[Federal Register Volume 64, Number 12 (Wednesday, January 20, 1999)]
[Notices]
[Pages 3117-3121]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-1163]
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FEDERAL RESERVE SYSTEM
Differences in Capital and Accounting Standards Among the Federal
Banking and Thrift Agencies; Report to Congressional Committees
AGENCY: Board of Governors of the Federal Reserve System (FRB).
ACTION: Notice of report to the Committee on Banking, Housing, and
Urban Affairs of the United States Senate and to the Committee on
Banking and Financial Services of the United States House of
Representatives.
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SUMMARY: This report was prepared by the FRB pursuant to section 121 of
the Federal Deposit Insurance Corporation Improvement Act of 1991 (12
U.S.C. 1831n(c)). Section 121 requires each Federal banking and thrift
agency to report annually to the above specified Congressional
Committees regarding any differences between the accounting or capital
standards used by such agency and the accounting or capital standards
used by other banking and thrift agencies. The report must be published
in the Federal Register.
FOR FURTHER INFORMATION CONTACT: Norah Barger, Assistant Director (202/
452-2402), Barbara Bouchard, Manager (202/452-3072), Charles Holm,
Manager, (202/452-3502), or Ali Emran, Senior Financial Analyst, (202/
452-2208), Division of Banking Supervision and Regulation. For the
hearing impaired only, Telecommunication Device for the Deaf (TDD),
Diane Jenkins (202/452-3544), Board of Governors of the Federal Reserve
System, 20th & C Street, NW, Washington DC 20551.
SUPPLEMENTARY INFORMATION: The text of the report follows:
Report to the Congressional Committees Regarding Differences in
Capital and Accounting Standards Among the Federal Banking and
Thrift Agencies
Introduction and Overview
This is the ninth annual report 1 on the differences in
capital standards and accounting practices that currently exist among
the three banking agencies (the Board of Governors of the Federal
Reserve System (FRB), the Office of the Comptroller of the Currency
(OCC), and the Federal Deposit Insurance Corporation (FDIC)) and the
Office of Thrift Supervision (OTS).2
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\1\ The first two reports prepared by the FRB were made pursuant
to section 1215 of the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 (FIRREA). The subsequent reports were made
pursuant to section 121 of the Federal Deposit Insurance Corporation
Improvement Act of 1991 (FDICIA), which superseded section 1215 of
FIRREA.
\2\ At the federal level, the Federal Reserve has primary
supervisory responsibility for state-chartered banks that are
members of the Federal Reserve System, as well as for all bank
holding companies and certain operations of foreign banking
organizations. The FDIC has primary responsibility for state
nonmember banks and FDIC-supervised savings banks. National banks
are supervised by the OCC. The OTS has primary responsibility for
savings and loan associations.
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Overview
As stated in the previous reports to Congress, the three bank
regulatory agencies have, for a number of years, employed a common
regulatory framework that establishes minimum
[[Page 3118]]
capital adequacy ratios for commercial banking organizations. In 1989,
all three banking agencies and the OTS adopted risk-based capital
frameworks that were based upon the international capital accord (Basle
Accord) developed by the Basle Committee on Banking Regulations and
Supervisory Practices (Basle Supervisors Committee) and endorsed by the
central bank governors of the G-10 countries.
The risk-based capital framework establishes minimum ratios of
capital to risk-weighted assets. The Basle Accord requires banking
organizations to have total capital (Tier 1 plus Tier 2) equal to at
least 8 percent, and Tier 1 capital equal to at least 4 percent, of
risk-weighted assets. Tier 1 capital includes common stock and surplus,
retained earnings, qualifying perpetual preferred stock and surplus,
and minority interest in consolidated subsidiaries, less disallowed
intangibles such as goodwill. Tier 2 capital includes certain
supplementary capital items such as general loan loss reserves,
subordinated debt, and certain other preferred stock and convertible
debt capital instruments, subject to appropriate limitations and
conditions. The amount of Tier 2 includable in total regulatory capital
is limited to 100 percent of Tier 1. In addition, institutions that
incorporate market risk exposure into their risk-based capital
requirements may use ``Tier 3'' capital (i.e., short-term subordinated
debt with certain restrictions on repayment provisions) to support
their exposure to market risk. Tier 3 capital is limited to
approximately 70 percent of an institution's measure for market risk.
