[Federal Register Volume 59, Number 201 (Wednesday, October 19, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-25662]
[[Page Unknown]]
[Federal Register: October 19, 1994]
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FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AB43
Capital; Capital Adequacy Guidelines
AGENCY: Federal Deposit Insurance Corporation (FDIC or Corporation).
ACTION: Notice of proposed rulemaking.
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SUMMARY: The FDIC is proposing to amend its risk-based capital
guidelines for state nonmember banks. The proposal would revise and
expand the set of conversion factors used to calculate the potential
future exposure of derivative contracts and recognize effects of
netting arrangements in the calculation of potential future exposure
for derivative contracts subject to qualifying bilateral netting
arrangements.
The FDIC is proposing these amendments on the basis of proposed
revisions to the Basle Accord announced on July 15, 1994. The effect of
the proposed amendments would be twofold. First, long-dated interest
rate and exchange rate contracts would be subject to new higher
conversion factors and new conversion factors would be set forth that
specifically apply to derivative contracts related to equities,
precious metals, and other commodities. Second, institutions would be
permitted to recognize a reduction in potential future exposure for
transactions subject to qualifying bilateral netting arrangements.
DATES: Comments must be received on or before December 5, 1994.
ADDRESSES: Send comments to Robert E. Feldman, Acting Executive
Secretary, Federal Deposit Insurance Corporation, 550 17th Street,
N.W., Washington, D.C. 20429. Comments may be hand delivered to room F-
402, 1776 F Street, N.W., Washington, D.C., on business days between
8:30 a.m. and 5:00 p.m. [Fax number: (202) 898-3838.] Comments may be
inspected at the FDIC's Reading Room, room 7118, 550 17th Street, N.W.,
Washington, D.C. between 9:00 a.m. and 4:30 p.m. on business days.
FOR FURTHER INFORMATION CONTACT: William A. Stark, Assistant Director,
(202) 898-6972, Division of Supervision, FDIC; Sharon K. Lee, Chief,
Capital Markets Policy and Training, (202) 898-6789, Division of
Supervision, FDIC; Jeffrey M. Kopchik, Counsel, (202) 898-3872, Legal
Division, FDIC, 550 17th Street, N.W., Washington, D.C. 20429.
SUPPLEMENTARY INFORMATION:
I. Background
The international risk-based capital standards (the Basle Accord or
Accord)\1\ set forth a framework for measuring capital adequacy under
which risk-weighted assets are calculated by assigning assets and off-
balance-sheet items to broad categories based primarily on their credit
risk, that is, the risk that a loss will be incurred due to an obligor
or counterparty default on a transaction.\2\ Off-balance-sheet
transactions are incorporated into risk-weighted assets by converting
each item into a credit equivalent amount which is then assigned to the
appropriate credit risk category according to the identity of the
obligor or counterparty, or if relevant, the guarantor or the nature of
the collateral.
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\1\The Basle Accord was proposed by the Basle Committee on
Banking Supervision (Basle Supervisors' Committee, BSC) and endorsed
by the central bank governors of the Group of Ten (G-10) countries
in July 1988. The Basle Supervisors' Committee is comprised of
representatives of the central banks and supervisory authorities
from the G-10 countries (Belgium, Canada, France, Germany, Italy,
Japan, Netherlands, Sweden, Switzerland, the United Kingdom, and the
United States) and Luxembourg.
In January 1989 the FDIC Board adopted a similar framework to be
used by state nonmember banks.
\2\Other types of risks, such as market risks, generally are not
addressed by the risk-based framework.
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The credit equivalent amount of an interest rate or exchange rate
contract (rate contract) is determined by adding together the current
replacement cost (current exposure) and an estimate of the possible
increases in future replacement cost, in view of the volatility of the
current exposure over the remaining life of the contract (potential
future exposure, also referred to as the add-on). Each credit
equivalent amount is then assigned to the appropriate risk category
generally based on identity of the counterparty. The maximum risk
weight applied to interest rate or exchange rate contracts is 50
percent.\3\
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\3\Exchange rate contracts with an original maturity of 14
calendar days or less and instruments traded on exchanges that
require daily payment of variation margin are excluded from the
risk-based capital ratio calculations.
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A. Current Exposure
A state nonmember bank that has a rate contract with a positive
mark-to-market value has a current exposure or a possible loss equal to
the mark-to-market value.\4\ For risk-based capital purposes, if the
mark-to-market value is zero or negative, then there is no replacement
cost associated with the contract and the current exposure is zero. The
sum of current exposures for a defined set of contracts is sometimes
referred to as the gross current exposure for that set of contracts.
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\4\The loss to a bank from a counterparty's default on a rate
contract is the cost of replacing the cash flows specified by the
contract. The mark-to-market value is the present value of the net
cash flows specified by the contract, calculated on the basis of
current market interest and exchange rates.
