[Federal Register Volume 59, Number 235 (Thursday, December 8, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-30156]
Federal Register / Vol. 59, No. 235 / Thursday, December 8, 1994 /
[[Page Unknown]]
[Federal Register: December 8, 1994]
VOL. 59, NO. 235
Thursday, December 8, 1994
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-0823]
Capital; Capital Adequacy Guidelines
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Final rule.
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SUMMARY: The Board of Governors of the Federal Reserve System is
amending its risk-based capital guidelines for state member banks and
bank holding companies. Under this final rule, institutions are
generally directed to not include in regulatory capital the ``net
unrealized holding gains (losses) on securities available for sale,''
the new common stockholders' equity account created by Statement of
Financial Accounting Standards Number 115 (FAS 115), Accounting for
Certain Investments in Debt and Equity Securities. Net unrealized
losses on marketable equity securities (i.e., equity securities with
readily determinable fair values), however, will continue to be
deducted from Tier 1 capital. This rule has the general effect of
valuing available-for-sale securities at amortized cost (i.e., based on
historical cost), rather than at fair value (i.e., generally at market
value), for purposes of calculating the risk-based and leverage capital
ratios.
EFFECTIVE DATE: December 31, 1994.
FOR FURTHER INFORMATION CONTACT: Rhoger H Pugh, Assistant Director
(202/728-5883), Norah M. Barger, Manager (202/452-2402), Arleen E.
Lustig, Supervisory Financial Analyst (202/452-2987), and John M.
Frech, Supervisory Financial Analyst (202/452-2275), Division of
Banking Supervision and Regulation, 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.
SUPPLEMENTARY INFORMATION:
Background
On December 28, 1993, the Board of Governors issued for public
comment a proposal to amend its risk-based capital guidelines1 for
state member banks and bank holding companies to include in Tier 1
capital the ``net unrealized holding gains and losses on securities
available for sale'' (58 FR 68563, December 28, 1993). The proposal
would have had the effect of valuing securities available for sale at
market value for purposes of calculating the risk-based and leverage
capital ratios. In its proposal, the Board offered several alternative
treatments, one of which was to not include such net unrealized gains
and losses in the calculation of regulatory capital. It is this
alternative treatment that the Board is adopting as a final rule. The
comment period ended on January 21, 1994.
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\1\The Board's risk-based capital guidelines implement, for
state member banks and bank holding companies, the international
bank capital standards as set forth in the Basle Accord. The Basle
Accord is a risk-based capital framework that was proposed by the
Basle Committee on Banking Regulations and Supervisory Practices and
endorsed by the central bank governors of the Group of Ten (G-10)
countries in July 1988. The 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.
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The proposal was in response to the issuance of FAS 115 on May 31,
1993, which established ``net unrealized holding gains (losses) on
securities available for sale'' as a new element of common
stockholders' equity. All banking organizations were required to adopt
FAS 115, for both generally accepted accounting principles (GAAP) and
regulatory reporting purposes, as of January 1, 1994, or the beginning
of their first fiscal year thereafter, if later. Earlier adoption was
permitted.
Since the final capital treatment of such net unrealized gains and
losses on available-for-sale securities was not in effect by year-end
1993, the Board directed state member banks and bank holding companies
to continue calculating the risk-based and leverage capital ratios on a
pre-FAS 115 basis. Accordingly, the net unrealized holding gains and
losses on available-for-sale debt securities were not included in
regulatory capital, and the amortized cost rather than the fair value
of available-for-sale debt securities generally continued to be used in
the calculation of both capital ratios. Moreover, equity securities
with readily determinable fair values continued to be valued at the
lower of cost or fair value for regulatory capital purposes. Both the
Federal Deposit Insurance Corporation (FDIC) and the Office of the
Comptroller of the Currency (OCC) followed this interim capital
treatment.
FAS 115
FAS 115 divides securities held by banking organizations among
three categories: (1) Securities held to maturity; (2) trading account
securities; and (3) securities available for sale.
Under FAS 115, trading securities are defined as those securities
that an institution buys and holds principally for the purpose of
selling in the near term. As under earlier accounting standards, these
securities are to be reported at fair value (i.e., generally at market
value), with net unrealized changes in their value reported directly in
the income statement as part of an institution's earnings.
Under FAS 115, securities held to maturity are to be recorded at
amortized cost. However, FAS 115 states that a banking organization may
include a security in the held-to-maturity category only if management
has ``the positive intent and ability to hold the security to
maturity.''
