[Federal Register Volume 62, Number 92 (Tuesday, May 13, 1997)]
[Notices]
[Pages 26355-26362]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-12515]
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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
[Docket Number 97-12]
Report to the Congress Regarding the Differences in Capital and
Accounting Standards Among the Federal Banking and Thrift Agencies
AGENCY: Office of the Comptroller of the Currency, Treasury.
ACTION: Report to the Committee on Banking, Housing, and Urban Affairs
of the United States Senate and to the Committee on Banking and
Financial Services of the United States House of Representatives
regarding differences in capital and accounting standards among the
federal banking and thrift agencies.
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SUMMARY: The Office of the Comptroller of the Currency (OCC) has
prepared this report as required by the Federal Deposit Insurance
Corporation Improvement Act of 1991 (FDICIA). FDICIA requires the OCC
to provide a report to Congress on any differences in capital standards
among the federal financial regulatory agencies. This notice is
intended to satisfy the FDICIA requirement that the report be published
in the Federal Register.
FOR FURTHER INFORMATION CONTACT: Roger Tufts, Senior Economic Advisor,
Office of the Chief National Bank Examiner (202) 874-5070, Eugene
Green, Deputy Chief Accountant, Office of the Chief Accountant (202)
874-4933, or Ronald Shimabukuro, Senior Attorney, Legislative and
Regulatory Activities Division, (202) 874-5090, Office of the
Comptroller of the Currency, 250 E Street, S.W., Washington, DC 20219.
SUPPLEMENTARY INFORMATION:
Differences in Capital and Accounting Standards Among the Federal
Banking and Thrift Agencies
Report to the Committee on Banking, Housing, and Urban Affairs of the
United States Senate and to the Committee on Banking and Financial
Services of the United States House of Representatives
Submitted by the Office of the Comptroller of the Currency
This report 1 describes the differences among the
capital requirements of the Office of the Comptroller of the Currency
(OCC) and those of the Board of Governors of the Federal Reserve System
(FRB), the Federal Deposit Insurance Corporation (FDIC) and the Office
of Thrift Supervision (OTS).2 The report is divided into
four sections. The first section provides a short overview of the
current capital requirements; the second section discusses the
differences in the capital standards; the third section briefly
discusses recent efforts of the Agencies to promote more consistent
capital standards; and the fourth section discusses the differences in
accounting standards related to capital. The report covers developments
through December 31, 1996.
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\1\ This report is made pursuant to section 121 of the Federal
Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), Pub.
L. 102-242, 105 Stat. 2236 (December 19, 1991), 12 U.S.C. 1831n(c).
Section 121 of FDICIA supersedes section 1215 of the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA),
Pub. L. 101-73, 103 Stat. 183 (August 9, 1989), which imposed
similar reporting requirement and was repealed.
\2\ The OCC is the primary supervisor of national banks. Bank
holding companies and state-chartered banks that are members of the
Federal Reserve System are supervised by the FRB. State-chartered
nonmember banks are supervised by the FDIC. The OTS supervises
savings associations and savings and loan holding companies. In this
report, the term ``Banking Agencies'' refers to the OCC, FRB and the
FDIC; the term ``Agencies'' refers to all four of the agencies,
including the OTS.
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A. Overview of the Risk-Based Capital Standards
Since the adoption of the risk-based capital guidelines in 1989,
all of the Agencies have applied similar capital standards to the
institutions they supervise. The risk-based capital guidelines
implement the Accord on International Convergence of Capital
Measurement and Capital Standards adopted in July, 1988, by the Basle
Committee on Banking Regulations and Supervisory Practices (Basle
Accord).
The risk-based capital guidelines establish a framework for
imposing capital requirements generally based on credit risk. Under the
risk-based capital guidelines, balance sheet assets and off-balance
sheet items are categorized, or ``risk-weighted,'' according to the
relative degree of credit risk inherent in the asset or off-balance
sheet item. The risk-based capital guidelines specify four risk-weight
categories--zero percent, 20 percent, 50 percent, and 100 percent.
Assets or off-balance sheet items with the lowest levels of credit risk
are risk-weighted in the lowest risk weight category; those presenting
greater levels of credit risk receive a higher risk weight. Thus, for
example, securities issued by the U.S. government are risk-weighted at
zero percent; one- to four-family home mortgages are risk-weighted at
50 percent; unsecured commercial loans are risk-weighted at 100
percent.
Off-balance sheet items must first be translated into an on-
balance-sheet credit equivalent amount by applying the conversion
factors, or multipliers, that are specified in the risk-based capital
guidelines of the Agencies. This credit equivalent amount is then
assigned to one of the four risk-weight categories. For example, a bank
may extend to its customer a line of credit that the customer may
borrow against for up to two years. The unused portion of this two year
line of credit--that is, the amount of available credit that the
customer has not borrowed--is carried as an off-balance sheet item.
Under the agencies' risk-based capital guidelines, this unused portion
is translated to an on-balance-sheet credit equivalent amount by
applying a 50 percent conversion factor, and the resulting amount is
then assigned to the 100 percent risk-weight category based on the
credit risk of the counterparty.
Once all the assets and off-balance sheet items have been risk-
weighted, the
[[Page 26356]]
total amount of all risk-weighted assets and off-balance sheet items is
used to determine the total amount of capital required for that
institution. Specifically, the risk-based capital guidelines of the
Agencies require each institution to maintain a ratio of total capital
to risk-weighted assets of 8 percent.
