[Federal Register Volume 67, Number 17 (Friday, January 25, 2002)]
[Rules and Regulations]
[Pages 3784-3807]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-794]



[[Page 3783]]

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Part II

Department of the Treasury
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Office of the Comptroller of the Currency



12 CFR Part 3



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Federal Reserve System
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12 CFR Parts 208 and 225



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Federal Deposit Insurance Corporation
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12 CFR Part 325



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

  Federal Register / Vol. 67, No. 17 / Friday, January 25, 2002 / Rules 
and Regulations  

[[Page 3784]]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket No. 02-01]
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), DOT; Board 
of Governors of the Federal Reserve System (Board); and Federal Deposit 
Insurance Corporation (FDIC).

ACTION: Final rule.

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SUMMARY: The OCC, Board and FDIC (collectively, the agencies) are 
amending their capital guidelines to establish special minimum capital 
requirements for equity investments in nonfinancial companies. The new 
capital requirements, which will apply symmetrically to equity 
investments of banks and bank holding companies, impose 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 final 
rule is substantially similar to the proposal that the agencies 
published for comment in February 2001.

EFFECTIVE DATE: April 1, 2002.

FOR FURTHER INFORMATION CONTACT: OCC: Tommy Snow, Director, Capital 
Policy (202/874-5070); Karen Solomon, Director (202/874-5090), or Ron 
Shimabukuro, Counsel (202/874-5090), Legislative and Regulatory 
Activities Division, Office of the Comptroller of the Currency, 250 E 
Street, SW, Washington, DC 20219.
    Board: Michael G. Martinson, Associate Director (202/452-3640), 
James A. Embersit, Assistant Director (202/452-5249), or Mary Frances 
Monroe, Senior Supervisory Financial Analyst (202/452-5231), Division 
of Banking Supervision and Regulation; Scott G. Alvarez, Associate 
General Counsel (202/452-3583), or Kieran J. Fallon, Senior Counsel 
(202/452-5270), Legal Division; Jean Nellie Liang, Assistant Director 
(202/452-2918), Division of Research & Statistics; Board of Governors 
of the Federal Reserve System, 20th Street and Constitution Avenue, NW, 
Washington, D.C. 20551. For users of Telecommunications Device for the 
Deaf (``TDD'') only, contact 202/263-4869.
    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), Legal 
Division, Federal Deposit Insurance Corporation, 550 17th Street, NW, 
Washington, DC 20429.

SUPPLEMENTARY INFORMATION:

A. Background

    In March 2000, the Board invited public comment on a proposal to 
amend its consolidated capital adequacy guidelines for bank holding 
companies to establish special capital requirements for investments 
made, directly or indirectly, by bank holding companies in nonfinancial 
companies.\1\ The Board's proposal, which was developed in consultation 
with the Secretary of the Treasury, applied to nonfinancial investments 
made directly or indirectly by a bank holding company under a variety 
of authorities, including investments made by financial holding 
companies under the merchant banking authority granted by the Gramm-
Leach-Bliley Act (GLB Act) and investments made directly or indirectly 
by a bank holding company through a small business investment company 
(SBIC). The Board's initial capital proposal would have assessed, at 
the holding company level, a 50 percent capital charge on the carrying 
value of each covered investment.
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    \1\ See 65 FR 16480, March 28, 2000.
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    In February 2001, the Board, OCC and FDIC jointly issued for 
comment a revised capital proposal (revised proposal).\2\ The revised 
proposal attempted to balance the concerns raised by commenters on the 
Board's initial proposal with the belief of the agencies that banking 
organizations must maintain sufficient capital to offset the risks 
associated with equity investment activities. In developing the revised 
proposal, the agencies were guided by several important principles, 
including that:
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    \2\ See 66 FR 10212, Feb. 14, 2001.
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     Equity investment activities in nonfinancial companies 
generally involve greater risks than traditional bank and financial 
activities;
     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 by a bank 
holding company or a bank; and
     The financial risks to an organization engaged in equity 
investment activities increase as the level of the organization's 
investments accounts for a larger portion of its capital, earnings and 
activities.
    In light of these principles, the revised proposal provided for a 
progression of Tier 1 marginal capital charges that increases with the 
size of the aggregate equity investment portfolio of the banking 
organization relative to its Tier 1 capital. The proposed Tier 1 charge 
ranged from 8 percent for investments that aggregated up to 15 percent 
of the banking organization's Tier 1 capital, to 25 percent for 
investments representing 25 percent or more of the banking 
organization's Tier 1 capital.
    The agencies proposed to apply these higher capital charges 
symmetrically to nonfinancial equity investments held by banks and bank 
holding companies. In particular, the agencies proposed to apply these 
charges to investments held directly or indirectly under the merchant 
banking authority of section 4(k)(4)(H) of the BHC Act; held directly 
or indirectly by bank holding companies in less than 5 percent of the 
shares of a nonfinancial company under section 4(c)(6) or 4(c)(7) of 
the BHC Act; made by bank holding companies or banks in nonfinancial 
companies through SBICs; held directly or indirectly by bank holding 
companies or banks in nonfinancial companies under the portfolio 
investment provisions of Regulation K; and held by banks in 
nonfinancial companies under section 24 of the Federal Deposit 
Insurance Act (FDI Act).
    The agencies proposed that the higher capital charges would not 
apply to SBIC investments of a bank or bank holding company to the 
extent such investments, in the aggregate, did not exceed 15 percent of 
the banking organization's Tier 1 capital. All SBIC investments, 
including any amount exempted from the higher proposed charges, would 
be included in the calculation of a banking organization's aggregate 
equity investment portfolio for purposes of determining the marginal 
capital charge applicable to non-SBIC

[[Page 3785]]

investments and SBIC investments that, in the aggregate, exceed 15 
percent of Tier 1 capital. The agencies also proposed to exempt from 
coverage investments made by state banks under the special grandfather 
rights established by section 24(f) of the FDI Act.
    The agencies requested comment on all aspects of the revised 
proposal and on a number of specific topics identified in the proposal. 
For example, the agencies requested comment on whether it would be 
necessary or appropriate to grandfather individual equity investments 
that were made before banking organizations received notice that the 
capital requirements for such investments might change.

B. Overview of Comments

    The agencies collectively received approximately 60 comments on the 
revised proposal, including many comments that were submitted to more 
than one of the agencies. Commenters included trade associations for 
the banking, securities and insurance industries, state banking 
departments and individual banks and bank holding companies. Some 
commenters supported the lower marginal capital charge structure and 
level of deductions adopted by the revised proposal. For example, some 
commenters stated that the marginal approach embodied in the revised 
proposal was appropriate, logical, and consistent with the agencies' 
responsibilities to ensure the safety and soundness of banking 
organizations. One large banking organization with a significant amount 
of equity investments also stated that the revised proposal would not 
have a significantly negative impact on its ability to make equity 
investments. Many commenters also supported the agencies' willingness 
to take steps to meaningfully address some of the issues raised by 
commenters concerning the initial proposal.
    A number of commenters, however, stated their belief that no 
special capital charge was necessary for equity investments. Some of 
these commenters argued that banking organizations are adept at 
managing the risks of these investment activities and that additional 
regulatory capital is not necessary to adequately support these 
activities. Some commenters also expressed concern that the higher 
capital charges imposed by the revised proposal would place banking 
organizations at a competitive disadvantage to independent securities 
firms and foreign banks in the market for making equity investments. In 
addition, several commenters asserted that the higher proposed charges 
would discourage independent securities firms that make equity 
investments as part of their business from affiliating with a bank. 
Commenters argued that these effects would frustrate Congress' desire, 
as expressed in the GLB Act, to permit a ``two-way street'' between 
securities firms and banking organizations.
    Some commenters also asserted that the agencies should delay 
adoption of a final rule and address the issue of the appropriate 
capital treatment for equity investments in connection with the broader 
revisions to the capital rules currently being considered by the Basel 
Committee on Banking Supervision (Basel Committee). A number of 
commenters also reiterated their position that banking organizations 
should be permitted to use their internal capital models to determine 
the amount of regulatory capital necessary to support the particular 
investment portfolio of the organization, subject to supervisory review 
of these models during the examination process. A few commenters 
suggested that a smaller, uniform capital charge or risk-weight (e.g. a 
10 percent Tier 1 capital deduction or a 250 percent risk-weight) would 
be adequate to offset the risk of all equity investments held by 
banking organizations, regardless of the size of the organization's 
overall equity investment portfolio.
    A number of commenters also contended that, if a higher capital 
charge was imposed, the capital charge should apply only to investments 
made by financial holding companies under the GLB Act's merchant 
banking authority, and not to any investment made by a banking 
organization under one or more of the legal authorities that were in 
effect prior to the GLB Act. Commenters asserted that banking 
organizations have a history of profitably making investments under 
these pre-existing authorities and that there is no evidence to support 
an increase in the regulatory capital charge for such investments. A 
few commenters also contended that the proposed higher capital charges 
should not apply to equity investments made by a company engaged in a 
nonfinancial activity so long as the company was ``predominantly'' 
engaged in financial activities.
    Commenters strongly supported several specific aspects of the 
revised proposal. For example, many commenters supported the decision 
by the agencies to exempt from the new capital charge SBIC investments 
that, in the aggregate, represented less than 15 percent of the banking 
organization's Tier 1 capital.\3\ Many of these commenters, however, 
also argued that any SBIC investments that were exempted from the 
higher proposed charges also should be excluded for purposes of 
determining the aggregate size of the banking organization's equity 
portfolio and, thus, the appropriate marginal charge to be applied to 
non-exempt investments. Commenters also supported the agencies' 
proposal to exclude from coverage investments made by insurance company 
subsidiaries of financial holding companies under section 4(k)(4)(I) of 
the BHC Act; investments made by state banks under the grandfather 
rights established by section 24(f) of the FDI Act (12 U.S.C. 
1831a(f)); and investments in debt instruments that do not serve as the 
functional equivalent of equity.
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    \3\ One large banking organization, however, opposed providing 
an exemption for SBIC investments on the grounds that these 
investments entail the same risks as other types of nonfinancial 
equity investments.
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    In addition, in response to the agencies' request for comments on 
the subject, many commenters asserted that any higher capital charges 
established for nonfinancial equity investments should not apply to 
investments made before March 13, 2000. These commenters noted that 
such investments were made before the industry was aware that a higher 
capital charge might be established for equity investments and argued 
that applying the higher charges to these pre-existing investments 
would be inequitable and could cause some investments to become 
unprofitable. Many of these commenters also argued that any 
grandfathered investments should not be included in the banking 
organization's aggregate equity portfolio for purposes of determining 
the marginal charge applicable to non-exempt investments made on or 
after March 13, 2000.
    Commenters also argued that the higher proposed capital charges 
should not be applied in determining a banking organization's Tier 1 
leverage ratio, because the leverage ratio generally does not account 
for the relative risks of a banking organization's assets. Finally, 
some commenters requested that the agencies clarify whether or how the 
proposed higher charges would apply to particular types of equity 
investments, including equity investments held in the trading account 
or for hedging purposes; investments that are acquired in satisfaction 
of a debt previously contracted (DPC); and investments made by a 
financial holding company under section 4(k)(1)(B) of the BHC Act in a

[[Page 3786]]

company that is engaged in activities that the Board has determined are 
``complementary'' to a financial activity.

C. Explanation of the Final Rule

    The agencies have carefully reviewed the revised proposal in light 
of all of the comments received. Following this review, the agencies 
have adopted a final rule that is substantially similar to the revised 
proposal that was issued for comment. As described further below, the 
agencies also have made several changes to the rule to address matters 
raised by commenters and to further clarify the scope and application 
of the rule. These changes include a grandfather provision designed to 
apply the rule's capital charges only to investments made on or after 
March 13, 2000.
    As an initial matter, the agencies believe it is important and 
appropriate to adopt a final rule at this time that establishes a 
regulatory minimum capital requirement for equity investments made by 
banking organizations in nonfinancial companies that is higher than the 
regulatory minimum capital charge that applies more broadly to banking 
assets. Data demonstrate that equity investments in nonfinancial 
companies generally involve greater risks than traditional banking and 
financial activities. An analysis of the annual returns for the period 
1946 through 1998 for publicly traded small capitalization stocks in 
the United States indicates that a banking organization would have to 
hold capital well in excess of the current regulatory minimum capital 
levels to maintain the margin of safety required to retain the lowest 
investment grade rating on a bond issued to finance a portfolio of 
small capitalization stocks. Furthermore, as discussed in the revised 
proposal, data from a study of venture capital investment firms over 
the past 25 years, information and analysis from two national rating 
agencies, and a survey of the internal capital allocation policies of 
several banking organizations and securities firms engaged in equity 
investment activities all indicate that equity investments require 
higher capital support than traditional banking activities. The 
performance of the U.S. equity markets over the past few quarters 
further evidences the volatility and risk of equity investments.
    The level and significance of equity investment activities at 
banking organizations also has increased substantially in the years 
since adoption of the original capital rules that govern banks and bank 
holding companies generally. For example, the size of SBICs owned by 
banking organizations more than doubled in the period from 1995 to 
1999, and aggregate equity investments held by banking organizations 
during that period more than quadrupled. In addition, as of June 30, 
2001, financial holding companies held more than $8.5 billion in 
investments under the new GLB Act authority to make merchant banking 
investments--authority that only became effective on March 13, 2000. 
Although the growth of these activities recently has slowed, equity 
investment activities have become, and are likely to continue to be, a 
significant business line for many banking organizations.
    In light of the increased significance of the equity investment 
activities of banking organizations and the risks associated with these 
investments, the agencies believe it is important to revise their 
capital rules to reflect more accurately the risks equity investments 
may pose to the safety and soundness of banking organizations. For 
these same reasons, the agencies do not believe it would be prudent or 
appropriate to delay adoption of a final rule, as some commenters 
suggested. The agencies are aware of, and are participating actively 
in, the ongoing comprehensive review and revision of the Basel Capital 
Accord, which is expected to include provisions addressing equity 
investment activities. The agencies believe this rule is consistent 
with the efforts of the Basel Committee to develop a minimum regulatory 
capital requirement for equities that is more risk-sensitive than the 
current 100-percent risk-weighting. The agencies note, moreover, that 
any revised Accord is not expected to become effective until 2005 at 
the earliest. The agencies view this final rule as an interim step or 
``bridge'' to the revised Accord. The agencies fully expect to revisit 
the capital charge applicable to equity investments once the Basle 
Capital Accord is revised, and will at that time decide whether and 
what, if any, revisions to the agencies' capital guidelines should be 
adopted in light of the final revised Accord.
    The agencies also continue to believe that internal capital models 
that take account of the different risks and capital needs of the 
credit and equity activities of a particular banking organization 
ultimately represent an effective method for determining the capital 
adequacy of an organization. The agencies do not believe that it would 
be appropriate at this time, however, to rely on internal capital 
models, as a replacement for regulatory minimum capital requirements, 
to address the higher risks associated with the equity investment 
activities of banking organizations. The stage of development and 
sophistication of internal models for assessing equity risk exposures 
varies widely across institutions. While modeling techniques for equity 
investments are being developed and refined at major U.S. banking 
organizations, few institutions have adequately robust modeling 
capabilities for equity investments at the present time.
    The agencies note that the Basel Committee is actively considering 
the circumstances under which it would be appropriate for a banking 
organization to calculate its capital requirements under an internal 
models-based approach. As part of this effort, the agencies are working 
as part of the Basel Committee to develop the criteria under which a 
banking organization could use internal measurement systems or internal 
models to estimate the organization's risk exposure to equity 
investments for risk-based capital purposes.\4\ The agencies will 
continue to work with banking organizations that seek to develop robust 
and effective internal models and with other domestic and international 
regulatory agencies to develop a regulatory framework that permits 
banking organizations to use models that meet appropriate quantitative 
and qualitative standards in assessing the organization's capital 
adequacy.
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    \4\ See Basel Committee on Banking Supervision, Working Paper on 
Risk Sensitive Approaches for Equity Exposures in the Banking Book 
for IRB Banks (August 2001) (``Equity Risk Working Paper'').
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    The Board notes that, once the final rule becomes effective on 
April 1, 2002, the aggregate investment review thresholds that 
currently apply to the merchant banking investments of financial 
holding companies will expire automatically.\5\ These thresholds 
currently require a financial holding company to obtain the Board's 
approval prior to making additional merchant banking investments if the 
aggregate carrying value of the holding company's existing merchant 
banking investments exceeds the lesser of 30 percent of Tier 1 capital, 
or 20 percent of Tier 1 capital after excluding investments in private 
equity funds. As the Board previously noted, these review thresholds 
were adopted as an interim measure pending adoption of a final rule 
addressing the appropriate regulatory capital treatment of merchant 
banking investments.
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    \5\ See 12 CFR 225.174(c); 12 CFR 1500.5(c).
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1. Equity Investments Covered by Final Rule

