[Federal Register Volume 66, Number 24 (Monday, February 5, 2001)]
[Notices]
[Pages 8993-9000]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-2958]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

[Docket Number 01-02]


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

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

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

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

FOR FURTHER INFORMATION CONTACT: Roger Tufts, Senior Economic Advisor, 
Office of the Chief National Bank Examiner (202) 874-5070; Louise A. 
Francis, National Bank Examiner, Office of the Chief Accountant (202) 
874-1306; Laura Goldman, Senior Attorney, Legislative and Regulatory 
Activities Division (202) 874-5090; or Ron Shimabukuro, Senior 
Attorney, Legislative and Regulatory Activities Division, (202) 874-
5090, Office of the Comptroller of the Currency, 250 E Street SW., 
Washington, DC 20219.

SUPPLEMENTARY INFORMATION:

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

Report to the Committee on Banking, Housing, and Urban Affairs of 
the United States Senate and to the Committee on Banking and 
Financial Services of the United States House of Representatives, 
Submitted by the Office of the Comptroller of the Currency

December 2000.
    This report \1\ describes the differences among the capital 
requirements of the Office of the Comptroller of the Currency (OCC) and 
those of the Board of Governors of the Federal Reserve System (FRB), 
the Federal Deposit Insurance Corporation (FDIC), and the Office of 
Thrift Supervision (OTS).\2\ The report is divided into five sections. 
The first section provides a short overview of the current capital 
requirements; the second section discusses the differences in the 
capital standards; the third section briefly discusses recent 
amendments made by the Agencies to their respective capital standards 
to promote more consistent capital standards; the fourth section 
discusses recent interagency proposals; and the fifth section discusses 
the differences in accounting standards related to capital.
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    \1\ This report is made pursuant to section 37(c) of the Federal 
Deposit Insurance Act (FDIA). 12 U.S.C. 1831n(c). Section 37(c) was 
added to the FDIA by section 121 of the Federal Deposit Insurance 
Corporation Improvement Act of 1991 (FDICIA), Pub. L. No. 102-242, 
105 Stat. 2236 (December 19, 1991). Section 121 of FDICIA supersedes 
section 1215 of the Financial Institutions Reform, Recovery, and 
Enforcement Act of 1989 (FIRREA), Pub. L. No. 101-73, 103 Stat. 183 
(August 9, 1989), which imposed similar reporting requirements.
    \2\ The OCC is the primary supervisor of national banks. Bank 
holding companies and state-chartered banks that are members of the 
Federal Reserve System are supervised by the FRB. State-chartered 
nonmember banks are supervised by the FDIC. The OTS supervises 
savings associations and savings and loan holding companies. In this 
report, the term ``Banking Agencies refers to the OCC, FRB, and the 
FDIC; the term ``Agencies'' refers to all four of the agencies, 
including the OTS.
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A. Overview of the Risk-Based Capital Standards

1. Credit Risk Component

    Since the adoption of the risk-based capital guidelines in 1989, 
all of the Agencies have applied similar capital standards to the 
institutions they supervise. The risk-based capital guidelines 
implement the Accord on International Convergence of Capital 
Measurement and Capital Standards adopted by the Basel Committee on 
Banking Supervision (Basel Accord) \3\ in July, 1988.
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    \3\ The Basel Committee on Banking Supervision has issued a 
consultative paper that describes and solicits views on substantial 
revisions to the Basel Accord. The paper, entitled ``A New Capital 
Adequacy Framework,'' was published in June, 1999. Comments were due 
by March 31, 2000.
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    The risk-based capital guidelines establish a framework for 
imposing capital requirements generally based on credit risk. Under the 
risk-based capital guidelines, balance sheet assets and off-balance 
sheet items are categorized, or ``risk weighted,'' according to the 
relative degree of credit risk inherent in the asset or off-balance 
sheet item. The risk-based capital guidelines specify four risk-weight 
categories--zero percent, 20 percent, 50 percent, and 100 percent. 
Assets or off-balance sheet items with the lowest levels of credit risk 
are placed in the lowest risk-weight category; those presenting greater 
levels of credit risk receive a higher risk weight. Thus, for example, 
securities issued by the U.S. government are risk weighted at zero 
percent; one- to four-family residential mortgages are risk weighted at 
50 percent; and unsecured commercial loans are risk weighted at 100 
percent.
    Off-balance sheet items must first be translated into an on-balance 
sheet credit equivalent amount by applying the conversion factors, or 
multipliers, that are specified in the risk-based capital guidelines of 
the Agencies. This credit equivalent amount is then assigned to one of 
the four risk-weight categories. For example, a bank may extend to its 
customer an unsecured line of credit that the customer may borrow 
against for up to two years. The unused portion of this two year line 
of credit--that is, the amount of available credit that the customer 
has not drawn--is reported as an off-balance sheet item. Under the 
Agencies' risk-based capital guidelines, this unused portion is 
translated into an on-balance sheet credit equivalent amount and then 
assigned a risk weight according to the credit risk of the 
counterparty.
    Once the assets and off-balance sheet items have been risk 
weighted, the total amount of all risk-weighted assets and off-balance 
sheet items is used to determine the minimum total amount of capital 
required for that institution. Specifically, the risk-based capital 
guidelines of the Agencies require each institution to maintain a ratio 
of total capital to risk-weighted assets of at least 8 percent. Total 
capital is comprised of two components--Tier 1 capital (core capital) 
and Tier 2 capital (supplementary capital). Tier 1 capital includes 
common stockholders' equity, noncumulative perpetual preferred stock 
and related surplus, and minority interests in consolidated 
subsidiaries.