Total capital is comprised of two components--Tier 1 capital (core
capital) and Tier 2 capital (supplementary capital).3 Tier 1
capital includes common stockholders' equity, noncumulative perpetual
preferred stock and related surplus, and minority interests in
consolidated subsidiaries. Tier 2 capital includes the allowance for
loan and lease losses, certain types of preferred stock, some hybrid
capital instruments, and certain subordinated debt. These Tier 2
capital instruments, as well as the total amount of Tier 2 capital, are
subject to limitations and conditions provided by the risk-based
capital guidelines of the Agencies. In addition, the risk-based capital
guidelines also require the deduction of certain assets from either
Tier 1 capital or total capital. For example, as described in section
B(6), all goodwill must be deducted from Tier 1 capital.
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\3\ In addition to Tier 1 and Tier 2 capital, the risk-based
capital guidelines of the Banking Agencies also permit certain banks
to hold limited amounts of Tier 3 capital to satisfy market risk
requirements. See section C(2) for further discussion.
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Institutions generally are expected to hold capital above the
required minimum level, and most institutions usually do exceed minimum
risk-based capital requirement. For example, most national banks
currently hold capital in excess of 10 percent of risk-weighted
assets.4 However, in addition to the risk-based capital
requirement, the Agencies also impose a leverage capital requirement,
expressed as the percentage of Tier 1 capital to total assets. Unlike
the risk-based capital ratio, the leverage capital ratio is based on
total assets, not total risk-weighted assets. This means that the
leverage capital ratio is computed without regard to the risk-weight
categories assigned to the assets and without including off-balance
sheet items.
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\4\ In addition to the risk-based capital guidelines, the
Agencies have issued regulations implementing the prompt corrective
action (PCA) provisions of the Federal Deposit Insurance Corporation
Improvement Act of 1991 (FDICIA). FDICIA requires that the Agencies
take certain supervisory actions if an institution's capital
declines to unacceptable levels. See 12 U.S.C. 1831o. As required by
the statute, the PCA regulations establish four capital categories
that are defined in terms of three separate capital measures (the
risk-based capital ratio, the leverage ratio, and the ratio of Tier
1 capital to risk-weighted assets). These four categories are: well
capitalized, adequately capitalized, undercapitalized, and
significantly undercapitalized. By way of illustration, an
institution is well capitalized if its risk-based capital ratio is
10 percent or greater; its leverage ratio is 5 percent or greater;
and its ratio of Tier 1 capital to risk-weighted assets is 6 percent
or greater. A fifth PCA category--critically undercapitalized--is
defined, as the statute requires, as a 2 percent ratio of tangible
equity to total assets. See 12 CFR Part 6 (1996) (the OCC's prompt
corrective action regulations).
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B. Remaining Differences in Capital Standards of the Agencies
Although the Agencies have adopted common leverage capital
requirements and risk-based capital guidelines, there remain some
technical differences in language and interpretation of the capital
standards. These differences are described in this section. Some of
these differences, however, may be eliminated through an interagency
rulemaking conducted pursuant to section 303 of the Riegle Community
Development and Regulatory Improvement Act of 1994 (CDRI
Act).5 The items in this section for which the Agencies have
agreed to propose uniform treatment are marked with an asterisk (*) and
further discussed in section C(1)(i) of this report.
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\5\ Pub. L. 103-325, section 303, 108 Stat. 2160, 2215 (1994)
(codified at 12 U.S.C. 1835). Section 303(a)(2) required that the
Agencies ``work jointly * * * to make uniform all regulations and
guidelines implementing common statutory or supervisory policies.''
See also Board of Governors of the Federal Reserve System, Federal
Deposit Insurance Corporation, Office of the Comptroller of the
Currency, and the Office of Thrift Supervision, Joint Report:
Streamlining of Regulatory Requirements (September 23, 1996)
(Progress report submitted by the Agencies to the Congress pursuant
to section 303(a)(3) of the CDRI Act).
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1. Leverage Capital Requirements*
Under the OCC leverage capital requirement, highly-rated banks
(composite CAMELS 6 rating of 1) must maintain a minimum
leverage capital ratio of at least 3 percent of Tier 1 capital to total
assets. All other banks must maintain an additional 100 to 200 basis
points of Tier 1 capital to total assets. The OCC leverage capital
requirement is the same as the rules of the other Banking Agencies.
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\6\ On December 9, 1996, the Federal Financial Institutions
Examination Council (FFIEC) adopted the revised Uniform Financial
Institutions Rating System (UFIRS or CAMELS rating system). The
UFIRS is an internal rating system used by the federal and state
banking regulators for assessing the soundness of financial
institutions on a uniform basis and for identifying those insured
institutions requiring special supervisory attention. Among other
things, the revised UFIRS added a sixth ``S'' component called
``Sensitivity to Market Risk'' to the CAMELS rating system. This
change reflects an increased emphasis by the Agencies on the quality
of risk management practices. A final notice was published in the
Federal Register on December 19, 1996, effective January 1, 1997.
See 61 FR 67021 (December 19, 1996).
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Saving associations are subject to a leverage ratio requirement of
3 percent of core capital 7 to adjusted total assets and a
tangible capital requirement of 1.5 percent of total assets. The OTS
has not yet adopted a final rule to amend its leverage ratio
requirement to be consistent with the leverage ratio requirements of
the other Banking Agencies. See 56 FR 16238 (April 22, 1991). OTS
regulated institutions, however, must satisfy the same percentage
requirements for leverage capital as banks in order to be considered
adequately capitalized for purposes of the PCA standards applicable to
all insured depository institutions. See 12 U.S.C. 1831o.
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\7\ While the definition of core capital is generally consistent
with the definition of Tier 1 capital, there are some differences.
Mutual savings associations may include certain nonwithdrawable
accounts and pledged deposits as core capital. In addition, under
section 221 of FIRREA, 12 U.S.C. 1828(n), qualifying supervisory
goodwill was permitted to be included in core capital for savings
associations; however, supervisory goodwill was phased out of core
capital at the end of 1994.
