[Federal Register Volume 59, Number 240 (Thursday, December 15, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-30771]
[[Page Unknown]]
[Federal Register: December 15, 1994]
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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 3
[Docket No. 94-22]
RIN 1557-AB14
FEDERAL RESERVE SYSTEM
12 CFR Part 208
[Regulation H; Docket No. R-0764]
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AB15
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
12 CFR Part 567
[No. 94-152]
RIN 1550-AA59
Risk-Based Capital Standards; Concentration of Credit Risk and
Risks of Nontraditional Activities
AGENCIES: Office of the Comptroller of the Currency (OCC), Treasury;
Board of Governors of the Federal Reserve System (Board); Federal
Deposit Insurance Corporation (FDIC); and Office of Thrift Supervision
(OTS), Treasury.
ACTION: Final rule.
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SUMMARY: The OCC, the Board, the FDIC and the OTS (collectively ``the
agencies'') are issuing this final rule to implement the portions of
section 305 of the Federal Deposit Insurance Corporation Improvement
Act of 1991 (FDICIA) that require the agencies to revise their risk-
based capital standards for insured depository institutions to ensure
that those standards take adequate account of concentration of credit
risk and the risks of nontraditional activities. The final rule amends
the risk-based capital standards by explicitly identifying
concentration of credit risk and certain risks arising from
nontraditional activities, as well as an institution's ability to
manage these risks, as important factors in assessing an institution's
overall capital adequacy.
EFFECTIVE DATE: January 17, 1995.
FOR FURTHER INFORMATION CONTACT: OCC: For issues relating to
concentration of credit risk and the risks of nontraditional
activities, Roger Tufts, Senior Economic Advisor (202/874-5070), Office
of the Chief National Bank Examiner. For legal issues, Ronald
Shimabukuro, Senior Attorney, Bank Operations and Assets Division (202/
874-4460), Office of the Comptroller of the Currency, 250 E Street,
S.W., Washington, DC 20219.
Board: For issues related to concentration of credit risk, David
Wright, Supervisory Financial Analyst, (202/728-5854) and for issues
related to the risks of nontraditional activities, William Treacy,
Supervisory Financial Analyst, (202/452-3859), Division of Banking
Supervision and Regulation; Scott G. Alvarez, Associate General Counsel
(202/452-3583), Gregory A. Baer, Managing Senior Counsel (202/452-
3236), Legal Division, Board of Governors of the Federal Reserve
System. For the hearing impaired only, Telecommunication Device for the
Deaf (TDD), Dorothea Thompson (202/452-3544), Board of Governors of the
Federal Reserve System, 20th and C Streets, NW., Washington, DC 20551.
FDIC: Daniel M. Gautsch, Examination Specialist (202/898-6912),
Stephen G. Pfeifer, Examination Specialist (202/898-8904), Division of
Supervision, or Fred S. Carns, Chief, Financial Markets Section,
Division of Research and Statistics (202/898-3930). For legal issues,
Pamela E. F. LeCren, Senior Counsel (202/898-3730) or Claude A. Rollin,
Senior Counsel (202/898-3985), Legal Division, Federal Deposit
Insurance Corporation, 550 17th Street, NW., Washington, DC 20429.
OTS: John Connolly, Senior Program Manager, Capital Policy (202)
906-6465; Dorene Rosenthal, Senior Attorney, Regulations, Legislation
and Opinions Division (202) 906-7268, Office of Thrift Supervision,
1700 G Street, NW., Washington, DC 20552.
SUPPLEMENTARY INFORMATION:
I. Background
The risk-based capital standards adopted by the agencies tailor an
institution's minimum capital requirement to broad categories of credit
risk embodied in its assets and off-balance-sheet instruments. These
standards require institutions to have total capital equal to at least
8 percent of their risk-weighted assets.1 Institutions with high
or inordinate levels of risk are expected to operate above minimum
capital standards. Currently, each agency addresses capital adequacy
through a variety of supervisory actions and considers the risks of
credit concentrations and nontraditional activities in taking those
varied supervisory actions.
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\1\As defined, risk-weighted assets include credit exposures
contained in off-balance-sheet instruments.
