[Federal Register: July 29, 2008 (Volume 73, Number 146)] [Proposed Rules] [Page 43981-44060] From the Federal Register Online via GPO Access [wais.access.gpo.gov] [DOCID:fr29jy08-19] [[Page 43981]] ----------------------------------------------------------------------- Part II Department of the Treasury Office of the Comptroller of the Currency 12 CFR Part 3 Federal Reserve System 12 CFR Parts 208 and 225 Federal Deposit Insurance Corporation 12 CFR Part 325 Department of the Treasury Office of Thrift Supervision 12 CFR Part 567 Risk-Based Capital Guidelines; Capital Adequacy Guidelines: Standardized Framework; Proposed Rule [[Page 43982]] ----------------------------------------------------------------------- DEPARTMENT OF THE TREASURY Office of the Comptroller of the Currency 12 CFR Part 3 [Docket ID: OCC-2008-0006] RIN 1557-AD07 FEDERAL RESERVE SYSTEM 12 CFR Parts 208 and 225 [Regulations H and Y; Docket No. R-1318] FEDERAL DEPOSIT INSURANCE CORPORATION 12 CFR Part 325 RIN 3064-AD29 DEPARTMENT OF THE TREASURY Office of Thrift Supervision 12 CFR Part 567 [No. 2008-002] RIN 1550-AC19 Risk-Based Capital Guidelines; Capital Adequacy Guidelines: Standardized Framework AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; and Office of Thrift Supervision, Treasury. ACTION: Joint notice of proposed rulemaking. ----------------------------------------------------------------------- SUMMARY: The Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), Federal Deposit Insurance Corporation (FDIC), and Office of Thrift Supervision (OTS) (collectively, the agencies) propose a new risk-based capital framework (standardized framework) based on the standardized approach for credit risk and the basic indicator approach for operational risk described in the capital adequacy framework titled ``International Convergence of Capital Measurement and Capital Standards: A Revised Framework'' (New Accord) released by the Basel Committee on Banking Supervision. The standardized framework generally would be available, on an optional basis, to banks, bank holding companies, and savings associations (banking organizations) that apply the general risk-based capital rules. DATES: Comments on this joint notice of proposed rulemaking must be received by October 27, 2008. ADDRESSES: Comments should be directed to: OCC: Because paper mail in the Washington, DC area and at the OCC is subject to delay, commenters are encouraged to submit comments by e- mail, if possible. Please use the title ``Risk-Based Capital Guidelines; Capital Adequacy Guidelines: Standardized Framework; Proposed Rule and Notice'' to facilitate the organization and distribution of the comments. You may submit comments by any of the following methods: Federal eRulemaking Portal--``Regulations.gov'': Go to http://www.regulations.gov, under the ``More Search Options'' tab click next to the ``Advanced Docket Search'' option where indicated, select ``Comptroller of the Currency'' from the agency drop-down menu, then click ``Submit.'' In the ``Docket ID'' column, select OCC-2008-0006 to submit or view public comments and to view supporting and related materials for this notice of proposed rulemaking. The ``How to Use This Site'' link on the Regulations.gov home page provides information on using Regulations.gov, including instructions for submitting or viewing public comments, viewing other supporting and related materials, and viewing the docket after the close of the comment period. E-mail: regs.comments@occ.treas.gov. Mail: Office of the Comptroller of the Currency, 250 E Street, SW., Mail Stop 1-5, Washington, DC 20219. Fax: (202) 874-4448. Hand Delivery/Courier: 250 E Street, SW., Attn: Public Information Room, Mail Stop 1-5, Washington, DC 20219. Instructions: You must include ``OCC'' as the agency name and ``Docket Number OCC-2008-0006'' in your comment. In general, OCC will enter all comments received into the docket and publish them on the Regulations.gov Web site without change, including any business or personal information that you provide such as name and address information, e-mail addresses, or phone numbers. Comments received, including attachments and other supporting materials, are part of the public record and subject to public disclosure. Do not enclose any information in your comment or supporting materials that you consider confidential or inappropriate for public disclosure. You may review comments and other related materials that pertain to this [insert type of rulemaking action] by any of the following methods: Viewing Comments Electronically: Go to http:// www.regulations.gov, under the ``More Search Options'' tab click next to the ``Advanced Document Search'' option where indicated, select ``Comptroller of the Currency'' from the agency drop-down menu, then click ``Submit.'' In the ``Docket ID'' column, select ``OCC-2008-0006'' to view public comments for this rulemaking action. Viewing Comments Personally: You may personally inspect and photocopy comments at the OCC's Public Information Room, 250 E Street, SW., Washington, DC. For security reasons, the OCC requires that visitors make an appointment to inspect comments. You may do so by calling (202) 874-5043. Upon arrival, visitors will be required to present valid government-issued photo identification and submit to security screening in order to inspect and photocopy comments. Docket: You may also view or request available background documents and project summaries using the methods described above. Board: You may submit comments, identified by Docket No. R-1318, by any of the following methods: Agency Web Site: http://www.federalreserve.gov. Follow the instructions for submitting comments at http://www.federalreserve.gov/ generalinfo/foia/ProposedRegs.cfm. Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. E-mail: regs.comments@federalreserve.gov. Include docket number in the subject line of the message. FAX: (202) 452-3819 or (202) 452-3102. Mail: Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, NW., Washington, DC 20551. All public comments are available from the Board's Web site at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted, unless modified for technical reasons. Accordingly, your comments will not be edited to remove any identifying or contact information. Public comments may also be viewed electronically or in paper form in Room MP-500 of the Board's Martin Building (20th and C Street, NW.) between 9 a.m. and 5 p.m. on weekdays. FDIC: You may submit by any of the following methods: Federal eRulemaking Portal: http://www.regulations.gov Follow the instructions for submitting comments. [[Page 43983]] Agency Web site: http://www.FDIC.gov/regulations/laws/ federal/propose.html. Mail: Robert E. Feldman, Executive Secretary, Attention: Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th Street, NW., Washington, DC 20429. Hand Delivered/Courier: The guard station at the rear of the 550 17th Street Building (located on F Street), on business days between 7 a.m. and 5 p.m. E-mail: comments@FDIC.gov. Public Inspection: Comments may be inspected and photocopied in the FDIC Public Information Center, Room E-1002, 3502 Fairfax Drive, Arlington, VA 22226, between 9 a.m. and 5 p.m. on business days. Instructions: Submissions received must include the Agency name and title for this notice. Comments received will be posted without change to http://www.FDIC.gov/regulations/laws/federal/propose.html, including any personal information provided. OTS: You may submit comments, identified by OTS-2008-0002, by any of the following methods: Federal eRulemaking Portal: ``Regulations.gov'': Go to http://www.regulations.gov, under the ``more Search Options'' tab click next to the ``Advanced