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2. Equity Investments
To the extent that a bank is permitted to hold equity securities
(such as securities obtained in connection with debts previously
contracted), the OCC risk-based capital guidelines generally require
these investments to be risk weighted at 100 percent. However, on a
case-by-case basis, the OCC may require deduction of equity investments
from the capital of the parent bank or impose other requirements in
order to assess an appropriate capital charge above the minimum capital
requirements. The other Banking Agencies have similar rules. The
capital treatment of equity investments is also discussed in section
B(5) of this report.
After the enactment of FIRREA, savings associations were required
to deduct equity investments that are impermissible for national banks
from capital gradually during a phase-in period. The phase-in period
ended July 1, 1996.
3. Assets subject to Guarantee Arrangements by the Federal Savings and
Loan Insurance Corporation (FSLIC)/Federal Deposit Insurance
Corporation
The OCC risk-based capital guidelines assign assets with FSLIC or
FDIC guarantees to the 20 percent risk-weight category, the same
category to which claims on depository institutions and government-
sponsored agencies are assigned. The other Banking Agencies also assign
these assets to the 20 percent weight category. The OTS assigns these
[[Page 26357]]
assets to the zero percent risk-weight category.
4. Limitation on Subordinated Debt and Limited-Life Preferred Stock
The OCC limits the amount of Tier 2 capital that may be included in
total capital to no more than 100 percent of Tier 1 capital. Consistent
with the Basle Accord, the OCC further limits the amount of
subordinated debt and limited-life preferred stock that may be included
in Tier 2 capital to 50 percent of Tier 1 capital. In addition, the OCC
risk-based capital guidelines require that subordinated debt and
limited-life preferred stock be discounted 20 percent in each of the
five years prior to maturity. The other Banking Agencies have similar
rules.
The OTS risk-based capital rules also limit Tier 2 capital to 100
percent of Tier 1 capital, but do not contain any sublimit on the total
amount of limited-life instruments that may be included within Tier 2
capital. In addition, the OTS allows savings associations the option of
either (1) discounting maturing capital instruments (issued on or after
November 7, 1989) by 20 percent a year over the last five years of
their term, or (2) including the full amount of such instruments,
provided that the amount maturing in any of the next seven years does
not exceed 20 percent of the total capital of the savings association.
5. Subsidiaries*
Consistent with the Basle Accord, the Banking Agencies generally
require that significant 8 majority-owned subsidiaries be
consolidated with the parent institution for both regulatory reporting
and capital purposes. If a subsidiary is not consolidated, the bank's
investment in the subsidiary constitutes a capital investment in the
subsidiary. The OCC risk-based capital guidelines specifically provide
that capital investments in an unconsolidated banking or financial
subsidiary must be deducted from the total capital of the bank. The OCC
risk-based capital guidelines also permit the OCC to require the
deduction of investments in other subsidiaries and associated companies
on a case-by-case basis. In addition, Part 5 of the OCC's regulations
requires deconsolidation of any subsidiary that engages as principal in
activities not permitted to be conducted in the bank directly, and
requires the bank's equity investment in that subsidiary to be deducted
from the capital of the bank. See 61 FR 60342 (November 27, 1996).
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\8\ A significant majority-owned subsidiary is a subsidiary in
which the investment by the parent bank represents a significant
financial interest of the parent bank as evidenced by (1) the bank
investment or advances to the subsidiary equals 5 percent or more of
the total equity capital of the bank, (2) the bank's proportional
share of the gross income or revenue of the subsidiary equals 5
percent or more of the gross income or revenue of the bank, (3) the
income (or loss before taxes) of the subsidiary amount to 5 percent
or more of the income (or loss before taxes) of the bank, or (4) the
subsidiary is the parent of a subsidiary that is considered a
significant subsidiary.
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The FRB risk-based capital guidelines for state member banks
generally require the deduction of investments in unconsolidated
banking and finance subsidiaries. The FRB may require an investment in
unconsolidated subsidiaries other than banking and finance subsidiaries
or joint ventures and associated companies, (1) to be deducted, (2) to
be appropriately risk-weighted against the proportionate share of the
assets of the entity, or (3) to be consolidated line-by-line with the
entity. In addition, the FRB may require the parent organization to
maintain capital above the minimum standard sufficient to compensate
for any risks associated with the investment.
The FRB risk-based capital guidelines also explicitly permit the
deduction of investments in certain subsidiaries that, while
consolidated for accounting purposes, are not consolidated for certain
specified supervisory or regulatory purposes. For example, the FRB
deducts investments in, and unsecured advances to, ``Section 20''
securities subsidiaries from the capital of the parent bank holding
company.
The FDIC accords similar treatment to certain type of securities
subsidiaries of state-chartered nonmember banks. Moreover, under the
FDIC rules, investments in, and extensions of credit to, certain
mortgage banking subsidiaries are also deducted in computing the
capital of the parent bank. Neither the OCC nor the FRB has a similar
requirement with regard to mortgage banking subsidiaries.
Under OTS risk-based capital guidelines, a distinction is made
between saving associations subsidiaries engaged in activities
permissible for national banks and their subsidiaries and saving
association subsidiaries engaged in activities ``impermissible'' for
national banks. This distinction is mandated by FIRREA. Subsidiaries of
savings associations that engage only in activities permissible for
national banks are consolidated on a line-for-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 national bank-impermissible activities are
deducted in computing tangible and core capital of the parent
association. The remaining assets (the percent of assets corresponding
to the nondeducted portion of the investment in the subsidiary) are
consolidated with the assets of the parent association. However,
investments, including loans outstanding as of April 12, 1989, to
subsidiaries that were engaged in impermissible activities prior to
that date, are grandfathered. These investments were required to be
phased-out of capital by July 1, 1994; however, the transition period
for investments made prior to April 12, 1989, in nonincludable real
estate subsidiaries could be extended, in certain circumstances, to
July 1, 1996. See 12 U.S.C. 1464(t)(5)(D). During this transition
period, investments in subsidiaries engaged in impermissible activities
that had not been phased out of capital were consolidated on a pro rata
basis.