    The final rule, like the revised proposal, applies symmetrically to 
equity investments made by bank

[[Page 3787]]

holding companies and banks. Bank holding companies and banks generally 
make equity investments in reliance on, and the capital charge applies 
only to investments held under, the following authorities--
     The merchant banking authority of section 4(k)(4)(H) of 
the BHC Act (12 U.S.C. 1843(k)(4)(H)) and subpart J of the Board's 
Regulation Y (12 CFR 225.170 et seq.);
     The authority to acquire up to 5 percent of the voting 
shares of any company under section 4(c)(6) or 4(c)(7) of the BHC Act 
(12 U.S.C. 1843(c)(6) and (c)(7));
     The authority to invest in SBICs under section 302(b) of 
the Small Business Investment Act of 1958 (15 U.S.C. 682(b));
     The portfolio investment provisions of Regulation K (12 
CFR 211.8(c)(3)), including the authority to make portfolio investments 
through Edge and Agreement corporations; \6\ and
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    \6\ Recently, the Board comprehensively revised Regulation K, 
which, among other things, governs the foreign activities of U.S. 
banking organizations. See 66 FR 54346, Oct. 26, 2001. As part of 
that action, the portfolio investment provisions previously located 
at 12 CFR 211.5(b)(1)(iii) were amended and moved to 12 CFR 
211.8(c)(3).
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     The authority to make investments under section 24 of the 
FDI Act (other than under section 24(f)) (12 U.S.C. 1831a).
    For purposes of the rule, an equity investment includes the 
purchase, acquisition or retention of any equity instrument (including 
common stock, preferred stock, partnership interests, interests in 
limited liability companies, trust certificates and 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. The rule generally does not apply to investments in 
nonconvertible senior or subordinated debt. The agencies, however, may 
impose the rule's higher charges on any instrument if the agency, based 
on a case-by-case review of the investment in the supervisory process, 
determines that the instrument serves as the functional equivalent of 
equity or exposes the banking organization to essentially the same 
risks as an equity instrument. The agencies believe this reservation of 
supervisory authority is appropriate to ensure that the higher capital 
charges apply to instruments that function as equity, and ensure that 
banking organizations do not evade the requirements of the rule through 
financial engineering.
    The capital charge applies only to investments held directly or 
indirectly in nonfinancial companies under one or more of the 
authorities listed above. For purposes of the final capital rule, a 
nonfinancial company is defined to mean 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 BHC Act. 
For investments held directly or indirectly by a bank, the term 
``nonfinancial company'' also does not include a company that engages 
only in activities that are permissible for the parent bank to conduct 
directly. The rule does not apply to investments made in companies that 
engage solely in banking and financial activities. Banking 
organizations have special expertise in managing the risks associated 
with banking and financial activities.
    A few commenters asserted that the proposed higher capital charges 
should apply only to merchant banking investments made by financial 
holding companies under section 4(k)(4)(H) of the BHC Act, or should 
not apply to investments made under one or more of the other investment 
authorities listed above. The risk of loss associated with a particular 
equity investment is likely to be the same regardless of the legal 
authority used by a banking organization to make the investment, or 
whether the investment is held by a bank holding company or a bank. 
Supervisory experience, particularly over the past few quarters, has 
confirmed that significant valuation declines may occur with respect to 
equity investments held under a variety of legal authorities. It is for 
these reasons that banking organizations are increasingly making 
investment decisions and managing equity investment risks across legal 
entities as a single business line within the organization. It is for 
these same reasons that the final rule, like the revised proposal, 
applies symmetrically to nonfinancial equity investments held by banks 
and bank holding companies and applies to equity investments made under 
each of the principal legal authorities currently available to banking 
organizations for making such investments.
    As noted above, the final rule applies to investments made by bank 
holding companies or banks in or through SBICs under section 302(b) of 
the Small Business Investment Act. In light of Congress' express desire 
to facilitate the funding of small businesses through SBICs, the 
statutory limits on the amount of capital a banking organization may 
invest in SBICs, and the existing regulatory framework governing the 
formation and operations of SBICs, the agencies proposed to exempt from 
the higher capital charges SBIC investments of banking organizations 
that, in the aggregate, did not exceed 15 percent of the Tier 1 capital 
of the banking organization.
    Commenters strongly supported this treatment. Accordingly, the 
final rule continues to provide an exception for SBIC investments. As 
described further below (see Part C.4 below), the rule does not place 
any additional regulatory capital charge on SBIC investments held 
directly or indirectly by a bank to the extent the aggregate adjusted 
carrying value of all such investments does not exceed 15 percent of 
the Tier 1 capital of the bank. For bank holding companies, no 
additional regulatory capital charge is imposed on SBIC investments 
held directly or indirectly by the holding company to the extent the 
aggregate adjusted carrying value of all such investments does not 
exceed 15 percent of the aggregate of the holding company's pro rata 
interests in the Tier 1 capital of its subsidiary banks.
    The rule also applies to investments held by state banks in a 
nonfinancial company under section 24 of the FDI Act. Section 24 
permits a state bank to acquire equity in a nonfinancial company 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. 
Because of the FDIC's practice in establishing higher capital charges, 
the final rule will not have the effect of imposing additional capital 
requirements on investments held under section 24 of the FDI Act.\7\
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    \7\ The final rule permits the Board of Directors of the FDIC, 
acting directly in exceptional cases and after a review of the 
proposed activity, to allow 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 may also impose a higher 
capital charge on any investment made under section 24 where 
appropriate.
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    The agencies proposed to exclude from coverage equity investments 
made

[[Page 3788]]

by state banks under the grandfather rights established by section 
24(f) of the FDI Act and commenters strongly supported this exception. 
Section 24(f) permits a state bank to make investments only in shares 
of publicly traded companies and registered investment companies, and 
only if the investment was permitted under a state law enacted as of a 
certain date and the state bank engaged in the investment activity as 
of a certain date. The FDI Act also provides that the total amount of 
investments made by a state bank under section 24(f) may not exceed the 
capital of the bank, and expressly authorizes the FDIC to require the 
divestiture of any investment made under the section if the FDIC 
determines the investment will have an adverse effect on the safety and 
soundness of the bank. In light of the limited scope of these 
investments and the statutory restrictions applicable to them, the 
agencies have adopted an exemption for these investments in the final 
rule.
    Some commenters asserted that the proposed higher charges should 
not apply to any investment made in a company that is predominantly 
engaged in banking or financial activities. These investments, by 
definition, involve some mixing of banking and commerce, and present 
special risks to the investing banking organization. In addition, the 
agencies believe that the adoption of a ``predominantly financial'' 
standard would create significant administrative and verification 
burdens for banking organizations and their supervisors, and could 
create opportunities for banking organizations to evade the higher 
capital charges established by the rule. In this regard, the agencies 
believe it would be difficult for banking organizations to establish 
and document adequately, and for the appropriate supervisor to monitor 
effectively, the mix of a company's financial and nonfinancial 
activities. On the other hand, the approach adopted by the final rule 
provides a clear standard for banking organizations and their 
supervisors to use in identifying investments covered by the rule 
while, at the same time, excluding from coverage investments in 
companies engaged solely in banking or financial activities that the 
banking organization could hold under their traditional authorities to 
engage in such activities.
    In response to questions raised by commenters, the agencies wish to 
clarify that the rule does not apply to investments made in a community 
development corporation to promote the public welfare under 12 U.S.C. 
24(Eleventh). In addition, the rule does not apply to equity securities 
that are acquired in satisfaction of a debt previously contracted (DPC) 
and that are held and divested in accordance with applicable law, or to 
unexercised warrants acquired by a bank as additional consideration for 
making a loan where the warrants are not held under one of the legal 
authorities covered by the rule.
    The final rule also does 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. Investments made by insurance 
underwriting affiliates of a financial holding company generally are 
already subject to higher capital charges under state insurance laws. 
The Board expects to monitor financial holding companies with insurance 
underwriting affiliates to ensure that they do not arbitrage any 
differences in the capital requirements applicable to equity 
investments made by insurance companies and other financial holding 
company affiliates. The Board also currently is considering the 
appropriate method for accounting for insurance companies and their 
investments under the Board's consolidated capital adequacy guidelines 
and will address any issues that arise in this area in a separate 
proposal.
    The agencies proposed to exempt from the higher capital charges any 
equity instrument that was held in the trading account of the relevant 
banking organization in accordance with generally accepted accounting 
principles (GAAP) and as part of an underwriting, market making or 
dealing activity.
    Several commenters asserted that the higher capital charges should 
not apply to any equity instrument that is held for hedging purposes, 
or to any equity instrument that is held in the trading account in 
accordance with GAAP. Some commenters also asked the agencies to 
clarify the scope of the proposed exemption for equity instruments held 
in the trading account.
    The final rule does not apply the higher capital charges to equity 
securities acquired and held by a bank or bank holding company as a 
bona fide hedge of an equity derivative transaction lawfully entered 
into by the bank or bank holding company. Moreover, banking 
organizations have separate authority to underwrite, deal in, and make 
a market in equity securities through a securities broker or dealer 
that is subject to special capital and accounting requirements, and 
securities lawfully acquired under these statutory provisions are not 
covered by the rule.\8\
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    \8\ See 12 U.S.C. 24a, 335 and 1831w (financial subsidiaries of 
national, state member and state nonmember banks, respectively); 12 
U.S.C. 1843(k)(4)(E) (financial holding companies); and 12 U.S.C. 
1843(c)(8) and J.P. Morgan & Co., Inc., 75 Federal Reserve Bulletin 
192 (1989), aff'd sub nom. Securities Industry Ass'n v. Board of 
Governors of the Federal Reserve System, 900 F.2d 360 (D.C. Cir. 
1990) (bank holding companies).
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    Because the trading account provision of the revised proposal was 
included for the purpose of exempting these types of holdings from the 
capital proposal, the agencies do not believe that, with the 
clarifications discussed above, a general exemption for investments 
held in the trading account is necessary. Moreover, a more general 
exception for equities held in the trading account, as advocated by 
some commenters, could allow banking organizations to evade the 
requirements of the rule by placing nonfinancial equity investments in 
their trading account. Accordingly, the final rule does not include a 
general exemption for investments that are held in the trading account.
    A few commenters questioned whether the proposed charges would 
apply to investments made by financial holding companies in a company 
engaged in ``complementary'' activities. Section 4(k)(1)(B) of the BHC 
Act (12 U.S.C. 1843(k)(1)(B)) permits a financial holding company to 
acquire a company engaged in a nonfinancial activity if the Board finds 
that the activity is complementary to a financial activity and does not 
pose a substantial risk to the safety or soundness of depository 
institutions or the financial system generally. A financial holding 
company must obtain the Board's prior approval to acquire a company 
under this authority.\9\ The Board will review and consider the 
appropriate capital treatment of investments made by a financial 
holding company under section 4(k)(1)(B) in connection with its review 
of any notice filed by a financial holding company to acquire a company 
engaged in a complementary activity, or in connection with its 
determination that a particular activity is ``complementary'' to a 
financial activity.\10\ Accordingly, the final rule does not apply to 
investments made by a financial holding company under the 
``complementary'' investment authority of section 4(k)(1)(B) of the BHC 
Act.
---------------------------------------------------------------------------

    \9\ See 12 CFR 225.89.
    \10\ See 65 FR 80384, Dec. 21, 2000 (requesting comment on a 
proposal to determine that certain data processing and data 
transmission activities are complementary to a financial activity 
and on the appropriate capital treatment for such investments).
---------------------------------------------------------------------------

    The agencies believe that the legal authorities covered by the rule 
represent

[[Page 3789]]

the principal legal authorities available to banking organizations for 
making equity investments in nonfinancial companies. The agencies 
intend to monitor developments relating to nonfinancial equity 
investments of banking organizations and may expand the types of 
investments covered by the rule if necessary to ensure that banking 
organizations maintain adequate capital to support their equity 
investment activities.

