[Federal Register Volume 65, Number 161 (Friday, August 18, 2000)]
[Notices]
[Pages 50534-50536]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-21036]


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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 Anna Lee Hewko, Financial Analyst (202/530-
6260), Division of Banking Supervision and Regulation. For the hearing 
impaired only, Telecommunication Device for the Deaf (TDD), Janice 
Simms (202/872-4984), Board of Governors of the Federal Reserve System, 
20th & C Streets, 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

    Section 121 of the Federal Deposit Insurance Corporation 
Improvement Act of 1991, 12 U.S.C. 1831n(c)) requires each Federal 
banking and thrift agency to report annually to the Committee on 
Banking, Housing, and Urban Affairs of the U.S. Senate and to the 
Committee on Banking and Financial Services of the U.S. House of 
Representatives 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.
    This is the tenth annual report 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).
    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 risk-based capital frameworks that were 
based upon the international capital accord (Basel Accord) developed by 
the Basel Committee on Banking Regulations and Supervisory Practices 
(Basel 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 Basel Accord requires banking 
organizations to have total capital (tier 1 plus tier 2) equal to at 
least eight percent, and tier one capital equal to at least four 
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 limited amounts of ``tier 3'' capital (i.e., 
short-term subordinated debt with certain restrictions on repayment 
provisions) to support their exposure to 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 Basel 
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 Basel 
Accord. The banking agencies' amendments generally require institutions 
with trading assets and liabilities greater than or equal to either ten 
percent of assets or $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.
    The three U.S. banking agencies are represented on the Basel 
Supervisors Committee, which in June 1999 issued a consultative paper 
outlining a proposed new capital adequacy framework. The new framework, 
which is still under development, is designed to improve the way 
regulatory capital requirements reflect underlying risks. As eventual 
changes to the Accord are implemented in the United States, the 
agencies will continue to work together to ensure consistent 
implementation across regulated entities.
    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 have long 
employed uniform leverage standards, whereas the OTS established, 
pursuant to FIRREA, a somewhat different standard. As discussed below, 
in March 1999, the agencies issued a final rule making the OTS's 
leverage capital requirements more consistent with those of the banking 
agencies.
    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,

[[Page 50535]]

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.'' Going forward, the agencies will continue to work together 
closely on areas of common interest as they implement the Gramm-Leach-
Bliley Act.

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 early in 1991, require the most highly-rated institutions to 
meet a minimum tier 1 capital leverage ratio of 3.0 percent. On March 
2, 1999, the agencies issued a final rule to require all other 
institutions to meet a minimum tier 1 leverage ratio of 4.0 percent. 
This final rule, which became effective April 1, 1999, also made the 
OTS's leverage capital standards more consistent with those of the 
banking agencies. As required by FIRREA, the OTS has established a 
capital ratio of 3.0 or 4.0 percent, depending upon a thrift's 
financial condition, 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.

Risk-Based Capital Ratio

    The agencies issued a final rule on March 2, 1999, to 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. This rule, which became 
effective April 1, 1999, established the following risk-based capital 
treatments:

Construction Loans on Presold Residential Property

    The agencies agreed to 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 once the property is sold, 
whether the sale occurs before or after the construction loan has been 
made.

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 agencies agreed to view 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 weight 
category, depending on 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 agencies evaluate the LTV ratio based on the combined 
loan amount. If the combined loan amount satisfies prudent underwriting 
standards and the loan is considered to be performing adequately, both 
the first and second lien are assigned to the 50 percent risk category. 
Otherwise, both liens are risk-weighted at 100 percent.

Mutual Funds

    The agencies agreed generally to assign all of a bank's holding in 
a mutual fund to the risk category appropriate to the asset with the 
highest risk weight that a particular mutual fund is permitted to hold 
under its prospectus. The agencies also agreed, on a case-by-case 
basis, to permit 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.

Elimination of Previous Differences in Accounting Standards

    Commercial banks file Uniform Reports of Condition and Income (Call 
Reports) with the three banking agencies using accounting standards for 
recognition and measurement purposes that are consistent with GAAP. 
Savings associations file Thrift Financial Reports with the OTS using 
accounting standards that are also consistent with GAAP. Accordingly, 
there are no material differences in the accounting standards used for 
regulatory reports filed with the three banking agencies and the OTS.

Capital Differences

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

Certain Collateralized 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 
and the collateral must be marked to market daily. Other collateralized 
claims, or portions thereof, are risk-weighted at 20 percent.
    The OCC rule incorporates similar conditions on collateralized 
claims eligible for a zero percent risk weight. The OCC's rule, 
however, permits portions of claims collateralized by cash or OECD 
government securities to receive a zero percent risk weight. Under the 
FDIC's and OTS's rules, portions of claims collateralized by cash or 
OECD government securities receive a 20 percent risk weight; a zero 
percent risk weight is not available for collateralized transactions.
    On August 16, 1996, the four agencies published a joint proposed 
rulemaking that would, if implemented, make uniform the agencies' risk-
based capital treatment for these types of 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 meet certain criteria, including 
daily mark to market and positive collateral margin requirements. 
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

[[Page 50536]]

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. The OTS also 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 Basel 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 Basel 
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, apply 
an appropriate risk-weighted capital charge against the proportionate 
share of the assets of the entity, require a line-by-line consolidation 
of the entity, or otherwise 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 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 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 does, 
however, reserve the right to require a national bank to deduct from 
capital, on a case-by-case basis, 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 
activities ``impermissible'' for national banks. Subsidiaries of thrift 
institutions that engage only in impermissible activities are 
consolidated on a line-by-line 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 
in 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 the 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.

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.

    By order of the Board of Governors of the Federal Reserve 
System, August 14, 2000.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 00-21036 Filed 8-17-00; 8:45 am]
BILLING CODE 6210-01-P