6. Nonresidential Construction and Land Loans
Under the OCC risk-based capital guidelines, loans for real estate
development and construction are assigned to the 100 percent risk-
weight category. Reserves or charge-offs are required for such loans
when weaknesses or losses develop. The OCC has 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 other Banking
Agencies have similar rules.
OTS generally also assigns these loans to the 100 percent risk-
weight category. However, if the amount of the loan exceeds 80 percent
of the fair value of the property, savings associations must deduct the
full amount of the excess portion from total capital.9
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\9\ Prior to July 1, 1994, only a percentage (as provided by a
phase-in schedule) of the excess portion was required to be deducted
from total capital.
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7. Mortgage-Backed Securities (MBS)
The OCC risk-based capital guidelines generally assign a risk
weight to privately-issued MBSs according to the underlying assets, but
in no case is a privately-issued MBS assigned to the zero percent risk-
weight category. Privately-issued MBSs, where the direct underlying
assets are mortgages, are generally assigned 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-weight
category. The other Banking Agencies have similar rules.
[[Page 26358]]
Similarly, the OTS assigns privately issued MBSs backed by
securities issued or guaranteed by government agencies or government-
sponsored enterprises to the 20 percent risk-weight category. However,
unlike the Banking Agencies, the OTS also assigns certain privately-
issued high quality mortgage-related securities with AA or better
investment ratings to the 20 percent risk-weight category. Like the
Banking Agencies, the OTS does not assign any privately issued MBS to
the zero percent category.
With respect to other MBSs, the Agencies 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.
8. Agricultural Loan Loss Amortization
In determining 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, 1991.10 The program also applies to losses
incurred between January 1, 1983, and December 31, 1991, as a result of
reappraisals and sales of agricultural other real estate owned and
agricultural personal property. These losses must be fully amortized
over a period not to exceed seven years and, in any case, must be fully
amortized by year-end 1998. Savings associations are not eligible to
participate in the agricultural loan loss amortization program
established by this statute.
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\10\ This program will sunset January 1, 1999. See 60 FR 27401
(May 24, 1995).
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9. Treatment of Junior Liens on One- to Four-Family Properties*
In some cases, a banking organization may make two loans secured by
the same residential property; one loan is secured by a first lien, the
other by a second lien. The OCC and the FDIC generally assign first
liens on one-to four-family properties to the 50 percent risk-weight
category. The assignment of first lien mortgages to the 50 percent
risk-weight category is based upon the expectation that banks will
adhere to the requirement for prudent underwriting standards with
respect to the maximum loan-to-value ratio, the borrower's paying
capacity and the long-term expectations for the real estate market in
which the bank is lending.
The OCC assigns all second liens on residential property to the 100
percent risk-weight category, regardless of whether the institution
also holds the first lien. The FDIC similarly assigns all second liens
to the 100 percent risk-weight category. However, in determining the
risk-weight of the first lien, the FDIC considers the first and second
liens together to assess whether the first lien satisfies prudent
underwriting standards. When evaluated together, if the first and
second liens are within the prudent loan-to-value ratio and satisfy all
other underwriting standards, then the first lien will be assigned to
the 50 percent risk-weight category; otherwise, it will be assigned to
the 100 percent risk-weight category.
The FRB and OTS consider the first and second liens as a single
loan, provided there are no intervening liens. Therefore, the total
amount of these transactions may be assigned to the 100 percent risk-
weight category, if, in the aggregate, the two loans exceed a prudent
loan-to-value ratio and, therefore, do not qualify for the 50 percent
risk-weight category. This approach is intended to avoid possible
circumvention of the capital requirements and capture the risks
associated with the combined transactions. However, if the total amount
of the transaction does satisfy a prudent loan-to-value ratio and other
underwriting standards, then both the first and second liens may be
assigned to the 50 percent risk-weight category.
10. Pledged Deposits and Nonwithdrawable Accounts
Pledged deposits and nonwithdrawable accounts that satisfy
specified OTS criteria may be included in core capital by mutual
savings associations. Pledged deposits and nonwithdrawable accounts
generally represent capital investments in mutual saving associations
under the same terms as perpetual noncumulative preferred stock. These
mutual saving associations accept capital investments in the form of
pledged deposits and nonwithdrawable accounts because mutual
associations are not legally authorized to issue common or preferred
stock. Income capital certificates and mutual capital certificates that
were issued by savings associations under applicable statutory
authority and regulations and held by the FDIC may be included in Tier
2 capital by savings associations.
These instruments are unique to savings associations and are not
held by commercial banks. Consequently, these instruments are not
addressed in the OCC risk-based capital guidelines.
11. Mutual Funds*
The OCC and the other Banking Agencies generally assign all of the
holdings of a bank in a mutual fund to the risk category appropriate to
the asset with the highest risk that a particular mutual fund is
permitted to hold under its operating rules. This approach takes into
account the maximum degree of risk to which a bank may be exposed when
investing in a mutual fund. On a case-by-case basis, however, the OCC
may permit a bank to risk weight the investments in a mutual fund on a
pro rata basis relative to the maximum risk weights of the assets the
mutual fund is permitted to hold but limited to no lower than a 20
percent risk weight.
The OTS applies a capital charge based on the riskiest asset that
is actually held by the mutual fund at a particular time. In addition,
the OTS and OCC guidelines also permit, on a case-by-case basis,
investments in mutual funds to be risk weighted on a pro rata basis
dependent on the actual composition of the fund.