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Section 305(b) of FDICIA, Pub. L. 102-242 (12 U.S.C. 1828 note),
requires the agencies to revise their risk-based capital standards for
insured depository institutions to ensure that those standards take
adequate account of interest rate risk, concentration of credit risk
and the risks of nontraditional activities. This final rule addresses
concentration of credit risk and the risks of nontraditional
activities. The agencies are addressing interest rate risk through
separate rulemakings. See OCC, Board and FDIC joint notice of proposed
rulemaking, 58 FR 48206 (September 14, 1993) and OTS final rulemaking,
58 FR 45799 (August 31, 1993). In addition, the agencies issued
separate final rules to implement the section 305 requirement that
risk-based capital standards reflect the actual performance and
expected risk of loss of multifamily mortgages.
For the risks related to concentration of credit and nontraditional
activities, the agencies published a joint notice of proposed
rulemaking on February 22, 1994. See 59 FR 8420. The agencies received
54 comments, including duplicate comments among the agencies. A
description of the joint proposed rule along with a discussion of the
comments follows.
II. Concentration of Credit Risk
A. Proposed Approach
In the joint proposed rule, the agencies stated that it was not
currently feasible to quantify the risk related to concentrations of
credit for use in a formula-based capital calculation. Although most
institutions can identify and track large concentrations of credit risk
by individual or related groups of borrowers, and some can identify
concentrations by industry, geographic area, country, loan type or
other relevant factors, there is no generally accepted approach to
identifying and quantifying the magnitude of risk associated with
concentrations of credit. In particular, definitions and analyses of
concentrations are not uniform within the industry and are based in
part on the subjective judgments of each institution using its
experience and knowledge of its specific borrowers, market areas and
products.
Nonetheless, techniques do exist to identify broad classes of
concentrations and to recognize significant exposures. The effective
tracking and management of such risk is important to ensuring the
safety and soundness of financial institutions. Institutions with
significant concentrations of credit risk require capital above the
regulatory minimums. As new developments in identifying and measuring
concentration of credit risk emerge, the agencies will consider
potential refinements to the risk-based capital standards.
Accordingly, the agencies proposed to take account of concentration
of credit risk in their risk-based capital guidelines or regulations by
amending the standards to explicitly cite concentrations of credit risk
and an institution's ability to monitor and control them as important
factors in assessing an institution's overall capital adequacy. The
joint proposed rule contemplated that in addition to reviewing
concentrations of credit risk pursuant to section 305, the agencies
also may review an institution's management of concentrations of credit
risk for adequacy and consistency with safety and soundness standards
regarding internal controls, credit underwriting or other relevant
operational and managerial areas to be promulgated pursuant to section
132 of FDICIA.
B. Comments
The vast majority of commenters supported the agencies' decision
not to propose any quantitative formula or standard. Many commenters,
however, expressed a general concern as to how the agencies would
implement and interpret the joint proposed rule. Commenters noted with
approval the agencies' observation that rulemaking in this area could
inadvertently create false incentives or unintended consequences that
might decrease the safety and soundness of the banking and thrift
industries or unnecessarily reduce the availability of credit to
potential borrowers. Several commenters, particularly smaller banks,
agreed with the agencies that, while portfolio diversification is a
desirable goal, it may also increase an institution's overall risk if
accomplished by lending in unfamiliar market areas to out-of-territory
borrowers or by rapid expansion of new loan products for which the
institution does not have adequate expertise.
A significant number of commenters went further, however,
suggesting that any requirement for institutions to hold additional
capital for significant concentrations of credit risk, including the
case-by-case approach proposed by the agencies, would hurt small banks
with limited portfolios and would encourage unhealthy diversification.
Under the ``Qualified Thrift Lender'' test, for example, thrifts must
hold 65 percent of their assets in qualifying categories. This
requirement necessarily ``concentrates'' a thrift's portfolio in
certain types of assets. Agricultural banks described their position as
similar, and therefore opposed any requirement of additional capital in
order to compensate for exposures to concentrations of credit.