Docket Search'' option where indicated, select ``Office of Thrift Supervision'' from the agency dropdown menu, then click ``Submit.'' In the ``Docket ID'' column, select ``OTS-2008-0002'' to submit or view public comments and to view supporting and related materials for this proposed rulemaking. The ``How to Use This Site'' link on the Regulations.gov home page provides information on using Regulations.gov, including instructions for submitting or viewing public comments, viewing other supporting and related materials, and viewing the docket after the close of the comment period. Mail: Regulation Comments, Chief Counsel's Office, Office of Thrift Supervision, 1700 G Street, NW., Washington, DC 20552, Attention: OTS-2008-0002. Facsimile: (202) 906-6518. Hand Delivery/Courier: Guard's Desk, East Lobby Entrance, 1700 G Street, NW., from 9 a.m. to 4 p.m. on business days, Attention: Regulation Comments, Chief Counsel's Office, Attention: OTS-2008-0002. Instructions: All submissions received must include the agency name and docket number for this rulemaking. All comments received will be entered into the docket and posted on Regulations.gov without change, including any personal information provided. Comments, including attachments and other supporting materials received are part of the public record and subject to public disclosure. Do not enclose any information in your comment or supporting materials that you consider confidential or inappropriate for public disclosure. Viewing Comments Electronically: Go to http:// www.regulations.gov, select ``Office of Thrift Supervision'' from the agency drop-down menu, then click ``Submit.'' Select Docket ID ``OTS- 2008-0002'' to view public comments for this notice of proposed rulemaking. Viewing Comments On-Site: You may inspect comments at the Public Reading Room, 1700 G Street, NW., by appointment. To make an appointment for access, call (202) 906-5922, send an e-mail to public.info@ots.treas.gov, or send a facsimile transmission to (202) 906-6518. (Prior notice identifying the materials you will be requesting will assist us in serving you.) We schedule appointments on business days between 10 a.m. and 4 p.m. In most cases, appointments will be available the next business day following the date we receive a request. FOR FURTHER INFORMATION CONTACT: OCC: Margot Schwadron, Senior Risk Expert, (202) 874-6022, Capital Policy Division; Carl Kaminski, Attorney; or Ron Shimabukuro, Senior Counsel, Legislative and Regulatory Activities Division, (202) 874- 5090; Office of the Comptroller of the Currency, 250 E Street, SW., Washington, DC 20219. Board: Barbara Bouchard, Associate Director, (202) 452-3072; or William Tiernay, Senior Supervisory Financial Analyst, (202) 872-7579, Division of Banking Supervision and Regulation; or Mark E. Van Der Weide, Assistant General Counsel, (202) 452-2263; or April Snyder, Counsel, (202) 452-3099, Legal Division. For the hearing impaired only, Telecommunication Device for the Deaf (TDD), (202) 263-4869. FDIC: Nancy Hunt, Senior Policy Analyst, (202) 898-6643; Ryan Sheller, Capital Markets Specialist, (202) 898-6614; or Bobby R. Bean, Chief, Policy Section, Capital Markets Branch, (202) 898-3575, Division of Supervision and Consumer Protection; or Benjamin W. McDonough, Senior Attorney, (202) 898-7411, or Michael B. Phillips, Counsel, (202) 898-3581, Supervision and Legislation Branch, Legal Division, Federal Deposit Insurance Corporation, 550 17th Street, NW., Washington, DC 20429. OTS: Michael Solomon, Director, Capital Policy Division, (202) 906- 5654; or Teresa Scott, Senior Project Manager, Capital Policy Division, (202) 906-6478, Office of Thrift Supervision, 1700 G Street, NW., Washington, DC 20552. SUPPLEMENTARY INFORMATION: Table of Contents I. Background II. Proposed Rule A. Applicability of the Standardized Framework B. Reservation of Authority C. Principle of Conservatism D. Merger and Acquisition Transition Provisions E. Calculation of Tier 1 and Total Qualifying Capital F. Calculation of Risk-Weighted Assets 1. Total Risk-Weighted Assets 2. Calculation of Risk-Weighted Assets for General Credit Risk 3. Calculation of Risk-Weighted Assets for Unsettled Transactions, Securitization Exposures, and Equity Exposures 4. Calculation of Risk-Weighted Assets for Operational Risk G. External and Inferred Ratings 1. Overview 2. Use of External Ratings H. Risk-Weight Categories 1. Exposures to Sovereign Entities 2. Exposures to Certain Supranational Entities and Multilateral Development Banks (MDBs) 3. Exposures to Depository Institutions, Foreign Banks, and Credit Unions 4. Exposures to Public Sector Entities (PSEs) 5. Corporate Exposures 6. Regulatory Retail Exposures 7. Residential Mortgage Exposures 8. Pre-Sold Construction Loans and Statutory Multifamily Mortgages 9. Past Due Loans 10. Other Assets I.Off-Balance Sheet Items J. OTC Derivative Contracts 1. Background 2. Treatment of OTC Derivative Contracts 3. Counterparty Credit Risk for Credit Derivatives 4. Counterparty Credit Risk for Equity Derivatives 5. Risk Weight for OTC Derivative Contracts K. Credit Risk Mitigation (CRM) 1. Guarantees and Credit Derivatives 2. Collateralized Transactions L. Unsettled Transactions M. Risk-Weighted Assets for Securitization Exposures 1. Securitization Overview and Definitions 2. Operational Requirements 3. Hierarchy of Approaches 4. Ratings-Based Approach (RBA) 5. Exposures that Do Not Qualify for the RBA 6. CRM for Securitization Exposures 7. Risk-Weighted Assets for Early Amortization Provisions 8. Maximum Capital Requirement N. Equity Exposures 1. Introduction and Exposure Measurement 2. Hedge Transactions 3. Measures of Hedge Effectiveness 4. Simple Risk-Weight Approach (SRWA) 5. Non-Significant Equity Exposures 6. Equity Exposures to Investment Funds [[Page 43984]] 7. Full Look-Through Approach 8. Simple Modified Look-Through Approach 9. Alternative Modified Look-Through Approach 10. Money Market Fund Approach O. Operational Risk 1. Basic Indicator Approach (BIA) 2. Advanced Measurement Approach (AMA) P. Supervisory Oversight and Internal Capital Adequacy Assessment Q. Market Discipline 1. Overview 2. General Requirements 3. Frequency/Timeliness 4. Location of Disclosures and Audit/Certification Requirements 5. Proprietary and Confidential Information 6. Summary of Specific Public Disclosure Requirements III. Regulatory Analysis A. Regulatory Flexibility Act Analysis B. OCC Executive Order 12866 Determination C. OTS Executive Order 12866 Determination D. OCC Executive Order 13132 Determination E. Paperwork Reduction Act F. OCC Unfunded Mandates Reform Act of 1995 Determination G. OTS Unfunded Mandates Reform Act of 1995 Determination H. Solicitation of Comments on Use of Plain Language I. Background In 1989, the agencies implemented a risk-based capital framework for U.S. banking organizations (general risk-based capital rules).\1\ The agencies based the framework on the ``International Convergence of Capital Measurement and Capital Standards'' (Basel I), released by the Basel Committee on Banking Supervision (Basel Committee) \2\ in 1988. The general risk-based capital rules established a uniform risk-based capital system that was more risk sensitive and addressed several shortcomings in the capital regimes the agencies used prior to 1989. --------------------------------------------------------------------------- \1\ 12 CFR part 3, Appendix A (OCC); 12 CFR parts 208 and 225, Appendix A (Board); 12 CFR part 325, Appendix A (FDIC); and 12 CFR part 567, subpart B (OTS). The risk-based capital rules generally do not apply to bank holding companies with less than $500 million in assets. 