2. Transition Rule for Investments Made Before March 13, 2000

    As noted above, the agencies specifically requested comment on 
whether the higher proposed capital charges should apply to individual 
investments made by a bank or bank holding company prior to March 13, 
2000. The agencies proposed that, if investments made prior to March 
13, 2000, were grandfathered, the amount of such investments be 
included in determining the aggregate size of the banking 
organization's equity investment portfolio and, thus, the appropriate 
marginal capital charge that would apply to investments that were not 
grandfathered.
    Commenters strongly supported grandfathering investments that were 
made prior to March 13, 2000. Commenters noted that these investments 
were made before the agencies publicly indicated that a higher 
regulatory capital charge might be imposed, and argued that applying 
the new charges retroactively to these investments would be unfair and 
could render certain existing investments unprofitable. Commenters also 
favored a permanent grandfather for individual investments made prior 
to March 13, 2000, rather than a phase-in period that would apply the 
new capital requirements to such investments over a period of years.
    After reviewing the comments received, the agencies have determined 
to exempt from the new capital charges any individual investment that 
was made by a bank or bank holding company before March 13, 2000, or 
that was made after such date pursuant to a binding written commitment 
entered into by the banking organization prior to March 13, 2000.\11\ 
These investments are modest in amount at most banking organizations 
and will be liquidated over time. As discussed further below (see Part 
C.4), the adjusted carrying value of any grandfathered investment must 
be included in determining the total amount of nonfinancial equity 
investments held by the banking organization in relation to its Tier 1 
capital and, thus, the marginal capital charge that applies to the 
organization's covered equity investments.\12\
---------------------------------------------------------------------------

    \11\ A few commenters asserted that grandfather rights should be 
granted to all investments made prior to the effective date of the 
final rule. The agencies do not believe granting broader grandfather 
rights for equity investments would be appropriate in light of the 
risks these investments pose to banking organizations. Also, the 
Board in its initial capital proposal specifically gave notice that 
it expected banking organizations to maintain capital in sufficient 
amounts to allow the organizations to transition to higher 
regulatory capital levels for equity investments if required. Thus, 
the agencies expect that banking organizations will not face 
significant burdens in complying with the final rule which, as noted 
above, imposes capital charges that are lower than those initially 
proposed.
    \12\ In addition, all grandfathered investments that are not 
subject to a deduction under the rule will be risk-weighted at 100 
percent and included in the banking organization's risk-weighted 
assets for purposes of calculating the organization's risk-based 
capital ratios.
---------------------------------------------------------------------------

    The final rule grants these grandfather rights only to investments 
that were made prior to March 13, 2000, or that were made on or after 
March 13, 2000 pursuant to a binding written commitment entered into 
prior to March 13, 2000.\13\ For example, if a bank holding company 
acquired 100 shares of a nonfinancial company under section 4(c)(6) of 
the BHC Act prior to March 13, 2000, the adjusted carrying value of 
that investment would be exempt from the rule's higher capital charges. 
However, if the bank holding company purchased additional shares of the 
company after March 13, 2000, or made a capital contribution to the 
company after March 13, 2000, the adjusted carrying value of the 
additional investment would be subject to the marginal capital charges 
of the rule (assuming that the additional investment was not made 
pursuant to a binding written commitment entered into before March 13, 
2000). Shares or other interests received by a banking organization 
through a stock split or stock dividend on an investment made prior to 
March 13, 2000, are not considered a new investment if the banking 
organization does not provide any consideration for the shares or 
interests received and the transaction does not materially increase the 
organization's proportional interest in the company. On the other hand, 
shares or interests acquired on or after March 13, 2000, through the 
exercise of options or warrants acquired before March 13, 2000, will be 
considered a new investment if the banking organization provides any 
consideration for the shares or interests received.
---------------------------------------------------------------------------

    \13\ For purposes of the rule a binding written commitment means 
a legally binding written agreement that requires the banking 
organization to acquire shares or other equity of the company, or 
make a capital contribution to the company, under terms and 
conditions set forth in the agreement. Options, warrants, and other 
agreements that give a banking organization the right to acquire 
equity or make an investment, but do not require the banking 
organization to take such actions, are not considered a binding 
written commitment for purposes of the rule.
---------------------------------------------------------------------------

    An investment qualifies for grandfather rights only if the banking 
organization has continuously held the investment since March 13, 2000. 
Thus, in the example discussed above, if the bank holding company sold 
and repurchased 40 shares of the nonfinancial company after March 13, 
2000, those 40 shares would no longer qualify for grandfather rights 
under the rule. The grandfather status of an investment is not affected 
if the banking organization determines to hold that investment under a 
different legal authority than the authority originally used to acquire 
the investment. A financial holding company could, for example, decide 
to hold certain investments made through an SBIC or under section 
4(c)(6) of the BHC Act prior to March 13, 2000, under the GLB Act's 
expanded merchant banking authority, and such decision would not affect 
the grandfathered treatment of the investment under the rule.

3. Marginal Capital Charge Structure

    The agencies are adopting a final marginal capital charge structure 
that is substantially as outlined in the revised proposal. This 
structure applies a higher capital charge to equity investments as the 
aggregate amount of the organization's nonfinancial equity investments 
increases in relation to its capital. This approach reflects the fact 
that the financial risks to a banking organization from equity 
investment activities increases as the level of these activities 
account for a larger portion of the organization's capital, earnings, 
and activities. The charges, which are reflected in the following 
table, are applied by making a deduction from the banking 
organization's Tier 1 capital.

[[Page 3790]]



         Table 1.--Deduction for Nonfinancial Equity Investments
------------------------------------------------------------------------
 Aggregate adjusted carrying value of all
   nonfinancial equity investments held    Deduction from Tier 1 Capital
  directly or indirectly by the banking       (as a percentage of the
organization (as a percentage of the Tier    adjusted carrying value of
  1 capital of the banking organization)          the investment)
------------------------------------------------------------------------
Less than 15 percent.....................  8 percent.
15 percent to 24.99 percent..............  12 percent.
25 percent and above.....................  25 percent.
------------------------------------------------------------------------

    Each tier of charges applies, on a marginal basis, to the adjusted 
carrying value of the banking organization's nonfinancial equity 
investments that fall within the specified range of the organization's 
Tier 1 capital.\14\ The total adjusted carrying value of a nonfinancial 
equity investment that is subject to a deduction under the rule is 
excluded from the banking organization's risk-weighted assets for 
purposes of computing the denominator of the organization's risk-based 
capital ratio.
---------------------------------------------------------------------------

    \14\ For purposes of determining the amount of a banking 
organization's nonfinancial equity investments as a percentage of 
its Tier 1 capital, Tier 1 capital is calculated before any 
deduction for disallowed mortgage servicing assets, disallowed 
nonmortgage servicing assets, disallowed purchased credit card 
relationships, disallowed credit enhancing interest-only strips 
(both purchased and retained), disallowed deferred tax assets, and 
nonfinancial equity investments.
    The agencies recently adopted amendments to their capital 
guidelines to better address the regulatory capital treatment of 
recourse obligations, residual interests (including credit enhancing 
interest-only strips) and direct credit substitutes. See 66 FR 59614 
(Nov. 29, 2001) (``Securitization Rule''). The amendments to the 
agencies' capital guidelines adopted by this final rule reflect the 
changes made to the capital guidelines by the Securitization Rule.
---------------------------------------------------------------------------

    The amount of the deduction is based on the adjusted carrying value 
of the banking organization's nonfinancial equity investments. The 
``adjusted carrying value'' of an investment is the value at which the 
investment is recorded on the balance sheet of the banking 
organization, reduced by (i) net unrealized gains that are included in 
carrying value but that have not been included in Tier 1 capital and 
(ii) associated deferred tax liabilities. 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 investment as 
reflected on the banking organization's balance sheet, less the sum of 
(i) unrealized gains on those investments included in the 
organization's other comprehensive income and not reflected in Tier 1 
capital and (ii) any associated deferred tax liabilities.
    Comments were mixed on using the adjusted carrying value of an 
investment for purposes of determining the amount of the required 
deduction. While some commenters favored this approach, others argued 
that it unfairly penalized well performing investments that are marked-
up with the unrealized gains flowing into Tier 1 capital.
    The agencies continue to believe that the adjusted carrying value 
of an investment provides an appropriate benchmark for applying the 
deduction because it reflects the full amount of an organization's 
capital exposure to equity investments. Adjusted carrying value 
reflects both the amount actually invested by the banking organization 
and any additional unrealized gains (or losses) on the investment that 
are reflected in the organization's Tier 1 capital. All of the adjusted 
carrying value of an investment is potentially subject to loss in the 
event of devaluation of the investment. Applying the charge to the 
adjusted carrying value of an investment also takes into account that 
some banking organizations use AFS accounting for GAAP reporting 
purposes, which is a prudent and appropriate accounting method in many 
situations and one that results in an effective 100 percent capital 
charge on unrealized gains.\15\
---------------------------------------------------------------------------

    \15\ The rule does not affect the treatment of unrealized gains 
and losses on AFS securities for purposes of calculating 
supplementary (Tier 2) capital. Under the agencies' risk-based 
capital rules, up to 45 percent of an organization's pretax net 
unrealized gains on AFS equity securities may be included in Tier 2 
capital.
---------------------------------------------------------------------------

4. SBIC Investments

    The final rule applies to equity investments made by bank holding 
companies and banks in nonfinancial companies through one or more SBICs 
that are consolidated with the banking organization, and to equity 
investments in one or more SBICs that are not consolidated with the 
banking organization. For the reasons discussed above, the final rule 
provides an accommodation for SBIC investments made by a bank holding 
company or bank provided such investments remain within traditional 
investment ranges. In particular, no additional capital charge is 
applied to SBIC investments held directly or indirectly by a bank to 
the extent the aggregate adjusted carrying value of all such 
investments does not exceed 15 percent of the Tier 1 capital of the 
bank. In the case of a bank holding company, no additional capital 
charge is applied to SBIC investments held directly or indirectly by 
the bank holding company to the extent the aggregate adjusted carrying 
value of all such investments does not exceed 15 percent of the 
aggregate of the holding company's pro rata interests in the Tier 1 
capital of its subsidiary banks.\16\ SBIC investments that are not 
subject to a deduction under the rule will be risk-weighted at 100 
percent and included in the banking organization's risk-weighted assets 
for purposes of calculating the organization's risk-based capital 
ratios.
---------------------------------------------------------------------------

    \16\ The amount a bank holding company may invest in the stock 
of an SBIC under section 4(c)(5) of the BHC Act and section 302(b) 
of the Small Business Investment Act is based on the bank holding 
company's proportionate interest in the capital and surplus of its 
subsidiary banks. See 12 CFR 225.111. The Board believes a similar 
methodology is appropriate for determining the level of SBIC 
investments held directly or indirectly by a bank holding company 
that qualify for an exemption from the rule's higher capital 
charges.
---------------------------------------------------------------------------

    The final rule continues to provide that a banking organization, in 
calculating the aggregate adjusted carrying value of its nonfinancial 
equity investments for purposes of determining the appropriate marginal 
charge to be applied to an equity investment subject to the rule, must 
include all nonfinancial equity investments held by the organization in 
or through an SBIC as well as all grandfathered investments that are 
exempt from the rule's higher capital charges. A number of commenters 
opposed this treatment and argued that this treatment would effectively 
subject exempt SBIC investments and grandfathered investments to the 
rule's higher capital charges.
    One of the principles that has guided the agencies during this 
rulemaking process is that the risks to a banking organization from 
equity investment activities increase as equity investments constitute 
a larger component of the

[[Page 3791]]

organization's capital and operations. Although the agencies, for the 
reasons discussed above, have determined to provide an exemption for 
SBIC investments and investments made prior to March 13, 2000, the 
agencies believe it is appropriate to consider the risks associated 
with an organization's total equity investment portfolio in determining 
the marginal charge that would apply to SBIC investments that exceed 
traditional levels and to investments made on or after March 13, 2000. 
This approach balances Congress' desire to promote the funding of small 
businesses through SBICs and the desire of banking organizations to 
preserve the existing capital treatment of investments made prior to 
March 13, 2000, with the agencies' strong belief, based on available 
data, that regulatory capital levels higher than the current 
requirements are necessary to support the greater risks associated with 
equity investments and ensure the safety and soundness of banking 
organizations. The agencies also note that this approach does not 
impose a higher capital charge on exempted SBIC investments or 
grandfathered investments. These investments would continue to be 
subject to the same capital requirements that apply to such investments 
today. However, these investments could cause a higher marginal capital 
charge to be imposed on each additional dollar of non-exempt and non-
grandfathered investments made by the banking organization to reflect 
the organization's higher concentration and exposure to equity 
investment activities.
    If a banking organization has an investment in a SBIC that is 
consolidated with the banking organization for accounting purposes, but 
that is not wholly owned by the banking organization, the adjusted 
carrying value of the organization's nonfinancial equity investments 
held through the SBIC is equal to the organization's proportionate 
share of the adjusted carrying value of the SBIC's equity investments 
in nonfinancial companies. The remainder of the adjusted carrying value 
of the SBIC's investments, which represents the minority interest 
holders' proportionate share, is excluded from the banking 
organization's risk-weighted assets.\17\
---------------------------------------------------------------------------

    \17\ If a banking organization has an investment in a SBIC that 
is not consolidated with the banking organization for accounting 
purposes, that organization may (but is not required to) reduce the 
adjusted carrying value of its investment in the SBIC 
proportionately to reflect the percentage of the SBIC's investments 
that are in companies engaged only in banking or financial 
activities. A banking organization may adjust its interest in a non-
consolidated SBIC in this manner only if the organization has 
current information that identifies the percentage of the SBIC's 
investments that are in companies engaged in a nonfinancial 
activity. This information must be available to examiners upon 
request.
---------------------------------------------------------------------------

    Similar treatment applies to investments that a bank holding 
company holds through equity investment funds that are controlled by 
the holding company (such as, by acting as general partner of the fund) 
but that are not wholly owned by the holding company. In these 
circumstances, the capital charge applies only to the holding company's 
proportionate share of the fund's investments even if the fund is 
consolidated in the holding company's financial reporting statements.
    In addition, if a less-than-wholly-owned SBIC or investment fund is 
consolidated into the banking organization's financial statements for 
accounting and reporting purposes, any minority interest resulting from 
the consolidation may not be included in the Tier 1 capital of the 
banking organization. The agencies believe this treatment is 
appropriate because the minority interest is not available to support 
the overall financial business of the banking organization and, 
therefore, should not be included in the banking organization's 
capital.
    The agencies do not expect that any nonfinancial company acquired 
by a banking organization under one of the legal authorities covered by 
the rule would be consolidated into the banking organization's 
financial statements, either because the investment is temporary or 
limited to a non-controlling stake. However, if consolidation does 
occur, any resulting minority interest also must be excluded from Tier 
1 capital because the minority interest is not available to support the 
general financial business of the banking organization.

5. Examples of Application of Rule's Marginal Charges

    The following two examples illustrate how the rule's marginal 
charges apply.