[[Page 8994]]

Tier 2 capital includes the allowance for loan and lease losses, 
certain types of preferred stock, some hybrid capital instruments, and 
certain subordinated debt. Some of the Tier 2 capital instruments, as 
well as the total amount of Tier 2 capital, are subject to limitations 
and conditions provided by the risk-based capital guidelines of the 
Agencies. In addition, the risk-based capital guidelines require the 
deduction of certain assets from either Tier 1 capital or total 
capital. Such assets include, for example, goodwill and certain other 
intangible assets and the amount of some servicing assets in excess of 
prescribed limits.
    In addition to Tier 1 and Tier 2 capital, the risk-based capital 
guidelines of the Banking Agencies also permit certain banks with 
significant trading activities to hold limited amounts of Tier 3 
capital to satisfy market risk requirements. See Section A.2. for a 
summary of the market risk component.
    Institutions generally are expected to hold capital above the 
required minimum level. In 1999, most national banks, for example, on 
average had risk-based capital ratios in excess of 11.72. percent. In 
addition to the risk-based capital requirement, the Agencies also 
impose a minimum leverage capital requirement, expressed as a 
percentage of Tier 1 capital to adjusted total assets. Unlike the risk-
based capital ratio, the leverage capital ratio is based on total 
balance sheets assets, not total risk-weighted assets. This means that 
the leverage capital ratio is computed without regard to risk-weight 
categories and without including off-balance sheet items.\4\
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    \4\ In addition to the risk-based capital guidelines, the 
Agencies have issued regulations implementing the prompt corrective 
action (PCA) provisions of the FDICIA. FDICIA requires that the 
Agencies take certain supervisory actions if an institution's 
capital declines to unacceptable levels. See 12 U.S.C. 1831o. The 
PCA regulations establish four capital categories that are defined 
in terms of three separate capital measures (the risk-based capital 
ratio, the leverage ratio, and the ratio of Tier 1 capital to risk-
weighted assets). These four categories are: Well capitalized, 
adequately capitalized, undercapitalized, and significantly 
undercapitalized. By way of illustration, an institution is well 
capitalized if its risk-based capital ratio is 10 percent or 
greater; its leverage ratio is 5 percent or greater; and its ratio 
of Tier 1 capital to risk-weighted assets is 6 percent or greater. A 
fifth PCA category--critically undercapitalized--is defined, as the 
statute requires, as a 2 percent ratio of tangible equity to total 
assets. See 12 CFR part 6 (1997) (OCC PCA regulations).
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2. Market Risk Component

    In 1996, the Banking Agencies amended their respective risk-based 
capital standards to take account of market risk. See 61 FR 47358 
(September 6, 1996).\5\ Generally, under the Banking Agencies' market 
risk rules, banks and bank holding companies with significant trading 
activities must measure and hold capital for exposure to general market 
risk and specific market risk. General market risk represents the 
change in market value of on- and off-balance sheet positions resulting 
from broad market movements arising from fluctuations in interest 
rates, equity prices, foreign exchange rates, and commodity prices. 
Specific market risk refers to changes in the market value of 
individual positions due to factors other than broad market movements 
and includes such risk as credit risk of an instrument's issuer.
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    \5\ Because of differences in portfolio characteristics and 
permissible activities between banks and thrifts, the OTS did not 
add a market risk component to its risk-based capital standards.
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    Under the 1996 market risk rule, an institution measured specific 
risk through a standardized approach or a valid internal model. The 
standardized approach uses a risk weighting process that relies on a 
category-based fixed capital charge. An institution using an internal 
model, however, faced a burdensome dual calculation of specific risk 
because it still had to use the standardized approach to determine the 
minimum specific risk charge. The rules required an institution to hold 
capital for specific risk at least equal to 50 percent of the specific 
risk charge calculated using the standardized approach.
    In light of advances in the modeling of specific risk, the Banking 
Agencies concluded that it was not necessary to impose a minimum 
specific risk charge. As a result, in December 1997, the Banking 
Agencies issued interim rule that eliminated the minimum specific risk 
capital charge for certain institutions using a qualifying internal 
model to measure specific risk. 62 FR 68064 (December 30, 1997) 
(interim rule with request for comments). The interim rule was adopted 
in final form, without substantive change, in April, 1999. 64 FR 19034 
(April 19, 1999).

3. Interest Rate Risk Component

    In 1995, the Banking Agencies amended their respective risk-based 
capital standards to include an evaluation of interest rate risk, as 
measured by a change in a bank's exposure to declines in the economic 
value of its capital as a result of changes in interest rates. 60 FR 
39490 (August 2, 1995). The Banking Agencies subsequently issued a 
joint policy statement that provides guidance on sound practices for 
managing interest rate risk and sets out standards for evaluating the 
effectiveness of a bank's interest rate risk management. 61 FR 33166 
(June 26, 1996).
    The OTS has adopted a regulation that adds an interest rate risk 
component to its risk-based capital standards. The OTS's regulation 
differs from the Banking Agencies' rules in that it establishes a 
standardized measure of interest rate risk and, when fully implemented, 
will require an explicit capital charge against that risk. The OTS's 
regulation would require a deduction from capital for thrifts with 
greater than normal interest rate risk exposure; the amount of the 
deduction would be one-half the difference between the thrift's actual 
level of exposure and the normal level of exposure. The OTS has 
partially implemented this rule by formally reviewing institutions' 
interest rate risk, but does not currently require thrifts to take 
deductions from capital.

B. Remaining Differences in Capital Standards of the Agencies

    Although the Agencies have adopted common leverage capital 
requirements and risk-based capital guidelines, a few differences in 
their respective capital standards remain. These differences are 
described in this section.

