[Federal Register Volume 72, Number 119 (Thursday, June 21, 2007)]
[Proposed Rules]
[Pages 34191-34197]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-11990]


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FARM CREDIT ADMINISTRATION

12 CFR Part 615

RIN 3052-AC25


Funding and Fiscal Affairs, Loan Policies and Operations, and 
Funding Operations; Capital Adequacy--Basel Accord

AGENCY: Farm Credit Administration.

ACTION: Advance notice of proposed rulemaking (ANPRM).

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SUMMARY: The Farm Credit Administration (FCA or we) is considering 
revisions to our risk-based capital rules to more closely align minimum 
capital requirements with risks taken by Farm Credit System (FCS or 
System) institutions. We are seeking comments to facilitate the 
development of a proposed rule that would increase the risk sensitivity 
of the regulatory capital framework without unduly increasing 
regulatory burden. This ANPRM addresses possible modifications to our 
risk-based capital rules that are similar to the recent proposals of 
the other Federal financial regulatory agencies. We are also seeking 
comments on other aspects of our regulatory capital framework.

DATES: You may send comments on or before November 19, 2007.

ADDRESSES: We offer several methods for the public to submit comments. 
For accuracy and efficiency reasons, commenters are encouraged to 
submit comments by e-mail or through the Agency's Web site or the 
Federal eRulemaking Portal. Regardless of the method you use, please do 
not submit your comment multiple times via different methods. You may 
submit comments by any of the following methods:
     E-mail: Send us an e-mail at [email protected].
     Agency Web site: http://www.fca.gov. Select ``Legal 
Info,'' then ``Pending Regulations and Notices.''
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Mail: Gary K. Van Meter, Deputy Director, Office of 
Regulatory Policy, Farm Credit Administration, 1501 Farm Credit Drive, 
McLean, VA 22102-5090.
     Fax: (703) 883-4477. Posting and processing of faxes may 
be delayed, as faxes are difficult for us to process and achieve 
compliance with section 508 of the Rehabilitation Act. Please consider 
another means to comment, if possible.
    You may review copies of comments we receive at our office in 
McLean, Virginia, or on our Web site at http://www.fca.gov. Once you 
are in the Web site, select ``Legal Info,'' and then select ``Public 
Comments.'' We will show your comments as submitted, but for technical 
reasons we may omit items such as logos and special characters. 
Identifying information that you provide, such as phone numbers and 
addresses, will be publicly available. However, we will attempt to 
remove e-mail addresses to help reduce Internet spam.

FOR FURTHER INFORMATION CONTACT: Laurie Rea, Associate Director, Office 
of Regulatory Policy, Farm Credit Administration, McLean, VA 22102-
5090, (703) 883-4232, TTY (703) 883-4434, or Wade Wynn, Policy Analyst, 
Office of Regulatory Policy, Farm Credit Administration, McLean, VA 
22102-5090, (703) 883-4262, TTY (703) 883-4434, or Rebecca Orlich, 
Senior Counsel, Office of General Counsel, Farm Credit Administration, 
McLean, VA 22102-5090, (703) 883-4020, TTY (703) 883-4020.

SUPPLEMENTARY INFORMATION:

I. Objectives

    The objective of this ANPRM is to gather information to facilitate 
the development of a comprehensive proposal that would:
    1. Promote safe and sound banking practices and a prudent level of 
regulatory capital;
    2. Improve the risk sensitivity of our regulatory capital 
requirements while avoiding undue regulatory burden;
    3. To the extent appropriate, minimize differences in regulatory 
capital requirements between System institutions and other federally 
regulated banking organizations; \1\ and
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    \1\ Banking organizations include commercial banks, savings 
associations, and their respective bank holding companies.
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    4. Foster economic growth in agriculture and rural America through 
the effective allocation of System capital.

II. Background

    The FCA's risk-based capital framework is based, in part, on the

[[Page 34192]]