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The Accord, as endorsed in 1988, provided that current exposure
would be determined individually for every rate contract entered into
by a banking organization. Generally, institutions were not permitted
to offset, that is, net, positive and negative mark-to-market values of
multiple rate contracts with a single counterparty\5\ to determine one
current exposure relative to that counterparty. In April 1993 the BSC
proposed a revision to the Accord, endorsed by the G-10 Governors in
July 1994, that permits institutions to net positive and negative mark-
to-market values of rate contracts subject to a qualifying, legally
enforceable, bilateral netting arrangement. Under the revision to the
Accord, institutions with qualifying netting arrangements could replace
the gross current exposure of a set of contracts included in such an
arrangement with a single net current exposure for purposes of
calculating the credit equivalent amount for the included contracts. If
the net market value is positive, then that market value equals the
current exposure for the netting contract. If the net market value is
zero or negative, then the current exposure is zero.
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\5\Netting by novation however, was recognized. Netting by
novation is accomplished under a written bilateral contract
providing that any obligation to deliver a given currency on a given
date is automatically amalgamated with all other obligations for the
same currency and value date. The previously existing contracts are
extinguished and a new contract, for the single net amount, is
legally substituted for the amalgamated gross obligations.
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On July 25, 1994, the FDIC issued a notice of proposed rulemaking
to amend its risk-based capital guidelines in accordance with the BSC
April 1993 proposal. 59 FR 37726, July 25, 1994.\6\ Generally, under
the proposal, a bilateral netting arrangement would be recognized for
risk-based capital purposes only if the netting arrangement is legally
enforceable. The bank would have to have a legal opinion(s) to this
effect. That proposal is consistent with the final July 1994 change to
the Accord.
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\6\The Board of Governors of the Federal Reserve System and the
Office of the Comptroller of the Currency issued a similar joint
netting proposal on May 20, 1994 and the OTS issued its netting
proposal on June 14, 1994.
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B. Potential Future Exposure
The second part of the credit equivalent amount, potential future
exposure, is an estimate of the additional exposure that may arise over
the remaining life of the contract as a result of fluctuations in
prices or rates. Such changes may increase the market value of the
contract in the future and, therefore, increase the cost of replacing
it if the counterparty subsequently defaults.
The add-on for potential future exposure is estimated by
multiplying the notional principal amount\7\ of the underlying contract
by a credit conversion factor that is determined by the remaining
maturity of the contract and the type of contract. The existing set of
conversion factors used to calculate potential future exposure,
referred to as the add-on matrix, is as follows:
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\7\The notional principal amount, or value, is a reference
amount of money used to calculate payment streams between the
counterparties. Principal amounts generally are not exchanged in
single-currency interest rate swaps, but generally are exchanged in
foreign exchange contacts (including cross-currency interest rate
swaps).
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Interest Exchange
rate rate
Remaining maturity contracts contracts
(percent) (percent)
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One year or less.................................. 0 1.0
Over one year..................................... 0.5 5.0
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The conversion factors were determined through simulation studies
that estimated the potential volatility of interest and exchange rates
and analyzed the implications of movements in those rates for the
replacement costs of various types of interest rate and exchange rate
contracts. The simulation studies were conducted only on rate
contracts, because at the time the Accord was being developed activity
in the derivatives market was for the most part limited to these types
of transactions. The analysis produced probability distributions of
potential replacement costs over the remaining life of matched pairs of
rate contracts.\8\ Potential future exposure was then defined in terms
of confidence limits for these distributions. The conversion factors
were intended to be a compromise between precision, on the one hand,
and complexity and burden, on the other.\9\
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\8\A matched pair is a pair of contracts with identical terms,
with the bank the buyer of one of the contracts and the seller of
the other.
\9\The methodology upon which the statistical analyses were
based is described in detail in a technical working paper entitled
``Potential Credit Exposure on Interest Rate and Foreign Exchange
Rate Related Instruments.'' This paper is available upon request
from the FDIC's Reading Room by calling (202) 898-8785.
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The add-on for potential future exposure is calculated for all
contracts, regardless of whether the market value is zero, positive, or
negative, or whether the current exposure is calculated on a gross or
net basis. The add-on will always be either a positive number or zero.
The recent revision to the Accord to recognize netting for the
calculation of current exposure does not affect the calculation of
potential future exposure, which generally continues to be calculated
on a gross basis. This means that an add-on for potential future
exposure is calculated separately for each individual contract subject
to the netting arrangement and then these individual future exposures
are added together to arrive at a gross add-on for potential future
exposure. For contracts subject to a qualifying bilateral netting
arrangement in accordance with the newly adopted Accord changes, the
gross add-on for potential future exposure would be added to the net
current exposure to arrive at one credit equivalent amount for the
contracts subject to the netting arrangement.
