[Federal Register Volume 66, Number 31 (Wednesday, February 14, 2001)]
[Proposed Rules]
[Pages 10212-10226]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-3131]


 ========================================================================
 Proposed Rules
                                                 Federal Register
 ________________________________________________________________________
 
 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
 
 ========================================================================
 

  Federal Register / Vol. 66, No. 31 / Wednesday, February 14, 2001 / 
Proposed Rules  

[[Page 10212]]



DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket No. 01-03]
RIN 1557-AB14

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R-1097]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325

RIN 3064-AC47


Capital; Leverage and Risk-Based Capital Guidelines; Capital 
Adequacy Guidelines; Capital Maintenance: Nonfinancial Equity 
Investments

AGENCIES: Office of the Comptroller of the Currency (OCC); Board of 
Governors of the Federal Reserve System (Board); and Federal Deposit 
Insurance Corporation (FDIC).

ACTION: Notice of proposed rulemaking.

-----------------------------------------------------------------------

SUMMARY: The OCC, Board, and FDIC (collectively, the agencies) are 
requesting comment on a proposed rule that would establish special 
minimum regulatory capital requirements for equity investments in 
nonfinancial companies. The proposed capital treatment would apply 
symmetrically to equity investments of banks and bank holding 
companies. As described in detail below, the proposal would apply a 
series of marginal capital charges on covered equity investments that 
increase with the level of a banking organization's overall exposure to 
equity investments relative to the organization's Tier 1 capital. The 
proposal replaces the capital proposal issued for public comment by the 
Board in March 2000 (Docket No. R-1067).

DATES: Comments must be received by April 16, 2001.

ADDRESSES:
    OCC: Comments should be addressed to Docket No. 01-03, 
Communications Division, Third Floor, Office of the Comptroller of the 
Currency, 250 E Street, SW., Washington, DC 20219. In addition, 
comments may be sent by facsimile transmission to fax number (202) 874-
5274 or by electronic mail to [email protected]. Comments 
will be available for inspection and photocopying at the same location.
    Board: Comments directed to the Board should refer to Docket No. R-
1097 and may be mailed to Ms. Jennifer J. Johnson, Secretary, Board of 
Governors of the Federal Reserve System, 20th Street and Constitution 
Avenue, NW., Washington, DC 20551 or mailed electronically to 
[email protected]. Comments addressed to Ms. Johnson 
also may be delivered to Room B-2222 of the Eccles Building between 
8:45 a.m. and 5:15 p.m., weekdays, or the security control room in the 
Eccles Building courtyard on 20th Street, NW (between Constitution 
Avenue and C Street) at any time. Comments may be inspected in Room MP-
500 of the Martin Building between 9 a.m. and 5 p.m. weekdays, except 
as provided in 12 CFR 261.8 of the Board's Rules Regarding Availability 
of Information.
    FDIC: Written comments should be addressed to Robert E. Feldman, 
Executive Secretary, Attention: Comments/OES, Federal Deposit Insurance 
Corporation, 550 17th Street, NW, Washington, DC 20429. Comments may be 
hand delivered to the guard station at the rear of the 550 17th Street 
Building (located on F Street) on business days between 7 a.m. and 5 
p.m. Send facsimile transmissions to fax number (202) 898-3838. 
Comments may be submitted electronically to [email protected]. Comments 
may be inspected and photocopied in the FDIC Public Information Center, 
Room 100, 801 17th Street, NW., Washington, DC 20429, between 9 a.m. 
and 4:30 p.m. on business days.

FOR FURTHER INFORMATION CONTACT:
    OCC: Tommy Snow, Director, Capital Policy (202/874-5070); Karen 
Solomon, Director (202/874-5090), or Ron Shimabukuro, Senior Attorney 
(202/874-5090), Legislative and Regulatory Activities Division, Office 
of the Comptroller of the Currency, 250 E Street, SW., Washington, DC 
20219.
    Board: Scott G. Alvarez, Associate General Counsel (202/452-3583), 
Kieran J. Fallon, Senior Counsel (202/452-5270), or Camille M. Caesar, 
Counsel (202/452-3513), Legal Division; Jean Nellie Liang, Chief, 
Capital Markets (202/452-2918), Division of Research & Statistics; 
Michael G. Martinson, Associate Director (202/452-3640) or James A. 
Embersit, Assistant Director (202/452-5249), Capital Markets, Division 
of Banking Supervision and Regulation; Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue, NW, 
Washington, D.C. 20551.
    FDIC: Mark S. Schmidt, Associate Director, (202/898-6918), Stephen 
G. Pfeifer, Examination Specialist, Accounting Section (202/898-8904), 
Curtis Vaughn, Examination Specialist (202/898-6759), Division of 
Supervision; Michael B. Phillips, Counsel, (202/898-3581); Thelma W. 
Diaz, Counsel (202/898-3765), Legal Division, Federal Deposit Insurance 
Corporation, 550 17th Street, NW., Washington, DC 20429.

SUPPLEMENTARY INFORMATION:

A. Background

1. Description of Original Capital Proposal

    In March, 2000, the Board in connection with publishing an interim 
rule implementing provisions of the Gramm-Leach-Bliley Act (GLB Act) 
that allow financial holding companies to engage in merchant banking 
activities, invited public comment on a proposal to establish capital 
requirements governing investments by bank holding companies in 
nonfinancial companies. (See 65 FR 16480). The capital proposal would 
assess, at the holding company level, a 50 percent capital charge on 
the carrying value of each investment.
    The capital proposal applied to investments, including equity and 
debt instruments under some circumstances, made by a bank holding 
company under any of its equity investment authorities, including its 
merchant banking authority, investment authority under Regulation K, 
authority to make investments through small business investment 
companies, authority to hold indirectly investments under section 24 of 
the Federal Deposit Insurance Act, and authority to make investments in

[[Page 10213]]

less than 5 percent of the shares of any company under sections 4(c)(6) 
and 4(c)(7) of the Bank Holding Company Act (BHC Act). This capital 
proposal did not apply, however, to shares that a bank holding company 
acquires in a company engaged only in financial activities, acquires in 
connection with its securities underwriting, dealing or market making 
activities and held in trading accounts, or acquires through an 
insurance underwriting company.

2. Brief Summary of Comments

    The Board and the Secretary of the Treasury together received more 
than 130 comments on the capital proposal. Commenters included members 
of Congress, other federal agencies, state banking departments, banking 
organizations, securities firms, trade associations for the banking and 
securities industries, law firms and individuals. Many commenters 
acknowledged that equity investment activities involve greater risks 
than traditional banking activities. For example, a trade association 
for the banking industry fully supported the proposed capital charge as 
appropriate to protect banking organizations and the financial system 
from the risks associated with merchant banking investment activities.
    Most commenters, however, opposed the capital proposal or one or 
more aspects of the proposal. Some commenters contended that the 
proposal, by applying a uniform 50-percent charge to all equity 
investments, failed adequately to take into account risk variances 
between different types of equity investments (e.g., private equity 
investments vs. investments in publicly traded stocks) or between 
different investment portfolios. A number of commenters argued that the 
proposal would frustrate Congress' desire to permit a ``two-way 
street'' between securities firms and banking organizations or would 
place bank holding companies, and particularly those with large equity 
investment portfolios, at a disadvantage in competing with nonbanking 
organizations and foreign banking organizations in the market for 
making equity investments. Some commenters also contended that the 
Board lacked the authority to establish special capital requirements 
for merchant banking and similar equity investments.
    Many commenters acknowledged that the internal capital models 
developed by banking organizations and securities firms frequently 
require equity investment activities to be supported by significant 
amounts of capital. Some commenters argued that banking organizations 
should be permitted to use their internal capital models to determine 
the appropriate amount of regulatory capital needed to support their 
investment activities. Others argued that, because banking 
organizations use internal models for a variety of purposes, it is not 
appropriate for the agencies to rely on selected data from those models 
as a principal basis for establishing a minimum regulatory capital 
requirement for equity investments. Commenters also argued that the 
banking agencies should not use data derived from internal models to 
support establishing a high regulatory capital requirement for equity 
investments without also using the data from these models to reduce the 
amount of regulatory capital needed to support more traditional banking 
assets, such as consumer and commercial loans.
    Many commenters suggested specific amendments or alternatives to 
the proposed capital charge. For example, some commenters suggested 
that the Board rely solely on the examination and supervisory process, 
as well as market discipline, to ensure that a bank holding company 
maintains adequate capital to support its equity investment activities. 
Other commenters argued that the proposal should be replaced with a 
rule that prohibits bank holding companies from including any 
unrealized gains on equity investments in their regulatory capital. 
Some commenters argued that the proposal should be amended to impose a 
lower capital charge on equity investments such as, for instance, by 
assigning equity investments a 200 percent risk-weight or by applying a 
capital charge higher than the current minimums only to equity 
investments that exceed some threshold amount of the banking 
organization's Tier 1 capital (e.g., 30 percent).
    Some commenters argued that a higher capital charge should be 
limited only to merchant banking investments made by financial holding 
companies under the new merchant banking authority in the GLB Act, and 
should not be applied to past or future investments made by banking 
organizations under other statutory authorities. Other commenters 
requested that specific investment authorities be excluded from the 
proposal. For example, a number of commenters argued that the proposal 
should not apply to investments made by small business investment 
company (SBIC) subsidiaries of a banking organization because SBICs are 
an important source of capital for small businesses, are subject to 
oversight by the Small Business Administration, and have not 
historically caused significant losses at banking organizations. Many 
state banking institutions also argued that the proposal should not 
apply to the equity investments made by state banks under the special 
grandfather provisions of section 24(f)(2) of the Federal Deposit 
Insurance Act (FDI Act). Others asserted that the capital charge should 
not be applied to investments approved on a case-by-case basis by the 
FDIC under section 24 of the FDI Act, to investments made under section 
4(c)(6) or 4(c)(7) of the BHC Act, or to debt instruments.
    A number of commenters asserted that a capital charge higher than 
the current minimums should not be applied to equity investments 
actually made prior to issuance of the capital proposal. Commenters 
argued that the business decisions concerning these investments were 
made based on the capital rules then in effect, and that applying a 
new, higher capital charge to these pre-existing investments would be 
unfair.

B. Revised Capital Adequacy Proposal

    The Board has carefully reviewed the comments regarding its initial 
capital proposal. In addition, the Board has consulted with the 
Treasury Department and has worked with the other Federal banking 
agencies to improve the proposal and to develop capital standards that 
would apply uniformly to equity investments held by bank holding 
companies and those held by depository institutions.
    The new proposal attempts to balance the concerns of commenters 
with the belief of the Federal banking agencies that banking 
organizations must maintain sufficient capital to offset the risk of an 
activity that generally involves risks that are higher than the risks 
associated with many traditional banking activities. In striking this 
balance, the new proposal focuses on establishing a regulatory capital 
requirement that the Federal banking agencies believe represents the 
minimum capital levels consistent with the safe and sound conduct of 
equity investment activities. The agencies fully expect that individual 
banking organizations in most cases will allocate higher economic 
capital levels, as appropriate, commensurate with the risk in the 
individual investment portfolios of the company.
    The banking agencies have been guided by several principles in 
considering the appropriate levels of capital that should be required 
as a regulatory minimum to support equity investment activities. First, 
equity investment activities in nonfinancial