One commenter felt that the potential risk of loss from
concentrations of credit should be reflected in the allowance for loan
and lease losses (ALLL). As described in the December 21, 1993
Interagency Policy Statement regarding the ALLL, the current amount of
the loan and lease portfolio that is not likely to be collected should
be reflected in the ALLL. In making a determination as to the
appropriate level for the ALLL, the policy statement identifies
concentrations of credit risk as one of several factors to be taken
into account by an institution. While both the ALLL and capital serve
as a cushion against losses, the difference between the ALLL and
capital is that the ALLL should be maintained at a level that is
adequate to absorb estimated losses, while capital is meant to provide
an additional cushion for unexpected future losses. Because the
magnitude and timing of losses from concentrations are hard to predict
and therefore come unexpectedly, institutions with significant levels
of concentrations of credit risk should hold capital above the
regulatory minimums. At the same time, institutions with concentrations
of credit that are experiencing a deterioration in credit quality and
collectability should reflect the increased risk in those
concentrations in the ALLL. Any identifiable loan and lease losses
should be recognized immediately by reducing the asset's value and the
ALLL.
C. Final Rules
After careful consideration of all the comments, the agencies have
decided to adopt the proposed rules on concentration of credit risk
without modification. The agencies believe that there is not currently
an acceptable method to add a quantitative formula to the risk-based
capital standards in order to measure concentration of credit risk.
However, the agencies also believe that institutions identified through
the examination process as having significant exposure to concentration
of credit risk or as not adequately managing concentration risk, should
hold capital in excess of the regulatory minimums.
The agencies have reached this conclusion for two reasons. First,
although the agencies recognize that in some cases concentrations of
credit are inevitable, they nonetheless can pose important risks. Other
things being equal, an institution that is not diversified faces risks
that a diversified institution does not, and accordingly presents risks
to the deposit insurance fund that a diversified institution does not.
Second, Congress in section 305 of FDICIA clearly mandated that these
risks be taken into account in determining an institution's capital
adequacy. OTS, however, does not believe it is appropriate to, and will
not, implement section 305 in a way that penalizes thrift institutions
for complying with the statutory Qualified Thrift Lender test. In
addition, the agencies are not encouraging out-of-territory lending as
a response to diversification concerns.
III. Risks of Nontraditional Activities
A. Proposed Approach
The agencies proposed to take account of the risks posed by
nontraditional activities by ensuring that, as members of the industry
began to engage in, or significantly expand their participation in, a
nontraditional activity, the risks of that activity would be promptly
analyzed and the activity given appropriate capital treatment. The
agencies also proposed to amend their risk-based capital standards to
explicitly cite the risks arising from nontraditional activities, and
management's ability to monitor and control these risks, as important
factors to consider in assessing an institution's overall capital
adequacy.
New developments in technology and financial markets have
introduced significant changes to the banking industry, and in some
cases have led institutions to engage in activities not traditionally
considered part of their business. Both in the risk-based capital
regulations and guidelines adopted by the agencies in 1989 and in
subsequent revisions and interpretations, the agencies have adopted
measures to take adequate account of the risks of nontraditional
activities under the risk-based capital standards. For example, the
FRB, FDIC and the OCC have recently published for comment a proposal to
change the way that the counterparty credit risks are measured and
incorporated into a risk-based capital ratio for equity index,
commodity, and precious metals off-balance sheet instruments. These
proposed changes were unique for each of the distinct products. The OTS
intends to issue a parallel proposal in the near future. As
nontraditional activities develop in the future, the agencies will
address each activity on a case-by-case basis. Thus, to the extent that
section 305 constitutes a mandate to the agencies to make certain that
risk-based capital standards are kept current with industry practices,
the agencies have been acting consistently with the intent of section
305.
B. Comments and Final Rules
While most comments focused on concentration of credit risk rather
than nontraditional activities, some commenters noted their approval of
the agencies' approach with regard to both parts of the rulemaking.
Only a few commenters criticized the agencies' proposal on
nontraditional activities, expressing concern that the agencies'
proposals were too vague for examiners to apply or that the proposals
were too inflexible.
After careful consideration of all the comments, the agencies are
adopting the joint proposed rule on nontraditional activities without
modification. The agencies believe that this final rule appropriately
recognizes that the effect of a nontraditional activity on an
institution's capital adequacy depends on the activity, the profile of
the institution, and the institution's ability to monitor and control
the risks arising from that activity. The agencies will continue their
efforts to incorporate nontraditional activities into risk-based
capital. In addition, to the extent appropriate, the agencies will
issue examination guidelines on new developments in nontraditional
activities or concentrations of credit to ensure that adequate account
is taken of the risks of these activities.
