[Federal Register Volume 61, Number 70 (Wednesday, April 10, 1996)]
[Notices]
[Pages 15947-15954]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-8873]
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FEDERAL RESERVE SYSTEM
Report to Congressional Committees Regarding Differences in
Capital and Accounting Standards Among the Federal Banking and Thrift
Agencies
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice of report to the Committee on Banking, Housing, and
Urban Affairs of the United States Senate and to the Committee on
Banking, Finance and Urban Affairs of the United States House of
Representatives.
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SUMMARY: This report has been prepared by the Federal Reserve Board
pursuant to section 121 of the Federal Deposit Insurance Corporation
Improvement Act of 1991. Section 121 requires each Federal banking and
thrift agency to report annually to the above specified Congressional
Committees regarding any differences between the accounting or capital
standards used by such agency and the accounting or capital standards
used by other banking and thrift agencies. The report must also contain
an explanation of the reasons for any discrepancy in such accounting or
capital standards. The report must be published in the Federal
Register.
FOR FURTHER INFORMATION CONTACT: Rhoger H Pugh, Assistant Director
(202/728-5883), Norah Barger, Manager (202/452-2402), Gerald A.
Edwards, Jr., Assistant Director (202/452-2741), Robert E. Motyka,
Supervisory Financial Analyst (202/452-3621), or Arthur W. Lindo,
Supervisory Financial Analyst (202/452-2695), 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 & C Streets NW., Washington, DC 20551.
Introduction and Overview
This is the sixth annual report 1 on the differences in
capital standards and accounting practices that currently exist among
the three banking agencies (the Board of Governors of the Federal
Reserve System (FRB), the Office of the Comptroller of the Currency
(OCC), and the Federal Deposit Insurance Corporation (FDIC)) and the
Office of Thrift Supervision (OTS).2 Section One of the report
focuses on differences in the agencies' capital standards; Section Two
discusses differences in accounting standards. The remainder of this
introduction provides an overview of the discussion contained in these
sections.
\1\ The first two reports prepared by the Federal Reserve Board
were made pursuant to section 1215 of the Financial Institutions
Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The third,
fourth, and fifth reports were made pursuant to section 121 of the
Federal Deposit Insurance Corporation Improvement Act of 1991
(FDICIA), which superseded section 1215 of FIRREA.
\2\ At the federal level, the Federal Reserve System has primary
supervisory responsibility for state-chartered banks that are
members of the Federal Reserve System as well as all bank holding
companies. The FDIC has primary responsibility for state nonmember
banks and FDIC-supervised savings banks. National banks are
supervised by the OCC. The OTS has primary responsibility for
savings and loan associations.
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Capital Standards
As stated in the previous reports to the Congress, the three bank
regulatory agencies have, for a number of years, employed a common
regulatory framework that establishes minimum capital adequacy ratios
for commercial banking organizations. In 1989, all three banking
agencies and the OTS adopted a risk-based capital framework that was
based upon the international capital accord (Basle Accord) developed by
the Basle Committee on Banking Regulations and Supervisory Practices
(referred to as the Basle Supervisors' Committee) and endorsed by the
central bank governors of the G-10 countries.
[[Page 15948]]
The risk-based capital framework establishes minimum ratios of
total and Tier 1 (core) capital to risk-weighted assets. The Basle
Accord requires banking organizations to have total capital equal to at
least 8 percent, and Tier 1 capital equal to at least 4 percent, of
risk-weighted assets after a phase-in period that ended on December 31,
1992. Tier 1 capital is principally comprised of common shareholders'
equity and qualifying perpetual preferred stock, less disallowed
intangibles, such as goodwill. The other component of total capital,
Tier 2, may include certain supplementary capital items, such as
general loan loss reserves and subordinated debt. The risk-based
capital requirements are viewed by the three banking agencies and the
OTS as minimum standards, and most institutions are expected to, and
generally do, maintain capital levels well above the minimums.
In addition to specifying identical ratios, the risk-based capital
framework implemented by the three banking agencies includes a common
definition of regulatory capital and a uniform system of risk weights
and categories. While the minimum standards and risk weighting
framework are common to all the banking agencies, there are some
technical differences in language and interpretation among the
agencies. The OTS employs a similar risk-based capital framework,
although it differs in some respects from that adopted by the three
banking agencies. These differences, as well as other technical
differences in the agencies' capital standards, are discussed in
Section One of this report.
In addition to the risk-based capital requirements, the agencies
also have established leverage standards setting forth minimum ratios
of capital to total assets. As discussed in Section One, the three
banking agencies employ uniform leverage standards, while the OTS has
established, pursuant to FIRREA, somewhat different standards.
The staffs of the agencies meet regularly to identify and address
differences and inconsistencies in their capital standards. The
agencies are committed to continuing this process in an effort to
achieve full uniformity in their capital standards. In this regard,
Section One contains discussions of the banking agencies' efforts
during the past year to achieve uniformity with respect to final rules
on the capital treatment of the sale of assets with recourse that were
required by Sections 208 and 350 of the Riegle Community Development
and Regulatory Improvement Act of 1994, implementation of proposed
amendments made by the Basle Supervisors' Committee to the Basle Accord
with regard to country transfer risk and, the recognition of the
effects of netting on potential future exposure of derivative
contracts, guidelines on interest rate risk, and the capital treatment
of certain assets to address recent accounting changes issued by the
Financial Accounting Standards Board (FASB), specifically FASB
statements nos. 115 (``Accounting for Certain Investments in Debt and
Equity Securities''), 109 (``Accounting for Income Taxes''), and 122
(``Accounting for Mortgage Servicing Rights'').
