appropriate risk-weighted capital
charge against the proportionate share of the assets of the entity, may
require a line-by-line consolidation of the entity, or otherwise may
require that the parent organization maintain a level of capital above
the minimum standard that is sufficient to compensate for any risk
associated with the investment.
The guidelines also permit the deduction of investments in
subsidiaries that, while consolidated for accounting purposes, are not
consolidated for certain specified supervisory or regulatory purposes.
For example, the Federal Reserve deducts investments in, and unsecured
advances to, Section 20 securities subsidiaries from the parent bank
holding company's capital. The FDIC accords similar treatment to
securities subsidiaries of state nonmember banks established pursuant
to Section 337.4 of the FDIC regulations.
Similarly, in accordance with Section 325.5(f) of the FDIC
regulations, a state nonmember bank must deduct investments in, and
extensions of credit to, certain mortgage banking subsidiaries in
computing the parent bank's capital. The Federal Reserve does not have
a similar requirement with regard to mortgage banking subsidiaries. The
OCC does not have requirements dealing specifically with the capital
treatment of either mortgage banking or securities subsidiaries. The
OCC, however, does reserve the right to require a national bank, on a
case-by-case basis, to deduct from capital investments in, and
extensions of credit to, any nonbanking subsidiary.
The deduction of investments in subsidiaries from the parent's
capital is designed to ensure that the capital supporting the
subsidiary is not also used as the basis of further leveraging and
risk-taking by the parent banking organization. In deducting
investments in, and advances to, certain subsidiaries from the parent's
capital, the Federal Reserve expects the parent banking organization to
meet or exceed minimum regulatory capital standards without reliance on
the capital invested in the particular subsidiary. In assessing the
overall capital adequacy of banking organizations, the Federal Reserve
may also consider the organization's fully consolidated capital
position.
Under the OTS capital guidelines, a distinction, mandated by
FIRREA, is drawn between subsidiaries that are engaged in activities
permissible for national banks and subsidiaries that are engaged in
``impermissible'' activities for national banks. Subsidiaries of thrift
institutions that engage only inpermissible activities are consolidated
on a line-by-line basis if majority-owned and on a pro rata basis if
ownership is between 5 and 50 percent. As a general rule, investments,
including loans, in subsidiaries that engage in impermissible
activities are deducted in determining the capital adequacy of the
parent.
Mortgage-Backed Securities (MBS)
The three banking agencies, in general, place privately-issued MBS
in a risk category appropriate to the underlying assets but in no case
to the zero percent risk category. In the case of privately-issued MBS
where the direct underlying assets are mortgages, this treatment
generally results in a risk weight of 50 percent or 100 percent.
Privately-issued MBS that have government agency or government-
sponsored agency securities as their direct underlying assets are
generally assigned to the 20 percent risk category.
The OTS assigns privately-issued high quality mortgage-related
securities to the 20 percent risk category. These are, generally,
privately-issued MBS with AA or better investment ratings.
Both the banking and thrift agencies automatically assign to the
100 percent risk weight category certain MBS, including interest-only
strips, residuals, and similar instruments that can absorb more than
their pro rata share of loss.
Agricultural Loan Loss Amortization
In the computation of regulatory capital, those banks accepted into
the agricultural loan loss amortization program pursuant to Title VIII
of the Competitive Equality Banking Act of 1987 are permitted to defer
and amortize losses incurred on agricultural loans between January 1,
1984 and December 31, 1991. The program also applies to losses incurred
between January 1, 1983 and December 31, 1991, as a result of
reappraisals and sales of
[[Page 3901]]
agricultural Other Real Estate Owned (OREO) and agricultural personal
property. These loans must be fully amortized over a period not to
exceed seven years and, in any case, must be fully amortized by year-
end 1998. Savings institutions are not eligible to participate in the
agricultural loan loss amortization program established by this
statute.
Treatment of Junior Liens on 1- to 4-Family Residential Properties
In some cases, a banking organization may make two loans on a
single residential property, one secured by a first lien, the other by
a second lien. In such a situation, the Federal Reserve views these two
transactions as a single lien, provided there are no intervening liens.