12. Collateralized Transactions*
Both the OCC and FRB permit certain loans and transactions
collateralized by cash and OECD government securities to qualify for a
zero percent risk weight. The FDIC and OTS risk weight loans and
transactions collateralized by cash and OECD government securities at
20 percent. See discussion in section C(1)(i) of this report.
C. Recent Interagency Rulemaking Projects
The three Banking Agencies have amended their capital adequacy
rules in several significant ways since they were originally adopted.
First, the credit risk framework of the risk-based capital guidelines
has been expanded to cover derivative contracts. Second, the risk-based
capital guidelines have been amended to incorporate a market risk
component which serves to supplement credit risk. Third, all four
Agencies have added an interest rate risk component to their capital
adequacy rules. In amending the capital adequacy rules, the practice of
the Agencies is to consult closely with one another even in instances
where joint rulemaking is not statutorily required. This ensures that
all insured depository institutions are subject to the same standards
to the maximum extent feasible. The following describes the most
significant rulemaking projects undertaken during the period covered by
this report.
[[Page 26359]]
1. Amendments to the Risk-Based Capital Credit Risk Framework
This section discusses regulatory efforts of the Agencies to amend
the credit risk framework of the risk-based capital guidelines.
a. Expanded Matrix for Derivative Contracts
On September 5, 1995, the OCC and the other Banking Agencies issued
a joint final rule on derivative contracts which amended the risk-based
capital guidelines to cover derivative contracts. See 60 FR 46170
(September 5, 1995); see also 59 FR 45243 (September 1, 1994) (OCC
proposed rule). Specifically, the rule expanded and revised the set of
off-balance sheet credit conversion factors used to calculate the
potential future credit exposure on derivative contracts and permitted
banks to net multiple derivative contracts executed with a single
counterparty that are subject to a qualifying bilateral netting
contract when calculating the potential future credit exposure.
b. Membership in the Organization for Economic Cooperation and
Development (OECD)
Under the risk-based capital guidelines, claims on, or guarantees
by, certain entities in OECD-based countries generally are subject to a
lower capital charge. See 12 CFR Part 3, Appendix A 3(a)(1)(iii)
(securities issued by the United States or the central government of an
OECD country subject to zero percent risk weight). On December 20,
1995, the OCC and the other Banking Agencies amended the definition of
``OECD-based country'' to exclude any country that has rescheduled its
external sovereign debt within the previous five years. See 60 FR 66042
(December 20, 1995). This rule was issued in response to a change by
the Basle Committee on Banking Regulations and Supervisory Practices to
the Basle Accord.
c. Unrealized Gains and Losses on Securities Available for Sale
The Agencies have all issued final rules on unrealized gains and
losses on securities available for sale. The final rules were developed
jointly by the OCC and the other Agencies in response to Financial
Accounting Standard (FAS) 115, which generally requires net unrealized
gains and losses on securities available for sale to be included in
capital. See Financial Accounting Standards Board, Statement of
Financial Accounting Standards Number 115 (Accounting for Certain
Investments in Debt and Equity Securities), No. 126-D (May 1993). The
Federal Financial Institutions Examination Council adopted FAS 115 for
regulatory reporting purposes beginning December 15, 1993.
The proposed rules of the Agencies would have adopted FAS 115 for
regulatory capital purposes by amending the definition of ``common
stockholders' equity'' in the capital guidelines to include both
unrealized gains and losses on securities available for sale. However,
after careful consideration of the comments received, the OCC, along
with the other Agencies, decided not to adopt the proposed rule because
of the potential volatility that could result if FAS 115 unrealized
gains and losses are required to be included in regulatory capital.
Consequently, the OCC final rule does not require national banks to use
FAS 115 for the purposes of computing regulatory capital. See 59 FR
60552 (November 25, 1994). The FDIC, the OTS and the FRB issued similar
final rules. See 59 FR 66662 (December 28, 1994) (FDIC final rule); 60
FR 42025 (August 15, 1995) (OTS final rule); and 59 FR 63641 (December
8, 1994) (FRB final rule).
d. Concentrations of Credit and Nontraditional Activities
The Agencies have implemented section 305 of FDICIA by amending
their capital adequacy rules to explicitly identify concentrations of
credit risk and certain risks arising from nontraditional activities as
important factors in assessing each institution's overall capital
adequacy. The four Agencies issued a joint final rule on the risks from
concentrations of credit and nontraditional activities. The final rule
was published in the Federal Register on December 15, 1994. See 59 FR
64561 (December 15, 1994).
e. Bilateral Netting Contracts
On December 28, 1994, the OCC and the OTS issued a joint final rule
on bilateral netting contracts. This final rule amended the risk-based
capital guidelines to permit netting of certain interest rate and
foreign exchange rate contracts in calculating the current exposure
portion of the credit equivalent amount of these contracts for risk-
based capital purposes. See 59 FR 66645 (December 28, 1994). The FRB
and the FDIC issued similar final rules. See 59 FR 62987 (December 7,
1994) (FRB final rule); and 59 FR 66656 (December 28, 1994) (FDIC final
rule).
f. Collateralized Transactions
The rule on collateralized transactions amended the OCC risk-based
capital guidelines to lower the risk weight from 20 percent to zero
percent on certain loans and transactions collateralized by cash or
government securities. The OCC issued its final rule on collateralized
transactions on December 28, 1994. See 59 FR 66642 (December 28, 1994).