``International Convergence of Capital Measurement and Capital 
Standards'' (Basel I) as published by the Basel Committee on Banking 
Supervision (Basel Committee) \2\ and is broadly consistent with the 
capital requirements of the other Federal financial regulatory 
agencies.\3\ We first adopted a risk-based capital framework for the 
System as part of our 1988 regulatory capital revisions \4\ required by 
the Agricultural Credit Act of 1987 \5\ and made subsequent revisions 
in 1997,\6\ 1998 \7\ and 2005.\8\ Under the current capital framework, 
each on- and off-balance sheet credit exposure is assigned to one of 
five broad risk-weighting categories to determine the risk-adjusted 
asset base, which is the denominator for computing the permanent 
capital, total surplus, and core surplus ratios. Our minimum regulatory 
capital requirements are contained in subparts H and K of part 615 of 
our regulations.\9\
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    \2\ The Basel Committee on Banking Supervision was established 
in 1974 by central banks with bank supervisory authorities in major 
industrialized countries. The Basel Committee formulates standards 
and guidelines related to banking and recommends them for adoption 
by member countries and others. All Basel Committee documents are 
available at http://www.bis.org.
    \3\ We refer collectively to the Office of the Comptroller of 
the Currency, the Board of Governors of the Federal Reserve System, 
the Federal Deposit Insurance Corporation, and the Office of Thrift 
Supervision as the ``other Federal financial regulatory agencies.''
    \4\ See 53 FR 39229 (October 6, 1988).
    \5\ Pub. L. 100-233 (January 6, 1988), section 301. The 1987 Act 
amended many provisions of the Farm Credit Act of 1971, as amended, 
which is codified at 12 U.S.C. 2001 et seq.
    \6\ See 62 FR 4429 (January 30, 1997).
    \7\ See 63 FR 39219 (July 22, 1998).
    \8\ See 70 FR 35336 (June 17, 2005).
    \9\ 12 CFR part 615, subparts H and K.
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    The financial services industry has changed significantly since we 
adopted the Basel I-based capital framework for the System. Financial 
markets have become increasingly global and interconnected. 
Deregulation and consolidation have created larger, more complex 
financial institutions. Technological innovation has enabled such 
institutions to create increasingly sophisticated and complex financial 
products and services. Risk management and measurement techniques have 
also vastly improved. Financial regulators and industry participants 
agree that Basel I is no longer the best regulatory capital framework 
for many of the larger, more complex financial institutions and should 
be modernized to better reflect recent developments in banking and 
capital market practices.
    For a number of years, the Basel Committee has worked to develop a 
new accord to incorporate the recent advancements in the financial 
services industry. In June 2004, it published the ``International 
Convergence of Capital Measurement and Capital Standards: A Revised 
Framework'' (Basel II) to promote improved risk measurement and 
management processes and more closely align capital requirements with 
risk.\10\ In September 2006, the other Federal financial regulatory 
agencies issued an interagency notice of proposed rulemaking for 
implementing Basel II in the United States (U.S. Basel II).\11\ U.S. 
Basel II would require core banks \12\ and permit opt-in banks \13\ 
(collectively referred to as Basel II banking organizations) to 
implement the new framework using the advanced internal ratings-based 
approach \14\ to calculate the regulatory capital requirement for 
credit risk and the advanced measurement approach \15\ to calculate the 
regulatory capital requirement for operational risk.\16\
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    \10\ See http://www.bis.org/publ/bcbsca.htm for the 2004 Basel 
II Accord as well as updates in 2005 and 2006.
    \11\ See 71 FR 55830 (September 25, 2006). This document is at 
http://www.federalreserve.gov/generalinfo/base12/USImplementation.htm.
    \12\ Core banks are banking organizations that have consolidated 
total assets of $250 billion or more or have consolidated on-balance 
sheet foreign exposures of $10 billion or more.
    \13\ Opt-in banks are banking organizations that do not meet the 
definition of a core bank but have the risk management and 
measurement capabilities to voluntarily implement the advanced 
approaches of Basel II with supervisory approval.
    \14\ A banking organization computes internal estimates of 
certain key risk parameters for each credit exposure or pool of 
exposures and feeds the results into regulatory formulas to 
determine the risk-based capital requirement for credit risk.
    \15\ Internal operational risk management systems and processes 
are used to compute risk-based capital requirements for operational 
risk.
    \16\ The proposed rule seeks comments on whether Basel II 
banking organizations should be permitted to use other credit and 
operational risk approaches.
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    Given the complexity and cost associated with adopting the advanced 
approaches, most U.S. banking organizations (collectively referred to 
as non-Basel II banking organizations) will not be required to 
implement, or choose to implement, U.S. Basel II. As a result, a 
bifurcated regulatory capital framework would be created in the United 
States, which could result in different regulatory capital charges for 
similar products offered by Basel II and non-Basel II banking 
organizations. Financial regulators, banking organizations, trade 
associations and other interested parties have raised concerns that the 
bifurcated structure could create a competitive disadvantage for non-
Basel II banking organizations.
    In December 2006, the other Federal financial regulatory agencies 
addressed these concerns by issuing an interagency notice of proposed 
rulemaking (Basel IA) to improve the risk sensitivity of the existing 
Basel I-based capital framework for non-Basel II banking 
organizations.\17\ Basel IA is intended to help minimize the potential 
differences in the regulatory minimum capital requirements of Basel II 
and non-Basel II banking organizations. The proposal would allow non-
Basel II banking organizations the option of adopting all the revisions 
of Basel IA or continuing to use the existing Basel I-based capital 
framework.\18\ Proposed Basel IA would: (1) Increase the number of 
risk-weight categories to which credit exposures may be assigned; (2) 
expand the use of external credit ratings to risk weight certain 
exposures; (3) expand the range of recognized collateral and eligible 
guarantors; (4) employ loan-to-value ratios to determine the risk 
weight of most residential mortgages; (5) increase the credit 
conversion factor for some commitments with an original maturity of 1 
year or less; (6) assess a risk-based capital charge for early 
amortizations in securitizations of revolving exposures; and (7) remove 
the 50-percent limit on the risk weight for certain derivative 
transactions.\19\
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    \17\ 71 FR 77446 (December 26, 2006). This document is at http://www.federalreserve.gov/generalinfo/basel2/USImplementation.htm.
    \18\ A banking organization that chooses to adopt Basel IA can 
return to the Basel I-based capital framework, provided the change 
is approved by its primary Federal regulator and is not for the 
purpose of capital arbitrage. The other Federal financial regulatory 
agencies have stated that they do not expect banking organizations 
to alternate between the Basel I and Basel IA risk-based capital 
rules.
    \19\ Neither the U.S. Basel II nor the Basel IA proposed rules 
would affect the existing leverage ratio or prompt corrective action 
standards.
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    FCA's objective is to develop a proposed rule that better reflects 
recent advances in banking and capital market practices, minimizes 
potential competitive distortions that could result from a bifurcated 
regulatory capital framework in the United States, and more closely 
aligns our minimum capital requirements with the relative risk factors 
inherent in the System. We are considering whether we should modify our 
risk-based capital rules so that they are consistent with Basel IA 
where appropriate. However, we are also considering how the 
modifications should be tailored to fit the System's distinct borrower-
owned lending cooperative structure and Government-sponsored enterprise 
(GSE) mission.\20\

