[Federal Register: July 29, 2008 (Volume 73, Number 146)]
[Proposed Rules]
[Page 43981-44060]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29jy08-19]
[[Page 43981]]
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Part II
Department of the Treasury
Office of the Comptroller of the Currency
12 CFR Part 3
Federal Reserve System
12 CFR Parts 208 and 225
Federal Deposit Insurance Corporation
12 CFR Part 325
Department of the Treasury
Office of Thrift Supervision
12 CFR Part 567
Risk-Based Capital Guidelines; Capital Adequacy Guidelines:
Standardized Framework; Proposed Rule
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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 3
[Docket ID: OCC-2008-0006]
RIN 1557-AD07
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-1318]
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AD29
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
12 CFR Part 567
[No. 2008-002]
RIN 1550-AC19
Risk-Based Capital Guidelines; Capital Adequacy Guidelines:
Standardized Framework
AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of
Governors of the Federal Reserve System; Federal Deposit Insurance
Corporation; and Office of Thrift Supervision, Treasury.
ACTION: Joint notice of proposed rulemaking.
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SUMMARY: The Office of the Comptroller of the Currency (OCC), Board of
Governors of the Federal Reserve System (Board), Federal Deposit
Insurance Corporation (FDIC), and Office of Thrift Supervision (OTS)
(collectively, the agencies) propose a new risk-based capital framework
(standardized framework) based on the standardized approach for credit
risk and the basic indicator approach for operational risk described in
the capital adequacy framework titled ``International Convergence of
Capital Measurement and Capital Standards: A Revised Framework'' (New
Accord) released by the Basel Committee on Banking Supervision. The
standardized framework generally would be available, on an optional
basis, to banks, bank holding companies, and savings associations
(banking organizations) that apply the general risk-based capital
rules.
DATES: Comments on this joint notice of proposed rulemaking must be
received by October 27, 2008.
ADDRESSES: Comments should be directed to:
OCC: Because paper mail in the Washington, DC area and at the OCC
is subject to delay, commenters are encouraged to submit comments by e-
mail, if possible. Please use the title ``Risk-Based Capital
Guidelines; Capital Adequacy Guidelines: Standardized Framework;
Proposed Rule and Notice'' to facilitate the organization and
distribution of the comments. You may submit comments by any of the
following methods:
Federal eRulemaking Portal--``Regulations.gov'': Go to
http://www.regulations.gov, under the ``More Search Options'' tab click
next to the ``Advanced Docket Search'' option where indicated, select
``Comptroller of the Currency'' from the agency drop-down menu, then
click ``Submit.'' In the ``Docket ID'' column, select OCC-2008-0006 to
submit or view public comments and to view supporting and related
materials for this notice of proposed rulemaking. The ``How to Use This
Site'' link on the Regulations.gov home page provides information on
using Regulations.gov, including instructions for submitting or viewing
public comments, viewing other supporting and related materials, and
viewing the docket after the close of the comment period.
E-mail: regs.comments@occ.treas.gov.
Mail: Office of the Comptroller of the Currency, 250 E
Street, SW., Mail Stop 1-5, Washington, DC 20219.
Fax: (202) 874-4448.
Hand Delivery/Courier: 250 E Street, SW., Attn: Public
Information Room, Mail Stop 1-5, Washington, DC 20219.
Instructions: You must include ``OCC'' as the agency name and
``Docket Number OCC-2008-0006'' in your comment. In general, OCC will
enter all comments received into the docket and publish them on the
Regulations.gov Web site without change, including any business or
personal information that you provide such as name and address
information, e-mail addresses, or phone numbers. Comments received,
including attachments and other supporting materials, are part of the
public record and subject to public disclosure. Do not enclose any
information in your comment or supporting materials that you consider
confidential or inappropriate for public disclosure.
You may review comments and other related materials that pertain to
this [insert type of rulemaking action] by any of the following
methods:
Viewing Comments Electronically: Go to http://
www.regulations.gov, under the ``More Search Options'' tab click next
to the ``Advanced Document Search'' option where indicated, select
``Comptroller of the Currency'' from the agency drop-down menu, then
click ``Submit.'' In the ``Docket ID'' column, select ``OCC-2008-0006''
to view public comments for this rulemaking action.
Viewing Comments Personally: You may personally inspect
and photocopy comments at the OCC's Public Information Room, 250 E
Street, SW., Washington, DC. For security reasons, the OCC requires
that visitors make an appointment to inspect comments. You may do so by
calling (202) 874-5043. Upon arrival, visitors will be required to
present valid government-issued photo identification and submit to
security screening in order to inspect and photocopy comments.
Docket: You may also view or request available background
documents and project summaries using the methods described above.
Board: You may submit comments, identified by Docket No. R-1318, by
any of the following methods:
Agency Web Site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: regs.comments@federalreserve.gov. Include docket
number in the subject line of the message.
FAX: (202) 452-3819 or (202) 452-3102.
Mail: Jennifer J. Johnson, Secretary, Board of Governors
of the Federal Reserve System, 20th Street and Constitution Avenue,
NW., Washington, DC 20551.
All public comments are available from the Board's Web site at
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, your
comments will not be edited to remove any identifying or contact
information. Public comments may also be viewed electronically or in
paper form in Room MP-500 of the Board's Martin Building (20th and C
Street, NW.) between 9 a.m. and 5 p.m. on weekdays.
FDIC: You may submit by any of the following methods:
Federal eRulemaking Portal: http://www.regulations.gov
Follow the instructions for submitting comments.
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Agency Web site: http://www.FDIC.gov/regulations/laws/
federal/propose.html.
Mail: Robert E. Feldman, Executive Secretary, Attention:
Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th
Street, NW., Washington, DC 20429.
Hand Delivered/Courier: The guard station at the rear of
the 550 17th Street Building (located on F Street), on business days
between 7 a.m. and 5 p.m.
E-mail: comments@FDIC.gov.
Public Inspection: Comments may be inspected and
photocopied in the FDIC Public Information Center, Room E-1002, 3502
Fairfax Drive, Arlington, VA 22226, between 9 a.m. and 5 p.m. on
business days.
Instructions: Submissions received must include the Agency name and
title for this notice. Comments received will be posted without change
to http://www.FDIC.gov/regulations/laws/federal/propose.html, including
any personal information provided.
OTS: You may submit comments, identified by OTS-2008-0002, by any
of the following methods:
Federal eRulemaking Portal: ``Regulations.gov'': Go to
http://www.regulations.gov, under the ``more Search Options'' tab click
next to the ``Advanced Docket Search'' option where indicated, select
``Office of Thrift Supervision'' from the agency dropdown menu, then
click ``Submit.'' In the ``Docket ID'' column, select ``OTS-2008-0002''
to submit or view public comments and to view supporting and related
materials for this proposed rulemaking. The ``How to Use This Site''
link on the Regulations.gov home page provides information on using
Regulations.gov, including instructions for submitting or viewing
public comments, viewing other supporting and related materials, and
viewing the docket after the close of the comment period.
Mail: Regulation Comments, Chief Counsel's Office, Office
of Thrift Supervision, 1700 G Street, NW., Washington, DC 20552,
Attention: OTS-2008-0002.
Facsimile: (202) 906-6518.
Hand Delivery/Courier: Guard's Desk, East Lobby Entrance,
1700 G Street, NW., from 9 a.m. to 4 p.m. on business days, Attention:
Regulation Comments, Chief Counsel's Office, Attention: OTS-2008-0002.
Instructions: All submissions received must include the
agency name and docket number for this rulemaking.
All comments received will be entered into the docket and posted on
Regulations.gov without change, including any personal information
provided. Comments, including attachments and other supporting
materials received are part of the public record and subject to public
disclosure. Do not enclose any information in your comment or
supporting materials that you consider confidential or inappropriate
for public disclosure.
Viewing Comments Electronically: Go to http://
www.regulations.gov, select ``Office of Thrift Supervision'' from the
agency drop-down menu, then click ``Submit.'' Select Docket ID ``OTS-
2008-0002'' to view public comments for this notice of proposed
rulemaking.
Viewing Comments On-Site: You may inspect comments at the
Public Reading Room, 1700 G Street, NW., by appointment. To make an
appointment for access, call (202) 906-5922, send an e-mail to
public.info@ots.treas.gov, or send a facsimile transmission to (202)
906-6518. (Prior notice identifying the materials you will be
requesting will assist us in serving you.) We schedule appointments on
business days between 10 a.m. and 4 p.m. In most cases, appointments
will be available the next business day following the date we receive a
request.
FOR FURTHER INFORMATION CONTACT:
OCC: Margot Schwadron, Senior Risk Expert, (202) 874-6022, Capital
Policy Division; Carl Kaminski, Attorney; or Ron Shimabukuro, Senior
Counsel, Legislative and Regulatory Activities Division, (202) 874-
5090; Office of the Comptroller of the Currency, 250 E Street, SW.,
Washington, DC 20219.
Board: Barbara Bouchard, Associate Director, (202) 452-3072; or
William Tiernay, Senior Supervisory Financial Analyst, (202) 872-7579,
Division of Banking Supervision and Regulation; or Mark E. Van Der
Weide, Assistant General Counsel, (202) 452-2263; or April Snyder,
Counsel, (202) 452-3099, Legal Division. For the hearing impaired only,
Telecommunication Device for the Deaf (TDD), (202) 263-4869.
FDIC: Nancy Hunt, Senior Policy Analyst, (202) 898-6643; Ryan
Sheller, Capital Markets Specialist, (202) 898-6614; or Bobby R. Bean,
Chief, Policy Section, Capital Markets Branch, (202) 898-3575, Division
of Supervision and Consumer Protection; or Benjamin W. McDonough,
Senior Attorney, (202) 898-7411, or Michael B. Phillips, Counsel, (202)
898-3581, Supervision and Legislation Branch, Legal Division, Federal
Deposit Insurance Corporation, 550 17th Street, NW., Washington, DC
20429.
OTS: Michael Solomon, Director, Capital Policy Division, (202) 906-
5654; or Teresa Scott, Senior Project Manager, Capital Policy Division,
(202) 906-6478, Office of Thrift Supervision, 1700 G Street, NW.,
Washington, DC 20552.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
II. Proposed Rule
A. Applicability of the Standardized Framework
B. Reservation of Authority
C. Principle of Conservatism
D. Merger and Acquisition Transition Provisions
E. Calculation of Tier 1 and Total Qualifying Capital
F. Calculation of Risk-Weighted Assets
1. Total Risk-Weighted Assets
2. Calculation of Risk-Weighted Assets for General Credit Risk
3. Calculation of Risk-Weighted Assets for Unsettled
Transactions, Securitization Exposures, and Equity Exposures
4. Calculation of Risk-Weighted Assets for Operational Risk
G. External and Inferred Ratings
1. Overview
2. Use of External Ratings
H. Risk-Weight Categories
1. Exposures to Sovereign Entities
2. Exposures to Certain Supranational Entities and Multilateral
Development Banks (MDBs)
3. Exposures to Depository Institutions, Foreign Banks, and
Credit Unions
4. Exposures to Public Sector Entities (PSEs)
5. Corporate Exposures
6. Regulatory Retail Exposures
7. Residential Mortgage Exposures
8. Pre-Sold Construction Loans and Statutory Multifamily
Mortgages
9. Past Due Loans
10. Other Assets
I.Off-Balance Sheet Items
J. OTC Derivative Contracts
1. Background
2. Treatment of OTC Derivative Contracts
3. Counterparty Credit Risk for Credit Derivatives
4. Counterparty Credit Risk for Equity Derivatives
5. Risk Weight for OTC Derivative Contracts
K. Credit Risk Mitigation (CRM)
1. Guarantees and Credit Derivatives
2. Collateralized Transactions
L. Unsettled Transactions
M. Risk-Weighted Assets for Securitization Exposures
1. Securitization Overview and Definitions
2. Operational Requirements
3. Hierarchy of Approaches
4. Ratings-Based Approach (RBA)
5. Exposures that Do Not Qualify for the RBA
6. CRM for Securitization Exposures
7. Risk-Weighted Assets for Early Amortization Provisions
8. Maximum Capital Requirement
N. Equity Exposures
1. Introduction and Exposure Measurement
2. Hedge Transactions
3. Measures of Hedge Effectiveness
4. Simple Risk-Weight Approach (SRWA)
5. Non-Significant Equity Exposures
6. Equity Exposures to Investment Funds
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7. Full Look-Through Approach
8. Simple Modified Look-Through Approach
9. Alternative Modified Look-Through Approach
10. Money Market Fund Approach
O. Operational Risk
1. Basic Indicator Approach (BIA)
2. Advanced Measurement Approach (AMA)
P. Supervisory Oversight and Internal Capital Adequacy
Assessment
Q. Market Discipline
1. Overview
2. General Requirements
3. Frequency/Timeliness
4. Location of Disclosures and Audit/Certification Requirements
5. Proprietary and Confidential Information
6. Summary of Specific Public Disclosure Requirements
III. Regulatory Analysis
A. Regulatory Flexibility Act Analysis
B. OCC Executive Order 12866 Determination
C. OTS Executive Order 12866 Determination
D. OCC Executive Order 13132 Determination
E. Paperwork Reduction Act
F. OCC Unfunded Mandates Reform Act of 1995 Determination
G. OTS Unfunded Mandates Reform Act of 1995 Determination
H. Solicitation of Comments on Use of Plain Language
I. Background
In 1989, the agencies implemented a risk-based capital framework
for U.S. banking organizations (general risk-based capital rules).\1\
The agencies based the framework on the ``International Convergence of
Capital Measurement and Capital Standards'' (Basel I), released by the
Basel Committee on Banking Supervision (Basel Committee) \2\ in 1988.