[[Page 10214]]

companies generally involve greater risks than traditional bank and 
financial activities. Analysis of the annual returns for a diversified 
portfolio of publicly-traded small cap stocks over the past seventy-
five years indicates that capital levels well in excess of the current 
regulatory minimum capital levels for banking organizations may be 
needed to support equity investment activities with the level of 
financial soundness expected of organizations that control insured 
depository institutions. Over the past twenty-five years, a study of 
venture capital investment firms indicates that, while some of these 
firms did very well, nearly 20 percent of these firms failed and a 
substantial number of others achieved only modest returns. Two national 
rating agencies have indicated that the private equity business is 
largely funded with equity capital and that equity portfolios, 
including mature and well diversified equity portfolios, require 
substantially more capital than loans.
    Firms and institutional investors that engage to a significant 
degree in equity investment activities typically support their equity 
investment activities with high levels of capital--often dollar for 
dollar--due to the greater risk and illiquidity of these types of 
investments and the higher leverage that often is employed by portfolio 
companies. In fact, the vast majority of commenters did not disagree 
that equity investment activities are riskier than traditional banking 
activities or that it is prudent to fund these types of investment 
activities with higher levels of capital.
    For these reasons, the agencies believe that capital in excess of 
the current regulatory minimum capital levels for more traditional 
banking activities should be required to allow a banking organization 
to conduct equity investment activities in a safe and sound manner.
    A second and related principle that guided the agencies in 
considering this new proposal is that the financial risks to an 
organization engaged in equity investment activities increase as the 
level of their investments accounts for a larger portion of the 
organization's capital, earnings and activities. Banking organizations 
have for some time engaged in equity investment activities using 
various authorities, including primarily SBICs and authority to make 
limited passive investments under sections 4(c)(6) and (7) of the BHC 
Act. When the current capital treatment, which requires a minimum of 4% 
Tier 1 capital (6% in the case of depository institutions that must 
meet the regulatory well-capitalized definition) was developed, these 
equity investment activities by bank holding companies and banks were 
small in relation to the more traditional lending and other activities 
of these organizations.
    The level of these investment activities has grown significantly in 
recent years, however. For example, investments made through SBICs 
owned by banking organizations have alone more than doubled in the past 
5 years. In addition, the merchant banking authority granted to 
financial holding companies by the GLB Act provides significant new 
authority to make equity investments without many of the restrictions 
that apply to other authorities currently used by banking organizations 
to make these investments. The agencies believe that it is appropriate 
to revisit the regulatory capital requirements applicable to equity 
investment activities in light of the dramatic growth in banking 
organizations' equity investment activities through existing 
authorities and the grant of this new and expanded merchant banking 
authority.
    A third principle guiding the agencies' efforts is that the risk of 
loss associated with a particular equity investment is likely to be the 
same regardless of the legal authority used to make the investment or 
whether the investment is held in the bank holding company or in the 
bank. In fact, the agencies' supervisory experience is that banking 
organizations are increasingly making investment decisions and managing 
equity investment risks across legal entities as a single business line 
within the organization. These organizations use different legal 
authorities available to different legal entities within the 
organization to conduct a unified equity investment business.
    In light of these principles, the agencies propose to amend their 
respective capital regulations and guidelines to establish special 
minimum regulatory capital requirements for equity investments in 
nonfinancial companies as described herein. This capital treatment 
would apply symmetrically to equity investment activities of bank 
holding companies and banks. Importantly, this new proposal applies a 
series of marginal capital charges that increase with the level of a 
banking organization's overall exposure to equity investment activities 
relative to the institution's Tier 1 capital.
    The Board, the OCC, and the FDIC each propose to amend their 
respective capital regulations and guidelines applicable to banks to 
incorporate the capital treatment described below. In addition, the 
Board proposes to amend its capital guidelines and regulations that 
apply on a consolidated basis to bank holding companies as described 
below.
    The agencies invite comment on all aspects of the proposal.

1. Scope of Coverage

    The proposed capital treatment discussed below would apply only to 
equity investments in nonfinancial companies. Specifically, the 
proposed capital treatment would apply to equity investments made in 
nonfinancial companies:
     By financial holding companies under the merchant banking 
authority of section 4(k)(4)(H) of the BHC Act;
     By bank holding companies (including financial holding 
companies) in less than 5 percent of the shares of a nonfinancial 
company under the authority of section 4(c)(6) or 4(c)(7) of the BHC 
Act;
     By bank holding companies (including financial holding 
companies) or banks in nonfinancial companies through SBICs;
     By bank holding companies (including financial holding 
companies) or banks under Regulation K; and
     By banking organizations under section 24 of the Federal 
Deposit Insurance Act.
    Many commenters, including a number of members of Congress, argued 
that investments in SBICs should not be subject to higher capital 
requirements. These commenters contended that SBICs serve the important 
public purpose of encouraging the development and funding of small 
businesses and that SBICs owned by banking organizations have generally 
been profitable to date.
    Congress has, through the Small Business Investment Act, expressed 
its desire to facilitate the funding of small businesses through SBICs 
and has by statute imposed limits on the formation, operation, funding 
and investments of SBICs. Congress has also imposed special limitations 
on the amount of capital that a banking organization may invest in an 
SBIC. In light of this congressional intent and these statutory limits, 
the revised proposal would not apply any special capital charge to 
investments in nonfinancial companies held by SBICs owned by banks or 
bank holding companies so long as these investments remain within 
traditional limits.
    The agencies note, however, that SBICs have grown significantly in 
the past few years, in part because of the appreciation of the value of 
SBIC investments on their books. Reflecting both the specific 
congressional

[[Page 10215]]

preference for SBICs and the appreciation in the value of SBIC 
investments, the proposal would apply special capital charges to equity 
investments made through SBICs only when the carrying value of those 
investments exceeds certain high thresholds relative to Tier 1 capital. 
The agencies note that nearly all SBICs owned by banking organizations 
currently are below the thresholds proposed.
    Commenters requested clarification regarding whether the capital 
charge would apply to certain other types of equity investments, 
including in particular investments in companies that engage solely in 
banking and financial activities that the investing company could 
conduct directly. Banking organizations have special expertise in 
managing the risks associated with financial activities. As a result, 
neither the original proposal made by the Board nor the new proposal by 
the banking agencies would apply to equity investments made in 
companies that engage in banking or financial activities that are 
permissible for the investing bank holding company or bank, as 
relevant, to conduct directly. The proposal also would not apply to an 
equity investment made under Regulation K in any company that is 
engaged solely in activities that have been determined to be financial 
in nature or incidental to financial services.
    A number of commenters, requested that the agencies clarify whether 
the capital proposal would apply to equity securities held in a trading 
account. The new proposal does not apply to securities that are held in 
a trading account in accordance with applicable accounting principles 
and as part of an underwriting, market making or dealing activity. 
Several commenters also requested clarification regarding whether the 
proposal would apply to investments that the primary supervisor of the 
bank or bank holding company has determined to be designed primarily to 
promote the public welfare and are held in community development 
corporations. The proposal would not apply to these investments.
    Many commenters argued that the proposed capital treatment should 
not be applied to investments in nonfinancial companies held by state 
banks in accordance with section 24 of the FDI Act. Commenters argued 
that state banks, especially state banks located in New England, have 
been authorized to make limited amounts of equity investments for more 
than 50 years and that these investments have provided diversification 
to their earnings when loans have been unprofitable.
    Section 24 of the FDI Act allows state banks to retain equity 
investments in nonfinancial companies made pursuant to state law under 
certain circumstances. In particular, section 24(f) permits certain 
state banks to retain shares of publicly traded companies and 
registered investment companies if the investment was permitted under a 
state law enacted as of a certain date, the state bank engaged in the 
investment activity as of a certain date and the total amount of equity 
investments made by the bank does not exceed the capital of the bank. 
Commenters argued that Congress specifically considered the risks to 
state banks from these investments when deciding to grandfather these 
equity investment activities.
    In addition to this grandfathered investment authority, a state 
bank may hold equity in other nonfinancial companies if the FDIC 
determines that the investment does not pose a significant risk to the 
deposit insurance fund. The FDIC is empowered to establish and has 
established higher capital requirements and other limitations on equity 
investments of state banks held under this authority, such as 
investments in companies engaged in real estate investment and 
development activities. The FDIC has to date in most cases required 
state banks that make these investments to limit the amount of the 
investment and to deduct these investments from the bank's capital, 
effectively imposing a 100 percent capital charge on these investments.
    For these reasons, the agencies propose to exclude from the special 
capital charge any investment in a nonfinancial company held by a state 
bank in accordance with the grandfather provisions of section 24(f) of 
the FDI Act. The proposal would apply to other equity investments in 
nonfinancial companies held by state banks in accordance with other 
provision of section 24.\1\
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    \1\ Under the proposal, the Board of Directors of the FDIC, 
acting directly, may, in exceptional cases and after a review of the 
proposed activity, permit a lower capital deduction for investments 
approved by the Board of Directors under section 24 of the FDI Act 
so long as the bank's investments under section 24 and SBIC 
investments represent, in the aggregate, less than 15 percent of the 
Tier 1 capital of the bank. The FDIC and the other banking agencies 
reserve the authority to impose higher capital charges where 
appropriate.
---------------------------------------------------------------------------

    A few commenters argued that the capital proposal should not be 
applied to any equity investment made by a bank or bank holding company 
prior to March 13, 2000. These investments were made at a time when the 
agencies had not proposed a higher regulatory capital charge, are 
modest in amount at most banking organizations, and will be liquidated 
over time. As explained below, the new capital proposal establishes a 
marginal capital structure that is different and, on average, lower 
than the original proposal. The new proposal also provides that no 
special capital charge would be imposed on investments made through an 
SBIC within certain thresholds. SBICs hold a very large portion of the 
investments made prior to March 13, 2000, by banking organizations. In 
light of these changes, the agencies request comment on whether it is 
necessary or appropriate to grandfather the individual investments made 
prior to March 13, 2000. The agencies also request comment on the 
alternative of allowing banking organizations to phase in over a period 
of time (such as 3 years) the proposed capital standards with regard to 
investments made prior to March 13, 2000.
    Commenters also argued that capital charges should not apply to 
debt that is extended to companies in which an organization has made an 
equity investment. The original proposal would have applied the 
proposed capital charge to any debt instrument with equity features 
(such as conversion rights, warrants or call options). In addition, the 
proposal would have applied a higher capital charge to any other type 
of debt extended to a company if the debt instrument is held by a 
banking organization that also owns at least 15 percent of the equity 
of the company. The original proposal included exceptions for short-
term, secured credit provided for working capital purposes, any 
extension of credit that meets the collateral requirements of section 
23A of the Federal Reserve Act, any extension of credit that is 
guaranteed by the U.S. Government, and any extension of credit at least 
50 percent of which is sold or participated out to unaffiliated 
parties.
    Commenters noted that the legal doctrine of equitable subordination 
affects the ability of investors to make loans to portfolio companies 
that serve as the functional equivalent of equity. Under this doctrine, 
courts in bankruptcy proceedings have, under certain circumstances, 
subordinated the claims of creditors that are also investors in a 
company to the claims of other creditors, effectively treating the debt 
held by the investor as if the debt were equity.
    After considering the comments on this matter, the agencies have 
revised the approach to debt instruments with

[[Page 10216]]

equity features. The new proposal applies the proposed capital 
treatment to equity features of debt (such as warrants and options to 
purchase equities in nonfinancial companies) and to debt instruments 
convertible into equity investments in nonfinancial companies where the 
equity feature or instrument is held under one of the authorities 
listed above. The primary supervisor will monitor the use of debt held 
under any authority as a method for providing the equivalent of equity 
funding to portfolio companies, and may, on a case-by-case basis in the 
supervisory process, require banking organizations to maintain higher 
capital against debt where circumstances indicate that the debt serves 
as the functional equivalent of equity.
    The original capital proposal made by the Board did not apply to 
equity investments made under section 4(k)(4)(I) of the BHC Act by an 
insurance underwriting affiliate of a financial holding company, and 
the revised proposal continues that approach. These investments 
generally are already subject to higher capital charges under state 
insurance laws. The Board requests comment regarding whether special 
capital requirements or other supervisory restrictions should be 
applied to assure that financial holding companies do not use insurance 
underwriting companies to arbitrage any differences in the capital 
requirements on equity investment activities that apply to insurance 
companies and other financial holding company affiliates. To the extent 
appropriate, the Board will address these matters in a separate 
proposal regarding the appropriate method for accounting for insurance 
companies under the Board's consolidated capital adequacy guidelines 
applicable to financial holding companies.
    The agencies believe that the authorities discussed above cover the 
principal authorities available to banking organizations to make equity 
investments in companies that engage in nonfinancial activities. The 
agencies request comment on whether there are other investment 
activities that should be covered by this capital proposal.
    As noted above, the new proposal would apply the special capital 
charge to investments in nonfinancial companies made in accordance with 
the portfolio investment provisions of Regulation K. This includes 
investments made through so-called Edge Act and Agreement corporations. 
This special capital treatment would not apply, for example, to the 
ownership of equity securities held by an Edge Act or Agreement 
corporation to hedge equity derivative transactions for foreign 
customers. The agencies request comment on whether it is appropriate to 
apply the capital charge to investments made through Edge Act 
corporations and Agreement corporations in nonfinancial companies 
overseas.