Risk-weighted assets are calculated by assigning risk weights of zero,
20, 50, and 100 percent to broad categories of assets and off-balance
sheet items based upon their relative credit risk. The OTS has adopted
a risk-based capital standard that in most respects is similar to the
framework adopted by the banking agencies. Differences between the OTS
capital rules and those of the banking agencies are noted elsewhere in
this report.
The measurement of capital adequacy in the present framework is
mainly directed toward assessing capital in relation to credit risk. In
December 1995, the G-10 Governors endorsed an amendment to the Basle
Accord that, in January 1998, required internationally-active banks to
measure and hold capital to support their market risk exposure.
Specifically, certain banks are required to hold capital against their
exposure to general market risk associated with changes in interest
rates, equity prices, exchange rates, and commodity prices, as well as
for exposure to specific risk associated with equity positions and
certain debt positions in the trading portfolio. The FRB, FDIC, and OCC
issued in August 1996 amendments to their respective risk-based capital
standards that implemented the market risk amendment to the Basle
Accord. The banking agencies' amendments generally require institutions
with trading assets and liabilities greater than or equal to 10 percent
of assets, or trading assets and liabilities greater than or equal to
$1 billion, to apply the market risk rules. The OTS did not amend its
capital rules in this regard since savings institutions do not have
such significant levels of trading activity.
In addition to the risk-based capital requirements, the agencies
also have established leverage standards setting forth minimum ratios
of capital to total assets. The three banking agencies employ uniform
leverage standards, while the OTS has established, pursuant to FIRREA,
a somewhat different standard. In October 1997, the agencies issued for
public comment a proposal that would eliminate these differences.
All of the agencies view the risk-based capital standards as a
minimum supervisory benchmark. In part, this is because the risk-based
capital framework focuses primarily on credit risk; it does not take
full or explicit account of certain other banking risks, such as
exposure to operational risk. The full range of risks to which
depository institutions are exposed are reviewed and evaluated
carefully during on-site examinations. In view of these risks, most
banking organizations are expected to, and generally do, maintain
capital levels well above the minimum risk-based and leverage capital
requirements.
The staffs of the agencies meet regularly to identify and address
differences and inconsistencies in the application of their capital
standards. The agencies are committed to continuing this process in an
effort to achieve full uniformity in their capital standards. In
addition, the agencies have considered the remaining differences as
part of a regulatory review undertaken to comply with section 303 of
the Riegle Community Development and Regulatory Improvement Act of 1994
(Riegle Act), which specifies that the agencies ``make uniform all
regulations and guidelines implementing common statutory or supervisory
policies.''
Efforts to Achieve Uniformity
Leverage Capital Ratio
The three banking agencies employ leverage standards based upon the
common definition of Tier 1 capital contained in their risk-based
capital guidelines. These standards, established in the second half of
1990 and in early 1991, require the most highly-rated institutions to
meet a minimum Tier 1 capital leverage ratio of 3.0 percent. For all
other institutions, these standards generally require an additional
cushion of at least 100 to 200 basis points, i.e., a minimum leverage
ratio of at least 4.0 to 5.0 percent, depending upon an organization's
financial condition. As required by FIRREA, the OTS has established a
3.0 percent core capital ratio and a 1.5 percent tangible capital
leverage ratio requirement for thrift institutions. Certain adjustments
discussed in this report apply to the core capital definition used by
savings associations.
In October 1997, the agencies issued a proposal to simplify and
make uniform their leverage capital standards. Under the proposal, the
three banking agencies' rules would require a minimum leverage ratio of
3.0 or 4.0 percent, depending upon a bank's financial condition and the
OTS' standards would become more consistent with those of the banking
agencies. The agencies are working to develop a rule finalizing the
proposal as soon as possible.