    Example 1: A financial holding company has $1 million in Tier 1 
capital and has nonfinancial equity investments with an aggregate 
adjusted carrying value of $270,000. All of the financial holding 
company's nonfinancial equity investments are held under the GLB 
Act's merchant banking authority and all were made after March 13, 
2000. The total amount of the financial holding company's required 
Tier 1 capital deduction would be $28,998, determined as follows: 
(i) 8 percent of the first $149,999 ($11,999); (ii) 12 percent of 
the amount between $150,000 and $249,999 ($11,999); and (iii) 25 
percent of the amount from $250,000 to $270,000 ($5,000).\18\ The 
average Tier 1 charge on the financial holding company's portfolio 
would be 10.74 percent.
---------------------------------------------------------------------------

    \18\ For purposes of these examples, all figures have been 
rounded to the nearest dollar.
---------------------------------------------------------------------------

    Example 2: A bank has $1 million in Tier 1 capital and has 
nonfinancial equity investments with an aggregate adjusted carrying 
value of $375,000. Of this amount, $100,000 represents the adjusted 
carrying value of investments made prior to March 13, 2000, and an 
additional $175,000 represents the adjusted carrying value of 
investments made through the bank's wholly owned SBIC. The $100,000 
in investments made prior to March 13, 2000, and $150,000 of the 
bank's SBIC investments would not be subject to the rule's marginal 
capital charges. These amounts are considered for purposes of 
determining the marginal charge that applies to the bank's covered 
investments (including the $25,000 of non-exempt SBIC investments). 
In this case, the total amount of the bank's Tier 1 capital 
deduction would be $31,250. This figure is 25 percent of $125,000, 
which is the amount of the bank's total nonfinancial equity 
portfolio subject to the rule's marginal capital charges. The 
average Tier 1 capital charge on the bank's entire nonfinancial 
equity portfolio would be 8.33 percent.

    The $31,250 charge in Example 2 reflects the provisions of the rule 
that impose no additional capital charge on investments made prior to 
March 13, 2000, and on SBIC investments to the extent such investments 
do not exceed 15 percent of Tier 1 capital. While these grandfathered 
and SBIC investments are not subject to a Tier 1 capital deduction 
under the final rule, these investments would be given a 100 percent 
risk-weight and would remain subject to the normal Tier 1 and total 
capital charges applicable to the organization's risk-weighted assets 
under the agencies's risk-based capital guidelines.

6. Leverage Ratio

    The revised proposal required banking organizations to apply the 
proposed capital deduction in calculating the organization's Tier 1 
capital. Consequently, the proposal would affect both the 
organization's risk-based capital ratio and its ratio of Tier 1 capital 
to average total assets (Tier 1 leverage ratio). The agencies requested 
comment on whether the final rule should be adjusted to eliminate 
application of the deduction for purposes of calculating the Tier 1 
leverage ratio and, if so, how this might be done. A small number of 
commenters addressed this issue, and generally opposed incorporating 
the higher capital charges for equity investments into the calculation 
of an organization's Tier 1 leverage ratio. Commenters asserted that 
the leverage ratio was

[[Page 3792]]

intended to provide an absolute measure of the bank's capital to asset 
ratio without adjusting the bank's assets according to the relative 
risk associated with different classes of assets.
    After carefully reviewing the comments on this issue, the agencies 
have decided to adopt the approach proposed, which applies the 
deduction to Tier 1 for both risk-based and leverage capital 
purposes.\19\ In reaching this conclusion, the agencies have carefully 
considered a number of factors and alternatives. The agencies have long 
used a uniform definition of Tier 1 capital for both risk-based and 
leverage capital purposes based, in part, on the view that the nature 
and composition of ``core'' capital does not differ depending on 
whether it is being compared to risk-weighted or average total assets. 
In addition, although the leverage ratio generally is intended to 
provide an absolute measure of a banking organization's ratio of core 
capital to average total assets, the agencies also previously have 
determined that certain types of assets that involve special risks 
should be deducted from, and not considered part of, Tier 1 capital for 
both risk-based and leverage capital purposes.\20\ As discussed above, 
equity investments involve significantly greater risks than those 
associated with traditional banking and financial activities and, 
accordingly, the agencies believe it is appropriate to require that 
these investments be deducted from core capital for leverage capital 
purposes in the manner provided in the rule.
---------------------------------------------------------------------------

    \19\ A few commenters also asserted that the agencies should, as 
a general matter, eliminate the Tier 1 leverage ratio for banking 
organizations. This suggestion is beyond the scope of this targeted 
rulemaking, and the agencies believe that the leverage ratio 
continues to be a useful tool in ensuring that banking organizations 
operate with adequate capital to support their activities.
    \20\ For example, the agencies' risk-based and leverage capital 
guidelines may require banking organizations to deduct all or a 
portion of the following assets from Tier 1 capital: goodwill; 
mortgage servicing assets, nonmortgage servicing assets, purchased 
credit card relationships, and credit-enhancing interest-only 
strips; other identifiable intangible assets; and deferred tax 
assets.
---------------------------------------------------------------------------

    The agencies note, moreover, that the most direct method of 
implementing the commenters' proposal would be to require banks to 
apply the rule's deductions only for risk-based capital purposes. Such 
an approach would result in many banking organizations having two 
separate Tier 1 capital amounts--one for risk-based purposes and one 
for leverage purposes. This dichotomy could create significant 
confusion in, and burden for, the industry, particularly because a 
number of regulatory and reporting requirements are based on an 
organization's ``Tier 1 capital'' and two such numbers might exist. The 
agencies also have considered potential alternative approaches that 
would implement the commenters' suggestion while, at the same time, 
retaining an uniform definition of Tier 1. These alternative 
approaches, however, also would significantly increase the complexity 
and burden of the rule.
    The agencies also have reviewed information obtained through the 
supervisory and examination process for a sample of banking 
organizations with a significant amount of equity investments. This 
review indicates that applying the rule's Tier 1 deductions for 
leverage capital purposes likely will have a de minimis impact on the 
leverage ratio of banking organizations at this time. For these 
reasons, the final rule requires banking organizations to make the 
rule's Tier 1 deductions for both risk-based and leverage capital 
purposes.
    The final rule provides that the total adjusted carrying value of a 
banking organization's nonfinancial equity investments that is subject 
to a deduction from Tier 1 capital will be excluded from the 
organization's average total consolidated assets for purposes of 
computing the denominator of the organization's Tier 1 leverage ratio. 
Any amount of equity investments that is not subject to a deduction 
under the rule (e.g. grandfathered investments and SBIC investments 
that, in the aggregate, do not exceed 15 percent of Tier 1 capital) 
must be included in the organization's average total consolidated 
assets.

7. Risk Management and the Supervisory Process

    Although strong capital adequacy is critically important to ensure 
that equity investment activities do not pose an undue risk to a 
banking organization, capital strength must be supplemented by strong 
internal controls and management practices to ensure that equity 
investment activities are conducted in a safe and sound manner. 
Accordingly, all banking organizations are expected to develop, 
maintain and employ sound risk management policies, procedures and 
systems that are reasonably designed to manage the risks associated 
with the organization's equity investment activities. These policies, 
procedures and systems should include established limits on the types 
and amounts of equity investments that may be made by the banking 
organization; parameters governing portfolio diversification; sound 
policies governing the valuation and accounting of investments; 
periodic reviews of the performance of individual investments and the 
aggregate portfolio; and strong internal controls, including investment 
review and authorization procedures and recordkeeping requirements. The 
level and complexity of an organization's risk management policies, 
procedures and systems should be commensurate to the size, nature and 
complexity of the organization's equity investment activities and 
consistent with any guidance published by the agencies.\21\
---------------------------------------------------------------------------

    \21\ See, e.g. Federal Reserve SR Letter No. 00-9 (SPE), 
Supervisory Guidance on Equity Investment and Merchant Banking 
Activities (June 22, 2000).
---------------------------------------------------------------------------

    The agencies note, moreover, that the capital requirements 
established by this final rule are viewed as the minimum capital levels 
required for a banking organization to adequately support its equity 
investment activities. The agencies' risk-based capital guidelines 
require banking organizations at all times to maintain capital that is 
commensurate with the level and nature of the risks to which they are 
exposed and the agencies fully expect that individual banking 
organizations will allocate higher economic capital levels, as 
appropriate, to support their equity investment activities in amounts 
commensurate with the risk in the individual investment portfolios of 
the organization.
    Furthermore, the agencies may impose a higher capital charge on the 
nonfinancial equity investments of a banking organization if the facts 
and circumstances indicate that a higher capital level is appropriate 
in light of the risks associated with the organization's investment 
activities. The agencies believe that strong capital levels above the 
minimum requirements are particularly important when a banking 
organization has a high degree of concentration in nonfinancial equity 
investments. As proposed, the agencies will apply heightened 
supervision to the equity investment activities of banking 
organizations with significant concentrations in equity investments. In 
addition, capital levels above the minimums established by this rule 
may be appropriate in light of the nature, concentration or performance 
of a particular organization's equity investments, or the sufficiency 
of the organization's policies, procedures, and systems used to monitor 
and control the risks associated with the organization's equity 
investments.

[[Page 3793]]

8. Regulatory Requirements Based on Tier 1 Capital

    A number of regulatory restrictions and reporting requirements are 
based on, or refer to, a bank's Tier 1 capital. For example, Tier 1 
capital is one component used in determining the dollar amount of 
covered transactions that a bank may have with any one affiliate and 
all affiliates in the aggregate under section 23A of the Federal 
Reserve Act, and the amount of extensions of credit that a national 
bank may have outstanding to a single borrower under the National Bank 
Act.\22\
---------------------------------------------------------------------------

    \22\ See 12 CFR 250.242; 12 CFR 32.2(b).
---------------------------------------------------------------------------

    The final rule requires banking organizations, in calculating their 
Tier 1 capital, to deduct the appropriate percentage of their 
nonfinancial equity investments from the sum of their core capital 
elements. The organization's Tier 1 capital is the amount remaining 
after the deduction for nonfinancial equity investments, and after any 
other deductions and adjustments required by the agencies' capital 
guidelines. Accordingly, banking organizations must use their Tier 1 
capital, calculated in the manner required by the agencies' capital 
guidelines as amended by this final rule, in determining their 
compliance with any regulatory restriction or reporting requirement 
that is based on Tier 1 capital.

D. Regulatory Flexibility Act Analysis

    OCC: The OCC hereby certifies, pursuant to section 605(b) of the 
Regulatory Flexibility Act, 5 U.S.C. 605(b), that the regulatory 
capital requirements will not have a significant economic impact on a 
substantial number of small entities. As described in detail elsewhere 
in the supplementary information, the final rule amends the OCC's risk-
based capital guidelines to apply a series of marginal capital charges 
that increase as the size of a national bank's portfolio of certain 
nonfinancial equity investments increases in relation to its Tier 1 
capital. For the following reasons, the OCC concludes that the new 
capital requirements are unlikely to have a significant economic impact 
on a substantial number of small banks.
    First, the final rule applies to only two categories of national 
bank investments: investments made pursuant to the Board's Regulation K 
and investments made in or through, SBICs. The majority of national 
bank nonfinancial equity investments are in the form of investments 
made in, or through, SBICs. The OCC believes that SBIC investment 
activities are conducted primarily by large banks rather than by small 
banks within the Small Business Administration's definition of ``small 
entity'' (asset size of $100 million or less).
    Moreover, several key features of the rule mitigate any effect that 
the increased capital requirements may have on small banks that do 
engage in nonfinancial equity investments covered by the rule. For 
example, in order to reduce regulatory burden on banking organizations 
and in response to comments on the revised proposal, nonfinancial 
equity investments made before March 13, 2000, are ``grandfathered.'' 
Commenters noted that because such investments were made before the 
industry was aware of the possibility of higher capital requirements, 
applying higher capital requirements to such investments could 
negatively impact the economics of the transactions. Moreover, the 
final rule does not apply the higher capital requirements to 
investments by national banks in community development corporations 
pursuant to 12 U.S.C. 24(Eleventh), to equity securities acquired in 
satisfaction of a debt previously contracted, or to certain unexercised 
warrants.
    Finally, the new capital requirements apply only to levels of 
investment that equal or exceed 15 percent of the bank's Tier 1 
capital. Most national banks will not be required to hold additional 
capital for the SBIC investments that they currently hold either 
because the investments are grandfathered or because the bank's level 
of investment is below 15 percent. As a result, the new capital charge 
should not deter prudent new investment in small companies, since most 
national banks could undertake new investments without tripping the 15 
percent threshhold.
    Board: In accordance with section 4(a) of the Regulatory 
Flexibility Act (5 U.S.C. 604(a)), the Board must publish a final 
regulatory flexibility analysis with this rulemaking. The rule amends 
the Board's consolidated risk-based and leverage capital adequacy 
guidelines for state member banks and bank holding companies to 
establish special minimum regulatory capital requirements for equity 
investments in nonfinancial companies. See 12 CFR Part 208, Appendix A 
and Appendix B (state member banks); 12 CFR Part 225, Appendix A and 
Appendix D (bank holding companies). As discussed more fully above, 
available data indicate that equity investments generally involve 
greater risks than the traditional banking and financial activities of 
banking organizations. Data also indicate that the level and 
significance of equity investment activities at banking organizations 
has increased significantly in recent years. The final rule modifies 
the Board's capital adequacy guidelines to better reflect the riskiness 
of equity investments and the potential risks such investments pose to 
the safety and soundness of insured depository institutions.
    The Board specifically requested comment on the likely burden that 
the revised proposal would impose on bank holding companies and state 
member banks. One bank holding company that owns or controls a 
substantial quantity of equity investments stated that the revised 
proposal would not have a significantly adverse impact on its ability 
to make equity investments. Some commenters, on the other hand, argued 
that the higher capital charges imposed by the rule would place banking 
organizations at a competitive disadvantage to independent securities 
firms and foreign banks in the market for making equity investments, or 
would discourage securities firms from affiliating with banks. In 
addition, some commenters also asserted that the agencies should adopt 
one or more alternative approaches suggested by the commenters. These 
alternatives included establishing a uniform capital charge or risk-
weight for all equity investments, relying on a banking organization's 
internal capital models to determine the appropriate amount of capital 
to support a banking organization's equity investment portfolio, and 
delaying adoption of a final rule pending completion of the ongoing 
revisions to the Basle Capital Accord.
    For the reasons discussed in detail above, the Board believes that 
the capital charges imposed by the final rule are necessary and 
appropriate to ensure that state member banks and bank holding 
companies maintain capital commensurate with the 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. The Board also has reviewed the alternatives suggested by 
commenters and, for the reasons discussed above, believes it would not 
be prudent or appropriate at this time to adopt these approaches as an 
alternative to the marginal regulatory capital charge structure 
implemented by the final rule.
    The Board notes, moreover, that the final rule includes several 
features that likely will reduce the potential effect of the rule on 
bank holding companies (including their bank and nonbank subsidiaries) 
and state member banks,