The original Basle Accord noted that the credit conversion factors
in the add-on matrix were provisional and would be subject to revision
if volatility levels or market conditions changed.
II. Basle Proposals for the Treatment of Potential Future Exposure
Since the original Accord was adopted, the derivatives market has
grown and broadened. The use of certain types of derivative instruments
not specifically addressed in the Accord--notably commodity, precious
metal, and equity-linked transactions\10\--has become much more
widespread. As a result of continued review of the method for
calculating the add-on for potential future exposure, in July 1994 the
BSC issued two proposals for public consultation.\11\ The first
proposal would expand the matrix of add-on factors used to calculate
potential future exposure to take into account innovations in the
derivatives market. The second proposal would recognize reductions in
the potential future exposure of derivative contracts that result from
entering into bilateral netting arrangements. The second proposal is an
extension of the recent revision to the Accord recognizing bilateral
netting arrangements for purposes of calculating current exposure and
would formally extend the recognition of netting arrangements to
equity, precious metals and other commodity derivative contracts. The
consultation period for these BSC proposals is scheduled to end on
October 10, 1994.
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\10\In general terms, these are off-balance sheet transactions
that have a return, or a portion of their return, linked to the
price of a particular commodity, precious metal, or equity or to an
index of commodity, precious metal or equity prices.
\11\The proposals are contained in a paper from the BSC entitled
``The Capital Adequancy Treatment of the Credit Risk Associated with
Certain Off-Balance Sheet Items'' that is available upon request
from FDIC's Reading Room by calling (202) 898--8785.
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A. Expansion of Add-On Matrix
A recently concluded BSC review of the add-on for potential future
exposure indicated that the current add-on factors used to calculate
the potential future exposure amount may produce insufficient capital
for certain types of derivative instruments, in particular, long-dated
interest rate contracts, commodity contracts, and equity-index
contracts. The BSC review indicated that the current add-on factors do
not adequately address the full range of contract structures and the
timing of cash flows. The review also showed that the conversion
factors many institutions are using to calculate potential future
exposure for commodity, precious metal, and equity contracts could
result in insufficient capital coverage in view of the volatility of
the indices or prices on the underlying assets from which these
contracts derive their value.\12\
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\12\While commodity, precious metal, and equity contracts were
not explicity covered by the original Accord, as the use of such
contracts became more prevalent, many G-10 bank supervisors,
including U.S. banking supervisors, have informally permitted
institutions to apply the conversion factors for exchange rate
contracts to these types of transactions pending development of a
more appropriate treatment.
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The BSC concluded that it was not appropriate to address these
problems with a significant departure from the existing methodology
used in the Accord. The BSC decided that it would be appropriate to
preserve the conversion factors existing in the Accord and add new
conversion factors. Consequently, the revision proposed by the BSC
retains the existing conversion factors for rate contracts but applies
new higher conversion factors to such contracts with remaining
maturities of five years and over.\13\ The proposal also introduces
conversion factors specifically applicable to commodity, precious
metal, and equity contracts. The new conversion factors were determined
on the basis of simulation studies that used the same general approach
that generated the original add-on conversion factors.\14\
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\13\The conversion factors for rate contracts with remaining
maturities of one to five years are currently applied to any
contracts with a remaining maturity of over one year.
\14\The methodology and results of the statistical analyses are
summarized in a paper entitled ``The Calculation of Add-Ons for
Derivative Contracts: The Expanded Matrix Approach'' which is
available upon request from the FDIC's Reading Room by calling (202)
898-8785.
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The proposed matrix is set forth below:
Conversion Factor Matrix*
[Numbers in percent]
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Precious
Interest Foreign metals, Other
Residual maturity rate exchange Equity** except commododities
and gold gold
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Less than one year................................... 0.0 1.0 6.0 7.0 12.0
One to five years.................................... 0.5 5.0 8.0 7.0 12.0
Five years or more................................... 1.5 7.5 10.0 8.0 15.0
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*For contracts with multiple exchanges of principal, the factors are to be multiplied by the number of remaining
payments in the contract.
**For contracts that automatically reset to zero value following a payment, the remaining maturity is set equal
to the time remaining until the next payment.
Gold is included within the foreign exchange column because the
price volatility of gold has been found to be comparable to the
exchange rate volatility of major currencies. In addition, the BSC
determined that gold's role as a financial asset distinguishes it from
other precious metals. The proposed matrix is designed to accommodate
the different structures of contracts, as well as the observed
disparities in the volatilities of the associated indices or prices of
the underlying assets.
Two footnotes are attached to the matrix to address two particular
contract structures. The first relates to contracts with multiple
exchanges of principal. Since the level of potential future exposure
rises generally in proportion to the number of remaining exchanges, the
conversion factors are to be multiplied by the number of remaining
payments (that is, exchanges of principal) in the contract. This
treatment is intended to ensure that the full level of potential future
exposure is adequately covered. The second footnote applies to equity
contracts that automatically reset to zero each time a payment is made.