2. Capital Charges

    As noted above, the agencies propose to amend their respective 
capital guidelines and rules to apply a different charge to equity 
investments in nonfinancial companies than is currently applied to 
traditional banking investments and activities. This proposal would 
apply symmetrically to banks and bank holding companies. This proposal 
would not have a significant effect on the capital levels of any major 
banking organization based on current investment levels.
    The proposal involves a progression of capital charges that 
increases with the size of the aggregate equity investment portfolio of 
the banking organization relative to its Tier 1 capital. This approach 
takes account of the greater impact that losses in a larger portfolio 
of equity investments relative to capital may have on the financial 
condition of a banking organization.
    As explained in the attached proposed amendment to the capital 
rules, the proposed capital charge would be applied by making a 
deduction from the organization's Tier 1 capital. This deduction would 
be based on the adjusted carrying value of equity investments in 
nonfinancial companies. The adjusted carrying value is the value at 
which the relevant investment is recorded on the balance sheet, reduced 
by net unrealized gains that are included in carrying value but that 
have not been included in Tier 1 capital and associated deferred tax 
liabilities.
    For the reasons explained above, no additional capital charge would 
be applied to SBIC investments made by a bank or bank holding company, 
so long as the adjusted carrying value of the investments does not 
exceed 15 percent of the Tier 1 capital of the depository institution 
that holds the investment or, in the case of an SBIC held directly by 
the bank holding company, 15 percent of the pro rata Tier 1 capital of 
all depository institutions controlled by the bank holding company. 
These investments would be included, however, in determining the 
aggregate size of the organization's investment portfolio for purposes 
of applying the marginal capital charges discussed below.
    For all investments other than SBIC investments, an 8 percent Tier 
1 capital charge would be applied so long as the adjusted carrying 
value of all such investments (plus all SBIC investments and other 
covered investments) represent less than 15 percent of Tier 1 capital. 
This difference in treatment for investments made outside of an SBIC 
recognizes the special limits that have been imposed on the operations 
of SBICs and preferences that Congress has granted to SBICs.
    In the case of a portfolio of covered investments that, in the 
aggregate (including SBIC investments and other covered investments), 
exceeds 15 percent of the organization's Tier 1 capital, a 12 percent 
Tier 1 capital charge would apply to the portion of the portfolio above 
the 15 percent threshold. The 12 percent marginal charge would apply to 
the adjusted carrying value of equity investments up to 25 percent of 
Tier 1 capital. In the case of a portfolio of covered investments that, 
in the aggregate, exceeds 25 percent of the organization's Tier 1 
capital, a 25 percent marginal Tier 1 capital charge would apply to the 
portion of the portfolio above the 25 percent threshold. The following 
table, which is included in the proposed regulation, reflects these 
capital charges.

         Table 1.--Deduction for Nonfinancial Equity Investments
------------------------------------------------------------------------
 Aggregate adjusted carrying value of all
  nonfinancial equity investments held by       Deduction from Tier 1
  the bank or bank holding company (as a     Capital (as a percentage of
  percentage of the Tier 1 capital of the    the adjusted carrying value
     bank or bank holding company) \2\           of the investment)
------------------------------------------------------------------------
Less than 15 percent......................  8 percent
15 percent to 24.99 percent...............  12 percent
25 percent and above......................  25 percent
------------------------------------------------------------------------
\2\ For purposes of calculating the percentage of equity investments
  relative to Tier 1 capital, Tier 1 capital is defined as the sum of
  core capital elements net of goodwill and net of all identifiable
  intangible assets other than mortgage servicing assets, nonmortgage
  servicing assets and purchased credit card relationships, but prior to
  the deduction for deferred tax assets and nonfinancial equity
  investments.

    The agencies propose to apply heightened supervision to the equity 
investment activities of banking organizations as appropriate, 
including in the event that the adjusted carrying value of all 
nonfinancial equity investments represents more than 50 percent of the 
organization's Tier 1 capital. The agencies may in any case impose a 
higher minimum capital charge on an organization as appropriate in 
light of the risk management systems;

[[Page 10217]]

risk, nature, size and composition of the organization's investments; 
market conditions; and other relevant information and circumstances.
    In the event that the agencies determine not to apply this special 
capital charge to equity investments made by a banking organization 
prior to March 13, 2000, the agencies propose to include the adjusted 
carrying value of an organization's investment portfolio made in 
grandfathered investments for purposes of determining the appropriate 
marginal capital charge on investments that are not grandfathered.
    Commenters questioned how the original capital proposal would apply 
to investments held through equity investment funds, in particular, 
through investment partnerships where the holding company may control 
the fund, usually through its role as general partner, but is not the 
sole participant in the fund. As noted in the original proposal, the 
capital charge in such instances would apply only to the holding 
company's proportionate share of the fund's investments. Such treatment 
would apply even if the partnership is consolidated in the holding 
company's financial reporting statements. Similarly, the new proposal 
provides that minority interest resulting from any such consolidation 
would not be included in the Tier 1 capital of the holding company. 
Such minority interest is not available to support the overall 
financial business of the holding company.
    Similar treatment is proposed for minority interest with respect to 
investments in nonfinancial companies under the authorities covered by 
the proposal. Generally, it would not be expected that any nonfinancial 
company whose shares are acquired pursuant to these authorities would 
be consolidated, either because the investment is temporary as in the 
case of merchant banking investments, or limited to a minority 
interest. However, if consolidation does occur, any resulting minority 
interest must be excluded from Tier 1 capital because the minority 
interest is not available to support the general financial business of 
the banking organization.
    The agencies invite comment on all aspects of the proposal, 
including in particular on the proposed marginal capital charges and 
the methods for calculating and applying the deduction to capital. The 
agencies recognize that the proposed capital deduction may have an 
effect on the calculation of the leverage ratio for the banking 
organization. Accordingly, the agencies also request comment on whether 
this effect is likely to be significant, whether an adjustment should 
be permitted to account for this effect, and, if so, what type of 
adjustment is appropriate.

3. Alternatives Suggested by Commenters

    Commenters offered a variety of alternatives to the original 
capital proposal. Among these suggestions were to rely on internal 
capital models, to rely on the supervisory process for determining 
appropriate capital charges on a case-by-case basis, to require banking 
organizations to adopt the regulatory equivalent of available-for-sale 
accounting, and to adopt a reduced capital charge.
    Many commenters suggested that the agencies rely fully on internal 
capital models developed by each banking organization to measure the 
capital needs of the organization across all of its activities. A 
number of commenters argued that the original capital proposal was 
flawed because it adopted a higher capital charge on equity investments 
in a manner similar to the internal capital models used by many banking 
organizations without at the same time allowing banking organizations 
to adopt features of these models that allocate less capital than the 
regulatory minimum capital requirements against other, less risky, 
activities.
    The agencies believe that internal capital models that take account 
of the different risks and capital needs of each of the activities of a 
particular banking organization ultimately represent an effective 
method for determining the capital adequacy of an organization. The 
agencies have encouraged the development of comprehensive internal 
capital models, and many banking organizations have begun to develop 
their own internal capital models. As yet, however, these models are 
largely untested and unable to capture the risks of many activities 
conducted by banking organizations. Moreover, the stage of development 
and sophistication of models varies greatly across organizations. In 
addition, as noted by many commenters, assessing the adequacy of 
capital by reference to risk models is most effective when applied 
across the entire organizational risk structure, rather than piece meal 
for selected assets or portfolios. As a result, the agencies do not 
believe that it is appropriate at this time to rely on internal 
modeling of equity portfolios as a replacement for regulatory minimum 
capital requirements. The agencies believe, however, that robust 
internal modeling can be an effective method for addressing capital 
adequacy. Accordingly, the agencies will review a banking 
organization's internal models in assessing the adequacy of the 
organization's capital levels in relation to its equity investment 
activities and expect to revisit the need for regulatory minimum 
capital requirements for equity investment activities as internal 
models become more sophisticated and reliable.
    Another alternative suggested by many commenters was that the 
agencies assess the appropriate regulatory capital levels for equity 
investment activities on a case-by-case basis through the supervisory 
process. These commenters argued that it was inappropriate for the 
agencies to adopt a single regulatory minimum capital requirement that 
would apply in the same way to all banking organizations engaged in 
equity investment activities, regardless of the differences in 
portfolio risks at different organizations. These commenters believed 
that the capital needs of individual organizations could be best 
assessed through the individual examination of each organization, with 
the agencies assessing higher capital requirements on a case-by-case 
basis to address particular risks at individual organizations.
    The agencies agree that examination and supervision are important 
methods for assuring that individual organizations are conducting 
equity investment activities in a safe and sound manner and have 
adequate capital to support those activities. The agencies expect to 
pay particular attention to the investment activities of banking 
organizations and to heighten that supervision as the level of 
concentration in these activities increases at an organization. The 
supervisory process will consider, among other things, the 
institution's internal allocation of capital to equity investment 
activities as an important element in assessing capital adequacy.
    However, the agencies believe that supervisory experience and 
analysis of equity investment activities over a long period of time 
indicate that it is prudent to establish minimum capital requirements 
for equity investment activities in addition to effective supervision 
and examination. Establishing minimum capital requirements by rule also 
reduces the potential that capital requirements at an organization will 
be arbitrarily set during the examination process. A uniform regulatory 
minimum capital rule also indicates to organizations that are entering 
this business line for the first time the agencies' expectations for 
additional capital to support these activities.
    Some commenters suggested that the agencies require that banking

[[Page 10218]]

organizations adopt the regulatory equivalent of available-for-sale 
(AFS) accounting. Commenters argued that this approach improves the 
capital strength of an organization by eliminating from Tier 1 capital, 
at least for regulatory reporting purposes, any reliance on unrealized 
gains on equity investments. This arguably reduces the volatility in 
capital that results from changes in the value of equity investments, 
which often occur unpredictably and quickly during the life of the 
investment, by preventing banking organizations from taking unrealized 
gains into income, and thus capital, for regulatory purposes.
    AFS accounting has been adopted by many organizations and 
represents a prudent and appropriate approach to accounting for equity 
investments in many situations. Nonetheless, the agencies have 
determined not to require the regulatory equivalent of this accounting 
treatment for regulatory capital calculations for several reasons. 
First, this approach does not address the risk associated with the 
initial cost of the investment. Instead, it effectively applies a 100 
percent capital charge on unrealized gains while maintaining the normal 
capital charge on the initial investment cost. For investments that are 
very profitable, this charge may be too high, while for investments 
that are not performing well, this capital charge is likely to be too 
low.
    In addition, an AFS approach creates differences in capital 
treatment for companies that acquired the same equity investment, with 
the same risk, on different dates. Under the AFS approach, an investor 
that has acquired an investment in the initial offering of stock of the 
portfolio company would be effectively required to hold more capital 
against the investment than a second investor that acquires the same 
amount of shares of the same company for a higher price at a later 
date.
    Moreover, a capital charge based on the AFS approach is easily 
manipulated through the sale and repurchase of equity of the same 
company. This manipulation would be difficult to monitor and prevent.
    While the agencies have not proposed adopting the regulatory 
equivalent of the AFS accounting approach, the agencies recognize that 
a regulatory minimum capital charge must take account of situations in 
which an investor determines to adopt this approach for GAAP reporting 
purposes. Accordingly, the capital charge proposed by the agencies is 
based on the ``adjusted carrying value'' of the relevant investment and 
the proposal would require deduction of the adjusted carrying value 
from risk-weighted assets for purposes of calculating the risk-based 
capital ratio. This treatment retains the flexibility of an investor to 
adopt AFS accounting or other accounting treatments permitted under 
GAAP.