Risk-Based Capital Ratio
The agencies worked together on a number of issues in 1998. Part of
the agencies' focus was on fulfilling the requirements of section 303
of the Riegle Act, which calls for uniform rules and guidelines. In
this regard, the agencies are working to finalize an outstanding
proposal that will eliminate interagency differences in the risk-based
capital treatment of presold residential properties, junior liens on 1-
to 4-family residential properties, and investments in mutual funds.
In addition, the agencies issued two joint final rules in 1998 that
amended the agencies' capital standards. The first permitted
institutions to include up to 45 percent of unrealized gains on certain
equity securities in Tier 2 capital. The second raised the Tier 1
capital limitation for mortgage servicing assets from 50 to 100 percent
of Tier 1 capital. The agencies also issued interim guidance on the
capital treatment for derivatives to address issues raised by a recent
change in accounting standards (Financial Accounting Standard (FAS) No.
133). The agencies continue to work
[[Page 3119]]
on outstanding matters such as the 1997 recourse proposal and the 1996
proposal on collateralized transactions.
Construction Loans on Presold Residential Property
The agencies all assign a qualifying loan to a builder to finance
the construction of a presold 1- to 4-family residential property to
the 50 percent risk category, provided certain conditions are
satisfied. The FRB and the FDIC permit a 50 percent risk weight once
the residential property is sold, whether the sale occurs before or
after the construction loan has been made. The OCC and the OTS permit
the 50 percent risk weight only if the property is sold to the
prospective property resident before the extension of credit to the
builder.
The agencies are working on a final rule that would adopt the FRB's
and FDIC's capital treatment of such loans.
Junior Liens on 1- to 4-Family Residential Properties
In some cases, a banking organization may make two loans on a
single residential property, one secured by a first lien, the other by
a second lien. In such a situation, the FRB views these two
transactions as a single loan secured by a first lien, provided there
are no intervening liens. The total amount of these transactions is
assigned to either the 50 percent or the 100 percent risk category,
depending upon whether certain other criteria are met.
One criterion is that the loan must be made in accordance with
prudent underwriting standards, including an appropriate ratio of the
loan balance to the value of the property (the loan-to-value ratio or
LTV). When considering whether a loan is consistent with prudent
underwriting standards, the FRB evaluates the LTV ratio based on the
combined loan amount. If the combined loan amount satisfies prudent
underwriting standards and is considered to be performing adequately,
both the first and second lien are assigned to the 50 percent risk
category. The FDIC also combines the first and second liens to
determine the appropriateness of the LTV ratio, but it applies the risk
weights differently than the FRB. If the LTV ratio based on the
combined loan amount satisfies prudent underwriting standards and is
considered to be performing adequately, the FDIC risk-weights the first
lien at 50 percent and the second lien at 100 percent; otherwise, both
liens are risk-weighted at 100 percent. The OCC treats all first and
second liens separately, with qualifying first liens risk-weighted at
50 percent and non-qualifying first liens and all second liens risk-
weighted at 100 percent. The OTS has interpreted its rule to treat
first and second liens to a single borrower as a single extension of
credit, similar to the FRB.
The agencies are working on a final rule that would adopt the FRB's
capital treatment of first and junior liens on 1-to 4-family
residential properties.
Mutual Funds
The three banking agencies generally assign all of a bank's holding
in a mutual fund to the risk category appropriate to the highest risk
asset that a particular mutual fund is permitted to hold under its
prospectus. The OCC also permits, on a case-by-case basis, an
institution's investment to be allocated on a pro rata basis among the
risk categories based on a pro rata distribution of allowable
investments under the fund's prospectus. The OTS applies a capital
charge appropriate to the riskiest asset that a mutual fund is actually
holding at a particular time. The OTS also permits, on a case-by-case
basis, pro rata allocation among risk categories based on the fund's
actual holdings. All of the agencies' rules provide that the minimum
risk weight for investment in mutual funds is 20 percent.