Accounting Standards
Over the years, the three banking agencies, under the auspices of
the Federal Financial Institutions Examination Council (FFIEC), have
developed Uniform Reports of Condition and Income (Call Reports) for
all commercial banks and FDIC-supervised savings banks. The reporting
standards followed by the three banking agencies are substantially
consistent, aside from a few limited exceptions, with generally
accepted accounting principles (GAAP) as they are applied by commercial
banks.3 The uniform bank Call Report serves as the basis for
calculating risk-based capital and leverage ratios, as well as for
other regulatory purposes. Thus, material differences in regulatory
accounting and reporting standards among commercial banks and FDIC-
supervised savings banks do not exist.
\3\ In those cases where bank Call Report standards are
different from GAAP, the regulatory reporting requirements are
intended to be more conservative than GAAP.
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The OTS requires each thrift institution to file the Thrift
Financial Report (TFR), which is generally consistent with GAAP. The
TFR differs in some respects from the bank Call Report in that, as
previously mentioned, there are a few areas in which the bank Call
Report departs from GAAP. A summary of the differences between the bank
Call Report and the TFR is presented in Section Two.
As in the past, the agencies are continuing interagency efforts to
reduce paperwork and regulatory burdens. The Federal Reserve has taken
a leadership role in coordinating these efforts in developing
supervisory guidance to further improve regulatory reporting
requirements. For example, during 1995, senior Federal Reserve and FASB
officials met a number of times to foster greater communication and
closer coordination on major accounting issues affecting the banking
industry. These efforts included discussion of a supervisory framework
for derivatives reporting, a FASB special report that clarifies the
reporting for debt and equity securities pursuant to FASB Statement No.
115, and the remaining few differences between GAAP and regulatory
reporting standards. Furthermore, in 1995 the agencies adopted for
regulatory reporting purposes a new FASB accounting standard on
mortgage servicing rights.
On November 3, 1995, the FFIEC announced that the agencies would
fully adopt GAAP as the reporting basis in the basic bank Call Report
schedules, effective with the March 1997 report date. The adoption of
GAAP will reduce regulatory burden by developing greater consistency in
the information collected in bank Call Reports, bank holding company FR
Y-9C reports, and general purpose financial statements. The adoption of
GAAP for Call Report purposes should eliminate the differences in
accounting standards among the agencies that are set forth later in
this report.
Section One--Differences in Capital Standards Among Federal Banking
Thrift Supervisory Agencies
Overview
Leverage Capital Ratios
The three banking agencies employ a leverage standard based upon
the common definition of Tier 1 capital contained in their risk-based
capital guidelines. These standards, established in the second half of
1990 and in early 1991, require the most highly-rated institutions to
meet a minimum Tier 1 capital ratio of 3 percent. For all other
institutions, these standards generally require an additional cushion
of at least 100 to 200 basis points, i.e., a minimum leverage ratio of
at least 4 to 5 percent, depending upon an organization's financial
condition.
As required by FIRREA, the OTS has established a 3 percent core
capital ratio and a 1.5 percent tangible capital leverage requirement
for thrift institutions. However, the OTS has not yet finalized a new
leverage rule, which has been under consideration for some time. This
leverage rule is intended to conform to the leverage rules of the three
banking agencies. The differences that will exist after the OTS has
adopted its new standard pertain to the definition of core capital.
While this definition generally conforms to Tier 1 bank capital,
certain adjustments discussed in this report apply to the core capital
definition used by savings associations.
[[Page 15949]]
Risk-Based Capital Ratios
The three banking agencies have adopted risk-based capital
standards consistent with the Basle Accord. These standards, which were
fully phased in at the end of 1992, require all commercial banking
organizations to maintain a minimum ratio of total capital (Tier 1 plus
Tier 2) to risk-weighted assets of 8 percent. Tier 1 capital includes
common stock and surplus, retained earnings, qualifying perpetual
preferred stock and surplus, and minority interests in consolidated
subsidiaries, less goodwill. Tier 1 capital must comprise at least 50
percent of the total risk-based capital requirement. Tier 2 capital
includes such components as general loan loss reserves, subordinated
term debt, and certain other preferred stock and convertible debt
capital instruments, subject to appropriate limitations and conditions.
Risk-weighted assets are calculated by assigning risk weights of 0, 20,
50, and 100 percent to broad categories of assets and off-balance sheet
items based upon their relative credit risks. The OTS has adopted a
risk-based capital standard that in most respects is similar to the
framework adopted by the banking agencies.
All the banking agencies view the risk-based capital standard as a
minimum supervisory benchmark. In part, this is because the risk-based
capital standard focuses primarily on credit risk; it does not take
full or explicit account of certain other banking risks, such as
exposure to changes in interest rates. The full range of risks to which
depository institutions are exposed are reviewed and evaluated
carefully during on-site examinations. In view of these risks, most
banking organizations are expected to operate with capital levels well
above the minimum risk-based and leverage capital requirements.