IV. Paperwork Reduction Act
No collections of information pursuant to section 3504(h) of the
Paperwork Reduction Act (44 U.S.C. 3501 et seq.) are contained in this
final rule. Consequently, no information has been submitted to the
Office of Management and Budget for review.
V. Regulatory Flexibility Act Statement
Each agency hereby certifies pursuant to section 605b of the
Regulatory Flexibility Act (5 U.S.C. 605(b)) that the final rule will
not have a significant economic impact on a substantial number of small
entities within the meaning of the Regulatory Flexibility Act (5 U.S.C.
601 et seq.). This final rule does not necessitate the development of
sophisticated recordkeeping or reporting systems by small institutions;
nor will small institutions need to seek out the expertise of
specialized accountants, lawyers, or managers in order to comply with
the regulation.
VI. Executive Order 12866
The OCC and OTS have determined that this final rule does not
constitute ``significant regulatory action'' for purposes of Executive
Order 12866.
List of Subjects
12 CFR Part 3
Administrative practice and procedure, Capital risk, National
banks, Reporting and recordkeeping requirements.
12 CFR Part 208
Accounting, Agriculture, Banks, Banking, Confidential business
information, Crime, Currency, Federal Reserve System, Mortgages,
Reporting and recordkeeping requirements, Securities.
12 CFR Part 325
Bank deposit insurance, Banks, Banking, Capital adequacy, Reporting
and recordkeeping requirements, Savings associations, State nonmember
banks.
12 CFR Part 567
Capital, Reporting and recordkeeping requirements, Savings
associations.
Authority and Issuance
OFFICE OF THE COMPTROLLER OF THE CURRENCY
12 CFR Chapter I
For the reasons set out in the joint preamble, 12 CFR part 3 is
amended as set forth below:
PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES
1. The authority citation for part 3 is revised to read as follows:
Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n
note, 3907 and 3909.
2. Section 3.1 is revised to read as follows:
This part is issued under the authority of 12 U.S.C. 1 et seq.,
93a, 161, 1818, 3907 and 3909.
3. Section 3.10 is revised to read as follows:
Sec. 3.10 Applicability.
The OCC may require higher minimum capital ratios for an individual
bank in view of its circumstances. For example, higher capital ratios
may be appropriate for:
(a) A newly chartered bank;
(b) A bank receiving special supervisory attention;
(c) A bank that has, or is expected to have, losses resulting in
capital inadequacy;
(d) A bank with significant exposure due to interest rate risk, the
risks from concentrations of credit, certain risks arising from
nontraditional activities, or management's overall inability to monitor
and control financial and operating risks presented by concentrations
of credit and nontraditional activities;
(e) A bank with significant exposure due to fiduciary or
operational risk;
(f) A bank exposed to a high degree of asset depreciation, or a low
level of liquid assets in relation to short-term liabilities;
(g) A bank exposed to a high volume of, or particularly severe,
problem loans;
(h) A bank that is growing rapidly, either internally or through
acquisitions; or
(i) A bank that may be adversely affected by the activities or
condition of its holding company, affiliate(s), or other persons or
institutions including chain banking organizations, with which it has
significant business relationships.
Dated: November 18, 1994.
Eugene A. Ludwig,
Comptroller of the Currency.
FEDERAL RESERVE SYSTEM
12 CFR Chapter II
For the reasons set forth in the joint preamble, 12 CFR Part 208 is
amended as set forth below:
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)
1. The authority citation for Part 208 continues to read as
follows:
Authority: 12 U.S.C. 36, 248(a), 248(c), 321-338a, 371d, 461,
481-486, 601, 611, 1814, 1823(j), 1828(o), 1831o, 1831p-1, 3105,
3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b, 78l(b), 78l(g),
78l(i), 78o-4(c)(5), 78q, 78q-1, and 78w; 31 U.S.C. 5318.