The general risk-based capital rules established a uniform risk-based
capital system that was more risk sensitive and addressed several
shortcomings in the capital regimes the agencies used prior to 1989.
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\1\ 12 CFR part 3, Appendix A (OCC); 12 CFR parts 208 and 225,
Appendix A (Board); 12 CFR part 325, Appendix A (FDIC); and 12 CFR
part 567, subpart B (OTS). The risk-based capital rules generally do
not apply to bank holding companies with less than $500 million in
assets. 71 FR 9897 (February 28, 2006).
\2\ The Basel Committee was established in 1974 by central banks
and governmental authorities with bank supervisory responsibilities.
Current member countries are Belgium, Canada, France, Germany,
Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden,
Switzerland, the United Kingdom, and the United States.
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In June 2004, the Basel Committee introduced a new capital adequacy
framework, the New Accord,\3\ that is designed to promote improved risk
measurement and management processes and better align minimum risk-
based capital requirements with risk. The New Accord includes three
options for calculating risk-based capital requirements for credit risk
and three options for operational risk. For credit risk, the three
approaches are: standardized, foundation internal ratings-based, and
advanced internal ratings-based. For operational risk, the three
approaches are: basic indicator (BIA), standardized, and advanced
measurement (AMA). The advanced internal ratings-based approach and the
AMA together are referred to as the ``advanced approaches.''
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\3\ ``International Convergence of Capital Measurement and
Capital Standards, A Revised Framework, Comprehensive Version,'' the
Basel Committee on Banking Supervision, June 2006. The text is
available on the Bank for International Settlements Web site at
http://www.bis.org/publ/bcbs128.htm.
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On September 25, 2006, the agencies issued a notice of proposed
rulemaking to implement the advanced approaches in the United States
(advanced approaches NPR).\4\ Many of the commenters on the advanced
approaches NPR requested that the agencies harmonize certain provisions
of the agencies' proposal with the New Accord and offer the
standardized approach in the United States. A number of these
commenters supported making the standardized approach available for all
U.S. banking organizations.
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\4\ 71 FR 55830 (September 25, 2006).
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On December 7, 2007, the agencies issued a final rule implementing
the advanced approaches (advanced approaches final rule).\5\ The
advanced approaches final rule is mandatory for certain banking
organizations and voluntary for others. In general, the advanced
approaches final rule requires a banking organization that has
consolidated total assets of $250 billion or more, has consolidated on-
balance sheet foreign exposure of $10 billion or more, or is a
subsidiary or parent of an organization that uses the advanced
approaches (core banking organization) to implement the advanced
approaches. The implementation of the advanced approaches has created a
bifurcated regulatory capital framework in the United States: one set
of risk-based capital rules for banking organizations using the
advanced approaches (advanced approaches organizations), and another
set for banking organizations that do not use the advanced approaches
(general banking organizations).
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\5\ 72 FR 69288 (December 7, 2007).
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On December 26, 2006, the agencies issued a notice of proposed
rulemaking (Basel IA NPR), which proposed modifications to the general
risk-based capital rules for general banking organizations.\6\ One
objective of the Basel IA NPR was to enhance the risk sensitivity of
the risk-based capital rules without imposing undue regulatory burden.
Specifically, the agencies proposed to increase the number of risk-
weight categories, expand the use of external ratings for assigning
risk weights, broaden recognition of collateral and guarantors, use
loan-to-value ratios (LTV ratios) to risk weight most residential
mortgages, increase the credit conversion factor for various short-term
commitments, assess a risk-based capital requirement for early
amortizations in securitizations of revolving retail exposures, and
remove the 50 percent risk-weight limit for derivative transactions.
The Basel IA NPR also sought comment on the extent to which certain
advanced approaches organizations should be permitted to use approaches
other than the advanced approaches in the New Accord.
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\6\ 71 FR 77446 (December 26, 2006).
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Most commenters on the Basel IA NPR supported the agencies' goal to
make the general risk-based capital rules more risk sensitive without
adding undue regulatory burden. However, a number of the commenters
representing a broad range of U.S. banking organizations and trade
associations urged the agencies to implement the New Accord's
standardized approach for credit risk in the United States. These
commenters generally stated that the standardized approach is more risk
sensitive than the Basel IA NPR and would more appropriately address
the industry's concerns regarding domestic and international
competitiveness. Most of these commenters requested that the U.S.
implementation of the standardized approach closely follow the New
Accord. Certain commenters also requested that the agencies make some
or all of the other options for credit risk and operational risk in the
New Accord available in the United States. For example, some commenters
preferred implementation of the standardized approach without a
separate capital requirement for operational risk. Other commenters
supported including one or more of the approaches in the New Accord for
operational risk.
II. Proposed Rule
After considering the comments on both the Basel IA and the
advanced approaches NPRs, the agencies have decided not to finalize the
Basel IA NPR and to propose instead a new risk-based capital framework
that would implement the standardized approach for credit risk, the BIA
for operational
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risk, and related disclosure requirements (collectively, this NPR or
this proposal). This NPR generally parallels the relevant approaches in
the New Accord. This NPR, however, diverges from the New Accord where
the U.S. markets have unique characteristics and risk profiles, notably
the proposal for risk weighting residential mortgage exposures. The
agencies have also sought to make this NPR consistent where relevant
with the advanced approaches final rule.
This NPR would not modify how a banking organization that uses the
standardized framework would calculate its leverage ratio
requirement.\7\ Banking organizations face risks other than credit and
operational risks that neither the New Accord nor this NPR addresses.
The leverage ratio is a straightforward measure of solvency that
supplements the risk-based capital requirements. Consequently, the
agencies continue to view the tier 1 leverage ratio and other
prudential safeguards such as Prompt Corrective Action as important
components of the regulatory capital regime.
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\7\ 12 CFR 3.6(b) and (c)(OCC); 12 CFR part 208, Appendix B and
12 CFR part 225, Appendix D (Board); 12 CFR 325.3 (FDIC); and 12 CFR
567.8 (OTS).
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Question 1a: The agencies seek comments on all aspects of this
proposal, including risk sensitivity, regulatory burden, and
competitive impact.
The agencies' general risk-based capital rules permit the use of
external ratings issued by a nationally recognized statistical rating
organization (NRSRO) to assign risk weights to recourse obligations,
direct credit substitutes, certain residual interests, and asset- and
mortgage-backed securities. The New Accord permits a banking
organization to use external ratings to determine risk weights for a
broad range of exposures, including sovereign, bank, corporate, and
securitization exposures. It also provides, within certain limitations,
for the use of both inferred ratings and issuer ratings. As discussed
in more detail later in this preamble, the agencies propose that
external, issuer, and inferred ratings be used to risk weight various
exposures. While the agencies believe that the use of ratings proposed
in this NPR can contribute to a more risk-sensitive framework, they are
aware of the limitations associated with using credit ratings for risk-
based capital purposes and, thus, are particularly interested in
comments on the use of such ratings for those purposes.
Numerous bank supervisory groups and committees, including the
Basel Committee on Banking Supervision, the Financial Stability Forum,
and the Senior Supervisors Group, have undertaken work to better
understand the causes for and possible responses to the recent market
events, discussing, among numerous other issues, the role of credit
ratings. In addition, in March, the President's Working Group on
Financial Markets (PWG) issued its report titled ``Policy Statement on
Financial Market Developments,'' providing an analysis of the
underlying factors contributing to the recent market stress and a set
of recommendations to address identified weaknesses. Among its
recommendations, the PWG encouraged regulators, including the Federal
banking agencies, to review the current use of credit ratings in the
regulation and supervision of financial institutions. In this regard,
the PWG policy statement noted that certain investors and asset
managers failed to obtain sufficient information or to conduct
comprehensive risk assessments, with some investors relying exclusively
on credit ratings for valuation purposes. More generally, the PWG
statement also noted market participants, including originators,
underwriters, asset managers, credit rating agencies, and investors,
failed to obtain sufficient information or to conduct comprehensive
risk assessments on complex instruments, including securitized credits
and their underlying asset pools.
The PWG policy statement also acknowledged the steps already taken
by credit rating agencies to improve the performance of credit ratings
and encouraged additional actions, potentially including the
publication of sufficient information about the assumptions underlying
their credit rating methodologies; changes to the credit rating process
to clearly differentiate ratings for structured products from ratings
for corporate and municipal securities; and ratings performance
measures for structured credit products and other asset-backed
securities readily available to the public in a manner that facilitates
comparisons across products and credit ratings.
Most directly relevant to this NPR, the agencies were encouraged to
reinforce steps taken by the credit rating agencies through revisions
to supervisory policy and regulation, including regulatory capital
requirements that use ratings. At a minimum, regulators were urged to
distinguish, as appropriate, between ratings of structured credit
products and ratings of corporate and municipal bonds in regulatory and
supervisory policies.
Question 1b: The agencies seek comment on the advantages and
disadvantages of the use of external credit ratings in risk-based
capital requirements for banking organizations and whether identified
weakness in the credit rating process suggests the need to change or
enhance any of the proposals in this NPR. The agencies also seek
comment on whether additional refinements to the proposals in the NPR
should be considered to address more broadly the prudent use of credit
ratings by banking organizations. For example, should there be
operational conditions for banking organizations to make use of credit
ratings in determining risk-based capital requirements, enhancements to
minimum capital requirements, or modifications to the supervisory
review process?
The agencies also note that efforts are underway by the BCBS to
review the treatment in the New Accord for certain off-balance sheet
conduits, resecuritizations, such as collateralized debt obligations
referencing asset-backed securities, and other securitization-related
risks. The agencies are fully committed to working with the BCBS in
this regard and also intend to review the agencies' current approach to
securitization transactions to assess whether modifications might be
needed. This review will take into account lessons learned from recent
market-related events and may result in additional proposals for
modification to the risk-based capital rules.
Question 1c: The agencies seek commenters' views on what changes to
the approaches set forth in this NPR, if any, should be considered as a
result of recent market events, particularly with respect to the
securitization framework described in this NPR.
A. Applicability of the Standardized Framework
Most commenters on the Basel IA NPR favored its opt-in approach,
whereby a banking organization could voluntarily decide whether or not
to use the proposed rules. They supported the flexibility of the opt-in
provision and the ability of a general banking organization to remain
under the general risk-based capital rules. Commenters observed that
many banking organizations choose to hold capital well in excess of
regulatory minimums and would not necessarily benefit from a more risk-
sensitive capital rule. For these commenters, limiting regulatory
burden was a higher priority than increasing the risk
[[Page 43986]]
sensitivity of their risk-based capital requirements.