71 FR 9897 (February 28, 2006). \2\ The Basel Committee was established in 1974 by central banks and governmental authorities with bank supervisory responsibilities. Current member countries are Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom, and the United States. --------------------------------------------------------------------------- In June 2004, the Basel Committee introduced a new capital adequacy framework, the New Accord,\3\ that is designed to promote improved risk measurement and management processes and better align minimum risk- based capital requirements with risk. The New Accord includes three options for calculating risk-based capital requirements for credit risk and three options for operational risk. For credit risk, the three approaches are: standardized, foundation internal ratings-based, and advanced internal ratings-based. For operational risk, the three approaches are: basic indicator (BIA), standardized, and advanced measurement (AMA). The advanced internal ratings-based approach and the AMA together are referred to as the ``advanced approaches.'' --------------------------------------------------------------------------- \3\ ``International Convergence of Capital Measurement and Capital Standards, A Revised Framework, Comprehensive Version,'' the Basel Committee on Banking Supervision, June 2006. The text is available on the Bank for International Settlements Web site at http://www.bis.org/publ/bcbs128.htm. --------------------------------------------------------------------------- On September 25, 2006, the agencies issued a notice of proposed rulemaking to implement the advanced approaches in the United States (advanced approaches NPR).\4\ Many of the commenters on the advanced approaches NPR requested that the agencies harmonize certain provisions of the agencies' proposal with the New Accord and offer the standardized approach in the United States. A number of these commenters supported making the standardized approach available for all U.S. banking organizations. --------------------------------------------------------------------------- \4\ 71 FR 55830 (September 25, 2006). --------------------------------------------------------------------------- On December 7, 2007, the agencies issued a final rule implementing the advanced approaches (advanced approaches final rule).\5\ The advanced approaches final rule is mandatory for certain banking organizations and voluntary for others. In general, the advanced approaches final rule requires a banking organization that has consolidated total assets of $250 billion or more, has consolidated on- balance sheet foreign exposure of $10 billion or more, or is a subsidiary or parent of an organization that uses the advanced approaches (core banking organization) to implement the advanced approaches. The implementation of the advanced approaches has created a bifurcated regulatory capital framework in the United States: one set of risk-based capital rules for banking organizations using the advanced approaches (advanced approaches organizations), and another set for banking organizations that do not use the advanced approaches (general banking organizations). --------------------------------------------------------------------------- \5\ 72 FR 69288 (December 7, 2007). --------------------------------------------------------------------------- On December 26, 2006, the agencies issued a notice of proposed rulemaking (Basel IA NPR), which proposed modifications to the general risk-based capital rules for general banking organizations.\6\ One objective of the Basel IA NPR was to enhance the risk sensitivity of the risk-based capital rules without imposing undue regulatory burden. Specifically, the agencies proposed to increase the number of risk- weight categories, expand the use of external ratings for assigning risk weights, broaden recognition of collateral and guarantors, use loan-to-value ratios (LTV ratios) to risk weight most residential mortgages, increase the credit conversion factor for various short-term commitments, assess a risk-based capital requirement for early amortizations in securitizations of revolving retail exposures, and remove the 50 percent risk-weight limit for derivative transactions. The Basel IA NPR also sought comment on the extent to which certain advanced approaches organizations should be permitted to use approaches other than the advanced approaches in the New Accord. --------------------------------------------------------------------------- \6\ 71 FR 77446 (December 26, 2006). --------------------------------------------------------------------------- Most commenters on the Basel IA NPR supported the agencies' goal to make the general risk-based capital rules more risk sensitive without adding undue regulatory burden. However, a number of the commenters representing a broad range of U.S. banking organizations and trade associations urged the agencies to implement the New Accord's standardized approach for credit risk in the United States. These commenters generally stated that the standardized approach is more risk sensitive than the Basel IA NPR and would more appropriately address the industry's concerns regarding domestic and international competitiveness. Most of these commenters requested that the U.S. implementation of the standardized approach closely follow the New Accord. Certain commenters also requested that the agencies make some or all of the other options for credit risk and operational risk in the New Accord available in the United States. For example, some commenters preferred implementation of the standardized approach without a separate capital requirement for operational risk. Other commenters supported including one or more of the approaches in the New Accord for operational risk. II. Proposed Rule After considering the comments on both the Basel IA and the advanced approaches NPRs, the agencies have decided not to finalize the Basel IA NPR and to propose instead a new risk-based capital framework that would implement the standardized approach for credit risk, the BIA for operational [[Page 43985]] risk, and related disclosure requirements (collectively, this NPR or this proposal). This NPR generally parallels the relevant approaches in the New Accord. This NPR, however, diverges from the New Accord where the U.S. markets have unique characteristics and risk profiles, notably the proposal for risk weighting residential mortgage exposures. The agencies have also sought to make this NPR consistent where relevant with the advanced approaches final rule. This NPR would not modify how a banking organization that uses the standardized framework would calculate its leverage ratio requirement.