2. Appendix A to Part 208 is amended by revising the fifth and
sixth paragraphs under ``I. Overview'' to read as follows:
Appendix A to Part 208--Capital Adequacy Guidelines for State Member
Banks: Risk-Based Measure
I. Overview
* * * * *
The risk-based capital ratio focuses principally on broad
categories of credit risk, although the framework for assigning
assets and off-balance-sheet items to risk categories does
incorporate elements of transfer risk, as well as limited instances
of interest rate and market risk. The framework incorporates risks
arising from traditional banking activities as well as risks arising
from nontraditional activities. The risk-based ratio does not,
however, incorporate other factors that can affect an institution's
financial condition. These factors include overall interest-rate
exposure; liquidity, funding and market risks; the quality and level
of earnings; investment, loan portfolio, and other concentrations of
credit risk; certain risks arising from nontraditional activities;
the quality of loans and investments; the effectiveness of loan and
investment policies; and management's overall ability to monitor and
control financial and operating risks, including the risks presented
by concentrations of credit and nontraditional activities.
In addition to evaluating capital ratios, an overall assessment
of capital adequacy must take account of those factors, including,
in particular, the level and severity of problem and classified
assets. For this reason, the final supervisory judgement on a bank's
capital adequacy may differ significantly from conclusions that
might be drawn solely from the level of its risk-based capital
ratio.
* * * * *
By order of the Board of Governors of the Federal Reserve
System, December 9, 1994.
Barbara R. Lowrey,
Associate Secretary of the Board.
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Chapter III
For the reasons set forth in the joint preamble, 12 CFR Part 325 is
amended as follows:
PART 325--CAPITAL MAINTENANCE
1. The authority citation for part 325 is revised 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), 1828 note, 1831n note, 1831o, 3907, 3909.
Sec. 325.3 [Amended]
2. Section 325.3(a) is amended in the fourth sentence by adding
``significant risks from concentrations of credit or nontraditional
activities,'' immediately after ``funding risks,'' and by adding ``will
take these other factors into account in analyzing the bank's capital
adequacy and'' immediately after `FDIC'' and before ``may''.
3. The fifth paragraph of the introductory text of Appendix A to
Part 325 is revised to read as follows:
Appendix A to Part 325--Statement of Policy on Risk-Based Capital
* * * * *
The risk-based capital ratio focuses principally on broad
categories of credit risk; however, the ratio does not take account
of many other factors that can affect a bank's financial condition.
These factors include overall interest rate risk exposure;
liquidity, funding and market risks; the quality and level of
earnings; investment, loan portfolio, and other concentrations of
credit risk; certain risks arising from nontraditional activities;
the quality of loans and investments; the effectiveness of loan and
investment policies; and management's overall ability to monitor and
control financial and operating risks, including the risk presented
by concentrations of credit and nontraditional activities. In
addition to evaluating capital ratios, an overall assessment of
capital adequacy must take account of each of these other factors,
including, in particular, the level and severity of problem and
adversely classified assets. For this reason, the final supervisory
judgment on a bank's capital adequacy may differ significantly from
the conclusions that might be drawn solely from the absolute level
of the bank's risk-based capital ratio.
* * * * *
By order of the Board of Directors.
Dated at Washington, DC, this 9th day of August 1994.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Acting Executive Secretary.
OFFICE OF THRIFT SUPERVISION
12 CFR Chapter V
For the reasons set forth in the joint preamble, 12 CFR Part 567 is
amended as follows:
SUBCHAPTER D--REGULATIONS APPLICABLE TO ALL SAVINGS ASSOCIATIONS
PART 567--CAPITAL
1. The authority citation for part 567 continues to read as
follows:
Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1467a, 1828
(note).
2. Section 567.3 is amended by revising paragraphs (b)(3) and
(b)(9) to read as follows:
Sec. 567.3 Individual minimum capital requirements.
* * * * *
(b) * * *
(3) A savings association that has a high degree of exposure to
interest rate risk, prepayment risk, credit risk, concentration of
credit risk, certain risks arising from nontraditional activities, or
similar risks; or a high proportion of off-balance sheet risk,
especially standby letters of credit;
* * * * *
(9) A savings association that has a record of operational losses
that exceeds the average of other, similarly situated savings
associations; has management deficiencies, including failure to
adequately monitor and control financial and operating risks,
particularly the risks presented by concentrations of credit and
nontraditional activities; or has a poor record of supervisory
compliance.
* * * * *
Dated: August 12, 1994.
By the Office of Thrift Supervision.
Jonathan L. Fiechter,
Acting Director.
[FR Doc. 94-30771 Filed 12-14-94; 8:45 am]
BILLING CODES: OCC 4810-33-P; Board 6210-01-P; FDIC 6714-01-P; OTS
6720-01-P