The credit risk associated with these contracts is similar to that of a
series of shorter contracts beginning and ending at each reset date.
For this type of equity contract the remaining maturity is set equal to
the time remaining until the next payment.
While the capital charges resulting from the application of the new
proposed conversion factors may not provide complete coverage for risks
associated with any single contract, the BSC believes the factors will
provide a reasonable level of prudential coverage for derivative
contracts on a portfolio basis. Like the original matrix, the proposed
expanded matrix is designed to provide a reasonable balance between
precision, and complexity and burden.
B. Recognition of the Effects of Netting
The simulation studies used to generate the conversion factors for
potential future exposure analyzed the implications of underlying rate
and price movements on the current exposure of contracts without taking
into account reductions in exposure that could result from legally
enforceable netting arrangements. Thus, the conversion factors are most
appropriately applied to non-netted contracts, and when applied to
legally enforceable netted contracts, they could in some cases,
overstate the potential future exposure.
Comments provided during the consultative process of revising the
Basle Accord to recognize qualifying bilateral netting arrangements and
further research conducted by the BSC, have suggested that netting
arrangements can reduce not only a banking organization's current
exposure for the transactions subject to the netting arrangement, but
also its potential future exposure for those transactions.\15\
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\15\While current exposure is intended to cover an
organization's credit exposure at one point in time, potential
future exposure provides an estimate of possible increases in future
replacement cost, in view of the volatility of current exposure over
the remaining life of the contract. The greater the tendency of the
current exposure to fluctuate over time, the greater the add-on for
potential future exposure should be to cover expected fluctuations.
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As a result, in July 1994 the BSC issued a proposal to incorporate
into the calculation of the add-on for potential future exposure a
method for recognizing the risk-reducing effects of qualifying netting
arrangements. Under the proposal, institutions could recognize these
effects only for transactions subject to legally enforceable bilateral
netting arrangements that meet the requirements of netting for current
exposure as set forth in the recent amendment to the Accord.
Depending on market conditions and the characteristics of a bank's
derivative portfolio, netting arrangements can have substantial effects
on a bank's potential future exposure to multiple derivative contracts
it has entered into with a single counterparty. Should the counterparty
default at some future date, the bank's exposure would be limited to
the net amount the counterparty owes on the date of default rather than
the gross current exposure of the included contracts. By entering into
a netting arrangement, a bank may reduce not only its current exposure,
but also its future exposure as well. Nevertheless, while in many
circumstances a netting arrangement can reduce the potential future
exposure of a counterparty portfolio, this is not always the case.\16\
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\16\For purposes of this discussion, a portfolio refers to a set
of contracts with a single counterparty. A bank's global portfolio
refers to all of the contracts in the institution's derivatives
portfolio that are subject to qualifying netting arrangements.
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The most important factors influencing whether a netting
arrangement will have an effect on potential future exposure are the
volatilities of the current exposure to the counterparty on both a
gross and net basis.\17\ The volatilities of net current exposure and
gross current exposure of the portfolio may not necessarily be the
same. Volatility of gross current exposure is influenced primarily by
the fluctuations of the market values of positively valued contracts.
Volatility of net current exposure on the other hand, is influenced by
the fluctuations of the market values of all contracts within the
portfolio. In those cases where net current exposure has a tendency to
fluctuate more over time than gross current exposure, a netting
arrangement will not reduce the potential future exposure. However, in
those situations where net current exposure has a tendency to fluctuate
less over time than gross current exposure, a netting arrangement can
reduce the potential future exposure.
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\17\Volatility in this discussion is the tendency of the market
value of a contract to vary or fluctuate over time. A highly
volatile portfolio would have a tendency to fluctuate significantly
over short periods of time. One of the most important factors
influencing a portfolio's volatility is the correlation of the
contracts within the portfolio, that is, the degree to which the
contracts in the portfolio respond similarly to changing market
conditions.
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Net current exposure is likely to be less volatile relative to the
volatility of gross current exposure when the portfolio of contracts as
a whole is more diverse than the subset of positively valued contracts.
When a netting arrangement is applied to a diversified portfolio and
the positively valued contracts within the portfolio as a group are
less diversified than the overall portfolio, then the effect of the
netting arrangement will be to reduce the potential future exposure for
the portfolio.
The BSC has studied and analyzed several alternatives for taking
into account the effects of netting when calculating the capital charge
for potential future exposure. In particular, the BSC reviewed one
general method proposed by commenters to the April 1993 netting
proposal. This method would reduce the amount of the add-on for
potential future exposure by multiplying the calculated gross add-on by
the ratio of the portfolio's net current exposure to gross current
exposure (the net-to-gross ratio or NGR). The NGR is used as a proxy
for the risk-reducing effects of the netting arrangement on the
potential future exposure. The more diversified the portfolio, the
lower the net current exposure tends to be relative to gross current
exposure.