Securities meeting the definition of the available-for-sale
category (i.e., all securities not held for trading that an institution
cannot justify categorizing as held-to-maturity) are to be reported at
fair value. Changes in the fair value of securities available for sale
are to be reported, net of tax effects, directly in a separate
component of common stockholders' equity. Consequently, any unrealized
appreciation or depreciation in the value of securities in the
available-for-sale category has no impact on the reported earnings of
an institution, but affects its GAAP equity capital position.
Initial Proposal
In late December 1993, the Board proposed amending the capital
adequacy guidelines for state member banks and bank holding companies
to reflect the provisions of FAS 115 (58 FR 68563, December 28, 1993).
Under the proposed amendment, the net amount of unrealized gains and
losses, adjusted for the effects of income taxes, on securities held in
the available-for-sale account would be included in Tier 1
capital2 and such securities would be booked at fair value rather
than at amortized cost for purposes of calculating the risk-based and
leverage capital ratios.
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\2\The Board's risk-based capital guidelines set forth a
definition of Tier 1 capital that includes common stockholders'
equity. These guidelines further state that common stockholders'
equity includes: (1) Common stock; (2) related surplus; and (3)
retained earnings, including capital reserves and adjustments for
the cumulative effect of foreign currency translation, net of
treasury stock.
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The Board proposed inclusion of net unrealized gains and losses on
available-for-sale securities in Tier 1 capital because it would make
the definition of Tier 1 capital more equivalent to the GAAP definition
of equity capital. In addition, the proposed Tier 1 capital treatment
for unrealized changes in the value of securities available for sale
could be viewed as an extension of the capital treatment currently
applied to net unrealized gains and losses on trading securities, which
are recognized in Tier 1 capital. This recognition has long been viewed
as consistent with the Basle Accord. Thus, it could be argued that
inclusion of unrealized gains and losses on securities available for
sale in Tier 1 capital is also consistent with the Basle Accord.
The Board also noted in its initial proposal that the inclusion of
net unrealized changes in the value of securities available for sale in
Tier 1 capital would affect the calculation of capital for purposes of
a number of laws and regulations that are based, in part, on the
institution's capital levels. Such laws and regulations include prompt
corrective action (12 CFR part 208, Subpart B), brokered deposit
restrictions (12 CFR 337.6), and the risk-related insurance premium
system (12 CFR part 327).
While proposing Tier 1 capital treatment for net unrealized gains
and losses on available-for-sale securities, the Board also sought
public comment on several alternative treatments. The other options
included:
(a) Excluding from regulatory capital all changes in the value of
securities available for sale, which would have the same effect as
valuing these securities on an amortized cost basis;
(b) Including losses in Tier 1 capital, while not recognizing any
gains for capital purposes, which would have the effect of valuing
securities available for sale on lower of cost or market basis;
(c) Including both the gains and losses in Tier 2 capital; and
(d) Including losses in Tier 1 capital, while including gains in
Tier 2 capital.
Comments Received
The Federal Reserve received letters from 59 public commenters.
Comments were received from 17 multinational and large regional banking
organizations, 24 community banking organizations, seven foreign banks,
six banking trade associations, two state banking supervisors, two
consultants, and one law firm. Twenty-one of the public commenters
supported the proposal to include ``net unrealized holding gains
(losses) on securities available for sale,'' in Tier 1 capital, while
38 opposed the proposal, including all seven foreign banks.
Public commenters opposed to the proposal included 18 out of the 24
community banks, 5 out of the 17 multinational and large regional
banking organizations, all seven foreign banking organizations, three
banking trade associations, two state banking supervisory
organizations, two consultants, and one law firm. Some of the common
reasons cited for opposing the proposal included:
(1) The additional volatility to capital resulting from marking-to-
market the available-for-sale securities and consequent fluctuations
for some institutions in their single borrower lender limits;
(2) The potential for temporary changes in interest rates to have
an adverse effect on the risk-based and leverage capital ratios that
would result in a lower prompt corrective action category or higher
FDIC risk-based insurance premiums;
(3) The distorting effect of applying market value accounting to
some items on only one side of the institution's balance sheet,
particularly since interest rate changes that cause changes in asset
values often give rise to offsetting changes to the value of the
deposit base, which existing accounting standards do not recognize; and
(4) The potential for organizations to become critically
undercapitalized and subject to closure as a result of temporary
changes in the market values of securities that the banking
organization has no intention of selling.
