[Federal Register Volume 72, Number 210 (Wednesday, October 31, 2007)]
[Proposed Rules]
[Pages 61568-61574]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-21422]


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

  Federal Register / Vol. 72, No. 210 / Wednesday, October 31, 2007 / 
Proposed Rules  

[[Page 61568]]



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 
possible modifications to our risk-based capital rules for Farm Credit 
System institutions (FCS or System) that are similar to the 
standardized approach delineated in the New Basel Capital Accord. We 
are seeking comments to facilitate the development of a proposed rule 
that would enhance our regulatory capital framework and more closely 
align minimum capital requirements with risks taken by System 
institutions. We are also withdrawing our previously published ANPRM.

DATES: You may send comments on or before March 31, 2008.

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]v.
     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 S. 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 for System institutions; \1\
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    \1\ 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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    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 federally 
regulated banking organizations; \2\ and
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    \2\ 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.
    In addition, we are withdrawing our previous ANPRM on capital, 
published in the Federal Register on June 21, 2007 (72 FR 34191), as 
described more fully below.

II. Background

    The FCA's risk-based capital requirements for System institutions 
are contained in subparts H and K of part 615 of our regulations.\3\ 
Our risk-based capital framework is based, in part, on the 
``International Convergence of Capital Measurement and Capital 
Standards'' (Basel I) as published by the Basel Committee on Banking 
Supervision (Basel Committee) \4\ and is broadly consistent with the 
capital requirements of the other Federal financial regulatory 
agencies.\5\ We first adopted a risk-based capital framework for the 
System as part of our 1988 regulatory capital revisions \6\ required by 
the Agricultural Credit Act of 1987 \7\ and made subsequent revisions 
in 1997,\8\ 1998 \9\ and 2005.\10\ 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

[[Page 61569]]