The BSC incorporated this method into its proposal. However, given
that there are portfolio-specific situations in which the NGR does not
provide a good indication of these effects, the BSC proposal gives only
partial weight to the effects of the NGR on the add-on for potential
future exposure. The proposed method would average the amount of the
add-on as currently calculated (Agross) and the same amount
multiplied by the NGR to arrive at a reduced add-on (Anet) for
contracts subject to qualifying netting arrangements in accordance with
the requirements set forth in the recently amended Accord. This formula
is expressed as:
Anet = .5(Agross + (NGR * Agross)).
For example, a bank with a gross current exposure of 500,000, a net
current exposure of 300,000, and a gross add-on for potential future
exposure of 1,200,000, would have an NGR of .6 (300,000/500,000) and
would calculate Anet as follows:
.5(1,200,000 + (.6 * 1,200,000))
Anet = 960,000
For banks with an NGR of 50 percent, the effect of this treatment would
be to permit a reduction in the amount of the add-on by 25 percent. The
BSC believes that most dealer banks are likely to have an NGR in the
vicinity of 50 percent.
The BSC proposal does not specify whether the NGR should be
calculated on a counterparty-by-counterparty basis or on an aggregate
basis for all transactions subject to qualifying, legally enforceable
netting arrangements. The proposal requests comment on whether the
choice of method could bias the results and whether there is a
significant difference in calculation burden between the two methods.
The BSC proposal also acknowledges that simulations using bank's
internal models for measuring credit risk exposure would most likely
produce the most accurate determination of the effect of netting
arrangements on potential future exposures. The proposal states that
the use of such models would be considered at some future date.
C. The FDIC Proposal
In light of the BSC proposal, the FDIC believes that it is
appropriate to seek comment on proposed revisions to the calculation of
the add-on for potential future exposure for derivative contracts.
Therefore, the FDIC is proposing to amend its risk-based capital
guidelines for state nonmember banks to expand the matrix of conversion
factors, and to permit institutions that make use of qualifying netting
arrangements to recognize the effects of those netting arrangements in
the calculation of the add-on for potential future exposure. The second
part of the proposed amendment is contingent on the adoption of a final
amendment to the FDIC's risk-based capital guidelines to recognize
bilateral close-out netting arrangements and would formally extend this
recognition to commodity, precious metals, and equity derivative
contracts.
With regard to the portion of the proposal to expand the conversion
factor matrix, the FDIC is proposing the same conversion factors set
forth in the BSC proposal. The FDIC agrees with the BSC that the
existing conversion factors applicable to long-dated transactions do
not provide sufficient capital for the risks associated with those
types of contracts. The FDIC also agrees with the BSC that the
conversion factors for foreign exchange transactions are significantly
too low for commodity, precious metal, and equity contracts due to the
volatility of the associated indices or the prices on the underlying
assets.\18\
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\18\Similar to the BSC proposal, the FDIC's proposed amendment
specifies that for equity contracts that automatically reset to zero
value following a payment, the remaining maturity is set equal to
the time remaining until the next payment. Also, for contracts with
multiple exchanges of principal, the conversion factors are to be
multiplied by the number of remaining payments in the contract.
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The FDIC is proposing the same formula as the BSC proposal to
calculate a reduction in the add-on for potential future exposure for
contracts subject to qualifying netting contracts. The FDIC recognizes
several advantages with this formula. First, the formula uses bank-
specific information to calculate the NGR. The NGR is simple to
calculate and uses readily available information. The FDIC believes the
use of the averaging factor of 0.5 is an important aspect of the
proposed formula because it means the add-on for potential future
exposure can never be reduced to zero and banks will always hold some
capital against derivative contracts, even in those instances where the
net current exposure is zero.
The FDIC is seeking comment on all aspects of this proposal. As
mentioned earlier, the BSC proposal seeks comment on whether the NGR
should be calculated on a counterparty-by-counterparty basis, or on a
global basis for all contracts subject to qualifying bilateral netting
arrangements. The FDIC's proposed regulatory language would require the
calculation of a separate NGR for each counterparty with which it has a
qualifying netting contract. However, the FDIC is also seeking comment
as to which method of calculating the NGR would be most efficient and
appropriate for institutions with numerous qualifying bilateral netting
arrangements. With either calculation method the NGR would be applied
separately to adjust the add-on for potential future exposure for each
netting arrangement. The FDIC notes that some preliminary findings
indicate that a global NGR may be less burdensome to apply since the
same NGR would be used for each counterparty with a netting
arrangement, but counterparty specific NGRs may provide a more accurate
indication of the credit risk associated with each counterparty.