[[Page 34193]]

We seek comments from all interested parties to help us develop a 
comprehensive proposal that would enhance our regulatory capital 
framework and increase the risk sensitivity of our risk-based capital 
rules without unduly increasing regulatory burden.
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    \20\ The System was created by Congress in 1916 and is the 
oldest GSE in the United States. System institutions provide credit 
and financially related services to farmers, ranchers, producers or 
harvesters of aquatic products, and farmer-owned cooperatives. They 
also make credit available for agricultural processing and marketing 
activities, rural housing, certain farm-related businesses, 
agricultural and aquatic cooperatives, rural utilities, and foreign 
and domestic entities in connection with international agricultural 
trade.
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III. Questions

    When addressing the following questions, we ask commenters to 
consider the overarching objectives of Basel II and Basel IA to more 
closely align capital with the specific risks taken by the financial 
institution rather than relying on a ``one-size-fits-all'' approach for 
determining regulatory minimum risk-based capital requirements. The 
System is a specialized lender to agriculture and rural America with a 
unique structure and risk profile. One of our objectives is to create a 
more dynamic risk-based capital framework that is more sensitive to the 
relative risks inherent in System lending and other mission-related 
activities. We seek comments on specific criteria that might be used to 
determine appropriate risk weights that meet this objective without 
creating undue burden. Specifically, we ask that you support your 
comments and recommendations with data, to the extent possible, in 
response to our questions.\21\
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    \21\ Please note that any data you submit will be made available 
to the public in our rulemaking file.
    \22 \ FCA's risk-weight categories are set forth in 12 CFR 
615.5211.
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A. Increase the Number of Risk-Weight Categories

    Our existing risk-based capital rules assign exposures to one of 
five risk-weight categories: 0, 20, 50, 100, and 200 percent.\22\ Basel 
IA proposes to add three new risk-weight categories to allow for 
greater differentiation of credit risk and solicits comment on whether 
a 10-percent risk-weight category would be appropriate for very low 
risk assets. The proposed risk-weight categories are 35, 75, and 150 
percent. The 35 and 75 percent risk-weight categories would provide the 
opportunity to increase the risk sensitivity for those exposures that 
are currently assigned a higher risk-based capital charge than may be 
warranted. The 150-percent risk-weight category would provide a more 
appropriate risk-based capital charge for higher risk exposures than is 
currently permitted under our existing capital rules.
    Question 1: We seek comment on what additional risk-weight 
categories, if any, we should consider for assigning risk weights to 
System institutions' on- and off-balance sheet exposures. If additional 
risk-weight categories are added, what assets should be included in 
each new risk-weight category?

B. Use of External Credit Ratings to Risk-Weight Exposures

1. Direct Exposures
    In recent years, the FCA has permitted System institutions to use 
external ratings to assign risk weights to certain credit exposures 
linked to nationally recognized statistical rating organizations 
(NRSROs) ratings.\23\ For example, in March 2003, we adopted an interim 
final rule that permitted System institutions to use NRSRO ratings to 
risk-weight highly rated investments in non-agency asset-backed 
securities (ABS) and mortgage-backed securities (MBS) to the 20-percent 
risk-weight category.\24\ In April 2004, we expanded the use of NRSRO 
ratings to assign risk weights to loans to other financing 
institutions.\25\ In June 2005, we adopted a ratings-based approach to 
assign risk weights to recourse obligations, direct credit substitutes 
(DCS), residual interests (other than credit-enhancing interest-only 
strips), and other ABS and MBS investments.\26\ Furthermore, we 
recently permitted the use of NRSRO ratings to assign risk weights to 
certain electric cooperative credit exposures.\27\
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    \23\ An NRSRO is a credit rating organization that is recognized 
by and registered with the Securities and Exchange Commission (SEC) 
as a nationally recognized statistical rating organization. See 12 
CFR 615.5201. See also Pub. L. 109-291.
    \24\ See 68 FR 15045 (March 28, 2003).
    \25\ Other financing institutions are non-System financial 
institutions that borrow from System banks. See 69 FR 29852 (May 26, 
2004).)
    \26\ These changes are consistent with those of the other 
Federal financial regulatory agencies. See 70 FR 35336 (June 17, 
2005).
    \27\ See ``Revised Regulatory Capital Treatment for Certain 
Electric Cooperatives Assets,'' FCA Bookletter BL-053 (February 12, 
2007).
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    Basel IA proposes to expand the use of NRSRO ratings to determine 
the risk-based capital charge for exposures to sovereign entities,\28\ 
non-sovereign entities,\29\ and securitizations, as displayed in Table 
1 (long-term exposures) and Table 2 (short-term exposures) set forth 
below. External ratings for direct exposures to sovereign entities 
would be based on the external rating of the exposure or the sovereign 
entity's issuer rating if the exposure is unrated. Direct exposures to 
non-sovereign entities and securitizations would be based only on the 
external rating of the exposure.
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    \28\ A sovereign entity is defined as a central government, 
including its agencies, departments, ministries, and the central 
bank. A sovereign entity does not include state, provincial, or 
local governments, or commercial enterprises owned by a central 
government.
    \29\ Non-sovereign entities include securities firms, insurance 
companies, bank holding companies, savings and loan holding 
companies, multilateral lending and regional development 
institutions, partnerships, limited liability companies, business 
trusts, special purpose entities, associations and other similar 
organizations.
    \30\ 71 FR 77452 (December 26, 2006).