risk-adjusted asset base, which is the denominator for computing the 
permanent capital, total surplus, and core surplus ratios.
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    \3\ Our regulations can be accessed at http://www.fca.gov/index.html.
    \4\ 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.
    \5\ 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.''
    \6\ See 53 FR 39229 (October 6, 1988).
    \7\ 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.
    \8\ See 62 FR 4429 (January 30, 1997).
    \9\ See 63 FR 39219 (July 22, 1998).
    \10\ See 70 FR 35336 (June 17, 2005).
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    For a number of years, the Basel Committee has worked to develop a 
more risk sensitive regulatory capital framework that incorporates 
recent innovations 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.\11\ Basel II has three pillars: (1) 
Minimum capital requirements for credit risk, operational risk, and 
market risk, (2) supervision of capital adequacy, and (3) market 
discipline through enhanced public disclosure. Banking organizations 
have various options for calculating the minimum capital requirements 
for credit and operational risk. For credit risk, the options are the 
standardized approach, the foundation internal ratings-based approach, 
and the advanced internal ratings-based approach (A-IRB). For 
operational risk, the options are the basic indicator approach, the 
standardized approach, and the advanced measurement approach (AMA).
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    \11\ See http://www.bis.org/publ/bcbsca.htm for the 2004 Basel 
II Accord as well as updates in 2005 and 2006.
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    In September 2006, the other Federal financial regulatory agencies 
issued an interagency notice of proposed rulemaking for implementing 
the advanced approaches of Basel II in the United States (the advanced 
capital framework).\12\ This advanced capital framework would require 
core banks \13\ and permit opt-in banks \14\ to use the A-IRB \15\ to 
calculate the regulatory capital requirement for credit risk and the 
AMA \16\ to calculate the regulatory capital requirement for 
operational risk.\17\
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    \12\ See 71 FR 55830 (September 25, 2006). This document is at 
http://www.federalreserve.gov/generalinfo/basel2/USImplementation.htm.
    \13\ 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.
    \14\ 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.
    \15\ 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.
    \16\ Internal operational risk management systems and processes 
are used to compute risk-based capital requirements for operational 
risk.
    \17\ The other Federal financial regulatory agencies also seek 
comments on whether core and opt-in banks should be permitted to use 
other credit and operational risk approaches.
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    Given the small number of core banks and the complexity and cost 
associated with voluntarily adopting the advanced approaches, only a 
small number of U.S. banking organizations are expected to implement 
the advanced capital framework. As a result, a bifurcated regulatory 
capital framework will be created in the United States, which could 
result in different regulatory capital charges for similar products 
offered by those that apply the advanced capital framework and those 
that do not. Financial regulators, banking organizations, trade 
associations and other interested parties have raised concerns that the 
bifurcated structure could create a significant competitive 
disadvantage for those that do not apply the advanced capital 
framework.
    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.\18\ Subsequently, the FCA issued an 
ANPRM,\19\ published in June 2007, addressing issues similar to those 
addressed in Basel IA. Basel IA was intended to help minimize the 
potential differences in the regulatory minimum capital requirements of 
those banks applying the advanced capital framework and those banks 
that would not. The other Federal financial regulatory agencies 
received a significant number of comments opposing their Basel IA 
proposal. Many commenters argued that the benefits of complying with 
Basel IA did not outweigh the burdens, and many questioned why the U.S. 
banking agencies were creating a separate rule that had only minor 
differences from the standardized approach under Basel II. On July 20, 
2007, the other Federal financial regulatory agencies announced that 
they intended to replace the Basel IA proposal with a proposed rule 
that would provide all non-core banks the option to adopt the 
standardized approach under Basel II.\20\ Their stated intent is to 
finalize a standardized approach for banks that do not adopt the 
advanced approaches before the core (and opt-in) banks begin their 
first transition period year under the advanced approaches of Basel II.
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    \18\ 71 FR 77446 (December 26, 2006). This document is at http://www.federalreserve.gov/generalinfo/basel2/USImplementation.htm.
    \19\ 72 FR 34191 (June 21, 2007).
    \20\ Joint Press Release, ``Banking Agencies Reach Agreement On 
Basel II Implementation,'' (July 20, 2007). This document is at 
http://www.occ.gov/ftp/release/2007-77.htm.
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    The other Federal financial regulatory agencies plan to replace 
Basel IA with a proposed rule patterned after the standardized approach 
under Basel II. Consequently, we are withdrawing our previous ANPRM and 
replacing it with one that is also consistent with the standardized 
approach. We intend to develop a proposed rule that is similar to the 
capital requirements of the other Federal financial regulatory agencies 
where appropriate but also tailored to fit the System's distinct 
borrower-owned lending cooperative structure and Government-sponsored 
enterprise (GSE) mission.
    The questions posed in this ANPRM are, for the most part, similar 
to the questions we asked in our previous ANPRM.\21\ We have revised 
the technical material in most places to conform to the standardized 
approach of Basel II. For example, we replaced the risk-weight 
categories that were in the Basel IA proposed rule with the risk-weight 
categories that are contained in the standardized approach under Basel 
II. We ask commenters to consider the revised material when answering 
the following questions. 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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    \21\ Questions 1, 3, 4, 5, 9 and 10 in this ANPRM are identical 
to those numbered questions posed in our previous ANPRM. Questions 
2, 6 and 11 are slightly different. Question 7 in this ANPRM 
replaces Questions 7 and 8 in our previous ANPRM. Questions 8, 12, 
and 16 are new to this ANPRM. Questions 13 through 15 are identical 
to Questions 12 through 14 in our previous ANPRM. Question 17 is 
identical to Question 15 in our previous ANPRM.
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III. Questions

    When addressing the following questions, we ask commenters to 
consider the overarching objectives of Basel II 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. Our objective is to 
develop 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

[[Page 61570]]