Regulatory Flexibility Act Analysis
The FDIC does not believe that adoption of this proposal would have
a significant economic impact on a substantial number of small business
entities (in this case, small banks), in accord with the spirit and
purposes of the Regulatory Flexibility Act (5 U.S.C 601 et. seq.). In
this regard, while some small banks with limited derivative portfolios
may experience an increase in capital charges, for most banks the
overall effect of the proposal will be to reduce regulatory burden and
to reduce the capital charge for certain transactions.
Paperwork Reduction Act
The FDIC has determined that its proposed amendments, if adopted,
would not increase the regulatory paperwork burden of state nonmember
banks pursuant to the provisions of the paperwork Reduction Act (44
U.S.C. 3501 et. seq.).
List of Subjects in 12 CFR Part 325
Bank deposit insurance, Banks, banking, Capital adequacy, Reporting
and recordkeeping requirements, Savings associations, State nonmember
banks.
For the reasons set forth in the preamble, the Board of Directors
of the FDIC proposes to amend 12 CFR part 325 as follows:
PART 325--CAPITAL MAINTENANCE
1. The authority citation for part 325 continues to read as
follows:
Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b),
1818(c), 1818(t), 1819 (Tenth), 1828(c), 1828(d), 1828(i), 1828(n),
1828(o), 1831o, 3907, 3909; Pub. L. 102-233, 105 Stat. 1761, 1789,
1790 (12 U.S.C. 1831n note) Pub. L. 102-242, 105 Stat. 2236, 2355,
2386 (12 U.S.C. 1828 note).
2. In appendix A to part 325, section II is amended by:
a. Revising the last sentence in section II.C. Category 3;
b. Redesignating footnotes 36 through 40 as footnotes 37 through
41;
c. Adding new footnote 35 at the end of the introductory text of
section II.D.; and
d. Revising the heading and the introductory text of section
II.E. (preceding paragraph E.1.) to read as follows:
APPENDIX A TO PART 325--STATEMENT OF POLICY ON RISK-BASED CAPITAL
* * * * *
II. * * *
C. * * *
Category 3 * * * In addition, the credit equivalent amount of
derivative contracts that do not qualify for a lower risk weight are
assigned to the 50 percent risk category.
* * * * *
D. * * *\35\ * * *
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\35\The sufficiency of collateral and guarantees for off-
balance-sheet items is determined by the market value of the
collateral or the amount of the guarantee in relation to the face
amount of the item, except for derivative contracts, for which this
determination is generally made in relation to the credit equivalent
amount. Collateral and guarantees are subject to the same provisions
noted under section II.B.
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* * * * *
E. Derivative Contracts (Interest Rate, Exchange Rate, Commodity and
Equity Derivative Contracts)
Credit equivalent amounts are computed for each of the following
off-balance-sheet derivative contracts:
Interest Rate Contracts
(1) Single currency interest rate swaps.
(2) Basis swaps
(3) Forward rate agreements.
(4) Interest rate options (including caps, collars, and floors
purchased).
(5) Any other instrument that gives rise to similar credit risks
(including when-issued securities and forward deposits accepted).
Exchange Rate Contracts
(1) Cross-currency interest rate swaps.
(2) Forward foreign exchange contracts.
(3) Currency options purchased.
(4) Any other instrument that gives rise to similar credit
risks.
Commodity (including precious metal) or Equity Derivative Contracts
(1) Commodity or equity linked swaps.
(2) Commodity or equity linked options purchased.
(3) Forward commodity or equity linked contracts.
(4) Any other instrument that gives rise to similar credit
risks.
Exchange rate contracts with an original maturity of fourteen
calendar days or less and derivative contracts traded on exchanges
that require daily payment of variation margin may be excluded from
the risk-based ratio calculation. Over-the-counter options
purchased, however, are included and treated in the same way as
other derivative contracts.
* * * * *
3. In Appendix A to part 325, section II.E.1., as that section
was proposed to be revised at 59 FR 37726, July 25, 1994, is revised
to read as follows:
II. * * *
E. * * *
1. Credit Equivalent Amounts for Derivative Contracts. The
credit equivalent amount of a derivative contract that is not
subject to a qualifying bilateral netting contract in accordance
with section II.E.3. of this appendix A is equal to the sum of (i)
the current exposure (which is equal to the mark-to-market
value,\41\ if positive, and is sometimes referred to as the
replacement cost) of the contract and (ii) an estimate of the
potential future credit exposure over the remaining life of the
contract.
---------------------------------------------------------------------------
\41\Mark-to-market values are measured in dollars, regardless of
the currency or currencies specified in the contract and should
reflect changes in both underlying rates, prices and indices, and
counterparty credit quality.
---------------------------------------------------------------------------
The current exposure is determined by the mark-to-market value
of the contract. If the mark-to-market value is positive, then the
current exposure is equal to that mark-to-market value. If the mark-
to-market value is zero or negative, then the current exposure is
zero.