1. Assets Subject To Guarantee Arrangements by the Federal Savings and 
Loan Insurance Corporation (FSLIC)/Federal Deposit Insurance 
Corporation

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

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

    The OCC limits the amount of Tier 2 capital that may be included in 
total capital to no more than 100 percent of Tier 1 capital. Consistent 
with the Basel Accord, under the OCC guidelines, the amount of 
subordinated debt and limited-life preferred stock included in Tier 2 
capital may not constitute more than 50 percent of Tier 1 capital. In 
addition, the OCC risk-based capital guidelines require that 
subordinated debt and limited-life preferred stock be discounted 20 
percent in each of the five years prior to maturity. The other Banking 
Agencies have similar rules.

[[Page 8995]]

    The OTS risk-based capital rules also limit the amount of Tier 2 
capital that may be included in total capital to 100 percent of Tier 1 
capital, but do not contain any sublimits on the total amount of 
limited-life instruments that may be included in Tier 2 capital. In 
addition, the OTS allows savings associations the option of either (1) 
discounting maturing capital instruments (issued on or after November 
7, 1989) by 20 percent a year over the last five years prior to 
maturity, or (2) including the full amount of such instruments, 
provided that the amount maturing in any of the next seven years does 
not exceed 20 percent of the total capital of the savings association.

3. Subsidiaries Other Than Financial Subsidiaries

    Consistent with the Basel Accord, the Banking Agencies generally 
require that ``significant majority-owned subsidiaries'' \6\ be 
consolidated with the parent institution for both regulatory reporting 
and capital purposes. If a subsidiary is not consolidated, the bank's 
investment in the subsidiary constitutes a capital investment in the 
subsidiary. The OCC risk-based capital guidelines specifically provide 
that capital investments in an unconsolidated subsidiary must be 
deducted from the total capital of the bank. The OCC risk-based capital 
guidelines also permit the OCC to require the deduction of investments 
in other subsidiaries and associated companies on a case-by-case basis. 
See 12 CFR Part 3, Appendix A, section 2(c)(4)(i).
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    \6\ A ``significant majority-owned subsidiary'' is a subsidiary 
in which the investment by the parent bank represents a significant 
financial interest of the parent bank as evidenced by one or more of 
the following: (1) The bank's investment in or advances to the 
subsidiary equals 5 percent or more of the total equity capital of 
the bank; (2) the bank's proportional share of the gross income or 
revenue of the subsidiary equals 5 percent or more of the gross in 
come or revenue of the bank; (3) the income or loss (before taxes) 
of the subsidiary amount to 5 percent or more of the income or loss 
(before taxes) of the bank; or (4) the subsidiary is the parent of a 
subsidiary that is considered a significant subsidiary. See FFIEC, 
Instructions to the Consolidated Reports of Condition and Income, 
Glossary A-76a (3-99).
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    The FRB risk-based capital guidelines for state member banks 
generally require the deduction of investments in unconsolidated 
subsidiaries. The FRB may require an investment in unconsolidated 
subsidiaries, other than banking and finance subsidiaries or joint 
ventures and associated companies to be: (1) Deducted, (2) 
appropriately risk weighted against the proportionate share of the 
assets of the entity, or (3) consolidated with the entity. In addition, 
the FRB may require the parent organization to maintain capital above 
the minimum standard sufficient to compensate for any risks associated 
with the investment. The FRB risk-based capital guidelines also 
explicitly permit the FRB to require the deduction of investments in 
certain subsidiaries that, while consolidated for accounting purposes, 
are not consolidated for certain specified supervisory or regulatory 
purposes.
    The FDIC similarly requires the deduction of investments in certain 
types of securities subsidiaries of state-chartered nonmember banks 
that, while consolidated for accounting purposes, are not consolidated 
for regulatory capital purposes. Moreover, under the FDIC rules, 
investments in, and extensions of credit to, certain mortgage banking 
subsidiaries \7\ are also deducted in computing the capital of the 
parent bank. Neither the OCC nor the FRB has a similar requirement with 
regard to mortgage banking subsidiaries.
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    \7\ The FDIC capital guidelines define finance subsidiaries as 
``any company that is primarily engaged in banking or finance and in 
which the bank, either directly or indirectly, owns more than 50 
percent of the outstanding voting stock but does not consolidate the 
company for regulatory capital purposes.'' 12 CFR part 325, Appendix 
A Sec. I(B)(2) note 9.
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    The OTS risk-based capital guidelines make a distinction, mandated 
by FIRREA, between saving associations subsidiaries engaged in 
activities permissible for national banks and savings association 
subsidiaries engaged in activities impermissible for national banks. 
Similar to the treatment of subsidiaries by the Banking Agencies, 
subsidiaries of savings associations that engage only in activities 
permissible for national banks are either consolidated on a line-for-
line basis, if majority-owned,\8\ or on a pro rata basis using the 
equity method of accounting, if not. The OTS has retained the right to 
review a savings association's investment in a subsidiary on a case-by-
case basis, regardless of the percentage of ownership held by the 
savings association.
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    \8\ Instead of referring to an ownership interest of 50 percent 
or greater, the OTS regulation refers to ownership interests that 
would not be consolidated under generally accewpted accounting 
principles (GAAP). Because such ownership interests are generally 
majority investments, the reference to GAAP would not present a 
difference in treatment of subsidiaries of Federal savings 
associations as compared to subsidiaries of other federal banking 
agencies.
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    Savings associations' investments in subsidiaries (which include 
loans to subsidiaries) that engage in national bank-impermissible 
activities, however, are deducted as a general rule in computing 
tangible and core capital of the parent association. The remaining 
assets (the percent of assets corresponding to the nondeducted portion 
of the investment in the subsidiary) are consolidated with the assets 
of the parent association.\9\
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    \9\ There is one statutory exception to this rule on 
consolidation for subsidiaries engaging in national bank-
impermissible activities. Investments in subsidiary insured 
depository institutions acquired before May 1, 1989, need not be 
deducted from the savings association's capital. Investments in such 
subsidiaries are permanently grandfathered by statute. See 12 U.S.C. 
1464(t)(5)(C)(ii). A subsidiary insured depository institution is 
``itself an insured depository institution or a company the sole 
investment of which is an insured depository institution.'' 12 
U.S.C.. 1464(t)(5)(C)(ii)(I).
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4. Financial Subsidiaries