         Table 1.--Basel IA Proposed Risk Weights Based on External Ratings for Long-Term Exposures\30\
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                                                                                                  Securitization
                                                                  Sovereign risk   Non-sovereign  exposure* risk
       Long-term rating category                 Example            weight (in      risk weight     weight (in
                                                                     percent)      (in percent)      percent)
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Highest investment grade rating........  AAA....................               0              20              20
Second highest investment grade rating.  AA.....................              20              20              20
Third highest investment grade rating..  A......................              20              35              35
Lowest investment grade rating-plus....  BBB+...................              35              50              50
Lowest investment grade rating.........  BBB....................              50              75              75
Lowest investment grade rating-minus...  BBB-...................              75             100             100
One category below investment grade....  BB+, BB................              75             150             200
One category below investment grade-     BB-....................             100             200             200
 minus.
Two or more categories below investment  B, CCC.................             150             200             (*)
 grade.

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Unrated**..............................  n/a....................             200             200             (*)
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* A securitization exposure includes ABS and MBS, recourse obligations, DCS, and residuals (other than a credit-
  enhancing interest-only strip). For long-term securitization exposures that are externally rated more than one
  category below investment grade, short-term exposures that are rated below investment grade, or any unrated
  securitization exposures, the existing risk-based capital treatment as described in the agencies' recourse
  rule would be used.
** Unrated sovereign exposures and unrated debt securities issued by non-sovereigns would receive the risk
  weight indicated in Tables 1 and 2. Other unrated exposures, for example, unrated loans to non-sovereigns,
  would continue to be risk weighted under the existing risk-based capital rules.


        Table 2.--Basel IA Proposed Risk Weights Based on External Ratings for Short-Term Exposures \31\
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                                                                                         Non-
                                                                         Sovereign    sovereign   Securitization
       Short-term rating category                    Example            risk weight  risk weight     exposure*
                                                                            (in          (in        risk weight
                                                                          percent)     percent)    (in percent)
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Highest investment grade rating.........  A-1, P-1....................            0           20             20
Second-highest investment grade rating..  A-2, P-2....................           20           35             35
Lowest investment grade.................  A-3, P-3....................           50           75             75
Unrated**...............................  n/a.........................          100          100              *
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* A securitization exposure includes ABS and MBS, recourse obligations, DCS, and residuals (other than a credit-
  enhancing interest-only strip). For long-term securitization exposures that are externally rated more than one
  category below investment grade, short-term exposures that are rated below investment grade, or any unrated
  securitization exposures, the existing risk-based capital treatment as described in the agencies' recourse
  rule would be used.
** Unrated sovereign exposures and unrated debt securities issued by non-sovereigns would receive the risk
  weight indicated in Tables 1 and 2. Other unrated exposures, for example, unrated loans to non-sovereigns,
  would continue to be risk-weighted under the existing risk-based capital rules.

    System institutions provide financing to agriculture and rural 
America through a variety of lending \32\ and investment \33\ products. 
They also hold highly rated liquid investments to manage liquidity, 
short-term surplus funds, and interest rate risk. Our existing risk-
based capital rules assign most agricultural and rural business \34\ 
loans and mission-related investment assets to the 100-percent risk-
weight category unless the risk exposure is mitigated by an acceptable 
guarantee or collateral. The FCA is considering the expanded use of 
NRSRO ratings to assign risk weights to other externally rated credit 
exposures in the System, such as corporate debt securities and loans.
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    \31\ 71 FR 77452 (December 26, 2006).
    \32\ The Farm Credit Banks provide wholesale funding to their 
affiliated associations who, in turn, make retail loans to eligible 
borrowers. CoBank, ACB, provides both wholesale funding to its 
affiliated associations and retail loans to cooperatives and other 
eligible borrowers.
    \33\ System banks and associations are permitted to make 
mission-related investments to agriculture and rural America. See 
``Investments in Rural America--Pilot Investment Programs,'' FCA 
Informational Memorandum (January 11, 2005).
    \34\ Agricultural businesses include farmer-owned cooperatives, 
food and fiber processors and marketers, manufacturers and 
distributors of agricultural inputs and services, and other 
agricultural-related businesses. Rural businesses include electric 
utilities and other energy-related businesses, communication 
companies, water and waste disposal businesses, ethanol plants, and 
other rural-related businesses.
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    Question 2: We seek comments on all aspects of the appropriateness 
of using NRSRO ratings to assign risk weights to credit exposures. If 
we expand the use of external ratings, how should we align the risk-
weight categories with NRSRO ratings to determine the appropriate 
capital charge for externally rated credit exposures? Should any 
externally rated positions be excluded from this new ratings-based 
approach?
2. Recognized Financial Collateral
    Our current risk-based capital rules assign lower risk weights to 
exposures collateralized by: (1) Cash held by a System institution or 
its funding bank; (2) securities issued or guaranteed by the U.S. 
Government, its agencies or Government-sponsored agencies; (3) 
securities issued or guaranteed by central governments in other OECD 
\35\ countries; (4) securities issued by certain multilateral lending 
or regional development institutions; or (5) securities issued by 
qualifying securities firms.
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    \35\ OECD stands for the Organization for Economic Cooperation 
and Development. The OECD is an international organization of 
countries that are committed to democratic government and the market 
economy. An up-to-date listing of member countries is available at 
http://www.oecd.org or http://www.oecdwash.org.
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    The banking industry has suggested that regulators recognize a 
wider variety of collateral types for the purpose of reducing risk-
based capital requirements. In response, the other Federal financial 
regulatory agencies have proposed to expand the types of eligible 
collateral for risk-weighting purposes. Basel IA assigns lower risk 
weights to exposures collateralized by: (1) Securities issued or 
guaranteed by sovereigns that are externally rated at least investment 
grade by an NRSRO (e.g., BBB- or Baa3) or the sovereign entity's issuer 
rating if the security is not rated; or (2) securities issued by non-
sovereign entities that are externally rated at least investment grade 
by an NRSRO (e.g., BBB or Baa2). The collateralized portion of the 
exposure would be assigned a risk weight (as listed in Table 1 and 
Table 2) according to the external rating of the collateral. The 
uncollateralized portion of the exposure would be assigned a risk 
weight according to the external rating of the exposure (or a sovereign 
entity's issuer rating where applicable).
    Question 3: We seek comment on whether recognizing additional types 
of eligible collateral would improve the risk sensitivity of our risk-
based capital rules without being overly burdensome.