The potential future credit exposure of a contract, including
contracts with negative mark-to-market values, is estimated by
multiplying the notional principal amount of the contract by one of
the following credit conversion factors, as appropriate:
Conversion Factor MatrixA
[Numbers in percent]
------------------------------------------------------------------------
Precious
Residual Interest Exchange metals, Other
maturity rate rate and EquityB except commodities
gold gold
------------------------------------------------------------------------
Less than one
year.......... 0.0 1.0 6.0 7.0 12.0
One to five
years......... 0.5 5.0 8.0 7.0 12.0
Five years or
more.......... 1.5 7.5 10.0 8.0 15.0
------------------------------------------------------------------------
AFor contracts with multiple exchanges of principal, the factors are to
be multiplied by the number of remaining payments in the contract.
BFor contracts that reset to zero value following a payment, the
remaining maturity is set equal to the time until the next payment.
No potential future exposure is calculated for single currency
interest rate swaps in which payments are made based upon two
floating rate indices (so called floating/floating or basis swaps);
the credit exposure on these contracts is evaluated solely on the
basis of their mark-to-market values.
4. In Appendix A to part 325, section II.E.2, as that section
was proposed to be revised at 59 FR 37726, July 25, 1994, is revised
to read as follows:
II. * * *
E. * * *
2. Risk Weights and Avoidance of Double Counting. Once the
credit equivalent amount for a derivative contract, or a group of
derivative contracts, has been determined, that amount is assigned
to the risk category appropriate to the counterparty, or, if
relevant, the guarantor or the nature of any collateral. However,
the maximum weight that will be applied to the credit equivalent
amount of such contracts is 50 percent.
In certain cases, credit exposures arising from the derivative
contracts covered by these guidelines may already be reflected, in
part, on the balance sheet. To avoid double counting such exposures
in the assessment of capital adequacy and, perhaps, assigning
inappropriate risk weights, counterparty credit exposures arising
from the types of instruments covered by these guidelines may need
to be excluded from balance sheet assets in calculating banks' risk-
based capital ratios.
The FDIC notes that the conversion factors set forth in section
II.E.1. of appendix A, which are based on observed volatilities of
the particular types of instruments, are subject to review and
modification in light of changing volatilities or market conditions.
Examples of the calculation of credit equivalent amounts for
these types of contracts are contained in table IV of this appendix
A.
5. In Appendix A to part 325, section II.E.3, as that section
was proposed to be added at 59 FR 37726, July 25, 1994, is revised
to read as follows:
II. * * *
E. * * *
3. Netting. For purposes of this appendix A, netting refers to
the offsetting of positive and negative mark-to-market values when
determining a current exposure to be used in the calculation of a
credit equivalent amount. Any legally enforceable form of bilateral
netting (that is, netting with a single counterparty) of derivative
contracts is recognized for purposes of calculating the credit
equivalent amount provided that:
* * * * *
(d) The bank maintains in its files documentation adequate to
support the netting of derivative contracts, including a copy of the
bilateral netting contract and necessary legal opinions.
A contract containing a walkaway clause is not eligible for
netting for purposes of calculating the credit equivalent
amount.\42\
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\42\For purposes of this section, a walkaway clause means a
provision in a netting contract that permits a non-defaulting
counterparty to make lower payments than it would make otherwise
under the contract, or no payments at all, to a defaulter or to the
estate of a defaulter, even if a defaulter or the estate of a
defaulter is a net creditor under the contract.
---------------------------------------------------------------------------
By netting individual contracts for the purpose of calculating
its credit equivalent amount, a bank represents that it has met the
requirements of this appendix A and all the appropriate documents
are in the bank's files and available for inspection by the FDIC.
Upon determination by the FDIC that a bank's files are inadequate or
that a netting contract may not be legally enforceable under any one
of the bodies of law described in paragraphs (b) (i) through (iii)
of this section, underlying individual contracts may be treated as
though they were not subject to the netting contract.
The credit equivalent amount of derivative contracts that are
subject to a qualifying bilateral netting contract is calculated by
adding (i) the net current exposure of the netting contract and (ii)
the sum of the estimates of potential future exposure for all
individual contracts subject to the netting contract, adjusted to
take into account the effects of the netting contract.
The net current exposure is the sum of all positive and negative
mark-to-market values of the individual contracts subject to the
netting contract. If the net sum of the mark-to-market values is
positive, then the net current exposure is equal to that sum. If the
net sum of the mark-to-market values is zero or negative, then the
net current exposure is zero.