Efforts to Incorporate Non-Credit Risks
The Federal Reserve has for some time been working with the other
U.S. banking agencies and with regulatory authorities abroad to develop
methods of measuring certain market and price risks and determining
appropriate capital standards for these risks. These efforts have
related to interest rate risk arising from all activities of a bank and
to market risk associated (principally) with an institution's trading
activities. Significant progress has been made in both areas.
Regarding domestic efforts, the banking agencies have for several
years been working to develop capital standards pertaining to interest
rate risk. This effort was undertaken both in response to a specific
statutory directive contained in section 305 of the FDICIA and to
improve the agencies' overall supervision of banking organizations.
Most recently, the agencies in August 1995 amended their capital
standards to emphasize the importance of reviewing the effect of
interest rate movements on the economic value of a bank's equity
capital. At the same time, the agencies also issued for public comment
a proposed measure of risk that supervisors would consider when
evaluating capital adequacy. The comments on that quantitative measure
and related reporting requirements remain under review by the agencies.
In the international forum, the Basle Supervisors Committee issued
a second proposal in April 1995 dealing with capital standards for
market risk arising from foreign exchange and commodity positions of
banks and from their traded debt and equity instruments. This proposal
was developed in order to foster a more equitable level of competition
among internationally active banking organizations and to provide these
institutions with greater incentives to manage this risk prudently. The
Committee's proposal was adopted on December 11, 1995 and permits
institutions to use either a standardized measure of risk developed by
supervisors or, alternatively, their own internal value-at-risk models
in measuring market risk and calculating their capital requirements.
This amendment to the 1988 Basle Capital Accord will go into effect no
later than the end of 1997, pending relevant rulemaking procedures in
member countries. The Federal Reserve, in cooperation with the other
U.S. banking agencies, expects to incorporate this amendment into its
own capital standards in early 1996.
Recent Interagency Efforts
In addition to coordinating efforts to incorporate noncredit risks,
the agencies worked together during 1995 to issue proposals for public
comment that would amend the agencies' respective risk-based capital
standards with respect to: 1) the sale of assets with recourse; 2)
higher capital charges for long-dated and noninterest and nonexchange
rate derivative contracts and reduced capital charges for the potential
future exposure of contracts that are affected by netting arrangements;
and 3) the definition of the OECD-based group of countries for the
purpose of specifying country transfer risk. The agencies also
coordinated efforts to make modifications in their capital guidelines
in light of recent changes in accounting standards.
Recourse
The agencies issued a joint proposal on May 24, 1994, that would
amend their respective risk-based capital guidelines with regard to
assets sold with recourse and direct credit substitutes. This
publication included a notice and an advanced notice of proposed
rulemakings. The intent of the notice of proposed rulemaking was to
allow banking organizations to maintain lower amounts of capital
against low-level recourse transactions. The advanced notice of
proposed rulemaking represented a preliminary proposal to use credit
ratings to match the risk-based capital assessment more closely to an
institution's relative risk of loss in certain asset securitizations.
Following issuance of this notice, Section 350 of the Riegle
Community Development and Regulatory Improvement Act of 1994 (Riegle
Act) was enacted. This Section required the agencies to amend their
respective risk-based capital standards to take account of low-level
recourse, which would also implement the proposed rulemaking on low-
level recourse transactions issued in May, 1994. The Board approved a
final rule on February 7, 1995, that was effective on March 22, 1995,
thus satisfying the requirements of Section 350 of the Riegle Act. The
FDIC and OCC also issued final rules in 1995 to implement Section 350.
The OTS already had a capital rule in place that satisfied the
requirements of Section 350.
In addition, Section 208 of the Riegle Act directed the Federal
banking agencies to revise the current regulatory capital treatment
applied to banks that sell small business obligations with recourse.
The Federal Reserve approved a final rule implementing Section 208
before the statutory deadline of March 22, 1995. However, because of
renewed interagency discussions, the Board issued a revised final rule
implementing Section 208 that was published in the Federal Register on
August 31, 1995. The other agencies also published interim rules
implementing Section 208 and expect to issue final rules in 1996. The
effect of the final rules is to lower the capital charge for certain
sales of small business loans with recourse.
With regard to the advance notice of proposed rulemaking, the
agencies met throughout 1995 to discuss various alternative approaches
that were suggested by commenters.
[[Page 15950]]
Derivative Contracts and Recognizing the Effects of Netting on
Potential Future Exposure
The agencies worked together on proposing amendments to their
respective risk-based capital guidelines that were based on proposed
revisions to the Basle Accord that the Basle Supervisors Committee
initiated in July 1994. The Board issued for public comment, on August
22, 1994, a proposed rulemaking that would: (1) increase the capital
charge for the potential future counterparty exposure of interest and
exchange rate contracts that are over five years in remaining maturity,
as well as of equity, precious metals, and other commodity-related
contracts; and (2) recognize the effects of bilateral netting
arrangements in calculating the potential future exposure for contracts
subject to qualifying netting arrangements. Effective at year-end 1995,
the G-10 Governors have approved a revision to the Basle Accord to
permit institutions to recognize the effects of bilateral netting
arrangements when calculating potential future exposure for contracts
subject to qualifying bilateral netting arrangements. The Board issued
a final rulemaking on September 5, 1995, the effective date of which
was October 1, 1995. The other banking agencies also issued rules
implementing these Basle revisions in 1995.
Country Transfer Risk
In July 1994, the G-10 Governors announced their intention to
modify the Basle Accord in 1995 with regard to country transfer risk.
