[Federal Register Volume 64, Number 12 (Wednesday, January 20, 1999)]
[Notices]
[Pages 3117-3121]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-1163]


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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: Norah Barger, Assistant Director (202/
452-2402), Barbara Bouchard, Manager (202/452-3072), Charles Holm, 
Manager, (202/452-3502), or Ali Emran, Senior Financial Analyst, (202/
452-2208), 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 ninth 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 FRB 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 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

[[Page 3118]]

capital adequacy ratios for commercial banking organizations. In 1989, 
all three banking agencies and the OTS adopted risk-based capital 
frameworks that were 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 total 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, in January 1998, required internationally-active banks to 
measure and hold capital to support their market risk exposure. 
Specifically, certain banks are 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 Basle 
Accord. The banking agencies' amendments generally require 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, 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. In October 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 operational risk. 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 the application of 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 Ratio
    The three banking agencies employ leverage standards 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 leverage ratio of 3.0 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 4.0 to 5.0 percent, depending upon an organization's 
financial condition. As required by FIRREA, the OTS has established a 
3.0 percent core capital ratio and a 1.5 percent tangible capital 
leverage ratio requirement for thrift institutions. Certain adjustments 
discussed in this report apply to the core capital definition used by 
savings associations.
    In October 1997, the agencies issued a proposal to simplify and 
make uniform their leverage capital standards. Under the proposal, the 
three banking agencies' rules would require a minimum leverage ratio of 
3.0 or 4.0 percent, depending upon a bank's financial condition and the 
OTS' standards would become more consistent with those of the banking 
agencies. The agencies are working to develop a rule finalizing the 
proposal as soon as possible.

Risk-Based Capital Ratio

    The agencies worked together on a number of issues in 1998. Part of 
the agencies' focus was on fulfilling the requirements of section 303 
of the Riegle Act, which calls for uniform rules and guidelines. In 
this regard, the agencies are working to finalize an outstanding 
proposal that will eliminate interagency differences in the risk-based 
capital treatment of presold residential properties, junior liens on 1- 
to 4-family residential properties, and investments in mutual funds.
    In addition, the agencies issued two joint final rules in 1998 that 
amended the agencies' capital standards. The first permitted 
institutions to include up to 45 percent of unrealized gains on certain 
equity securities in Tier 2 capital. The second raised the Tier 1 
capital limitation for mortgage servicing assets from 50 to 100 percent 
of Tier 1 capital. The agencies also issued interim guidance on the 
capital treatment for derivatives to address issues raised by a recent 
change in accounting standards (Financial Accounting Standard (FAS) No. 
133). The agencies continue to work

[[Page 3119]]

on outstanding matters such as the 1997 recourse proposal and the 1996 
proposal on collateralized transactions.
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 FRB 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 only if the property is sold to the 
prospective property resident before the extension of credit to the 
builder.
    The agencies are working on a final rule that would adopt the FRB's 
and FDIC's capital treatment of such loans.
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 FRB views these two 
transactions as a single loan secured by a first lien, provided there 
are no intervening liens. The total amount of these transactions is 
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 
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 FRB evaluates the LTV ratio based on the 
combined loan amount. If the combined loan amount satisfies prudent 
underwriting standards and is considered to be performing adequately, 
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 FRB. If the LTV ratio based on the 
combined loan amount satisfies prudent underwriting standards and is 
considered to be performing adequately, 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 FRB.
    The agencies are working on a final rule that would adopt the FRB's 
capital treatment of first and junior liens on 1-to 4-family 
residential properties.
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 
prospectus. 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 a pro rata distribution of allowable 
investments under the fund's prospectus. 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 are working on a final rule that would adopt the 
banking agencies' general treatment of a mutual fund investment and 
would permit institutions, at their option, to assign such an 
investment to risk categories on a pro rata basis according to the 
investment limits in the mutual fund prospectus.