[[Page 3794]]

including in particular small banking organizations and other small 
entities. As described fully above, the rule exempts from the higher 
capital charges SBIC investments held by banks and bank holding 
companies that remain within traditional limits, investments made by 
banking organizations prior to March 13, 2000, and investments made by 
state banks under the special grandfather rights granted by section 
24(f) of the FDI Act. For covered investments, the rule applies a 
series of marginal capital charges that increase as the size of the 
banking organization's equity investment portfolio increases in 
relation to its Tier 1 capital. The highest marginal Tier 1 charge (25 
percent) is well below the uniform charge initially proposed (50 
percent).
    In addition, once the final rule becomes effective on April 1, 
2002, the aggregate investment review thresholds currently applicable 
to the merchant banking investments of financial holding companies will 
expire automatically. See 12 CFR 225.174(c); 12 CFR 1500.5(c). Thus, 
adoption of the final rule will relieve financial holding companies of 
all sizes from any burden associated with seeking formal Board approval 
to expand their merchant banking activities.
    The Board's supervisory experience also indicates that a 
significant number of small banks and bank holding companies do not 
engage in the type of equity investment activities covered by the 
rule.\23\ In addition, the Board's risk-based and leverage capital 
guidelines generally do not apply to bank holding companies that have 
less than $150 million in consolidated total assets and, accordingly, 
the amendments made by the final rule generally would not apply to such 
small bank holding companies. The Board also has reviewed information 
concerning a sample banking organizations that are actively engaged in 
equity investment activities and, based on this review, believes the 
final rule is not likely to have a significantly adverse impact on 
banking organizations or their ability to engage in equity investment 
activities.
---------------------------------------------------------------------------

    \23\ For purposes of the Regulatory Flexibility Act, small 
entities are defined to include state member banks and bank holding 
companies that have $100 million or less in assets. See 13 CFR 
121.201.
---------------------------------------------------------------------------

    FDIC: The final rule amends the FDIC's risk-based and leverage 
capital standards for state nonmember banks (12 CFR part 325). These 
amendments 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 regulatory capital 
requirements will not have a significant economic impact on a 
substantial number of small entities because of the exclusion in this 
final rule for grandfathered equity investments by state banks under 
section 24(f) of the FDI Act and the grandfather provision that was 
added to this final rule for nonfinancial equity investments made 
before March 13, 2000.
    Since March 13, 2000, the FDIC has received approximately 37 
applications and notices under section 24 of the FDI Act for equity 
investment activities in nonfinancial companies. It is anticipated that 
most of these equity investment activities would be covered under this 
rule. However, the capital charges required in this final rule for 
nonfinancial equity investments would be less than the capital charges 
imposed by the FDIC for the great majority of the nonfinancial equity 
investment activities approved by the FDIC under section 24 since March 
13, 2000. Also, these section 24 notices and applications have involved 
investments that generally were significantly below 15 percent of the 
respective banks' Tier 1 capital.
    In order to reduce regulatory burden on banking organizations and 
in response to comments on the revised proposal, the final rule 
provides for a ``grandfather'' provision for nonfinancial equity 
investments made before March 13, 2000. These commenters noted such 
investments were made before the industry was aware that a higher 
capital charge might be established for nonfinancial equity 
investments.
    In addition, the FDIC notes that the final rule includes several 
features that likely will reduce the potential effect of the rule on 
banking organizations and, especially, small banking organizations and 
other small entities. The final rule exempts from the higher capital 
charges SBIC investments held by banking organizations that remain 
within traditional limits, and equity investments made by state 
nonmember banks under the grandfather rights granted by Congress in 
section 24(f) of the FDI Act. For covered investments, the rule applies 
a series of marginal capital charges that increase as the size of the 
banking organization's equity investment portfolio increases in 
relation to its Tier 1 capital. The highest marginal Tier 1 charge (25 
percent) under the final rule is well below the uniform capital charge 
initially proposed by the Board for bank holding companies (50 percent 
of Tier 1 capital).
    In response to questions raised by commenters, the agencies have 
clarified in this preamble to the final rule that the rule does not 
apply to investments made in a community development corporation to 
promote welfare under 12 U.S.C. 24 (Eleventh). In addition, the rule 
does not apply to equity securities that are acquired in satisfaction 
of a DPC and that are held and divested in accordance with applicable 
law, or to unexercised warrants acquired by a bank as additional 
consideration for making a loan where the warrants are not held under 
one of the legal authorities covered by this final rule.

E. Paperwork Reduction Act

    OCC: The OCC has determined that this final rule 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.).
    Board: In accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3505; 5 CFR 1320 App. A.1), the Board has reviewed this final 
rule under the authority delegated to the Board by the Office of 
Management and Budget. No collections of information as defined in the 
Paperwork Reduction Act are contained in the final rule.
    FDIC: The FDIC has determined that this final rule 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.).

F. Executive Order 12866 Determination

    OCC: The OCC has determined that this final rule does not 
constitute a ``significant regulatory action'' for the purposes of 
Executive Order 12866. The final rule amends the OCC's risk-based 
capital guidelines with respect to the regulatory capital treatment 
applicable to certain nonfinancial equity investments by national 
banks. While the general effect of this final rule is to raise the 
capital requirements for certain nonfinancial equity investments held 
by banking organizations, for the following reasons, the OCC does not 
believe that this final rule will have a significant economic impact on 
national banks.
    This final rule applies a series of marginal capital charges that 
increase as the size of the banking organization's equity investment 
portfolio increases in relation to its Tier 1 capital. Specifically 
with respect to national banks, the final rule only applies to two 
categories of national bank investments: investments made pursuant to 
the Board's Regulation K and investments made in or through SBICs. The 
majority of

[[Page 3795]]

national bank nonfinancial equity investments are in the form of 
investments made in, or through SBICs. However, under the final rule 
SBIC investments held by a national bank in amounts that remain within 
traditional limits (15 percent of Tier 1 capital) are exempted from the 
higher capital requirements. The final rule also clarifies that the 
higher capital requirements do not apply to national bank investments 
in community development corporations pursuant to 12 U.S.C. 24 
(Eleventh), to equity securities acquired in satisfaction of a debt 
previously contracted, or to certain unexercised warrants.
    In addition, in order to reduce regulatory burden on banking 
organizations and in response to comments on the revised proposal, 
nonfinancial equity investments made before March 13, 2000, are 
``grandfathered.'' Commenters noted that because such investments were 
made before the industry was aware of the possibility of higher capital 
requirements, applying higher capital requirements to such investments 
could negatively impact the economics of the transactions.

G. 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 rule 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. While the general effect of 
this final rule is to raise the capital requirements for nonfinancial 
equity investments held by banking organizations, for the following 
reasons, the OCC does not believe that this final rule will result in 
expenditures of $100 million or more in any one year.
    This final rules applies a series of marginal capital charges that 
increase as the size of the banking organization's equity investment 
portfolio increases in relation to its Tier 1 capital. Specifically 
with respect to national banks, the final rule only applies to two 
categories of national bank investments: investments made pursuant to 
the Board's Regulation K and investments made in or through SBICs. The 
majority of national bank nonfinancial equity investments are in the 
form of investments made in, or through SBICs. However, under the final 
rule SBIC investments held by a national bank in amounts that remain 
within traditional limits (15 percent of Tier 1 capital) are exempted 
from the higher capital requirements. The final rule also clarifies 
that the higher capital requirements do not apply to national bank 
investments in community development corporations pursuant to 12 U.S.C. 
24 (Eleventh), to equity securities acquired in satisfaction of a debt 
previously contracted, or to certain unexercised warrants.
    In addition, in order to reduce regulatory burden on banking 
organizations and in response to comments on the revised proposal, 
nonfinancial equity investments made before March 13, 2000, are 
``grandfathered.'' Commenters noted that because such investments were 
made before the industry was aware of the possibility of higher capital 
requirements, applying higher capital requirements to such investments 
could negatively impact the economics of the transactions.

H. 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 invited comment on whether the proposed rule was 
drafted in plain language and clearly presented. No commenters 
specifically addressed this issue. The agencies have used a variety of 
``plain language'' techniques to ensure that the final rule is 
presented in a clear fashion, including using numerous topical headings 
in the rule, easy-to-read tables to set forth the marginal capital 
charge structure adopted by the rule, and textual examples to 
illustrate application of the rule. The agencies believe the final rule 
is written plainly and clearly.

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 record keeping 
requirements, Securities.

12 CFR Part 325

    Administrative practice and procedure, Banks, banking, Capital 
adequacy, Reporting and record keeping 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 joint preamble, the Office of the 
Comptroller of the Currency amends part 3 of chapter I of title 12 of 
the Code of Federal Regulations 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. The first sentence in paragraph (a) of section 3.2 is amended to 
read as follows:


Sec. 3.2  Definitions.

* * * * *
    (a) Adjusted total assets means the average total assets figure 
required to be computed for and stated in a bank's most recent 
quarterly Consolidated Report of Condition and Income (Call Report) 
minus end-of-quarter intangible assets, deferred tax assets, and 
credit-enhancing interest-only strips, that are deducted from Tier 1 
capital, and minus nonfinancial equity investments for which a Tier 1 
capital deduction is required pursuant to section 2(c)(5) of appendix A 
of this part 3. * * *
* * * * *


    3. 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)

[[Page 3796]]

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 amended;
    D. In section 2, new paragraph (c)(1)(v) is added;
    E. In section 2, paragraph (c)(5) is redesignated as paragraph 
(c)(6);
    F. In sections 3 and 4, Tables A through D are redesignated as 
Tables B through E, respectively;
    G. All references to ``Table A'' are revised to read ``Table B'';
    H. All references to ``Table B'' are revised to read ``Table C'';
    I. All references to ``Table C'' are revised to read ``Table D'';
    J. All references to ``Table D'' are revised to read ``Table E''; 
and
    K. In section 2, new paragraph (c)(5), including new Table A, is 
added. The additions and revisions 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)(5) 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 and reduced by any 
associated deferred tax liabilities. 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 nonfinancial 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 under generally accepted 
accounting principles is discussed in section 2(c)(5)(ii) of this 
appendix A. For investments in a nonfinancial company that is 
consolidated for accounting purposes, 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 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)(5) 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 any 
other instrument, including 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 or exposes the bank to essentially the same risks as an 
equity instrument.
* * * * *
    (19) Nonfinancial equity investment means any equity investment 
held by a bank in a nonfinancial company 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 211.8(c)(3)). 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 in the manner 
provided in section 2(c)(5)(ii)(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 a 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) * * *
    (v) Nonfinancial equity investments as provided by section 
2(c)(5) of this appendix A.
* * * * *
    (5) Nonfinancial equity investments--(i) General. (A) A bank 
must deduct from its Tier 1 capital the appropriate percentage, as 
determined in accordance with Table A, of the adjusted carrying 
value of all nonfinancial equity investments held by the bank and 
its subsidiaries.

         Table A.--Deduction for Nonfinancial Equity Investments
------------------------------------------------------------------------
 Aggregate adjusted carrying value of all
   nonfinancial equity investments held    Deduction from Tier 1 Capital
  directly or indirectly by banks (as a       (as a percentage of the
 percentage of the Tier 1 capital of the     adjusted carrying value of
                 bank)\1\                         the investment)
------------------------------------------------------------------------
Less than 15 percent.....................  8.0 percent.
Greater than or equal to 15 percent but    12.0 percent.
 less than 25 percent.
Greater than or equal to 25 percent......  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
  disallowed mortgage servicing assets, disallowed nonmortgage servicing
  assets, disallowed purchased credit card relationships, disallowed
  credit-enhancing interest only strips (both purchased and retained),
  disallowed 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 equal to, or 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)(5) 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

[[Page 3797]]

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.
    (ii) Small business investment company investments. (A) 
Notwithstanding section 2(c)(5)(i) 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)(5)(ii)(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 
equity investments in nonfinancial companies. 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 equity 
investments in nonfinancial companies, 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 equity investments in 
nonfinancial companies. The amount by which the adjusted carrying 
value of the bank's investment in the SBIC is reduced under this 
paragraph 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 equals or 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 A, 
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 nonfinancial equity investments 
for which no deduction is required) must be included in determining, 
for purposes of Table A the total amount of nonfinancial equity 
investments held by the bank in relation to its Tier 1 capital.
    (iii) Nonfinancial equity investments excluded. (A) 
Notwithstanding section 2(c)(5)(i) and (ii) of this appendix A, no 
deduction from Tier 1 capital is required for the following:
    (1) Nonfinancial equity investments (or portion of such 
investments) made by the bank prior to March 13, 2000, and 
continuously held by the bank since March 13, 2000.
    (2) Nonfinancial equity investments made on or after March 13, 
2000, pursuant to a legally binding written commitment that was 
entered into by the bank prior to March 13, 2000, and that required 
the bank to make the investment, if the bank has continuously held 
the investment since the date the investment was acquired.
    (3) Nonfinancial equity investments received by the bank through 
a stock split or stock dividend on a nonfinancial equity investment 
made prior to March 13, 2000, provided that the bank provides no 
consideration for the shares or interests received, and the 
transaction does not materially increase the bank's proportional 
interest in the nonfinancial company.
    (4) Nonfinancial equity investments received by the bank through 
the exercise on or after March 13, 2000, of an option, warrant, or 
other agreement that provides the bank with the right, but not the 
obligation, to acquire equity or make an investment in a 
nonfinancial company, if the option, warrant, or other agreement was 
acquired by the bank prior to March 13, 2000, and the bank provides 
no consideration for the nonfinancial equity investments.
    (B) Any excluded nonfinancial equity investments described in 
section 2(c)(5)(iii)(A) of this appendix A must be included in 
determining the total amount of nonfinancial equity investments held 
by the bank in relation to its Tier 1 capital for purposes of Table 
A. In addition, any excluded nonfinancial equity investments will be 
risk weighted at 100 percent and included in the bank's risk-
weighted assets.
* * * * *

    Dated: January 4, 2002.
John D. Hawke, Jr.,
Comptroller of the Currency.