Specifically, it was agreed to revise the definition of the OECD-based
group of countries 4 that are accorded a preferential risk weight.
The revision, which was adopted by the Basle Supervisors Committee and
endorsed by the G-10 Governors in 1995, retains the OECD-based group of
countries as the principle criterion for preferential risk weight
status, but exclude for five years any country that reschedules its
external sovereign debt. The Board and the OCC issued a joint notice of
proposed rulemaking on October 14, 1994, that sought public comment on
an amendment to their respective risk-based capital guidelines. The
Board and the OCC worked with the FDIC to issue a final rule that is
expected to be issued in early 1996.
\4\ The OECD-based group of countries currently includes members
of the Organization of Economic Cooperation and Development and
countries that have concluded special lending arrangements with the
International Monetary Fund (IMF) associated with the Fund's General
Arrangements to Borrow. Saudi Arabia is the only non-OECD country
that has concluded such arrangements.
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Capital Impact of Recent Changes to Accounting Standards
Recently, FASB issued pronouncements concerning new and modified
financial accounting standards. The adoption of some of these standards
for regulatory reporting purposes had the potential of affecting the
definition and calculation of regulatory capital. Accordingly, the
staffs of the agencies worked together to propose uniform regulatory
capital responses to such accounting changes. Over this past year, the
agencies dealt with the capital effects of these accounting issues in
the manner described below.
FAS 115, ``Accounting for Certain Investments in Debt and Equity
Securities.''
As discussed in last year's report, the agencies issued in 1993 and
early 1994 proposed amendments to their respective risk-based capital
standards that would include in Tier 1 capital the net unrealized
changes in value of securities available for sale for purposes of
calculating the risk-based and leverage capital ratios of banking
organizations. On November 10, 1994, the FFIEC recommended to the
agencies that they not adopt FAS 115 for capital purposes. Acting on
this recommendation, the Board, on November 30, 1994, adopted a final
rule effective December 31, 1994. Under the final rule, institutions
are generally directed not to include in Tier 1 capital the component
of common stockholders' equity, net unrealized holding gains and losses
on securities available for sale, which was created by FAS 115. The
other agencies approved similar rules in 1995.
FAS 109, ``Accounting for Income Taxes.''
The agencies issued in 1993 proposals to limit the amount of
deferred tax assets includable in calculating Tier 1 capital. Under the
proposals, certain deferred tax assets are limited to the lesser of 10
percent of Tier 1 capital or the amount of such assets the institution
expects to realize in the subsequent year. On November 18, 1994, the
FFIEC recommended that the agencies finalize these proposals. In 1995,
the Board, along with the other banking agencies, issued a final rule
that was similar to the proposal.
FAS 122, ``Accounting for Mortgage Servicing Rights.''
The Board, along with the OCC, FDIC, and OTS, issued an interim
final rule, which became effective on August 1, 1995, that amends the
agencies' capital adequacy guidelines to treat originated mortgage
servicing rights (OMSRs) the same as purchased mortgage servicing
rights (PMSRs) for regulatory capital purposes. These rules were
developed in response to the issuance of FAS 122, which eliminates the
distinction between OMSRs and PMSRs by requiring OMSRs to be
capitalized as balance sheet assets, a treatment previously required
only for PMSRs. Under the interim rule, both OMSRs and PMSRs are
included in (not deducted from) regulatory capital when determining
Tier 1 (core) capital for purposes of the agencies' risk-based and
leverage capital standards and in the calculation of tangible equity
for purposes of prompt corrective action. OMSRS are subject to the
regulatory capital limitations that previously applied only to PMSRs.
Staffs of the agencies have reviewed the comments and interagency
discussions are expected to begin shortly in anticipation of a final
rule sometime in 1996.
Specific Capital Differences
Differences among the risk-based capital standards of the OTS and
the three banking agencies are discussed below.
Certain Collateralized Transactions
On December 23, 1992, the Federal Reserve Board issued an amendment
to its risk-based and leverage capital guidelines that lowers from 20
to 0 percent the risk category for collateralized transactions meeting
certain criteria. This preferential treatment is only available for
claims fully collateralized by cash on deposit in the bank or by
securities issued or guaranteed by OECD central governments or U.S.
government agencies. In addition, a positive margin of collateral must
be maintained on a daily basis fully taking into account any change in
the banking organization's exposure to the obligor or counterparty
under a claim in relation to the market value of the collateral held in
support of that claim.
As reported in the previous two reports, the OCC, on August 18,
1993, issued a proposal for public comment that would also lower the
risk weight for certain collateralized transactions. On December 28,
1994, the OCC issued a final rule that is somewhat similar to the
Board's final rule, but permits any
[[Page 15951]]
portion of a claim collateralized by cash or OECD government securities
to receive a zero percent risk weight, provided that the collateral is
marked to market daily and a positive margin is maintained. The FDIC
and OTS have rules in place that permit portions of claims
collateralized by cash or OECD government securities to receive a 20
percent risk weight. Staffs of the four agencies have been meeting in
an attempt to resolve these differences.
Equity Investments
In general, commercial banks that are members of the Federal
Reserve System are not permitted to invest in equity securities, nor
are they generally permitted to engage in real estate investment or
development activities. To the extent that commercial banks are
permitted to hold equity securities (for example, in connection with
debts previously contracted), the three banking agencies generally
assign such investments to the 100 percent risk category for risk-based
capital purposes.