\7\ Banking organizations face risks other than credit and operational risks that neither the New Accord nor this NPR addresses. The leverage ratio is a straightforward measure of solvency that supplements the risk-based capital requirements. Consequently, the agencies continue to view the tier 1 leverage ratio and other prudential safeguards such as Prompt Corrective Action as important components of the regulatory capital regime. --------------------------------------------------------------------------- \7\ 12 CFR 3.6(b) and (c)(OCC); 12 CFR part 208, Appendix B and 12 CFR part 225, Appendix D (Board); 12 CFR 325.3 (FDIC); and 12 CFR 567.8 (OTS). --------------------------------------------------------------------------- Question 1a: The agencies seek comments on all aspects of this proposal, including risk sensitivity, regulatory burden, and competitive impact. The agencies' general risk-based capital rules permit the use of external ratings issued by a nationally recognized statistical rating organization (NRSRO) to assign risk weights to recourse obligations, direct credit substitutes, certain residual interests, and asset- and mortgage-backed securities. The New Accord permits a banking organization to use external ratings to determine risk weights for a broad range of exposures, including sovereign, bank, corporate, and securitization exposures. It also provides, within certain limitations, for the use of both inferred ratings and issuer ratings. As discussed in more detail later in this preamble, the agencies propose that external, issuer, and inferred ratings be used to risk weight various exposures. While the agencies believe that the use of ratings proposed in this NPR can contribute to a more risk-sensitive framework, they are aware of the limitations associated with using credit ratings for risk- based capital purposes and, thus, are particularly interested in comments on the use of such ratings for those purposes. Numerous bank supervisory groups and committees, including the Basel Committee on Banking Supervision, the Financial Stability Forum, and the Senior Supervisors Group, have undertaken work to better understand the causes for and possible responses to the recent market events, discussing, among numerous other issues, the role of credit ratings. In addition, in March, the President's Working Group on Financial Markets (PWG) issued its report titled ``Policy Statement on Financial Market Developments,'' providing an analysis of the underlying factors contributing to the recent market stress and a set of recommendations to address identified weaknesses. Among its recommendations, the PWG encouraged regulators, including the Federal banking agencies, to review the current use of credit ratings in the regulation and supervision of financial institutions. In this regard, the PWG policy statement noted that certain investors and asset managers failed to obtain sufficient information or to conduct comprehensive risk assessments, with some investors relying exclusively on credit ratings for valuation purposes. More generally, the PWG statement also noted market participants, including originators, underwriters, asset managers, credit rating agencies, and investors, failed to obtain sufficient information or to conduct comprehensive risk assessments on complex instruments, including securitized credits and their underlying asset pools. The PWG policy statement also acknowledged the steps already taken by credit rating agencies to improve the performance of credit ratings and encouraged additional actions, potentially including the publication of sufficient information about the assumptions underlying their credit rating methodologies; changes to the credit rating process to clearly differentiate ratings for structured products from ratings for corporate and municipal securities; and ratings performance measures for structured credit products and other asset-backed securities readily available to the public in a manner that facilitates comparisons across products and credit ratings. Most directly relevant to this NPR, the agencies were encouraged to reinforce steps taken by the credit rating agencies through revisions to supervisory policy and regulation, including regulatory capital requirements that use ratings. At a minimum, regulators were urged to distinguish, as appropriate, between ratings of structured credit products and ratings of corporate and municipal bonds in regulatory and supervisory policies. Question 1b: The agencies seek comment on the advantages and disadvantages of the use of external credit ratings in risk-based capital requirements for banking organizations and whether identified weakness in the credit rating process suggests the need to change or enhance any of the proposals in this NPR. The agencies also seek comment on whether additional refinements to the proposals in the NPR should be considered to address more broadly the prudent use of credit ratings by banking organizations. For example, should there be operational conditions for banking organizations to make use of credit ratings in determining risk-based capital requirements, enhancements to minimum capital requirements, or modifications to the supervisory review process? The agencies also note that efforts are underway by the BCBS to review the treatment in the New Accord for certain off-balance sheet conduits, resecuritizations, such as collateralized debt obligations referencing asset-backed securities, and other securitization-related risks. The agencies are fully committed to working with the BCBS in this regard and also intend to review the agencies' current approach to securitization transactions to assess whether modifications might be needed. This review will take into account lessons learned from recent market-related events and may result in additional proposals for modification to the risk-based capital rules. Question 1c: The agencies seek commenters' views on what changes to the approaches set forth in this NPR, if any, should be considered as a result of recent market events, particularly with respect to the securitization framework described in this NPR. A. Applicability of the Standardized Framework Most commenters on the Basel IA NPR favored its opt-in approach, whereby a banking organization could voluntarily decide whether or not to use the proposed rules. They supported the flexibility of the opt-in provision and the ability of a general banking organization to remain under the general risk-based capital rules. Commenters observed that many banking organizations choose to hold capital well in excess of regulatory minimums and would not necessarily benefit from a more risk- sensitive capital rule. For these commenters, limiting regulatory burden was a higher priority than increasing the risk [[Page 43986]] sensitivity of their risk-based capital requirements. The agencies acknowledge this concern and propose to make the standardized framework optional for banking organizations that do not use the advanced approaches final rule to calculate their risk-based capital requirements.\8\ Under this NPR, a banking organization that opts to use the standardized framework generally would have to notify its primary Federal supervisor in writing of its intent to use the new rules at least 60 days before the beginning of the calendar quarter in which it first uses the standardized framework. This notice must include a list of any affiliated depository institutions or bank holding companies, if applicable, that seek supervisory exemption from the use of the standardized framework. Before it notifies its primary Federal supervisor, the banking organization should review its ability to implement the proposed rule and evaluate the potential impact on its regulatory capital. --------------------------------------------------------------------------- \8\ The agencies are not proposing in this NPR to make this standardized framework available to banking organizations for which the application of the advanced approaches final rule is mandatory, unless such a banking organization is exempted in writing from the advanced approaches final rule by its primary Federal supervisor. --------------------------------------------------------------------------- Under this proposal, a banking organization that opts to use this standardized framework could return to the general risk-based capital rules by notifying its primary Federal supervisor in writing at least 60 days before the beginning of the calendar quarter in which it intends to opt out of the standardized framework. The banking organization would have to include in its notice an explanation of its rationale for ceasing to use the standardized framework and identify the risk-based capital framework it intends to use. The primary Federal supervisor would review this notice to ensure that the use of the general risk-based capital rules would be appropriate for that banking organization.