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We also seek comment on what additional types of collateral, if any, we 
should consider and what effect the collateral should have on the risk 
weighting of System exposures.
3. Eligible Guarantors
    Our existing capital rules permit the use of third party guarantees 
to lower the risk weight of certain exposures. Guarantors include: (1) 
The U.S. Government, its agencies or Government-sponsored agencies; (2) 
U.S. state and local governments; (3) central governments and banks in 
OECD countries; (4) central governments in non-OECD countries (local 
currency exposures only); (5) banks in non-OECD countries (short-term 
claims only); (6) certain multilateral lending and regional development 
institutions; and (7) qualifying securities firms.
    Basel IA proposes to include guarantees from any entity that has 
long-term senior debt (without credit enhancements) rated at least 
investment grade by an NRSRO or, if the entity is a sovereign, an 
issuer rating that is at least investment grade (e.g., BBB- or Baa3 for 
sovereigns and BBB or Baa2 for non-sovereigns).\36\ The guaranteed 
portion of the exposure would be assigned a risk weight (as detailed in 
Table 1) according to the NRSRO rating of the eligible guarantor's 
long-term senior debt or, if the guarantor is a sovereign and its long-
term debt is not rated, then the exposure would be assigned a risk 
weight according to the NRSRO rating of the sovereign. Non-guaranteed 
portions of the exposure would be assigned to the external rating of 
the exposure (or a sovereign entity's issuer rating where applicable).
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    \36\ See 71 FR 77453 (December 26, 2006). A recognized third 
party guarantee would have to: (1) Be written and unconditional, and 
if the third party is a sovereign, be backed by the full faith and 
credit of the sovereign; (2) cover all or a pro rata portion of 
contractual payments of the obligor on the reference exposure; (3) 
give the beneficiary a direct claim against the protection provider; 
(4) be non-cancelable by the protection provider for reasons other 
than the breach of the contract by the beneficiary; (5) be legally 
enforceable against the protection provider in a jurisdiction where 
the protection provider has sufficient assets against which a 
judgment may be attached and enforced; and (6) require the 
protection provider to make payment to the beneficiary on the 
occurrence of a default (as defined in the guarantee) of the obligor 
on the reference exposure without first requiring the beneficiary to 
demand payment from the obligor.
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    Question 4: We seek comment on what additional types of third party 
guarantees, if any, we should recognize and what effect such guarantees 
should have on the risk weighting of System exposures.

C. Direct Loans to System Associations

    The FCA is considering ways to better align our risk-based capital 
requirements for direct loans with System associations. System banks 
make direct loans to their affiliated associations who, in turn, make 
retail loans to eligible borrowers. Our current risk-based capital 
rules assign a 20-percent risk weight to direct loans at the bank level 
and another risk weight (depending upon the type of loan) to retail 
loans at the association level.\37\ The 20-percent risk weight is 
intended to recognize the risks to the banks associated with lending to 
their affiliated associations. The other Federal financial regulatory 
agencies also assign a 20-percent risk weight to similar GSE and OECD 
depository institution exposures.\38\ We are exploring methods to 
improve the risk sensitivity of our risk-based capital rules by 
assigning different risk weights to direct loan exposures based on the 
System association's distinct risk profile.
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    \37\ Our risk-based capital rules also assign a 20-percent risk 
weight to similar GSE and OECD depository institution exposures.
    \38\ Basel IA would retain the 20-percent risk weight for these 
types of exposures. See 71 FR 77451 and 77454 (December 26, 2006).
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    Question 5: We seek comment on what evaluative criteria or methods 
we might use to assign risk weights to direct loans to System 
associations. How should the criteria be used to adjust the risk weight 
as the quality of the direct loan changes over time?