C. Regulatory Flexibility Act Analysis

    OCC: This proposal would amend the OCC's risk-based capital 
guidelines and leverage capital rules for national banks. The 
amendments made by the proposal would establish the regulatory capital 
requirements applicable to a national bank's equity investment in a 
nonfinancial company made through a SBIC pursuant to section 302(b) of 
the Small Business Investment Act of 1958 or under the portfolio 
investment provisions of the Board's Regulation K.
    The OCC hereby certifies, pursuant to section 5(b) of the 
Regulatory Flexibility Act (5 U.S.C. 603(a)), that the proposed 
amendments will not, if promulgated in final rule form, have a 
significant economic impact on a substantial number of small entities.
    For the purposes of the Regulatory Flexibility Act, small entities 
are defined to include any national bank that has $100 million in 
assets or less. See 5 U.S.C. 601(3) and (6), 15 U.S.C. 632(a), and 13 
CFR 121.201. With respect to national banks, this proposal would only 
apply to equity investments in a nonfinancial company either made 
through a SBIC pursuant to section 302(b) of the Small Business 
Investment Act of 1958 or under the portfolio investment provisions of 
Regulation K. The OCC does not believe that it is likely that a 
substantial number of small national banks engage in these kinds of 
equity investment activities. Moreover, even with respect to any small 
national banks that might engage in the types of equity investments 
covered by this proposal, the OCC does not believe that the proposal 
rule will require these banks to raise significant amounts of new 
capital. For these reasons, the OCC does not believe that this 
proposal, if promulgated in final rule form, will have a significant 
economic impact on a substantial number of small national banks.
    Nevertheless, the OCC specifically seeks comment on any burden that 
this proposal would impose on small national banks.
    Board: In accordance with section 3(a) of the Regulatory 
Flexibility Act (5 U.S.C. 603(a)), the Board must publish an initial 
regulatory flexibility analysis with this rulemaking. The rule proposes 
and requests comment on amendments to the Board's consolidated risk-
based and leverage capital adequacy guidelines for bank holding 
companies (Part 225, Appendix A and Appendix D) and state member banks 
(Part 208, Appendix A and Appendix D).
    These amendments would establish the regulatory capital 
requirements applicable to the merchant banking investments of 
financial holding companies and similar investment activities of bank 
holding companies and state member banks. The Board hereby certifies, 
pursuant to 5 U.S.C. 605(b), that the proposed capital amendments will 
not, if promulgated through a final rule, have a significant economic 
impact on a substantial number of small entities because small entities 
that the Board regulates, specifically, financial or bank holding 
companies or state member banks that have less than $150 million in 
consolidated assets, generally do not engage in these investment 
activities to any significant degree. In addition, because the Board's 
risk-based and leverage capital guidelines do not generally apply to 
bank holding companies, including financial holding companies, that 
have less than $150 million in consolidated assets, the proposed rule 
will have no impact upon such organizations.
    For the reasons discussed above, the Board believes that the 
proposed amendments to its capital guidelines are necessary and 
appropriate to ensure that bank holding companies and state member 
banks maintain capital commensurate with the levels of risk associated 
with their equity investment activities and that these activities do 
not pose an undue risk to the safety and soundness of insured 
depository institutions. This notice of proposed rulemaking contains a 
detailed discussion of the Board's reasons for issuing the proposed 
rule and of the alternatives to the rule that the Board has considered.
    The Board specifically seeks comment on the likely burden that the 
proposed rule will impose on bank holding companies and state member 
banks.
    FDIC: The rule proposes and requests comment on amendments to the 
FDIC's risk-based and leverage capital standards for state nonmember 
banks (Part 325). These amendments would establish the regulatory 
capital requirements applicable to certain nonfinancial equity 
investments of state nonmember banks. The FDIC hereby certifies, 
pursuant to section 605(b) of the Regulatory Flexibility Act, 5 U.S.C. 
605(b), that the proposed capital amendments will not, if promulgated 
through a final rule, have a significant economic impact on a 
substantial number of small entities because small

[[Page 10219]]

entities that the FDIC regulates, specifically, state nonmember banks 
that have less than $100 million in consolidated assets, generally do 
not engage in nonfinancial equity investment activities covered by this 
proposed rule to any significant degree.

D. Paperwork Reduction Act

    OCC: In accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3506; 5 CFR 1320 App. A.1), the OCC has reviewed the proposal 
under the authority delegated to the OCC by the Office of Management 
and Budget. No collections of information pursuant to the Paperwork 
Reduction Act are contained in the proposal.
    Board: In accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3506; 5 CFR 1320 App. A.1), the Board has reviewed the proposed 
rule under the authority delegated to the Board by the Office of 
Management and Budget. No collections of information pursuant to the 
Paperwork Reduction Act are contained in the proposed rule.
    FDIC: The FDIC has determined that this proposal does not involve a 
collection of information pursuant to the provisions of the Paperwork 
Reduction Act of 1995 (44 U.S.C. 3501, et seq.).

E. Executive Order 12866 Determination

    OCC: The Comptroller of the Currency has determined that this 
proposed rule, if adopted as a final rule, would not constitute a 
``significant regulatory action'' for the purposes of Executive Order 
12866.

F. Unfunded Mandates Act of 1995

    OCC: Section 202 of the Unfunded Mandates Reform Act of 1995, 2 
U.S.C. 1532 (Unfunded Mandates Act), requires that an agency prepare a 
budgetary impact statement before promulgating any rule likely to 
result in a Federal mandate that may result in the expenditure by 
State, local, and tribal governments, in the aggregate, or by the 
private sector, of $100 million or more in any one year. If a budgetary 
impact statement is required, section 205 of the Unfunded Mandates Act 
also requires the agency to identify and consider a reasonable number 
of regulatory alternatives before promulgating the rule. The OCC has 
determined that this proposed regulation will not result in 
expenditures by State, local, and tribal governments, in the aggregate, 
or by the private sector, of $100 million or more in any one year. 
Accordingly, the OCC has not prepared a budgetary impact statement or 
specifically addressed the regulatory alternatives considered.

G. Solicitation of Comments on Use of ``Plain Language''

    Section 722 of the GLB Act requires the agencies to use ``plain 
language'' in all proposed and final rules published after January 1, 
2000. The agencies invite comments about how to make the proposed rule 
easier to understand, including answers to the following questions:
    (1) Have the agencies organized the material in an effective 
manner? If not, how could the material be better organized?
    (2) Are the terms of the rule clearly stated? If not, how could the 
terms be more clearly stated?
    (3) Does the rule contain technical language or jargon this is 
unclear? If so, which language requires clarification?
    (4) Would a different format (with respect to the grouping and 
order of sections and use of headings) make the rule easier to 
understand?
    (5) Would increasing the number of sections (and making each 
section shorter) clarify the rule? If so, which portions of the rule 
should be changed in this respect?
    (6) What additional changes would make the rule easier to 
understand?
    The agencies also solicit comment about whether including factual 
examples in the rule in order to illustrate its terms is appropriate. 
Are there alternatives that the agencies should consider to illustrate 
the terms in the rule?

List of Subjects

12 CFR Part 3

    Administrative practice and procedure, Capital, National banks, 
Reporting and recordkeeping requirements, Risk.

12 CFR Part 208

    Accounting, Agriculture, Banks, banking, Confidential business 
information, Crime, Currency, Federal Reserve System, Mortgages, 
Reporting and recordkeeping requirements, Securities.

12 CFR Part 225

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

12 CFR Part 325

    Administrative practice and procedure, Banks, banking, Capital 
adequacy, Reporting and recordkeeping requirements, State non-member 
banks.

Department of the Treasury

Office of the Comptroller of the Currency

12 CFR Chapter I

Authority and Issuance

    For the reasons set out in the preamble, part 3 of chapter I of 
title 12 of the Code of Federal Regulations is proposed to be amended 
as follows:

PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES

    1. The authority citation for part 3 continues to read as follows:

    Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n 
note, 1835, 3907, and 3909.

    2. In Appendix A to part 3:
    A. In section 1, paragraphs (c)(17) through (c)(31) are 
redesignated as paragraphs (c)(20) through (c)(34); paragraphs (c)(12) 
through (c)(16) are redesignated as paragraphs (c)(14) through (c)(18); 
and paragraphs (c)(1) through (c)(11) are redesignated as paragraphs 
(c)(2) through (c)(12);
    B. In section 1, new paragraphs (c)(1), (c)(13) and (c)(19) are 
added;
    C. In section 2, paragraph (a)(3) is revised;
    D. In section 2, new paragraph (c)(1)(iv) is added;
    E. In section 2, paragraph (c)(4) is redesignated as paragraph 
(c)(5); and
    F. In section 2, new paragraph (c)(4) is added to read as follows:

Appendix A to Part 3--Risk-Based Capital Guidelines

Section 1. Purpose, Applicability of Guidelines, and Definitions

* * * * *
    (c) * * *
    (1) Adjusted carrying value means, for purposes of section 
2(c)(4) of this appendix A, the aggregate value that investments are 
carried on the balance sheet of the bank reduced by any unrealized 
gains on the investments that are reflected in such carrying value 
but excluded from the bank's Tier 1 capital. For example, for 
investments held as available-for-sale (AFS), the adjusted carrying 
value of the investments would be the aggregate carrying value of 
the investments (as reflected on the consolidated balance sheet of 
the bank) less any unrealized gains on those investments that are 
included in other comprehensive income and that are not reflected in 
Tier 1 capital, and less any associated deferred tax liabilities. 
Unrealized losses on AFS equity investments must be deducted from 
Tier 1 capital in accordance with section 1(c)(8) of this appendix 
A. The treatment of small business investment companies that are 
consolidated for accounting purposes is discussed in section 
2(c)(4)(iv) of this appendix A. For investments in a nonfinancial 
company that is consolidated for accounting purposes, the

[[Page 10220]]

bank's adjusted carrying value of the investment is determined under 
the equity method of accounting (net of any intangibles associated 
with the investment that are deducted from the bank's Tier 1 capital 
in accordance with section 2(c)(2) of this appendix A). Even though 
the assets of the nonfinancial company are consolidated for 
accounting purposes, these assets (as well as the credit equivalent 
amounts of the company's off-balance sheet items) are excluded from 
the bank's risk-weighted assets.
* * * * *
    (13) Equity investment means, for purposes of section 1(c)(19) 
and section 2(c)(4) of this appendix A, any equity instrument 
including warrants and call options that give the holder the right 
to purchase an equity instrument, any equity feature of a debt 
instrument (such as a warrant or call option), and any debt 
instrument that is convertible into equity. An investment in 
subordinated debt or other types of debt instruments may be treated 
as an equity investment if the OCC determines that the instrument is 
the functional equivalent of equity.
* * * * *
    (19) Nonfinancial equity investment means any equity investment 
in a nonfinancial company made by the bank through a small business 
investment company (SBIC) under section 302(b) of the Small Business 
Investment Act of 1958 (15 U.S.C. 682(b)) or under the portfolio 
investment provisions of Regulation K (12 CFR 211.5(b)(1)(iii)). An 
equity investment in a SBIC made under section 302(b) of the Small 
Business Investment Act of 1958 that is not consolidated with the 
bank is treated as a nonfinancial equity investment in the manner 
provided in section 2(c)(4)(iv)(C) of this appendix A. A 
nonfinancial company is an entity that engages in any activity that 
has not been determined to be permissible for the bank to conduct 
directly or to be financial in nature or incidental to financial 
activities under section 4(k) of the Bank Holding Company Act (12 
U.S.C. 1843(k)).
* * * * *

Section 2. Components of Capital

* * * * *
    (a) * * *
    (3) Minority interests in the equity accounts of consolidated 
subsidiaries, except that minority interests in a small business 
investment company or investment fund that holds nonfinancial equity 
investments and minority interests in a subsidiary that is engaged 
in nonfinancial activities and is held under one of the legal 
authorities listed in section 1(c)(19) of this appendix A are not 
included in Tier 1 capital or total capital.
* * * * *
    (c) * * *
    (1) * * *
    (iv) Nonfinancial equity investments as provided by section 
2(c)(4) of this appendix A.
* * * * *
    (4) Nonfinancial equity investments. (i) General. A bank must 
deduct from its Tier 1 capital the appropriate percentage, as 
determined in accordance with Table 1, of the adjusted carrying 
value of all nonfinancial equity investments made by the bank or by 
its direct or indirect subsidiaries.
    (ii) Nonfinancial equity investments in the trading account. 
Section 2(c)(4) of this appendix A does not apply to, and no 
deduction is required for, any nonfinancial equity investment that 
is held in the trading account in accordance with applicable 
accounting principles and as part of an underwriting, market making 
or dealing activity.
    (iii) Amount of deduction from Tier 1 capital. (A) The bank must 
deduct from its Tier 1 capital the appropriate percentage, as 
determined in accordance with Table 1, of the adjusted carrying 
value of all nonfinancial equity investments held by the bank and 
its subsidiaries.