The agencies acknowledge this concern and propose to make the
standardized framework optional for banking organizations that do not
use the advanced approaches final rule to calculate their risk-based
capital requirements.\8\ Under this NPR, a banking organization that
opts to use the standardized framework generally would have to notify
its primary Federal supervisor in writing of its intent to use the new
rules at least 60 days before the beginning of the calendar quarter in
which it first uses the standardized framework. This notice must
include a list of any affiliated depository institutions or bank
holding companies, if applicable, that seek supervisory exemption from
the use of the standardized framework. Before it notifies its primary
Federal supervisor, the banking organization should review its ability
to implement the proposed rule and evaluate the potential impact on its
regulatory capital.
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\8\ The agencies are not proposing in this NPR to make this
standardized framework available to banking organizations for which
the application of the advanced approaches final rule is mandatory,
unless such a banking organization is exempted in writing from the
advanced approaches final rule by its primary Federal supervisor.
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Under this proposal, a banking organization that opts to use this
standardized framework could return to the general risk-based capital
rules by notifying its primary Federal supervisor in writing at least
60 days before the beginning of the calendar quarter in which it
intends to opt out of the standardized framework. The banking
organization would have to include in its notice an explanation of its
rationale for ceasing to use the standardized framework and identify
the risk-based capital framework it intends to use. The primary Federal
supervisor would review this notice to ensure that the use of the
general risk-based capital rules would be appropriate for that banking
organization.\9\ The agencies expect that a banking organization would
not alternate between the general risk-based capital rules and this
standardized framework.
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\9\ The primary Federal supervisor may waive the 60-day notice
period for opting in to the standardized framework and for returning
to the general risk-based capital rules.
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Any general banking organization could generally continue to
calculate its risk-based capital requirements using the general risk-
based capital rules without notifying its primary Federal supervisor.
The primary Federal supervisor would, however, have the authority to
require a general banking organization to use a different risk-based
capital rule if that supervisor determines that a particular capital
rule is appropriate in light of the banking organization's asset size,
level of complexity, risk profile, or scope of operations.
Under section 1(b) of the proposed rule, if a bank holding company
opts in to the standardized framework, its subsidiary depository
institutions also would apply the standardized framework. Similarly, if
a depository institution opts in to the standardized framework, its
parent bank holding company (where applicable) and any subsidiary
depository institutions of the parent holding company generally would
be required to apply the standardized rules as well. Savings and loan
holding companies, however, are not subject to risk-based capital
rules. Accordingly, if a savings association opts in to the proposed
rule, the proposed rule would not apply to the savings and loan holding
company or to a subsidiary depository institution of that holding
company, unless the subsidiary depository institution is directly
controlled by the savings association.
The agencies believe that this approach serves as an important
safeguard against regulatory capital arbitrage among affiliated banking
organizations. The agencies recognize, however, that there may be
infrequent situations where the use of the standardized rules could
create undue burden at individual depository institutions within a
corporate family. Therefore, under section 1(c) of the proposed rule, a
banking organization that would otherwise be required to apply the
standardized rule because a related banking organization has elected to
apply it may instead use the general risk-based capital rules if its
primary Federal supervisor determines in writing that that application
of the standardized framework is not appropriate in light of the
banking organization's asset size, level of complexity, risk profile,
or scope of operations. When seeking such a determination, the banking
organization should provide a rationale for its request. The primary
Federal supervisor may consider potential capital arbitrage issues
within a corporate structure in making its determination.
Question 2: The agencies seek comment on the proposed applicability
of the standardized framework and in particular on the degree of
flexibility that should be provided to individual depository
institutions within a corporate family, keeping in mind regulatory
burden issues as well as ways to minimize the potential for regulatory
capital arbitrage.
In the advanced approaches final rule, the agencies require core
banking organizations to use only the most advanced approaches provided
in the New Accord. As proposed, the standardized framework generally
would be available only for banking organizations that are not core
banking organizations.
Question 3: The agencies seek comment on whether or to what extent
core banking organizations should be able to use the proposed
standardized framework.
B. Reservation of Authority
Under this NPR, a primary Federal supervisor could require a
banking organization to hold an amount of capital greater than would
otherwise be required if that supervisor determines that the risk-based
capital requirements under the standardized framework are not
commensurate with the banking organization's credit, market,
operational, or other risks. In addition, the agencies expect that
there may be instances when the standardized framework would prescribe
a risk-weighted asset amount for one or more exposures that was not
commensurate with the risks associated with the exposures. In such a
case, the banking organization's primary Federal supervisor would
retain the authority to require the banking organization to assign a
different risk-weighted asset amount for the exposures or to deduct the
amount of the exposures from regulatory capital. Similarly, this NPR
proposes to authorize a banking organization's primary Federal
supervisor to require the banking organization to assign a different
risk-weighted asset amount for operational risk if the supervisor were
to find that the risk-weighted asset amount for operational risk
produced by the banking organization under this NPR is not commensurate
with the operational risks of the banking organization.
C. Principle of Conservatism
The agencies believe that in some cases it may be reasonable to
allow a banking organization not to apply a provision of the proposed
rule if not doing so would yield a more conservative result. Under
section 1(f) of the proposed rule, a banking organization may choose
not to apply a provision of the rule to one or more exposures provided
that: (i) The banking organization can demonstrate on an ongoing basis
to the satisfaction of its primary Federal supervisor that not applying
the provision would, in all
[[Page 43987]]
circumstances, unambiguously generate a risk-based capital requirement
for each exposure greater than that which would otherwise be required
under the rule; (ii) the banking organization appropriately manages the
risk of those exposures; (iii) the banking organization provides
written notification to its primary Federal supervisor prior to
applying this principle to each exposure; and (iv) the exposures to
which the banking organization applies this principle are not, in the
aggregate, material to the banking organization.
The agencies emphasize that a conservative capital requirement for
a group of exposures does not reduce the need for appropriate risk
management of those exposures. Moreover, the principle of conservatism
applies to the determination of capital requirements for specific
exposures; it does not apply to the disclosure requirements in section
71 of the proposed rule.
D. Merger and Acquisition Transition Provisions
A banking organization that uses the standardized framework and
that merges with or acquires another banking organization operating
under different risk-based capital rules may not be able to quickly
integrate the acquired organization's exposures into its risk-based
capital system. Under this NPR, a banking organization that uses the
standardized framework and that merges with or acquires a banking
organization that uses the general risk-based capital rules could
continue to use the general risk-based capital rules to calculate the
risk-based capital requirements for the merged or acquired banking
organization's exposures for up to 12 months following the last day of
the calendar quarter during which the merger or acquisition is
consummated. The risk-weighted assets of the merged or acquired company
calculated under the general risk-based capital rules would be included
in the banking organization's total risk-weighted assets. Deductions
associated with the exposures of the merged or acquired company would
be deducted from the banking organization's tier 1 capital and tier 2
capital.
Similarly, where both banking organizations calculate their risk-
based capital requirements under the standardized framework, but the
merged or acquired banking organization uses different aspects of the
framework, the banking organization may continue to use the merged or
acquired banking organization's own systems to determine its
organization's risk-weighted assets for, and deductions from capital
associated with, the merged or acquired banking organization's
exposures for the same time period.
A banking organization that merges with or acquires an advanced
approaches banking organization may use the advanced approaches risk-
based capital rules to determine the risk-weighted asset amounts for,
and deductions from capital associated with, the merged or acquired
banking organization's exposures for up to 12 months after the calendar
quarter during which the merger or acquisition consummates. During the
period when the advanced approaches risk-based capital rules apply to
the merged or acquired company, any allowance for loan and lease losses
(ALLL) associated with the merged or acquired company's exposures must
be excluded from the banking organization's tier 2 capital. Any excess
eligible credit reserves associated with the merged or acquired banking
organization's exposures may be included in that banking organization's
tier 2 capital up to 0.6 percent of that banking organization's risk-
weighted assets. (Excess eligible credit reserves would be determined
according to section 13(a)(2) of the advanced approaches risk-based
capital rules.)
If a banking organization relies on these merger provisions, it
would be required to disclose publicly the amounts of risk-weighted
assets and total qualifying capital calculated under the applicable
risk-based capital rules for the acquiring banking organization and for
the merged or acquired banking organization.
E. Calculation of Tier 1 and Total Qualifying Capital
This NPR would maintain the minimum risk-based capital ratio
requirements of 4.0 percent tier 1 capital to total risk-weighted
assets and 8.0 percent total qualifying capital to total risk-weighted
assets. A banking organization's total qualifying capital is the sum of
its tier 1 (core) capital elements and tier 2 (supplemental) capital
elements, subject to various limits, restrictions, and deductions
(adjustments). The agencies are not restating the elements of tier 1
and tier 2 capital in the proposed rule. Those capital elements
generally would be unchanged from the general risk-based capital
rules.\10\ Deductions or other adjustments would also be unchanged,
except for those provisions discussed below.
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\10\ See 12 CFR part 3, Appendix A, section 2 (national banks);
12 CFR part 208, Appendix A, section II (state member banks); 12 CFR
part 225, Appendix A, section II (bank holding companies); 12 CFR
part 325, Appendix A, section I (state nonmember banks); and 12 CFR
567.5 (savings associations).
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Under this NPR, a banking organization would make certain other
adjustments to determine its tier 1 and total qualifying capital. Some
of these adjustments would be made only to tier 1 capital. Other
adjustments would be made 50 percent to tier 1 capital and 50 percent
to tier 2 capital. If the amount deductible from tier 2 capital exceeds
the banking organization's actual tier 2 capital, the banking
organization would have to deduct the shortfall amount from tier 1
capital. Consistent with the agencies' general risk-based capital
rules, a banking organization would have to have at least 50 percent of
its total qualifying capital in the form of tier 1 capital.
Under this NPR, a banking organization would deduct from tier 1
capital any after-tax gain-on-sale resulting from a securitization.
Gain-on-sale means an increase in a banking organization's equity
capital that results from a securitization, other than an increase in
equity capital that results from the banking organization's receipt of
cash in connection with the securitization. The agencies included this
deduction to offset accounting treatments that produce an increase in a
banking organization's equity capital and tier 1 capital at the
inception of a securitization, for example, a gain attributable to a
credit-enhancing interest-only strip receivable (CEIO) that results
from Financial Accounting Standard (FAS) 140 accounting treatment for
the sale of underlying exposures to a securitization special purpose
entity (SPE).\11\ The agencies expect that the amount of the required
deduction would diminish over time as the banking organization realizes
the increase in equity capital and, thus, tier 1 capital booked at the
inception of the securitization, through actual receipt of cash flows.
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\11\ See Statement of Financial Accounting Standards No. 140,
``Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities'' (September 2000).
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Under the general risk-based capital rules, a banking organization
must deduct CEIOs, whether purchased or retained, from tier 1 capital
to the extent that the CEIOs exceed 25 percent of the banking
organization's tier 1 capital. Under this NPR, a banking organization
would have to deduct CEIOs from tier 1 capital to the extent they
represent after-tax gain-on-sale, and would have to deduct any CEIOs
that do not constitute an after-tax gain-on-sale 50 percent from tier 1
capital and 50 percent from tier 2 capital.
[[Page 43988]]
Under the FDIC, OCC, and Board general risk-based capital rules, a
banking organization must deduct from its tier 1 capital certain
percentages of the adjusted carrying value of its nonfinancial equity
investments. In contrast, OTS general risk-based capital rules require
the deduction of most investments in equity securities from total
capital.\12\ Under this NPR, however, a banking organization would not
deduct these investments. Instead, the banking organization's equity
exposures generally would be subject to the treatment provided in Part
V of this proposed rule.
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\12\ OTS general risk-based capital rules require savings
associations to deduct all ``equity investments'' from total
capital. 12 CFR 567.5(c)(2)(ii). ``Equity investments'' are defined
to include: (i) Investments in equity securities (other than
investments in subsidiaries, equity investments that are permissible
for national banks, indirect ownership interests in certain pools of
assets (for example, mutual funds), Federal Home Loan Bank stock and
Federal Reserve Bank stock); and (ii) investments in certain real
property. 12 CFR 567.1. The proposed treatment of investments in
equity securities is discussed above. Equity investments in real
estate would continue to be deducted to the same extent as under the
general risk-based capital rules.