All seven foreign banks that commented on the proposal opposed the
inclusion of the net unrealized gains and losses on available-for-sale
securities in Tier 1 on the grounds that such treatment for the new
equity account is inconsistent with the Basle Accord. In their view,
this account is more comparable to securities revaluation reserves,
which, under the Accord, are substantially discounted and accorded Tier
2 status, rather than disclosed reserves, which receive an unlimited
Tier 1 treatment under the Accord.
Twelve of the 17 multinational and large regional banking
organizations commented favorably on the proposal, as did three banking
trade associations. However, five multinational and large regional
banking organizations opposed the proposal citing concerns similar to
those given by smaller institutions. The 21 commenters favoring the
proposal gave two main reasons for their support:
(1) The proposed Tier 1 treatment of the new account would parallel
the GAAP equity treatment for unrealized gains and losses and, thus,
institutions could avoid having to maintain two sets of accounting
records for available-for-sale securities; and
(2) Tier 1 treatment would be consistent with the intent of section
121 of the Federal Deposit Insurance Corporation Improvement Act of
1991 (FDICIA), which stipulates that regulatory accounting standards be
no less stringent than GAAP.
In its proposal, the Board asked for specific comment on six
issues. Ten public commenters commented on the first issue, which
concerned the extent to which FAS 115 may permit an institution to sell
securities from the held-to-maturity account without calling into
question the institution's intent or ability to continue to hold other
securities reported in that account. All 10 commenters stated that FAS
115 provides a specific set of circumstances under which banking
organizations can sell securities from the held-to-maturity account
without tainting the remaining securities in that account.
Seven banking institutions commented on the second issue, which
concerned requests for examples of isolated, nonrecurring, and unusual
events involving demands for liquidity that would permit the sale or
transfer of held-to-maturity securities under FAS 115. The most common
examples cited were changes in tax law, deterioration in the credit-
worthiness of a security issuer, and natural disasters.
The third issue concerned alternatives to the proposed Tier 1
capital treatment. Twenty-three organizations commented on the
alternatives included in the Board's request for public comment. These
alternatives included: Excluding all such changes from capital;
deducting losses from Tier 1 capital, and either not recognizing any
gains for capital purposes or including them in Tier 2 capital; and
including both the gains and losses in Tier 2 capital.
Of the 23 commenters, six were multinational or large regional
banking organizations that supported the proposal. Generally, these
organizations did not favor any of the alternatives. However, 13
commenters, including the seven foreign banks that opposed the
proposal, stated that they preferred Tier 2 treatment for net
unrealized gains and losses on available-for sale securities over Tier
1 treatment. Four commenters preferred not including the net unrealized
gains and losses on available-for-sale securities in regulatory
capital.
The fourth issue concerned the extent to which the above
alternatives might create an incentive for banking organizations to
sell securities that have appreciated to realize the gains in Tier 1
capital, while holding securities that have depreciated to avoid
reductions in Tier 1 capital. Six commenters offered views on this
issue. Most of these commenters felt that including unrealized gains
and losses in regulatory capital would provide some disincentive for
banks not to pursue such a strategy. Another commenter stated that
while the exclusion of the net unrealized gains and losses could lead a
company to selectively sell only securities in which it had a gain, the
Securities and Exchange Commission (SEC) would question such a
practice.
In setting forth the fifth issue, the Board asked commenters to
suggest the appropriate manner for maintaining an Allocated Transfer
Risk Reserve (ATRR) for certain foreign debt securities (e.g., ``Brady
Bonds'') held as securities available for sale. Three multinational
banking institutions responded to this issue. All three organizations
stated that the ATRR should not be applied to such foreign securities
since such securities are reflected on banks' financial statements at
market value.
The last issue concerned the importance of maintaining consistent
application of the Basle capital standards. Fourteen banking
organizations and associations commented on this issue. Seven
commenters, all of which were foreign banks, stated that the proposal
to include the new common equity component in Tier 1 was inconsistent
with the provisions of the Basle Accord. They stated that Tier 1
treatment could create competitive inequality with international banks.
Moreover, they stated that Tier 1 treatment could cause inconsistency
between the Tier 1 measure applied to U.S. banks and the Tier 1 measure
applied by other banks regulated by different accounting rules,
reducing the meaningfulness of the capital adequacy comparisons.
However, three banking organizations, all of which supported the Tier 1
proposal, stated that the proposal was consistent with the Basle Accord
and, therefore, would not reduce the meaningfulness of comparisons.