         Table 1.--Deduction for Nonfinancial Equity Investments
------------------------------------------------------------------------
 Aggregate adjusted carrying value of all
   nonfinancial equity investments held         Deduction from Tier 1
 directly or indirectly by the bank (As a    Capital (As a percentage of
  percentage of the Tier 1 capital of the    the adjusted carrying value
                 bank) \1\                       of the investment)
------------------------------------------------------------------------
Less than 15 percent......................  8.0 percent.
15 percent but less than 25 percent.......  12.0 percent.
25 percent or greater.....................  25.0 percent.
------------------------------------------------------------------------
\1\ For purposes of calculating the adjusted carrying value of
  nonfinancial equity investments as a percentage of Tier 1 capital,
  Tier 1 capital is defined as the sum of the Tier 1 capital elements
  net of goodwill and net of all identifiable intangible assets other
  than mortgage servicing assets, nonmortgage servicing assets and
  purchased credit card relationships, but prior to the deduction for
  deferred tax assets and nonfinancial equity investments.

    (B) Deductions for nonfinancial equity investments must be 
applied on a marginal basis to the portions of the adjusted carrying 
value of nonfinancial equity investments that fall within the 
specified ranges of the bank's Tier 1 capital. For example, if the 
adjusted carrying value of all nonfinancial equity investments held 
by a bank equals 20 percent of the Tier 1 capital of the bank, then 
the amount of the deduction would be 8 percent of the adjusted 
carrying value of all investments up to 15 percent of the bank's 
Tier 1 capital, and 12 percent of the adjusted carrying value of all 
investments in excess of 15 percent of the bank's Tier 1 capital.
    (C) The total adjusted carrying value of any nonfinancial equity 
investment that is subject to deduction under section 2(c)(4) of 
this appendix A is excluded from the bank's weighted risk assets for 
purposes of computing the denominator of the bank's risk-based 
capital ratio. For example, if 8 percent of the adjusted carrying 
value of a nonfinancial equity investment is deducted from Tier 1 
capital, the entire adjusted carrying value of the investment will 
be excluded from risk-weighted assets in calculating the denominator 
of the risk-based capital ratio.
    (D) Banks engaged in equity investment activities, including 
those banks with a high concentration in nonfinancial equity 
investments (e.g., in excess of 50 percent of Tier 1 capital) will 
be monitored and may be subject to heightened supervision, as 
appropriate, by the OCC to ensure that such banks maintain capital 
levels that are appropriate in light of their equity investment 
activities, and the OCC may impose a higher capital charge in any 
case where the circumstances, such as the level of risk of the 
particular investment or portfolio of investments, the risk 
management systems of the bank, or other information, indicate that 
a higher minimum capital requirement is appropriate.
    (iv) Small business investment company investments. (A) 
Notwithstanding section 2(c)(4)(iii) of this appendix A, no 
deduction is required for nonfinancial equity investments that are 
made by a bank or its subsidiary through a SBIC that is consolidated 
with the bank, or in a SBIC that is not consolidated with the bank, 
to the extent that such investments, in the aggregate, do not exceed 
15 percent of the Tier 1 capital of the bank. Except as provided in 
paragraph (c)(4)(iv)(B) of this section, any nonfinancial equity 
investment that is held through or in a SBIC and not deducted from 
Tier 1 capital will be assigned to the 100 percent risk-weight 
category and included in the bank's consolidated risk-weighted 
assets.
    (B) If a bank has an investment in a SBIC that is consolidated 
for accounting purposes but the SBIC is not wholly owned by the 
bank, the adjusted carrying value of the bank's nonfinancial equity 
investments held through the SBIC is equal to the bank's 
proportionate share of the SBIC's adjusted carrying value of its 
nonfinancial equity investments. The remainder of the SBIC's 
adjusted carrying value (i.e., the minority interest holders' 
proportionate share) is excluded from the risk-weighted assets of 
the bank.
    (C) If a bank has an investment in a SBIC that is not 
consolidated for accounting purposes and has current information 
that identifies the percentage of the SBIC's assets that are 
nonfinancial equity investments, the bank may reduce the adjusted 
carrying value of its investment in the SBIC proportionately to 
reflect the percentage of the adjusted carrying value of the SBIC's 
assets that are not nonfinancial equity investments. The amount by 
which the adjusted carrying value of the bank's investment in the 
SBIC is reduced under this provision will be risk weighted at 100 
percent and included in the bank's risk-weighted assets.
    (D) To the extent the adjusted carrying value of all 
nonfinancial equity investments that the bank holds through a 
consolidated SBIC or in a nonconsolidated SBIC exceeds, in the 
aggregate, 15 percent of the Tier 1 capital of the bank, the 
appropriate percentage of such amounts, as set forth in Table 1, 
must be deducted from the bank's Tier 1 capital. In addition, the 
aggregate adjusted carrying value of all nonfinancial equity 
investments held through a consolidated SBIC and in a 
nonconsolidated SBIC (including any investments for which no 
deduction is required) must be included

[[Page 10221]]

in determining for purposes of Table 1 the total amount of 
nonfinancial equity investments held by the bank in relation to its 
Tier 1 capital.
    (v) Transition period. [Comment requested].

    Dated: January 26, 2001.
John D. Hawke, Jr.,
Comptroller of the Currency.

Federal Reserve System

Authority and Issuance

    For the reasons set forth in the preamble, the Board of Governors 
of the Federal Reserve System proposes to amend parts 208 and 225 of 
chapter II of title 12 of the Code of Federal Regulations as follows:

PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL 
RESERVE SYSTEM (REGULATION H)

    1. The authority citation for part 208 continues to read as 
follows:

    Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-338a, 
371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d), 1823(j), 
1828(o), 1831o, 1831p-1, 1831r-1, 1831w, 1835a, 1882, 2901-2907, 
3105, 3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b, 781(b), 781(g), 
781(i), 78o-4(c)(5), 78q, 78q-1, and 78w; 31 U.S.C. 5318; 42 U.S.C. 
4012a, 4104a, 4104b, 4106, and 4128.

    2. In Appendix A to part 208, the following amendments are made:
    a. In section II.A., one sentence is added at the end of paragraph 
1.c., Minority interest in equity accounts of consolidated 
subsidiaries;
    b. In section II.B., a new paragraph (v) is added at the end of the 
introductory text and a new paragraph 5 is added at the end of section 
II.B; and
    c. In sections III. and IV., footnotes 24 through 57 are 
redesignated as footnotes 29 through 62, respectively.

Appendix A to Part 208--Capital Adequacy Guidelines for State 
Member Banks: Risk-Based Measure

* * * * *
    II. * * *
    A. * * *
    1. * * *
    c. * * * Minority interests in small business investment 
companies and investment funds that hold nonfinancial equity 
investments (as defined in section II.B.5.b. of this appendix) and 
minority interests in subsidiaries that are engaged in nonfinancial 
activities and held under one of the legal authorities listed in 
section II.B.5.b are not included in the bank's Tier 1 or total 
capital base.
    B. * * *
    (v) Nonfinancial equity investments-portions are deducted from 
the sum of core capital elements in accordance with section II.B.5 
of this appendix.
* * * * *
    5. Nonfinancial equity investments--a. General. A bank must 
deduct from its Tier 1 capital the appropriate percentage (as 
determined below) of the adjusted carrying value of all nonfinancial 
equity investments made by the parent bank or by its direct or 
indirect subsidiaries.
    b. Scope of nonfinancial equity investments. i. A nonfinancial 
equity investment means any equity investment made by the bank in a 
nonfinancial company through a small business investment company 
(SBIC) under section 302(b) of the Small Business Investment Act of 
1958 \24\ or under the portfolio investment provisions of the 
Board's Regulation K (12 CFR 211.5(b)(1)(iii)).\25\ A nonfinancial 
company is an entity that engages in any activity that has not been 
determined to be permissible for the bank to conduct directly, or to 
be financial in nature or incidental to financial activities under 
section 4(k) of the Bank Holding Company Act (12 U.S.C. 1843(k)).
---------------------------------------------------------------------------

    \24\ An equity investment made under section 302(b) of the Small 
Business Investment Act of 1958 in a SBIC that is not consolidated 
with the bank is treated as a nonfinancial equity investment.
    \25\ See 12 CFR 211.5(b)(1)(iii); and 15 U.S.C. 682(b).
---------------------------------------------------------------------------

    ii. This section II.B.5. does not apply to, and no deduction is 
required for, any nonfinancial equity investment that is held in the 
trading account in accordance with applicable accounting principles 
and as part of an underwriting, market making or dealing activity.
    c. Amount of deduction from core capital. i. The bank must 
deduct from its Tier 1 capital the appropriate percentage, as set 
forth in Table 1, of the adjusted carrying value of all nonfinancial 
equity investments held by the bank and its subsidiaries. The amount 
of the deduction increases as the aggregate amount of nonfinancial 
equity investments held by the bank and its subsidiaries increases 
as a percentage of the bank's Tier 1 capital.

         Table 1.--Deduction for Nonfinancial Equity Investments
------------------------------------------------------------------------
 Aggregate adjusted carrying value of all
   nonfinancial equity investments held         Deduction from Tier 1
 directly or indirectly by the bank (as a    Capital (as a percentage of
  percentage of the Tier 1 capital of the    the adjusted carrying value
                 bank) \1\                       of the investment)
------------------------------------------------------------------------
Less than 15 percent......................  8 percent.
15 percent to 24.99 percent...............  12 percent.
25 percent and above......................  25 percent.
------------------------------------------------------------------------
\1\ For purposes of calculating the adjusted carrying value of
  nonfinancial equity investments as a percentage of Tier 1 capital,
  Tier 1 capital is defined as the sum of core capital elements net of
  goodwill and net of all identifiable intangible assets other than
  mortgage servicing assets, nonmortgage servicing assets and purchased
  credit card relationships, but prior to the deduction for deferred tax
  assets and nonfinancial equity investments.

    ii. These deductions are applied on a marginal basis to the 
portions of the adjusted carrying value of nonfinancial equity 
investments that fall within the specified ranges of the parent 
bank's Tier 1 capital. For example, if the adjusted carrying value 
of all nonfinancial equity investments held by a bank equals 20 
percent of the Tier 1 capital of the bank, then the amount of the 
deduction would be 8 percent of the adjusted carrying value of all 
investments up to 15 percent of the bank's Tier 1 capital, and 12 
percent of the adjusted carrying value of all investments in excess 
of 15 percent of the bank's Tier 1 capital.
    iii. The total adjusted carrying value of any nonfinancial 
equity investment that is subject to deduction under this paragraph 
is excluded from the bank's risk-weighted assets for purposes of 
computing the denominator of the bank's risk-based capital 
ratio.\26\
---------------------------------------------------------------------------