    The Gramm-Leach-Bliley Act (GLBA) authorizes national banks to 
conduct certain expanded financial activities through financial 
subsidiaries. Section 121(a) of the GLBA \10\ imposes a number of 
conditions and requirements upon national banks that have financial 
subsidiaries, including specifying the treatment that applies for 
regulatory capital purposes. The statute requires that a national bank 
deduct from assets and tangible equity the aggregate amount of its 
equity investments (including retained earnings) in financial 
subsidiaries. The statute further requires that the financial 
subsidiary's assets and liabilities not be consolidated with those of 
the parent national bank. The OCC has issued regulations implementing 
these requirements, as well as the other requirements that GLBA imposes 
on national banks that have financial subsidiaries.\11\
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    \10\ GLBA, Pub. L. No. 106-102, Sec. 121, 113 Stat. 1338-1373-81 
(November 12, 1999) (codified at 12 U.S.C. 24a).
    \11\ See 65 FR 12905, 12906, 12915 (March 10, 2000) (OCC final 
rule) (capital deduction and deconsolidation requirements codified 
at 12 CFR 5.39(h)).
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    State banks that establish financial subsidiaries are also subject 
to certain requirements. GLBA amends the Federal Deposit Insurance Act 
to provide that an insured state bank is, among other limitations, 
subject to the capital deduction and deconsolidation requirements that 
apply to a national bank if the state bank holds an interest in a 
subsidiary that is engaging as principal in activities that would only 
be permissible for a national bank to conduct through a financial 
subsidiary.\12\ Under GLBA a state member bank that holds an interest 
in any financial subsidiary--whether conducting activities as principal 
or agent--must comply with all of the

[[Page 8996]]

same conditions and limitations that apply to a national bank, 
including the capital deduction and deconsolidation requirement.\13\ 
The FRB and the FDIC have each issued interim final rules that 
incorporate these requirements.\14\ The GLBA did not provide new 
authority to savings associations to have financial subsidiaries, so it 
has not been necessary for the OTS to make similar changes to its 
regulations.
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    \12\ See GLBA, Sec. 121(d)(1) (capital deduction and 
deconsolidation requirement codified at 12 U.S.C. 1831w(a)(2)).
    \13\ Id. at Sec. 121(d)(2), amending 12 U.S.C. 335.
    \14\ See 65 FR 14810 (March 20, 2000) (FRB); 65 FR 15526 (March 
23, 2000) (FDIC).
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5. Merchant Banking Activities

    The GLBA authorizes financial holding companies to acquire or 
control shares, assets, or ownership interests of any nonfinancial 
company as part of a bona fide underwriting, or merchant or investment 
banking activity.\15\ The FRB has recently issued a proposed regulation 
that would apply a 50 percent capital charge at the holding company 
level, not only to investments made by bank holding companies pursuant 
to the new merchant banking investment authority, but also to 
investments made by holding companies--including bank subsidiaries--in 
small business investment companies (SBICs) pursuant to longstanding 
authority in the Small Business Investment Act.\16\ The Banking 
Agencies currently apply an 8 percent capital charge to investments in 
SBICs. Adoption of the FRB regulation as proposed would therefore 
create a significant difference in the capital requirement that the FRB 
applies--through its supervision of financial holding company capital--
to bank-level investments in SBICs and the capital requirement that the 
Banking Agencies apply to those same investments. The Agencies 
currently are discussing this issue in an effort to resolve the 
potential differences in capital requirements for SBIC investments.
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    \15\ GLBA Sec. 103(a), 113 Stat. at 1344 (merchant banking 
authority codified at 12 U.S.C. 1843(k)(4)(H)).
    \16\ 65 FR 16480, 16481 (March 28, 2000).
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6. Mortgage-Backed Securities (MBS)

    The OCC risk-based capital guidelines generally assign a risk 
weight to privately issued MBSs according to the underlying assets, but 
in no case is a privately issued MBS assigned to the zero percent risk-
weight category. Privately issued MBSs, where the direct underlying 
assets are mortgages, are generally assigned a risk weight of 50 
percent or 100 percent. Privately issued MBSs that have government 
agency or government-sponsored agency securities as their direct 
underlying assets are generally assigned to the 20 percent risk-weight 
category. The other Banking Agencies have similar rules.
    Similarly, the OTS assigns privately issued MBSs backed by 
securities issued or guaranteed by government agencies or government-
sponsored enterprises to the 20 percent risk-weight category. Unlike 
the Banking Agencies, however, the OTS also assigns certain privately-
issued high quality mortgage-related securities with AA or better 
investment ratings to the 20 percent risk-weight category. Like the 
Banking Agencies, the OTS does not assign any privately issued MBS to 
the zero percent category.

7. Nonresidential Construction and Land Loans

    Under the OCC risk-based capital guidelines, loans for real estate 
development and construction are assigned to the 100 percent risk-
weight category. Reserves or charge-offs are required for such loans 
when weaknesses or losses develop. The OCC has no requirement for an 
automatic charge-off when the amount of a loan exceeds the fair value 
of the property pledged as collateral for the loan. The other Banking 
Agencies have similar rules.
    OTS generally also assigns these loans to the 100 percent risk-
weight category. If the amount of the loan exceeds 80 percent of the 
fair value of the property, however, savings associations must deduct 
the full amount of the excess portion from total capital.

8. Pledged Deposits and Nonwithdrawable Accounts

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

C. Recent Interagency Amendments to Capital Rules

    The following describes the Agencies' most significant recent 
rulemaking projects.