Under the three banking agencies' rules, the agencies may, on a
case-by-case basis, deduct equity investments from the parent bank's
capital or make other adjustments, if necessary, to assess an
appropriate capital charge above the minimum requirement. The banking
agencies' treatment of investments in subsidiaries is discussed below.
The OTS risk-based capital standards require that thrift
institutions deduct certain equity investments from capital over a
phase-in period, which ended on July 1, 1994, as explained more fully
below in the section on subsidiaries.
FSLIC/FDIC--Covered Assets (Assets Subject to Guarantee Arrangements by
the FSLIC or FDIC)
The three banking agencies generally place these assets in the 20
percent risk category, the same category to which claims on depository
institutions and government-sponsored agencies are assigned.
The OTS places these assets in the zero percent risk category.
Limitation on Subordinated Debt and Limited-Life Preferred Stock
Consistent with the Basle Accord, the three banking agencies limit
the amount of subordinated debt and limited-life preferred stock that
may be included in Tier 2 capital. This limit, in effect, states that
these components together may not exceed 50 percent of Tier 1 capital.
In addition, maturing capital instruments must be discounted by 20
percent in each of the last five years prior to maturity.
Neither subordinated debt nor limited-life preferred stock is a
permanent source of funds, and subordinated debt cannot absorb losses
while the bank continues to operate as a going-concern. On the other
hand, both capital components can provide a cushion of protection to
the FDIC insurance fund. Thus, the 50 percent limitation permits the
inclusion of some subordinated debt in capital, while assuring that
permanent stockholders' equity capital remains the predominant element
in bank regulatory capital.
The OTS has no limitation on the total amount of limited-life
preferred stock or maturing capital instruments that may be included
within Tier 2 capital. In addition, the OTS allows thrifts the option
of: (1) discounting maturing capital instruments issued on or after
November 7, 1989, by 20 percent a year over the last 5 years of their
term--the approach required by the banking agencies; or (2) including
the full amount of such instruments provided that the amount maturing
in any of the next seven years does not exceed 20 percent of the
thrift's total capital.
Subsidiaries
Consistent with the Basle Accord and long-standing supervisory
practices, the three banking agencies generally consolidate all
significant majority-owned subsidiaries of the parent organization for
capital purposes. This consolidation assures that the capital
requirements are related to all of the risks to which the banking
organization is exposed.
As with most other bank subsidiaries, banking and finance
subsidiaries generally are consolidated for regulatory capital
purposes. However, in cases where banking and finance subsidiaries are
not consolidated, the Federal Reserve, consistent with the Basle
Accord, generally deducts investments in such subsidiaries in
determining the adequacy of the parent bank's capital.
The Federal Reserve's risk-based capital guidelines provide a
degree of flexibility in the capital treatment of unconsolidated
subsidiaries (other than banking and finance subsidiaries) and
investments in joint ventures and associated companies. For example,
the Federal Reserve may deduct investments in such subsidiaries from an
organization's capital, may apply an appropriate risk-weighted capital
charge against the proportionate share of the assets of the entity, may
require a line-by-line consolidation of the entity, or otherwise may
require that the parent organization maintain a level of capital above
the minimum standard that is sufficient to compensate for any risks
associated with the investment.
The guidelines also permit the deduction of investments in
subsidiaries that, while consolidated for accounting purposes, are not
consolidated for certain specified supervisory or regulatory purposes.
For example, the Federal Reserve deducts investments in, and unsecured
advances to, Section 20 securities subsidiaries from the parent bank
holding company's capital. The FDIC accords similar treatment to
securities subsidiaries of state nonmember banks established pursuant
to Section 337.4 of the FDIC regulations.
Similarly, in accordance with Section 325.5(f) of the FDIC
regulations, a state nonmember bank must deduct investments in, and
extensions of credit to, certain mortgage banking subsidiaries in
computing the parent bank's capital. (The Federal Reserve does not have
a similar requirement with regard to mortgage banking subsidiaries. The
OCC does not have requirements dealing specifically with the capital
treatment of either mortgage banking or securities subsidiaries. The
OCC, however, does reserve the right to require a national bank, on a
case-by-case basis, to deduct from capital investments in, and
extensions of credit to, any nonbanking subsidiary.)
The deduction of investments in subsidiaries from the parent's
capital is designed to ensure that the capital supporting the
subsidiary is not also used as the basis of further leveraging and
risk-taking by the parent banking organization. In deducting
investments in, and advances to, certain subsidiaries from the parent's
capital, the Federal Reserve expects the parent banking organization to
meet or exceed minimum regulatory capital standards without reliance on
the capital invested in the particular subsidiary. In assessing the
overall capital adequacy of banking organizations, the Federal Reserve
may also consider the organization's fully consolidated capital
position.
Under the OTS capital guidelines, a distinction, mandated by
FIRREA, is drawn between subsidiaries that are engaged in activities
that are permissible for national banks and subsidiaries that are
engaged in ``impermissible'' activities for national banks.