\9\ The agencies expect that a banking organization would not alternate between the general risk-based capital rules and this standardized framework. --------------------------------------------------------------------------- \9\ The primary Federal supervisor may waive the 60-day notice period for opting in to the standardized framework and for returning to the general risk-based capital rules. --------------------------------------------------------------------------- Any general banking organization could generally continue to calculate its risk-based capital requirements using the general risk- based capital rules without notifying its primary Federal supervisor. The primary Federal supervisor would, however, have the authority to require a general banking organization to use a different risk-based capital rule if that supervisor determines that a particular capital rule is appropriate in light of the banking organization's asset size, level of complexity, risk profile, or scope of operations. Under section 1(b) of the proposed rule, if a bank holding company opts in to the standardized framework, its subsidiary depository institutions also would apply the standardized framework. Similarly, if a depository institution opts in to the standardized framework, its parent bank holding company (where applicable) and any subsidiary depository institutions of the parent holding company generally would be required to apply the standardized rules as well. Savings and loan holding companies, however, are not subject to risk-based capital rules. Accordingly, if a savings association opts in to the proposed rule, the proposed rule would not apply to the savings and loan holding company or to a subsidiary depository institution of that holding company, unless the subsidiary depository institution is directly controlled by the savings association. The agencies believe that this approach serves as an important safeguard against regulatory capital arbitrage among affiliated banking organizations. The agencies recognize, however, that there may be infrequent situations where the use of the standardized rules could create undue burden at individual depository institutions within a corporate family. Therefore, under section 1(c) of the proposed rule, a banking organization that would otherwise be required to apply the standardized rule because a related banking organization has elected to apply it may instead use the general risk-based capital rules if its primary Federal supervisor determines in writing that that application of the standardized framework is not appropriate in light of the banking organization's asset size, level of complexity, risk profile, or scope of operations. When seeking such a determination, the banking organization should provide a rationale for its request. The primary Federal supervisor may consider potential capital arbitrage issues within a corporate structure in making its determination. Question 2: The agencies seek comment on the proposed applicability of the standardized framework and in particular on the degree of flexibility that should be provided to individual depository institutions within a corporate family, keeping in mind regulatory burden issues as well as ways to minimize the potential for regulatory capital arbitrage. In the advanced approaches final rule, the agencies require core banking organizations to use only the most advanced approaches provided in the New Accord. As proposed, the standardized framework generally would be available only for banking organizations that are not core banking organizations. Question 3: The agencies seek comment on whether or to what extent core banking organizations should be able to use the proposed standardized framework. B. Reservation of Authority Under this NPR, a primary Federal supervisor could require a banking organization to hold an amount of capital greater than would otherwise be required if that supervisor determines that the risk-based capital requirements under the standardized framework are not commensurate with the banking organization's credit, market, operational, or other risks. In addition, the agencies expect that there may be instances when the standardized framework would prescribe a risk-weighted asset amount for one or more exposures that was not commensurate with the risks associated with the exposures. In such a case, the banking organization's primary Federal supervisor would retain the authority to require the banking organization to assign a different risk-weighted asset amount for the exposures or to deduct the amount of the exposures from regulatory capital. Similarly, this NPR proposes to authorize a banking organization's primary Federal supervisor to require the banking organization to assign a different risk-weighted asset amount for operational risk if the supervisor were to find that the risk-weighted asset amount for operational risk produced by the banking organization under this NPR is not commensurate with the operational risks of the banking organization. C. Principle of Conservatism The agencies believe that in some cases it may be reasonable to allow a banking organization not to apply a provision of the proposed rule if not doing so would yield a more conservative result. Under section 1(f) of the proposed rule, a banking organization may choose not to apply a provision of the rule to one or more exposures provided that: (i) The banking organization can demonstrate on an ongoing basis to the satisfaction of its primary Federal supervisor that not applying the provision would, in all [[Page 43987]] circumstances, unambiguously generate a risk-based capital requirement for each exposure greater than that which would otherwise be required under the rule; (ii) the banking organization appropriately manages the risk of those exposures; (iii) the banking organization provides written notification to its primary Federal supervisor prior to applying this principle to each exposure; and (iv) the exposures to which the banking organization applies this principle are not, in the aggregate, material to the banking organization. The agencies emphasize that a conservative capital requirement for a group of exposures does not reduce the need for appropriate risk management of those exposures. Moreover, the principle of conservatism applies to the determination of capital requirements for specific exposures; it does not apply to the disclosure requirements in section 71 of the proposed rule. D. Merger and Acquisition Transition Provisions A banking organization that uses the standardized framework and that merges with or acquires another banking organization operating under different risk-based capital rules may not be able to quickly integrate the acquired organization's exposures into its risk-based capital system. Under this NPR, a banking organization that uses the standardized framework and that merges with or acquires a banking organization that uses the general risk-based capital rules could continue to use the general risk-based capital rules to calculate the risk-based capital requirements for the merged or acquired banking organization's exposures for up to 12 months following the last day of the calendar quarter during which the merger or acquisition is consummated. The risk-weighted assets of the merged or acquired company calculated under the general risk-based capital rules would be included in the banking organization's total risk-weighted assets. Deductions associated with the exposures of the merged or acquired company would be deducted