Final Rule
After consideration of the public comments and further deliberation
on the issues involved, the Board is adopting a final rule that amends
the risk-based capital guidelines to explicitly state that net
unrealized gains and losses on available-for-sale securities generally
are not be included in capital. Under the final rule, however,
unrealized losses on marketable equity securities would continue to be
deducted from Tier 1 capital. This final rule was developed in close
coordination with the other federal banking agencies and results in a
capital treatment for net unrealized gains and losses on securities
available for sale that is the same as the interim capital treatment
agreed to by the agencies in December 1993.
The Board is adopting one of the alternative capital treatments
suggested in December 1993 as a final rule rather than the Tier 1
treatment proposed for a number of reasons. First, most commenters
opposed the Board's proposal to include the FAS 115 net unrealized
gains and losses in risk-based capital calculations because of concerns
about the potential volatility in regulatory capital. As discussed
under the section entitled ``Comments Received,'' commenters noted that
the inclusion of the net unrealized gains and losses on available-for-
sale securities would result in fluctuations in regulatory capital due
to temporary changes in interest rates. Thus, an institution's capital
as calculated for prompt corrective action, risk-based insurance
deposit premiums, lending limits, and other limits based on capital
would be affected by unrealized changes in the value of securities that
it may not intend or need to sell.
Some commenters also expressed concerns about having to reflect in
regulatory capital changes in the market value of selected items on one
side of the balance sheet but not the other side. In this regard, the
Board notes that it and the other banking agencies opposed FAS 115 as
representing piecemeal adoption of mark-to-market accounting when it
was issued for public comment. By not adopting FAS 115 for regulatory
capital purposes, the Board is taking an action that is consistent with
the position, which was taken by the agencies at the time FAS 115 was
proposed, that the standard could produce distorted financial
statements because it marked some balance sheet items to market but
ignored changes in the market value of other items, including
liabilities, that could have offsetting price changes. In addition, the
Board has long opposed proposals to adopt mark-to-market accounting
because of the difficulty in determining the market values of various
assets and liabilities and the inappropriateness of using this
accounting method for institutions that do not actively trade in
marketable financial assets.
The Board believes that not including the FAS 115 net unrealized
gains and losses in capital is consistent with the Basle Accord, which
(except for trading account assets) generally does not permit Tier 1
capital to be increased by unrealized gains on securities. In addition,
the Board finds that FDICIA 121's requirement that the accounting
principles used in regulatory reports be no less stringent than GAAP
does not apply to the Board's definition of regulatory capital. This
finding suggests that excluding net gains and losses from regulatory
capital is consistent with FDICIA 121. Moreover, consistent with past
opinions expressed by the Board, the Board is not convinced that
marking to market available-for-sale securities as FAS 115 requires is
necessarily a more stringent reporting treatment than valuing such
securities at amortized cost. While mark-to-market treatment results in
the recognition of unrealized losses in GAAP equity capital, it also
permits the unlimited recognition of unrealized gains in such capital.
Furthermore, the Board believes that concerns about not deducting
net unrealized losses on available-for-sale securities are overstated
since the regulatory reports filed by banking organizations that are
available to the public have long collected information on the
amortized cost and market value of all securities held in their
portfolios (including those held as long-term investments). Thus,
examiners and analysts can readily take any depreciation, as well as
any appreciation, in a banking organization's securities portfolio into
consideration in the determination of the institution's overall capital
adequacy.
Finally, the Board has decided to continue to deduct net unrealized
losses on marketable equity securities since, unlike debt securities,
equities have no maturity date and an uncertain final value. This
decision is consistent with longstanding supervisory practice.
Regulatory Flexibility Act Analysis
Pursuant to section 605(b) of the Regulatory Flexibility Act, the
Board hereby certifies that this final rule will not have a significant
impact on a substantial number of small business entities (in this
case, small banking organizations). The risk-based capital guidelines
generally do not apply to bank holding companies with consolidated
assets of less than $150 million; thus, the final rule will not affect
such companies.
Paperwork Reduction Act and Regulatory Burden
The Board has determined that this final rule will not increase the
regulatory paperwork burden of banking organizations pursuant to the
provisions of the Paperwork Reduction Act (44 U.S.C. 3501 et seq.).