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A banking organization also would have to deduct from total capital
the amount of certain unsettled transactions and certain securitization
exposures. These deductions are provided in section 21, section 38, and
Part IV of this proposed rule.
Consistent with the advanced approaches final rule, for bank
holding companies with consolidated insurance underwriting subsidiaries
that are functionally regulated (or subject to comparable supervision
and minimum regulatory capital requirements in their home
jurisdiction), the following treatment would apply. The assets and
liabilities of the subsidiary would be consolidated for purposes of
determining the bank holding company's risk-weighted assets. The bank
holding company, however, would deduct 50 percent from tier 1 capital
and 50 percent from tier 2 capital an amount equal to the insurance
underwriting subsidiary's minimum regulatory capital requirement as
determined by its functional (or equivalent) regulator. For U.S.
regulated insurance subsidiaries, this amount generally would be 200
percent of the subsidiary's Authorized Control Level as established by
the appropriate state insurance regulator. Under the general risk-based
capital rules, such subsidiaries typically are fully consolidated with
the bank holding company.
While the elements of tier 1 and tier 2 capital are the same across
the general risk-based capital rules, the advanced approaches final
rule, and this NPR, the deductions from those elements are different
for each of the three risk-based capital frameworks. As a result, each
framework has a distinct definition of tier 1, tier 2, and total
qualifying capital.
Securitization-related deductions create a significant difference
in the calculation of tier 1 and tier 2 capital across the three
frameworks. Under the general risk-based capital rules, only certain
CEIOs must be deducted from capital; all other high-risk exposures for
which dollar-for-dollar capital must be held may be ``grossed-up'' in
accordance with the regulatory reporting instructions, effectively
increasing the denominator of the risk-based capital ratio but not
affecting the numerator. In contrast, under the advanced approaches
final rule and this NPR, certain high risk securitization exposures
must be deducted directly from total capital. Other significant
differences in the definition of tier 1, tier 2, and total qualifying
capital across the three frameworks include the treatment of
nonfinancial equity investments for banks and bank holding companies,
certain equity investments for savings associations, certain unsettled
transactions, consolidated insurance underwriting subsidiaries of bank
holding companies, and the ALLL/eligible credit reserves.
The different definitions of tier 1, tier 2, and total capital
across the risk-based capital frameworks raise a number of issues. The
agencies clarified in the preamble to the advanced approaches rule that
a banking organization's tier 1 capital and tier 2 capital for all non-
regulatory-capital supervisory and regulatory purposes (for example,
lending limits and Regulation W quantitative limits) is the banking
organization's tier 1 capital and tier 2 capital as calculated under
the risk-based capital framework to which it is subject. The agencies
did not specifically state a position regarding the numerator of the
leverage ratio. One potential approach is for each banking organization
to use its applicable risk-based definition of tier 1 capital for
determining both the risk-based and leverage capital ratios. Another
potential approach is to define a numerator for the tier 1 leverage
ratio that would be the same for all banking organizations. This
approach could require banks to calculate one measure of tier 1 capital
for risk-based capital purposes and another measure of tier 1 capital
for leverage ratio purposes.\13\
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\13\ To the extent that the agencies decide to change the
numerator of the leverage ratio, they would propose such changes in
a separate rulemaking. As a related matter, the OTS advanced
approaches final rule incorrectly states that the leverage ratio is
calculated using the revised definition of tier 1 and tier 2
capital. This NPR would remove this provision until the agencies
conclusively resolve this matter.
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Question 4: Given the potential for three separate definitions of
tier 1 capital under the three frameworks, the agencies solicit comment
on all aspects of the tier 1 leverage ratio numerator, including issues
related to burden and competitive equity.
F. Calculation of Risk-Weighted Assets
(1) Total Risk-Weighted Assets
Under this NPR, a banking organization's total risk-weighted assets
would be the sum of its total risk-weighted assets for general credit
risk, unsettled transactions, securitization exposures, equity
exposures, and operational risk. Banking organizations that use the
market risk rule (MRR) would supplement their capital calculations with
those provisions.\14\
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\14\ 12 CFR part 3, Appendix B (national banks); 12 CFR part
208, Appendix E (state member banks); 12 CFR part 225, Appendix E
(bank holding companies); and 12 CFR part 325, Appendix C (state
nonmember banks). OTS intends to codify a market risk capital rule
for savings associations at 12 CFR part 567, Appendix D.
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(2) Calculation of Risk-Weighted Assets for General Credit Risk
For each of its general credit risk exposures (that is, credit
exposures that are not unsettled transactions subject to section 38 of
the proposed rule, securitization exposures, or equity exposures), a
banking organization must first determine the exposure amount and then
multiply that amount by the appropriate risk weight set forth in
section 33 of the proposed rule. General credit risk exposures include
exposures to sovereign entities; exposures to supranational entities
and multilateral development banks; exposures to public sector
entities; exposures to depository institutions, foreign banks, and
credit unions; corporate exposures; regulatory retail exposures;
residential mortgage exposures; pre-sold construction loans; statutory
multifamily mortgage exposures; and other assets.
Generally, the exposure amount for the on-balance sheet component
of an exposure is the banking organization's carrying value for the
exposure. If the exposure is classified as a security available for
sale, however, the exposure amount is the banking organization's
carrying value of the exposure adjusted for unrealized gains and
losses. The exposure amount for the off-balance sheet component of an
exposure is typically determined by multiplying the
[[Page 43989]]
notional amount of the off-balance sheet component by the appropriate
credit conversion factor (CCF) under section 34 of the proposed rule.
The exposure amount for over-the-counter (OTC) derivative contracts is
determined under section 35 of the proposed rule. Exposure amounts for
collateralized OTC derivative contracts, repo-style transactions, or
eligible margin loans may be determined under particular rules in
section 37 of the proposed rule.
(3) Calculation of Risk-Weighted Assets for Unsettled Transactions,
Securitization Exposures, and Equity Exposures
(a) Unsettled Transactions
Risk-weighted assets for specified unsettled and failed securities,
foreign exchange, and commodities transactions are calculated according
to paragraph (f) of section 38 of the proposed rule.\15\
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\15\ Certain transaction types are excluded from the scope of
section 38, as provided in paragraph (b) of section 38.
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(b) Securitization Exposures
Risk-weighted assets for securitization exposures are calculated
according to Part IV of the proposed rule. Generally, a banking
organization would calculate the risk-weighted asset amount of a
securitization exposure by multiplying the amount of the exposure as
determined in section 42 of the proposed rule by the appropriate risk
weight in section 43 of this NPR.
Part IV of the proposed rule provides a hierarchy of approaches for
calculating risk-weighted assets for securitization exposures. Among
the approaches included in Part IV is a ratings-based approach (RBA),
which calculates the risk-weighted asset amount of a securitization
exposure by multiplying the amount of the exposure by risk-weights that
correspond to the applicable external or applicable inferred rating of
the securitization. Part IV provides other treatments for specific
types of securitization exposures including deduction from capital for
certain exposures, and different risk-weighted asset computations for
certain securitizations exposures that do not qualify for the RBA and
for securitizations that have an early amortization provision.
(c) Equity Exposures
Risk-weighted assets for equity exposures are calculated according
to the rules in Part V of the proposed rule. Generally, risk-weighted
assets for equity exposures that are not exposures to investment funds
would be calculated according to the simple risk-weight approach (SRWA)
in section 52 of this proposed rule. Risk-weighted assets for equity
exposures to investment funds would, with certain exceptions, be
calculated according to one of three look-through approaches or, if the
investment fund qualifies, calculated according to the money market
fund approach. These approaches are described in section 53 of the
proposed rule.
(4) Calculation of Risk-Weighted Assets for Operational Risk
Risk-weighted assets for operational risk are calculated under the
BIA provided in section 61 of this proposed rule.
G. External and Inferred Ratings
(1) Overview
The agencies' general risk-based capital rules permit the use of
external ratings issued by a nationally recognized statistical rating
organization (NRSRO) to assign risk weights to recourse obligations,
direct credit substitutes, residual interests (other than a credit-
enhancing interest-only strip), and asset- and mortgage-backed
securities.\16\ Under the ratings-based approach in the general risk-
based capital rules, a banking organization must use the lowest NRSRO
external rating if multiple ratings exist. The approach also requires
one rating for a traded exposure and two ratings for a non-traded
exposure and allows the use of inferred ratings within a securitization
structure. When the agencies revised their general risk-based capital
rules to permit the use of external ratings issued by an NRSRO for
these exposures, the agencies acknowledged that these ratings
eventually could be used to determine the risk-based capital
requirements for other types of debt instruments, such as externally
rated corporate bonds.
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\16\ Some synthetic structures also may be subject to the
external rating approach. For example, certain credit-linked notes
issued from a synthetic securitization are risk weighted according
to the rating given to the notes. 66 FR 59614, 59622 (November 29,
2001).
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The New Accord would permit a banking organization to use external
ratings to determine risk weights for a broad range of exposures. It
also provides for the use of both inferred and, within certain
limitations, issuer ratings, but discourages the use of unsolicited
ratings. Generally consistent with the New Accord, and in response to
favorable comments on the Basel IA NPR's proposal to expand the use of
external ratings, the agencies propose that external, issuer, and
inferred ratings be used to risk weight various exposures.
This proposed use of ratings is a more risk-sensitive approach than
relying on membership in the Organization for Economic Cooperation and
Development (OECD) \17\ to differentiate the risk of exposures to
sovereign entities, depository institutions, foreign banks, and credit
unions. The proposed approach also would use a greater number of risk
weights than the general risk-based capital rules, which would further
improve the risk sensitivity of a banking organization's risk-based
capital requirements.
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\17\ The OECD-based group of countries comprises all full
members of the OECD, as well as countries that have concluded
special lending arrangements with the International Monetary Fund
(IMF) associated with the IMF's General Arrangements to Borrow. The
list of OECD countries is available on the OECD Web site at http://
www.oecd.org.
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Consistent with the agencies' general risk-based capital rules and
the advanced approaches final rule, the agencies propose to recognize
only credit ratings that are issued by an NRSRO. For the purposes of
this NPR, NRSRO means an entity registered with the U.S. Securities and
Exchange Commission (SEC) as an NRSRO under section 15E of the
Securities Exchange Act of 1934 (15 U.S.C. 78o-7).\18\
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\18\ See 17 CFR 240.17g-1. On September 29, 2006, the President
signed the Credit Rating Agency Reform Act of 2006 (``Reform Act'')
(Pub. L. 109-291) into law. The Reform Act requires a credit rating
agency that wants to represent itself as an NRSRO to register with
the SEC. The agencies may review their risk-based capital rules,
guidance and proposals from time to time to determine whether any
modification of the agencies' definition of an NRSRO is appropriate.
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(2) Use of External Ratings
Under this NPR, a banking organization would use the applicable
external rating of an exposure (for certain exposures that have
external ratings) to determine its risk weight. Additionally,
consistent with the New Accord, the banking organization would infer a
rating for certain exposures that do not have external ratings from the
issuer rating of the obligor or from the external rating of another
specific issue of the obligor. The agencies' proposal for the use of
external and inferred ratings, however, differs in some respects from
the New Accord, as described below.
(a) External Ratings
Under this NPR, an external rating means a credit rating that is
assigned by an NRSRO to an exposure, provided that the credit rating
fully reflects the entire amount of credit risk with regard to all
payments owed to the holder of the exposure. If, for example, a holder
is
[[Page 43990]]
owed principal and interest on an exposure, the credit rating must
fully reflect the credit risk associated with timely repayment of
principal and interest. If a holder is owed only principal on an
exposure, the credit rating must fully reflect only the credit risk
associated with timely repayment of principal. Furthermore, a credit
rating would qualify as an external rating only if it is published in
an accessible form and is or will be included in the transition
matrices made publicly available by the NRSRO that summarize the
historical performance of positions rated by the NRSRO. An external
rating may be either solicited or unsolicited by the obligor issuing
the rated exposure. This definition is consistent with the definition
of ``external rating'' in the advanced approaches final rule.