FEDERAL RESERVE SYSTEM

12 CFR Chapter II

Authority and Issuance

    For the reasons set forth in the joint preamble, the Board of 
Governors of the Federal Reserve System amends 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, 24a, 36, 92a, 93a, 248(a), 248(c), 321-
338a, 371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9), 
1823(j), 1828(o), 1831, 1831o, 1831p-1, 1831r-1, 1831w, 1835a, 
1842(l), 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--
    i. The undesignated paragraph following paragraph 1.(iii) is 
revised;
    ii. One sentence is added at the end of paragraph 1.c.; and
    iii. The first undesignated paragraph following paragraph 2.(v) is 
revised.
    b. In section II.B--
    i. A new paragraph (v) is added following paragraph (iv) Deferred 
tax assets;
    ii. Paragraph 1.e.ii is revised;
    iii. Paragraph 4.b is revised; and
    iv. A new paragraph 5 is added at the end of section II.B.
    c. In sections III. and IV., footnotes 21 through 48 are 
redesignated as footnotes 27 through 54, respectively.
    d. Attachment II is revised.

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

* * * * *
    II. * * *
    A. * * *
    1. * * *
    Tier 1 capital is generally defined as the sum of core capital 
elements \5\ less any amounts of goodwill, other intangible assets, 
interest-only strips receivables and nonfinancial equity investments 
that are required to be deducted in accordance with section II.B. of 
this appendix A.
---------------------------------------------------------------------------

    \5\ [Reserved]
---------------------------------------------------------------------------

* * * * *
    c. * * * Minority interests in small business investment 
companies, investment funds that hold nonfinancial equity 
investments (as defined in section II.B.5.b. of this appendix A), 
and subsidiaries engaged in nonfinancial activities are not included 
in the bank's Tier 1 or total capital base if the bank's interest in 
the company or fund is held under one of the legal authorities 
listed in section II.B.5.b.
* * * * *
    2. * * *
    The maximum amount of tier 2 capital that may be included in a 
bank's qualifying total capital is limited to 100 percent of tier 1

[[Page 3798]]

capital (net of goodwill, other intangible assets, interest-only 
strips receivables and nonfinancial equity investments that are 
required to be deducted in accordance with section II.B. of this 
appendix A).
* * * * *
    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.
* * * * *
    1. * * *
    e. * * *
    ii. For purposes of calculating these limitations on mortgage 
servicing assets, nonmortgage servicing assets, purchased credit 
card relationships, and credit-enhancing I/Os, 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 of any disallowed 
mortgage servicing assets, any disallowed nonmortgage servicing 
assets, any disallowed purchased credit card relationships, any 
disallowed credit-enhancing I/Os (both purchased and retained), any 
disallowed deferred tax assets, and any nonfinancial equity 
investments.
* * * * *
    4. * * *
    b. The reported amount of deferred-tax assets, net of any 
valuation allowance for deferred-tax assets, in excess of the lesser 
of these two amounts is to be deducted from a bank's core capital 
elements in determining tier 1 capital. For purposes of calculating 
the 10 percent limitation, 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 of any disallowed mortgage servicing assets, any 
disallowed nonmortgage servicing assets, any disallowed purchased 
credit card relationships, any disallowed credit-enhancing I/Os, any 
disallowed deferred-tax assets, and any nonfinancial equity 
investments. There generally is no limit in tier 1 capital on the 
amount of deferred-tax assets that can be realized from taxes paid 
in prior carry-back years or from future reversals of existing 
taxable temporary differences.
* * * * *
    5. Nonfinancial equity investments--a. General. A bank must 
deduct from its core capital elements the sum of the appropriate 
percentages (as determined below) of the adjusted carrying value of 
all nonfinancial equity investments held by the bank or by its 
direct or indirect subsidiaries. For purposes of this section 
II.B.5, investments held by a bank include all investments held 
directly or indirectly by the bank or any of its subsidiaries.
    b. Scope of nonfinancial equity investments. A nonfinancial 
equity investment means any equity investment held 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 (15 U.S.C. 682(b)); \21\ or under the portfolio investment 
provisions of the Board's Regulation K (12 CFR 211.8(c)(3)). 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)).
---------------------------------------------------------------------------

    \21\ An equity investment made under section 302(b) of the Small 
Business Investment Act of 1958 in an SBIC that is not consolidated 
with the bank is treated as a nonfinancial equity investment.
---------------------------------------------------------------------------

    c. Amount of deduction from core capital. i. The bank must 
deduct from its core capital elements the sum of the appropriate 
percentages, as set forth in Table 1, of the adjusted carrying value 
of all nonfinancial equity investments held by the bank. The amount 
of the percentage deduction increases as the aggregate amount of 
nonfinancial equity investments held by the bank 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 Core Capital
 directly or indirectly by the bank (as a   Elements (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 any
  disallowed mortgage servicing assets, any disallowed nonmortgage
  servicing assets, any disallowed purchased credit card relationships,
  any disallowed credit enhancing I/Os (both purchased and retained),
  any disallowed deferred tax assets, and any 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.\22\
---------------------------------------------------------------------------

    \22\ 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 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 each bank maintains capital levels that are appropriate 
in light of its 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 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 held by a bank through one 
or more SBICs that are consolidated with the bank or in one or more 
SBICs that are not consolidated with the bank to the extent that

[[Page 3799]]

all 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 that is not required to be 
deducted from Tier 1 capital under this section II.B.5.d. will be 
assigned a 100 percent risk-weight and included in the bank's 
consolidated risk-weighted assets.\23\
---------------------------------------------------------------------------

    \23\ If a bank has an investment in an 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 adjusted carrying value of the SBIC's equity 
investments in nonfinancial companies. 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 an SBIC that is not 
consolidated for accounting purposes and has current information 
that identifies the percentage of the SBIC's assets that are equity 
investments in nonfinancial companies, 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 equity investments in 
nonfinancial companies. If a bank reduces the adjusted carrying 
value of its investment in a non-consolidated SBIC to reflect 
financial investments of the SBIC, the amount of the adjustment 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 one or 
more SBICs that are consolidated with the bank or in one or more 
SBICs that are not consolidated with the bank 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 core capital elements. 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. No deduction under this section II.B.5 
is required to be made with respect to the adjusted carrying value 
of any nonfinancial equity investment (or portion of such an 
investment) that was made by the bank prior to March 13, 2000, or 
that was made by the bank after such date pursuant to a binding 
written commitment \24\ entered into prior to March 13, 2000, 
provided that in either case the bank has continuously held the 
investment since the relevant investment date.\25\ For purposes of 
this section II.B.5.e., a nonfinancial equity investment made prior 
to March 13, 2000, includes any shares or other interests received 
by the bank through a stock split or stock dividend on an investment 
made prior to March 13, 2000, provided the bank provides no 
consideration for the shares or interests received and the 
transaction does not materially increase the bank's proportional 
interest in the company. The exercise on or after March 13, 2000, of 
options or warrants acquired prior to March 13, 2000, is not 
considered to be an investment made prior to March 13, 2000, if the 
bank provides any consideration for the shares or interests received 
upon exercise of the options or warrants. Any nonfinancial equity 
investment (or portion thereof) that is not required to be deducted 
from Tier 1 capital under this section II.B.5.e. must be included in 
determining the total amount of nonfinancial equity investments held 
by the bank in relation to its Tier 1 capital for purposes of Table 
1. In addition, any nonfinancial equity investment (or portion 
thereof) that is not required to be deducted from Tier 1 capital 
under this section II.B.5.e. will be assigned a 100-percent risk 
weight and included in the bank's consolidated risk-weighted assets.
---------------------------------------------------------------------------

    \24\ A ``binding written commitment'' means a legally binding 
written agreement that requires the bank to acquire shares or other 
equity of the company, or make a capital contribution to the 
company, under terms and conditions set forth in the agreement. 
Options, warrants, and other agreements that give a bank the right 
to acquire equity or make an investment, but do not require the bank 
to take such actions, are not considered a binding written 
commitment for purposes of this section II.B.5.
    \25\ For example, if a bank made an equity investment in 100 
shares of a nonfinancial company prior to March 13, 2000, the 
adjusted carrying value of that investment would not be subject to a 
deduction under this section II.B.5. However, if the bank made any 
additional equity investment in the company after March 13, 2000, 
such as by purchasing additional shares of the company (including 
through the exercise of options or warrants acquired before or after 
March 13, 2000) or by making a capital contribution to the company 
and such investment was not made pursuant to a binding written 
commitment entered into before March 13, 2000, the adjusted carrying 
value of the additional investment would be subject to a deduction 
under this section II.B.5. In addition, if the bank sold and 
repurchased, after March 13, 2000, 40 shares of the company, the 
adjusted carrying value of those 40 shares would be subject to a 
deduction under this section II.B.5.
---------------------------------------------------------------------------

    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 and associated deferred tax 
liabilities. 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.\26\
---------------------------------------------------------------------------

    \26\ Unrealized gains on AFS equity investments may be included 
in supplementary capital to the extent permitted under section 
II.A.2.e. of this appendix A. 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 A.
---------------------------------------------------------------------------

    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 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) 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 common 
stock, preferred stock, partnership interests, interests in limited 
liability companies, trust certificates and 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 A. An 
investment in any other instrument (including subordinated debt) may 
be treated as an equity investment if, in the judgment of the 
Federal Reserve, the instrument is the functional equivalent of 
equity or exposes the state member bank to essentially the same 
risks as an equity instrument.
* * * * *

  Attachment II--Summary of Definition of Qualifying Capital for State
                            Member Banks \*\
                   [Using the Year-End 1992 Standard]
------------------------------------------------------------------------
               Components                      Minimum requirements
------------------------------------------------------------------------
CORE CAPITAL (Tier 1)..................  Must equal or exceed 4% of
                                          weighted-risk assets.
Common stockholders' equity............  No limit.
Qualifying noncumulative perpetual       No limit; banks should avoid
 preferred stock.                         undue reliance on preferred
                                          stock in tier 1.

[[Page 3800]]

 
Minority interest in equity accounts of  Banks should avoid using
 consolidated.                            minority interests to
                                          subsidiaries introduce
                                          elements not otherwise
                                          qualifying for tier 1 capital.
Less: Goodwill, other intangible
 assets, credit-enhancing interest-only
 strips and nonfinancial equity
 investments required to be deducted
 from capital \1\
SUPPLEMENTARY CAPITAL (Tier 2).........  Total of tier 2 is limited to
                                          100% of tier 1.\2\
    Allowance for loan and lease losses  Limited to 1.25% of weighted-
                                          risk assets.\2\
    Perpetual preferred stock..........  No limit within tier 2.
    Hybrid capital instruments and       No limit within tier 2.
     equity contract notes.
    Subordinated debt and intermediate-  Subordinated debt and
     term preferred stock (original       intermediate-term preferred
     weighted average maturity of 5       stock are limited to 50% of
     years or more).                      tier 1,2 amortized for capital
                                          purposes as they approach
                                          maturity.
    Revaluation reserves (equity and     Not included; banks encouraged
     building).                           to disclose; may be evaluated
                                          on a case-by-case basis for
                                          international comparisons; and
                                          taken into account in making
                                          an overall assessment of
                                          capital.
DEDUCTIONS (from sum of tier 1 and tier
 2)
    Investments in unconsolidated        As a general rule, one-half of
     subsidiaries.                        the aggregate investments will
                                          be deducted from tier 1
                                          capital and one-half from tier
                                          2 capital.\3\
Reciprocal holdings of banking
 organizations' capital securities
    Other deductions (such as other      On a case-by-case basis or as a
     subsidiaries or joint ventures) as   matter of policy.
     determined by supervisory
     authority after a formal
     rulemaking.
          TOTAL CAPITAL (tier 1 + tier   Must equal or exceed 8% of
           2--deductions).                weighted-risk assets.
------------------------------------------------------------------------
\1\ Requirements for the deduction of other intangible assets, residual
  interests and nonfinancial equity investments are set forth in section
  II.B. of this appendix.
\2\ Amounts in excess of limitations are permitted but do not qualify as
  capital.
\3\ A proportionately greater amount may be deducted from tier 1
  capital, if the risks associated with the subsidiary so warrant.
* See discussion in section II of the guidelines for a complete
  description of the requirements for, and the limitations on, the
  components of qualifying capital.

* * * * *

    3. In Appendix B to part 208, in section II.b., footnotes 2 and 3 
are 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; amounts of credit-enhancing interest-only strips 
that 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 amount of the total adjusted carrying value of 
nonfinancial equity investments that is subject to a deduction from 
Tier 1 capital.\3\
---------------------------------------------------------------------------

    \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; amounts of 
credit enhancing interest-only strips in excess of 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.
    \3\ Deductions from Tier 1 capital and other adjustments are 
discussed more fully in section II.B in appendix A of this part.
---------------------------------------------------------------------------

* * * * *

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 amendments are made:
    a. In section II.A--
    i. The undesignated paragraph following paragraph 1.(iv) is 
revised;
    ii. One sentence is added at the end of paragraph 1.c; and
    iii. The first undesignated paragraph following paragraph 2.(v) is 
revised.
    b. In section II.B--
    i. A new paragraph (v) is added following paragraph (iv) Deferred 
tax assets;
    ii. Paragraph 1.e.ii is revised;
    iii. Paragraph 4.b is revised; and
    iv. A new paragraph 5 is added at the end of section II.B.
    c. In sections III. and IV., footnotes 24 through 51 are 
redesignated as footnotes 31 through 58, respectively.
    d. Attachment II is revised.