    \26\ For example, if 8 percent of the adjusted carrying value of 
a nonfinancial equity investment is deducted from Tier 1 capital, 
the entire adjusted carrying value of the investment will be 
excluded form risk-weighted assets in calculating the denominator 
for the risk-based capital ratio.
---------------------------------------------------------------------------

    iv. As noted in section I, this Appendix establishes minimum 
risk-based capital ratios and banks are at all times expected to 
maintain capital commensurate with the level and nature of the risks 
to which they are exposed. The risk to a bank from nonfinancial 
equity investments increases with its concentration in such 
investments and strong capital levels above the minimum requirements 
are particularly important when a bank has a high degree of 
concentration in nonfinancial equity investments (e.g., in excess of 
50 percent of Tier 1 capital). The Federal Reserve intends to 
monitor banks and apply heightened supervision to equity investment 
activities as appropriate, including where the bank has a high 
degree of concentration in nonfinancial equity investments, to 
ensure that banks maintain capital levels that are appropriate in 
light of their equity investment activities. The Federal Reserve 
also reserves authority to impose a higher capital charge in any 
case where the circumstances, such as the level of

[[Page 10222]]

risk of the particular investment or portfolio of investments, the 
risk management systems of the bank, or other information, indicate 
that a higher minimum capital requirement is appropriate.
    d. SBIC investments. i. No deduction is required for 
nonfinancial equity investments that are made by a bank through an 
SBIC that is consolidated with the bank or in an SBIC that is not 
consolidated with the bank to the extent that such investments, in 
the aggregate, do not exceed 15 percent of the bank's Tier 1 
capital. Any nonfinancial equity investment that is held through or 
in an SBIC and not deducted from Tier 1 capital will be assigned a 
100 percent risk-weight and included in the bank's consolidated 
risk-weighted assets.\27\
---------------------------------------------------------------------------

    \27\ If a bank has an investment in a SBIC that is consolidated 
for accounting purposes but that is not wholly owned by the bank, 
the adjusted carrying value of the bank's nonfinancial equity 
investments through the SBIC is equal to the bank's proportionate 
share of the SBIC's adjusted carrying value of its nonfinancial 
equity investments. The remainder of the SBIC's adjusted carrying 
value (i.e., the minority interest holders' proportionate share) is 
excluded from the risk-weighted assets of the bank. If a bank has an 
investment in a SBIC that is not consolidated for accounting 
purposes and has current information that identifies the percentage 
of the SBIC's assets that are nonfinancial equity investments, the 
bank may reduce the adjusted carrying value of its investment in the 
SBIC proportioantely to reflect the percentage of the adjusted 
carrying value of the SBIC's assets that are not nonfinancial equity 
investments. The amount by which the adjusted carrying value of the 
bank's investment in the SBIC is reduced under this provision will 
be risk weighted at 100 percent and included in the bank's risk-
weighted assets.
---------------------------------------------------------------------------

    ii. To the extent the adjusted carrying value of all 
nonfinancial equity investments that a bank holds through a 
consolidated SBIC or in a non-consolidated SBIC exceeds, in the 
aggregate, 15 percent of the bank's Tier 1 capital, the appropriate 
percentage of such amounts (as set forth in Table 1) must be 
deducted from the bank's Tier 1 capital. In addition, the aggregate 
adjusted carrying value of all nonfinancial equity investments held 
through a consolidated SBIC and in a non-consolidated SBIC 
(including any investments for which no deduction is required) must 
be included in determining for purposes of Table 1 the total amount 
of nonfinancial equity investments held by the bank in relation to 
its Tier 1 capital.
    e. Transition provisions. [Comment requested.]
    f. Adjusted carrying value. i. For purposes of this section 
II.B.5., the ``adjusted carrying value'' of investments is the 
aggregate value at which the investments are carried on the balance 
sheet of the bank reduced by any unrealized gains on those 
investments that are reflected in such carrying value but excluded 
from the bank's Tier 1 capital. For example, for investments held as 
available-for-sale (AFS), the adjusted carrying value of the 
investments would be the aggregate carrying value of the investments 
(as reflected on the consolidated balance sheet of the bank) less: 
any unrealized gains on those investments that are included in other 
comprehensive income and not reflected in Tier 1 capital; and 
associated deferred tax liabilities.\28\
---------------------------------------------------------------------------

    \28\ Unrealized gains on AFS investments may be included in 
supplementary capital to the extent permitted under section II.A.2.e 
of this appendix. In addition, the unrealized losses on AFS equity 
investments are deducted from Tier 1 capital in accordance with 
section II.A.1.a of this appendix.
---------------------------------------------------------------------------

    ii. As discussed above with respect to consolidated SBICs, some 
equity investments may be in companies that are consolidated for 
accounting purposes. For investments in a nonfinancial company that 
is consolidated for accounting purposes under generally accepted 
accounting principles, the bank's adjusted carrying value of the 
investment is determined under the equity method of accounting (net 
of any intangibles associated with the investment that are deducted 
from the bank's core capital in accordance with section II.B.1 of 
this appendix). Even though the assets of the nonfinancial company 
are consolidated for accounting purposes, these assets (as well as 
the credit equivalent amounts of the company's off-balance sheet 
items) should be excluded from the bank's risk-weighted assets for 
regulatory capital purposes.
    g. Equity investments. For purposes of this section II.B.5., an 
equity investment means any equity instrument (including warrants 
and call options that give the holder the right to purchase an 
equity instrument), any equity feature of a debt instrument (such as 
a warrant or call option), and any debt instrument that is 
convertible into equity where the instrument or feature is held 
under one of the legal authorities listed in section II.B.5.b. of 
this appendix. An investment in subordinated debt or other types of 
debt instruments may be treated as an equity investment if, in the 
judgment of the Federal Reserve, the instrument is the functional 
equivalent of equity.
* * * * *
    3. In Appendix B to part 208, in section II.b., footnote 2 is 
revised and the fourth sentence of section II.b. is revised to read 
as follows:

Appendix B to Part 208--Capital Adequacy Guidelines for State 
Member Banks: Tier 1 Leverage Measure

* * * * *
    II. * * *
    b. * * *\2\ As a general matter, average total consolidated 
assets are defined as the quarterly average total assets (defined 
net of the allowance for loan and lease losses) reported on the 
bank's Reports of Condition and Income (Call Reports), less 
goodwill; amounts of mortgage servicing assets, nonmortgage 
servicing assets, and purchased credit card relationships that, in 
the aggregate, are in excess of 100 percent of Tier 1 capital; 
amounts of nonmortgage servicing assets and purchased credit card 
relationships that, in the aggregate, are in excess of 25 percent of 
Tier 1 capital; all other identifiable intangible assets; any 
investments in subsidiaries or associated companies that the Federal 
Reserve determines should be deducted Tier 1 capital; deferred tax 
assets that are dependent upon future taxable income, net of their 
valuation allowance, in excess of the limitations set forth in 
section II.B.4 of Appendix A of this part; and the total adjusted 
carrying value of nonfinancial equity investments that are subject 
to a deduction from capital.
---------------------------------------------------------------------------

    \2\ Tier 1 capital for state member banks includes common 
equity, minority interest in the equity accounts of consolidated 
subsidiaries, and qualifying noncumulative perpetual preferred 
stock. In addition, as a general matter, Tier 1 capital excludes 
goodwill; amounts of mortgage servicing assets, nonmortgage 
servicing assets, and purchased credit card relationships that, in 
the aggregate, exceed 100 percent of Tier 1 capital; nonmortgage 
servicing assets and purchased credit card relationships that, in 
the aggregate, exceed 25 percent of Tier 1 capital; other 
identifiable intangible assets; deferred tax assets that are 
dependent upon future taxable income, net of their valuation 
allowance, in excess of certain limitations; and a percentage of the 
bank's nonfinancial equity investments. The Federal Reserve may 
exclude certain other investments in subsidiaries or associated 
companies as appropriate.
---------------------------------------------------------------------------

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

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

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

    2. In Appendix A to part 225, the following revisions are made:
    a. In section II.A., one sentence is added at the end of paragraph 
1.c., Minority interest in equity accounts of consolidated 
subsidiaries;
    b. In section II.B., a new paragraph (v) is added at the end of the 
introductory text and a new paragraph 5 is added at the end of section 
II.B; and
    c. In sections III. and IV., footnotes 24 through 57 are 
redesignated as footnotes 29 through 62, respectively.

Appendix A to Part 225--Capital Adequacy Guidelines for Bank 
Holding Companies: Risk-Based Measure

* * * * *
    II. * * *
    A. * * *
    1. * * *
    c. * * * Minority interests in small business investment 
companies and investment funds that hold nonfinancial equity 
investments (as defined in section II.B.5.b. of this appendix) and 
minority interests in subsidiaries that are engaged in nonfinancial 
activities and held under one of the legal authorities listed in 
section II.B.5.b are not included in a banking organization's Tier 1 
or total capital base.
* * * * *
    B. * * *
    (v) Nonfinancial equity investments--portions are deducted from 
the sum of core capital elements in accordance with section II.B.5 
of this appendix.
* * * * *

[[Page 10223]]

    5. Nonfinancial equity investments--a. General. A bank holding 
company must deduct from its Tier 1 capital the appropriate 
percentage (as determined below) of the adjusted carrying value of 
all nonfinancial equity investments made by the parent bank holding 
company or by its direct or indirect subsidiaries.
    b. Scope of nonfinancial equity investments. i. A nonfinancial 
equity investment means any equity investment made by the bank 
holding company: pursuant to the merchant banking authority of 
section 4(k)(4)(H) of the BHC Act and subpart J of the Board's 
Regulation Y (12 CFR part 225); under section 4(c)(6) or 4(c)(7) of 
BHC Act in a nonfinancial company or in a company that makes 
investments in nonfinancial companies; in a nonfinancial company 
through a small business investment company (SBIC) under section 
302(b) of the Small Business Investment Act of 1958; \24\ in a 
nonfinancial company under the portfolio investment provisions of 
the Board's Regulation K (12 CFR 211.5(b)(1)(iii)); or in a 
nonfinancial company under section 24 of the Federal Deposit 
Insurance Act (other than section 24(f)).\25\ A nonfinancial company 
is an entity that engages in any activity that has not been 
determined to be financial in nature or incidental to financial 
activities under section 4(k) of the Bank Holding Company Act (12 
U.S.C. 1843(k)).
---------------------------------------------------------------------------

    \24\ An equity investment made under section 302(b) of the Small 
Business Investment Act of 1958 in a SBIC that is not consolidated 
with the parent banking organizations is treated as a nonfinancial 
equity investment.
    \25\ See 12 U.S.C. 1843(c)(6), (c)(7) and (k)(4)(H); 15 U.S.C. 
682(b); 12 CFR 211.5(b)(1)(iii); and 12 U.S.C. 1831a(f). In a case 
in which the Board of the FDIC, acting directly in exceptional cases 
and after a review of the proposed activity, has permitted a lesser 
capital deduction for an investment approved by the Board of 
Directors under section 24 of the Federal Deposit Insurance Act, 
such deduction shall also apply to the consolidated bank holding 
company capital calculation so long as the bank's investments under 
section 24 and SBIC investments represent, in the aggregate, less 
than 15 percent of the Tier 1 capital of the bank.
---------------------------------------------------------------------------

    ii. This section II.B.5. does not apply to, and no deduction is 
required for, any nonfinancial equity investment that is held in the 
trading account in accordance with applicable accounting principles 
and as part of an underwriting, market making or dealing activity.
    c. Amount of deduction from core capital. i. The bank holding 
company must deduct from its Tier 1 capital the appropriate 
percentage, as set forth in Table 1, of the adjusted carrying value 
of all nonfinancial equity investments held by the bank holding 
company and its subsidiaries. The amount of the deduction increases 
as the aggregate amount of nonfinancial equity investments held by 
the bank holding company and its subsidiaries increases as a 
percentage of the bank holding company's Tier 1 capital.