Under this NPR, a banking organization would determine the risk
weight for certain exposures with external ratings based on the
applicable external ratings of the exposures. If an exposure to a
sovereign or public sector entity (PSE), a corporate exposure, or a
securitization exposure has only one external rating, that rating is
the applicable external rating. If such an exposure has multiple
external ratings, the applicable external rating would be the lowest
external rating. This approach for determining the applicable external
rating differs from the New Accord. In the New Accord, if an exposure
has two external ratings, a banking organization would apply the lower
rating to the exposure to determine the risk weight. If an exposure has
three or more external ratings, the banking organization would use the
second lowest external rating to risk weight the exposure. The agencies
believe that the proposed approach, which is designed to mitigate the
potential for external ratings arbitrage, more reliably promotes safe
and sound banking practices.
(b) Inferred Ratings
Consistent with the New Accord, the agencies propose that a banking
organization must, subject to certain conditions, infer a rating on an
exposure to a sovereign entity or a PSE or on a corporate exposure that
does not have an applicable external rating (unrated exposure).\19\ An
inferred rating may be based on the issuer rating of the sovereign,
PSE, or corporate obligor or based on another externally rated exposure
of that obligor. Exposures with an inferred rating would be treated the
same as exposures with an identical external rating.
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\19\ The treatment of inferred ratings for securitization
exposures is discussed in section M.(4) of this preamble.
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(i) Determining Inferred Ratings
To determine the risk weight for an unrated exposure to a sovereign
entity or a PSE, or for an unrated corporate exposure, a banking
organization must first determine if, within the framework established
in this NPR, the exposure has one or more inferred ratings. An unrated
exposure may have inferred ratings based both on the issuer ratings of
the obligor and the external ratings of specific issues of the obligor.
A banking organization would not be able to use an external rating
assigned to an obligor or specific issues of the obligor to infer a
rating for an exposure to the obligor's affiliate.
(A) Inferred Rating Based on an Issuer Rating
Under this NPR, a senior unrated exposure to a sovereign entity or
a PSE, or a senior unrated corporate exposure where the corporate
issuer has one or more issuer ratings, has inferred ratings based on
those issuer ratings. For purposes of inferring a rating from an issuer
rating, a senior exposure would be an exposure that ranks at least pari
passu (that is, equal) with the obligor's general creditors in the
event of bankruptcy, insolvency, or other similar proceeding. This NPR
defines an issuer rating as a credit rating assigned by an NRSRO to the
obligor that reflects the obligor's capacity and willingness to satisfy
all of its financial obligations, and is published in an accessible
form and is or will be included in the transition matrices made
publicly available by the NRSRO that summarize the historical
performance of the NRSRO's ratings.
(B) Inferred Rating Based on a Specific Issue Rating
Under this NPR, an unrated exposure to a sovereign entity or a PSE,
or an unrated corporate exposure may have one or more inferred ratings
based on external ratings assigned to another exposure issued by the
obligor. An unrated exposure would have an inferred rating equal to the
external rating of another exposure issued by the same obligor and
secured by the same collateral (if any), if the externally rated
exposure: (i) Ranks pari passu with the unrated exposure (or at the
banking organization's option, is subordinated in all respects to the
unrated exposure); (ii) has a long-term rating; (iii) does not benefit
from any credit enhancement that is not available to the unrated
exposure, (iv) has an effective remaining maturity that is equal to or
longer than that of the unrated exposure, and (v) is denominated in the
same currency as the unrated exposure. The currency requirement would
not apply where the unrated exposure that is denominated in a foreign
currency arises from a participation in a loan extended by a
multilateral development bank or is guaranteed by a multilateral
development bank against convertibility and transfer risk. If the
banking organization's participation is only partially guaranteed
against convertibility and transfer risk, the banking organization
could use the external rating for the portion of the participation that
benefits from the multilateral development bank's participation. If the
externally rated exposure does not meet these requirements, it cannot
be used to infer a rating for the unrated exposure.
The inferred rating approach provides a special treatment for
inferred ratings from low-quality ratings (ratings that correspond to a
risk weight of 100 percent or greater for an exposure to a PSE and 150
percent for an exposure to a sovereign entity or a corporate exposure).
An unrated exposure would have inferred rating(s) equal to the long-
term external rating(s) of exposures with low-quality ratings that are
issued by the same obligor and that are senior in all respects to the
unrated exposure.
This approach for inferred ratings differs from the New Accord,
which would require that any low-quality rating of an exposure issued
by an obligor be assigned to any unrated exposure to the obligor. The
agencies have concluded that this treatment could result in an
inappropriately high capital charge in some circumstances. For example,
an obligor for business reasons may choose to issue subordinated debt
that receives a low-quality rating. The New Accord suggests this low-
quality rating should be assigned to unrated senior exposures of the
obligor, even if the unrated senior exposures are also senior to
exposures with a high-quality rating. Under this NPR, a banking
organization in that situation could assign the high-quality rating to
the unrated senior secured exposure.
(ii) Determining the Applicable Inferred Rating
Once a banking organization has determined all the inferred ratings
for an unrated exposure, it must determine the applicable inferred
rating for the exposure. Under this NPR, the applicable inferred rating
for an exposure that has only one inferred rating would be the inferred
rating. If the unrated exposure has two or more
[[Page 43991]]
inferred ratings, the applicable inferred rating would be the lowest
inferred rating.
The agencies believe that this approach for determining the
applicable inferred rating for an unrated exposure is appropriately
risk sensitive and consistent with the principles for use of external
ratings in this NPR and the advanced approaches final rule. The
agencies are aware, however, that the proposed use of unsolicited
external ratings in this NPR may raise certain issues. The New Accord
suggests that banking organizations generally should use solicited
ratings and expresses concern that NRSROs might potentially use
unsolicited ratings to put pressure on issuers to obtain solicited
ratings.
Question 5: The agencies seek comment on the use of solicited and
unsolicited external ratings as proposed in this NPR.
H. Risk-Weight Categories
(1) Exposures to Sovereign Entities
The agencies' general risk-based capital rules generally assign a
risk weight to an exposure to a sovereign entity based on the type of
exposure and membership of the sovereign in the OECD. Consistent with
the New Accord, the agencies propose to risk weight an exposure to a
sovereign entity based on the exposure's applicable external or
applicable inferred rating (see Table 1).\20\
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\20\ The ratings examples used throughout this document are
illustrative and do not express any preferences or determinations on
any NRSRO.
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For purposes of this NPR, sovereign entity means a central
government (including the U.S. government) or an agency, department,
ministry, or central bank of a central government. In the United
States, this definition would include the twelve Federal Reserve Banks.
The definition would not include commercial enterprises owned by the
central government that are engaged in activities involving trade,
commerce, or profit, which are generally conducted or performed in the
private sector.
Where a sovereign entity's banking supervisor allows a banking
organization under its jurisdiction to apply a lower risk weight to the
same exposure to that sovereign than Table 1 provides, a U.S. banking
organization would be able to assign that lower risk weight to its
exposures to that sovereign entity provided the exposure is denominated
in that sovereign entity's domestic currency, and the banking
organization has at least the equivalent amount of liabilities in that
currency.
Table 1.--Exposures to Sovereign Entities
------------------------------------------------------------------------
Applicable external or applicable
inferred rating for an exposure to Example Risk weight
a sovereign entity (in percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 0
Second-highest investment grade AA................. 0
rating.
Third-highest investment grade A.................. 20
rating.
Lowest investment grade rating..... BBB................ 50
One category below investment grade BB................. 100
Two categories below investment B.................. 100
grade.
Three categories or more below CCC................ 150
investment grade.
No applicable rating............... N/A................ 100
------------------------------------------------------------------------
(2) Exposures to Certain Supranational Entities and Multilateral
Development Banks
Consistent with the New Accord's treatment of exposures to
supranational entities, the agencies propose to assign a zero percent
risk weight to exposures to the Bank for International Settlements, the
European Central Bank, the European Commission, and the International
Monetary Fund.
Generally consistent with the New Accord, the agencies also propose
that an exposure to a multilateral development bank (MDB) receive a
zero percent risk weight. This proposed risk weight would apply only to
those MDBs listed below and is based on the generally high credit
quality of these MDBs, their strong shareholder support, and a
shareholder structure comprised of a significant proportion of
sovereign entities with high quality issuer ratings. In this NPR, MDB
means the International Bank for Reconstruction and Development, the
International Finance Corporation, the Inter-American Development Bank,
the Asian Development Bank, the African Development Bank, the European
Bank for Reconstruction and Development, the European Investment Bank,
the European Investment Fund, the Nordic Investment Bank, the Caribbean
Development Bank, the Islamic Development Bank, the Council of Europe
Development Bank, and any other multilateral lending institution or
regional development bank in which the U.S. government is a shareholder
or contributing member or which the primary Federal supervisor
determines poses comparable credit risk. Exposures to regional
development banks and multilateral lending institutions that do not
meet these requirements would generally be treated as corporate
exposures.
(3) Exposures to Depository Institutions, Foreign Banks, and Credit
Unions
The agencies' general risk-based capital rules assign a risk weight
of 20 percent to all exposures to U.S. depository institutions, foreign
banks, and credit unions incorporated in an OECD country. Short-term
exposures to such entities incorporated in a non-OECD country receive a
20 percent risk weight and long-term exposures to such entities in
these countries receive a 100 percent risk weight.
Since this NPR eliminates the OECD/non-OECD distinction, the
agencies propose that exposures to a depository institution, a foreign
bank, or a credit union receive a risk weight based on the lowest
issuer rating of the entity's sovereign of incorporation. In this NPR,
sovereign of incorporation means the country where an entity is
incorporated, chartered, or similarly established. In general,
exposures to a depository institution, foreign bank, or credit union
would receive a risk weight one category higher than the risk weight
assigned to an exposure to the entity's sovereign of incorporation. For
exposures to a depository institution, foreign bank, or credit union
where the sovereign of incorporation is rated one or two categories
below investment grade or is unrated, the risk weight
[[Page 43992]]
would be 100 percent. If the sovereign of incorporation is rated three
or more categories below investment grade, these exposures would
receive a risk weight of 150 percent. Table 2 illustrates the proposed
risk weights for exposures to depository institutions, foreign banks,
and credit unions. A depository institution is defined as in section 3
of the Federal Deposit Insurance Act (12 U.S.C. 1813), and foreign bank
means a foreign bank as defined in section 211.2 of the Federal Reserve
Board's Regulation K (12 CFR 211.2) other than a depository
institution.
Table 2.--Exposures to Depository Institutions, Foreign Banks, and
Credit Unions
------------------------------------------------------------------------
Exposure risk
Lowest issuer rating of the Example weight (in
sovereign of incorporation percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 20
Second-highest investment grade AA................. 20
rating.
Third-highest investment grade A.................. 50
rating.
Lowest investment grade rating..... BBB................ 100
One category below investment grade BB................. 100
Two categories below investment B.................. 100
grade.
Three categories or more below CCC................ 150
investment grade.
No issuer rating................... N/A................ 100
------------------------------------------------------------------------
Consistent with the general risk-based capital rules and the New
Accord, exposures to a depository institution or foreign bank that are
includable in the regulatory capital of that institution would receive
a risk weight no lower than 100 percent unless the exposure is subject
to deduction as a reciprocal holding.\21\
---------------------------------------------------------------------------
\21\ 12 CFR part 3, Appendix A, section 2(c)(6)(ii) (OCC); 12
CFR parts 208 and 225, Appendix A, section II.B.3 (FRB); 12 CFR part
325, Appendix A, I.B.(4) (FDIC); and 12 CFR 567.5(c)(2)(i) (OTS).
---------------------------------------------------------------------------
The proposal outlined above is consistent with one of the two
options available in the New Accord for risk weighting claims on banks.
The alternative approach, which the agencies propose for exposures to
PSEs, risk weights exposures based on the applicable external or
applicable inferred rating of the exposures. This alternative approach
for exposures to PSEs is described below.
Question 6: The agencies seek comment on this proposed approach, as
well as on the appropriateness of applying the alternative approach to
exposures to depository institutions, credit unions, and foreign banks.