The sum of the estimates of potential future exposure for all
individual contracts subject to the netting contract (Agross),
adjusted to reflect the effects of the netting contract (Anet),
is determined through application of a formula. The formula, which
employs the ratio of the net current to the gross current exposure
(NGR), is expressed as:
Anet = .5(Agross + (NGR * Agross))
Gross potential future exposure, or Agross, is calculated
by summing the estimates of potential future exposure (determined in
accordance with section II.E.1. of this appendix A) for each
individual contract subject to the qualifying bilateral netting
contract.\43\ The NGR is determined as the ratio of the net current
exposure of the netting contract to the gross current exposure of
the netting contract. The gross current exposure is the sum of the
current exposures of all individual contracts subject to the netting
contract calculated in accordance with section II.E.1. of this
appendix A. The effect of this treatment is that Anet is the
average of Agross and Agross adjusted by the NGR.
---------------------------------------------------------------------------
\43\For purposes of calculating gross potential future credit
exposure for foreign exchange contracts and other similar contracts
in which notional principal is equivalent to cash flows, total
notional principal is defined as the net receipts to each party
falling due on each value date in each currency.
---------------------------------------------------------------------------
6. In Appendix A to part 325, the chart in Table III and its
heading, as that section was proposed to be amended at 59 FR 37726,
July 25, 1994, is revised to read as follows:
Table III. * * *
* * * * *
Credit Conversion for Derivative Contracts
* * * * *
Conversion Factor MatrixA
[Numbers in percent]
------------------------------------------------------------------------
Residual Interest Exchange Precious Other
maturity rate rate EquityB metals commodities
------------------------------------------------------------------------
Less than one
year.......... 0.0 1.0 6.0 7.0 12.0
One to five
years......... 0.5 5.0 8.0 7.0 12.0
Five years or
more.......... 1.5 7.5 10.0 8.0 15.0
------------------------------------------------------------------------
AFor contracts with multiple exchanges of principal, the factors are to
be multiplied by the number of remaining payments in the contract.
BFor contracts that reset to zero value following a payment, the
remaining maturity is set equal to the time until the next payment.
* * * * *
6. In Appendix A to part 325, Table IV, as that table was proposed
to be added at 59 FR 37726, July 25, 1994, is revised to read as
follows:
Table IV.--Calculation of Credit Equivalent Amounts for Derivative Contracts
----------------------------------------------------------------------------------------------------------------
Potential exposure + = Credit equivalent amount
----------------------------------------------- ---------------------------------------------------
Notional Current Potential Market-to Current Credit
Type of contract (remaining principal exposure Exposure market exposure equivalent
maturity) (dollars) (dollars) value (dollars) amount
----------------------------------------------------------------------------------------------------------------
(1) 120-Day Forward Foreign
Exchange........................ 5,000,000 .01 50,000 100,000 100,000 150,000
(2) 6-Year Forward Foreign
Exchange........................ 6,000,000 .075 450,000 -120,000 0 450,000
(3) 3-Year Interest Rate Swap.... 10,000,000 .005 50,000 200,000 200,000 250,000
(4) 1-Year Oil Swap.............. 10,000,000 .12 1,200,000 -250,000 0 1,200,000
(5) 7-Year Interest Rate Swap.... 20,000,000 .015 300,000 -1,300,000 0 300,000
------------------------------------------------------------------------------
Total...................... ........... ............ 2,050,000 ........... 300,000 2,350,000
----------------------------------------------------------------------------------------------------------------
If contracts (1) through (5) above are subject to a qualifying
bilateral netting contract, then the following applies:
------------------------------------------------------------------------
Potential
future Net current Credit
exposure (from exposure* equivalent
above) amount
------------------------------------------------------------------------
(1).................. 50,000
(2).................. 450,000
(3).................. 50,000
(4).................. 1,200,000
(5).................. 300,000
----------------
Total.......... 2,050,000 + 0 = 2,050,000
------------------------------------------------------------------------
*The total of the mark-to-market values from above is -1,370,000. Since
this is a negative amount, the net current exposure is zero.
To recognize the effects of netting on potential future
exposure, the following formula applies:
Anet = .5 (Agross + (NGR * Agross))
In the above example:
NGR = 0 (0/300,000)
Anet = .5 (2,050,000 + (0 * 2,050,000))
Anet = 1,025,000
Credit Equivalent Amount: 1,025,000 + 0 = 1,025,000
If the net current exposure was a positive amount, for example,
$200,000, the credit equivalent amount would be calculated as
follows:
NGR = .67 (200,000/300,000)
Anet = .5(2,050,000 + (.67 * 2,050,000))
Anet = 1,711,750
Credit Equivalent Amount: 1,711,750 + 200,000 = 1,911,750
By order of the Board of Directors.
Dated at Washington, D.C. this 27 day of September, 1994.
Federal Deposit Insurance Corporation
Robert E. Feldman,
Acting Executive Secretary.
[FR Doc. 94-25662 Filed 10-18-94; 8:45 am]
BILLING CODE 6714-01-P