creating undue burden. Specifically, we ask that you support your 
comments with data, to the extent possible, in response to our 
questions.\22\
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    \22\ Please note that any data you submit will be made available 
to the public in our rulemaking file.
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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.\23\ The 
standardized approach of Basel II adds risk-weight categories of 35, 
75, and 150 percent and replaces the 200-percent risk-weight category 
with a 350-percent risk-weight category.\24\ The 35-percent risk-weight 
category would apply to certain residential mortgages. The 75-percent 
risk-weight category would apply to certain retail claims (e.g., small 
business loans). The 150-percent and 350-percent risk-weight categories 
would apply to certain higher risk externally rated exposures (e.g., 
those below investment grade).
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    \23\ FCA's risk-weight categories are set forth in 12 CFR 
615.5211.
    \24\ Basel IA proposed adding risk-weight categories of 35, 75, 
and 150 percent.
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    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 Assign 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.\25\ For example, in March 2003, we adopted an interim 
final rule that permitted System institutions to use NRSRO ratings to 
place highly rated investments in non-agency asset-backed securities 
(ABS) and mortgage-backed securities (MBS) in the 20-percent risk-
weight category.\26\ In April 2004, we expanded the use of NRSRO 
ratings to assign risk weights to loans to other financing 
institutions.\27\ 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.\28\ Furthermore, we 
recently permitted the use of NRSRO ratings to assign risk weights to 
certain electric cooperative credit exposures.\29\
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    \25\ A 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.
    \26\ See 68 FR 15045 (March 28, 2003).
    \27\ Other financing institutions are non-System financial 
institutions that borrow from System banks. See 69 FR 29852 (May 26, 
2004).
    \28\ These changes are consistent with those of the other 
Federal financial regulatory agencies. See 70 FR 35336 (June 17, 
2005).
    \29\ See ``Revised Regulatory Capital Treatment for Certain 
Electric Cooperatives Assets,'' FCA Bookletter BL-053 (February 12, 
2007).
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    The standardized approach of Basel II expands the use of NRSRO 
ratings to determine the risk-based capital charge for long-term 
exposures to sovereign entities, non-central government public sector 
entities (PSEs), banks,\30\ corporate entities, and securitizations as 
displayed in Table 1 set forth below.\31\
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    \30\ Banks include multilateral development banks and securities 
firms.
    \31\ Basel IA proposed the categories sovereign entities, non-
sovereign entities, and securitizations with different risk-weight 
categories.

       Table 1.--The Standardized Approach Risk Weights Based on External Ratings for Long-Term Exposures
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                                                PSE and bank *  risk
                                   Sovereign        weights  (in         Corporate
       Credit assessment          risk weight         percent)          risk weight     Securitization **  risk
                                 (in percent)  ----------------------  (in percent)      weight  (in percent)
                                                 Option 1   Option 2
----------------------------------------------------------------------------------------------------------------
AAA to AA-....................               0         20         20              20  20.
A+ to A-......................              20         50         50              50  50.
BBB+ to BBB-..................              50        100         50             100  100.
BB+ to BB-....................             100        100        100             100  350.
B+ to B-......................             100        100        100             150  Deduction.***
Below B-......................             150        150        150             150  Deduction.***
Unrated.......................             100        100         50             100  Deduction.***
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* The Standardized Approach provides two options for PSEs and bank exposures: (1) Option 1 assigns a risk weight
  one category below that of sovereigns; (2) Option 2 assigns a risk weight based on the individual bank rating.
  Option 2 also provides risk weights for short-term claims as follows: (1) AAA to BBB- and unrated = 20
  percent; (2) BB+ to B-= 50 percent; and (3) Below B-= 150 percent.
** Short-term rating categories are as follows: (1) A-1/P-1 = 20 percent; (2) A-2/P-2 = 50 percent; (3) A-3/P-3
  = 100 percent; and (4) All other ratings or unrated = Deduction.
*** Banks must deduct the entire amount from capital. However, if banks originate a securitization and the most
  senior exposure is unrated, the bank may use the ``look through'' treatment, which is the average risk weight
  of the underlying exposures subject to supervisory review.

    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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    \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

[[Page 61571]]

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? We ask commenters to consider the substantial 
reliance on NRSRO ratings as a means of evaluating the quality of debt 
investments in view of recent events in the subprime mortgage market.
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 standardized approach of Basel II has two methods for 
recognizing a wider variety of collateral types for risk-weighting 
purposes.\36\ Under the simple approach, the collateralized portion of 
the exposure would be assigned a risk weight (as listed in Table 1) 
according to the external rating of the collateral. The remainder of 
the exposure would be assigned a risk weight appropriate to the 
counterparty. Collateral would be subject to a 20-percent floor unless 
the collateral is cash, certain government securities or repurchase 
agreements, and it would be marked-to-market and revalued every 6 
months. Securities issued by sovereigns or PSEs must be rated at least 
BB-or its equivalent by a NRSRO. Securities issued by other entities 
must be rated at least BBB-or its equivalent by an NRSRO. Short-term 
debt instruments used as collateral must be rated at least A-3/P-3 or 
its equivalent by an NRSRO.
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    \36\ Basel IA proposed assigning lower risk weights to exposures 
collateralized by securities issued by sovereigns or non-sovereigns 
that were externally rated at least investment grade.
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    Under the comprehensive approach, the banking organization adjusts 
the value of the exposure by the discounted value of the collateral. 
Discount values, known as supervisory haircuts, are displayed in Table 
2 set forth below. For example, sovereign debt rated A+ with a 5-year 
maturity used as collateral is discounted by 3 percent, and corporate 
debt rated A+ with a 5-year maturity is discounted at 6 percent.