Subsidiaries of thrift institutions that engage only in permissible
activities are consolidated on a line-by-line basis if majority-owned
and on a pro rata basis if ownership is between 5 percent and 50
percent. As a general rule, investments, including loans, in
subsidiaries that engage in impermissible activities are deducted in
determining the capital adequacy of the
[[Page 15952]]
parent. However, investments, including loans, outstanding as of April
12, 1989, to subsidiaries that were engaged in impermissible activities
prior to that date are grandfathered and were phased-out of capital
over a transition period that expired on July 1, 1994. During this
transition period, investments in subsidiaries engaged in impermissible
activities that have not been phased-out of capital were consolidated
on a pro rata basis.
Nonresidential Construction and Land Loans
The three banking agencies assign loans for real estate development
and construction purposes to the 100 percent risk category. Reserves or
charge-offs are required, in accordance with examiner judgment, when
weaknesses or losses develop in such loans. The banking agencies have
no requirement for an automatic charge-off when the amount of a loan
exceeds the fair value of the property pledged as collateral for the
loan.
The OTS generally assigns these loans to the 100 percent risk
category. However, if the amount of the loan exceeds 80 percent of the
fair value of the property, that excess portion must be deducted from
capital in accordance with a phase-in arrangement, which ended on July
1, 1994.
Mortgage-Backed Securities (MBS)
The three banking agencies, in general, place privately-issued MBSs
in a risk category appropriate to the underlying assets but in no case
to the zero percent risk category. In the case of privately-issued MBSs
where the direct underlying assets are mortgages, this treatment
generally results in a risk weight of 50 percent or 100 percent.
Privately-issued MBSs that have government agency or government-
sponsored agency securities as their direct underlying assets are
generally assigned to the 20 percent risk category.
The OTS assigns privately-issued high quality mortgage-related
securities to the 20 percent risk category. These are, generally,
privately-issued MBSs with AA or better investment ratings.
At the same time, both the banking and thrift agencies
automatically assign to the 100 percent risk weight category certain
MBSs, including interest-only strips, residuals, and similar
instruments that can absorb more than their pro rata share of loss. The
Federal Reserve, in conjunction with the other banking agencies and the
OTS, issued, on January 10, 1992, more specific guidance as to the
types of ``high risk'' MBSs that will qualify for a 100 percent risk
weight.
Assets Sold with Recourse
In general, recourse arrangements allow the purchaser of an asset
to ``put'' the asset back to the originating institution under certain
circumstances, for example, if the asset ceases to perform
satisfactorily. This, in turn, can expose the originating institution
to any loss associated with the asset. On May 25, 1994, the three
banking agencies and the OTS, under the auspices of the FFIEC, sought
public comment on various aspects of the capital treatment of recourse
transactions by publishing a Notice of Proposed Rulemaking (NPR) and an
Advance Notice of Proposed Rulemaking (ANPR), which is a more
preliminary step in the formal rulemaking process.
The NPR proposed to amend the banking agencies' risk-based capital
guidelines by:
(1) reducing the risk-based capital charge for ``low level''
recourse arrangements to an amount equal to the maximum contractual
recourse obligation;
(2) requiring equivalent capital treatment of recourse arrangements
and direct credit substitutes that provide first dollar loss
protection. This would increase the capital assessment for first loss
standby letters of credit and purchased subordinated interests that
only provide partial credit enhancement; and,
(3) defining ``recourse'' and associated terms such as ``standard
representations and warranties.''
The ANPR proposed incorporating into the risk-based capital
guidelines a framework based on formal credit ratings for assessing
capital against exposures with different levels of risk in certain
asset securitizations. Thus, if there is more risk in a particular
position with a securitized transaction, a higher capital charge should
be accorded.
As described more fully above, Section 350 of the Riegle Act
required the agencies to finalize a rule amending their respective
risk-based capital standards to take account of low-level recourse, as
was proposed by the NPR issued by the agencies. The low-level approach
was implemented by the Federal Reserve by a final rule issued on
February 7, 1995, and made effective on March 22, 1995, which satisfied
the requirements of Section 350 of the Riegle Act. The FDIC and OCC
also issued final rules in 1995 to implement Section 350. The OTS
already had a capital rule in place that satisfied the requirements of
Section 350.
Section 208 of the Riegle Act directed the Federal banking agencies
to revise the current regulatory capital treatment applied to banks
that sell small business obligations with recourse. The Federal Reserve
approved a final rule implementing Section 208 before the statutory
deadline of March 22, 1995. However, because of renewed interagency
discussions, the Board issued a revised final rule implementing Section
208 that was published in the Federal Register on August 31, 1995. The
other agencies also published final rules implementing Section 208 this
year.
With regard to the ANPR, the agencies have been meeting throughout
the past year to consider approaches suggested by commenters.
Agricultural Loan Loss Amortization
In the computation of regulatory capital, those banks accepted into
the agricultural loan loss amortization program pursuant to Title VIII
of the Competitive Equality Banking Act of 1987 are permitted to defer
and amortize losses incurred on agricultural loans between January 1,
1984 and December 31, 1991.
The program also applies to losses incurred between January 1, 1983
and December 31, 1991, as a result of reappraisals and sales of
agricultural Other Real Estate Owned (OREO) and agricultural personal
property. These loans must be fully amortized over a period not to
exceed seven years and, in any case, must be fully amortized by year-
end 1998. Thrifts are not eligible to participate in the agricultural
loan loss amortization program established by this statute.