The agencies are working on a final rule that would adopt the
banking agencies' general treatment of a mutual fund investment and
would permit institutions, at their option, to assign such an
investment to risk categories on a pro rata basis according to the
investment limits in the mutual fund prospectus.
Joint Final Rules To Amend Risk-Based Capital Standards and Changes
Reflecting the Impact of Accounting Standards
Two joint final rules were issued by the agencies in the third
quarter of 1998. The first pertains to unrealized gains on certain
equity securities. The second reflects the capital impact of recent
changes to accounting standards.
From time to time, the Financial Accounting Standards Board (FASB)
issues new and modified financial accounting standards. The adoption of
some of these standards for regulatory reporting purposes has the
potential of affecting the definition and calculation of regulatory
capital. Accordingly, the staffs of the agencies work together to
propose uniform regulatory capital responses to such accounting
changes. Over this past year, the agencies dealt with certain capital
effects of Statement of Financial Accounting Standard (FAS) No. 125,
``Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities,'' which supersedes FAS No. 122,
``Accounting for Mortgages Servicing Rights'' and with the impact of
FAS No. 133, ``Accounting for Derivative Instruments and Hedging
Activities,'' on current capital rules.
Unrealized Gains on Certain Equity Securities
On August 26, 1998, the agencies issued a joint final rule that
allows banking organizations to include up to 45 percent of net
unrealized holding gains on certain available-for-sale equity
securities in Tier 2 capital under the agencies' risk-based capital
rules. The rule became effective on October 1, 1998. The full amount of
net unrealized gains on such securities are included as a component of
equity capital under U.S. generally accepted accounting principles
(GAAP), but until the adoption of this rule they were not included in
regulatory capital. The agencies' capital rules, consistent with GAAP,
will continue to require banking organizations to deduct the amount of
net unrealized losses on their available-for-sale equity securities
from Tier 1 capital. To be consistent with a restriction in the Basle
Accord, the agencies have restricted the inclusion of net unrealized
gains on equity securities in Tier 2 capital to no more than 45 percent
of such net unrealized gains.
FAS 125, ``Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities''
The agencies issued a final rule on August 10, 1998, which amended
their capital treatments for servicing assets on both mortgage assets
and financial assets other than mortgages. The final rule reflects
changes in accounting standards for servicing assets made in FAS 125,
which extended the accounting treatment for mortgage servicing to
servicing on all financial assets. The amendment raised the capital
limitation on the sum of all mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card relationships (PCCRs) from
50 percent of Tier 1 capital to 100 percent of Tier 1 capital.
Furthermore, it subjected the sum of nonmortgage servicing assets and
PCCRs to a sublimit of 25 percent of Tier 1 capital.
FAS 133, ``Accounting for Derivative Instruments and Hedging
Activities''
On December 29, 1998, the agencies issued interim guidance on the
regulatory capital treatment of derivatives. The interim guidance
clarifies how derivatives should be treated under the agencies' current
[[Page 3120]]
capital rules in light of FAS 133 accounting changes. Although FAS 133
does not become effective until fiscal years beginning after June 15,
1999, early adoption is permitted.
Joint Proposal To Amend Risk Based Capital Standards
Recourse
The agencies published in the Federal Register on November 5, 1997,
uniform, proposed rules that would use credit ratings to match the
risk-based capital assessment more closely to an institution's relative
risk of loss in certain asset securitizations. The agencies are
discussing comments received and are working on developing a revised
proposal.
Capital Differences
Remaining differences among the risk-based capital standards of the
OTS and the three banking agencies are discussed below.