D. Small Agricultural and Rural Business Loans

    Our existing risk-based capital rules assign small agricultural and 
rural business loans to the 100-percent risk-weight category unless the 
credit risk is mitigated by an acceptable guarantee or acceptable 
collateral. The other Federal financial regulatory agencies are 
exploring options to permit small business loans to qualify for a 75-
percent risk weight.\39\ They are also considering criteria for short-
term loans that do not amortize, such as working capital loans and 
other revolving lines of credit.\40\
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    \39\ See 71 FR 77462-77463 (December 26, 2006). The agencies 
suggest the following criteria for qualifying loans: (1) Total 
credit exposure to the business must not exceed $1 million; (2) 
loan(s) must be personally guaranteed by the owner(s) of the 
business and fully collateralized by the assets of the business; (3) 
loan(s) must be prudently underwritten, performing, and fully 
amortize within 7 years; (4) businesses must maintain a minimum debt 
service coverage ratio of 1.3; (5) loan(s) must not have been 
restructured; and (6) proceeds are not to be used to service any 
other outstanding loan obligation.
    \40\ For example, loans or draws from a revolving line of credit 
that mature in 18 months could forgo the amortization requirement 
provided the loan is to be repaid from anticipated proceeds of 
previously established financial transactions and the proceeds are 
pledged for the repayment of the loan.
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    Question 6: We seek comment on what approaches we might use to 
improve the risk sensitivity of our risk-based capital rules for small 
agricultural and rural business loans. More specifically, what 
qualifying criteria might we use to assign small agricultural and rural 
business loans to risk-weight categories of less than 100 percent?

E. Loans Secured by Liens on Real Estate

1. First-Lien Loans
    The FCA is considering ways to use loan-to-value ratios (LTV) and 
other criteria to determine the risk-based capital charges for farm 
real estate and qualified residential loans. Our existing capital rules 
assign farm real estate loans to the 100-percent risk-weight category 
and qualified residential loans \41\ to the 50-percent risk-weight 
category. Basel IA proposes to risk weight first-lien residential 
mortgages, including mortgages held for sale and mortgages held in 
portfolio, based on LTV as outlined in Table 3 (farm real estate loans 
are not included in this table).\42\ Basel IA proposes to include the 
risk-mitigating effects of loan-level private mortgage insurance in the 
calculation of LTV, provided the loan-level insurer is not affiliated 
with the banking organization and has long-term senior debt (without 
credit enhancement) externally rated at least the third highest 
investment grade by an NRSRO (e.g., AA or Aa2).
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    \41\ Qualified residential loans are rural home loans (as 
defined by 12 CFR 613.3030) and single-family residential loans to 
bona fide farmers, ranchers, or producers or harvesters of aquatic 
products that meet the requirements listed in 12 CFR 615.5201.
    \42\ See 71 FR 77456 (December 26, 2006). Basel IA proposes to 
require institutions to calculate LTV at origination using the lower 
of the purchase price of the property or the value at origination in 
conformance with appraisal regulations and real estate lending 
guidelines. LTV would be updated quarterly to reflect any decrease 
in the principal balance, or if a negative amortization loan, an 
increase in the principal balance. Property values are updated only 
if a mortgage is refinanced and the banking organization extends 
additional funds.
    \43\ See 71 FR 77455 (December 26, 2006).

  Table 3.--Basel IA Proposed LTV and Risk Weights for 1-4 Family First
                               Liens \43\
------------------------------------------------------------------------
                                                             Risk weight
             Loan-to-value ratio  (in percent)                    (in
                                                               percent)
------------------------------------------------------------------------
60 or less.................................................           20
Greater than 60 and less than or equal to 80...............           35

[[Page 34196]]

 
Greater than 80 and less than or equal to 85...............           50
Greater than 85 and less than or equal to 90...............           75
Greater than 90 and less than or equal to 95...............          100
Greater than 95............................................          150
------------------------------------------------------------------------

    The other Federal financial regulatory agencies are also evaluating 
approaches that would consider borrower creditworthiness in conjunction 
with LTV to determine the appropriate risk weight for first-lien 
mortgages.\44\ Borrowers would be grouped by credit history using 
default odds obtained from credit reporting agencies' validation 
charts. A banking organization would determine a borrower's default 
odds by mapping the borrower's credit score to the credit reporting 
agencies' validation charts.
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    \44\ See 71 FR 77456 (December 26, 2006).
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    Question 7: We seek comment on all aspects of using LTV to 
determine the risk-based capital charge for farm real estate and 
qualified residential loans. Specifically, we ask that you address farm 
real estate and qualified residential loans separately when answering 
the following questions:
     How might we determine the value (e.g., the denominator of 
the LTV) of the real estate at origination?
     How should PMI or guarantees be treated in the calculation 
of LTV?
     How should LTV be adjusted over time?
     How should LTV be mapped to risk-weight categories?
     How might loan characteristics such as loan size, 
availability of credit scores, and payment frequency be used in 
conjunction with LTV?
     How might borrower creditworthiness be used in conjunction 
with LTV and how might they be mapped to risk-weight categories?
2. Junior-Lien Loans
    Our existing regulations permit System institutions to make short- 
and intermediate-term loans secured by a junior lien on a property as 
long as the System institution also holds the first lien on the 
property. Further, System institutions can make loans secured by stand-
alone junior liens, provided the financing is used exclusively for 
repairs, remodeling, or other improvements to qualified rural 
homes.\45\ Loans secured by junior liens are risk-weighted at 50 
percent if the institution holds a first lien on a mortgage that is 
classified as a qualified residential loan. All other loans secured by 
junior liens are risk-weighted at 100 percent.
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    \45\ See 12 CFR 614.4200(b)(4).
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    Basel IA proposes to risk-weight junior-lien mortgages based on a 
combined LTV.\46\ For example, if a banking organization holds a first 
lien on a property, then the junior lien loan would be added to the 
first lien to determine the combined LTV and assigned the appropriate 
risk weight as outlined in Table 3.\47\ For stand-alone junior liens, 
the banking organization would follow the same procedures, except the 
junior-lien loan would be combined with all senior-lien loans (all 
principal amounts outstanding would be aggregated) to determine the LTV 
and assigned the appropriate risk weight as outlined in Table 4.
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    \46\ See 71 FR 77458-77459 (December 26, 2006).
    \47\ The steps for determining the risk-adjusted value of the 
unfunded portion of a junior-lien loan (e.g., a line of credit) 
would be as follows: (1) The unfunded commitment is multiplied by 
the appropriate credit conversion factor to determine the on-balance 
sheet credit equivalent; (2) the on-balance sheet credit equivalent 
is added to the first lien and the funded portion of the junior-lien 
loan to determine the combined LTV; and (3) the combined LTV is 
assigned the appropriate risk weight as outlined in Table 3. The 
unfunded commitment would be adjusted accordingly as the borrower 
utilizes the junior-lien loan.
    \48\ See 71 FR 77459 (December 26, 2006).