  Table 2.--Standard Supervisory Haircuts in the Comprehensive Approach
                          for Credit Mitigation
------------------------------------------------------------------------
                                                 Sovereigns     Other
    Issue rating for debt          Residual      and PSEs *   issuers **
          securities               maturity         (in          (in
                                                  percent)     percent)
------------------------------------------------------------------------
AAA to AA- or A-.............  <= 1 year......          0.5            1
                               > 1 year, <= 5             2            4
                                years.
                               > 5 years......            4            8
A+ to BBB- or A-2/A-3/P-3....  <= 1 year......            1            2
                               > 1 year, <= 5             3            6
                                years.
                               > 5 years......            6           12
BB+ to BB-...................  All............           15  ...........
------------------------------------------------------------------------
* Includes PSEs treated as sovereigns.
** Includes PSEs not treated as sovereigns.

    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. 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.
    The standardized approach of Basel II expands the range of eligible 
guarantors to include sovereign entities, PSEs, banks and securities 
firms that have a lower risk weight than the counterparty.\37\ All 
other guarantors must be rated A- (or its equivalent) or better by a 
NRSRO. The guarantee must: (1) Represent a direct claim on the 
protection provider, (2) be explicitly referenced to specific exposures 
or pools of exposures, (3) be irrevocable, and (4) unconditional. The 
guarantor's risk weight would be substituted for the risk weight 
assigned to the exposure. Non-guaranteed portions of the exposure would 
be assigned to the external rating of the exposure.
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    \37\ Basel IA proposed to include guarantees from any entity 
that had long-term senior debt rated at least investment grade (or 
issuer rating if a sovereign).
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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.\38\ The 20-percent risk weight is 
intended to recognize the risks to the banks associated with lending to 
their

[[Page 61572]]

affiliated associations. 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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    \38\ Our risk-based capital rules also assign a 20-percent risk 
weight to similar GSE and OECD depository institution exposures.
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    Question 5: We seek comment on what evaluative criteria or methods 
we should 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 standardized approach of Basel II applies a 75-percent 
risk weight to certain retail claims \39\ provided: (1) The exposure is 
to an individual person or persons or to a small business, (2) the 
exposure is in the form of a revolving credit, line of credit, personal 
term loan or lease, or small business facility or commitment, (3) the 
regulatory supervisor is satisfied that the retail portfolio is 
sufficiently diversified to warrant such a risk weight, and (4) the 
total credit exposure to the borrower does not exceed approximately 
$1.4 million.\40\
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    \39\ The other Federal financial regulatory agencies stated in 
Basel IA that they were exploring options to permit certain small 
business loans to qualify for a 75-percent risk weight.
    \40\ We present a comparable threshold in terms of U.S. dollars. 
The standardized approach of Basel II has a threshold of [euro]1 
million.
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    Question 6: We seek comment on what approaches we should use to 
improve the risk sensitivity of our risk-based capital rules for small 
agricultural and rural business loans. More specifically, what criteria 
should we use to classify an agricultural or rural business as a small 
business? What criteria should we use to assign risk-weights of less 
than 100 percent to these types of loans?

E. Loans Secured by Liens on Real Estate

    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. The standardized approach of Basel II assigns a 35-percent 
risk weight to all prudently underwritten residential mortgages. Basel 
IA had proposed to risk-weight loans secured by first and second liens 
on residential real estate based on LTV. We continue to believe that 
LTV is a viable option for determining appropriate risk-weights for 
farm real estate and qualified residential loans. We are also 
considering approaches that would combine borrower creditworthiness and 
other loan characteristics in conjunction with LTV.
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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.
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    Question 7: We seek comment on all aspects of using LTV to 
determine the appropriate risk-weight for farm real estate, qualified 
residential loans, or any other asset class. We also welcome comments 
on other methods that could be used to improve the risk sensitivity of 
our risk-based capital rules for these types of loans.