(4) Exposures to Public Sector Entities (PSEs)
The agencies' general risk-based capital rules assign a 20 percent
risk weight to general obligations of states and other political
subdivisions of OECD countries.\22\ Exposures to entities that rely on
revenues from specific projects, rather than general revenues (for
example, revenue bonds), receive a risk weight of 50 percent.
Generally, other exposures to state and political subdivisions of OECD
countries (including industrial revenue bonds) and exposures to
political subdivisions of non-OECD countries receive a risk weight of
100 percent.
---------------------------------------------------------------------------
\22\ Political subdivisions of the United States include a
state, county, city, town or other municipal corporation, a public
authority, and generally any publicly owned entity that is an
instrument of a state or municipal corporation.
---------------------------------------------------------------------------
Consistent with the New Accord, the agencies propose that an
exposure to a PSE receive a risk weight based on the applicable
external or applicable inferred rating of the exposure. This approach
would apply to both general obligation and revenue bonds. In no case,
however, may an exposure to a PSE receive a risk weight that is lower
than the risk weight that corresponds to the lowest issuer rating of a
PSE's sovereign of incorporation (see Table 1 for risk weights for
exposures to sovereign entities).
The proposed rule defines a PSE as a state, local authority, or
other governmental subdivision below the level of a sovereign entity.
This definition would not include commercial companies owned by a
government that engage in activities involving trade, commerce, or
profit, which are generally conducted or performed in the private
sector. Table 3 illustrates the risk weights for exposures to PSEs.
Table 3.--Exposures to Public Sector Entities: Long-Term Credit Rating
------------------------------------------------------------------------
Applicable external or applicable
inferred rating of an exposure to a Example Risk weight
PSE (in percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 20
Second-highest investment grade AA................. 20
rating.
Third-highest investment grade A.................. 50
rating.
Lowest investment grade rating..... BBB................ 50
One category below investment grade BB................. 100
Two categories below investment B.................. 100
grade.
Three categories or more below CCC................ 150
investment grade.
No applicable rating............... N/A................ 50
------------------------------------------------------------------------
The New Accord also suggests that a national supervisor may permit
a banking organization to assign a risk weight to an exposure to a PSE
as if it were an exposure to the sovereign entity in whose jurisdiction
the PSE is established. The agencies are not proposing to risk weight
exposures to PSEs in the United States in this manner. In certain
cases, however, the agencies have allowed a banking organization to
rely on the risk weight
[[Page 43993]]
that a foreign banking supervisor assigns to its own PSEs. Therefore,
the agencies propose to allow a banking organization to risk weight an
exposure to a foreign PSE according to the risk weight that the foreign
banking supervisor assigns. In no event, however, could the risk weight
for an exposure to a foreign PSE be lower than the lowest risk weight
assigned to that PSE's sovereign of incorporation.
The New Accord contains an alternative approach to risk weight
exposures to a PSE, which is based on the lowest issuer rating of the
PSE's sovereign of incorporation. The agencies are proposing this
approach for exposures to depository institutions, foreign banks, and
credit unions as described in the previous section.
Question 7: The agencies seek comment on the pros and cons of the
proposed approach for risk weighting exposures to PSEs as well as on
the appropriateness of applying, instead, the approach proposed in this
NPR for depository institutions.
The New Accord does not incorporate the use of short-term ratings
for exposures to PSEs. The agencies recognize, however, that an NRSRO
may assign a short-term municipal rating to an exposure to a PSE that
has a maturity of up to three years (for example, a bond anticipation
note). Further, the agencies understand that there are different
techniques for comparing these short-term ratings to other types of
ratings, both short-term and long-term. The agencies are considering
whether to permit the use of these short-term ratings for risk
weighting short-term exposures to PSEs using the risk weights in Table
4.
Table 4.--Public Sector Entities: Short-Term Ratings
------------------------------------------------------------------------
Applicable external rating of an Risk weight
exposure to a PSE Example (in percent)
------------------------------------------------------------------------
Highest investment grade........... SP-1/MIG-1......... 20
Second-highest investment grade.... SP-2/MIG-2......... 50
Third-highest investment grade..... SP-3/MIG-3......... 100
Below investment grade............. Non-prime.......... 150
No applicable external rating...... N/A................ 50
------------------------------------------------------------------------
Question 8: The agencies solicit comment on the use of short-term
ratings for exposures to PSEs generally and specifically on the ratings
and related risk weights in Table 4.
(5) Corporate Exposures
Under the agencies' general risk-based capital rules, most
corporate exposures receive a risk weight of 100 percent. Exposures to
securities firms incorporated in the United States or in an OECD
country may receive a 20 percent risk weight if they meet certain
requirements, and exposures to U.S. government-sponsored agencies or
entities (GSEs) may also receive a 20 percent risk weight. GSEs include
an agency or corporation originally established or chartered by the
U.S. Government to serve public purposes specified by the U.S.
Congress, but whose obligations are not explicitly guaranteed by the
full faith and credit of the U.S. Government.
In this NPR, corporate exposure means a credit exposure to a
natural person or a company (including an industrial development bond,
an exposure to a GSE, or an exposure to a securities broker or dealer)
that is not an exposure to: a sovereign entity, the Bank for
International Settlements, the European Central Bank, the European
Commission, the International Monetary Fund, an MDB, a depository
institution, a foreign bank, a credit union, or a PSE; a regulatory
retail exposure; a residential mortgage exposure; a pre-sold
construction loan; a statutory multifamily mortgage; a securitization
exposure; or an equity exposure.
Consistent with the New Accord, the agencies propose to permit a
banking organization to elect one of two methods to risk weight
corporate exposures. Regardless of the method a banking organization
chooses, it would have to use that approach consistently for all
corporate exposures. First, a banking organization could risk weight
all of its corporate exposures at 100 percent without regard to
external ratings. Second, a banking organization could risk weight a
corporate exposure based on its applicable external or applicable
inferred rating. Table 5 provides the proposed risk weights for
corporate exposures with applicable external or applicable inferred
ratings based on long-term credit ratings. Table 6 provides the
proposed risk weights for corporate exposures with applicable external
ratings based on short-term credit ratings.
If a corporate exposure has no external rating, that exposure could
not receive a risk weight lower than the risk weight that corresponds
to the lowest issuer rating of the obligor's sovereign of incorporation
in Table 1. In addition, if an obligor has any exposure with a short-
term external rating that corresponds to a risk weight of 150 percent
under Table 6, a banking organization would assign a 150 percent risk
weight to any corporate exposure to that obligor that does not have an
external rating and that ranks pari passu with or is subordinated to
the externally rated exposure.
Table 5.--Corporate Exposures: Long-Term Credit Rating
------------------------------------------------------------------------
Exposure risk
Applicable external or applicable Example weight (in
inferred rating percent)
------------------------------------------------------------------------
Highest investment grade rating.... AAA................ 20
Second-highest investment grade AA................. 20
rating.
Third-highest investment grade A.................. 50
rating.
Lowest investment grade rating..... BBB................ 100
One category below investment grade BB................. 100
Two categories below investment B.................. 150
grade.
Three categories or more below CCC................ 150
investment grade.
No applicable rating............... N/A................ 100
------------------------------------------------------------------------
[[Page 43994]]
Table 6.--Corporate Exposures: Short-Term Credit Rating
------------------------------------------------------------------------
Exposure risk
Applicable external rating Example weight (in
percent)
------------------------------------------------------------------------
Highest investment grade........... A-1/P-1............ 20
Second-highest investment grade.... A-2/P-2............ 50
Third-highest investment grade..... A-3/P-3............ 100
Below investment grade............. B, C, and non-prime 150
No applicable external rating...... N/A................ 100
------------------------------------------------------------------------
As provided in the New Accord, this NPR (outside of the
securitization framework) would not allow a banking organization to
infer a rating from an exposure based on a short-term external rating.
Consistent with this position, this NPR does not include the New Accord
provision that assigns a risk weight of at least 100 percent to all
unrated short-term exposures of an obligor if any rated short-term
exposure of that obligor receives a 50 percent risk weight.
Question 9: The agencies seek comment on the appropriateness of
including either or both of these aspects of the New Accord in any
final rule implementing the standardized framework.
The New Accord would treat securities firms that meet certain
requirements like depository institutions. The agencies propose,
however, to risk weight exposures to securities firms as corporate
exposures, parallel with the treatment of bank holding companies and
savings association holding companies.
The agencies also propose that exposures to GSEs be treated as
corporate exposures and risk weighted based on the NRSRO credit
ratings. These ratings on individual GSE exposures are often based in
part on the NRSRO assessments of the extent to which the U.S.
government might come to the financial aid of a GSE. The agencies
believe that risk-weight determinations should not be based on the
possibility of U.S. government financial assistance, except where the
U.S. government has legally committed to provide such assistance.
In addition to the credit ratings on individual GSE exposures, the
NRSROs also publish issuer ratings that evaluate the financial strength
of some GSEs without respect to any implied financial assistance from
the U.S. government. These financial strength ratings are monitored by
the issuing NRSROs but are not included in the NRSROs' transition
matrices. Accordingly, the financial strength ratings would not meet
the definition of an external rating in this NPR. Further, the use of
these ratings is also problematic because NRSROs provide financial
strength ratings for issuers, but not for specific issues, and do not
provide the same level of differentiation between short- and long-term
debt and various levels of subordination as NRSRO ratings of specific
exposures. In addition, NRSROs have not published financial strength
ratings for all GSEs.
Question 10: The agencies seek comment on the use of financial
strength ratings to determine risk weights for exposures to GSEs, and
seek comment on how such ratings might be applied. The agencies also
seek input on how subordination and maturity of exposures could be
embodied in such an approach, and what requirements should be developed
for recognizing ratings assigned to GSEs.
(6) Regulatory Retail Exposures
The general risk-based capital rules generally assign a risk weight
of 100 percent to non-mortgage retail exposures, secured or unsecured,
including personal, auto, and credit card loans. Consistent with the
New Accord, the agencies propose that a banking organization apply a 75
percent risk weight to regulatory retail exposures that meet the
following criteria: (i) A banking organization's aggregate exposure to
a single obligor does not exceed $1 million; (ii) the exposure is part
of a well diversified portfolio; and (iii) the exposure is not an
exposure to a sovereign entity, the Bank for International Settlements,
the European Central Bank, the European Commission, the International
Monetary Fund, an MDB, a PSE, a depository institution, a foreign bank,
or a credit union; an acquisition, development and construction loan; a
residential mortgage exposure; a pre-sold construction loan; a
statutory multifamily mortgage; a securitization exposure; an equity
exposure; or a debt security. Examples of regulatory retail exposures
would include a revolving credit or line of credit (including credit
card and overdraft lines of credit), a personal term loan or lease
(including an installment loan, auto loan or lease, student or
educational loan, personal loan), and a facility or commitment to a
company.
Any retail exposure that does not meet these requirements generally
would be considered a corporate exposure and would receive a risk
weight based on the risk-weight tables for corporate exposures (see
Tables 5 and 6).
Question 11: The agencies seek comment on whether a specific
numerical limit on concentration should be incorporated into the
provisions for regulatory retail exposures. For example, the New Accord
suggests a 0.2 percent limit on an aggregate exposure to one obligor as
a measure of concentration within the regulatory retail portfolio. The
agencies solicit comment on the appropriateness of a 0.2 percent limit
as well as on other types of measures of portfolio concentration that
may be appropriate.
(7) Residential Mortgage Exposures
The general risk-based capital rules assign exposures secured by
one-to-four family residential properties to either the 50 percent or
100 percent risk weight category. Most exposures secured by a first
lien on a one-to-four family residential property meet the criteria to
receive a 50 percent risk weight.\23\ The New Accord applies a
similarly broad treatment to residential mortgages. It provides a risk
weight of 35 percent for most first-lien residential mortgage exposures
that meet prudential criteria such as the existence of a substantial
margin of additional security over the amount of the loan.