 Table 4.--Basel IA Proposed LTV and Risk Weights for 1-4 Family Junior
                               Liens \48\
------------------------------------------------------------------------
                                                             Risk weight
              Loan-to-value ratio (in percent)                   (in
                                                               percent)
------------------------------------------------------------------------
60 or less.................................................           75
Greater than 60 and less than or equal to 90...............          100
Greater than 90............................................          150
------------------------------------------------------------------------

    Question 8: We seek comment on all aspects of using combined LTV to 
risk-weight junior-lien loans. Specifically, how should combined LTV be 
calculated at origination and adjusted over time? How should the 
combined LTVs be used to assign stand-alone junior-lien loans to risk-
weight categories?

F. Short- and Long-Term Commitments

    Under Sec.  615.5212, off-balance sheet commitments are generally 
risk-weighted in two steps: (1) The off-balance sheet commitment is 
multiplied by a credit conversion factor (CCF)\49\ to determine its on-
balance sheet credit equivalent; and (2) the on-balance sheet credit 
equivalent is assigned to the appropriate risk-weight category in Sec.  
615.5211 according to the obligor, after considering any applicable 
collateral and guarantees.\50\ Basel IA proposes to retain the zero-
percent CCF for commitments that are unconditionally cancelable\51\ but 
assign a 10-percent CCF to all other short-term commitments. Further, 
Basel IA seeks comment on alternative approaches that would apply a 
single CCF of 20 percent to all short- and long-term commitments that 
are not unconditionally cancelable.
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    \49\ A CCF is a number by which an off-balance sheet item is 
multiplied to obtain a credit equivalent before placing the item in 
a risk-weight category.
    \50\ 50 Our existing regulations assign a zero-percent CCF to 
unused commitments with an original maturity of 14 months or less. 
Unused commitments with an original maturity of greater that 14 
months can also receive a zero-percent CCF provided the commitment 
is unconditionally cancelable and the System institution has the 
contractual right to make a separate credit decision before each 
drawing under the lending arrangement. All other unused commitments 
with an original maturity of greater than 14 months are assigned a 
50-percent CCF.
    \51\ An unconditionally cancelable commitment is one that can be 
canceled for any reason at any time without prior notice.
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    Question 9: We seek comment on what approaches we might use to risk 
weight short- and long-term commitments that are not unconditionally 
cancelable.

G. Adjusting Risk Weights on Exposures Over Time

    The FCA welcomes comment on additional approaches or criteria 
(other than NRSRO credit ratings and LTVs addressed in previous 
sections) that might be used to adjust the risk weight of exposures 
throughout the life of the asset. Our existing risk-based capital rules 
assign a static risk weight to assets within a given asset class 
without allowing for risk-weight adjustments as asset quality improves 
or deteriorates. For example, most loans to System borrowers are risk-
weighted at 100 percent throughout the life of the loan without making 
risk-weight adjustments based on credit classifications or other credit 
performance factors.
    Question 10: We seek comment on what methods we might use to adjust 
the risk weight of credit exposures as the asset quality or default 
probability changes over time.

H. Capital Charge for Operational Risk

    The FCA welcomes comments on possible approaches for determining a 
capital charge for operational risk. The broad risk-weighting 
categories under our existing capital rules are intended to implicitly 
cover operational and other types of risks. As we move to a more risk-
sensitive capital framework, it may be more appropriate to apply an 
explicit capital charge for operational risk, especially to cover risks 
associated with

[[Page 34197]]

off-balance sheet activity. Basel IA is designed to implicitly cover 
risks other than credit risk, and therefore, does not propose an 
explicit capital charge for operational risk.
    Question 11: We seek comment on whether we should consider a risk-
based capital charge for operational risk.