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

* * * * *
    II. * * *
    A. * * *
    1. * * *
    Tier 1 capital is generally defined as the sum of core capital 
elements \6\ less any amounts of goodwill, other intangible assets, 
interest-only strips receivables and nonfinancial equity investments 
that are required to be deducted in accordance with section II.B. of 
this appendix A.
---------------------------------------------------------------------------

    \6\ [Reserved]
---------------------------------------------------------------------------

* * * * *
    c. * * * Minority interests in small business investment 
companies, investment

[[Page 3801]]

funds that hold nonfinancial equity investments (as defined in 
section II.B.5.b. of this appendix A), and subsidiaries engaged in 
nonfinancial activities are not included in the banking 
organization's Tier 1 or total capital base if the banking 
organization's interest in the company or fund is held under one of 
the legal authorities listed in section II.B.5.b.
* * * * *
    2. * * *
    The maximum amount of tier 2 capital that may be included in an 
institution's qualifying total capital is limited to 100 percent of 
tier 1 capital (net of goodwill, other intangible assets, interest-
only strips receivables and nonfinancial equity investments that are 
required to be deducted in accordance with section II.B. of this 
appendix A).
* * * * *
    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 A.
* * * * *
    1. * * *
    e. * * *
    ii. For purposes of calculating these limitations on mortgage 
servicing assets, nonmortgage servicing assets, purchased credit 
card relationships, and credit-enhancing I/Os, 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 of any disallowed 
mortgage servicing assets, any disallowed nonmortgage servicing 
assets, any disallowed purchased credit card relationships, any 
disallowed credit-enhancing I/Os (both purchased and retained), any 
disallowed deferred tax assets, and any nonfinancial equity 
investments.
* * * * *
    4. * * *
    b. The reported amount of deferred-tax assets, net of any 
valuation allowance for deferred-tax assets, in excess of the lesser 
of these two amounts is to be deducted from a banking organization's 
core capital elements in determining tier 1 capital. For purposes of 
calculating the 10 percent limitation, 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 of any disallowed mortgage 
servicing assets, any disallowed nonmortgage servicing assets, any 
disallowed purchased credit card relationships, any disallowed 
credit-enhancing I/Os, any disallowed deferred-tax assets, and any 
nonfinancial equity investments. There generally is no limit in tier 
1 capital on the amount of deferred-tax assets that can be realized 
from taxes paid in prior carry-back years or from future reversals 
of existing taxable temporary differences.
* * * * *
    5. Nonfinancial equity investments--a. General. A bank holding 
company must deduct from its core capital elements the sum of the 
appropriate percentages (as determined below) of the adjusted 
carrying value of all nonfinancial equity investments held by the 
parent bank holding company or by its direct or indirect 
subsidiaries. For purposes of this section II.B.5, investments held 
by a bank holding company include all investments held directly or 
indirectly by the bank holding company or any of its subsidiaries.
    b. Scope of nonfinancial equity investments. A nonfinancial 
equity investment means any equity investment held by the bank 
holding company: under 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 225.175 et seq.); 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 211.8(c)(3)); 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 an SBIC that is not consolidated 
with the parent banking organization 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. In a case in 
which the Board of Directors 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.
---------------------------------------------------------------------------

    c. Amount of deduction from core capital. i. The bank holding 
company must deduct from its core capital elements the sum of the 
appropriate percentages, as set forth in Table 1, of the adjusted 
carrying value of all nonfinancial equity investments held by the 
bank holding company. The amount of the percentage deduction 
increases as the aggregate amount of nonfinancial equity investments 
held by the bank holding company 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 directly or         Deduction from Core Capital
   indirectly by the bank holding      Elements (as a percentage of the
  company (as a percentage of the       adjusted carrying value of the
    Tier 1 capital of the parent                 investment)
      banking 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 any
  disallowed mortgage servicing assets, any disallowed nonmortgage
  servicing assets, any disallowed purchased credit card relationships,
  any disallowed credit enhancing I/Os (both purchased and retained),
  any disallowed deferred tax assets, and any 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

[[Page 3802]]

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 each organization maintains capital 
levels that are appropriate in light of its 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 held by a bank holding 
company through one or more SBICs that are consolidated with the 
bank holding company or in one or more SBICs that are not 
consolidated with the bank holding company to the extent that all 
such investments, in the aggregate, do not exceed 15 percent of the 
aggregate of the bank holding company's pro rata interests in the 
Tier 1 capital of its subsidiary banks. Any nonfinancial equity 
investment that is held through or in an SBIC and not required to be 
deducted from Tier 1 capital under this section II.B.5.d. 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 an 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 
adjusted carrying value of the SBIC's equity investments in 
nonfinancial companies. 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 equity investments in nonfinancial companies, 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 equity investments 
in nonfinancial companies. If a bank holding company reduces the 
adjusted carrying value of its investment in a non-consolidated SBIC 
to reflect financial investments of the SBIC, the amount of the 
adjustment 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 holding company holds 
through one or more SBICs that are consolidated with the bank 
holding company or in one or more SBICs that are not consolidated 
with the bank holding company 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 core capital 
elements. 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. No deduction under this section II.B.5 
is required to be made with respect to the adjusted carrying value 
of any nonfinancial equity investment (or portion of such an 
investment) that was made by the bank holding company prior to March 
13, 2000, or that was made after such date pursuant to a binding 
written commitment \28\ entered into by the bank holding company 
prior to March 13, 2000, provided that in either case the bank 
holding company has continuously held the investment since the 
relevant investment date.\29\ For purposes of this section 
II.B.5.e., a nonfinancial equity investment made prior to March 13, 
2000, includes any shares or other interests received by the bank 
holding company through a stock split or stock dividend on an 
investment made prior to March 13, 2000, provided the bank holding 
company provides no consideration for the shares or interests 
received and the transaction does not materially increase the bank'' 
holding company's proportional interest in the company. The exercise 
on or after March 13, 2000, of options or warrants acquired prior to 
March 13, 2000, is not considered to be an investment made prior to 
March 13, 2000, if the bank holding company provides any 
consideration for the shares or interests received upon exercise of 
the options or warrants. Any nonfinancial equity investment (or 
portion thereof) that is not required to be deducted from Tier 1 
capital under this section II.B.5.e. must be included in determining 
the total amount of nonfinancial equity investments held by the bank 
holding company in relation to its Tier 1 capital for purposes of 
Table 1. In addition, any nonfinancial equity investment (or portion 
thereof) that is not required to be deducted from Tier 1 capital 
under this section II.B.5.e. will be assigned a 100-percent risk 
weight and included in the bank holding company's consolidated risk-
weighted assets.
---------------------------------------------------------------------------

    \28\ A ``binding written commitment'' means a legally binding 
written agreement that requires the banking organization to acquire 
shares or other equity of the company, or make a capital 
contribution to the company, under terms and conditions set forth in 
the agreement. Options, warrants, and other agreements that give a 
banking organization the right to acquire equity or make an 
investment, but do not require the banking organization to take such 
actions, are not considered a binding written commitment for 
purposes of this section II.B.5.
    \29\ For example, if a bank holding company made an equity 
investment in 100 shares of a nonfinancial company prior to March 
13, 2000, that investment would not be subject to a deduction under 
this section II.B.5. However, if the bank holding company made any 
additional equity investment in the company after March 13, 2000, 
such as by purchasing additional shares of the company (including 
through the exercise of options or warrants acquired before or after 
March 13, 2000) or by making a capital contribution to the company, 
and such investment was not made pursuant to a binding written 
commitment entered into before March 13, 2000, the adjusted carrying 
value of the additional investment would be subject to a deduction 
under this section II.B.5. In addition, if the bank holding company 
sold and repurchased shares of the company after March 13, 2000, the 
adjusted carrying value of the re-acquired shares would be subject 
to a deduction under this section II.B.5.
---------------------------------------------------------------------------

    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 and associated deferred tax liabilities. 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.\30\
---------------------------------------------------------------------------

    \30\ Unrealized gains on AFS investments may be included in 
supplementary capital to the extent permitted under section II.A.2.e 
of this appendix A. 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 A.
---------------------------------------------------------------------------

    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

[[Page 3803]]

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 common 
stock, preferred stock, partnership interests, interests in limited 
liability companies, trust certificates and 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 any other instrument (including subordinated debt) may 
be treated as an equity investment if, in the judgment of the 
Federal Reserve, the instrument is the functional equivalent of 
equity or exposes the state member bank to essentially the same 
risks as an equity instrument.
* * * * *

   Attachment II--Summary of Definition of Qualifying Capital for Bank
                           Holding Companies*
                   [Using the Year-End 1992 Standard]
------------------------------------------------------------------------
               Components                      Minimum requirements
------------------------------------------------------------------------
CORE CAPITAL (Tier 1)..................  Must equal or exceed 4% of
                                          weighted-risk assets.
    Common stockholders' equity........  No limit.
    Qualifying noncumulative perpetual   No limit; bank holding
     preferred stock.                     companies should avoid undue
                                          reliance on preferred stock in
                                          tier 1.
    Qualifying cumulative perpetual      Limited to 25% of the sum of
     preferred stock.                     common stock, qualifying
                                          perpetual stock, and minority
                                          interests.
    Minority interest in equity          Organizations should avoid
     accounts of consolidated             using minority interests to
     subsidiaries.                        introduce elements not
                                          otherwise qualifying for tier
                                          1 capital.
Less: Goodwill, other intangible
 assets, credit-enhancing interest-only
 strips and nonfinancial equity
 investments required to be deducted
 from capital \1\
SUPPLEMENTARY CAPITAL (Tier 2).........  Total of tier 2 is limited to
                                          100% of tier 1. \2\
    Allowance for loan and lease losses  Limited to 1.25% of weighted-
                                          risk assets. \2\
    Perpetual preferred stock..........  No limit within tier 2.
    Hybrid capital instruments and       No limit within tier 2.
     equity contract notes.
    Subordinated debt and intermediate-  Subordinated debt and
     term preferred stock (original       intermediate-term preferred
     weighted average maturity of 5       stock are limited to 50% of
     years or more).                      tier 1 \2\; amortized for
                                          capital purposes as they
                                          approach maturity.
Revaluation reserves (equity and         Not included; organizations
 building).                               encouraged to disclose; may be
                                          evaluated on a case-by-case
                                          basis for international
                                          comparisons; and taken into
                                          account in making an overall
                                          assessment of capital.
DEDUCTIONS (from sum of tier 1 and tier
 2)
    Investments in unconsolidated        As a general rule, one-half of
     subsidiaries.                        the aggregate investments will
                                          be deducted from tier 1
                                          capital and one-half from tier
                                          2 capital. \3\
Reciprocal holdings of banking
 organizations' capital securities
    Other deductions (such as other      On a case-by-case basis or as a
     subsidiaries or joint ventures) as   matter of policy after a
     determined by supervisory            formal rulemaking.
     authority.
      TOTAL CAPITAL (tier 1 + tier 2-    Must equal or exceed 8% of
       deductions).                       weighted-risk assets.
------------------------------------------------------------------------
\1\ Requirements for the deduction of other intangible assets and
  residual interests are set forth in section II.B.1. of this appendix.
\2\ Amounts in excess of limitations are permitted but do not qualify as
  capital.
\3\ A proportionately greater amount may be deducted from tier 1
  capital, if the risks associated with the subsidiary so warrant.
* See discussion in section II of the guidelines for a complete
  description of the requirements for, and the limitations on, the
  components of qualifying capital.

* * * * *


    3. In Appendix D to part 225, in section II.b., footnotes 3 and 4 
are 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; amounts of credit-enhancing interest-only strips 
that 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 from Tier 1 capital; deferred tax assets that are dependent 
upon future taxable income, net of their valuation allowance, in 
excess of the limitation set forth in section II.B.4 of appendix A 
of this part; and the amount of the total adjusted carrying value of 
nonfinancial equity investments that is subject to a deduction from 
Tier 1 capital. \4\
---------------------------------------------------------------------------

    \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; amounts of 
nonmortgage servicing assets and purchased credit card relationships 
that, in the aggregate, exceed 25 percent of Tier 1 capital; amounts 
of credit-enhancing interest-only strips that 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 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.
    \4\ Deductions from Tier 1 capital and other adjustments are 
discussed more fully in section II.B. of appendix A of this part.
---------------------------------------------------------------------------

* * * * *

    By order of the Board of Governors of the Federal Reserve 
System.


[[Page 3804]]


    Dated: January 7, 2002.

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, the Board of 
Directors of the Federal Deposit Insurance Corporation amends part 325 
of chapter III of title 12 of the Code of Federal Regulations 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 (v) and (x) are revised to read as 
follows:


Sec. 325.2  Definitions.

* * * * *
    (v) 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, nonmortgage servicing assets, and purchased credit 
card relationships eligible for inclusion in core capital pursuant to 
Sec. 325.5(f)), minus credit-enhancing interest-only strips that are 
not 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 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), minus investments in financial 
subsidiaries subject to 12 CFR part 362, subpart E, and minus the 
amount of the total adjusted carrying value of nonfinancial equity 
investments that is subject to a deduction from Tier 1 capital as set 
forth in section II.B.(6) of appendix A to this part.
* * * * *
    (x) 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 savings associations, 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 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)), minus credit-enhancing interest-only strips that are 
not 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 assets classified loss and any other assets that 
are deducted in determining Tier 1 capital, and minus the amount of the 
total adjusted carrying value of nonfinancial equity investments that 
is subject to a deduction from Tier 1 capital as set forth in section 
II.B.(6) of appendix A to this part. For banking institutions, the 
average of total assets is found in the Call Report schedule of 
quarterly averages. For savings associations, the consolidated total 
assets figure is found in Schedule CSC of the Thrift Financial Report.
* * * * *

    3. Paragraphs (f)(3), (f)(4), and (g)(2)(i) of Sec. 325.5 are 
revised to read as follows:


Sec. 325.5  Miscellaneous.

* * * * *
    (f) * * *
    (3) Tier 1 capital limitations. (i) The maximum allowable amount of 
mortgage servicing assets, purchased credit card relationships, and 
nonmortgage servicing assets in the aggregate will be limited to the 
lesser of:
    (A) 100 percent of 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 credit-enhancing interest-
only strips, any disallowed deferred tax assets, and any nonfinancial 
equity investments; or
    (B) The sum of the amounts of mortgage servicing assets, purchased 
credit card relationships, and nonmortgage servicing assets, determined 
in accordance with paragraph (f)(2) of this section.
    (ii) The maximum allowable amount of credit-enhancing interest-only 
strips, whether purchased or retained, will be limited to the lesser 
of:
    (A) 25 percent of 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 credit-enhancing interest-
only strips, any disallowed deferred tax assets, and any nonfinancial 
equity investments; or
    (B) The sum of the face amounts of all credit-enhancing interest-
only strips.
    (4) Tier 1 capital sublimit. In addition to the aggregate 
limitation on mortgage servicing assets, purchased credit card 
relationships, and nonmortgage servicing assets set forth in paragraph 
(f)(3) of this section, a sublimit will apply to purchased credit card 
relationships and nonmortgage servicing assets. The maximum allowable 
amount of the aggregate of purchased credit card relationships and 
nonmortgage servicing assets will be limited to the lesser of:
    (i) 25 percent of 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 credit-enhancing interest-
only strips, any disallowed deferred tax assets, and any nonfinancial 
equity investments; or
    (ii) The sum of the amounts of purchased credit card relationships 
and nonmortgage servicing assets determined in accordance with 
paragraph (f)(2) of this section.
    (g) * * *
    (2) Tier 1 capital limitations. (i) The maximum allowable amount of 
deferred tax assets that are dependent upon future taxable income, net 
of any valuation allowance for deferred tax assets, will be limited to 
the lesser of:
    (A) The amount of deferred tax assets that are dependent upon 
future taxable income that is expected to be realized within one year 
of the calendar quarter-end date, based on projected future taxable 
income for that year; or
    (B) 10 percent of the amount of Tier 1 capital that exists before 
the deduction of any disallowed mortgage servicing assets, any 
disallowed nonmortgage servicing assets, any disallowed purchased 
credit card relationships, any disallowed credit-enhancing interest-
only strips, any disallowed deferred tax assets, and any nonfinancial 
equity investments.
* * * * *

    4. In appendix A to part 325:
    A. Revise section I.A.1 (Core capital elements (Tier 1));.
    B. Amend section II.B. by adding a new paragraph (6);

[[Page 3805]]

    C. Amend section II. by redesignating footnotes 16 through 40 as 
footnotes 23 through 47, respectively; and
    D. Revise Table I.