---------------------------------------------------------------------------
\23\ 12 CFR part 3, Appendix A, section 3(c)(iii) (OCC); 12 CFR
parts 208 and 225, Appendix A, section III.C.3 (Board); 12 CFR part
325, Appendix A, section II.C.3 (FDIC); and 12 CFR 567.1 (definition
of ``qualifying mortgage loan'') and 12 CFR 567.6(a)(1)(iii)(B) (50
percent risk weight) (OTS).
---------------------------------------------------------------------------
In the Basel IA NPR, the agencies proposed to assign a risk weight
for one-to-four family residential mortgage exposures based on the LTV
ratio. The agencies noted that the LTV ratio is a meaningful indicator
of potential loss and borrower default. Commenters on the Basel IA NPR
generally supported
[[Page 43995]]
this LTV ratio approach. In this NPR, the agencies propose
substantially the same treatment for residential mortgage exposures as
was proposed in the Basel IA NPR. Given the characteristics of the U.S.
residential mortgage market, the agencies believe that the risk weights
in the New Accord do not reflect the appropriate spectrum of risk for
these assets. The agencies believe the wider range of risk weights that
the agencies proposed in the Basel IA NPR is more appropriate for the
U.S. residential mortgage market.
The agencies believe that an LTV ratio approach to residential
mortgage exposures would not impose a significant burden on banking
organizations because LTV information is readily available and is
commonly used in the underwriting process. Use of LTV ratios to assign
risk weights to residential mortgage exposures would not substitute
for, or otherwise release a banking organization from, its
responsibility to have prudent loan underwriting and risk management
practices consistent with the size, type, and risk of its mortgage
business.\24\ Through the supervisory process, the agencies would
continue to assess a banking organization's underwriting and risk
management practices consistent with supervisory guidance and safety
and soundness. The agencies would continue to use their supervisory
authority to require a banking organization to hold additional capital
for residential mortgage exposures where appropriate.
---------------------------------------------------------------------------
\24\ See, for example, ``Interagency Guidance on Nontraditional
Mortgage Product Risks,'' 71 FR 58609 (Oct. 4, 2006) and ``Statement
on Subprime Mortgage Lending,'' 72 FR 37569 (July 10, 2007).
---------------------------------------------------------------------------
The proposed rule defines a residential mortgage exposure as an
exposure (other than a pre-sold construction loan) that is primarily
secured by a one-to-four family residential property. The proposed rule
identifies two types of residential mortgage exposures (first-lien
residential mortgage exposures and junior-lien residential mortgage
exposures), and provides a separate treatment for each type of
exposure. A first-lien residential mortgage exposure is a residential
mortgage exposure secured by a first lien or a residential mortgage
exposure secured by first and junior lien(s) where no other party holds
an intervening lien. This treatment is similar to the treatment of
mortgage exposures under the general risk-based capital rules. A
junior-lien residential mortgage exposure is a residential mortgage
exposure that is secured by a junior lien and that is not a first-lien
residential mortgage exposure.
(a) Exposure Amount
The proposed rule provides that a banking organization would hold
capital for both the funded and the unfunded portions of residential
mortgage exposures. For the funded portion of a residential mortgage
exposure, the banking organization would assign a risk weight to the
carrying value of the exposure (that is, the principal amount of the
exposure). For the unfunded portion of a residential mortgage exposure
(for example, potential exposure from a negative amortization feature
or a home equity line of credit (HELOC)), a banking organization would
risk weight the notional amount of the exposure (that is, the maximum
contractual commitment) multiplied by the appropriate credit conversion
factor. For a residential mortgage exposure that has both funded and
unfunded components, a banking organization would calculate separate
risk-weighted asset amounts for the unfunded and funded portions, based
on separately calculated LTV ratios as discussed below.
(b) Risk Weights
The agencies propose that a banking organization risk weight first-
lien residential mortgage exposures that meet certain qualifying
criteria according to Table 7. The risk weights in Table 7 would apply
only to a first-lien residential mortgage exposure that is secured by
property that is owner-occupied or rented, is prudently underwritten,
is not 90 days or more past due, and is not on nonaccrual. A first-lien
residential mortgage exposure that has been restructured may receive a
risk weight lower than 100 percent, only if the banking organization
updates the LTV ratio at the time of the restructuring and according to
the discussion below and in section 33 of the proposed rule. First-lien
residential mortgage exposures that do not meet these criteria would
receive a 100 percent risk weight if they have an LTV ratio less than
or equal to 90 percent, and would receive a 150 percent risk weight if
they have an LTV ratio greater than 90 percent.
Table 7.--Risk Weights for First-Lien Residential Mortgage Exposures
------------------------------------------------------------------------
Risk weight
Loan-to-value ratio (in percent) (in percent)
------------------------------------------------------------------------
Less than or equal to 60................................ 20
Greater than 60 and less than or equal to 80............ 35
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
------------------------------------------------------------------------
Under the general risk-based capital rules, a banking organization
must assign a risk weight to an exposure secured by a junior lien on
residential property at 100 percent, unless the banking organization
also holds the first lien and there are no intervening liens. The New
Accord does not specifically discuss the treatment of exposures secured
by junior liens on residential property.
The agencies continue to believe that stand-alone junior-lien
residential mortgage exposures have a different risk profile than
first-lien residential mortgage exposures and should be risk weighted
accordingly. Under the proposed rule, a banking organization would
compute an LTV ratio as described below for a junior-lien residential
mortgage exposure that is not 90 days or more past due or on nonaccrual
based upon the loan amounts for the junior-lien residential mortgage
exposure and all senior exposures as described below. The banking
organization would then assign a risk weight to the exposure amount of
the junior-lien residential mortgage exposure according to Table 8.
This treatment is similar to the Basel IA NPR and recognizes that
stand-alone junior-lien residential mortgage exposures generally
default at a higher rate than first-lien residential mortgage
exposures. A banking organization would risk weight a junior-lien
residential mortgage exposure that is 90 days or more past due or on
nonaccrual at 150 percent.
Table 8.--Risk Weights for Junior-Lien Residential Mortgage Exposures
------------------------------------------------------------------------
Risk weight
Loan-to-value ratio (in percent) (in percent)
------------------------------------------------------------------------
Less than or equal to 60................................ 75
Greater than 60 and less than or equal to 90............ 100
Greater than 90......................................... 150
------------------------------------------------------------------------
[[Page 43996]]
(c) Loan-to-Value Ratio Calculation
The agencies propose that a banking organization calculate the LTV
ratio on an ongoing basis as described below. The denominator of the
LTV ratio, that is, the value of the property, would be equal to the
lesser of the acquisition cost for the property (for a purchase
transaction) or the estimate of a property's value at the origination
of the exposure or, at the banking organization's option, at the time
of restructuring. The estimate of value would be based on an appraisal
or evaluation of the property in conformance with the agencies'
appraisal regulations \25\ and should conform to the ``Interagency
Appraisal and Evaluation Guidelines'' \26\ and the ``Real Estate
Lending Guidelines.'' \27\ If a banking organization's first-lien
residential mortgage exposure consists of both first and junior liens
on a property, a banking organization could update the estimate of
value at the origination of the junior-lien mortgage.
---------------------------------------------------------------------------
\25\ 12 CFR part 34, subpart C (OCC); 12 CFR part 208, subpart E
and part 225, subpart G (Board); 12 CFR part 323 (FDIC); and 12 CFR
part 564 (OTS).
\26\ ``The Comptroller's Handbook for Commercial Real Estate and
Construction Lending'', Appendix E (OCC); SR 94-55 (Board); FIL-74-
94 (FDIC); and 12 CFR part 564 (OTS).
\27\ 12 CFR part 34, subpart D, Appendix A (OCC); 12 CFR part
208, subpart E, Appendix C and part 225, subpart G (Board); 12 CFR
part 365 (FDIC); and 12 CFR 560.100-101 (OTS).
---------------------------------------------------------------------------
The numerator of the ratio, that is, the loan amount, would depend
on whether the exposure is funded or unfunded, and on whether the
exposure is a first-lien residential mortgage exposure or a junior-lien
residential mortgage exposure. The loan amount of the funded portion of
a first-lien residential mortgage exposure would be the principal
amount of the exposure. The loan amount of the funded portion of a
junior-lien residential mortgage exposure would be the principal amount
of the exposure plus the maximum contractual amounts of all senior
exposures secured by the same residential property. Senior unfunded
commitments may include negative amortization features and HELOCs.
A banking organization would be required to calculate a separate
loan amount and LTV ratio for the unfunded portion of a residential
mortgage exposure. The loan amount of the unfunded portion of a
residential mortgage exposure would be the loan amount of the funded
portion of the exposure, as described above, plus the unfunded portion
of the maximum contractual amount of the commitment.
The agencies believe that a banking organization should be able to
reflect the risk mitigating effects of loan-level private mortgage
insurance (PMI) when calculating the LTV ratio of a residential
mortgage exposure. Loan-level PMI is insurance that protects a lender
in the event of borrower default up to a predetermined portion of the
residential mortgage exposure and that does not have a pool-level cap
that could effectively reduce coverage below the predetermined amount
of the exposure. Under this proposed rule, a banking organization could
reduce the loan amount of a residential mortgage exposure up to the
amount covered by loan-level PMI, provided the PMI issuer is a
regulated mortgage insurance company, is not an affiliate \28\ of the
banking organization, and (i) has long-term senior debt (without credit
enhancement) that has an external rating that is in at least the third-
highest investment grade rating category or (ii) has a claims-paying
rating that is in at least the third-highest investment grade rating
category. The agencies believe that pool-level PMI generally should not
be reflected in the calculation of the LTV ratio, because pool-level
PMI is not structured in such a way that a banking organization can
determine the LTV ratio for a mortgage loan.
---------------------------------------------------------------------------
\28\ An affiliate of a banking organization is defined as any
company that controls, is controlled by, or is under common control
with, the banking organization. A person or company controls a
company if it: (i) Owns, controls, or holds the power to vote 25
percent or more of a class of voting securities of the company, or
(ii) consolidates the company for financial reporting purposes.
---------------------------------------------------------------------------
Question 12: The agencies request comment on all aspects of the
proposed treatment of PMI under this framework.
(d) Example of LTV Ratio Calculation
Assume a banking organization originates a first-lien residential
mortgage exposure with a negative amortization feature; the property is
valued at $100,000; the original and outstanding principal amount of
the exposure is $81,000; and the negative amortization feature has a 10
percent cap and extends for ten years (that is, the mortgage loan
balance can contractually negatively amortize to 110 percent of the
original balance over the next 10 years). The funded loan amount of
$81,000 has an 81 percent LTV ratio, which is risk weighted at 50
percent (based on Table 7). The negative amortization feature is an
unfunded commitment with a maximum contractual amount of $8,100. It
would receive a 50 percent CCF, resulting in an exposure amount of
$4,050. The loan amount of the unfunded portion would be $81,000 funded
amount plus the $8,100 maximum contractual unfunded amount, resulting
in an LTV of 89.1 percent. The unfunded commitment exposure amount of
$4,050 would therefore receive a 75 percent risk weight (based on Table
7). The total risk-weighted assets for the exposure would be $43,538,
as illustrated in Table 9:
Table 9.--Example of Proposed Risk-Based Capital Calculation for First-
Lien Residential Mortgage Exposures With Negative Amortization Features
------------------------------------------------------------------------
------------------------------------------------------------------------
Funded Risk-Weighted Assets Calculation
------------------------------------------------------------------------
(1) Amount to Risk Weight............................... $81,000
(2) Funded LTV Ratio = Funded Loan Amount / Property 81%
Value = $81,000/$100,000 =.............................
(3) Risk Weight based on Table 7........................ 50%
(4) RW Assets for Funded Loan Amount = $81,000 x .50 =.. $40,500
------------------------------------------------------------------------
Unfunded Risk-Weighted Assets Calculation
------------------------------------------------------------------------
(1) Exposure Amount = Unfunded Maximum Amount x CCF = $4,050
$8,100 x .50 =.........................................
(2) Unfunded LTV Ratio = (Funded Amount + Unfunded 89.1%
Amount)/Property Value = ($81,000 + $8,100)/$100,000 =.