         Table 1.--Deduction for Nonfinancial Equity Investments
------------------------------------------------------------------------
 Aggregate adjusted carrying value of all
   nonfinancial equity investments held         Deduction from Tier 1
directly or indirectly by the bank holding   Capital (as a percentage of
  company (as a percentage of the Tier 1     the adjusted carrying value
       capital of the parent banking             of the investment)
             organization)\1\
------------------------------------------------------------------------
Less than 15 percent......................  8 percent.
15 percent to 24.99 percent...............  12 percent.
25 percent and above......................  25 percent.
------------------------------------------------------------------------
\1\ For purposes of calculating the adjusted carrying value of
  nonfinancial equity investments as a percentage of Tier 1 capital,
  Tier 1 capital is defined as the sum of core capital elements net of
  goodwill and net of all identifiable intangible assets other than
  mortgage servicing assets, nonmortgage servicing assets and purchased
  credit card relationships, but prior to the deduction for deferred tax
  assets and nonfinancial equity investments.

    ii. These deductions are applied on a marginal basis to the 
portions of the adjusted carrying value of nonfinancial equity 
investments that fall within the specified ranges of the parent 
holding company's Tier 1 capital. For example, if the adjusted 
carrying value of all nonfinancial equity investments held by a bank 
holding company equals 20 percent of the Tier 1 capital of the bank 
holding company, then the amount of the deduction would be 8 percent 
of the adjusted carrying value of all investments up to 15 percent 
of the company's Tier 1 capital, and 12 percent of the adjusted 
carrying value of all investments in excess of 15 percent of the 
company's Tier 1 capital.
    iii. The total adjusted carrying value of any nonfinancial 
equity investment that is subject to deduction under this paragraph 
is excluded from the bank holding company's risk-weighted assets for 
purposes of computing the denominator of the company's risk-based 
capital ratio.\26\
---------------------------------------------------------------------------

    \26\ For example, if 8 percent of the adjusted carrying value of 
a nonfinancial equity investment is deducted from Tier 1 capital, 
the entire adjusted carrying value of the investment will be 
excluded from risk-weighted assets in calculating the denominator 
for the risk-based capital ratio.
---------------------------------------------------------------------------

    iv. As noted in section I, this appendix establishes minimum 
risk-based capital ratios and banking organizations are at all times 
expected to maintain capital commensurate with the level and nature 
of the risks to which they are exposed. The risk to a banking 
organization from nonfinancial equity investments increases with its 
concentration in such investments and strong capital levels above 
the minimum requirements are particularly important when a banking 
organization has a high degree of concentration in nonfinancial 
equity investments (e.g., in excess of 50 percent of Tier 1 
capital). The Federal Reserve intends to monitor banking 
organizations and apply heightened supervision to equity investment 
activities as appropriate, including where the banking organization 
has a high degree of concentration in nonfinancial equity 
investments, to ensure that organizations maintain capital levels 
that are appropriate in light of their equity investment activities. 
The Federal Reserve also reserves authority to impose a higher 
capital charge in any case where the circumstances, such as the 
level of risk of the particular investment or portfolio of 
investments, the risk management systems of the banking 
organization, or other information, indicate that a higher minimum 
capital requirement is appropriate.
    d. SBIC investments. i. No deduction is required for 
nonfinancial equity investments that are made by a bank holding 
company or a subsidiary through an SBIC that is consolidated with 
the bank holding company or in a SBIC that is not consolidated with 
the bank holding company to the extent that such investments, in the 
aggregate, do not exceed 15 percent of the aggregate Tier 1 capital 
of the subsidiary banks of the bank holding company. Any 
nonfinancial equity investment that is held through or in an SBIC 
and not deducted from Tier 1 capital will be assigned a 100 percent 
risk-weight and included in the parent holding company's 
consolidated risk-weighted assets.\27\
---------------------------------------------------------------------------

    \27\ If a bank holding company has an investment in a SBIC that 
is consolidated for accounting purposes but that is not wholly owned 
by the bank holding company, the adjusted carrying value of the bank 
holding company's nonfinancial equity investments through the SBIC 
is equal to the holding company's proportionate share of the SBIC's 
adjusted carrying value of its nonfinancial equity investments. The 
remainder of the SBIC's adjusted carrying value (i.e. the minority 
interest holders' proportionate share) is excluded from the risk-
weighted assets of the bank holding company. If a bank holding 
company has an investment in a SBIC that is not consolidated for 
accounting purposes and has current information that identifies the 
percentage of the SBIC's assets that are nonfinancial equity 
investments, the bank holding company may reduce the adjusted 
carrying value of its investment in the SBIC proportionately to 
reflect the percentage of the adjusted carrying value of the SBIC's 
assets that are not nonfinancial equity investments. The amount by 
which the adjusted carrying value of the company's investment in the 
SBIC is reduced under this provision will be risk weighted at 100 
percent and included in the bank holding company's risk-weighted 
assets.
---------------------------------------------------------------------------

    ii. To the extent the adjusted carrying value of all 
nonfinancial equity investments that a bank holding company holds 
through a consolidated SBIC or in a non-consolidated SBIC exceeds, 
in the aggregate, 15 percent of the aggregate Tier 1 capital of the 
company's subsidiary banks, the appropriate percentage of such 
amounts (as set forth in Table 1) must be deducted from the bank 
holding company's Tier 1 capital. In addition, the aggregate 
adjusted carrying value of all nonfinancial equity investments held 
through a consolidated SBIC and in a non-consolidated SBIC 
(including any investments for which no deduction is required) must 
be included in determining for purposes of Table 1 the total amount 
of nonfinancial equity investments held by the bank holding company 
in relation to its Tier 1 capital.
    e. Transition provisions. [Comment requested.]

[[Page 10224]]

    f. Adjusted carrying value. i. For purposes of this section 
II.B.5., the ``adjusted carrying value'' of investments is the 
aggregate value at which the investments are carried on the balance 
sheet of the consolidated bank holding company reduced by any 
unrealized gains on those investments that are reflected in such 
carrying value but excluded from the bank holding company's Tier 1 
capital. For example, for investments held as available-for-sale 
(AFS), the adjusted carrying value of the investments would be the 
aggregate carrying value of the investments (as reflected on the 
consolidated balance sheet of the bank holding company) less: any 
unrealized gains on those investments that are included in other 
comprehensive income and not reflected in Tier 1 capital; and 
associated deferred tax liabilities.\28\
---------------------------------------------------------------------------

    \28\ Unrealized gains on AFS investments may be included in 
supplementary capital to the extent permitted under section II.A.2.e 
of this Appendix. In addition, the unrealized losses on AFS equity 
investments are deducted from Tier 1 capital in accordance with 
section II.A.1.a of this Appendix.
---------------------------------------------------------------------------

    ii. As discussed above with respect to consolidated SBICs, some 
equity investments may be in companies that are consolidated for 
accounting purposes. For investments in a nonfinancial company that 
is consolidated for accounting purposes under generally accepted 
accounting principles, the parent banking organization's adjusted 
carrying value of the investment is determined under the equity 
method of accounting (net of any intangibles associated with the 
investment that are deducted from the consolidated bank holding 
company's core capital in accordance with section II.B.1 of this 
Appendix). Even though the assets of the nonfinancial company are 
consolidated for accounting purposes, these assets (as well as the 
credit equivalent amounts of the company's off-balance sheet items) 
should be excluded from the banking organization's risk-weighted 
assets for regulatory capital purposes.
    g. Equity investments. For purposes of this section II.B.5, an 
equity investment means any equity instrument (including warrants 
and call options that give the holder the right to purchase an 
equity instrument), any equity feature of a debt instrument (such as 
a warrant or call option), and any debt instrument that is 
convertible into equity where the instrument or feature is held 
under one of the legal authorities listed in section II.B.5.b. 
above. An investment in subordinated debt or other types of debt 
instruments may be treated as an equity investment if, in the 
judgment of the appropriate federal banking agency, the instrument 
is the functional equivalent of equity.
* * * * *
    3. In Appendix D to part 225, in section II.b., footnote 3 is 
revised and the fourth sentence of section II.b. is revised to read as 
follows.

Appendix D to Part 225--Capital Adequacy Guidelines for Bank 
Holding Companies; Tier 1 Leverage Measure

* * * * *
    II. * * *
    b. * * *\3\ As a general matter, average total consolidated 
assets are defined as the quarterly average total assets (defined 
net of the allowance for loan and lease losses) reported on the 
organization's Consolidated Financial Statements (FR Y-9C Report), 
less goodwill; amounts of mortgage servicing assets, nonmortgage 
servicing assets, and purchased credit card relationships that, in 
the aggregate, are in excess of 100 percent of Tier 1 capital; 
amounts of nonmortgage servicing assets and purchased credit card 
relationships that, in the aggregate, are in excess of 25 percent of 
Tier 1 capital; all other identifiable intangible assets; deferred 
tax assets that are dependent upon future taxable income, net of 
their valuation allowance, in excess of the limitations set forth in 
section II.B.4 of appendix A of this part; the total adjusted 
carrying value of nonfinancial equity investments that are subject 
to a deduction from capital; and other investments in subsidiaries 
or associated companies that the Federal Reserve determines should 
be deducted from Tier 1 capital.
---------------------------------------------------------------------------

    \3\ Tier 1 capital for banking organizations includes common 
equity, minority interest in the equity accounts of consolidated 
subsidiaries, qualifying noncumulative perpetual preferred stock, 
and qualifying cumulative perpetual preferred stock. (Cumulative 
perpetual preferred stock is limited to 25 percent of Tier 1 
capital.) In addition, as a general matter, Tier 1 capital excludes 
goodwill; amounts of mortgage servicing assets, nonmortgage 
servicing assets, and purchased credit card relationships that, in 
the aggregate, exceed 100 percent of Tier 1 capital; nonmortgage 
servicing assets and purchased credit card relationships that, in 
the aggregate, exceed 25 percent of Tier 1 capital; all other 
identifiable intangible assets; deferred tax assets that are 
dependent upon future taxable income, net of their valuation 
allowance, in excess of certain limitations; and a percentage of the 
organization's nonfinancial equity investments. The Federal Reserve 
may exclude certain other investments in subsidiaries or associated 
companies as appropriate.

    By order of the Board of Governors of the Federal Reserve 
System, February 1, 2001.
Jennifer J. Johnson,
Secretary of the Board.

Federal Deposit Insurance Corporation

12 CFR Chapter III

Authority and Issuance

    For the reasons set forth in the joint preamble, part 325 of 
chapter III of title 12 of the Code of Federal Regulations is proposed 
to be amended as follows:

PART 325-CAPITAL MAINTENANCE

    1. The authority citation for part 325 continues to read as 
follows:

    Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b), 
1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n), 
1828(o), 1831o, 1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat. 
1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 105 Stat. 
2236, 2355, as amended by Pub. L. 103-325, 108 Stat. 2160, 2233 (12 
U.S.C. 1828 note); Pub. L. 102-242, 105 Stat. 2236, 2386, as amended 
by Pub. L. 102-550, 106 Stat. 3672, 4089 (12 U.S.C. 1828 note).

    2. In Sec. 325.2, paragraphs (t) and (v) are revised to read as 
follows:


Sec. 325.2  Definitions.