Certain Collateral Transactions
The FRB permits certain collateralized transactions to be risk-
weighted at zero percent. This preferential treatment is available only
for claims fully collateralized by cash on deposit in the bank or by
securities issued or guaranteed by OECD central governments or U.S.
government agencies. A positive margin of collateral must be maintained
on a daily basis fully taking into account any change in the banking
organization's exposure to the obligor or counterparty under a claim in
relation to the market value of the collateral held in support of that
claim. Other collateralized claims, or portions thereof, are risk-
weighted at 20 percent.
The OCC permits portions of claims collateralized by cash or OECD
government securities to receive a zero percent risk weight, provided
that the collateral is marked to market daily and a positive margin is
maintained. The FDIC's and OTS's rules permit portions of claims
collateralized by cash or OECD government securities to receive a 20
percent risk weight.
The four agencies, on August 16, 1996, published a joint proposed
rulemaking that would, if implemented, eliminate capital differences
among the agencies' risk-based capital treatment for collateralized
transactions. Under the proposed rule, portions of claims
collateralized by cash or OECD government securities could be assigned
a zero percent risk weight, provided the transactions met certain
criteria, which would be uniform among the agencies. Agency staffs are
working to finalize this outstanding proposal as soon as possible.
FSLIC/FDIC--Covered Assets (assets subject to guarantee arrangements by
the FSLIC or FDIC)
The three banking agencies generally place these assets in the 20
percent risk category, the same category to which claims on depository
institutions and government-sponsored agencies are assigned. The OTS
places these assets in the zero percent risk category.
Limitation of Subordinated Debt and Limited-Life Preferred Stock
The three banking agencies limit the amount of subordinated debt
and limited-life preferred stock that may be included in Tier 2 capital
to 50 percent of Tier 1 capital. In addition, maturing capital
instruments must be discounted by 20 percent in each of the last five
years prior to maturity. The OTS has no limitation on the total amount
of limited-life preferred stock or maturing capital instruments that
may be included within Tier 2 capital. In addition, the OTS allows
savings institutions the option of: (1) discounting maturing capital
instruments issued on or after November 7, 1989 by 20 percent per year
over the last five years of their term; or (2) including the full
amount of such instruments, provided that the amount maturing in any of
the next seven years does not exceed 20 percent of the thrift's total
capital.
Subsidiaries
Consistent with the Basle Accord and long-standing supervisory
practices, the three banking agencies generally consolidate all
significant majority-owned subsidiaries of the parent organization for
capital purposes. This consolidation assures that the capital
requirements are related to all of the risks to which the banking
organization is exposed. As with most other bank subsidiaries, banking
and finance subsidiaries generally are consolidated for regulatory
capital purposes. However, in cases where banking and finance
subsidiaries are not consolidated, the FRB, consistent with the Basle
Accord, generally deducts investments in such subsidiaries in
determining the adequacy of the parent bank's capital.
The FRB's risk-based capital guidelines provide a degree of
flexibility in the capital treatment of unconsolidated subsidiaries
(other than banking and finance subsidiaries) and investments in joint
ventures and associated companies. For example, the FRB may deduct
investments in such subsidiaries from an organization's capital, may
apply an appropriate risk-weighted capital charge against the
proportionate share of the assets of the entity, may require a line-by-
line consolidation of the entity, or otherwise may require that the
parent organization maintain a level of capital above the minimum
standard that is sufficient to compensate for any risk associated with
the investment.
The guidelines also permit the deduction of investments in
subsidiaries that, while consolidated for accounting purposes, are not
consolidated for certain specified supervisory or regulatory purposes.
The FDIC accords similar treatment to securities subsidiaries of state
nonmember banks established pursuant to Sec. 337.4 of the FDIC
regulations.
Similarly, in accordance with Sec. 325.5(f) of the FDIC
regulations, a state nonmember bank must deduct investments in, and
extensions of credit to, certain mortgage banking subsidiaries in
computing the parent bank's capital. The FRB does not have a similar
requirement with regard to mortgage banking subsidiaries. The OCC does
not have requirements dealing specifically with the capital treatment
of either mortgage banking or securities subsidiaries. The OCC,
however, reserves the right to require a national bank, on a case-by-
case basis, to deduct from capital investments in, and extensions of
credit to, any nonbanking subsidiary.