from the banking organization's tier 1 capital and tier 2 capital. Similarly, where both banking organizations calculate their risk- based capital requirements under the standardized framework, but the merged or acquired banking organization uses different aspects of the framework, the banking organization may continue to use the merged or acquired banking organization's own systems to determine its organization's risk-weighted assets for, and deductions from capital associated with, the merged or acquired banking organization's exposures for the same time period. A banking organization that merges with or acquires an advanced approaches banking organization may use the advanced approaches risk- based capital rules to determine the risk-weighted asset amounts for, and deductions from capital associated with, the merged or acquired banking organization's exposures for up to 12 months after the calendar quarter during which the merger or acquisition consummates. During the period when the advanced approaches risk-based capital rules apply to the merged or acquired company, any allowance for loan and lease losses (ALLL) associated with the merged or acquired company's exposures must be excluded from the banking organization's tier 2 capital. Any excess eligible credit reserves associated with the merged or acquired banking organization's exposures may be included in that banking organization's tier 2 capital up to 0.6 percent of that banking organization's risk- weighted assets. (Excess eligible credit reserves would be determined according to section 13(a)(2) of the advanced approaches risk-based capital rules.) If a banking organization relies on these merger provisions, it would be required to disclose publicly the amounts of risk-weighted assets and total qualifying capital calculated under the applicable risk-based capital rules for the acquiring banking organization and for the merged or acquired banking organization. E. Calculation of Tier 1 and Total Qualifying Capital This NPR would maintain the minimum risk-based capital ratio requirements of 4.0 percent tier 1 capital to total risk-weighted assets and 8.0 percent total qualifying capital to total risk-weighted assets. A banking organization's total qualifying capital is the sum of its tier 1 (core) capital elements and tier 2 (supplemental) capital elements, subject to various limits, restrictions, and deductions (adjustments). The agencies are not restating the elements of tier 1 and tier 2 capital in the proposed rule. Those capital elements generally would be unchanged from the general risk-based capital rules.\10\ Deductions or other adjustments would also be unchanged, except for those provisions discussed below. --------------------------------------------------------------------------- \10\ See 12 CFR part 3, Appendix A, section 2 (national banks); 12 CFR part 208, Appendix A, section II (state member banks); 12 CFR part 225, Appendix A, section II (bank holding companies); 12 CFR part 325, Appendix A, section I (state nonmember banks); and 12 CFR 567.5 (savings associations). --------------------------------------------------------------------------- Under this NPR, a banking organization would make certain other adjustments to determine its tier 1 and total qualifying capital. Some of these adjustments would be made only to tier 1 capital. Other adjustments would be made 50 percent to tier 1 capital and 50 percent to tier 2 capital. If the amount deductible from tier 2 capital exceeds the banking organization's actual tier 2 capital, the banking organization would have to deduct the shortfall amount from tier 1 capital. Consistent with the agencies' general risk-based capital rules, a banking organization would have to have at least 50 percent of its total qualifying capital in the form of tier 1 capital. Under this NPR, a banking organization would deduct from tier 1 capital any after-tax gain-on-sale resulting from a securitization. Gain-on-sale means an increase in a banking organization's equity capital that results from a securitization, other than an increase in equity capital that results from the banking organization's receipt of cash in connection with the securitization. The agencies included this deduction to offset accounting treatments that produce an increase in a banking organization's equity capital and tier 1 capital at the inception of a securitization, for example, a gain attributable to a credit-enhancing interest-only strip receivable (CEIO) that results from Financial Accounting Standard (FAS) 140 accounting treatment for the sale of underlying exposures to a securitization special purpose entity (SPE).\11\ The agencies expect that the amount of the required deduction would diminish over time as the banking organization realizes the increase in equity capital and, thus, tier 1 capital booked at the inception of the securitization, through actual receipt of cash flows. --------------------------------------------------------------------------- \11\ See Statement of Financial Accounting Standards No. 140, ``Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities'' (September 2000). --------------------------------------------------------------------------- Under the general risk-based capital rules, a banking organization must deduct CEIOs, whether purchased or retained, from tier 1 capital to the extent that the CEIOs exceed 25 percent of the banking organization's tier 1 capital. Under this NPR, a banking organization would have to deduct CEIOs from tier 1 capital to the extent they represent after-tax gain-on-sale, and would have to deduct any CEIOs that do not constitute an after-tax gain-on-sale 50 percent from tier 1 capital and 50 percent from tier 2 capital. [[Page 43988]] Under the FDIC, OCC, and Board general risk-based capital rules, a banking organization must deduct from its tier 1 capital certain percentages of the adjusted carrying value of its nonfinancial equity investments. In contrast, OTS general risk-based capital rules require the deduction of most investments in equity securities from total capital.\12\ Under this NPR, however, a banking organization would not deduct these investments. Instead, the banking organization's equity exposures generally would be subject to the treatment provided in Part V of this proposed rule. --------------------------------------------------------------------------- \12\ OTS general risk-based capital rules require savings associations to deduct all ``equity investments'' from total capital. 12 CFR 567.5(c)(2)(ii). ``Equity investments'' are defined to include: (i) Investments in equity securities (other than investments in subsidiaries, equity investments that are permissible for national banks, indirect ownership interests in certain pools of assets (for example, mutual funds), Federal Home Loan Bank stock and Federal Reserve Bank stock); and (ii) investments in certain real property. 