See section C(1)(i) for a description of the plan of the Agencies to
issue uniform rules with respect to collateralized transactions.
g. Deferred Tax Assets
The OCC final rule on deferred tax assets amended the risk-based
capital guidelines to limit the amount of certain deferred tax assets
that may be included in an institution's Tier 1 capital to the lesser
of (1) the amount of deferred tax assets the institution expects to
realize within one year or (2) 10 percent of Tier 1 capital. This final
rule was developed jointly by the Agencies in response to FAS 109,
which was adopted for regulatory reporting purposes beginning January
1, 1993. See Financial Accounting Standards Board, Statement of
Financial Accounting Standards Number 109 (Accounting for Income
Taxes), No. 112-A (February 1992). FAS 109 provides guidance on the
accounting treatment of income taxes and generally allows banks to
report certain deferred tax assets they could not previously recognize.
The OCC issued its final rule on February 10, 1994. See 60 FR 7903
(February 10, 1994). The FRB and the FDIC issued similar final rules.
See 59 FR 65920 (December 22, 1994) (FRB); and 60 FR 8182 (February 13,
1995) (FDIC). The OTS had adopted this general approach through the
issuance of a Thrift Bulletin. See TB-56 (January 1993).
h. Mortgage Servicing Rights
On August 1, 1995, the OCC, the other Banking Agencies, and the OTS
issued a joint interim rule with request for comment on the capital
treatment of originated mortgage servicing rights (OMSR). See 60 FR
39266 (August 1, 1995). The interim rule was developed in response to
FAS 122 on mortgage servicing rights which eliminates the accounting
distinction between OMSRs and purchased mortgage servicing rights
(PMSR). See Financial Accounting Standards Board, Statement of
Financial Accounting Standards Number 122 (Accounting for Mortgage
Servicing Rights). Specifically, the interim rule amends the capital
adequacy rules to treat OMSRs the same as PMSRs for regulatory capital
purposes. Therefore, subject to an overall 50 percent limit of Tier 1
capital, both OMSRs and PMSRs may be included in capital for regulatory
capital and PCA purposes.
[[Page 26360]]
i. CDRI Act Section 303(a)(2) Capital Amendments
In addition to the general ongoing efforts of the Agencies to
achieve uniform capital and accounting standards, as part of the
interagency review of regulations under section 303(a)(2) of the
RCDRIA, the Agencies currently are evaluating the capital and
accounting differences in this report in contemplation of changes to
achieve greater uniformity. The Agencies already have issued a joint
proposed rule on collateralized transactions as part of their efforts
under section 303(a)(2) of the CDRI Act. See 61 FR 42565 (August 16,
1996). Under this joint proposed rule, the FDIC and OTS would adopt a
collateralized transactions rule lowering the risk weight from 20
percent to zero percent on certain loans and transactions
collateralized by cash or government securities; the OCC and FRB would
revise their current collateralized transactions rule to use more
uniform language.
In addition to collateralized transactions, the Agencies have
identified several other provisions as appropriate for revision under
section 303(a)(2) of the CDRI Act. These provisions include the capital
treatment of presold residential construction loans, junior liens on
one to four-family residential properties, and mutual funds,
investments in subsidiaries and the minimum leverage capital
requirement. See Joint Report: Streamlining of Regulatory Requirements,
pages I-6 through I-9.
2. Market Risk Component
The joint final rule issued by the Banking Agencies on market risk
amended the risk-based capital guidelines to incorporate a measure for
market risk in foreign exchange and commodity activities and in the
trading of debt and equity instruments. Market risk generally
represents the risk of loss attributable to on and off-balance sheet
positions caused by movements in market prices. The effect of the final
rule is to require certain banks with relatively large amounts of
trading activities to hold additional capital based on the measure of
their market risk exposure as determined by the banks own internal
value-at-risk model. The final rule also establishes a third capital
category, Tier 3 capital, which generally consists of certain short
term subordinated debt subject to a lock-in clause that prevent the
issuer from repayment if the bank's risk-based capital ratio falls
below 8 percent. Tier 3 capital can only be used to satisfy market risk
capital requirements. The joint final rule was issued by the Banking
Agencies on September 6, 1996. See 61 FR 47358 (September 6, 1996).
3. Interest Rate Risk Component
The joint final rule issued by the Banking Agencies on interest
rate risk amended the capital adequacy rules to clarify the authority
of the Banking Agencies to specifically include in their evaluation of
bank capital an assessment of the exposure to declines to bank's
capital due to changes in interest rates. The final rule on interest
rate risk was issued jointly by the OCC and the other Banking Agencies
on August 2, 1995. See 60 FR 39490 (August 2, 1995). The Banking
Agencies also have issued a joint policy statement on interest rate
risk on June 26, 1996. See 61 FR 33166 (June 26, 1996). The joint
policy statement provides guidance to banks on measuring and managing
their interest rate risk exposure.
The OTS has adopted an interest rate risk component to its risk-
based capital guidelines, which became effective on January 1, 1994.
Once fully implemented, under the OTS rule thrift institutions with an
above normal level of interest rate risk will be subject to a capital
charge commensurate to their risk exposure. Unlike the interest rate
risk rules of the Banking Agencies, the OTS rule, when implemented,
would impose an automatic capital charge for interest rate risk over a
specified level. In addition, under the OTS rule, the OTS collects data
and computes the interest rate risk exposure and corresponding capital
charge for all thrift institutions required to report.