    (t) Tier 1 capital or core capital means the sum of common 
stockholders' equity, noncumulative perpetual preferred stock 
(including any related surplus), and minority interests in consolidated 
subsidiaries, minus all intangible assets (other than mortgage 
servicing assets, and purchased credit card relationships eligible for 
inclusion in core capital pursuant to Sec. 325.5(f)), minus deferred 
tax assets in excess of the limit set forth in Sec. 325.5(g), minus:
    (1) Identified losses (to the extent that Tier 1 capital would have 
been reduced if the appropriate accounting entries to reflect the 
identified losses had been recorded on the insured depository 
institution's books);
    (2) Investments in financial subsidiaries subject to 12 CFR part 
362, subpart E; and
    (3) A percentage of the bank's nonfinancial equity investments as 
set forth in section I.B of appendix A to this part.
* * * * *
    (v) Total assets means the average of total assets required to be 
included in a banking institution's ``Reports of Condition and Income'' 
(Call Report) or, for a savings association, the consolidated total 
assets required to be included in the ``Thrift Financial Report,'' as 
these reports may from time to time be revised, as of the most recent 
report date (and after making any necessary subsidiary adjustments for 
state nonmember banks as described in Secs. 325.5(c) and 325.5(d) of 
this part), minus:
    (1) Intangible assets (other than mortgage servicing assets, 
nonmortgage servicing assets, and purchased credit card relationships 
eligible for inclusion in core capital pursuant to Sec. 325.5(f));
    (2) Deferred tax assets in excess of the limit set forth in 
Sec. 325.5(g);
    (3) Assets classified loss and any other assets that are deducted 
in determining Tier 1 capital; and
    (4) The total adjusted carrying value of nonfinancial equity 
investments subject to a deduction from Tier 1 capital under section 
I.B. of appendix A to this part.
    3. In appendix A to part 325, the following amendments are made:
    a. A new paragraph is added at the end of section I.A.1.
    b. In section I.B., a new paragraph (6) is added at the end.
    c. In section II of Appendix A to part 325, footnotes 11 through 42 
are

[[Page 10225]]

redesignated as footnotes 17 through 48, respectively.

Appendix A to Part 325--Statement of Policy on Risk-Based Capital

* * * * *
    I. * * *
    A. * * *
    1. * * *
    Minority interests in small business investment companies and 
investment funds that hold nonfinancial equity investments (as 
defined in section I.B(6)(ii) of this appendix) and minority 
interests in subsidiaries that are engaged in nonfinancial 
activities and held under one of the legal authorities listed in 
section I.B(6)(ii)are not included in a bank's Tier 1 or total 
capital base.
* * * * *
    B. * * *
    (6) Nonfinancial equity investments. (i) General. A bank must 
deduct from its Tier 1 capital the appropriate percentage (as 
determined below) of the adjusted carrying value of all nonfinancial 
equity investments.
    (ii) Scope of nonfinancial equity investments. (A) A 
nonfinancial equity investment means any equity investment made by 
the bank: in a nonfinancial company through a small business 
investment company (SBIC) under section 302(b) of the Small Business 
Investment Act of 1958;\11\ and in a nonfinancial company under the 
portfolio investment provisions of Regulation K issued by the Board 
of Governors of the Federal Reserve System (12 CFR 
211.5(b)(1)(iii)).\12\ It also includes any bank investment made in 
a nonfinancial company under section 24 of the Federal Deposit 
Insurance Act (12 U.S.C. 1831a(f)), other than an investment held in 
accordance with section 24(f) of that Act.\13\ A nonfinancial 
company is an entity that engages in any activity that has not been 
determined to be permissible for the bank to conduct directly, or to 
be financial in nature or incidental to financial activities under 
section 4(k) of the Bank Holding Company Act.
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    \11\ An equity investment made under section 302(b) of the Small 
Business Investment Act of 1958 in a SBIC that is not consolidated 
with the bank is treated as a nonfinancial equity investment.
    \12\ See 12 CFR 211.5(b)(1)(iii); and 15 U.S.C. 682(b).
    \13\ The Board of Directors of the FDIC, acting directly, may, 
in exceptional cases and after a review of the proposed activity, 
permit a lower capital deduction for investments approved by the 
Board of Directors under section 24 of the FDI Act so long as the 
bank's investments under section 24 and SBIC investments represent, 
in the aggregate, less than 15 percent of the Tier 1 capital of the 
bank. The FDIC and the other banking agencies reserve the authority 
to impose higher capital charges where appropriate.
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    (B) This section I.B.(6) does not apply to, and no deduction is 
required for, any nonfinancial equity investment that is held in the 
trading account in accordance with applicable accounting principles 
and as part of an underwriting, market making or dealing activity.
    (iii) Amount of deduction from core capital. (A) The bank must 
deduct from its Tier 1 capital the appropriate percentage, as set 
forth in the table following this paragraph, of the adjusted 
carrying value of all nonfinancial equity investments held by the 
bank and its subsidiaries. The amount of the deduction increases as 
the aggregate amount of nonfinancial equity investments held by the 
bank and its subsidiaries increases as a percentage of the bank's 
Tier 1 capital.

              Deduction for Nonfinancial Equity Investments
------------------------------------------------------------------------
 Aggregate adjusted carrying value of all
   nonfinancial equity investments held         Deduction from Tier 1
 directly or indirectly by the bank (as a    Capital (as a percentage of
  percentage of the Tier 1 capital of the    the adjusted carrying value
                 bank \1\                        of the investment)
------------------------------------------------------------------------
Less than 15 percent......................  8 percent.
15 percent to 24.99 percent...............  12 percent.
25 percent and above......................  25 percent.
------------------------------------------------------------------------
\1\ In determining the adjusted carrying value of nonfinancial equity
  investments as a percentage of Tier 1 capital, the capital amount used
  in calculating this percentage is the amount of Tier 1 capital that
  exists before the deduction of any disallowed mortgage servicing
  assets, any disallowed purchased credit card relationships, any
  disallowed nonmortgage servicing assets, any disallowed deferred tax
  assets, and before the deduction of any nonfinancial equity
  investments.

    (B) These deductions are applied on a marginal basis to the 
portions of the adjusted carrying value of nonfinancial equity 
investments that fall within the specified ranges of the parent 
bank's Tier 1 capital. For example, if the adjusted carrying value 
of all nonfinancial equity investments held by a bank equals 20 
percent of the Tier 1 capital of the bank, then the amount of the 
deduction would be 8 percent of the adjusted carrying value of all 
investments up to 15 percent of the bank's Tier 1 capital, and 12 
percent of the adjusted carrying value of all investments in excess 
of 15 percent of the bank's Tier 1 capital.
    (C) The total adjusted carrying value of any nonfinancial equity 
investment that is subject to deduction under this paragraph is 
excluded from the bank's risk-weighted assets for purposes of 
computing the denominator of the bank's risk-based capital ratio and 
from total assets for purposes of calculating the denominator of the 
leverage ratio.\14\
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    \14\ For example, if 8 percent of the adjusted carrying value of 
a nonfinancial equity investment is deducted from the numerator for 
Tier 1 capital, the entire adjusted carrying value of the investment 
will be excluded from both risk-weighted assets and total assets in 
calculating the respective denominators for the risk-based capital 
and leverage ratios.
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    (D) This appendix establishes minimum risk-based capital ratios 
and banks are at all times expected to maintain capital commensurate 
with the level and nature of the risks to which they are exposed. 
The risk to a bank from nonfinancial equity investments increases 
with its concentration in such investments and strong capital levels 
above the minimum requirements are particularly important when a 
bank has a high degree of concentration in nonfinancial equity 
investments (e.g., in excess of 50 percent of Tier 1 capital). The 
FDIC intends to monitor banks and apply heightened supervision to 
equity investment activities as appropriate, including where the 
bank has a high degree of concentration in nonfinancial equity 
investments, to ensure that banks maintain capital levels that are 
appropriate in light of their equity investment activities. The FDIC 
also reserves authority to impose a higher capital charge in any 
case where the circumstances, such as the level of risk of the 
particular investment or portfolio of investments, the risk 
management systems of the bank, or other information, indicate that 
a higher minimum capital requirement is appropriate.
    (iv) SBIC investments. (A) No deduction is required for 
nonfinancial equity investments that are made by a bank through an 
SBIC that is consolidated with the bank or in an SBIC that is not 
consolidated with the bank to the extent that such investments, in 
the aggregate, do not exceed 15 percent of the bank's Tier 1 
capital. Any nonfinancial equity investment that is held through an 
SBIC or in an SBIC and not deducted from Tier 1 capital will be 
assigned a 100 percent risk-weight and included in the bank's 
consolidated risk-weighted assets.\15\
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    \15\ If a bank has an investment in a SBIC that is consolidated 
for accounting purposes but that is not wholly owned by the bank, 
the adjusted carrying value of the bank's nonfinancial equity 
investments through the SBIC is equal to the bank's proportionate 
share of the SBIC's adjusted carrying value of its nonfinancial 
equity investments. The remainder of the SBIC's adjusted carrying 
value (i.e., the minority interest holders' proportionate share) is 
excluded from the risk-weighted assets of the bank. If a bank has an 
investment in a SBIC that is not consolidated for accounting 
purposes and has current information that identifies the percentage 
of the SBIC's assets that are nonfinancial equity investments, the 
bank may reduce the adjusted carrying value of its investment in the 
SBIC proportionately to reflect the percentage of the adjusted 
carrying value of the SBIC's assets that are not nonfinancial equity 
investments. The amount by which the adjusted carrying value of the 
bank's investment in the SBIC is reduced under this provision will 
be risk weighted at 100 percent and included in the bank's risk-
weighted assets.
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    (B) To the extent the adjusted carrying value of all 
nonfinancial equity investments held through a consolidated SBIC or 
held in a non-consolidated SBIC exceed, in the aggregate, 15 percent 
of the bank's Tier 1 capital, the appropriate percentage of such 
amounts (as set forth in the table in section I.B.(6)(iii)(A)) must 
be deducted from the common stockholders' equity in determining the 
bank's Tier 1 capital. In addition, the aggregate adjusted carrying 
value of all nonfinancial equity investments held by a bank through 
a consolidated SBIC and in a non-consolidated SBIC (including any 
investments for which no deduction is required) must be included in 
determining for purposes of the table in section I.B.(6)(iii)(A) the 
total amount of nonfinancial equity investments held by the bank in 
relation to its Tier 1 capital.
    (v) Transition provisions. [Comment requested.]

[[Page 10226]]

    (vi) Adjusted carrying value. (A) For purposes of this section 
I.B.(6), the ``adjusted carrying value'' of investments is the 
aggregate value at which the investments are carried on the balance 
sheet of the bank reduced by any unrealized gains on those 
investments that are reflected in such carrying value but excluded 
from the bank's Tier 1 capital. For example, for nonfinancial equity 
investments held as available-for-sale, the adjusted carrying value 
of the investments would be the aggregate carrying value of those 
investments (as reflected on the balance sheet of the bank) less: 
any unrealized gains on those investments that are included in other 
comprehensive income and not reflected in Tier 1 capital; and 
associated deferred tax liabilities.\16\
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    \16\ Unrealized gains on available-for-sale equity investments 
may be included in Tier 2 capital to the extent permitted under 
section I.A.2.(f) of this Appendix. In addition, the net unrealized 
loss on available-for-sale equity investments are deducted from Tier 
1 capital in accordance with section I.A.1. of this Appendix.
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    (B) As discussed above with respect to consolidated SBICs, some 
equity investments may be in companies that are consolidated for 
accounting purposes. For investments in a nonfinancial company that 
is consolidated for accounting purposes under generally accepted 
accounting principles, the bank's adjusted carrying value of the 
investment is determined under the equity method of accounting (net 
of any intangibles associated with the investment that are deducted 
from the bank's core capital in accordance with section I.A.1 of 
this Appendix). Even though the assets of the nonfinancial company 
are consolidated for accounting purposes, these assets (as well as 
the credit equivalent assets of the company's off-balance sheet 
items) should be excluded from the bank's risk-weighted assets for 
regulatory capital purposes.
    (vii) Equity investments. For purposes of this section I.B.(6), 
an equity investment means any equity instrument (including warrants 
and call options that give the holder the right to purchase an 
equity instrument), any equity feature of a debt instrument (such as 
a warrant or call option), and any debt instrument that is 
convertible into equity where the instrument or feature is held 
under one of the legal authorities listed in section I.B.(6)(ii) of 
this appendix. An investment in subordinated debt or other types of 
debt instruments may be treated as an equity investment if, in the 
judgment of the FDIC, the instrument is the functional equivalent of 
equity.

    By order of the Board of Directors, Federal Deposit Insurance 
Corporation.

    Dated at Washington, D.C., this 19th day of January, 2001.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 01-3131 Filed 2-13-01; 8:45 am]
BILLING CODE 4810-33-P, 6210-01-P, 6714-01-P