12 CFR 567.1. The proposed treatment of investments in equity securities is discussed above. Equity investments in real estate would continue to be deducted to the same extent as under the general risk-based capital rules. --------------------------------------------------------------------------- A banking organization also would have to deduct from total capital the amount of certain unsettled transactions and certain securitization exposures. These deductions are provided in section 21, section 38, and Part IV of this proposed rule. Consistent with the advanced approaches final rule, for bank holding companies with consolidated insurance underwriting subsidiaries that are functionally regulated (or subject to comparable supervision and minimum regulatory capital requirements in their home jurisdiction), the following treatment would apply. The assets and liabilities of the subsidiary would be consolidated for purposes of determining the bank holding company's risk-weighted assets. The bank holding company, however, would deduct 50 percent from tier 1 capital and 50 percent from tier 2 capital an amount equal to the insurance underwriting subsidiary's minimum regulatory capital requirement as determined by its functional (or equivalent) regulator. For U.S. regulated insurance subsidiaries, this amount generally would be 200 percent of the subsidiary's Authorized Control Level as established by the appropriate state insurance regulator. Under the general risk-based capital rules, such subsidiaries typically are fully consolidated with the bank holding company. While the elements of tier 1 and tier 2 capital are the same across the general risk-based capital rules, the advanced approaches final rule, and this NPR, the deductions from those elements are different for each of the three risk-based capital frameworks. As a result, each framework has a distinct definition of tier 1, tier 2, and total qualifying capital. Securitization-related deductions create a significant difference in the calculation of tier 1 and tier 2 capital across the three frameworks. Under the general risk-based capital rules, only certain CEIOs must be deducted from capital; all other high-risk exposures for which dollar-for-dollar capital must be held may be ``grossed-up'' in accordance with the regulatory reporting instructions, effectively increasing the denominator of the risk-based capital ratio but not affecting the numerator. In contrast, under the advanced approaches final rule and this NPR, certain high risk securitization exposures must be deducted directly from total capital. Other significant differences in the definition of tier 1, tier 2, and total qualifying capital across the three frameworks include the treatment of nonfinancial equity investments for banks and bank holding companies, certain equity investments for savings associations, certain unsettled transactions, consolidated insurance underwriting subsidiaries of bank holding companies, and the ALLL/eligible credit reserves. The different definitions of tier 1, tier 2, and total capital across the risk-based capital frameworks raise a number of issues. The agencies clarified in the preamble to the advanced approaches rule that a banking organization's tier 1 capital and tier 2 capital for all non- regulatory-capital supervisory and regulatory purposes (for example, lending limits and Regulation W quantitative limits) is the banking organization's tier 1 capital and tier 2 capital as calculated under the risk-based capital framework to which it is subject. The agencies did not specifically state a position regarding the numerator of the leverage ratio. One potential approach is for each banking organization to use its applicable risk-based definition of tier 1 capital for determining both the risk-based and leverage capital ratios. Another potential approach is to define a numerator for the tier 1 leverage ratio that would be the same for all banking organizations. This approach could require banks to calculate one measure of tier 1 capital for risk-based capital purposes and another measure of tier 1 capital for leverage ratio purposes.\13\ --------------------------------------------------------------------------- \13\ To the extent that the agencies decide to change the numerator of the leverage ratio, they would propose such changes in a separate rulemaking. As a related matter, the OTS advanced approaches final rule incorrectly states that the leverage ratio is calculated using the revised definition of tier 1 and tier 2 capital. This NPR would remove this provision until the agencies conclusively resolve this matter. --------------------------------------------------------------------------- Question 4: Given the potential for three separate definitions of tier 1 capital under the three frameworks, the agencies solicit comment on all aspects of the tier 1 leverage ratio numerator, including issues related to burden and competitive equity. F. Calculation of Risk-Weighted Assets (1) Total Risk-Weighted Assets Under this NPR, a banking organization's total risk-weighted assets would be the sum of its total risk-weighted assets for general credit risk, unsettled transactions, securitization exposures, equity exposures, and operational risk. Banking organizations that use the market risk rule (MRR) would supplement their capital calculations with those provisions.\14\ --------------------------------------------------------------------------- \14\ 12 CFR part 3, Appendix B (national banks); 12 CFR part 208, Appendix E (state member banks); 12 CFR part 225, Appendix E (bank holding companies); and 12 CFR part 325, Appendix C (state nonmember banks). OTS intends to codify a market risk capital rule for savings associations at 12 CFR part 567, Appendix D. --------------------------------------------------------------------------- (2) Calculation of Risk-Weighted Assets for General Credit Risk For each of its general credit risk exposures (that is, credit exposures that are not unsettled transactions subject to section 38 of the proposed rule, securitization exposures, or equity exposures), a banking organization must first determine the exposure amount and then multiply that amount by the appropriate risk weight set forth in section 33 of the proposed rule. General credit risk exposures include exposures to sovereign entities; exposures to supranational entities and multilateral development banks; exposures to public sector entities; exposures to depository institutions, foreign banks, and credit unions; corporate exposures; regulatory retail exposures; residential mortgage exposures; pre-sold construction loans; statutory multifamily mortgage exposures; and other assets. Generally, the exposure amount for the on-balance sheet component of an exposure is the banking organization's carrying value for the exposure. If the exposure is classified as a security available for sale, however, the exposure amount is the banking organization's carrying value of the exposure adjusted for unrealized gains and losses. The exposure amount for the off-balance sheet component of an exposure is typically determined by multiplying the [[Page 43989]] notional amount of the off-balance sheet component by the appropriate credit conversion factor (CCF) under section 34 of the proposed rule. The exposure amount for over-the-counter (OTC) derivative contracts is determined under section 35 of the proposed rule. Exposure amounts for collateralized OTC derivative contracts, repo-style transactions, or eligible margin loans may be determined under particular rules in section 37 of the proposed rule. (3) Calculation of Risk-Weighted Assets for Unsettled Transactions, Securitization Exposures, and Equity Exposures (a) Unsettled Transactions Risk-weighted assets for specified unsettled and failed securities, foreign exchange, and commodities transactions are calculated according to paragraph (f) of section 38 of the proposed rule.