Section 302 of the Riegle Community Development and Regulatory
Improvement Act of 1994 (Pub. L. 103-325, 108 Stat. 2160) provides that
the federal banking agencies must consider the administrative burdens
and benefits of any new regulations that impose additional requirements
on insured depository institutions. Section 302 also requires such a
rule to take effect on the first day of the calendar quarter following
final publication of the rule, unless the agency, for good cause,
determines an earlier effective date is appropriate.
The new capital rule does not impose any new requirements on
depository institutions of bank holding companies for purposes of
calculating their risk-based and leverage capital ratios. The amended
rule clarifies the capital treatment of a common stockholders' equity
component, ``net unrealized holding gains (losses) on securities
available for sale,'' created by FAS 115, but does not change current
treatment. For these reasons, the Board has determined that an
effective date of December 31, 1994, is appropriate. For these same
reasons, in accordance with 5 U.S.C. 553(d)(3), the Board finds there
is good cause not to follow the 30-day notice requirements of 5 U.S.C.
553(d) and to make the rule effective on December 31, 1994.
List of Subjects
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 225
Administrative practice and procedure, Banks, Banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
For the reasons set forth in the preamble, the Board is amending 12
CFR parts 208 and 225 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 is revised 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 sections II.A.1.a.
and II.A.2.f to read as follows:
Appendix A to Part 208--Capital Adequacy Guidelines for State Member
Banks: Risk-Based Measure
* * * * *
II. * * *
A. * * *
1. * * *
a. Common stockholders' equity. For purposes of calculating the
risk-based capital ratio, common stockholders' equity is limited to
common stock; related surplus; and retained earnings, including
capital reserves and adjustments for the cumulative effect of
foreign currency translation, net of any treasury stock; less net
unrealized holding losses on available-for-sale equity securities
with readily determinable fair values. For this purpose, net
unrealized holding gains on such equity securities and net
unrealized holding gains (losses) on available-for-sale debt
securities are not included in common stockholders' equity.
* * * * *
2. * * *
f. Revaluation reserves. i. Such reserves reflect the formal
balance sheet restatement or revaluation for capital purposes of
asset carrying values to reflect current market values. The federal
banking agencies generally have not included unrealized asset
appreciation in capital ratio calculations, although they have long
taken such values into account as a separate factor in assessing the
overall financial strength of a bank.
ii. Consistent with long-standing supervisory practice, the
excess of market values over book values for assets held by state
member banks will generally not be recognized in supplementary
capital or in the calculation of the risk-based capital ratio.
However, all banks are encouraged to disclose their equivalent of
premises (building) and security revaluation reserves. The Federal
Reserve will consider any appreciation, as well as any depreciation,
in specific asset values as additional considerations in assessing
overall capital strength and financial condition.
* * * * *
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
1. The authority citation for part 225 is revised to read as
follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1831i, 1831p-1,
1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, and
3909.
2. Appendix A to part 225 is amended by revising sections II.A.1.a.
and II.A.2.f to read as follows:
Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Risk-Based Measure
* * * * *
II. * * *
A. * * *
1. * * *
a. Common stockholders' equity. For purposes of calculating the
risk-based capital ratio, common stockholders' equity is limited to
common stock; related surplus; and retained earnings, including
capital reserves and adjustments for the cumulative effect of
foreign currency translation, net of any treasury stock; less net
unrealized holding losses on available-for-sale equity securities
with readily determinable fair values. For this purpose, net
unrealized holding gains on such equity securities and net
unrealized holding gains (losses) on available-for-sale debt
securities are not included in common stockholders' equity.
* * * * *
2. * * *
f. Revaluation reserves. i. Such reserves reflect the formal
balance sheet restatement or revaluation for capital purposes of
asset carrying values to reflect current market values. The Federal
Reserve generally has not included unrealized asset appreciation in
capital ratio calculations, although it has long taken such values
into account as a separate factor in assessing the overall financial
strength of a banking organization.
ii. Consistent with long-standing supervisory practice, the
excess of market values over book values for assets held by bank
holding companies will generally not be recognized in supplementary
capital or in the calculation of the risk-based capital ratio.
However, all bank holding companies are encouraged to disclose their
equivalent of premises (building) and security revaluation reserves.
The Federal Reserve will consider any appreciation, as well as any
depreciation, in specific asset values as additional considerations
in assessing overall capital strength and financial condition.
* * * * *
Board of Governors of the Federal Reserve System, December 2, 1994.
Barbara R. Lowrey,
Associate Secretary of the Board.
[FR Doc. 94-30156; Filed 12-7-94; 8:45 am]
BILLING CODE 6210-01-P