F. Loans 90 Days or More Past Due or in Nonaccrual \42\
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    \42\ This section was not in the previous ANPRM.
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    Our existing risk-based capital rules assign most loans to the 100-
percent risk-weight category unless the credit risk is mitigated by an 
acceptable guarantee or collateral. When exposures reach 90 days or 
more past due or are in nonaccrual status, there is a higher 
probability that the financial institution might incur a loss. The 
standardized approach of Basel II addresses this potentially higher 
risk of loss by assigning the unsecured portion of a loan that is 90 
days or more past due (net of specific provisions) as follows:
     150-percent risk weight when specific provisions are less 
than 20 percent of the outstanding amount of the loan;
     100-percent risk weight when specific provisions are 20 
percent or more of the outstanding amount of the loan;
     When specific provisions are 50 percent or more of the 
outstanding amount of the loan, the supervisor has the discretion to 
reduce the risk weight to 50 percent.
    Question 8: We seek comment on all aspects related to risk-
weighting exposures that reach 90 days or more past due or are in 
nonaccrual status.

G. 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) \43\ 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.\44\ The standardized approach of Basel II 
assigns a 0-percent CCF to unconditionally cancelable commitments,\45\ 
a 20-percent CCF to short-term commitments, and a 50-percent CCF to 
long-term commitments.\46\
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    \43\ 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.
    \44\ Our existing regulations assign a 0-percent CCF to unused 
commitments with an original maturity of 14 months or less. Unused 
commitments with an original maturity of greater than 14 months can 
also receive a 0-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.
    \45\ An unconditionally cancelable commitment is one that can be 
canceled for any reason at any time without prior notice.
    \46\ Basel IA proposed to retain the 0-percent CCF for all 
unconditionally cancelable commitments, apply a 10-percent CCF to 
all other short-term commitments, and retain the 50-percent CCF for 
all long-term commitments.
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    Question 9: We seek comment on what approaches we should use to 
risk weight short- and long-term commitments that are not 
unconditionally cancelable.

H. Adjusting Risk Weights on Exposures Over Time

    The FCA welcomes comment on additional approaches or criteria 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 
providing 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 should use to 
adjust the risk weight of credit exposures as the asset quality or 
default probability changes over time.

I. 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 primarily

[[Page 61573]]

designed to protect against credit or counterparty risk. As we move 
toward a more risk-sensitive capital framework, it may be appropriate 
to apply an explicit capital charge for operational risk, especially to 
cover risks associated with off-balance sheet activity.
    Basel II defines operational risk as the risk of loss resulting 
from inadequate or failed internal processes, people, systems, or from 
external events. This definition includes legal risk but excludes 
strategic and reputational risk. As previously mentioned, Basel II has 
three methods for applying a capital charge for operational risk. Under 
the basic indicator approach, the operational capital charge is equal 
to 15 percent of the 3-year average of positive annual gross income. 
Under the standardized approach, the operational capital charge is 
equal to the sum of a fixed percentage of the 3-year average of the 
gross income of eight business lines.\47\ Under the AMA, the 
operational capital charge is derived from a bank's internal 
operational risk management systems and processes.
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    \47\ Each business line is multiplied by a fixed percentage and 
then summed together to determine the annual gross income. The eight 
lines of business are corporate finance (18 percent), trading and 
sales (18 percent), retail banking (12 percent), commercial banking 
(15 percent), payment and settlement (18 percent), agency services 
(15 percent), asset management (12 percent), and retail brokerage 
(12 percent).
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    Question 11: We seek comment on what approach we should consider, 
if any, in determining a risk-based capital charge for operational 
risk.