Treatment of Junior Liens on 1- to 4-Family Residential Properties
In some cases, a banking organization may make two loans on a
single residential property, one loan secured by a first lien, the
other by a second lien. In such a situation, the Federal Reserve views
these two transactions as a single loan, provided there are no
intervening liens. This could result in assigning the total amount of
these transactions to the 100 percent risk weight category, if, in the
aggregate, the two loans exceeded a prudent loan-to-value ratio and,
therefore, did not qualify for the 50 percent risk weight. This
approach is intended to avoid possible circumvention of the capital
requirements and capture the risks associated with the combined
transactions.
The FDIC, OCC, and the OTS generally assign the loan secured by the
first lien to the 50 percent risk-weight category and the loan secured
by the
[[Page 15953]]
second lien to the 100 percent risk-weight category.
Pledged Deposits and Nonwithdrawable Accounts
The capital guidelines of the OTS permit thrift institutions to
include in capital certain pledged deposits and nonwithdrawable
accounts that meet the criteria of the OTS. Income Capital Certificates
and Mutual Capital Certificates held by the OTS may also be included in
capital by thrift institutions. These instruments are not relevant to
commercial banks, and, therefore, they are not addressed in the three
banking agencies' capital guidelines.
Mutual Funds
The three banking agencies generally assign all of a bank's
holdings in a mutual fund to the risk category appropriate to the
highest risk asset that a particular mutual fund is permitted to hold
under its operating rules. The purpose of this is to take into account
the maximum degree of risk to which a bank may be exposed when
investing in a mutual fund in view of the fact that the future
composition and risk characteristics of the fund's holding cannot be
known in advance.
The OTS applies a capital charge appropriate to the riskiest asset
that a mutual fund is actually holding at a particular time. In
addition, both the OTS and the OCC guidelines also permit, on a case-
by-case basis, investments in mutual funds to be allocated on a pro
rata basis in a manner consistent with the actual composition of the
mutual fund.
Section Two--Differences in Accounting Standards Among Federal Banking
and Thrift Supervisory Agencies
Under the auspices of the FFIEC, the three banking agencies have
developed uniform reporting standards for commercial banks which are
used in the preparation of the Call Report. The FDIC has also applied
these uniform Call Report standards to savings banks under its
supervision. The income statement and balance sheet accounts presented
in the Call Report are used by the bank supervisory agencies for
determining the capital adequacy of banks and for other regulatory,
supervisory, surveillance, analytical, and general statistical
purposes.
Section 121 of FDICIA requires accounting principles applicable to
financial reports (including the Call Report) filed by federally
insured depository institutions with a federal banking agency to be
uniform and consistent with generally accepted accounting principles
(GAAP). However, under Section 121, a federal banking agency may
require institutions to use accounting principles ``no less stringent
than GAAP'' when the agency determines that a specific accounting
standard under GAAP does not meet these new accounting objectives. The
banking agencies believe that GAAP generally satisfies the three
accounting objectives included in FDICIA Section 121. The three
accounting objectives in FDICIA Section 121 mandate that accounting
principles should:
1. Result in financial statements and reports of condition that
accurately reflect the institution's capital;
2. Facilitate effective supervision of depository institutions; and
3. Facilitate prompt corrective action at least cost to the
insurance funds.
As indicated above, Section 121 of FDICIA requires the Federal
Reserve and the other federal banking agencies to utilize accounting
principles for regulatory reports that are consistent with GAAP or are
no less stringent than GAAP. The reporting instructions for Call
Reports that are required by the three banking agencies are
substantially consistent, aside from a few limited exceptions, with
GAAP as applied by commercial banks. In those cases where accounting
principles applicable to bank Call Reports are different from GAAP, the
regulatory accounting principles are intended to be more conservative
than GAAP. Thus, the accounting principles that are followed for
regulatory reporting purposes are consistent with the objectives and
mandate of FDICIA Section 121.
The OTS has developed and maintains a separate reporting system for
the thrift institutions under its supervision. The TFR is based on GAAP
as applied by thrifts.
On November 3, 1995, the FFIEC announced that it is adopting GAAP
as the reporting basis for the basic balance sheet, income statement,
and related schedules in the bank Call Reports, effective with the
March 1997 report date. This action will eliminate the existing
differences between GAAP and regulatory accounting principles. The
agencies believe that the FFIEC action is consistent with the
objectives of FDICIA 121 and the objectives of Section 307(b) of the
Riegle Community Development and Regulatory Improvement Act of 1994,
which requires the agencies to work jointly to develop a single form
for the filing of core information by banks, savings associations, and
bank holding companies. The adoption of GAAP for Call Report purposes
should eliminate the differences in accounting standards among the
agencies that are set forth below.
A summary of the primary differences in accounting principles by
the federal banking and thrift agencies for regulatory reporting
purposes are set forth below, based on a study developed on an
interagency basis:
Futures and Forward Contracts
The banking agencies, as a general rule, do not permit the deferral
of gains and losses by banks on futures and forwards whether or not
they are used for hedging purposes. All changes in market value of
futures and forward contracts are reported in current period income.
The banking agencies adopted this reporting standard as a supervisory
policy prior to the adoption of FASB Statement No. 80, which allows
hedge accounting, under certain circumstances. Contrary to this general
rule, hedge accounting in accordance with FASB Statement No. 80 is
permitted by the three banking agencies only for futures and forward
contracts used in mortgage banking operations.