Joint Final Rules To Amend Risk-Based Capital Standards and Changes 
Reflecting the Impact of Accounting Standards

    Two joint final rules were issued by the agencies in the third 
quarter of 1998. The first pertains to unrealized gains on certain 
equity securities. The second reflects the 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 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'' and with the impact of 
FAS No. 133, ``Accounting for Derivative Instruments and Hedging 
Activities,'' on current capital rules.

Unrealized Gains on Certain Equity Securities

    On August 26, 1998, the agencies issued a joint final rule that 
allows banking organizations to include up to 45 percent of net 
unrealized holding gains on certain available-for-sale equity 
securities in Tier 2 capital under the agencies' risk-based capital 
rules. The rule became effective on October 1, 1998. The full amount of 
net unrealized gains on such securities are included as a component of 
equity capital under U.S. generally accepted accounting principles 
(GAAP), but until the adoption of this rule they were not included in 
regulatory capital. The agencies' capital rules, consistent with GAAP, 
will continue to require banking organizations to deduct the amount of 
net unrealized losses on their available-for-sale equity securities 
from Tier 1 capital. To be consistent with a restriction in the Basle 
Accord, the agencies have restricted the inclusion of net unrealized 
gains on equity securities in Tier 2 capital to no more than 45 percent 
of such net unrealized gains.

FAS 125, ``Accounting for Transfers and Servicing of Financial Assets 
and Extinguishments of Liabilities''

    The agencies issued a final rule on August 10, 1998, which amended 
their capital treatments for servicing assets on both mortgage assets 
and financial assets other than mortgages. The final rule reflects 
changes in accounting standards for servicing assets made in FAS 125, 
which extended the accounting treatment for mortgage servicing to 
servicing on all financial assets. The amendment raised the capital 
limitation on the sum of all mortgage servicing assets, nonmortgage 
servicing assets, and purchased credit card relationships (PCCRs) from 
50 percent of Tier 1 capital to 100 percent of Tier 1 capital. 
Furthermore, it subjected the sum of nonmortgage servicing assets and 
PCCRs to a sublimit of 25 percent of Tier 1 capital.

FAS 133, ``Accounting for Derivative Instruments and Hedging 
Activities''

    On December 29, 1998, the agencies issued interim guidance on the 
regulatory capital treatment of derivatives. The interim guidance 
clarifies how derivatives should be treated under the agencies' current

[[Page 3120]]

capital rules in light of FAS 133 accounting changes. Although FAS 133 
does not become effective until fiscal years beginning after June 15, 
1999, early adoption is permitted.

Joint Proposal To Amend Risk Based Capital Standards

Recourse

    The agencies published in the Federal Register on November 5, 1997, 
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. The agencies are 
discussing comments received and are working on developing a revised 
proposal.

Capital Differences

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

Certain Collateral Transactions

    The FRB 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 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.
    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. Under the proposed rule, portions of claims 
collateralized by cash or OECD government securities could be assigned 
a zero percent risk weight, provided the transactions met certain 
criteria, which would be uniform among the agencies. Agency staffs are 
working to finalize this outstanding proposal as soon as possible.

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 each 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 per 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 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 FRB, consistent with the Basle 
Accord, generally deducts investments in such subsidiaries in 
determining the adequacy of the parent bank's capital.
    The FRB'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 FRB 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. 
The FDIC accords similar treatment to securities subsidiaries of state 
nonmember banks established pursuant to Sec. 337.4 of the FDIC 
regulations.
    Similarly, in accordance with Sec. 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 FRB 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, reserves 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 FRB 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 FRB also considers 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 in impermissible 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

[[Page 3121]]

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 generally 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 VII 
of the Competitive Equality Banking Act of 1987 are permitted to defer 
and amortize losses incurred on agricultural loans between January 1, 
1984 and December 31, 1991. The program also applies to losses incurred 
between January 1, 1983 and December 31, 1991, as a result of 
reappraisals and sales of agricultural Other Real Estate Owned 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.

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, are not addressed in the banking 
agencies' capital rules.

Accounting Standards

    Over the years, the three banking agencies, under the auspices of 
the 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 measurement purposes are consistent with 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 13, 1999.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 99-1163 Filed 1-19-99; 8:45 am]
BILLING CODE 6210-01-P