4. Recourse
In general, recourse is the risk of loss retained by an institution
when it sells an asset. Recourse arrangements allow the purchaser of an
asset to seek recovery against the institution that sold the asset
under the conditions in the agreement. Under the current risk-based
capital guidelines of the Banking Agencies, sales of assets involving
recourse generally must be reported as financings which means that the
assets are retained on the balance sheet of the selling bank. The OTS
treats sales with recourse as sales for regulatory reporting and
leverage ratio purposes if they meet the criteria under generally
accepted accounting principles (GAAP) for sales treatment, including
the establishment of a recourse liability account for reasonably
estimated losses from the recourse obligation.
a. Low Level Recourse
Prior to the adoption of the final rule on low level recourse, the
risk-based capital guidelines of the Banking Agencies had the effect of
requiring a full leverage and risk-based capital charge whenever assets
are sold with recourse, even if the institution's maximum exposure
under the recourse obligation is less than the capital charge on the
asset sold. On April 10, 1995, the OCC issued a final rule on low level
recourse. See 60 FR 17986 (April 10, 1995). This final rule amends the
risk-based capital guidelines to limit the amount of capital that a
bank must hold to the maximum contractual loss exposure retained by the
bank under the recourse obligation if that amount is less than the
amount of the effective capital requirement for the underlying asset.
This final rule implements the requirements of section 350 of the CDRI
Act (12 U.S.C. 4808), which generally limits the risk-based capital
charge for assets transferred with recourse to the amount of recourse
the bank is contractually liable under the recourse agreement. The FRB
and the FDIC issued similar final rules. See 60 FR 8177 (February 13,
1995) (FRB final rule); and 60 FR 15858 (March 28, 1995) (FDIC final
rule). The OTS capital rules already reflected this position on low
level recourse.
b. Recourse and Direct Credit Substitutes
On May 25, 1994, the Agencies jointly issued an advance notice of
proposed rulemaking (ANPR) on recourse. See 59 FR 27116 (May 25, 1995).
The ANPR proposed an approach that would use credit ratings to more
closely match the risk-based capital assessment to an institution's
relative risk of loss in certain asset securitizations.
c. Small Business Loan Recourse
Section 208 of the CDRI Act (12 U.S.C. 1835) generally reduces the
amount of capital required to be held by certain qualified institutions
for recourse retained in certain transfers of small business loans and
leases of personal property. Currently, the Agencies are engaged in
rulemaking to implement section 208. The FRB issued a final rule on
August 31, 1995. See 60 FR 45612 (August 31, 1995). The FDIC, OTS, and
the OCC, have issued interim rules with request for comment. See 60 FR
45606 (August 31, 1995) (FDIC interim rule); 60 FR 45618 (August 31,
1995) (OTS interim rule); and 60 FR 47455 (September 13, 1995) (OCC
interim rule).
[[Page 26361]]
D. Interagency Differences in Accounting Principles
The regulatory reporting standards for all commercial banks,
whether regulated by the OCC, the FRB, or the FDIC, are prescribed in
the instructions to the Call Report. The Call Report instructions are
prepared by the Federal Financial Institutions Examination Council
(FFIEC) and require banks to follow generally accepted accounting
principles (GAAP) for reports of condition and income required to be
filed with the Banking Agencies except as permitted under section 121
of FDICIA. Under section 121 of FDICIA, the Banking Agencies must
require financial institutions to use accounting principles ``no less
stringent than GAAP'' for reports of condition and income to be filed
with the Banking Agencies. Reporting in accordance with GAAP generally
satisfies this statutory requirement.
Although the accounting and reporting requirements imposed by the
Banking Agencies were, for the most part, already consistent with GAAP,
on November 3, 1995, the FFIEC announced the full adoption of GAAP as
the reporting basis for the Call Report. Proposed Call Report changes
to further conform the Call Report with GAAP were published for comment
on September 16, 1996. See 61 FR 48687 (September 16, 1996). The final
Call Report changes were published on February 21, 1997. See 62 FR 8078
(February 21, 1997).
The OTS requires each savings association to file the Thrift
Financial Report. That report is filed on a basis consistent with GAAP
as it is applied by savings associations, which differs in a few
respects from GAAP as GAAP applies to banks. These current differences
in accounting principles between the banks and thrift institutions
result in some differences in financial statement presentation and in
amounts of regulatory capital required to be maintained by these
institutions. The following summarizes the significant differences
between the Thrift Financial Report and the Call Report as of year-end
1996. However, the implementation of the current Call Report changes to
move toward the full adoption of GAAP by the Banking Agencies will
essentially eliminate substantive accounting differences among the
Agencies. As a result most of the accounting differences discussed in
this section will be eliminated. To the degree, any accounting
differences remain, the Agencies will continue to work toward
reconciling those remaining differences.
1. Futures and Forward Contracts
Differences in this area result because the Banking Agencies
generally require future and forward contracts to be marked to market,
whereas under GAAP savings associations may defer gains and losses
resulting from certain hedging activities.
The Banking Agencies do not follow GAAP, but require banks to
report changes in the market value of futures and forward contracts,
even when used as hedges, in current income. However, futures contracts
used to hedge mortgage banking operations are reported in accordance
with GAAP. The accounting for futures and forward contracts is being
reexamined by the Financial Accounting Standards Board (FASB) as part
of an ongoing project on accounting for derivatives.
The OTS requires savings associations to follow GAAP to account for
futures contracts. Accordingly, when specified hedging criteria are
satisfied, the accounting for the futures contract is matched with the
accounting for the hedged item. Changes in the market value of the
futures contract are recognized in income when the income effects of
the hedged item are recognized. This reporting can result in the
deferral of both gains and losses. Although there is no specific GAAP
for forward contracts, the OTS applies these same principles to forward
contracts.
2. Push-Down Accounting
When a depository institution is acquired in a purchase
transaction, the holding company is required to revalue all of the
assets and liabilities of the depository institution at fair value at
the time of acquisition. When push-down accounting is applied, the same
fair value adjustments recorded by the parent holding company are also
recorded at the depository institution level.
All of the agencies require the use of push-down accounting when
there has been a substantial change in the ownership of the
institution. However, differing standards have been applied to
determine when this substantial change has occurred.