\15\ --------------------------------------------------------------------------- \15\ Certain transaction types are excluded from the scope of section 38, as provided in paragraph (b) of section 38. --------------------------------------------------------------------------- (b) Securitization Exposures Risk-weighted assets for securitization exposures are calculated according to Part IV of the proposed rule. Generally, a banking organization would calculate the risk-weighted asset amount of a securitization exposure by multiplying the amount of the exposure as determined in section 42 of the proposed rule by the appropriate risk weight in section 43 of this NPR. Part IV of the proposed rule provides a hierarchy of approaches for calculating risk-weighted assets for securitization exposures. Among the approaches included in Part IV is a ratings-based approach (RBA), which calculates the risk-weighted asset amount of a securitization exposure by multiplying the amount of the exposure by risk-weights that correspond to the applicable external or applicable inferred rating of the securitization. Part IV provides other treatments for specific types of securitization exposures including deduction from capital for certain exposures, and different risk-weighted asset computations for certain securitizations exposures that do not qualify for the RBA and for securitizations that have an early amortization provision. (c) Equity Exposures Risk-weighted assets for equity exposures are calculated according to the rules in Part V of the proposed rule. Generally, risk-weighted assets for equity exposures that are not exposures to investment funds would be calculated according to the simple risk-weight approach (SRWA) in section 52 of this proposed rule. Risk-weighted assets for equity exposures to investment funds would, with certain exceptions, be calculated according to one of three look-through approaches or, if the investment fund qualifies, calculated according to the money market fund approach. These approaches are described in section 53 of the proposed rule. (4) Calculation of Risk-Weighted Assets for Operational Risk Risk-weighted assets for operational risk are calculated under the BIA provided in section 61 of this proposed rule. G. External and Inferred Ratings (1) Overview The agencies' general risk-based capital rules permit the use of external ratings issued by a nationally recognized statistical rating organization (NRSRO) to assign risk weights to recourse obligations, direct credit substitutes, residual interests (other than a credit- enhancing interest-only strip), and asset- and mortgage-backed securities.\16\ Under the ratings-based approach in the general risk- based capital rules, a banking organization must use the lowest NRSRO external rating if multiple ratings exist. The approach also requires one rating for a traded exposure and two ratings for a non-traded exposure and allows the use of inferred ratings within a securitization structure. When the agencies revised their general risk-based capital rules to permit the use of external ratings issued by an NRSRO for these exposures, the agencies acknowledged that these ratings eventually could be used to determine the risk-based capital requirements for other types of debt instruments, such as externally rated corporate bonds. --------------------------------------------------------------------------- \16\ Some synthetic structures also may be subject to the external rating approach. For example, certain credit-linked notes issued from a synthetic securitization are risk weighted according to the rating given to the notes. 66 FR 59614, 59622 (November 29, 2001). --------------------------------------------------------------------------- The New Accord would permit a banking organization to use external ratings to determine risk weights for a broad range of exposures. It also provides for the use of both inferred and, within certain limitations, issuer ratings, but discourages the use of unsolicited ratings. Generally consistent with the New Accord, and in response to favorable comments on the Basel IA NPR's proposal to expand the use of external ratings, the agencies propose that external, issuer, and inferred ratings be used to risk weight various exposures. This proposed use of ratings is a more risk-sensitive approach than relying on membership in the Organization for Economic Cooperation and Development (OECD) \17\ to differentiate the risk of exposures to sovereign entities, depository institutions, foreign banks, and credit unions. The proposed approach also would use a greater number of risk weights than the general risk-based capital rules, which would further improve the risk sensitivity of a banking organization's risk-based capital requirements. --------------------------------------------------------------------------- \17\ The OECD-based group of countries comprises all full members of the OECD, as well as countries that have concluded special lending arrangements with the International Monetary Fund (IMF) associated with the IMF's General Arrangements to Borrow. The list of OECD countries is available on the OECD Web site at http:// www.oecd.org. --------------------------------------------------------------------------- Consistent with the agencies' general risk-based capital rules and the advanced approaches final rule, the agencies propose to recognize only credit ratings that are issued by an NRSRO. For the purposes of this NPR, NRSRO means an entity registered with the U.S. Securities and Exchange Commission (SEC) as an NRSRO under section 15E of the Securities Exchange Act of 1934 (15 U.S.C. 78o-7).\18\ --------------------------------------------------------------------------- \18\ See 17 CFR 240.17g-1. On September 29, 2006, the President signed the Credit Rating Agency Reform Act of 2006 (``Reform Act'') (Pub. L. 109-291) into law. The Reform Act requires a credit rating agency that wants to represent itself as an NRSRO to register with the SEC. The agencies may review their risk-based capital rules, guidance and proposals from time to time to determine whether any modification of the agencies' definition of an NRSRO is appropriate. --------------------------------------------------------------------------- (2) Use of External Ratings Under this NPR, a banking organization would use the applicable external rating of an exposure (for certain exposures that have external ratings) to determine its risk weight. Additionally, consistent with the New Accord, the banking organization would infer a rating for certain exposures that do not have external ratings from the issuer rating of the obligor or from the external rating of another specific issue of the obligor. The agencies' proposal for the use of external and inferred ratings, however, differs in some respects from the New Accord, as described below. (a) External Ratings Under this NPR, an external rating means a credit rating that is assigned by an NRSRO to an exposure, provided that the credit rating fully reflects the entire amount of credit risk with regard to all payments owed to the holder of the exposure. If, for example, a holder is [[Page 43990]] owed principal and interest on an exposure, the credit rating must fully reflect the credit risk associated with timely repayment of principal and interest. If a holder is owed only principal on an exposure, the credit rating must fully reflect only the credit risk associated with timely repayment of principal. Furthermore, a credit rating would qualify as an external rating only if it is published in an accessible form and is or will be included in the transition matrices made publicly available by the NRSRO that summarize the historical performance of positions rated by the NRSRO. An external rating may be either solicited or unsolicited by the obligor issuing the rated exposure. This definition is consistent with the definition of ``external rating'' in the advanced approaches final rule. Under this NPR, a banking organization would determine the risk weight for certain exposures with external ratings based on the applicable external ratings of the exposures. If an exposure to a sovereign or public sector entity (PSE), a corporate exposure, or a securitization expos