J. Disclosure \48\
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    \48\ This section was not in the previous ANPRM.
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    The FCA recognizes that market discipline contributes to a safe and 
sound banking environment and enhances risk management practices. 
Pillar III of Basel II is designed to complement the minimum capital 
requirements and supervisory review process by encouraging market 
discipline through meaningful public disclosure. The disclosure 
requirements are intended to allow market participants to assess key 
information about an institution's risk profile and associated level of 
capital to better evaluate risk management performance, earnings 
potential and financial strength.
    Pillar III of Basel II presents the following general disclosure 
requirements: (1) Banks should have a formal disclosure policy approved 
by the board of directors that addresses the institution's approach for 
determining the disclosures it should make; \49\ (2) banks should 
implement a process for assessing the appropriateness of their 
disclosures, including validation and frequency of them; (3) banks 
should decide which disclosures are relevant based on the materiality 
concept; \50\ and (4) the disclosures should be made on a semi-annual 
basis, subject to certain exceptions.\51\
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    \49\ Disclosure is a qualifying criterion under Pillar I to 
obtain lower risk weightings and/or to apply specific methodologies.
    \50\ Pillar III of Basel II provides minimum disclosure 
requirements on capital structure and adequacy, and risk exposure 
and assessment on credit risk, market risk, operational risk, 
equities, and interest rate risk in the banking book.
    \51\ Disclosure of key capital ratios should be made on a 
quarterly basis. Qualitative disclosures providing a general summary 
of a bank's risk management objective and policies, reporting system 
and definitions may be published on an annual basis.
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    The other Federal financial regulatory agencies have proposed the 
following additional requirements in the advanced capital framework: 
(1) The disclosures would follow U.S. generally accepted accounting 
principles, SEC mandates, and existing regulatory reporting 
requirements; (2) the banks would be required to disclose quantitative 
information on a quarterly basis following SEC deadlines; (3) the 
disclosures would be made publicly available (for example, on a Web 
site) for each of the last 3 years (that is, 12 quarters); \52\ (4) 
disclosure of key financial ratios must be provided in the footnotes to 
the year-end audited financial statements; \53\ (5) the chief financial 
officer must certify that the disclosures are appropriate; and (6) the 
board of directors and senior management are responsible for 
establishing the internal control structure over financial reporting.
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    \52\ U.S. Basel II banks are encouraged to provide this 
information in one place on the entity's public Web site.
    \53\ These disclosures would be tested by external auditors as 
part of the financial statement audit.
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    Question 12: We seek comment on all aspects of the Basel II public 
disclosure requirements. Specifically, how would the System apply the 
public disclosure requirements of Pillar III given its unique 
cooperative structure?

K. 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) \54\ of 103 percent \55\ 
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).\56\ 
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.
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    \54\ The net collateral ratio is a bank's net collateral as 
defined in 12 CFR 615.5301(c) divided by the bank's adjusted total 
liabilities.
    \55\ See 12 CFR 615.5335(a).
    \56\ 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 13: 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.

L. Regulatory Capital Directives \57\
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    \57\ 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 \58\ 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.\59\ An early intervention capital directive 
framework could provide a clearer

[[Page 61574]]

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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    \58\ 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)).
    \59\ See 12 U.S.C. 1831o for the prompt corrective action 
provisions that apply to commercial banks and savings associations.
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    Question 14: 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.

M. 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.
    As described above, the other Federal financial regulatory agencies 
are in the process of proposing two sets of capital rules for the 
financial institutions they regulate. The implementation of the 
advanced capital framework would be limited, for the most part, to the 
largest, internationally active banks that meet certain infrastructure 
requirements. Other banks would implement a simpler capital framework 
patterned after the standardized approach of Basel II.
    While our expectation is to implement a revised capital framework 
similar to the standardized approach of Basel II, we also recognize 
that some aspects of the advanced approaches may be appropriate for the 
larger, more complex System institutions. However, we are still 
reviewing the advanced approaches of Basel II and its potential 
application to the System. Therefore, we are not seeking comments on 
specific aspects of the advanced approaches 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 
and recent best practices for economic capital modeling.
    Question 15: 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?

N. Reporting Requirements and Transition Period 60
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    \60\ This section was not in the previous ANPRM.
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    The other Federal financial regulatory agencies have announced that 
they will be replacing Basel IA with a proposed rule that would provide 
all non-core banks the option of adopting the standardized approach 
under Basel II. Their stated intent is to finalize a standardized 
approach for non-core banks before the core banks begin their first 
transition period year under the advanced capital framework. Our 
objective is to minimize, to the extent possible, the time interval 
between the issuance of their final rule and ours. We also need a 
transition period to make appropriate modifications to the Call 
Reporting System to track the new risk-based capital requirements.
    Question 16: We seek comment on an appropriate timetable for 
implementing our new risk-based capital rules. Specifically, what is an 
appropriate time interval between the issuance of the other Federal 
financial regulatory agencies' final rule on the standardized approach 
of Basel II and ours? How long should the transition period be to allow 
System institutions to adjust to the new risk-based capital rules?
    Question 17: Additionally, we seek comment on any other methods 
that may be used to increase the risk sensitivity of our risk-based 
capital rules.

    Dated: October 25, 2007.
Roland E. Smith,
Secretary, Farm Credit Administration Board.
[FR Doc. E7-21422 Filed 10-30-07; 8:45 am]
BILLING CODE 6705-01-P