1. Unrealized Gains and Losses on Securities Available for Sale

    Under the Agencies' risk-based capital standards Tier 1 capital is 
defined to include common stockholders' equity, noncumulative preferred 
stock, and minority interests in the equity accounts of consolidated 
subsidiaries. Common stockholders' equity is further defined to include 
common stock, related surplus, and retained earnings (including capital 
reserves and adjustments for the cumulative effect of foreign currency 
translation), less net unrealized holding losses on available-for-sale 
equity securities with readily determinable fair values.\17\ Tier 2 
capital is defined, subject to certain limitations and conditions, to 
include the allowance for loan and lease losses, cumulative perpetual 
preferred stock and related surplus, convertible preferred stock, and 
certain other subordinated debt and hybrid capital instruments.
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    \17\ For regulatory capital purposes, institutions record net 
unrealized gains or losses on available-for-sale securities (debt 
and equity) in accordance with the Financial Accounting Standard 
(FAS) 115, which generally requires net unrealized gains and losses 
on securities available for sale to be included in capital. See 
Financial Accounting Standards Board, Statement of Financial 
Accounting Standards Number 115 (Accounting for Certain Investments 
in Debt and Equity Securities), No. 126-D (May 1993). The FFIEC 
adopted FAS 115 for regulatory reporting purposes beginning December 
14, 1993.
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    The Basel Accord, however, also permits up to 45 percent of the 
gross (i.e., pretax) unrealized gains on equity securities to be 
included in Tier 2 capital. The 55 percent discount applies to the 
unrealized gains to reflect potential volatility of this form of 
unrealized capital, as well as the tax liability charges that might be 
incurred if the unrealized gain were realized or otherwise taxed 
currently.
    On September 1, 1998, the Agencies issued a final rule authorizing 
this treatment for banks and thrifts. See 63 FR 46518 (September 1, 
1998). Specifically, this rule permits institutions to include in Tier 
2 capital up to 45 percent of the pretax net unrealized holding gains 
\18\ on certain

[[Page 8997]]

available-for-sale equity securities. The equity securities must be 
valued in accordance with GAAP and have readily determinable fair 
values,\19\ which the institutions should be able to substantiate. In 
the event an Agency determines that an institution's available-for-sale 
equity securities are not prudently valued, the institution may be 
precluded from including all or a portion of the eligible pretax net 
unrealized gains on those securities in Tier 2 capital.
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    \18\ This is the excess amount of the fair value over historical 
cost as reported in the institution's most recent quarterly 
regulatory report (e.g., the Consolidated Report of Condition and 
Income (Call Report) for banks supervised by the OCC, the FRB, or 
the FDIC; the Thrift Financial Report (TFR) for thrift institutions 
supervised by the OTS; and the Y-9C Report for bank holding 
companies supervised by the FRB).
    \19\ The Agencies intend to rely on the guidance set forth in 
FAS 115 for purposes of determining whether equity securities have 
fair values that are ``readily determinable.''
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2. Servicing Assets

    On August 4, 1997, the Agencies issued a joint notice of proposed 
rulemaking with request for comment on the capital treatment of 
mortgage and non-mortgage servicing assets. See 62 FR 42006 (August 4, 
1997). The Agencies issued the proposed rule in response to FAS 125, 
which became effective January 1, 1997. FAS 125 required the recording 
of servicing on all financial assets serviced for others, including 
loans other than mortgages. See Financial Accounting Standards Board, 
Statement of Financial Accounting Standards Number 125 (Accounting for 
Transfers and Servicing of Financial Assets and Extinguishment of 
Liabilities). FAS 125 superseded FAS 122, which had eliminated the 
accounting distinction between originated mortgage servicing rights 
(OMSR) and purchased mortgage servicing rights (PMSR). See Financial 
Accounting Standards Board, Statement of Financial Accounting Standards 
Number 122 (Accounting for Mortgage Servicing Rights).
    The Agencies proposed to increase the amount of mortgage servicing 
assets (MSAs) (consisting of both OMSRs and PMSRs) included in Tier 1 
capital from 50 to 100 percent. The Agencies' proposal also included a 
requirement that MSAs continue to be subject to a 10 percent valuation 
discount which permits only the lesser of book value or 90 percent of 
fair market value to be included in Tier 1 capital. On August 10, 1998, 
the Agencies published a final rule adopting these and other changes to 
the risk-based capital treatment of servicing assets. See 63 FR 42668 
(August 10, 1998).