The Banking Agencies require push-down accounting when there is at
least a 95 percent change in ownership of the institution. This
approach is consistent with interpretations of the Securities and
Exchange Commission.
The OTS requires push-down accounting when there is at least a 90
percent change of ownership.
3. Excess Service Fees
Excess service fees are created when a bank sells mortgage loans,
but retains the servicing rights. Excess service fees represent the
present value of the servicing fees in excess of the normal servicing
fee. Savings associations consider excess servicing fees in the
determination of the gain or loss on a loan sale, whereas banks
generally recognize the excess fee over the life of the loan.
The Banking Agencies require banks to follow GAAP for residential
first mortgage loans. This requires that when loans are sold with
servicing retained and the stated servicing fee is sufficiently higher
than a normal servicing fee, the sales price is adjusted to determine
the gain or loss from the sale. This allows additional gain recognition
for the excess servicing fee at the time of sale and recognizes a
normal servicing fee in each subsequent year. This gain cannot exceed
the gain assuming the loans were sold with servicing released. In
addition, the Banking Agencies allow limited recognition at the time of
sale of excess servicing fees for SBA loans.
For all other loans, the Banking Agencies require that excess
servicing fees retained on loans sold be recognized over the
contractual life of the transferred assets.
The OTS follows GAAP in valuing all excess service fees. Therefore,
the accounting stated above for sales of mortgage loans with excess
servicing at banking institutions would apply to all loan sales with
excess servicing at savings associations.
4. In-substance Defeasance of Debt
The Banking Agencies do not permit banks to defease their
liabilities in accordance with FAS 76, whereas saving associations may
eliminate defeased liabilities from the balance sheet. FAS 76 concerns
the extinguishment of debt. Specifically, FAS 76 specifies that debt is
to be considered extinguished if the debtor is relieved of primary
liability for the debt by the creditor and it is probable that the
debtor will not be required to make future payments as guarantor of the
debt. In addition, even though the creditor does not relieve the debtor
of its primary obligation, debt is to be considered extinguished if (1)
the debtor irrevocably places cash or other essentially risk-free
monetary assets in a trust solely for satisfying that debt and (2) the
possibility that the debtor will be required to make further payments
is remote. The Banking Agencies report in-substance defeased debt as a
liability and the securities contributed to the trust as assets with no
recognition of any gain or loss on the transaction.
[[Page 26362]]
The OTS accounts for debt that has been in-substance defeased in
accordance with GAAP. Therefore, when a debtor irrevocably places risk-
free monetary assets in a trust solely for satisfying the debt and the
possibility that the debtor will be required to make further payments
is remote, the debt is considered extinguished. The transfer can result
in a gain or loss in the current period.
5. Sales of Assets with Recourse
Banks generally do not report sales of receivables if any risk of
loss is retained. Savings associations report sales when the risk of
loss can be estimated in accordance with FAS 77.
The Banking Agencies generally allow banks to report transfers of
receivables 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, assets transferred with recourse are reported
as financings, not sales.
However, this rule does not apply to the transfer of mortgage loans
under certain government programs (GNMA, FNMA, etc.). Transfers of
mortgages under one of these programs are automatically treated as
sales. Furthermore, private transfers of pools of mortgages are also
reported as sales if the transferring institution does not retain more
than an insignificant risk of loss on the assets transferred.
The OTS follows GAAP to account for a transfer of all receivables
with recourse. A transfer of receivables with recourse is recognized as
a sale if: (1) the seller 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.
6. Negative Goodwill
The Banking Agencies require that negative goodwill be reported as
a liability, and not netted against the goodwill asset.
The OTS permits negative goodwill to offset the goodwill assets
resulting from other acquisitions.
7. Offsetting of Amounts Related to Certain Contracts
Financial Accounting Standards Board Interpretation Number (FIN) 39
became effective in 1994. FIN 39 allows the offsetting of assets and
liabilities on the balance sheet (e.g., loans, deposits, etc.), as well
as the netting of assets and liabilities arising from off-balance sheet
derivatives instruments, when four conditions are met. These conditions
relate to whether a valid right of offset exists. FIN 41, which also
became effective in 1994, provides for the netting of repurchase and
reverse repurchase agreements when certain conditions are met.
The Banking Agencies have adopted FIN 39 solely for on-balance
sheet amounts arising from conditional and exchange contracts (e.g.,
interest rate swaps, options, etc.). The Banking Agencies have not
adopted FIN 41. The Call Report's existing guidance, which generally
prohibits netting of assets and liabilities, is currently followed in
all other cases. The OTS policy on netting of assets and liabilities is
consistent with GAAP.
8. Specific Valuation Allowance for and Charge-offs of Troubled Loans
The Banking Agencies generally consider real estate loans that lack
acceptable cash flows or other repayment sources to be ``collateral
dependent.'' When the fair value of the collateral of such a loan has
declined below book value, the loan is reduced to fair value. This
approach is consistent with GAAP applicable to banks and FAS 114.
The OTS requires a specific valuation allowance against or partial
charge-off of a loan when its book value exceeds its ``value.'' The
``value'' is defined as either the present value of the expected future
cash flows discounted at the loan's effective interest rate, the
observable market price, or the fair value of the collateral. This
policy is also consistent with the requirements of FAS 114.
Effective March 31, 1995, the OTS required that losses on
collateral dependent loans be measured based on the fair value of the
collateral. Accordingly, after March 31, 1995, the OTS policy regarding
the recognition of losses on collateral dependent loans became
comparable to that of the Bank Agencies.
Dated: May 6, 1997.
Eugene A. Ludwig,
Comptroller of the Currency.
[FR Doc. 97-12515 Filed 5-12-97; 8:45 am]
BILLING CODE 4810-33-P