The deduction of investments in subsidiaries from the parent's
capital is designed to ensure that the capital supporting the
subsidiary is not also used as the basis of further leveraging and
risk-taking by the parent banking organization. In deducting
investments in, and advances to, certain subsidiaries from the parent's
capital, the FRB expects the parent banking organization to meet or
exceed minimum regulatory capital standards without reliance on the
capital invested in the particular subsidiary. In assessing the overall
capital adequacy of banking organizations, the FRB also considers the
organization's fully consolidated capital position.
Under the OTS capital guidelines, a distinction, mandated by
FIRREA, is drawn between subsidiaries that are engaged in activities
permissible for national banks and subsidiaries that are engaged in
``impermissible'' activities for national banks. Subsidiaries of thrift
institutions that engage only in impermissible activities are
consolidated on a line-by-line basis if majority-owned, and on a pro
rata basis if ownership is between 5 and 50
[[Page 3121]]
percent. As a general rule, investments, including loans, in
subsidiaries that engage in impermissible activities are deducted in
determining the capital adequacy of the parent.
Mortgage-Backed Securities (MBS)
The three banking agencies generally place privately-issued MBS in
a risk category appropriate to the underlying assets, but in no case to
the zero percent risk category. In the case of privately-issued MBS
where the direct underlying assets are mortgages, this treatment
generally results in a risk weight of 50 percent or 100 percent.
Privately-issued MBS that have government agency or government-
sponsored agency securities as their direct underlying assets are
generally assigned to the 20 percent risk category.
The OTS assigns privately-issued, high-quality mortgage-related
securities to the 20 percent risk category. These are, generally,
privately-issued MBS with AA or better investment ratings.
Both the banking and thrift agencies automatically assign to the
100 percent risk weight category certain MBS, including interest-only
strips, residuals, and similar instruments that can absorb more than
their pro rata share of loss.
Agricultural Loan Loss Amortization
In the computation of regulatory capital, those banks accepted into
the agricultural loan loss amortization program pursuant to Title VII
of the Competitive Equality Banking Act of 1987 are permitted to defer
and amortize losses incurred on agricultural loans between January 1,
1984 and December 31, 1991. The program also applies to losses incurred
between January 1, 1983 and December 31, 1991, as a result of
reappraisals and sales of agricultural Other Real Estate Owned and
agricultural personal property. These loans must be fully amortized
over a period not to exceed seven years and, in any case, must be fully
amortized by year-end 1998. Savings institutions are not eligible to
participate in the agricultural loan loss amortization program
established by this statute.
Pledged Deposits and Nonwithdrawable Accounts
The capital guidelines of the OTS permit thrift institutions to
include in capital certain pledged deposits and nonwithdrawable
accounts that meet the criteria of the OTS. Income Capital Certificates
and Mutual Capital Certificates held by the OTS may also be included in
capital by thrift institutions. These instruments are not relevant to
commercial banks, and, therefore, are not addressed in the banking
agencies' capital rules.
Accounting Standards
Over the years, the three banking agencies, under the auspices of
the FFIEC, have developed Uniform Reports of Condition and Income (Call
Reports) for all commercial banks and FDIC-supervised savings banks.
The reporting standards followed by the three banking agencies for
recognition and measurement purposes are consistent with GAAP. The
agencies adopted GAAP as the reporting basis for the Call Report,
effective for March 1997 reports. The adoption of GAAP for Call Report
purposes eliminated the differences in accounting standards among the
agencies that were set forth in previous reports to Congress. Thus,
there are no material differences in regulatory accounting standards
for regulatory reports filed with the federal banking agencies by
commercial banks, savings banks, and savings associations.
By order of the Board of Governors of the Federal Reserve
System, January 13, 1999.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 99-1163 Filed 1-19-99; 8:45 am]
BILLING CODE 6210-01-P