3. CDRI Act Section 303(a)(2) Capital Amendments

    As part of the interagency review of regulations undertaken 
pursuant to section 303(a)(2) of the Riegle Community Development and 
Regulatory Improvement Act of 1994 (CDRI Act),\20\ the Agencies adopted 
joint final rules to eliminate differences in their rules in five 
areas: leverage capital requirements, construction loans on presold 
residential properties, junior liens on 1- to 4-family residential 
properties, and mutual funds. See 64 FR 10194 (March 2, 1999). A review 
of the capital treatment of collateralized transactions was also 
proposed as part of the section 303(a)(2) CDRI Act review; however, 
this proposed rule was issued separately and is discussed in section 
D.2 of this report. See 1996 Report at I-6 to I-9.
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    \20\ Pub. L. No. 103-325, Sec. 303, 108 Stat. 2160, 2215 (1994) 
(codified at 12 U.S.C. 4803). Section 303(a)(2) required that the 
Agencies ``work jointly * * * to make uniform all regulations and 
guidelines implementing common statutory or supervisory policies.'' 
See also Board of Governors of the Federal Reserve System, Federal 
Deposit Insurance Corporation, Office of the Comptroller of the 
Currency, and the Office of Thrift Supervision, Joint Report: 
Streamlining of Regulatory Requirements (September 23, 1996) (report 
submitted by the Agencies to the Congress pursuant to section 
303(a)(3) of the CDRI Act; referred to hereafter as the 1996 
Report), updated by Joint Report: Update on Review of Regulations 
and Paperwork Reductions (Section 402 of the Credit Union Membership 
Access Act) (August 5, 1999).
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a. Leverage Capital Requirements
    The OCC, together with the Banking Agencies, adopted revisions to 
their leverage capital requirements to clarify that highly-rated 
institutions with a CAMELS \21\ rating of 1 need only maintain a 3 
percent minimum leverage ratio and that all other institutions must 
maintain a 4 percent minimum leverage ratio. In addition, the OTS 
amended its leverage capital standard to be consistent with the Banking 
Agencies by stating that higher-than-minimum capital levels may be 
required if warranted, and that institutions should maintain capital 
levels consistent with their risk exposures. See 64 FR 10194 (March 2, 
1997).
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    \21\ On December 9, 1996, the Federal Financial Institutions 
Examination Council (FFIEC) adopted revisions to the Uniform 
Financial Institutions Rating System (UFIRS). The UFIRS is used by 
federal and state banking regulators for assessing the soundness of 
financial institutions on a uniform basis and for identifying those 
insured institutions requiring special supervisory attention. The 
condition of each institution is reflected in the ``CAMELS'' rating, 
which provides a measure of a bank's Capital, Asset Quality, 
Management, Earnings, Liquidity, and Sensitivity to market risk. See 
61 FR 67021 (December 19, 1996).
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b. Construction Loans on Presold Residential Properties
    Under former OCC and OTS rules, loans to a builder to finance the 
construction of a presold 1- to 4-family residential property could not 
receive a 50 percent risk weight unless, prior to the extension of 
credit to the builder, the property was sold to an individual who would 
occupy the residence upon completion of the construction. In contrast, 
the Board and FDIC considered this type of construction loan to be 
eligible for a 50 percent risk weight once the property is sold, 
regardless of whether the institution made the loan to the builder 
before or after the individual purchased the residence from the 
builder.
    To permit a uniform treatment of qualifying residential 
construction loans, the OCC and OTS revised its risk-based capital 
standards to adopt the Board and FDIC's treatment of these loans. The 
Agencies now uniformly permit qualifying residential construction loans 
to be eligible for the 50 percent risk weight category at the time the 
property is sold, regardless of when the institution made the loan to 
the builder. See 64 FR 10194 (March 2, 1997).
c. Junior Liens on 1- to 4-Family Properties
    The Agencies have adopted a uniform risk-based capital treatment of 
real estate loans secured by junior liens on 1- to 4-family residential 
properties. The Agencies' former rules were not uniform in their 
treatment of these junior liens in instances where the lending 
institution held the first lien and no other party held an intervening 
lien. The OCC and OTS rules treated all first and junior liens 
separately, even if the lending institution held both liens and no 
party held an intervening lien, and risk weighted qualifying first 
liens which conform to prudent underwriting standards at 50 percent and 
non-qualifying first liens and all junior liens at 100 percent. In 
contrast, the FRB and FDIC rules treated the first and junior liens as 
a single loan secured by a first lien held by the lending institution, 
provided there were no intervening liens and assigned the combined loan 
amount to either the 50 percent or 100 percent risk-weight category 
depending on whether certain criteria are met.
    Under the joint final rule, the Agencies adopted the Board's 
capital treatment of junior liens as the uniform interagency approach. 
This approach combines first and junior liens as a single exposure and 
risk weights the combined exposure at either 50 or 100

[[Page 8998]]

percent, as appropriate, taking into account the loan-to-value ratio of 
the combined exposure. To qualify for the 50 percent risk category, the 
combined loan must be made in accordance with prudent underwriting 
standards, including an appropriate LTV ratio.\22\ In addition, none of 
the combined loans may be 90 days or more past due, or be in nonaccrual 
status. Loans that do not meet all of these criteria must be assigned 
in their entirety to the 100 percent risk category. See 64 FR 10194 
(March 2, 1997).
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    \22\ Prudent underwriting standards include an appropriate ratio 
of the loan balance to the value of the property. A loan secured by 
a one- to four-family residential property is considered prudently 
underwritten if the loan complies with the Interagency Guidelines 
for Real Estate Lending. See, e.g., 12 CFR part 34, subpart D (OCC).
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d. Mutual Funds
    The Agencies have adopted a uniform treatment of an institution's 
investment in a mutual fund. Under this uniform approach, the Agencies 
generally assign an institution's total investment in a mutual fund to 
the risk category appropriate to the highest risk-weighted asset the 
fund may hold in accordance with its stated investment limits set forth 
in its prospectus. Alternatively, institutions also have the option of 
assigning the investment on a pro rata basis to different risk 
categories according to the investment limits in the fund's prospectus.
    Regardless of the risk-weighting method used, the minimum risk 
weight that may be assigned to such a pool is 20 percent. If an 
institution assigns the asset on a pro rata basis, and the sum of the 
investment limits in the fund's prospectus exceeds 100 percent, the 
institution must assign the highest pro rata amounts of its total 
investment to the highest risk category. In addition, if a mutual fund 
is permitted to hold an immaterial amount of highly liquid, high 
quality securities that do not qualify for a preferential risk weight, 
then those securities may be disregarded in determining the fund's risk 
weight. However, if a fund engages in any activities that are deemed to 
be speculative in nature or has any other characteristics that are 
inconsistent with the preferential risk-weighting assigned to the 
fund's assets, the institution's investment in the fund will be 
assigned to the 100 percent risk-weight category. See 64 FR 10194 
(March 2, 1997).