I. Capital Leverage Ratio

    We are considering whether we should supplement our existing risk-
based capital rules with a minimum capital leverage ratio requirement 
for all FCS institutions to further promote the safety and soundness of 
the System. Our existing capital regulations require System banks to 
maintain a minimum net collateral ratio (NCR) \52\ of 103 percent \53\ 
but do not impose a capital leverage ratio on System associations. The 
NCR provides a level of protection for operating and other forms of 
risk at System banks, but it does not differentiate higher quality from 
lower quality capital. The other Federal financial regulatory agencies 
currently supplement their risk-based capital rules with a leverage 
ratio of Tier 1 capital to total assets (Tier 1 leverage ratio).\54\ 
The Tier 1 leverage ratio consists of only the most reliable and 
permanent forms of capital such as common stock, non-cumulative 
perpetual preferred stock, and retained earnings. Neither the U.S. 
Basel II nor the Basel IA proposed rules would affect the existing 
leverage ratio.
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    \52\ The net collateral ratio is a bank's net collateral as 
defined by 12 CFR 615.5301(c) divided by the bank's adjusted total 
liabilities.
    \53\ See 12 CFR 615.5335(a).
    \54\ See 12 CFR 3.6(b) and (c); 12 CFR part 208, appendix B and 
12 CFR part 225, appendix D; 12 CFR 325.3; and 12 CFR 567.8.
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    Question 12: We seek comment on whether our capital rules should 
include a minimum capital leverage ratio requirement for all System 
institutions. We also seek comment on changes, if any, that should be 
made to the existing regulatory minimum NCR requirement applicable to 
System banks that would make it more comparable to the Tier 1 ratio 
used by the other Federal financial regulatory agencies.

J. Regulatory Capital Directives \55\
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    \55\ 12 CFR part 615, subpart M.
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    We are considering whether we should modify our capital rules to 
specify potential early intervention criteria for the issuance of 
capital directives. Currently, FCA has the discretion to issue a 
capital directive \56\ when an institution's capital is insufficient. 
The FCA, however, has not defined capital or other financial early 
intervention thresholds to require an institution to take corrective 
action as described in Sec.  615.5355. Early intervention approaches 
have been used in other contexts, including the System's Market Access 
Agreement and the statutory requirements applicable to other regulated 
financial institutions. An early intervention capital directive 
framework could provide a clearer indication of when we would impose 
additional and increasing supervisory oversight on an institution to 
address continuing deterioration in its financial condition and capital 
position from credit, interest rate, or other financial risks.
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    \56\ A capital directive is defined in Sec.  615.5355(a) as an 
order issued to an institution that does not have or maintain 
capital at or greater than the minimum ratios set forth in 12 CFR 
615.5205, 615.5330, and 615.5335, or established under subpart L of 
part 615, or by a written agreement under an enforcement or 
supervisory action, or as a condition of approval of an application. 
The FCA's authority is set forth in sections 4.3(b)(2) and 4.3A(e) 
of the Farm Credit Act (12 U.S.C. 2154(b)(2) and 2154a(e)).
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    Question 13: We seek comment on revising our current capital 
directive regulations to include an early intervention framework. We 
also seek comment on potential financial thresholds, such as capital 
ratios or risk measures, that would trigger an FCA capital directive 
action.

K. Multi-Dimensional Regulatory Structure

    As stated above, one of FCA's objectives is to implement a revised 
capital framework that improves the risk sensitivity of our capital 
rules while avoiding undue regulatory burden. There are currently five 
banks and 95 associations in the System with varying degrees of asset 
size, complexity of operations, and sophistication in their risk 
management practices. Some System institutions have the risk management 
capabilities to apply more complex, risk-sensitive regulatory capital 
requirements than other System institutions. It may be appropriate for 
the FCA to adopt more than one set of capital rules to account for 
these differences. However, this approach could result in different 
capital requirements for the same type of transaction and increase 
examination and oversight costs.
    The other Federal financial regulatory agencies are proposing more 
than one set of capital rules for the financial institutions they 
regulate. For example, implementation of U.S. Basel II would be 
limited, for the most part, to the largest, internationally active 
banks that meet certain infrastructure requirements. Basel IA would 
permit non-Basel II banking organizations the option of applying the 
revised Basel IA-based capital framework or remaining subject to the 
existing Basel I-based capital framework.\57\ Consequently, a 
trifurcated regulatory capital framework would be created in the United 
States.
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    \57\ A banking organization that chooses to apply Basel IA must 
do so in its entirety. However, a banking organization has the 
option of risk weighting existing mortgage loans using the existing 
Basel I-based capital rules. This option would apply only to those 
mortgage loans that the banking organization owned at the time it 
chose to apply Basel IA.
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    While our expectation is to implement a revised capital framework 
similar to Basel IA, we also recognize that some aspects of Basel II 
may be appropriate for the larger, more complex System institutions. 
However, we are still reviewing Basel II and its potential application 
to the System. Therefore, we are not seeking comments on Basel II at 
this time. Rather, we are considering the overall regulatory capital 
framework for the System in light of the changes occurring in the 
financial services industry such as the Basel II and Basel IA proposed 
rules and recent best practices for economic capital modeling.
    Question 14: We seek comment on the most appropriate risk-based 
capital framework for the System and the reasons we should implement 
one framework over another. Should we consider creating a uniform 
regulatory capital structure for the System or a multi-dimensional 
regulatory structure and allow each System institution the option of 
choosing which capital framework it will apply? How might this new 
risk-based capital framework increase the costs or regulatory burden to 
the System? Would the increased costs be justified by improved risk 
sensitivity, risk management, and more efficient capital allocation?
    Question 15: Additionally, we seek comment on any other methods 
that may be used to increase the risk sensitivity of our risk-based 
capital rules.

    Dated: June 15, 2007.
Roland E. Smith,
Secretary, Farm Credit Administration Board.
 [FR Doc. E7-11990 Filed 6-20-07; 8:45 am]
BILLING CODE 6705-01-P