The OTS practice is to follow FASB Statement No. 80 for futures
contracts. In accordance with this statement, when hedging criteria are
satisfied, the accounting for the futures contract is related to the
accounting for the hedged item. Changes in the market value of the
futures contract are recognized in income when the effects of related
changes in the price or interest rate of the hedged item are
recognized. Such reporting can result in deferred gains and losses
which would be reflected as liabilities and assets on the thrift's
balance sheet in accordance with GAAP.
Excess Servicing Fees
As a general rule, the three banking agencies do not follow GAAP
for excess servicing fees. Excess servicing results when loans are sold
with servicing retained and the stated servicing fee rate is greater
than the normal servicing fee rate. With the exception of sales of
pools of first lien one-to-four family residential mortgages for which
the banking agencies' approach is consistent with FASB Statement No.
65, excess servicing fee income in banks must be reported as realized
over the life of the transferred asset, not recognized up front as
required by FASB Statement No. 65.
The OTS allows the present value of the future excess servicing fee
to be treated as an adjustment to the sales price for purposes of
recognizing gain or loss on the sale. This approach is consistent with
FASB Statement No. 65.
[[Page 15954]]
In-Substance Defeasance of Debt
The banking agencies do not permit banks to report defeasance of
their debt obligations in accordance with FASB Statement No. 76.
Defeasance involves a debtor irrevocably placing risk-free monetary
assets in a trust solely for satisfying the debt. Under FASB Statement
No. 76, the assets in the trust and the defeased debt are removed from
the balance sheet and a gain or loss for the current period can be
recognized. However, for Call Report purposes, banks may not remove
assets or defeased liabilities from their balance sheets or recognize
resulting gains or losses. FASB has recently proposed to amend GAAP to
adopt an approach similar to the Call Report treatment for these
transactions.
OTS practice is to follow FASB Statement No. 76.
Sales of Assets with Recourse
In accordance with FASB Statement No. 77, a transfer of receivables
with recourse is recognized as a sale if: (1) the transferor surrenders
control of the future economic benefits; (2) the transferor's
obligation under the recourse provisions can be reasonably estimated;
and (3) the transferee cannot require repurchase of the receivables
except pursuant to the recourse provisions.
The practice of the three banking agencies is generally to permit
commercial banks to report transfers of receivables with recourse as
sales only when the transferring institution (1) retains no risk of
loss from the assets transferred and (2) has no obligation for the
payment of principal or interest on the assets transferred. As a
result, virtually no transfers of assets with recourse can be reported
as sales. However, this rule does not apply to the transfer of first
lien 1- to 4-family residential or agricultural mortgage loans under
certain government-sponsored programs (including the Federal National
Mortgage Association and the Federal Home Loan Mortgage Corporation).
Transfers of mortgages under these programs are generally treated as
sales for Call Report purposes.
Furthermore, private transfers of first lien 1- to 4-family
residential mortgages are also reported as sales if the transferring
institution retains only an insignificant risk of loss on the assets
transferred. However, the seller's obligation under recourse provisions
related to sales of mortgage loans under the government programs is
viewed as an off-balance sheet exposure. Thus, for risk-based capital
purposes, capital is generally expected to be held for recourse
obligations associated with such transactions.
The OTS policy is to follow FASB Statement No. 77. However, in the
calculation of risk-based capital under the OTS guidelines, off-balance
sheet recourse obligations generally are converted at 100 percent. This
effectively negates the sale treatment recognized on a GAAP basis for
risk-based capital purposes, but not for leverage capital purposes.
Thus, by making this adjustment in the risk-based capital calculation,
the differences between the OTS and the banking agencies for capital
adequacy measurement purposes, are substantially reduced.
Push-Down Accounting
When a depository institution is acquired in a purchase
transaction, but retains its separate corporate existence, the
institution is required to revalue all of the assets and liabilities at
fair value at the time of acquisition. When push-down accounting is
applied, the same revaluation made by the parent holding company is
made at the depository institution level.
The three banking agencies require push-down accounting when there
is at least a 95 percent change in ownership. This approach is
generally consistent with interpretations of the Securities and
Exchange Commission.
The OTS requires push-down accounting when there is at least a 90
percent change in ownership.
Negative Goodwill
The three banking agencies require that negative goodwill be
reported as a liability, and not be netted against goodwill assets.
Such a policy ensures that all goodwill assets are deducted in
regulatory capital calculations, consistent with the Basle Accord.
The OTS permits negative goodwill to offset goodwill assets
reported in the financial statements.
Offsetting
The three banking agencies generally prohibit netting of assets and
liabilities in the Call Report. However, FASB Interpretation No. 39
(FIN 39) netting requirements have been adopted for Call Report
purposes solely for assets and liabilities that arise from off-balance-
sheet instruments. For example, under FIN 39, the assets and
liabilities arising from these contracts may be netted when there is a
legally enforceable bilateral master netting agreement.
The OTS policy on netting for all assets and liabilities is
consistent with GAAP, as set forth in FIN 39. FIN 39 allows
institutions to offset assets and liabilities (e.g., loans and
deposits) when four conditions are met. Moreover, the OTS permits
netting for off-balance sheet conditional and exchange contracts to the
same extent as the banking agencies.
By order of the Board of Governors of the Federal Reserve
System, April 4, 1996.
Jennifer J. Johnson,
Deputy Secretary of the Board.
[FR Doc. 96-8873 Filed 4-9-96; 8:45am]
BILLING CODE 6210-01-P