The total amount of these transactions would be assigned to either the
50 percent or the 100 percent risk category depending upon whether
certain other criteria are met.
One criterion is that the loan must be made in accordance with
prudent underwriting standards, including an appropriate ratio of the
current loan balance to the value of the property (the loan-to-value
ratio or LTV). When considering whether a loan is consistent with
prudent underwriting standards, the Federal Reserve evaluates the LTV
ratio based on the combined loan amount. If the combined loan amount
satisfies prudent underwriting standards, both the first and second
lien are assigned to the 50 percent risk category. The FDIC also
combines the first and second liens to determine the appropriateness of
the LTV ratio, but it applies the risk weights differently than the
Federal Reserve. If the LTV ratio based on the combined loan amount
satisfies prudent underwriting standards, the FDIC risk weights the
first lien at 50 percent and the second lien at 100 percent, otherwise
both liens are risk weighted at 100 percent. The OCC treats all first
and second liens separately, with qualifying first liens risk weighted
at 50 percent and non-qualifying first liens and all second liens risk
weighted at 100 percent. The OTS has interpreted its rule to treat
first and second liens to a single borrower as a single extension of
credit, similar to the Federal Reserve.
Under the proposal issued by the agencies in October 1997, the
agencies would follow the OCC capital treatment for first and second
liens.
Pledged Deposits and Nonwithdrawable Accounts
The capital guidelines of the OTS permit thrift institutions to
include in capital certain pledged deposits and nonwithdrawable
accounts that meet the criteria of the OTS. Income Capital Certificates
and Mutual Capital Certificates held by the OTS may also be included in
capital by thrift institutions. These instruments are not relevant to
commercial banks, and, therefore, they are not addressed in the banking
agencies' capital rules.
Construction Loans on Presold Residential Property
The agencies all assign a qualifying loan to a builder to finance
the construction of a presold 1- to 4-family residential property to
the 50 percent risk category provided certain conditions are satisfied.
The Federal Reserve and the FDIC permit a 50 percent risk weight once
the residential property is sold, whether the sale occurs before or
after the construction loan has been made. The OCC and the OTS permit
the 50 percent risk weight treatment only if the property is sold to an
individual who will occupy the residence upon completion of
construction before the extension of credit to the builder.
The agencies' October proposal set forth the treatment followed by
the Federal Reserve and the FDIC.
Mutual Funds
The three banking agencies generally assign all of a bank's holding
in a mutual fund to the risk category appropriate to the highest risk
asset that a particular mutual fund is permitted to hold under its
operating rules. The OCC also permits, on a case-by-case basis, an
institution's investment to be allocated on a pro rata basis among the
risk categories based on the percentages of a portfolio authorized to
be invested in a particular risk weight category. The OTS applies a
capital charge appropriate to the riskiest asset that a mutual fund is
actually holding at a particular time. The OTS also permits, on a case-
by-case basis pro rata allocation among risk categories based on the
fund's actual holdings. All of the agencies' rules provide that the
minimum risk weight for investment in mutual funds is 20 percent.
The agencies have proposed following the banking agencies' general
treatment and permitting institutions, at their option, to assign such
investment on a pro rata basis according to the investment limits in
the mutual fund prospectus.
Accounting Standards
Over the years, the three banking agencies, under the auspices of
the Federal Financial Institutions Examination Council (FFIEC), have
developed Uniform Reports of Condition and Income (Call Reports) for
all commercial banks and FDIC-supervised savings banks. The reporting
standards followed by the three banking agencies for recognition and
measuring purposes are consistent with generally accepted accounting
principles (GAAP). The agencies adopted GAAP as the reporting basis for
the Call Report, effective for March 1997 reports. The adoption of GAAP
for Call Report purposes eliminated the differences in accounting
standards among the agencies that were set forth in previous reports to
Congress. Thus, there are no material differences in regulatory
accounting standards for regulatory reports filed with the federal
banking agencies by commercial banks, savings banks, and savings
associations.
By order of the Board of Governors of the Federal Reserve
System, January 21, 1998.
William W. Wiles,
Secretary of the Board.
[FR Doc. 98-1812 Filed 1-26-98; 8:45 am]
BILLING CODE 6210-01-P