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

* * * * *
    I. * * *
    A. * * *
    1. Core capital elements (Tier 1) consists of:
    i. Common stockholders' equity capital (includes common stock 
and related surplus, undivided profits, disclosed capital reserves 
that represent a segregation of undivided profits, and foreign 
currency translation adjustments, less net unrealized holding losses 
on available-for-sale equity securities with readily determinable 
fair values);
    ii. Noncumulative perpetual preferred stock,\2\ including any 
related surplus; and
---------------------------------------------------------------------------

    \2\ Preferred stock issues where the dividend is reset 
periodically based, in whole or in part, upon the bank's current 
credit standing, including but not limited to, auction rate, money 
market or remarketable preferred stock, are assigned to Tier 2 
capital, regardless of whether the dividends are cumulative or 
noncumulative.
---------------------------------------------------------------------------

    iii. Minority interests in the equity capital accounts of 
consolidated subsidiaries.
    At least 50 percent of the qualifying total capital base should 
consist of Tier 1 capital. Core (Tier 1) capital is defined as the 
sum of core capital elements minus all 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)),\3\ minus credit-enhancing 
interest-only strips that are not eligible for inclusion in core 
capital pursuant to Sec. 325.5(f)), minus any disallowed deferred 
tax assets, and minus any amount of nonfinancial equity investments 
required to be deducted pursuant to section II.B.(6) of this 
Appendix.
---------------------------------------------------------------------------

    \3\ An exception is allowed for intangible assets that are 
explicitly approved by the FDIC as part of the bank's regulatory 
capital on a specific case basis. These intangibles will be included 
in capital for risk-based capital purposes under the terms and 
conditions that are specifically approved by the FDIC.
---------------------------------------------------------------------------

    Although nonvoting common stock, noncumulative perpetual 
preferred stock, and minority interests in the equity capital 
accounts of consolidated subsidiaries are normally included in Tier 
1 capital, voting common stockholders' equity generally will be 
expected to be the dominant form of Tier 1 capital. Thus, banks 
should avoid undue reliance on nonvoting equity, preferred stock and 
minority interests.
    Although minority interests in consolidated subsidiaries are 
generally included in regulatory capital, exceptions to this general 
rule will be made if the minority interests fail to provide 
meaningful capital support to the consolidated bank. Such a 
situation could arise if the minority interests are entitled to a 
preferred claim on essentially low risk assets of the subsidiary. 
Similarly, although credit-enhancing interest-only strips and 
intangible assets in the form of mortgage servicing assets, 
nonmortgage servicing assets and purchased credit card relationships 
are generally recognized for risk-based capital purposes, the 
deduction of part or all of the credit-enhancing interest-only 
strips, mortgage servicing assets, nonmortgage servicing assets and 
purchased credit card relationships may be required if the carrying 
amounts of these assets are excessive in relation to their market 
value or the level of the bank's capital accounts. Credit-enhancing 
interest-only strips, mortgage servicing assets, nonmortgage 
servicing assets, purchased credit card relationships and deferred 
tax assets that do not meet the conditions, limitations and 
restrictions described in Sec. 325.5(f) and (g) of this part will 
not be recognized for risk-based capital purposes.
    Minority interests in small business investment companies, 
investment funds that hold nonfinancial equity investments (as 
defined in section II.B.(6)(ii) of this appendix A), and 
subsidiaries that are engaged in nonfinancial activities are not 
included in a bank's Tier 1 or total capital base if the bank's 
interest in the company or fund is held under one of the legal 
authorities listed in section II.B.(6)(ii) of this appendix A.
* * * * *
    II.B. * * *
    (6) Nonfinancial equity investments. (i) General. A bank must 
deduct from its Tier 1 capital the sum of the appropriate percentage 
(as determined below) of the adjusted carrying value of all 
nonfinancial equity investments held by the bank or by its direct or 
indirect subsidiaries. For purposes of this section II.B.(6), 
investments held by a bank include all investments held directly or 
indirectly by the bank or any of its subsidiaries.
    (ii) Scope of nonfinancial equity investments. A nonfinancial 
equity investment means any equity investment held 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 (15 U.S.C. 682(b));\16\ under the portfolio investment 
provisions of Regulation K issued by the Board of Governors of the 
Federal Reserve System (12 CFR 211.8(c)(3)); or under section 24 of 
the Federal Deposit Insurance Act (12 U.S.C. 1831a), other than an 
investment held in accordance with section 24(f) of that Act.\17\ 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)).
---------------------------------------------------------------------------

    \16\ 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.
    \17\ 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 reserves the authority to impose higher capital 
charges on any investment where appropriate.
---------------------------------------------------------------------------

    (iii) Amount of deduction from core capital. (A) The bank must 
deduct from its Tier 1 capital the sum of the appropriate 
percentages, as set forth in the table following this paragraph, of 
the adjusted carrying value of all nonfinancial equity investments 
held by the bank. The amount of the percentage deduction increases 
as the aggregate amount of nonfinancial equity investments held by 
the bank 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 directly or     Deduction from Tier 1 Capital (as a
    indirectly by the bank (as a     percentage of the adjusted carrying
percentage of the Tier 1 capital of        value of the investment)
           the bank) \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 any
  disallowed mortgage servicing assets, any disallowed nonmortgage
  servicing assets, any disallowed purchased credit card relationships,
  any disallowed credit-enhancing interest-only strips (both purchased
  and retained), any disallowed deferred tax assets, and any
  nonfinancial equity investments.


[[Page 3806]]

    (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.\18\
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    \18\ 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 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 each bank maintains capital levels that 
are appropriate in light of its 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 held by a bank through one 
or more SBICs that are consolidated with the bank or in one or more 
SBICs that are not consolidated with the bank to the extent that all 
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 that is not required to be 
deducted from Tier 1 capital under this section II.B.(6)(iv) will be 
assigned a 100 percent risk-weight and included in the bank's 
consolidated risk-weighted assets.\19\
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    \19\ 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 adjusted carrying value of the SBIC's investments in 
nonfinancial companies. 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 equity investments in 
nonfinancial companies, 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 equity investments in nonfinancial companies. If a bank 
reduces the adjusted carrying value of its investment in a non-
consolidated SBIC to reflect financial investments of the SBIC, the 
amount of the adjustment 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 that a bank holds through one or 
more SBICs that are consolidated with the bank or in one or more 
SBICs that are not consolidated with the bank exceeds, 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 
II.B.(6)(iii)(A)) must be deducted from the bank's 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 II.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. No deduction under this section 
II.B.(6) is required to be made with respect to the adjusted 
carrying value of any nonfinancial equity investment (or portion of 
such an investment) that was made by the bank prior to March 13, 
2000, or that was made by the bank after such date pursuant to a 
binding written commitment \20\ entered into prior to March 13, 
2000, provided that in either case the bank has continuously held 
the investment since the relevant investment date.\21\ For purposes 
of this section II.B.(6)(v) a nonfinancial equity investment made 
prior to March 13, 2000, includes any shares or other interests 
received by the bank through a stock split or stock dividend on an 
investment made prior to March 13, 2000, provided the bank provides 
no consideration for the shares or interests received and the 
transaction does not materially increase the bank's proportional 
interest in the company. The exercise on or after March 13, 2000, of 
options or warrants acquired prior to March 13, 2000, is not 
considered to be an investment made prior to March 13, 2000, if the 
bank provides any consideration for the shares or interests received 
upon exercise of the options or warrants. Any nonfinancial equity 
investment (or portion thereof) that is not required to be deducted 
from Tier 1 capital under this section II.B.(6)(v) must be included 
in determining the total amount of nonfinancial equity investments 
held by the bank in relation to its Tier 1 capital for purposes of 
the table in section II.B.(6)(iii)(A). In addition, any nonfinancial 
equity investment (or portion thereof) that is not required to be 
deducted from Tier 1 capital under this section II.B.(6)(v) will be 
assigned a 100-percent risk weight and included in the bank's 
consolidated risk-weighted assets.
---------------------------------------------------------------------------

    \20\ A ``binding written commitment'' means a legally binding 
written agreement that requires the bank to acquire shares or other 
equity of the company, or make a capital contribution to the 
company, under terms and conditions set forth in the agreement. 
Options, warrants, and other agreements that give a bank the right 
to acquire equity or make an investment, but do not require the bank 
to take such actions, are not considered a binding written 
commitment for purposes of this section II.B.(6)(v).
    \21\ For example, if a bank made an equity investment in 100 
shares of a nonfinancial company prior to March 13, 2000, the 
adjusted carrying value of that investment would not be subject to a 
deduction under this section II.B.(6). However, if the bank made any 
additional equity investment in the company after March 13, 2000, 
such as by purchasing additional shares of the company (including 
through the exercise of options or warrants acquired before or after 
March 13, 2000) or by making a capital contribution to the company 
and such investment was not made pursuant to a binding written 
commitment entered into before March 13, 2000, the adjusted carrying 
value of the additional investment would be subject to a deduction 
under this section II.B.(6). In addition, if the bank sold and 
repurchased, after March 13, 2000, 40 shares of the company, the 
adjusted carrying value of those 40 shares would be subject to a 
deduction under this section II.B.(6).
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    (vi) Adjusted carrying value. (A) For purposes of this section 
II.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 and associated deferred tax 
liabilities. For example, for equity investments held as available-
for-sale (AFS), the adjusted carrying value of the investments would 
be the aggregate carrying value of those 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.\22\
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    \22\ 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 A. In addition, the net 
unrealized losses on available-for-sale equity investments are 
deducted from Tier 1 capital in accordance with section I.A.(1) of 
this appendix A.
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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

[[Page 3807]]

the bank's core capital in accordance with section I.A.(1) 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) 
should be excluded from the bank's risk-weighted assets for 
regulatory capital purposes.
    (vii) Equity investments. For purposes of this section II.B.(6), 
an equity investment means any equity instrument (including common 
stock, preferred stock, partnership interests, interests in limited 
liability companies, trust certificates and 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.(6)(ii) of this appendix A. 
An investment in any other instrument (including subordinated debt) 
may be treated as an equity investment if, in the judgment of the 
FDIC, the instrument is the functional equivalent of equity or 
exposes the bank to essentially the same risks as an equity 
instrument.
* * * * *

               Table I.--Definition of Qualifying Capital
------------------------------------------------------------------------
               Components                      Minimum requirements
------------------------------------------------------------------------
(1) CORE CAPITAL (Tier 1)..............  Must equal or exceed 4% of
                                          weighted-risk assets.
    (a) Common stockholders' equity....  No limit.\1\
    (b) Noncumulative perpetual          No limit.\1\
     preferred stock and any related
     surplus.
    (c) Minority interest in equity      No limit.\1\
     accounts of consolidated.
    (d) Less: All intangible assets      (\2\).
     other than certain mortgage
     servicing assets, nonmortgage
     servicing assets and purchased
     credit card relationships.
    (e) Less: Certain credit-enhancing   (\3\).
     interest-only strips and
     nonfinancial equity investments
     required to be deducted from
     capital.
    (f) Less: Certain deferred tax       (\4\).
     assets.
(2) SUPPLEMENTARY CAPITAL (Tier 2).....  Total of tier 2 is limited to
                                          100% of tier 1.\5\
    (a) Allowance for loan and lease     Limited to 1.25% of weighted-
     losses.                              risk assets.\5\
    (b) Unrealized gains on certain      Limited to 45% of pretax net
     equity securities.\6\.               unrealized gains.\6\
    (c) Cumulative perpetual and long-   No limit within tier 2; long-
     term preferred stock (original       term preferred is amortized
     maturity of 20 years or more) and    for capital purposes as it
     any related surplus.                 approaches maturity.
    (d) Auction rate and similar         No limit within Tier 2.
     preferred stock (both cumulative
     and non-cumulative).
    (e) Hybrid capital instruments       No limit within Tier 2.
     (including mandatory convertible
     debt securities).
    (f) Term subordinated debt and       Term subordinated debt and
     intermediate-term preferred stock    intermediate-term preferred
     (original weighted average           stock are limited to 50% of
     maturity of five years or more).     Tier 1 \5\ and amortized for
                                          capital purposes as they
                                          approach maturity.
(3) DEDUCTIONS (from sum of tier 1 and
 tier 2)
    (a) Investments in banking and
     finance subsidiaries that are not
     consolidated for regulatory
     capital purposes
    (b) Intentional, reciprocal cross-
     holdings of capital securities
     issued by banks
    (c) Other deductions (such as        On a case-by-case basis or as a
     investment in other subsidiaries     matter of policy after formal
     or joint ventures) as determined     consideration of relevant
     by supervisory authority.            issues.
(4) TOTAL CAPITAL......................  Must equal or exceed 8% of
                                          weighted-risk assets.
------------------------------------------------------------------------
\1\ No express limits are placed on the amounts of nonvoting common,
  noncumulative perpetual preferred stock, and minority interests that
  may be recognized as part of Tier 1 capital. However, voting common
  stockholders' equity capital generally will be expected to be the
  dominant form of Tier 1 capital and banks should avoid undue reliance
  on other Tier 1 capital elements.
\2\ The amounts of mortgage servicing assets, nonmortgage servicing
  assets and purchased credit card relationships that can be recognized
  for purposes of calculating Tier 1 capital are subject to the
  limitations set forth in Sec.  325.5(f). All deductions are for
  capital purposes only; deductions would not affect accounting
  treatment.
\3\ The amounts of credit-enhancing interest-only strips that can be
  recognized for purposes of calculating Tier 1 capital are subject to
  the limitations set forth in Sec.  325.5(f). The amounts of
  nonfinancial equity investments that must be deducted for purposes of
  calculating Tier 1 capital are set forth in section II.B.(6) of
  appendix A to part 325.
\4\ Deferred tax assets are subject to the capital limitations set forth
  in Sec.  325.5(g).
\5\ Amounts in excess of limitations are permitted but do not qualify as
  capital.
\6\ Unrealized gains on equity securities are subject to the capital
  limitations set forth in paragraph I.A(2)(f) of appendix A to part
  325.

* * * * *

    Dated at Washington, DC, this 10th day of December, 2001.

    By order of the Board of Directors, Federal Deposit Insurance 
Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 02-794 Filed 1-24-02; 8:45 am]
BILLING CODE 4810-33-P; 6210-01-P; 6714-01-P