D. Recent Interagency Proposals

1. Recourse \23\ and Direct Credit Substitutes

    As a result of the adoption of GAAP as the reporting basis for 
Uniform Reports of Condition and Income (Call Reports) in 1997, banks 
now may remove assets transferred with recourse from their balance 
sheets if the transfers qualify for sale treatment under GAAP.\24\ 
Prior to the adoption of GAAP, the Banking Agencies' regulatory 
accounting principles (RAP) precluded banks from removing assets sold 
with recourse from the bank's balance sheet, thereby requiring them to 
maintain leverage capital against assets sold with recourse.
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    \23\ Section 208 of the CDRI Act (12 U.S.C. 1835) prescribes 
modified risk-based capital requirements for transfers of small 
business loans or leases of personal property with recourse that are 
sales under GAAP. This modified risk-based capital treatment 
generally reduces the amount of capital required to be held by 
certain qualified institutions for recourse retained in certain 
transfers of small business loans and leases of personal property. 
Specifically, section 208 permits such qualified institutions to 
include in its risk-weighted assets only the amount of the retained 
recourse, not the full value of assets transferred with recourse, 
multiplied by the appropriate risk-weight percentage. The Agencies 
have issued final rules implementing section 208. See 60 FR 45612 
(August 31, 1995) (FRB final rule); see also 62 FR 55490 (October 
24, 1997) (OCC, FDIC, and OTS joint final rule).
    \24\ In their Call Report instructions, the Agencies define 
recourse as the risk of credit loss an institution retains when it 
sells an asset.
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    The OTS capital rules, however, had previously enabled thrifts to 
remove assets sold with recourse from their balance sheets when such 
transactions qualify as sales under GAAP. Consequently, thrifts have 
not had to hold leverage capital against assets sold with recourse. The 
Banking Agencies' adoption of GAAP has resolved this difference in the 
capital treatment of sales with recourse. The Agencies' current risk-
based capital guidelines prescribe a single treatment for most assets 
transferred with recourse, regardless of whether the transaction is 
reported under GAAP as a financing or a sale of assets.
    Direct credit substitutes are arrangements in which an institution 
assumes the risk of credit loss from assets that it did not originate. 
The Banking Agencies' current capital rules treat direct credit 
substitutes and recourse differently.\25\ The OTS, however, treats some 
direct credit substitutes, such as purchased-subordinated interests, 
under its general recourse provisions and others, such as financial 
guarantee-type letters of credits, differently than recourse.
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    \25\ When an asset is transferred with recourse, risk-based 
capital must be held against the full amount of the transferred 
asset (not just the amount of the recourse), subject to the low-
level recourse rule. 12 U.S.C. 4808(b)(1). The low-level recourse 
rule limits the maximum risk-based capital requirement to the bank's 
maximum contractual obligation. A bank that provides an equivalent 
direct credit substitute, in contrast, must hold capital only 
against the face amount of the direct credit substitute.
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    On November 5, 1997 and again on March 8, 2000, the Agencies issued 
proposed rules on the regulatory capital treatment of recourse 
obligations and direct credit substitutes. The proposed rules would 
treat direct credit substitutes and recourse obligations consistently 
and would use credit ratings to match the risk-based capital assessment 
more closely to a banking organization's relative retention or 
assumption of credit risk in asset securitizations. See 62 FR 59944 
(November 5, 1997) and 65 FR 12320 (March 8, 2000). The March 2000 
proposed rule also would assess a capital surcharge against banks that 
sponsor revolving securitizations (i.e. credit card securitizations) 
that contain early amortization features.\26\
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    \26\ An early amortization feature requires the sponsor of a 
securitization to accelerate the paydown of senior securities in a 
securitization upon the occurrence of triggering events, such as a 
certain number of defaults or prepayments.
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2. Collateralized Transactions

    The Agencies currently have different rules on the risk weighting 
of collateralized transactions. Both the OCC and FRB permit certain 
loans and transactions collateralized by cash and government securities 
of the Organization for Economic Cooperation and Development (OECD) to 
qualify for a zero percent risk weight. The FDIC and OTS risk weight 
loans and transactions collateralized by cash and OECD government 
securities at 20 percent.
    To ensure uniform treatment of collateralized transactions, the 
Agencies are considering revisions to their capital rules. The FDIC and 
OTS have proposed to adopt a collateralized transactions rule lowering 
the risk weight from 20 percent to zero percent on certain loans and 
transactions collateralized by cash or government securities, while the 
OCC and FRB propose to revise their current collateralized transactions 
rule to use more uniform language. See 61 FR 42565 (August 16, 1996).

3. Residual Interests

    On September 27, 2000, the Agencies issued a proposed rule to amend 
the regulatory capital treatment of certain residual interests created 
in asset securitizations or other transfers of financial assets. The 
proposed rule is

[[Page 8999]]

intended to better align regulatory capital requirements with the risk 
exposure of residual interests, to encourage conservative valuation 
methods, and to restrict excessive concentrations in these assets. 
Residual interest are defined to include retained on-balance sheet 
residual interests, created through the sale of assets, that absorb 
more than a pro rata share of credit loss through subordination 
provisions or other credit enhancement techniques. Residual interests, 
as defined, would include subordinated security interests, cash 
collateral accounts, interest-only strips, and any other on-balance 
sheet assets that serve as credit enhancements. The definition of 
residual interests would exclude those residual interests that do not 
serve as credit enhancements as well as residual interests purchased by 
a third party.
    The proposed rule would (1) require dollar-for-dollar capital 
charge against the value of residual interests, even if the amount of 
capital exceeded the capital charge for the underlying assets supported 
by the residuals (in effect removing the cap imposed by the low level 
recourse rule) and (2) include residual interests within the 25 percent 
of Tier 1 capital sublimit already established for non-mortgage 
servicing assets and purchased credit card relationships. Any amounts 
above the sublimit would be deducted from Tier 1 capital. Any residual 
interests excluded in determining the Tier 1 capital numerator for the 
leverage and risk-based capital ratios would also be excluded from the 
denominators of these ratios to avoid double counting. See 65 FR 57993 
(September 27, 2000).