(3) Risk Weight based on Table 7........................ 75%
(4) RW Assets for Unfunded Amount = $4,050 x 0.75....... $3,038
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[[Page 43997]]
Total Risk-Weighted Assets for a Loan with Negative Amortizing Features
------------------------------------------------------------------------
RW Assets for Funded Amount + RW for Unfunded Amount = $43,538
$40,500 + $3,038 =.....................................
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Note: The funded and unfunded amount of the loan will change over time
once the loan begins to negatively amortize.
(e) Alternative LTV Ratio Calculation
The agencies are considering an alternative for calculating the LTV
ratio and risk-weighted asset amount for residential mortgage exposures
with unfunded commitments. This alternative is less complex but may
result in different capital implications. Under the alternative, a
banking organization would not calculate a separate risk-weighted asset
amount for the funded and unfunded portion of the residential mortgage
exposure. The alternative calculation would require only the
calculation of a single LTV ratio representing a combined funded and
unfunded amount when calculating the LTV ratio for a given exposure.
Under the alternative, the loan amount of a first-lien residential
mortgage exposure would equal the funded principal amount (or combined
exposures provided there is no intervening lien) plus the exposure
amount of any unfunded commitment (that is, the unfunded amount of the
maximum contractual amount of any commitment multiplied by the
appropriate CCF). The loan amount of a junior-lien residential mortgage
exposure would equal the sum of: (i) The funded principal amount of the
exposure, (ii) the exposure amount of any undrawn commitment associated
with the junior-lien exposure, and (iii) the exposure amount of any
senior exposure held by a third party on the date of origination of the
junior-lien exposure. Where a senior exposure held by a third party
includes an undrawn commitment, such as a HELOC or a negative
amortization feature, the loan amount for a junior-lien residential
mortgage exposure would include the maximum contractual amount of that
commitment multiplied by the appropriate CCF. The denominator of the
LTV ratio would be the same under both alternatives.
Question 13: The agencies seek comment on the pros and cons
associated with the two alternatives for calculating the LTV ratio.
While the agencies believe risk weighting one-to-four family
residential mortgage exposures based on the LTV ratio appropriately
captures a large number of mortgage exposures with differing risk, the
agencies have considered basing the risk weight for these exposures on
other parameters. Examples include using pricing information that the
Home Mortgage Disclosure Act (HMDA) requires many banking organizations
to report, or borrower credit scores.
Question 14: The agencies seek industry views on any other risk-
sensitive methods that could be used to segment residential mortgage
exposures by risk level and solicit comment on how such alternatives
might be applied.
(8) Pre-Sold Construction Loans and Statutory Multifamily Mortgages
The general risk-based capital rules assign 50 percent and 100
percent risk weights to certain one-to-four family residential pre-sold
construction loans and multifamily residential loans. The agencies
adopted these provisions as a result of the Resolution Trust
Corporation Refinancing, Restructuring, and Improvement Act of 1991
(RTCRRI Act). The RTCRRI Act mandates that each agency provide in its
capital regulations (i) a 50 percent risk weight for certain one-to-
four-family residential pre-sold construction loans and multifamily
residential loans that meet specific statutory criteria in the RTCRRI
Act and any other underwriting criteria imposed by the agencies, and
(ii) a 100 percent risk weight for one-to-four-family residential pre-
sold construction loans for residences for which the purchase contract
is cancelled.
Consistent with the RTCRRI Act, a pre-sold construction loan would
be subject to a 50 percent risk weight unless the purchase contract is
cancelled. The NPR defines a pre-sold construction loan as any one-to-
four family residential pre-sold construction loan for a residence
meeting the requirements under section 618(a)(1) or (2) of the RTCRRI
Act and under 12 CFR part 3, Appendix A, section 3(a)(3)(iv) (for
national banks); 12 CFR part 208, Appendix A, section III.C.3. (for
state member banks); 12 CFR part 225, Appendix A, section III.C.3. (for
bank holding companies); 12 CFR part 325, Appendix A, section II.C.
(for state nonmember banks), and that is not 90 days or more past due
or on nonaccrual; or 12 CFR 567.1 (definition of ``qualifying
residential construction loan'') (for savings associations), and that
is not on nonaccrual.
Also consistent with the RTCRRI Act, under the NPR, a statutory
multifamily mortgage would receive a 50 percent risk weight. The NPR
defines statutory multifamily mortgage as any multifamily residential
mortgage meeting the requirements under section 618(b)(1) of the RTCRRI
Act, and under 12 CFR part 3, Appendix A, section 3(a)(3)(v) (for
national banks); 12 CFR part 208, Appendix A, section III.C.3. (for
state member banks); 12 CFR part 225, Appendix A, section III.C.3. (for
bank holding companies); 12 CFR part 325, Appendix A, section II.C.a.
(for state nonmember banks); or 12 CFR 567.1 (definition of
``qualifying multifamily mortgage loan'') and 12 CFR 567.6(a)(1)(iii)
(for savings associations), and that is not on nonaccrual.\29\ A
multifamily mortgage that does not meet the definition of a statutory
mortgage would be treated as a corporate exposure.
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\29\ Under these proposed definitions, a loan that is 90 days or
more past due or on nonaccrual would not qualify as a pre-sold
construction loan or a statutory multifamily mortgage. These loans
would be accorded the treatment described in the next section.
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(9) Past Due Loans
Under the general risk-based capital rules, the risk weight of a
loan generally does not change if the loan becomes past due, with the
exception of certain residential mortgage loans. The New Accord
provides risk weights ranging from 50 to 150 percent for loans that are
more than 90 days past due, depending on the amount of specific
provisions a banking organization has recorded.
Most banking organizations in the United States do not recognize
specific provisions. Therefore, the treatment of past due exposures in
the New Accord is not applicable for those banking organizations.
Accordingly, to reflect impaired credit quality, the agencies propose
to risk weight most exposures that are 90 days or more past due or on
nonaccrual at 150 percent, except for past due residential mortgage
exposures. A banking organization could reduce the risk weight of the
exposure to reflect financial collateral or eligible guarantees.
[[Page 43998]]
Question 15: The agencies seek comment on whether, for those
banking organizations that are required to maintain specific
provisions, it would be appropriate to follow the New Accord treatment,
that is, the risk weight would vary depending on the amount of specific
provisions the banking organization has recorded.
(10) Other Assets
The agencies propose to use the following risk weights, which are
generally consistent with the risk weights in the general risk-based
capital rules, for other exposures: (i) A banking organization could
assign a zero percent risk weight to cash owned and held in all of its
offices or in transit; to gold bullion held in its own vaults, or held
in another depository institution's vaults on an allocated basis, to
the extent gold bullion assets are offset by gold bullion liabilities;
and to derivative contracts that are publicly traded on an exchange
that requires the daily receipt and payment of cash-variation margin;
(ii) a banking organization could assign a 20 percent risk weight to
cash items in the process of collection; and (iii) a banking
organization would have to apply a 100 percent risk weight to all
assets not specifically assigned a different risk weight under this NPR
(other than exposures that are deducted from tier 1 or tier 2 capital).
I. Off-Balance Sheet Items
Under the general risk-based capital rules, a banking organization
generally determines the risk-based asset amount for an off-balance
sheet exposure using a two-step process. The banking organization
applies a CCF to the off-balance sheet amount to obtain an on-balance
sheet credit equivalent amount and then applies the appropriate risk
weight to that amount.
In general, the agencies propose to calculate the exposure amount
of an off-balance sheet item by multiplying the off-balance sheet
component, which is usually the notional amount, by the applicable CCF.
The agencies also propose to retain most of the CCFs in the general
risk-based capital rules.\30\ Consistent with the New Accord, however,
the agencies propose that a banking organization apply a 20 percent CCF
to all commitments with an original maturity of one year or less
(short-term commitments) that are not unconditionally cancelable rather
than the zero percent in the general risk-based capital rules. The
agencies believe that a 20 percent CCF for these short-term commitments
better reflects the risk of these exposures.
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\30\ The discussion of the risk-based capital treatment for off-
balance sheet securitization exposures, including liquidity
facilities for asset-backed commercial paper, is presented in Part
IV of the proposed rule. Equity commitments are discussed in Part V
of the proposed rule.
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For purposes of this NPR, a commitment means any legally binding
arrangement that obligates a banking organization to extend credit or
to purchase assets. In this NPR, unconditionally cancelable means, with
respect to a commitment, that a banking organization may, at any time,
with or without cause, refuse to extend credit under the facility (to
the extent permitted under applicable law). In the case of a
residential mortgage exposure that is a line of credit, a banking
organization is deemed able to unconditionally cancel the commitment if
it can, at its option, prohibit additional extensions of credit, reduce
the credit line, and terminate the commitment to the full extent
permitted by applicable law.
Under this NPR, if a banking organization commits to provide a
commitment on an off-balance sheet item, that is, a commitment to make
a commitment, the agencies propose that a banking organization apply
the lower of the two applicable CCFs. If a banking organization
provides a commitment that is structured as a syndication, it would
only be required to calculate the exposure amount for its pro rata
share of the commitment.
There is no reference to note issuance facilities (NIFs) and
revolving underwriting facilities (RUFs) in the proposed rule as the
agencies are not aware that any such transactions exist in the United
States.
Under the agencies' general risk-based capital rules, capital is
required against any on-balance sheet exposures that arise from
securities financing transactions (that is, repurchase agreements,
reverse repurchase agreements, securities lending transactions, and
securities borrowing transactions); for example, capital is required
against the cash receivable that a banking organization generates when
it borrows a security and posts cash collateral to obtain the security.
A banking organization faces counterparty credit risk on securities
financing transactions, however, regardless of whether the transaction
generates an on-balance sheet exposure. In contrast to the general
risk-based capital rules, this NPR requires a banking organization to
hold risk-based capital against all securities financing transactions.
Similar to other exposures, a banking organization would determine the
exposure amount of a securities financing transaction and then risk
weight that amount based on the counterparty or, if applicable,
collateral or guarantee.
In general, a banking organization must apply a 100 percent CCF to
the off-balance sheet component of a repurchase agreement or securities
lending or borrowing transaction. The off-balance sheet component of a
repurchase agreement equals the sum of the current market values of all
positions the banking organization has sold subject to repurchase. The
off-balance sheet component of a securities lending transaction is the
sum of the current market values of all positions the banking
organization has lent under the transaction. For securities borrowing
transactions, the off-balance sheet component is the sum of the current
market values of all non-cash positions the banking organization has
posted as collateral under the transaction. In certain circumstances, a
banking organization may instead determine the exposure amount of the
transaction as described in the collateralized transaction section of
this preamble and in section 37 of the proposed rule.
J. OTC Derivative Contracts
(1) Background
Under the general risk-based capital rules for over-the-counter
(OTC) derivative contracts, a banking organization must hold risk-based
capital for counterparty credit risk.\31\ To determine the capital
requirement, a banking organization must first compute a credit
equivalent amount for a contract and then apply to that amount a risk
weight based on the obligor, counterparty, eligible guarantor, or
recognized collateral. For an OTC derivative contract that is not
subject to a qualifying bilateral netting contract, the credit
equivalent amount is the sum of (i) the greater of the current exposure
(mark-to-market value) or zero and (ii) an estimate of the potential
future credit exposure (PFE). PFE is the notional principal amount of
the contract multiplied by a credit conversion factor.
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\31\ OTS rules on the calculation of credit equivalent amounts
for derivative contracts differ from the rules of the other
agencies. That is, OTS rules address only interest rate and foreign
exchange rate contracts and include certain other differences.
Accordingly, the description of the current provisions in this
preamble primarily reflects the other banking agencies' rules.
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Under the general risk-based capital rules for OTC derivative
contracts subject to a qualifying bilateral netting contract, the
credit equivalent amount is calculated by adding the net current
exposure of the netting contract and the sum of the estimates of PFE
for the individual contracts. The net current
[[Page 43999]]
exposure is the sum of all positive and negative mark-to-market values
of the individual contracts but not less than zero. A banking
organization recognizes the effects of the bilateral netting contract
on the gross potential future exposure of the contracts by calculating
an adjusted add-on amount based on the ratio of net current exposure to
gross current exposure, either on a counterparty-by-counterparty basis
or on an aggregate basis.
(2) Treatment of OTC Derivative Contracts
Consistent with the treatment in the New