4. Simplified Capital Framework for Non-Complex Institutions

    The Agencies have published an advance notice of proposed 
rulemaking (ANPR) on a simplified regulatory capital framework for non-
complex banking institutions. See 65 FR 66193 (November 3, 2000). 
Currently, banks and thrifts are required to maintain minimum levels of 
risk-based capital under a framework established by the Basel Accord. 
However, the Agencies believe that the size, complexity, and risk 
profile of many banking institutions may warrant the application of a 
simplified capital framework that could reduce the regulatory burden 
associated with existing capital standards (or any future modification 
of those standards). Under such a framework, banks deemed non-complex 
would be subject to simplified capital requirements.
    The ANPR describes non-complex banks as being relatively small in 
terms of asset size and operations, possessing a relatively simple 
balance sheet, being principally engaged in traditional banking 
activities, and not having significant off-balance-sheet exposures. It 
is also noted that such banks generally have regulatory capital far in 
excess of the required minimums. The ANPR suggests that in order to be 
eligible for the non-complex framework a bank should maintain a level 
of capital sufficiently high such that more precise risk-based measures 
are not necessary.
    The ANPR considers the potential for using the nature of a bank's 
activities, its asset size, and its risk profile as determinants of 
eligibility for the simplified regulatory capital framework. Three 
options for setting minimum regulatory capital requirements for non-
complex banks are presented: (1) A risk-based ratio, (2) a simple 
leverage ratio, and (3) a modified leverage ratio that incorporates 
certain off-balance-sheet exposures.

5. Securities Borrowing Transactions

    The banking agencies have issued an interim rule that revises the 
market risk capital treatment for certain securities borrowing 
transactions. See 65 FR 75856 (December 5, 2000). Specifically, the 
interim rule generally would lower the capital requirements for certain 
qualifying securities borrowing transactions by permitting the 
collateralized portion of the securities borrowing transaction to be 
subject to the market risk capital requirements instead of the risk-
based capital requirements. In order to qualify for the lower market 
risk capital requirement under this joint interim rule, a bank must be 
subject to the market risk capital requirements and the securities 
borrowing transaction must result in a receivable that arises from the 
posting of the cash collateral. Only the portion of the receivable 
collateralized by the market value of the securities borrowed qualifies 
for the lower market risk capital requirement; uncollateralized 
portions must continue to be risk weighted under the risk-based capital 
guidelines. Moreover, the interim rule only applies to securities 
borrowing transactions collateralized by cash--securities borrowing 
transactions collateralized by securities must continue to be risk-
weighted according to the securities posted as collateral. In addition, 
the securities borrowing transaction must satisfy other prudential 
requirements, including the conditions that the borrowed securities 
must be marked-to-market daily and the cash collateral must be subject 
to a daily margin maintenance requirement.
    In a typical securities borrowing transaction, a bank will borrow 
securities from a securities lender and will post collateral in the 
form of cash or highly marketable securities with the securities lender 
in an amount that fully covers the value of the securities borrowed 
plus an additional margin. If cash is posted as collateral, generally 
accepted accounting principles require the cash to be treated as a loan 
from the bank to the securities lender. Under the current capital 
guidelines, the securities borrower must hold capital against the full 
amount of the loan which would be the standard 100 percent risk weight 
for nonbank securities lenders. If the collateral is in the form of 
securities, the risk-based capital charge is based on the capital 
charge that would be imposed on the securities posted as collateral. 
The borrowed securities are generally treated as an off-balance sheet 
item that does not require capital. The banking agencies believe that 
current capital requirement is inordinately high given the actual risks 
associated with securities borrowing transactions that are 
collateralized by cash. The current capital treatment fails to 
recognize that the bank holding the borrowed securities is at risk only 
for the amount of the cash collateral posted that exceeds the value of 
the securities it holds. Moreover, the current capital requirement is 
inconsistent with the capital requirements imposed by other U.S. and 
foreign regulators for the same transactions.

E. Interagency Differences in Accounting Principles

    The Banking Agencies, under the auspices of the FFIEC, developed 
Call Reports setting forth the regulatory reporting standards for all 
commercial banks and FDIC supervised savings banks. In the past, the 
Call Reports were mostly consistent with GAAP. The instructions to the 
Call Report required banks to follow GAAP for reports of condition and 
income filed with the Banking Agencies, except as permitted under 
section 121 of FDICIA. Section 121 of FDICIA requires financial 
institutions to use accounting principles ``no less stringent than 
[GAAP].'' 12 U.S.C. 1831n(a)(2)(B). Although the accounting and 
reporting requirements imposed by the Banking Agencies were already 
mostly consistent with GAAP, effective March 1997, the Banking Agencies 
fully adopted GAAP as the reporting basis for the Call Report.
    The OTS requires each savings association to file the Thrift 
Financial Report. That report requires savings associations to prepare 
all financial statements included in the report on a

[[Page 9000]]

basis fully consistent with GAAP. Accordingly, the Banking Agencies' 
adoption of GAAP for Call Report purposes in 1997 has eliminated the 
significant differences in regulatory reporting standards between the 
Agencies.\27\
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    \27\ Differences in reporting standards between the banking 
agencies and the OTS were eliminated in 1997 in the following areas: 
sales of assets with recourse, futures and forward contracts, excess 
servicing fees, offsetting of assets and liabilities, and in-
substance defeasance of debt.

    Dated: December 6, 2000.
John D. Hawke, Jr.,
Comptroller of the Currency.
[FR Doc. 01-2958 Filed 2-2-01; 8:45 am]
BILLING CODE 4810-33-P